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

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

[X]  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934 for the quarterly period ended June 30, 1998

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

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

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

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

                             1225 Eagle Gate Tower
                          60 East South Temple Street
                          Salt Lake City, Utah 84111
             -----------------------------------------------------
             (Address of principal executive offices and zip code)

                                (801) 328-8700
              ----------------------------------------------------  
              (Registrant's telephone number, including area code)


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

As of August 12, 1998, 52,055,406 shares of the issuer's Common Stock, par value
$.0001 per share, were issued and outstanding.
<PAGE>
 
                                  INTRODUCTION

         This Amendment No. 1 to the Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1998 of Fonix Corporation (the "Company") is
submitted to amend the following Items:

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


                        PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.

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

                                       2
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)

<TABLE> 
<CAPTION> 
ASSETS
                                                                                                June 30,           December 31,
                                                                                                 1998                  1997
                                                                                          -------------------- ---------------------
<S>                                                                                       <C>                   <C> 
Current assets:
       Cash and cash equivalents                                                             $ 22,123,499          $ 20,501,676
       Notes receivable                                                                           831,140               600,000
       Accounts receivable                                                                         66,153                     -
       Interest and other receivables                                                              20,968                14,919
       Prepaid expense                                                                            178,345                32,094
                                                                                          -------------------- ---------------------

              Total current assets                                                             23,220,105            21,148,689

Property and equipment, net of accumulated depreciation of $757,989 and
   $464,100, respectively                                                                       1,973,906             1,567,279

Intangible assets, net of accumulated amortization of $641,514 and $25,509, respectively       15,547,786               138,951

Other assets                                                                                      104,874                39,647
                                                                                         -------------------- ---------------------

              Total assets                                                                   $ 40,846,671          $ 22,894,566
                                                                                         ==================== =====================

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
       Revolving note payable                                                                $ 19,838,783          $ 18,612,272
       Revolving note payable - related party                                                           -               551,510
       Accounts payable                                                                           688,222               291,638
       Accrued liabilities                                                                        338,040               505,619
       Accrued liabilities - related party                                                         22,786               459,502
       Capital lease obligation - current portion                                                  53,171                49,325
                                                                                         -------------------- ---------------------

              Total current liabilities                                                        20,941,002            20,469,866

Capital lease obligation, net of current portion                                                   24,628                52,225
                                                                                         -------------------- ---------------------

              Total liabilities                                                                20,965,630            20,522,091
                                                                                         -------------------- ---------------------

Commitments and contingencies (Notes 9,10,11 and 12)

Stockholders' equity:
       Preferred stock                                                                            500,000             5,812,444
       Common stock                                                                                 5,183                 4,358
       Additional paid-in capital                                                              78,132,576            38,637,059
       Outstanding warrants                                                                     3,258,928             2,936,360
       Deferred consulting expense                                                               (266,750)                    -
       Deficit accumulated during the development stage                                       (61,748,896)          (45,017,746)
                                                                                         -------------------- ---------------------

              Total stockholders' equity                                                       19,881,041             2,372,475
                                                                                         -------------------- ---------------------

              Total liabilities and stockholders' equity                                     $ 40,846,671          $ 22,894,566
                                                                                         ==================== =====================
</TABLE> 
    See accompanying notes to condensed consolidated financial statements.

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

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

                                                                                                                     October 1,
                                                                                                                        1993
                                                     Three Months Ended                 Six Months Ended            (Inception) to
                                                        June 30,                            June 30,                   June 30,
                                          -----------------------------------------------------------------------
                                                1998               1997              1998              1997              1998
                                          ---------------     -------------     --------------     --------------    -------------  
<S>                                       <C>                 <C>               <C>                <C>               <C> 
                                          $     1,176,500     $           -     $    2,472,285     $            -    $   2,472,285
                                          ---------------     -------------     --------------     --------------    -------------  
Purchased in-process research 
  and development                                       -                 -          9,315,000                -          9,315,000
Research and development                        2,960,292         1,455,221          5,661,495          3,065,279       23,598,788
General and administrative                      2,585,398         2,457,278          4,064,261          3,750,669       26,310,931
                                          ---------------     -------------     --------------     --------------    -------------  

    Total expenses                              5,545,690         3,912,499         19,040,756          6,815,948       59,224,719
                                          ---------------     -------------     --------------     --------------    -------------  

                                               (4,369,190)       (3,912,499)       (16,568,471)        (6,815,948)     (56,752,434)
                                          ---------------     -------------     --------------     --------------    -------------  

Interest income                                   292,405           296,876            563,882            602,425        3,155,949
Interest expense                                 (282,977)       (1,240,622)          (594,901)        (1,506,185)      (4,447,444)
                                          ---------------     -------------     --------------     --------------    -------------  

    Total other income (expense), net               9,428          (943,746)           (31,019)          (903,760)      (1,291,495)
                                          ---------------     -------------     --------------     --------------    -------------  

                                               (4,359,762)       (4,856,245)       (16,599,490)        (7,719,708)     (58,043,929)


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

                                          $    (4,359,762)    $  (4,856,245)    $  (16,599,490)    $   (7,719,708)   $ (58,895,245)
                                          ===============     =============     ==============     ==============    ============= 


                                          $         (0.08)    $       (0.12)    $        (0.34)    $        (0.18)
                                          ===============     =============     ==============     ==============    ============= 
</TABLE> 

    See accompanying notes to condensed consolidated financial statements.

                                       4
<PAGE>
 
                                fonix corporation
                          [A Development Stage Company]

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                Increase (Decrease) in Cash and Cash Equivalents
<TABLE> 
<CAPTION> 
                                                                                                                     October 1,
                                                                                                                        1993
                                                                                     Six Months Ended              (Inception) to
                                                                                         June 30,                     June 30,
                                                                           -------------------------------------
                                                                                  1998               1997               1998
                                                                           ------------------- ----------------- -------------------
<S>                                                                         <C>                  <C>              <C> 
Cash flows from operating activities:
       Net loss                                                                 $ (16,599,490)     $ (7,719,708)      $ (58,895,245)
       Adjustments to reconcile net loss to net cash
         used in operating activities:
          Issuance of common stock for services                                             -           915,000           5,437,240
          Issuance of common stock for patent                                         100,807                 -             100,807
          Non-cash expense related to issuance of debentures,
            warrants, preferred and common stock                                            -           941,543           3,967,337
          Non-cash compensation expense related to issuance
            of stock options                                                          320,100                 -           2,603,000
          Non-cash portion of purchased in-process research and development         8,814,768                 -           8,814,768
          Write-off of assets received in acquisition                                       -                 -               1,281
          Depreciation and amortization                                               889,926           146,243           1,379,535
          Extraordinary loss on extinguishment of debt                                      -                 -             881,864
          Extraordinary gain on forgiveness of debt                                         -                 -             (30,548)
          Changes in assets and liabilities, net of acquisition:
              Accounts receivable                                                     (52,425)                -             (52,425)
              Interest and other receivables                                           (6,050)           71,863             (20,969)
              Prepaid financing costs                                                       -          (315,000)                  -
              Prepaid assets                                                         (412,201)         (287,142)           (444,295)
              Other assets                                                            (65,227)          (13,735)           (104,874)
              Accounts payable                                                        390,460            39,478           2,462,298
              Accrued liabilities - related party                                    (436,716)         (403,434)             22,786
              Accrued liabilities                                                    (184,152)       (1,002,540)            449,448
                                                                           ------------------- ----------------- -------------------

          Net cash used in operating activities                                    (7,240,200)       (7,627,432)        (33,427,992)
                                                                           ------------------- ----------------- -------------------

Cash flows from investing activities:
       Acquisition of AcuVoice, Inc.                                               (7,246,119)                -          (7,246,119)
       Purchase of property and equipment, net of acquisition                        (670,646)         (536,978)         (2,702,025)
       Investment in intangible assets, net of acquisition                                  -           (15,264)           (164,460)
       Issuance of notes receivable                                                  (781,140)         (883,600)         (3,264,740)
       Payments received on notes receivable                                                -           933,600           1,883,600
                                                                           ------------------- ----------------- -------------------

          Net cash used in investing activities                                    (8,697,905)         (502,242)        (11,493,744)
                                                                           ------------------- ----------------- -------------------

Cash flows from financing activities:
       Net proceeds from revolving note payable                                     1,226,511         1,592,630          19,838,783
       Net payments on revolving note payable - related party                        (551,510)                -                   -
       Proceeds from other notes payable                                                    -                 -           2,351,667
       Payments on other notes payable                                                (49,250)                -          (1,829,056)
       Principal payments on capital lease obligation                                 (23,751)                -             (67,132)
       Proceeds from issuance of convertible debentures, net                                -         3,000,000           3,185,000
       Proceeds from sale of warrants                                                 322,928                 -             922,928
       Proceeds from sale of common stock, net                                     16,635,000           425,000          37,339,545
       Proceeds from sale of Series B and C preferred stock, net                            -                 -           5,303,500
                                                                           ------------------- ----------------- -------------------

          Net cash provided by financing activities                                17,559,928         5,017,630          67,045,235
                                                                           ------------------- ----------------- -------------------

Net increase (decrease) in cash and cash equivalents                                1,621,823        (3,112,044)         22,123,499

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

Cash and cash equivalents at end of period                                       $ 22,123,499      $ 19,693,742        $ 22,123,499
                                                                           =================== ================= ===================
</TABLE> 
    See accompanying notes to condensed consolidated financial statements.

                                       5

<PAGE>
 
                                fonix corporation
                          [A Development Stage Company]

           CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
                                   (Unaudited)
<TABLE> 
<CAPTION> 

                                                                                                                     October 1,
                                                                                                                        1993
                                                                                          Six Months Ended         (Inception) to
                                                                                              June 30,                June 30,
                                                                                     ----------------------------
Supplemental disclosure of cash flow information:                                        1998           1997            1998
                                                                                     -------------- ------------- ------------------
<S>                                                                                  <C>            <C>               <C> 
         Cash paid during the period for interest                                        $ 639,472     $ 534,248        $ 2,676,491
</TABLE> 
Supplemental Schedule of Non-cash Investing and Financing Activities:

         For the Six months ended June 30, 1998:

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

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

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

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


    See accompanying notes to condensed consolidated financial statements.

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

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

These condensed 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 as of the balance sheet dates and for the periods
presented.

Operating results for the three and six months ended June 30, 1998, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998.  The Company suggests that these condensed consolidated
financial statements be read in conjunction with the consolidated financial
statements and the notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 1997.

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

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information."  SFAS No.
131 establishes new standards for public companies to report information about
their operating segments, products and services, geographic areas and major
customers.  This statement is effective for financial statements issued for
periods beginning after December 15, 1997.  SFAS No. 131 need not be applied to
interim financial statements in the initial year of its application.
Accordingly, the Company will adopt SFAS No. 131 beginning with its consolidated
financial statements for the year ended December 31, 1998.

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

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, 1998 and 1997, there were outstanding common stock equivalents to
purchase 13,966,667 and 8,667,667 shares of common stock, respectively, that
were not included in the computation of diluted net loss per common share as
their effect would have been anti-dilutive, thereby decreasing the net loss per
common share.   Net loss per common share amounts have been restated for all
periods presented to reflect basic and diluted per share presentations.

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

The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the three and six months ended June 30,
1998 and 1997:
<TABLE>
<CAPTION>
                                                           Three Months Ended June 30,
                                                --------------------------------------------------
                                                           1998                     1997
                                                ------------------------   -----------------------
                                                               Per Share                 Per Share
                                                    Loss        Amount         Loss        Amount
                                                ------------   ---------   -----------  ----------
<S>                                             <C>            <C>         <C>          <C>
Net loss                                        $ (4,359,762)              $(4,856,245)
Preferred stock dividends                                  -                         -
                                                ------------               -----------
Net loss attributable to common
 stockholders                                   $ (4,359,762)     $(0.08)  $(4,856,245)     $(0.12)
                                                ============   =========   ===========  ==========
Weighted average common shares
 outstanding                                      51,343,293                42,105,189
                                                ============               ===========
</TABLE>

<TABLE>
<CAPTION>
                                                             Six Months Ended June 30,
                                                -------------------------------------------------- 
                                                           1998                     1997
                                                -------------------------  ----------------------- 
                                                               Per Share                 Per Share
                                                    Loss         Amount        Loss        Amount
                                                ------------   ----------  -----------   --------- 
<S>                                             <C>            <C>         <C>           <C>
Net loss                                        $(16,599,490)              $(7,719,708)

Preferred stock dividends                           (131,660)                        -
                                                ------------               -----------
Net loss attributable to common
 stockholders                                   $(16,731,150)     $(0.34)  $(7,719,708)     $(0.18)
                                                ============   =========   ===========   =========
Weighted average common shares
 outstanding                                      48,557,594                41,982,952
                                                ============               ===========
</TABLE>

2.  ACQUISITION

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

                                       8
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

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

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

The following unaudited pro forma financial statement data for the three and six
months ended June 30, 1998 and 1997 present the results of operations of the
Company as if the acquisition of AcuVoice, Inc. had occurred at the beginning of
each six-month period.  The pro forma results have been prepared for comparative
purposes only and do not purport to be indicative of what would have occurred
had the acquisition been made at the beginning of the applicable period or of
future results.  A $9,315,000 expense related to the purchased in-process
research and development was recorded at the date of the acquisition and is not
presented in the following pro forma financial statement data since it is a non
recurring charge directly attributable to the acquisition.
<TABLE>
<CAPTION>
 
                                                    Three Months Ended June 30,  Six Months Ended June 30,
                                                   ----------------------------  -------------------------
                                                      1998            1997          1998           1997
                                                   ------------  ------------  -------------  ------------
<S>                                             <C>             <C>           <C>            <C>
 
Revenues                                           $ 1,176,500   $    95,900    $ 2,519,020   $   113,149
 
Loss from operations                                (4,369,190)   (4,417,096)    (7,815,183)   (7,919,000)
 
Net loss attributable to common
   stockholders                                     (4,359,762)   (5,360,840)    (7,838,436)   (8,822,702)
 
Basic and diluted net loss
   per common share                                      (0.08)        (0.12)         (0.16)        (0.20)
</TABLE>

3.  CERTIFICATE OF DEPOSIT

As of June 30, 1998, the Company had a $20,000,000 short-term certificate of
deposit at a bank which amount is included in cash and cash equivalents.  The
certificate bore interest at 5.55 percent per annum at June 30, 1998.  Interest
is payable monthly.  This certificate is pledged as collateral on a revolving
note payable (see Note 6).

4.  NOTES RECEIVABLE

As of June 30, 1998, the Company had a short-term, unsecured, demand note
receivable from an unrelated entity in the amount of $100,000 which was issued
in connection with the Company's intended acquisition of that entity.  Interest
begins to accrue at six percent per annum on the date which is 90 days after the
Company demands payment, which the Company may do in the event both parties
agree that the acquisition will not proceed.

As of June 30, 1998, the Company had a short-term, unsecured, demand note
receivable from an unrelated entity in the amount of $250,000 which was issued
in connection with the Company's intended acquisition of that entity.  Interest

                                       9
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


begins to accrue at six percent per annum on the date which is 90 days after the
Company demands payment, which the Company may do in the event both parties
agree that the acquisition will not proceed.

As of June 30, 1998, the Company had a short-term, unsecured, demand note
receivable from an unrelated entity in the amount of $481,140 which was issued
in connection with the Company's intended acquisition of that entity.  Interest
begins to accrue at six percent per annum on the date which is 90 days after the
Company demands payment, which the Company may do in the event both parties
agree that the acquisition will not proceed. Subsequent to June 30, 1998, the
Company has advanced an additional $141,000 to the same entity under similar
terms.

5.  INTANGIBLE ASSETS

Intangible assets consist of purchased core technology and goodwill in
connection with the acquisition of AcuVoice, Inc. and direct costs incurred by
the Company in applying for patents covering its technologies.  Amortization is
computed on a straight-line basis over the estimated useful life of the core
technology and goodwill of eight years, and of the patents of five years.

6.  REVOLVING NOTE PAYABLE

As of June 30, 1998, the Company had a revolving note payable to a bank in the
amount of $19,838,783.  Loaned amounts under the revolving note payable are
limited, in the aggregate at any time, to $20,000,000.  The weighted average
outstanding balance during the six months ended June 30, 1998 was $17,378,973.
This note was due August 4, 1998, bore interest at 6.55 percent per annum, and
was secured by a certificate of deposit in the amount of $20,000,000 (see Note
3).  This revolving note is renegotiated quarterly and interest is payable
monthly.  Subsequent to June 30, 1998, similar terms were negotiated to extend
the maturity date of the note to October 29, 1998.  The Company plans to
continue renewing the note indefinitely.

7.  STOCKHOLDERS' EQUITY

Common Stock - During the six months ended June 30, 1998, the Company issued
8,249,309 shares of common stock. Of such shares, 3,777,778 shares were issued
in connection with a private placement (see below), 2,692,216  shares were
issued in connection with the acquisition of AcuVoice, Inc. (see Note 2),
1,489,501 shares were issued upon the conversion of convertible preferred stock
and related dividends, 265,000 shares were issued upon the exercise of
previously granted warrants and options and 24,814 shares were issued for the
purchase of a patent.

Private Placement - On March 12, 1998, the Company completed a private placement
(the "Offering") of up to 6,666,666 shares of its restricted common stock to
seven accredited investors.  The total purchase price to be paid by the
investors pursuant to the Offering is $30,000,000.  Of that amount, $15,000,000
was received by the Company on March 12, 1998, in return for which the Company
issued a total of 3,333,333 shares of restricted common stock. Finders' fees of
$870,000 were paid in connection with the $15,000,000 received.  The remainder
of the purchase price was to be paid by the investors on July 27, 1998 (60 days
after the effectiveness of a registration statement that the Company filed with
the Securities and Exchange Commission covering the common stock issued and
issuable to the investors) (the "Second Funding Date"), provided that, as of
such date, certain conditions were satisfied.  Certain conditions precedent to
receiving the additional funding were not met as of July 27, 1998 (see Note 12).
On June 29, 

                                       10
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


1998, some of the investors paid to the Company $2,000,000. In return for that
payment, the Company issued 444,445 additional shares under the terms and
conditions set forth in the Offering documents.

Additionally, the investors in the Offering had certain "reset" rights pursuant
to which the investors would receive additional shares of restricted common
stock ("Reset Shares") if the average market price of the Company's common stock
for the 60-day periods following the initial closing date and the Second Funding
Date did not equal or exceed $5.40 per share (see Note 12).

Series B Preferred Stock - In January 1998, 27,500 shares of Series B
Convertible Preferred Stock and related dividends were converted into 193,582
shares of common stock.  At June 30, 1998, no shares of  Series B Convertible
Preferred Stock were outstanding.

Series C Preferred Stock - During the three months ended March 31, 1998, 185,000
shares of Series C Convertible Preferred Stock and related dividends were
converted into 1,295,919 shares of the Company's common stock.  At June 30,
1998, no shares of  Series C Convertible Preferred Stock were outstanding.

Common Stock Options - During the six months ended June 30, 1998, the Company
granted 1,325,000 stock options. 450,000 of such options having an exercise
price of $5.16 per share were granted to three individuals who are executive
officers and directors of the Company and who each beneficially own more than
ten percent of the Company's common stock. 355,000 and 420,000 of such options
were granted to various employees at exercise prices of $3.34 and $6.50 per
share, respectively, and 100,000 options were granted to an unrelated party for
services at $3.75 per share. The term of all options granted during such six
month period is ten years from the date of grant. As of June 30, 1998, the
Company had a total of 11,855,000 options outstanding.

On June 1, 1998, the Company's board of directors approved the 1998 Stock Option
and Incentive Plan (the "Plan") for directors, employees and other persons
acting on behalf of the Company, under which the aggregate number of shares
authorized for issuance is 10,000,000.  On July 14, 1998, the Company's
shareholders approved the Plan.  The Plan is administered by a committee
consisting of two or more directors of the Company.  The exercise price of such
options is the closing market price of the stock on the date the options are
granted.  The option term is ten years from the date of grant.  As of June 30,
1998, no options had been granted under the Plan.

8.  RELATED-PARTY TRANSACTIONS

Related-party transactions with entities owned by three individuals who are
directors and executive officers of the Company and each of whom beneficially
own more than ten percent of the Company's issued and outstanding common stock
not otherwise disclosed herein for the six months ended June 30, 1998 and 1997
were as follows:

                                       11
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)
<TABLE>
<CAPTION>
                            Six Months Ended June 30,
                            -------------------------
                                1998         1997
                            ------------  -----------
<S>                         <C>           <C>
Expenses:
     Base rent                   $54,235      $38,600

Liabilities:
     Accrued liabilities          22,786        8,309
</TABLE>

During 1996, disinterested members of the Company's Board of Directors
authorized the Company to reimburse three executive officers for all taxes
payable by them in conjunction with the 1995 exercise of 3,700,000 warrants by a
company owned by them.  The total authorized reimbursement was $1,150,000 in
1997 and $1,350,000 in 1996.  As of June 30, 1998, the Company had paid
$2,477,214 of the authorized reimbursement, $317,730 of which was paid during
the six months ended June 30, 1998.  The unpaid balance of the authorized
reimbursement is included in accrued liabilities-related party in the
accompanying condensed consolidated balance sheet as of June 30, 1998.

9.  STATEMENTS 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").  The Company and Siemens are jointly pursuing the development of
Siemens' integrated circuits incorporating the Company's technologies for use in
certain telecommunications applications.  On February 20, 1998, the Company
received $2,691,066 in cash from Siemens.  Of that amount: (1) $1,291,712 was
paid to the Company as a non-refundable payment to license certain automated
speech recognition technologies for which the Company has no further obligation;
(2) $322,928 was paid to purchase warrants to acquire 1,000,000 shares of fonix
restricted common stock at an average exercise price of $20 per share with
expiration dates ranging from December 31, 1998 to December 31, 1999; and (3)
$1,076,426 was paid to the Company to acquire, if Siemens so elected, shares of
the Company's restricted common stock or to become a non-refundable license
payment.  In June 1998, Siemens elected to apply the $1,076,426 portion as a
non-refundable payment to license certain automated speech recognition
technologies for which the Company has no further obligation.  The Company
recorded the $1,291,712 license payment as revenue during the three months ended
March 31, 1998 and the $1,076,426 license payment as revenue during the three
months ended June 30, 1998.

10.  RESEARCH AND DEVELOPMENT

In October 1993, the Company entered into an agreement with Synergetics, Inc.
(the "Synergetics Agreement"), a research and development entity, whereby
Synergetics was to develop certain technologies related to the Company's
automated speech recognition ("ASR") technologies.  The president of the Company
is one of seven members of the board of directors of Synergetics, and three
executive officers, directors and ten percent beneficial owners of the Company
own less than five percent of the common stock of Synergetics.  Under the terms
of the Synergetics Agreement, as subsequently modified, the Company acquired
intellectual property rights, technologies and technology rights that were
developed by Synergetics and that pertained to the ASR  technologies.  The
Company agreed to provide all funding necessary for Synergetics to develop
commercially viable technologies.  There was no minimum requirement or maximum
limit with respect to the amount of the funding to be provided by the Company.
However, under the terms 

                                       12
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

of the Synergetics Agreement, the Company was obligated to use its best efforts
in raising the necessary funding for the engineering, development and marketing
of the ASR technologies. As part of the Synergetics Agreement, the Company
agreed to pay Synergetics a royalty of ten percent of gross revenues from sales
of its ASR technologies (the "Royalty"). Under the terms of the Synergetics
Agreement, the Company paid to Synergetics $935,957 and $1,502,438 for the three
and six months ended June 30, 1998, respectively, for research and development
efforts.

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

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

warrants has been declared effective by the Securities and Exchange Commission.
Upon the tender to the Company of any Project Shares a corresponding percentage
of the Royalty will be canceled.

11.  COMMITMENTS AND CONTINGENCIES

Operating Lease Agreement - In June 1998, the Company entered into a long-term
noncancelable operating lease agreement for a facility in Cupertino, California,
which houses its fonix/AcuVoice subsidiary.  Future aggregate minimum
obligations under this operating lease are as follows:

 
   Years ending December 31,
 
          1998                         $  163,883
          1999                            292,899
          2000                            308,474
          2001                            320,531
          2002                            332,589
          Thereafter                      140,672
                                       ----------
 
            Total                      $1,559,048
                                       ==========

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 is $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. The options have a ten-year term and
are fully vested.  In connection with this transaction, the Company recorded

                                       13
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

$320,100 of consulting expense, $266,750 of which has been deferred and will be
recognized ratably over the life of the agreement.

Litigation - On March 11, 1998, an action (the "J&L Action") was filed against
the Company in the Supreme Court of the State of New York for the County of New
York by Jesup & Lamont Securities Corporation.  The J&L Action alleges that the
Company must pay a fee in excess of $1,200,000 plus 30,000 shares of the
Company's restricted common stock in connection with the Offering (see Note 7).
The Company has filed an answer and limited discovery has taken place. The
Company's Board of Directors and its management believe that the J&L Action is
without merit, and the Company intends to vigorously defend the action.  There
can be no assurance that the Company will prevail in the J&L Action, or that the
pendency of the lawsuit will not adversely affect the Company's operations. As
the outcome of this matter cannot be reasonably determined, the Company has not
accrued for any potential losses.

The Polomba Action - On July 9, 1998, the Company settled a case brought by a
shareholder of the Company against certain directors of the Company and K.L.S.
Enviro Resources, Inc. ("KLSE"), a third party affiliated with certain of the
director-defendants.  Pursuant to the settlement, the Company is to receive
warrants to purchase 583,000 shares of KLSE common stock at a purchase price of
$0.40 per share.

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

12.  SUBSEQUENT EVENTS

On July 2, 1998 and August 4, 1998, the Company advanced $50,000 and $50,000,
respectively to an unrelated entity in connection with the Company's intended
acquisition of that entity.  This  unsecured, demand note receivable begins to
accrue interest at six percent per annum on the date which is 90 days after the
Company demands payment, which the Company may do in the event both parties
agree that the acquisition will not proceed.

On July 10, 1998, the Company advanced $50,000 to an unrelated entity in
connection with the Company's intended acquisition of that entity.  This
unsecured, demand note receivable begins to accrue interest at six percent per
annum on the date which is 90 days after the Company demands payment, which the
Company may do in the event both parties agree that the acquisition will not
proceed.

In connection with the Offering discussed in Note 7, July 27, 1998 was the
Second Funding Date.  As of that date, the conditions precedent to the
investors' obligations to provide the additional $13,000,000 of funding were not
satisfied. Nevertheless, some of the investors provided $3,000,000 in additional
funding in exchange for which the Company issued a total of 666,666 shares of
common stock subject to the terms and conditions of the Offering documents.  As
of August 19, 1998, the Company had not issued any Reset Shares pursuant to the
Offering documents.  The investors in the Offering and the Company have agreed
in principle to restructure the reset provisions of the Offering documents,
although there can be no assurance that any such restructuring agreement will be
consummated.

                                       14
<PAGE>
 
                               fonix corporation
                         [A Development Stage Company]
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

On July 31, 1998, the Company signed a definitive Agreement and Plan of Merger
pursuant to which Articulate Systems, Inc., a Delaware corporation with its
principal place of business is Boston, Massachusetts ("Articulate") will be
merged into a wholly owned subsidiary of the Company.  Articulate is a provider
of sophisticated voice recognition products to specialized segments of the
health care industry.  The Company anticipates that the Articulate merger will
close during the third quarter of 1998, although there can be no assurance that
the merger will close or that it will be successful.

                                       15
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

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

Overview
--------

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

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

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

Other than the arrangements with Siemens and OGI, the Company has no licensing
or co-development agreements with respect to the Core Technologies with any
third party.  The Company is presently engaged in discussions with potential
licensees and co-developers.  There can be no assurance, however, that the
Company will be able to license its Core Technologies to third parties other
than Siemens or enter into additional co-development or strategic alliance
agreements.

The Company's primary development objective is to further develop, refine and
enhance the main components of its Core Technologies.  The Company's initial
marketing direction is to focus on licensing its Core Technologies to third
parties and co-developers.  These licenses will be made broadly available to
many segments of the computer industry, 

                                       16
<PAGE>
 
including application software, operating systems, computers and microprocessor
chips, and research and development entities worldwide, including academia,
government, industry and commercial speech product developers who may want to
take advantage of the Company's Core Technologies in their existing products.
The Company anticipates that it will sell or license its Core Technologies on
terms advantageous to the Company, and that run-time product license royalty
rates will vary according to applications, sales volumes, and end-user pricing
of products using the Core Technologies. The Company may reserve exclusive
rights in some fields of use for the internal development of high value end-user
products and applications.

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

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

In addition to fonix/AcuVoice, the Company presently is considering other
mergers and acquisitions involving additional complementary technologies (see
Note 12 to the condensed consolidated financial statements).  There can be no
assurance that any other acquisitions will be consummated, or that the AcuVoice,
Inc. or Articulate mergers, or any other acquisition or merger already
consummated or to be consummated in the future, will result in increased
opportunities for the Company to enter into profitable licensing arrangements or
that such additional technologies can be successfully integrated with the Core
Technologies.  To the extent the Company finances such acquisitions by issuances
of its capital stock, additional, and possibly substantial, dilution will result
to existing shareholders.

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

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

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

                                       17
<PAGE>
 
At the date of acquisition, AcuVoice IPR&D efforts were focused on the continued
development and evolution of the next generation of these products.
Specifically, the Company is working to expand voice capacity to include both a
male and female voice, and to expand language capacity to include Japanese,
Mandarin Chinese, French, German, and Spanish. In addition to the technological
issues resulting from these efforts, the Company also intends to enhance the
next generation applications with a stronger Text-to-Speech engine, sound bank,
SAPI 4.0, SDK, and user dictionary; and increased VOX file output,
documentation, C++ API and JSAPI.  AcuVoice is also developing an ESL product
for the Windows 95/Windows NT environments that would have a customized
dictionary and sample English sentences, and a highly scalable multi-channel
version for applications that would operate in Windows NT/Solaris environments.

The developmental projects at the time of the acquisition were not
technologically feasible and had no alternative future use. This conclusion was
attributable to the fact that AcuVoice had not completed a working model that
had been tested and proven to work at performance levels which were expected to
be commercially viable, and that the technologies constituting the projects had
no alternative use other than their intended use. The value is attributable
solely to the development efforts completed as of the acquisition date. The
acquired IPR&D was valued at approximately $9.3 million based on an analysis of
forecasted income.

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

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

Valuation Methodology

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

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

                                       18
<PAGE>
 
Because the Company does not account for expenses by product, it is not possible
to determine the actual expenses associated with the technology acquired from
AcuVoice.  The Company currently believes that expenses associated with
completing the purchased IPR&D and integrating the technology with the Company's
existing products are approximately consistent with the Company's estimates used
in the analysis and that completion dates for the development projects discussed
above concur with projections used at the time of the acquisition. Research and
development spending with respect to these offerings is expected to continue at
a rate that is consistent with the Company's overall research and development
spending. The Company does not believe that the acquisition resulted in any
material changes in its profit margins or in selling, general and administrative
expenses. The Company does not believe that it achieved any material expense
reductions or synergies as a result of the acquisition.

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

The forecasts used in valuing the IPR&D were based upon assumptions the Company
believed to be reasonable but which were inherently uncertain and unpredictable.
For these reasons, actual results may vary from projected results. The Company
currently markets the AcuVoice acquired and subsequently-developed products.
Management intends to continue AcuVoice's development program until the Company
is able to successfully introduce the new suite of products.

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

Three months ended June 30, 1998 compared with three months ended June 30, 1997

During the three months ended June 30, 1998, the Company recorded revenues of
$1,176,500, of which $100,074 is from the operations of fonix/AcuVoice and
$1,076,426 is from Siemens as a non-refundable license fee, for which the
Company has no further obligation.

Prior to March 1997, the Company conducted its scientific research and
development activities through Synergetics, Inc., a research and development
entity ("Synergetics"), pursuant to product development and assignment contracts
between the Company and Synergetics (collectively, the "Synergetics Agreement").
Under that arrangement, Synergetics provided personnel and facilities and the
Company financed scientific research and development of the ASR technologies on
an as-required basis.  There was no minimum requirement or maximum limit with
respect to the amount of funding the Company was obligated to provide to
Synergetics under the Synergetics Agreement, and the Company was obligated to
use its best efforts in raising all of the necessary funding for the development
of the ASR technologies. Synergetics submitted pre-authorized work orders and
budgets, which were then reviewed and approved by the Company.  All funds paid
to Synergetics have been accounted for by the Company as research and
development expense.  Under the Synergetics Agreement, the Company had also
agreed to pay a royalty to Synergetics equal to ten percent of revenues from
sales of the ASR technologies or products incorporating the ASR technologies
(the "Royalty"). On March 13, 1997, the Company and Synergetics reached an
agreement in principle to modify the Synergetics Agreement with regard to the
development and assignment of the Company's ASR technologies.  Most research and
development activities previously conducted by Synergetics were moved in-house
to the Company in or about March 1997.  On April 6, 1998, the Company and
Synergetics entered into a Royalty Modification Agreement, under which the
Company agreed, subject to its compliance with applicable securities laws, to
make an offer to exchange common 

                                       19
<PAGE>
 
stock purchase warrants having an exercise price of $10 per share for the
Project Shares at the rate of one warrant to purchase 800 fonix common shares
for each Project Share. The warrants, if and when issued, will not be
exercisable until the earlier of (1) the date the Company's common stock has
traded for a period of 15 consecutive trading days at a minimum of $37.50 per
share or (2) September 30, 2000. The offer of warrants to holders of Project
Shares cannot be made by the Company until a registration statement covering the
total number of warrants issuable upon the exercise of the warrants has been
declared effective by the Securities and Exchange Commission. Upon the tender to
the Company of any Project Shares a corresponding percentage of the Royalty will
be canceled. Assignment to the Company of all technology relating to the ASR
technologies is confirmed by the Modification Agreement.

From inception on October 1, 1993 through June 30, 1998, the Company has
invested $23,598,788 in research and development relating to its Core
Technologies.  During the three months ended June 30, 1998, the Company incurred
research and development expenses of $2,960,292, an increase of $1,505,071 over
the same period in the previous year. This increase is due primarily to the
addition of research and development personnel, equipment and facilities.
Approximately $201,000 of such increase is for development costs associated with
AcuVoice.  The Company anticipates similar or increased research and development
costs as it continues to expand, develop and market its Core Technologies.

General and administrative expenses were $2,585,398 and $2,457,278,
respectively, for the three months ended June 30, 1998 and 1997.  Consulting and
outside services were $97,346 and $1,209,693 for the three months ended June 30,
1998 and 1997, respectively, a decrease of $1,112,347 over the three months
ended June 30, 1997.  Additionally, the Company incurred increased expenses in
salaries, legal and accounting, travel and depreciation and amortization of
$196,365, $211,719, $177,451 and $567,668, respectively.  The $567,668 increase
in depreciation and amortization is primarily attributable to the amortization
of intangible assets acquired in connection with the acquisition of AcuVoice.

Due to minimal revenues and significant research and development and general and
administrative expenses, the Company has incurred losses from operations since
inception totaling $56,752,434, of which $4,369,190 and $3,912,499 were incurred
during the three months ended June 30, 1998 and 1997, respectively.   At June
30, 1998, the Company had an accumulated deficit of $61,748,896 and
stockholders' equity of $19,881,041.  The Company anticipates that its
investment in ongoing scientific research and development of the Core
Technologies will continue at present or increased levels for at least the
remainder of fiscal 1998.

Net other income was $9,428 for the three months ended June 30, 1998, an
increase in net other income of $953,174 over the three months ended June 30,
1997.  This increase was due to decreased interest expense of $957,645 from the
comparable period in 1997 for debt financing for the Company.

Six months ended June 30, 1998 compared with six months ended June 30, 1997

During the six months ended June 30, 1998, the Company recorded revenues of
$2,472,285, of which $2,368,138 was a non-refundable license fee from Siemens,
for which the Company has no further obligation.

During the six months ended June 30, 1998, the Company incurred research and
development expenses of $5,661,495, an increase of $2,596,216 over the same
period in the previous year.  This increase is due primarily to the addition of
research and development personnel, equipment and facilities.  Approximately
$220,000 of such increase is for development costs associated with AcuVoice,
Inc.  The Company anticipates similar or increased research and development
costs as it expands and continues to develop and market its Core Technologies.
Additionally, the Company purchased in-process research and development totaling
$9,315,000 during the six months ended June 30, 1998, in connection with the
acquisition of AcuVoice, Inc.

                                       20
<PAGE>
 
General and administrative expenses were $4,064,261 and $3,750,669,
respectively, for the six months ended June 30, 1998 and 1997.   Consulting and
outside services were $108,391 and $1,698,651 for the six months ended June 30,
1998 and 1997, respectively, a decrease of $1,590,260 over the six months ended
June 30, 1997.  Additionally, the Company incurred increased expenses in
salaries, legal and accounting, travel and depreciation and amortization of
$511,407, $388,148, $239,157 and $642,086, respectively.  The $642,086 increase
in depreciation and amortization is primarily attributable to the amortization
of intangible assets in connection with the acquisition of AcuVoice, Inc.

The Company incurred losses from operations of $16,568,471 and $6,815,948 during
the six months ended June 30, 1998 and 1997, respectively.  The significant
increase in losses from operations is primarily due to purchased in-process
research and development charges of $9,315,000 associated with the acquisition
of AcuVoice, Inc.  The Company anticipates that its investment in ongoing
scientific research and development of the Core Technologies will continue at
present or increased levels for at least the remainder of fiscal 1998.

Net other expense was $31,019 for the six months ended June 30, 1998, a decrease
in net other expense of $872,741 over the six months ended June 30, 1997.  This
decrease was primarily due to decreased interest expense of $911,284 from the
comparable period in 1997 for debt financing for the Company.

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

The Company's current assets exceeded its current liabilities by $2,279,103 at
June 30, 1998 compared to $678,823 at December 31, 1997.  The current ratio was
1.11 at June 30, 1998, compared to 1.03 at December 31, 1997.  Current assets
increased by $2,071,416 to $23,220,105 from December 31, 1997 to June 30, 1998.
Current liabilities increased by $471,136 to $20,941,002 during the same period.
The increase in working capital from December 31, 1997 to June 30, 1998 was
primarily attributable to an increase in cash due to  the sale of common stock.
Total assets were $40,846,671 at June 30,1998 compared to $22,894,566 at
December 31, 1997.

From its inception, the Company's principal source of capital has been private
and other exempt sales of the Company's debt and equity securities.  During the
six months ended June 30, 1998, the Company issued 8,249,309 shares of common
stock.  Of such shares, 3,777,778 shares were issued in connection with a
private placement (see below), 2,692,216  shares were issued in connection with
the acquisition of AcuVoice, Inc., 1,489,501 shares were issued upon the
conversion of convertible preferred stock and related dividends, 265,000 shares
were issued upon the exercise of previously granted warrants and options and
24,814 shares were issued for the purchase of a patent.

On March 12, 1998, the Company completed a private placement (the "Offering") of
up to 6,666,666 shares of its restricted common stock to seven accredited
investors.  The total purchase price to be paid by the investors pursuant to the
Offering is $30,000,000.  Of that amount, $15,000,000 was received by the
Company on March 12, 1998, in return for which the Company issued a total of
3,333,333 shares of restricted common stock.  Finders' fees of $870,000 were
paid in connection with the $15,000,000 received.  The remainder of the purchase
price was to be paid by the investors on July 27, 1998 (60 days after the
effectiveness of a registration statement that the Company filed with the
Securities and Exchange Commission covering the common stock issued and issuable
to the investors) (the "Second Funding Date"), provided that, as of such date,
certain conditions were satisfied.  Certain conditions precedent to receiving
the additional funding were not met as of July 27, 1998.  On June 29, 1998, some
of the investors paid the Company $2,000,000.  In return for that payment, the
Company issued 444,445 additional shares under the terms and conditions set
forth in the Offering documents.

Additionally, the investors in the Offering had certain "reset" rights pursuant
to which the investors would receive additional shares of restricted common
stock if the average market price of the Company's common stock for the 60-day

                                       21
<PAGE>
 
periods following the initial closing date and the Second Funding Date did not
equal or exceed $5.40 per share (see Note 12 to the condensed consolidated
financial statements).

In connection with the Offering, July 27, 1998 was the Second Funding Date.  As
of that date, the conditions precedent to the investors' obligations to provide
an additional $13,000,000 of funding were not satisfied.  Nevertheless, some of
the investors provided $3,000,000 in additional funding in exchange for which
the Company issued 666,666 shares of common stock subject to the terms and
conditions of the Offering documents.  As of August 19, 1998, the Company had
not issued any Reset Shares pursuant to the Offering documents.  The investors
in the Offering and the Company have agreed in principle to restructure the
reset provisions of the Offering documents, although there can be no assurance
that any such restructuring agreement will be consummated.

In January 1998, 27,500 shares of Series B Convertible Preferred Stock and
related dividends were converted into 193,582 shares of common stock.  At June
30, 1998, no shares of  Series B Convertible Preferred Stock were outstanding.

During the three months ended March 31, 1998, 185,000 shares of Series C
Convertible Preferred Stock and related dividends were converted into 1,295,919
shares of the Company's common stock.  At June 30, 1998, no shares of Series C
Convertible Preferred Stock were outstanding.

During the six months ended June 30, 1998, the Company granted 1,325,000 stock
options.  450,000 of such options having an exercise price of $5.16 per share
were granted to three individuals who are executive officers and directors of
the Company and who each beneficially own more than ten percent of the Company's
common stock.  355,000 and 420,000 of such options were granted to various
employees at exercise prices of $3.34 and $6.50 per share, respectively, and
100,000 options were granted to an unrelated party for services at $3.75 per
share.  The term of all options granted during such six month period is ten
years from the date of grant.  As of June 30, 1998, the Company had a total of
11,855,000 options outstanding.

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

The Company has established a relationship with a major regional federally
insured financial institution pursuant to which the Company is permitted to
borrow against its own funds on deposit with the institution.  As of June 30,
1998, the Company had funds on deposit of $20,000,000.  As of June 30, 1998, the
Company owed $19,838,783 to the institution, compared with $18,612,272 as of
December 31, 1997.  The weighted average outstanding balance during the six
months ended June 30, 1998 was $17,378,973.  This note was due August 4, 1998
and bore interest at 6.55 percent per annum.  Subsequent to June 30, 1998,
similar terms were negotiated to extend the maturity date of the note to October
29, 1998.  This revolving note is renegotiated quarterly and the Company plans
to continue renewing the note indefinitely.  The net difference between the rate
of interest paid by the institution for the Company's funds on deposit at the
institution and the interest rate paid to the Company by the institution is
approximately one percent.  Interest income and expense is payable monthly and
the principal amount is payable in full at maturity.

                                       22
<PAGE>
 
The Company will need to raise additional funds to satisfy its cash requirements
during the next twelve months. Scientific research and development, corporate
operations and marketing expenses will continue to require substantial
additional capital.  In addition, the Company recently has acquired AcuVoice,
Inc. and is actively seeking additional complementary acquisition opportunities.
On July 31, 1998, the Company signed a definitive agreement pursuant to which
Articulate Systems, Inc. will be merged into a wholly owned subsidiary of the
Company, which acquisition will require approximately $13,200,000 in cash at the
anticipated closing in the third quarter of 1998, although there can be no
assurance that the merger will close.  These and other acquisition transactions
will require substantial additional capital resources, even if the Company uses
its securities in payment of all or part of the purchase price of such
acquisitions.  Because the Company presently has only limited revenue from
operations, the Company intends to continue to rely primarily on financing
through sales of its equity and debt securities to satisfy future capital
requirements until such time as the Company is able to enter into additional
acceptable third-party licensing or co-development arrangements such that it
will be able to finance ongoing operations out of license, royalty and sales
revenues.  There can be no assurance that the Company will be able to sell its
equity and debt securities or enter into such arrangements, such that sufficient
operating capital will be available when and in the amounts needed. Furthermore,
the issuance of equity securities or other securities which are or may become
convertible to the equity securities of the Company in connection with such
financing (or in connection with acquisitions) will result in dilution to the
stockholders of the Company which could be substantial.

The Company presently has no plans to purchase any new plants or office
facilities.  The Company presently anticipates that it will incur approximately
$950,000 in capital expenditures for equipment Company-wide over the next twelve
months.

Year 2000

The Year 2000 issue affects virtually all companies and organizations, including
the Company.  If a company does not successfully address its Year 2000 issues,
it may face material adverse consequences.  The Company has formed a committee
to address the Year 2000 issue and is in the process of insuring that its
internal computer systems and computer interface technology being developed by
the Company are Year 2000 compliant.  With respect to third-party providers
whose services are critical to the Company, the Company intends to monitor the
efforts of such providers as they become Year 2000 compliant.  Management is
presently not aware of any Year 2000 issues that have been encountered by any
such third-party which could materially affect the Company's operations.
Notwithstanding the foregoing, there can be no assurance that the Company will
not experience operational difficulties as a result of Year 2000 issues, either
arising out of internal operations, or caused by third-party service providers,
which individually or collectively could have an adverse impact on business
operations or require the Company to incur unanticipated expenses to remedy any
problems.

Outlook

Corporate Objectives, Technology Vision and Acquisition Strategy

The Company has positioned itself as a developer of "next generation" speech and
human-computer interface technologies that will provide multiple product
solutions for business, consumer and service applications. The fonix management
team has assembled leading talents in the speech recognition, speech synthesis
and other arenas related to its Core Technologies.  The Board of Directors and
management have developed a business strategy that identifies the Company's
strengths and objectives, outlines a vision of the next major market
opportunities in the computer, telephony and electronics industries and
articulates a corporate and technology strategy that includes strategic
alliances, collaborative development agreements, strategic acquisitions and,
ultimately, marketing a suite of fonix-branded products.

                                       23
<PAGE>
 
Management believes the primary strengths of fonix include:

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

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

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

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

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

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

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

                                       24
<PAGE>
 
This next generation technology presents important product and service
opportunities for fonix in a variety of industry segments, including:

     .    semiconductors
     .    telecommunications
     .    computers
     .    software
     .    consumer electronics
     .    entertainment

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

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

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

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

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

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

               Special Note Regarding Forward-Looking Statements

Certain statements contained herein under,  "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Outlook,"
including statements concerning (i) the Company's strategy, (ii) the Company's
expansion plans, (iii) the market for and potential applications of the
Company's technologies, (iv) the results of research and development efforts,
and (v) the growth of the Company's business contain certain forward-looking
statements concerning the Company's operations, economic performance and
financial condition.  Because such 

                                       25
<PAGE>
 
statements involve risks and uncertainties, actual results may differ materially
from those expressed or implied by such forward-looking statements. Factors that
could cause such differences include, but are not necessarily limited to, those
discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.

                                       26
<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:          March 12, 1999                           /s/ Douglas L. Rex
     -----------------------------------------          -----------------------
                                                        Douglas L. Rex,
                                                        Chief Financial Officer

                                       27