<PAGE>

                  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 June 30, 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 August 18, 1999, 70,860,944 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
                                                                                               June 30,            December 31,
                                                                                                 1999                 1998
                                                                                         --------------------- --------------------
<S>                                                                                      <C>                   <C>
Current assets:
        Cash and cash equivalents                                                        $            490,614  $        20,045,539
        Notes receivable                                                                                    -              245,000
        Accounts receivable, net of allowance for doubtful accounts of $72,903
           and $8,115, respectively                                                                 1,024,598              219,908
        Prepaid expenses                                                                               76,027               51,866
        Inventory                                                                                     121,968               77,386
        Interest and other receivables                                                                 24,144                8,276
        Employee advances                                                                                   -               67,231
                                                                                         --------------------- --------------------

              Total current assets                                                                  1,737,351           20,715,206

Property and equipment, net of accumulated depreciation of $1,668,089 and
     $1,195,390, respectively                                                                       1,980,322            2,328,012

Intangible assets, net of accumulated amortization of $5,191,162 and $2,599,554,
     respectively                                                                                  36,175,894           38,816,421

Other assets                                                                                          134,748              130,288
                                                                                         --------------------- --------------------

              Total assets                                                               $         40,028,315  $        61,989,927
                                                                                         ===================== ====================

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
        Bank overdraft                                                                   $                  -  $           138,034
        Revolving notes payable                                                                        50,000           20,038,193
        Notes payable - related parties                                                             6,673,153            8,491,880
        Notes payable - other                                                                       6,187,556              560,000
        Accounts payable                                                                            3,639,210            3,536,074
        Accrued liabilities                                                                         1,565,316              981,774
        Accrued liabilities - related parties                                                         922,407              900,004
        Deferred revenues                                                                           1,225,593              695,997
        Capital lease obligation - current portion                                                     28,118               52,225
                                                                                         --------------------- --------------------

              Total current liabilities                                                            20,291,353           35,394,181

Capital lease obligation, net of current portion                                                       46,385                    -
Series C 5% convertible debentures                                                                  6,500,000                    -
                                                                                         --------------------- --------------------

              Total liabilities                                                                    26,837,738           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 3, 8, 9, 10, 13, 14, and 16)

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; 972,334 shares outstanding in 1999
                    (aggregate liquidation preference of $20,093,163)                              22,718,024           22,200,936
              Series E, 4% cumulative convertible; 43,500 shares outstanding in 1999
                    (aggregate liquidation preference of $896,390)                                  1,028,071            3,257,886
        Common stock, $.0001 par value; 100,000,000 shares authorized;
              69,059,142 and 64,324,480 shares outstanding, respectively                                6,906                6,432
        Additional paid-in capital                                                                 93,640,482           88,517,711
        Outstanding warrants                                                                        3,642,750            3,323,258
        Deferred consulting expense                                                                         -             (106,700)
        Deficit accumulated during the development stage                                         (110,175,656)         (92,933,777)
                                                                                         --------------------- --------------------

              Total stockholders' equity                                                           11,360,577           24,765,746
                                                                                         --------------------- --------------------

              Total liabilities and stockholders' equity                                 $         40,028,315  $        61,989,927
                                                                                         ===================== ====================
</TABLE>




     See accompanying notes 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         Six Months Ended            (Inception) to
                                                                June 30,                    June 30,                 June 30,
                                                    -------------- -------------  -------------- --------------
                                                          1999           1998            1999            1998          1999
                                                    -------------- -------------  -------------- --------------  ---------------

<S>                                                 <C>            <C>            <C>            <C>             <C>
Revenues                                            $     655,051  $  1,176,500   $   1,765,383  $   2,472,285   $    4,655,067
Cost of revenues                                          129,398             -         354,837              -          431,181
                                                    -------------- -------------  -------------- --------------  ---------------

      Gross margin                                        525,653     1,176,500       1,410,546      2,472,285        4,223,886
                                                    -------------- -------------  -------------- --------------  ---------------

Expenses:
      Selling, general and administrative               2,874,910     2,084,622       6,550,472      3,464,702       38,868,003
      Product development and research                  2,346,907     2,960,292       5,318,186      5,661,495       36,876,227
      Amortization of goodwill and purchased core
        technology                                      1,287,581       500,776       2,575,162        599,559        5,116,316
      Purchased in-process research and development             -             -               -      9,315,000       13,136,000
                                                    -------------- -------------  -------------- --------------  ---------------

           Total expenses                               6,509,398     5,545,690      14,443,820     19,040,756       93,996,546
                                                    -------------- -------------  -------------- --------------  ---------------

Loss from operations                                   (5,983,745)   (4,369,190)    (13,033,274)   (16,568,471)     (89,772,660)
                                                    -------------- -------------  -------------- --------------  ---------------

Other income (expense):
      Interest income                                           -       292,405          22,046        563,882        3,689,437
      Interest expense                                   (534,042)     (282,977)     (2,801,421)      (594,901)      (8,181,070)
      Cancellation of common stock reset provision              -             -               -              -       (6,111,577)
                                                    -------------- -------------  -------------- --------------  ---------------

           Total other income (expense), net             (534,042)        9,428      (2,779,375)       (31,019)     (10,603,210)
                                                    -------------- -------------  -------------- --------------  ---------------

Loss before extraordinary items                        (6,517,787)   (4,359,762)    (15,812,649)   (16,599,490)    (100,375,870)

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

Net loss                                            $  (6,517,787) $ (4,359,762)  $ (15,812,649) $ (16,599,490)  $ (101,227,186)
                                                    ============== =============  ============== ==============  ===============


Basic and diluted net loss per common share               $ (0.10)      $ (0.08)        $ (0.26)       $ (0.34)
                                                    ============== =============  ============== ==============
</TABLE>






See accompanying notes 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
                                                                                        Six Months Ended           (Inception) to
                                                                                            June 30,                  June 30,
                                                                              ---------------------------------
                                                                                    1999             1998              1999
                                                                              ----------------- --------------- -----------------
<S>                                                                           <C>               <C>             <C>
Cash flows from operating activities:
       Net loss                                                               $    (15,812,649) $  (16,599,490) $   (101,227,186)
       Adjustments to reconcile net loss to net cash
         used in operating activities:
           Issuance of common stock for services                                       100,000               -         5,587,554
           Issuance of common stock for patent                                               -         100,807           100,807
           Non-cash expense related to issuance of notes payable, debentures,
             warrants, preferred and common stock                                    2,169,556               -        12,248,470
           Non-cash compensation expense related to issuance
             of stock options                                                          119,240         320,100         2,615,540
           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                                             3,113,226         889,926         6,888,680
           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                                                     (804,690)        (52,425)         (953,188)
              Employee advances                                                          7,245               -           (59,986)
              Interest and other receivables                                           (15,868)         (6,050)          (21,351)
              Inventory                                                                (44,582)              -           (64,803)
              Prepaid assets                                                           (24,161)       (412,201)          (71,627)
              Other assets                                                              (4,460)        (65,227)         (124,305)
              Accounts payable                                                         103,136         390,460         5,116,872
              Accrued liabilities                                                      583,542        (184,152)        1,225,331
              Accrued liabilities - related party                                       22,403        (436,716)          170,162
              Deferred revenues                                                        529,596               -           610,862
                                                                              ----------------- --------------- -----------------

           Net cash used in operating activities                                    (9,958,466)     (7,240,200)      (52,962,571)
                                                                              ----------------- --------------- -----------------

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                                              (67,677)       (670,646)       (3,404,147)
       Investment in intangible assets                                                       -               -          (164,460)
       Issuance of notes receivable                                                          -        (781,140)       (3,228,600)
       Payments received on notes receivable                                           245,000               -         2,128,600
                                                                              ----------------- --------------- -----------------

           Net cash provided by (used in) investing activities                         177,323      (8,697,905)      (19,991,780)
                                                                              ----------------- --------------- -----------------

Cash flows from financing activities:
       Bank overdraft                                                                 (138,034)              -                 -
       Net proceeds (payment) from revolving note payable                          (19,988,193)      1,226,511               750
       Net proceeds (payments) from revolving note payable - related parties        (1,758,741)       (551,510)       (1,677,100)
       Proceeds from other notes payable                                             5,453,760               -         8,365,427
       Payments on other notes payable                                                       -         (49,250)       (1,779,806)
       Principal payments on capital lease obligations                                 (35,054)        (23,751)         (127,760)
       Proceeds from advances                                                                -               -                 -
       Proceeds from issuance of convertible debentures, net                         6,254,240               -         9,439,240
       Proceeds from sale of warrants                                                  438,240         322,928         1,511,168
       Proceeds from sale of common stock, net                                               -      16,635,000        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                      (9,773,782)     17,559,928        73,444,965
                                                                              --------------------------------- -----------------

Net (decrease) increase in cash and cash equivalents                               (19,554,925)      1,621,823           490,614

Cash and cash equivalents at beginning of period                                    20,045,539      20,501,676                 -
                                                                              ----------------- --------------- -----------------

Cash and cash equivalents at end of period                                    $        490,614  $   22,123,499  $        490,614
                                                                              ================= =============== =================
</TABLE>



See accompanying notes 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
                                                                     Six Months Ended                       (Inception) to
                                                                         June 30,                               June 30,
                                                         ---------------------------------------
Supplemental disclosure of cash flow information:            1999                     1998                        1999
                                                         -------------            --------------            -----------------

<S>                                                        <C>                       <C>                       <C>
     Cash paid during the period for interest              $  381,118                $  639,472                $ 3,811,124
</TABLE>

Supplemental Schedule of Non-cash Investing and Financing Activities:

     For the Six Months Ended June 30, 1999:

       The Company  entered into capital lease  obligations for equipment in the
amount of $57,332.

       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.

       A  total of 100,000  shares  previously  pledged to a law firm by certain
officers and directors of the Company as collateral  for legal work were sold by
the law firm and the  proceeds  were  used to pay for  legal  services  totaling
$72,335.

       Preferred  stock  dividends  of  $997,146  were  recorded  related to the
beneficial  conversion  features of Series D and Series E convertible  preferred
stock.

       Preferred stock dividends of $432,084 were accrued on Series D and Series
E convertible preferred stock.

       The Company issued  200,000 shares of common stock to an unrelated  party
for consulting fees valued at $100,000.

       A total of  36,000  shares of Series D  convertible  preferred  stock and
related  dividends of $15,741 were  converted  into  1,288,479  shares of common
stock.

       A total of  91,572  shares of Series E  convertible  preferred  stock and
related  dividends of $33,616 were  converted  into  3,246,183  shares of common
stock.

     For the Six Months Ended June 30, 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 notes 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 and six months  ended June 30,  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, as amended, 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, 2000. 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
condensed  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 June 30, 1999 and 1998,  there were outstanding  common stock  equivalents to
purchase 108,565,042 and 13,966,667 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.

The following table is a  reconciliation  of the net loss numerator of basic and
diluted  net loss per common  share for the three and six months  ended June 30,
1999 and 1998:


                                       6
<PAGE>





<TABLE>
<CAPTION>
                                                              Three Months Ended June 30,
                                                  ---------------------------------------------------------
                                                          1999                            1998
                                                  --------------------------   ----------------------------
                                                                 Per Share                      Per Share
                                                   Loss           Amount           Loss          Amount
<S>                                             <C>                 <C>         <C>                <C>
Net loss                                        $  (6,517,787)                  $ (4,359,762)
Preferred stock dividends                            (301,669)                          -
                                                --------------                  -------------
Net loss attributable to common
   stockholders                                 $  (6,819,456)      $(0.10)     $ (4,359,762)       $(0.08)
                                                ==============      =======     =============       =======
Weighted average common shares
    outstanding                                    67,067,853                     51,343,293
                                                ==============                  =============
</TABLE>


<TABLE>
<CAPTION>
                                                                Six Months Ended June 30,
                                               ----------------------------------------------------------------
                                                          1999                             1998
                                               -----------------------------   --------------------------------

                                                                Per Share                         Per Share
                                                  Loss            Amount            Loss           Amount
<S>                                            <C>                <C>           <C>                    <C>
Net loss                                       $ (15,812,649)                   $  (16,599,490)
Preferred stock dividends                         (1,429,230)                         (131,660)
                                               --------------                   ---------------
Net loss attributable to common
   stockholders                                $ (17,241,879)      $(0.26)      $  (16,731,150)        $(0.34)
                                               ==============      =======      ===============        =======
Weighted average common shares
    outstanding                                   65,779,527                        48,557,594
                                               ==============                   ===============
</TABLE>


2.  ACQUISITIONS

The  Company  acquired  AcuVoice,  Inc.  ("AcuVoice")  in March  1998.  AcuVoice
developed and marketed text-to-speech ("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 embedded
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 and six
months ended June 30, 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



                                       7
<PAGE>




results.   Purchased   in-process   research  and  development  related  to  the
acquisitions   of  AcuVoice  and  Articulate  of  $9,315,000   and   $3,821,000,
respectively,  were  recorded  at the  dates  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.

<TABLE>
<CAPTION>
                                              Three Months Ended                     Six Months Ended
                                                 June 30,1998                          June 30, 1998
                                             --------------------                    ------------------

<S>                                         <C>                                 <C>
Revenues                                    $   1,558,024                       $      3,183,788

Loss from operations                            (6,061,615)                          (11,336,701)

Net loss attributable to common
   stockholders                                 (6,448,954)                          (12,645,822)

Basic and diluted net loss
   per common share                                  (0.10)                                (0.22)
</TABLE>


3.  POTENTIAL SALE OF HEALTHCARE SOLUTIONS GROUP

On May 19, 1999,  the Company  entered into an agreement to sell the  operations
and a  significant  portion  of the  assets of its  HealthCare  Solutions  Group
("HSG") to Lernout & Hauspie Speech  Products N.V.  ("L&H"),  an unrelated third
party, for $28,000,000,  of which $24,000,000 is to be paid at closing,  and the
remaining  $4,000,000 to be paid as an earnout in two installments of $2,000,000
each over the next two years based on  performance  of the HSG  expected  during
those  subsequent  two  years.  The  sale is  subject  to  approval  by  Fonix's
shareholders,  and is scheduled to close during the third  quarter of 1999.  The
proceeds  from  the  sale  will be  used  to  reduce  certain  of the  Company's
liabilities  and to provide working capital to allow Fonix to focus on marketing
and development  opportunities for its Interactive  Technology  Solutions Group.
However,  because the requirements to consummate the sale have not yet been met,
the  Company  has not  given  effect  to the  potential  sale  in the pro  forma
financial statement data reflected in Note 2.

4.  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 6). 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.

5.  INTANGIBLE ASSETS

Intangible   assets  consist  of  purchased  core  technology  and  goodwill  in
connection with the acquisitions 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
$5,191,162 and $2,599,554 at June 30, 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 June 30, 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.



                                       8
<PAGE>



6.  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  4).  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 June 30, 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. This note is payable on demand, matures April 1, 2007, bears
interest  at the  bank's  prime rate  (7.75  percent at June 30,  1999) plus 2.0
percent  and  requires  interest  to  be  paid  monthly.  The  weighted  average
outstanding  balance during the six months ended June 30, 1999 was $50,000.  The
weighted average interest rate was 9.75 percent during this period.

At June 30,  1999,  the Company had a note  payable to a lender in the amount of
$588,000 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 on a monthly  basis,  currently to August 31, 1999, by paying the lender or
capitalizing  accrued  interest plus a fee of 1% of the loan balance each month.
The Company  anticipates that this loan will be paid in full upon the closing of
the sale of the HSG to L&H (see Note 3). The Company further anticipates that it
will request additional extensions of the due date if the sale of the HSG to L&H
has not closed by August 31,  1999.  The note is  personally  guaranteed  by two
officers  and  directors  and a former  officer and director of the Company (the
"Guarantors").  The  Company  anticipates  that it will enter into an  indemnity
agreement with the guarantors  relating to this and other guarantees and pledges
(see Note 10).

At June 30,  1999,  the  Company  had a notes  payable  to L&H in the  amount of
$1,100,000.  The note was 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" (7.75 percent at June 30, 1999) plus 2.0
percent.  The  loan is  secured  by all the  assets  of  Fonix/Articulate,  Inc.
("Fonix/ASI"),   a  wholly  owned  subsidiary  of  the  Company,  including  its
intellectual property rights represented by patents,  copyrights and trademarks.
L&H agreed to extend the due date to the  earlier of the  closing of the sale of
the HSG to L&H or September 30, 1999 (see Note 3).

At June 30, 1999,  the Company had a second note payable to L&H in the amount of
$4,600,000. This note was payable in full including accrued interest on July 28,
1999 and bears interest on the same terms as the loan of $1,100,000 described in
the  preceding  paragraph.  The loan is secured  by all the assets of  Fonix/ASI
including its intellectual  property rights  represented by patents,  copyrights
and  trademarks.  The loan is  further  secured  by all the  Company's  stock of
Fonix/ASI.  L&H agreed to extend the due date to the  earlier of the  closing of
the sale of the HSG to L&H or  September  30,  1999 (see Note 3).  This note was
authorized for a total of $4,900,000 and the additional $300,000 was received by
the Company in July 1999.  On August 12, 1999,  L&H agreed to increase this loan
by an  additional  $1,200,000  subject to the  existing  terms of the loan.  The
Company received funds from this loan on August 13, 1999.

The cost of warrants  issued to L&H in connection  with the above two notes (see
Note 9)  determined  under the  Black-Scholes  pricing model was $246,240 and is
being amortized as a financing  expense over the period of the loans. As of June
30,  1999  the  unamortized  financing  expense  was  $100,444.


                                       9
<PAGE>

7.  RELATED-PARTY NOTES PAYABLE

At June 30,  1999,  the Company had  unsecured  demand  notes  payable to former
Articulate  stockholders  in the aggregate  amount of $4,063,597  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,  extended the date on which demand could be
made to March 15, 1999 and  increased  the interest rate to 11 percent per year.
No additional  demand has been  received for payment of this note. In 1998,  the
Company also  negotiated  extensions  of $1,803,683 of the notes to May 30, 1999
and  adjusted the  interest  rate to 10 percent per year.  During the six months
ended June 30, 1999, the Company made partial  payments  totaling  $800,000 on a
$2,535,235  note  and  agreed  to pay  the  balance  of all of  these  notes  in
connection with the sale of the HSG to L&H (see Note 3).

At June 30,  1999,  the Company had  unsecured  demand  notes  payable to former
Articulate employees in the aggregate amount of $452,900 and accrued liabilities
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  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 accrued  liability of $404,100
of accrued liabilities by the former Articulate employees.

At June 30,  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 the sale of the HSG to L&H (see Note 3). The aggregate remaining balance of
$77,625 of the notes payable to former shareholders of Papyrus will also be paid
in connection with the closing of the sale of the HSG to L&H (see Note 3).

At June 30,  1999,  the Company had an unsecured  revolving  note payable in the
amount of $257,965 in principal and $7,173 in accrued interest to SMD, a company
owned by two  individuals  who are  executive  officers  and  directors  and one
individual  who is a former  officer  and  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 six months ended June 30, 1999
was $134,217.  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 June 30, 1999 was  $257,965.  In 1999,  advances to
the three individuals in the amount of $59,986 were applied as a partial payment
of this note.

At June 30, 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 12). This note is payable on demand.
No demand has been received by the Company.

At June 30, 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 September 30, 1999.

At June 30, 1999, the Company had an unsecured note payable to an officer of the
Company in the amount of $68,691  which  bears  interest at an annual rate of 10
percent and was due on or before July 31,  1999.  The holder of this note agreed
to extend the due date to August 31, 1999.

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



                                       10
<PAGE>

8.  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 (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 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  shares 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 the 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 10). 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.  The
Guarantors  guaranteed  the  obligations of the Company under the Debentures and
pledged  6,000,000 shares of common stock of the Company  beneficially  owned by
them as collateral security for their obligations under their guarantee.

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 holders' sales of the Guarantors' shares (see Note 10).

On June 29,  1999,  the Company  received  notice from the Nasdaq  Stock  Market
indicating  that  unless the minimum bid price for the  Company's  common  stock
returned to at least $1.00 per share for at least ten  consecutive  trading days
prior to September  29, 1999,  the  Company's  shares would be delisted from the
Nasdaq SmallCap Market on October 1, 1999 (see Note 13). If the Company's common
stock is delisted  from the Nasdaq  SmallCap  Market and is not relisted  within
three  trading  days,  an event of default  would  result under the terms of the
Debentures.  Upon the  occurrence  of an event of default,  the full  $6,500,000
principal  amount of all of the Debentures,  together with accrued  interest and
all other amounts owing in respect  thereof,  would become  immediately  due and
payable in cash.

9.  STOCKHOLDERS' EQUITY

Series D and E  Preferred  Stock - During  the six months  ended June 30,  1999,
36,000  shares of Series D  Convertible  Preferred  Stock and  91,572  shares of
Series E Convertible  Preferred Stock,  together with related dividends on each,
were converted into 1,288,479 shares and 3,246,183 shares, respectively,  of the
Company's common stock. After the above conversions,  972,334 shares of Series D
and 43,500 shares of Series E Convertible Preferred Stock remain outstanding.

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.  Subsequently,  because the common

                                       11
<PAGE>


stock had not been  received,  the Series D and Series E holders  rescinded  the
February 3 conversions,  as they 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.

On June 29,  1999,  the Company  received  notice from the Nasdaq  Stock  Market
indicating  that  unless the minimum bid price for the  Company's  common  stock
returned to at least $1.00 per share for at least ten  consecutive  trading days
prior to September  29, 1999,  the  Company's  shares would be delisted from the
Nasdaq SmallCap Market on October 1, 1999 (see Note 13). If the Company's common
stock is delisted  from the Nasdaq  SmallCap  Market and is not relisted  within
three  trading  days,  the terms of the  Series D and Series E  Preferred  Stock
require  the  Company  to pay to each  holder of Series D or Series E  Preferred
Stock a fee of two  percent  of the  purchase  price of the Series D or Series E
Preferred  Stock,  to be paid in cash,  for each month during which the stock is
delisted.  Common Stock  Issued - On June 2, 1999,  the Company  issued  200,000
shares of common  stock  (having a market  value of $100,000 on that date) to an
unrelated individual in payment for consulting services rendered.

Common Stock  Options - During the six months  ended June 30, 1999,  the Company
granted  754,500  stock  options to  employees  and 9,500  stock  options to two
consultants at exercise  prices ranging from $0.59 to $1.78 per share.  The term
of all options  granted  during this six month period is ten years from the date
of grant. Of the stock options issued,  726,334 vested immediately,  18,834 vest
six months after issuance and 18,832 vest one year after issuance.  The weighted
average  fair value of the options  granted to  employees  during the six months
ended June 30, 1999 was $1.31 per share using the  Black-Scholes  pricing model.
Had  compensation  expense for the issuance of 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 $18,226,654 or
$0.28 per share for the six months ended June 30, 1999. As of June 30, 1999, the
Company had a total of 16,139,282 options outstanding.

Common Stock  Warrants - During the six months ended June 30, 1999,  the Company
granted  warrants to L&H in connection with loans totaling  $6,000,000 which L&H
made to the Company in April and May 1999 (see Note 6). These warrants allow L&H
to purchase  850,000  shares of common  stock of the Company at exercise  prices
ranging from $0.60 to $0.70 per share.  Of the warrants,  250,000 expire October
18, 1999 and 600,000  expire May 17,  2001.  The fair value of the  warrants was
$0.14 and $0.35 per share for the 250,000 and  600,000  warrants,  respectively,
using the Black-Scholes pricing model. The cost of the warrants totaled $246,240
and is being amortized as a financing expense over the period of the loans.

10.  RELATED-PARTY  TRANSACTIONS

Related-party  transactions  with  entities  owned  by two  individuals  who are
executive  officers and directors and one individual who is a former officer and
director of the Company  and who each  beneficially  own more than 10 percent of
the Company's issued and outstanding common stock not otherwise disclosed herein
as of and for the six months ended June 30, 1999 and 1998 were as follows:

<TABLE>
<CAPTION>
                                                               1999           1998
                                                              ------         -----
<S>                                                          <C>            <C>
Expenses:
     Base rent                                               $ 62,208       $ 54,235

Liabilities:
     Accrued liabilities                                            -         22,786
</TABLE>

The Company  rents  office  space  under a  month-to-month  lease from  Studdert
Companies  Corporation  ("SCC").  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 to the Company 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 6 and 8). As security for some of
the  guarantees,  the Guarantors  have also pledged shares of Fonix common stock


                                       12
<PAGE>


beneficially  owned by them. The guaranteed  obligations and the related pledged
Fonix shares as of June 30, 1999 are as follows:


<TABLE>
<CAPTION>
                                                           Amount               Shares
                                                         Guaranteed             Pledged
<S>       <C>                                       <C>                       <C>
 Series C 5% Convertible Debentures                 $    6,500,000            6,000,000
 Note payable                                              560,000                    -
</TABLE>

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  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 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.

In December 1998, the 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.  In May 1999, 100,000 of the shares
previously  pledged by the  Guarantors  to another  creditor of the Company were
sold by the  creditor  and the  proceeds,  totaling  $72,335,  were  used to pay
amounts owed by the Company.  These  respective  amounts are now included in the
unsecured revolving note payable to SMD described in Note 7.

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.

11.  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.  In connection
with the license  agreement  Siemens  purchased  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. As of
June 30, 1999, 600,000 of the warrants originally issued had expired and 400,000
of the warrants  remain  outstanding at an average  exercise price of $27.50 per
share.

12.  PRODUCT DEVELOPMENT AND RESEARCH

Synergetics  - In October  1993,  the Company  entered  into an  agreement  with
Synergetics,  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 during the
six months ended June 30, 1999 for product  development and research efforts. No
amounts were expended during the three months ended June 30, 1999.

IMC2 - In March 1998, the Company entered into a professional services agreement
with IMC2, a research  and  development  entity,  to provide  assistance  to the
Company  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


                                       13
<PAGE>

expended  $66,000 and  $132,000  during the three and six months  ended June 30,
1999, respectively.

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 six months ended June 30, 1999
for research and development  efforts. No amounts were expended during the three
months ended June 30, 1999.

13.  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.  In  connection  with this
agreement,  the firm was  granted  options  to  purchase  100,000  shares of the
Company's common stock at $3.75 per share. In May 1999, the Company negotiated a
termination  of this agreement for a cash payment of  approximately  $33,000 and
the grant of warrants was rescinded.

Operating Lease Agreement - In March 1999, the Company entered into an agreement
to lease office space in Cleveland, Ohio for sales and installation personnel of
the HSG.  The lease is for three  years at a monthly  rate of $4,260  and became
effective  May 1,  1999.  L&H will  assume  this  lease in  connection  with its
purchase of the HSG.

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

<TABLE>
<CAPTION>
         Years ending December 31,
<S>               <C>                                          <C>
                  1999                                         $  25,560
                  2000                                            51,120
                  2001                                            51,120
                  2002                                            17,040
                                                               ---------
                  Total                                         $144,840
</TABLE>


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 $13,961 per
month, or approximately 40 percent of the Company's monthly 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.  Effective  May 25,
1999,  the Company  entered into an agreement to sublease 8,048 square feet of a
total  10,048  square feet making up its  Cupertino,  California  facility to an
unrelated  third party.  The remaining 2,000 square feet occupied by the Company
is to be turned over to the  sublessee  no sooner than six months nor later than
nine months from the  commencement of the sublease.  The agreement  requires the
sublessee  to pay  $28,346  per  month,  or  approximately  80  percent,  of the
Company's  obligation under the primary lease agreement  through the six to nine
month  period of reduced  occupancy  by the Company  and 100 percent  thereafter
through May 31, 2003.

Capital  Lease  Obligations  - In  January  1999,  the  Company  entered  into a
noncancellable capital lease arrangement for telephone equipment at its facility
in Woburn, Massachusetts. In May 1999, the Company entered into a noncancellable
capital lease arrangement for telephone  equipment at its facility in Cleveland,
Ohio.  Future aggregate  minimum  obligations  under these capital leases are as
follows:

<TABLE>
<CAPTION>
         Years ending December 31,
<S>               <C>                                                  <C>
                  1999                                                 $    7,394
                  2000                                                     14,788
                  2001                                                     14,788
                  2002                                                     14,788
                  2003                                                     14,788
</TABLE>
                                       14
<PAGE>

<TABLE>
<CAPTION>
<S>                                                                    <C>
                  Thereafter                                                2,675
                                                                       -----------
                    Total future minimum lease payments                    69,211
                     Less amounts representing interest                   (14,726)
                                                                       -----------
                       Present value of future minimum lease payments  $   54,495
</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 $16,648 and $63,525 was incurred during the
three and six months ended June 30, 1999, respectively, in connection with these
agreements.  There  were no  sales  of  products  incorporating  these  licensed
technologies during the six months ended June 30, 1998.

Potential  Delisting  of the  Company's  Common  Stock  by  Nasdaq  -  Potential
delisting of the Company's  common stock from the Nasdaq  SmallCap  Market could
have an adverse effect on the liquidity of the Company's  common stock and would
trigger  certain  rights of holders of the  Company's  Debentures  and Preferred
Stock.

The Company's  common stock currently trades on the Nasdaq SmallCap Market which
requires,  for  continued  listing,  a minimum  bid price of at least  $1.00 per
share.  At June 29, 1999, the Company's  common stock had traded below $1.00 for
more than 30 consecutive  trading days. On June 29, 1999, the Company received a
letter from the Nasdaq Market  indicating  that unless the minimum bid price for
the Company's  common stock returned to at least $1.00 per share for at least 10
consecutive trading days prior to September 29, 1999, the Company's shares would
be delisted from the Nasdaq  SmallCap Market on October 1, 1999. The Company has
the  right  to  appeal  the  Nasdaq  Stock   Market's   notice  and/or   listing
determination on or before September 29, 1999.

If the Company's common stock is delisted from the Nasdaq SmallCap  Market,  the
Company  believes  that its common  stock  would  qualify for listing on the OTC
Bulletin Board. However, the result of delisting from the Nasdaq SmallCap Market
could be a reduction in the liquidity of any investment in the Company's  common
stock,  even if the Company's  shares are thereafter  traded on the OTC Bulletin
Board.  Further,  delisting could reduce the ability of holders of the Company's
common stock to purchase or sell shares as quickly and as  inexpensively as they
have done historically.

Additionally, if the Company's common stock is delisted from the Nasdaq SmallCap
Market and is not relisted  within three trading days, an event of default would
result under the terms of the  Debentures.  Upon the  occurrence  of an event of
default, the full $6,500,000 principal amount of all of the Debentures, together
with accrued  interest and all other  amounts  owing in respect  thereof,  would
become  immediately due and payable in cash. The requirement to pay such amounts
would  deplete the  Company's  existing  cash,  and would require the Company to
incur additional debt, thus further  increasing the Company's debt  obligations.
There can be no assurance  that the Company  would be able to borrow the amounts
needed to pay the holders of the Debentures or that such  financing,  if it were
available  to the  Company,  would be  available  on terms  satisfactory  to the
Company.  Presently,  the Company does not have  sufficient cash or other liquid
assets to pay the amount  which  would be due if the  holders of the  Debentures
declared a default thereunder.

Finally,  if the  Company's  common stock is delisted  from the Nasdaq  SmallCap
Market and is not relisted  within three trading days, the terms of the Series D
and Series E Preferred Stock require the Company to pay to each holder of Series
D or Series E Preferred  Stock a fee of two percent of the purchase price of the
Series D or Series E Preferred  Stock,  to be paid in cash,  for each month that
the stock is delisted.  The  requirement  to pay such amounts  would deplete the
Company's existing cash, and would require the Company to incur additional debt,
thus  further  increasing  the  Company's  debt  obligations.  There  can  be no
assurance that the Company would be able to borrow the amounts needed to pay the
holders of the Series D or Series E Preferred Stock or that such  financing,  if
it were available to the Company,  would be available on terms  satisfactory  to
the  Company.  Presently,  the Company  does not have  sufficient  cash or other
liquid assets to pay the amount which would be due.


                                       15
<PAGE>

14. LITIGATION

Clarke - On August 28, 1998, John R. Clarke and Perpetual Growth Fund, a company
Clarke's  spouse  purportedly  owns,  commenced an action against the Company in
federal court for the Southern District of New York. Clarke and Perpetual Growth
asserted claims for breach of contract relating to certain financing the Company
received  during 1998.  Specifically,  Clarke and Perpetual  Growth alleged that
they entered into a contract with the Company under which the Company  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 the  Company in July and August  1998,  and the  Company's
offerings  of  Series  D  and  Series  E  preferred  stock,   totaling  together
$12,000,000, in August and September 1998.

The Company believes that the Clarke lawsuit is without merit and filed a motion
to  dismiss  based  upon the  court's  lack of  personal  jurisdiction  over the
Company. The court granted the Company's motion to dismiss. Clarke and Perpetual
Growth have appealed the dismissal.  The Company 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,  the Company 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 the Company 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 appeared to be
false.  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 970,586
shares of  restricted  common  stock issued to the five former  shareholders  in
connection  with the  acquisition.  The  Company  agreed  to pay the  Settlement
Payment on or before  August 31,  1999 or, if the  definitive  proxy  soliciting
consents from the  shareholders  of the Company is effective prior to August 31,
1999, upon the closing of the sale of the HSG assets (see Note 3) 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. If the Company
closes  the sale of the HSG (see  Note 3) the  Company's  rights  in and to this
litigation will be acquired by L&H.

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.


                                       16
<PAGE>

15.  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 HSG includes the development,  manufacture, sale, installation 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 the Company's products and technologies into their
own products or product  development  efforts.  These products and  technologies
include ASR, handwriting and TTS applications.

The following tables reflect  selected  financial  information  relating to each
business  segment for the three and six months ended June 30, 1999 and 1998, and
as of June 30, 1999 and December 31, 1998:

<TABLE>
<CAPTION>
                                                    Three Months June 30,                         Six Months Ended June 30,


                                               1999                  1998                    1999                    1998
                                         ----------------      -----------------      ------------------       ----------------
<S>                                      <C>                   <C>                    <C>                      <C>
Revenues:
   HSG                                   $        423,481      $               -      $        1,480,007       $              -
   ITSG                                           231,570              1,176,500                 285,376              2,472,285
                                         ----------------      -----------------      ------------------       ----------------
                                         $        655,051      $       1,176,500      $        1,765,383       $      2,472,285
                                         ================      =================      ==================       ================
Gross margin:
   HSG                                   $        302,032      $               -      $        1,138,410       $              -
   ITSG                                           223,621              1,176,500                 272,136              2,472,285
                                         ----------------      -----------------      ------------------       ----------------
                                                  528,653              1,176,500               1,410,546              2,472,285
                                         ----------------      -----------------      ------------------       ----------------

Product development and research
 expenses:
   HSG                                            488,383                      -                 946,836                      -
   ITSG                                         1,858,524              2,960,292               4,371,350              5,661,495
                                         ----------------      -----------------      ------------------       ----------------
                                                2,346,907              2,960,292               5,318,186              5,661,495
                                         ----------------      -----------------      ------------------       ----------------
Selling, general and administrative
 expenses:
   HSG                                            946,800                      -               1,877,292                      -
   ITSG                                         1,928,110              2,084,622               4,673,180              3,464,702
                                         ----------------      -----------------      ------------------       ----------------
                                                2,874,910              2,084,622               6,550,472              3,464,702
                                         ----------------      -----------------      ------------------       ----------------
Amortization of goodwill and purchased
 core technology:
   HSG                                            638,279                      -               1,259,943                      -
   ITSG                                           649,302                500,776               1,315,219                599,559
                                         ----------------      -----------------      ------------------       ----------------
                                                1,287,581                500,776               2,575,162                599,559
                                         ----------------      -----------------      ------------------       ----------------
Purchased in-process research and
 development:
</TABLE>


                                       17
<PAGE>



<TABLE>
<CAPTION>
<S>                                      <C>                   <C>                    <C>                      <C>
   HSG                                                  -                      -                       -                      -
   ITSG                                                 -                      -                       -              9,315,000
                                         ----------------      -----------------      ------------------       ----------------
                                                        -                      -                       -              9,315,000
                                         ----------------      -----------------      ------------------       ----------------

Loss from operations:
   HSG                                        (1,771,430)                      -             (2,945,661)                      -
   ITSG                                       (4,212,315)            (4,369,190)            (10,087,613)           (16,568,471)
                                         ----------------      -----------------      ------------------       ----------------
                                         $    (5,983,745)      $     (4,369,190)      $     (13,033,274)       $   (16,568,471)
                                         ================      =================      ==================       ================
</TABLE>


<TABLE>
<CAPTION>
                                                           As of June     As of December
                                                            30, 1999            31, 1998
                                                         ----------------     ----------------

<S>                                                      <C>                    <C>
Assets:
   HSG                                                   $      19,704,628      $     19,760,394
   ITSG                                                         20,323,687            42,229,533
                                                         -----------------      ----------------
                                                         $      40,028,315      $     61,989,927
                                                         =================      ================
</TABLE>

16.  SUBSEQUENT EVENTS

Resignation of Stephen M. Studdert,  Director - Effective July 15, 1999, Stephen
M. Studdert resigned as a member of the Board of Directors of the Company.

Marketing  Support  Agreement  for HSG products - Effective  July 31, 1999,  the
Company and L&H entered into an agreement  pursuant to which L&H  exercised  its
option to become a  distributor  of HSG  products  under the  Technology  Option
Agreement  executed May 19, 1999. At the same time, the Company  transferred and
assigned to L&H certain pending sales orders, all license agreements, client and
customer contracts relating to ongoing  maintenance and service  obligations and
the right to use and exploit for L&H's  benefit all of the  existing  sale leads
and  opportunities  of the HSG (the "Assigned  Contracts").  The Company further
granted L&H the right to receive all  payments  due and owing under the Assigned
Contracts  as if the sale of the HSG to L&H had  occurred  on July 1, 1999.  Any
payments due L&H from the Assigned  Contracts  but paid to the Company  prior to
the date of the Marketing  Support  Agreement,  less $400,000 (but not less than
zero), shall reduce the purchase price of the HSG by that amount. If the closing
of the sale of HSG to L&H does not occur by  September  3,  1999,  such  prepaid
amounts, less the credit of up to $400,000, are immediately due and payable. The
Company and L&H further  agreed that L&H would assume all of the  obligations of
the Company under the Assigned Contracts.  L&H also agreed to engage the Company
to  provide  marketing,  sales,  product  implementation  and  installation  and
customer  support  services  on behalf of L&H in order to (i) fulfill all of the
obligations  of the Company  under the  Assigned  Contracts  and (ii)  otherwise
market and sell HSG's products and certain products of L&H.

Guarantee of Company  Obligations  - In August 1999,  the Company had  unsecured
advances from a bank in the form of a bank overdraft in the  approximate  amount
of  $100,000  that were  personally  guaranteed  by an officer  of the  Company.
Subsequent  to the granting of the  guarantee  the overdraft has been reduced to
approximately $3,000.


                                       18
<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  SUCH  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 ASR and related technologies such
as TTS (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 ASR 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 ASR systems during that period. This improvement includes vocabulary
size, recognition accuracy and continuous speech recognition ability.  Currently
available ASR 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.

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 ASR 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
only on  traditional  Hidden Markov Models ("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


                                       19
<PAGE>


access and consumer electronic devices controlled by natural language.

HealthCare Solutions Group Products

The three PowerScribe  products now being sold by the HealthCare Solutions Group
("HSG")  are  PowerScribeRAD,   PowerScribeRAD   Software  Development  Kit  and
PowerScribeEM.  PowerScribe  products  use  state-of-the-art  continuous  speech
recognition engines licensed from Dragon Systems, which enable 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.

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.
During  the six  months  ended  June  30,  1999,  the  Company  received  in the
aggregate, $1,480,007 in revenue from sales of the PowerScribe Radiology product
marketed by the HSG.

On May 19, 1999,  the Company  entered into an agreement to sell the  operations
and a  significant  portion of the assets of its HSG to L&H, an unrelated  third
party, for $28,000,000,  of which $24,000,000 is to be paid at closing,  and the
remaining  $4,000,000 to be paid as an earnout in two installments of $2,000,000
each over the next two years based on agreed upon performance  milestones of the
HSG for those  subsequent two years.  The sale is subject to approval by Fonix's
shareholders,  and is scheduled to close during the third  quarter of 1999.  The
proceeds  from  the  sale  will be  used  to  reduce  certain  of the  Company's
liabilities  and to provide working capital to allow Fonix to focus on marketing
and development opportunities for its Interactive Technology Solutions Group.

Interactive Technology Solutions Group Products

The  Interactive  Technologies  Solutions  Group  ("ITSG")  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 ITSG is to form relationships with third parties who
can  incorporate the Company's  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.
ITSG  products  include  FAAST,  AcuVoice AV 1700 and AV 2001 TTS  systems,  and
handwriting recognition products.

Embedded Technologies

Fonix  has  developed  an  application  development  tool,  the  Fonix  Advanced
Application  Speech  Toolkit  (FASSTtm)  which  allows  developers  to simulate,
prototype and create code for embedded  applications using the Company's TTS and
ASRT.  This system  currently  supports the  Company's  speech  recognition  for
command and control  applications and  Fonix/AcuVoice  TTS 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 Infineon  (formerly  Siemens) TriCore  micro-controller,  the
Intel StrongArm RISC processor,  Epson EOC-33  micro-controller,  MIPS RISC core
and the Hitachi SH#3 RISC processor. The beta version of the FAAST system became
available for developers in June 1999. A beta version of the system is currently
being used  internally at Fonix to support the  development of embedded  systems
applications  for  several   companies  which   manufacture  and  sell  consumer
electronic, automotive, and cell phone devices.

Speech 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

                                       20
<PAGE>


proprietary ASRT 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.

The  Company's  TTS  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  ("SDK")  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.

During  the six  months  ended  June  30,  1999,  the  Company  received  in the
aggregate,   $285,376  in  revenue  from  licensing  or  sale  of  the  AcuVoice
technologies  and  products.

Handwriting Recognition

The Company markets the Allegro  handwriting  recognition  software developed by
Papyrus. Allegro is a single letter recognition system like the popular Graffiti
handwriting  recognition  software for the  PalmPilot  PDA  (Personal  Dictation
Assistant).  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.  The Company also markets  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.

During the six months ended June 30, 1999, the Company  received no revenue from
licensing  or sale  of the  handwriting  recognition  technologies.

Resignation of Stephen M. Studdert, Director

On April 30,  1999,  Stephen M.  Studdert  resigned  as Chairman of the Board of
Directors of Fonix. On July 15, 1999, Mr.  Studdert  resigned as a member of the
Board of Directors of the Company.

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  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.


                                       21
<PAGE>


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 has  completed  its review of most  products  and  systems and
expects to complete its review of all internal  systems for Year 2000 compliance
by  September  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 June 30, 1999 compared with three months ended June 30, 1998

During the three months ended June 30, 1999,  the Company  recorded  revenues of
$655,051,  a decrease of $521,449 over the same period in the previous  year. In
the 1998 period the Company received $1,076,426 from Siemens as a non-refundable
license  fee for which the Company had no further  obligation  of any kind.  The
1999  revenues  are  primarily  from  sales and  licensing  fees  related to the
PowerScribe dictation product and TTS technologies and products.

Selling,  general and administrative expenses were $2,874,910 and $2,084,622 for
the three months ended June 30, 1999 and 1998, respectively. Salaries, wages and
related costs were  $1,289,949  and $879,201 for the three months ended June 30,
1999  and  1998,  respectively,  an  increase  of  $410,748.  This  increase  is
attributable to increases in personnel costs resulting from the  acquisitions of
AcuVoice,  Articulate  and  Papyrus.  Legal and  accounting  expenses  increased
$136,110.  This  increase  is  attributed  primarily  to the  costs of legal and
accounting  services  related to the  issuance  of the  Series C 5%  Convertible
Debentures (the  "Debentures")  and the potential sale of the HSG assets to L&H.
Marketing  expenses  increased  $842,411  and  consulting  and outside  services
increased  by  $72,030.  The  increase  in  Marketing  expenses  was  due to the
acquisition of the PowerScribe Products marketing personnel of MRC, the creation
of a marketing  group for the TTS  products  and an  increase  in the  marketing
effort for the ITSG.

The Company  incurred  product  development and research  expenses of $2,346,907
during the three months  ended June 30,  1999,  a decrease of $613,385  over the
same  period  in  the  previous  year.   This  decrease  was  due  primarily  to
management's  cost  reduction  initiatives  implemented  in February  1999.  The
Company  anticipates similar decreases in product development and research costs
as it begins to complete the  development  of certain TTS products and completes
the sale the HSG to L&H.  During the three  months ended June 30, 1999 and 1998,
the  Company   expended  a  total  of   approximately   $320,000   and  $30,000,
respectively,  in connection with the development of the AcuVoice and Articulate
purchased in-process research and development projects.

Amortization  of goodwill and purchased core  technologies  were  $1,287,581 and
$500,776  for the three  months  ended  June 30,  1999 and  1998,  respectively,
representing an increase of $786,805. This increase is primarily attributable to
the   amortization  of  intangible   assets  acquired  in  connection  with  the
acquisitions of Articulate and Papyrus.

The Company incurred losses from operations of $5,983,745 and $4,369,190  during
the three  months  ended June 30, 1999 and 1998,  respectively.  The increase in
losses from  operations  is due  primarily to increases in selling,  general and
administrative expenses and amortization expense, offset in part by decreases in
product  development  and  research  costs.  The  Company  anticipates  that its
investment in ongoing scientific product  development and research will continue
at present  or  decreased  levels for the  remainder  of fiscal  1999,  assuming
availability of working capital.


                                       22
<PAGE>


Net other  expense was $534,042  for the three  months  ended June 30, 1999,  an
increase of $543,470  over the three months ended June 30, 1998.  This  increase
was due  primarily  to an increase in  interest  expense of $251,065  related to
financing  costs  associated  with  the  issuance  of  the  Debentures  and to a
reduction in interest income of $292,405 from  certificates of deposit that were
converted to cash to retire a bank line of credit in January 1999.

Six months ended June 30, 1999 compared with six months ended June 30, 1998

During the six months  ended June 30,  1999,  the Company  recorded  revenues of
$1,765,383, a decrease of $706,902 over the same period in the previous year. In
the 1998 period the Company received its first revenues of $2,472,285, of which,
$2,368,138  was paid by Siemens as a  non-refundable  license  fee for which the
Company had no further  obligation of any kind.  The 1999 revenues are primarily
from sales and licensing fees related to the PowerScribe  dictation  product and
TTS technologies and products.

Selling,  general and administrative expenses were $6,550,472 and $3,464,702 for
the six months ended June 30, 1999 and 1998,  respectively.  Salaries, wages and
related costs were  $3,348,575  and $1,526,389 for the six months ended June 30,
1999 and 1998,  respectively,  an  increase  of  $1,822,186.  This  increase  is
attributable to increases in personnel costs resulting from the  acquisitions of
AcuVoice,  Articulate  and  Papyrus.  Legal and  accounting  expenses  increased
$374,802.  This  increase  is  attributed  primarily  to the  costs of legal and
accounting services related to the issuance of the Debentures, and the potential
sale of the HSG  assets to L&H.  Marketing  expenses  increased  $1,966,616  and
consulting and outside services increased by $166,134. The increase in Marketing
expenses  was  due to the  acquisition  of the  PowerScribe  products  marketing
personnel of MRC, the creation of a marketing  group for the TTS products and an
increase in the marketing effort for the ITSG.

The Company  incurred  product  development and research  expenses of $5,318,186
during the six months ended June 30, 1999, a decrease of $343,309  over the same
period in the previous  year.  This decrease was due  primarily to  management's
cost reduction initiatives implemented in February 1999. The Company anticipates
similar  decreases in product  development  and  research  costs as it begins to
complete the  development  of certain TTS and  completes  the sale of the HSG to
L&H. During the six months ended June 30, 1999 and 1998, the Company  expended a
total of approximately  $600,000 and $60,000,  respectively,  in connection with
the development of the AcuVoice and Articulate purchased in-process research and
development projects.

Amortization  of goodwill and purchased core  technologies  were  $2,575,162 and
$599,559  for the six  months  ended  June  30,  1999  and  1998,  respectively,
representing an increase of $1,975,603.  This increase is primarily attributable
to the  amortization  of  intangible  assets  acquired  in  connection  with the
acquisitions of AcuVoice, Articulate and Papyrus.

The Company  incurred  losses from  operations of  $13,033,274  and  $16,568,471
during the six months ended June 30, 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 six months ended June 30,
1998,  offset  in part by  increases  in  selling,  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 decreased levels for the remainder of fiscal 1999,  assuming  availability of
working capital.

Net other  expense was  $2,779,375  for the six months ended June 30,  1999,  an
increase of  $2,748,356  over the six months ended June 30, 1998.  This increase
was due primarily to an increase in interest  expense of  $2,206,520  related to
financing  costs  associated  with the  issuance of the Debentures.

In-Process Research and Development

At the dates of acquisition  of AcuVoice and  Articulate,  management  estimated
that each of the  acquired  in-process  research  and  development  projects  of
AcuVoice  and  Articulate  were  approximately  75 percent  complete and that an
additional  $1.0 million would be required to develop each of these  projects to
commercial viability. Additionally,  management anticipated release dates of the
fourth quarter of 1999 for the AcuVoice projects,  and the first quarter of 2000
for the  Articulate  projects.  As of June 30, 1999,  the Company has expended a
total of approximately $280,000 and $720,000 in connection with the AcuVoice and
Articulate acquired in-process research and development projects,  respectively,


                                       23
<PAGE>

and  management  estimates that a total of  approximately  $720,000 and $280,000
will be required to complete the AcuVoice and Articulate projects, respectively.
Management  also  estimates  that the  AcuVoice and  Articulate  projects are 82
percent and 93 percent complete, respectively, as of June 30, 1999, and that the
release dates are the same as anticipated at the date of acquisition.

Liquidity and Capital Resources

The  Company  must  raise  additional  funds  to be able  to  satisfy  its  cash
requirements during the next 12 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 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.

On May 19, 1999,  the Company  entered into an agreement to sell the  operations
and a  significant  portion of the assets of its HSG to L&H, an unrelated  third
party, for $28,000,000,  of which $24,000,000 is to be paid at closing,  and the
remaining  $4,000,000 to be paid as an earnout in two installments of $2,000,000
each over the next two years subject to the  achievement of certain  performance
milestones of the HSG. The sale is subject to approval by Fonix's  shareholders,
and is scheduled to close during the third  quarter of 1999.  The proceeds  from
the sale will be used to reduce  certain  of the  Company's  liabilities  and to
provide  working  capital to allow Fonix to focus on marketing  and  development
opportunities for its ITSG.

The  Company  had  negative  working  capital of  $18,554,002  at June 30,  1999
compared to negative  working  capital of  $14,678,975 at December 31, 1998. The
current  ratio was 0.09:1 at June 30, 1999  compared  to 0.59:1 at December  31,
1998.  Current assets  decreased by $18,977,855 to $1,737,351  from December 31,
1998  to  June  30,  1999.  Current  liabilities  decreased  by  $15,102,828  to
$20,291,353  during  the same  period.  The  decrease  in working  capital  from
December 31, 1998 to June 30, 1999, was primarily  attributable  to increases in
accounts and notes payable,  accrued liabilities and deferred revenues offset in
part by decreases in related party notes payable.  Total assets were $40,028,315
at June 30,1999 compared to $61,989,927 at December 31, 1998.

During the six months ended June 30, 1999,  the Company  granted  754,500  stock
options to  employees  and 9,500 stock  options to two  consultants  at exercise
prices  ranging from $0.59 to $1.78 per share.  The term of all options  granted
during  this six month  period is ten years  from date of grant.  As of June 30,
1999, the Company had a total of 16,139,282 options outstanding.

During the six months ended June 30, 1999, the Company  granted  warrants to L&H
in connection  with loans totaling  $5,700,000  which L&H made to the Company in
April and May 1999. The warrants allow L&H to purchase  850,000 shares of common
stock of the Company at exercise  prices  ranging from $0.60 to $0.70 per share.
Of these  warrants  250,000  expire  October 18, 1999 and 600,000 expire May 17,
2001.

On January 29, 1999, the Company  entered into a Securities  Purchase  Agreement
with four  investors  pursuant to which the Company sold its  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
shares 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


                                       24
<PAGE>

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 the 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 the
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 two officers
and  directors   and  a  former   officer  and  director  of  the  Company  (the
"Guarantors").  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.  The  Guarantors
guaranteed  the  obligations  of the Company  under the  Debentures  and pledged
6,000,000  shares of common stock of the Company  beneficially  owned by them as
collateral security for their obligations under their guarantees.

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 holders' sales of the Guarantors' shares.

On June 29,  1999,  the Company  received  notice from the Nasdaq  Stock  Market
indicating  that  unless the minimum bid price for the  Company's  common  stock
returned to at least $1.00 per share for at least ten  consecutive  trading days
prior to September  29, 1999,  the  Company's  shares would be delisted from the
Nasdaq  SmallCap  Market on October 1, 1999.  If the  Company's  common stock is
delisted  from the Nasdaq  SmallCap  Market  and is not  relisted  within  three
trading  days,  an  event  of  default  would  result  under  the  terms  of the
Debentures.  Upon the  occurrence  of an event of default,  the full  $6,500,000
principal  amount of all of the Debentures,  together with accrued  interest and
all other amounts owing in respect  thereof,  would become  immediately  due and
payable in cash.

During the six months ended June 30, 1999, 36,000 shares of Series D Convertible
Preferred  Stock and  91,572  shares of Series E  Convertible  Preferred  Stock,
together  with related  dividends on each,  were  converted  into  1,288,479 and
3,246,183 shares,  respectively,  of the Company's common stock. After the above
conversions,  972,334  shares  of  Series  D  and  43,500  shares  of  Series  E
Convertible Preferred Stock remain outstanding.

If the Company's common stock is delisted from the Nasdaq SmallCap Market and is
not relisted  within three trading days,  the terms of the Series D and Series E
Preferred  Stock require the Company to pay to each holder of Series D or Series
E Preferred  Stock a fee of two percent of the purchase price of the Series D or
Series E Preferred Stock in cash for each month that the stock is delisted.

At June 30, 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. This note is payable on demand, matures April 1, 2007, bears
interest  at the  bank's  prime rate  (7.75  percent at June 30,  1999) plus 2.0
percent  and  requires  interest  to  be  paid  monthly.  The  weighted  average
outstanding  balance during the six months ended June 30, 1999 was $50,000.  The
weighted average interest rate was 9.75 percent during this period.

At June 30,  1999,  the Company had a note  payable to a lender in the amount of
$588,000 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 on a monthly  basis,  currently to August 31, 1999, by paying the lender or
capitalizing  accrued  interest plus a fee of 1% of the loan balance each month.
The Company  anticipates that this loan will be paid in full upon the closing of
the sale of the HSG to L&H. The Company further anticipates that it will request
additional  extensions  of the due  date  if the  sale of the HSG to L&H has not
closed by August 31, 1999. The note is personally guaranteed by two officers and
directors  and a  former  officer  and  director  of the  Company.  The  Company
anticipates  that it will enter into an indemnity  agreement with the guarantors
relating to this and other guarantees and pledges.

At June 30,  1999,  the  Company  had a notes  payable  to L&H in the  amount of
$1,100,000.  The note was payable in full including accrued interest on July 28,


                                       25
<PAGE>

1999 and  bears  interest  at the prime  rate as  published  in The Wall  Street
Journal under the heading "Money Rates" (7.75 percent at June 30, 1999) plus 2.0
percent.  The loan is  secured by all the assets of  Fonix/ASI,  a wholly  owned
subsidiary  of  the  Company,   including  its   intellectual   property  rights
represented by patents,  copyrights and trademarks. L&H agreed to extend the due
date to the  earlier of the  closing of the sale of the HSG to L&H or  September
30, 1999.

At June 30, 1999,  the Company had a second note payable to L&H in the amount of
$4,600,000. This note was payable in full including accrued interest on July 28,
1999 and bears interest on the same terms as the loan of $1,100,000 described in
the  preceding  paragraph.  The loan is secured  by all the assets of  Fonix/ASI
including its intellectual  property rights  represented by patents,  copyrights
and  trademarks.  The loan is  further  secured  by all the  Company's  stock of
Fonix/ASI.  L&H agreed to extend the due date to the  earlier of the  closing of
the sale of the HSG to L&H or September 30, 1999. This note was authorized for a
total of $4,900,000 and the  additional  $300,000 was received by the Company in
July 1999. On August 12, 1999, L&H agreed to increase this loan by an additional
$1,200,000 subject to the existing terms of the loan. The Company received funds
from  this  loan on  August  13,  1999.

The cost of  warrants  issued  to L&H in  connection  with the  above  two notes
determined  under the  Black-Scholes  pricing  model was  $246,240  and is being
amortized as a financing  expense  over the period of the loans.  As of June 30,
1999 the unamortized financing expense was $100,444.

At June 30,  1999,  the Company had  unsecured  demand  notes  payable to former
Articulate  stockholders  in the aggregate  amount of $4,063,597  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,  extended the date on which demand could be
made to March 15, 1999 and  increased  the interest rate to 11 percent per year.
No additional  demand has been  received 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 six months ended
June 30,  1999,  the  Company  made  partial  payments  totaling  $800,000  on a
$2,535,235  note  and  agreed  to pay  the  balance  of all of  these  notes  in
connection with the sale of the HSG to L&H.

At June 30,  1999,  the Company had  unsecured  demand  notes  payable to former
Articulate employees in the aggregate amount of $452,900 and accrued liabilities
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  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  of  accrued
liabilities by the former Articulate employees.

At June 30,  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 the sale of the HSG to L&H. The aggregate  remaining  balance of $77,625 of
the  notes  payable  to  former  shareholders  of  Papyrus  will also be paid in
connection with the closing of the sale of the HSG to L&H.

At June 30,  1999,  the Company had an unsecured  revolving  note payable in the
amount of $257,965 in principal and $7,173 in accrued interest to SMD, a company
owned by two  individuals  who are  executive  officers  and  directors  and one
individual  who is a former  officer  and  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 six months ended June 30, 1999
was $134,217.  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 June 30, 1999 was  $257,965.  In 1999,  advances to
the three individuals in the amount of $59,986 were applied as a partial payment
of this note.

The Guarantors  guaranteed certain  obligations of the Company.  As security for
some of the  guarantees,  the  Guarantors  also pledged  shares of the Company's
common stock  beneficially  owned by them. In March 1999,  143,230 of the shares


                                       26
<PAGE>

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.  In May  1999,  100,000  of  the  shares
previously  pledged by the  Guarantors  to another  creditor of the Company were
sold by the  creditor  and the  proceeds,  totaling  $72,335,  were  used to pay
amounts owed by the Company.  These  respective  amounts are now included in the
unsecured revolving note payable to SMD described above.

At June 30, 1999, the Company had an unsecured, non-interest bearing demand note
payable in the amount of $100,000 to  Synergetics,  a research  and  development
entity.  This note is  payable on demand.  No demand  has been  received  by the
Company.

At June 30, 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 September 30, 1999.

At June 30, 1999, the Company had an unsecured note payable to an officer of the
Company in the amount of $68,691  which  bears  interest at an annual rate of 10
percent and was due on or before July 31,  1999.  The holder of this note agreed
to extend the due date to August 31, 1999.

The Company  presently has no plans to purchase any new research and development
or office facilities.

Potential  Delisting  of the  Company's  Common  Stock  by  Nasdaq  -  Potential
delisting  from the Nasdaq  SmallCap  Market could have an adverse effect on the
liquidity of the  Company's  common stock and would  trigger  certain  rights of
holders of the Company's Debentures and Preferred Stock.

The Company's  common stock currently trades on the Nasdaq SmallCap Market which
requires,  for  continued  listing,  a minimum  bid price of at least  $1.00 per
share.  At June 29, 1999, the Company's  common stock had traded below $1.00 for
more than 30 consecutive  trading days. On June 29, 1999, the Company received a
letter from the Nasdaq stock market indicating that unless the minimum bid price
for the Company's common stock returned to at least $1.00 per share for at least
ten consecutive  trading days prior to September 29, 1999, the Company's  shares
would be  delisted  from the Nasdaq  SmallCap  Market on  October  1, 1999.  The
Company has the right to appeal the Nasdaq stock market's  notice and/or listing
determination on or before September 29, 1999.

If the Company's common stock is delisted from the Nasdaq SmallCap  Market,  the
Company  believes  that its common  stock  would  qualify for listing on the OTC
Bulletin Board. However, the result of delisting from the Nasdaq SmallCap Market
could be a reduction in the liquidity of any investment in the Company's  common
stock,  even if the Company's  shares are thereafter  traded on the OTC Bulletin
Board.  Further,  delisting could reduce the ability of holders of the Company's
common stock to purchase or sell shares as quickly and as  inexpensively as they
have done historically.

Additionally, if the Company's common stock is delisted from the Nasdaq SmallCap
Market and is not relisted  within three trading days, an event of default would
result under the terms of the  Debentures.  Upon the  occurrence  of an event of
default, the full $6,500,000 principal amount of all of the Debentures, together
with accrued  interest and all other  amounts  owing in respect  thereof,  would
become  immediately due and payable in cash. The requirement to pay such amounts
would  deplete the  Company's  existing  cash,  and would require the Company to
incur additional debt, thus further  increasing the Company's debt  obligations.
There can be no assurance  that the Company  would be able to borrow the amounts
needed to pay the holders of the Debentures or that such  financing,  if it were
available  to the  Company,  would be  available  on terms  satisfactory  to the
Company.  Presently,  the Company does not have  sufficient cash or other liquid
assets to pay the amount  which  would be due if the  holders of the  Debentures
declared a default thereunder.

Finally,  if the  Company's  common stock is delisted  from the Nasdaq  SmallCap
Market and is not relisted  within three trading days, the terms of the Series D
and Series E Preferred Stock require the Company to pay to each holder of Series
D or Series E Preferred  Stock a fee of two percent of the purchase price of the
Series D or Series E Preferred  Stock,  to be paid in cash,  for each month that
the stock is delisted.  The  requirement  to pay such amounts  would deplete the
Company's existing cash, and would require the Company to incur additional debt,
thus  further  increasing  the  Company's  debt  obligations.  There  can  be no
assurance that the Company would be able to borrow the amounts needed to pay the


                                       27
<PAGE>

holders of the Series D or Series E Preferred Stock or that such  financing,  if
it were available to the Company,  would be available on terms  satisfactory  to
the  Company.  Presently,  the Company  does not have  sufficient  cash or other
liquid assets to pay the amount which would be due.

                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, as amended, 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 the Company in
federal court for the Southern District of New York. Clarke and Perpetual Growth
asserted claims for breach of contract relating to certain financing the Company
received  during 1998.  Specifically,  Clarke and Perpetual  Growth alleged that
they entered into a contract with the Company under which the Company  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 the  Company in July and August  1998,  and the  Company's
offerings  of  Series  D  and  Series  E  preferred  stock,   totaling  together
$12,000,000, in August and September 1998.

The Company believes that the Clarke lawsuit is without merit and filed a motion
to  dismiss  based  upon the  court's  lack of  personal  jurisdiction  over the
Company. The court granted the Company's motion to dismiss. Clarke and Perpetual
Growth have appealed the dismissal.  The Company 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,  the Company 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 the Company 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 appeared to be
false.  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


                                       28
<PAGE>


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 970,586
shares of  restricted  common  stock issued to the five former  shareholders  in
connection  with the  acquisition.  The  Company  agreed  to pay the  Settlement
Payment on or before  August 31,  1999 or, if the  definitive  proxy  soliciting
consents from the  shareholders  of the Company is effective prior to August 31,
1999, upon the closing of the sale of the HSG assets (see Note 3) or the Company
and the five former  Papyrus  shareholders  are free to pursue their  respective
claims.

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

Series D and E  Preferred  Stock - During  the six months  ended June 30,  1999,
36,000  shares of Series D  Convertible  Preferred  Stock and  91,572  shares of
Series E Convertible  Preferred Stock,  together with related dividends on each,
were converted into 1,288,479 shares and 3,246,183 shares, respectively,  of the
Company's common stock. After the above conversions,  972,334 shares of Series D
and 43,500 shares of Series E Convertible Preferred Stock remain outstanding.

Common  Stock Issued - On June 2, 1999,  the Company  issued  200,000  shares of
common  stock  (having a market  value of $100,000 on that date) to an unrelated
individual in payment for consulting services rendered.

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


                                       29
<PAGE>


         (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
                           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


                                       30
<PAGE>


         (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 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



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<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:          August 18, 1998           /s/ Douglas L. Rex
     ------------------------------      ---------------------------------------
                                         Douglas L. Rex, Chief Financial Officer