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

                                   FORM 10-Q/A


[X]      Quarterly  report  pursuant to Section 13 or 15(d) of the  Securities
         Exchange  Act of 1934 for the  quarterly  period  ended
         September 30, 1999

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

                         Commission file number 0-23862

                                Fonix Corporation
             (Exact name of registrant as specified in its charter)

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

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

                                (801) 328-0161
              (Registrant's telephone number, including area code)

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

As of December 29, 1999, 124,337,123 shares of the issuer's Class A Common Stock
and 1,985,000  shares of Class B Non-Voting  Common Stock,  par value $.0001 per
share, were issued and outstanding.





<PAGE>


         This  Amendment  No. 1 to the  Quarterly  Report  on Form 10-Q of Fonix
Corporation is submitted to amend the following  Items,  which  originally  were
submitted as part of the Quarterly Report filed with the Securities and Exchange
Commission as of November 22, 1999:

Part I
         Item 1.  Financial Statements                                         3

         Item 2.  Management's Discussion and Analysis of Financial
                  Condition and Results of Operations                         20

Part II

         Item 1.  Legal Proceedings                                           33

Pursuant to SEC Rule 12b-15,  the foregoing  Items, as amended  hereby,  are set
forth below in their entirety.

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.

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


                                Table of Contents


Interim unaudited condensed consolidated financial statements for the period
ended September 30, 1999

Condensed Consolidated Balance Sheets (Unaudited)                              3

Condensed Consolidated Statements of Operations (Unaudited)                    4

Condensed Consolidated Statements of Cash Flows (Unaudited) -
     Increase (Decrease) in Cash and Cash Equivalents                          5

Condensed Consolidated Statements of Cash Flows (Unaudited) (Continued)        6

Notes to Condensed Consolidated Financial Statements (Unaudited)               7







                                       2

<PAGE>
                       Fonix Corporation and Subsidiaries
                          [A Development Stage Company]

                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)

<TABLE>
<CAPTION>
ASSETS
                                                                                             September 30,     December 31,
                                                                                               1999              1998
                                                                                          ---------------     ------------
<S>                                                                                       <C>                 <C>
Current assets:
     Cash and cash equivalents                                                            $    2,048,257      $ 20,045,539
     Notes receivable                                                                                  -          245,000
     Accounts receivable, net of allowance for doubtful accounts of
          $74,000 and $8,000, respectively                                                       331,451          219,908
     Prepaid expenses                                                                              7,901           51,866
     Inventory                                                                                     1,894            4,804
     Interest and other receivables                                                               20,712            3,722
     Employee advances                                                                                 -           67,231
                                                                                          ---------------     ------------

         Total current assets                                                                  2,410,215       20,638,070

Cash held in escrow                                                                            2,500,000                -

Property and equipment, net of accumulated depreciation of $1,740,234
     and $1,168,023, respectively                                                              1,347,061        2,145,031

Intangible assets, net of accumulated amortization of $3,757,780 and
     $1,770,668, respectively                                                                 16,034,270       19,437,290

Other assets                                                                                     106,536          107,945

Net long term assets of discontinued operations                                                        -       19,584,455
                                                                                          ---------------     ------------

         Total assets                                                                     $   22,398,082      $ 61,912,791
                                                                                          ===============     ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Bank overdraft                                                                       $            -      $   138,034
     Revolving notes payable                                                                           -       20,038,193
     Notes payable - related parties                                                              77,625        8,491,880
     Notes payable - other                                                                             -          560,000
     Capital lease obligation                                                                      5,180           52,225
     Accounts payable                                                                          1,756,032        3,536,074
     Accrued liabilities                                                                       2,659,267          981,774
     Accrued liabilities - related parties                                                     1,998,590          900,004
     Income taxes payable                                                                        250,000                -
     Deferred revenues                                                                            63,722           20,000
     Net current liabilities of discontinued operations                                                -          598,861
                                                                                          ---------------     ------------

         Total current liabilities                                                             6,810,416       35,317,045

Series C 5% convertible debentures                                                             3,971,107                -
                                                                                          ---------------     ------------

         Total liabilities                                                                    10,781,523       35,317,045
                                                                                          ---------------     ------------

Common stock and related repricing rights subject to redemption; 1,801,802 shares and
     repricing rights outstanding (aggregate redemption value of $2,500,000)                   1,830,000        1,830,000
                                                                                          ---------------     ------------

Commitments and contingencies (Notes 8, 9, and 15)

Stockholders' equity:
     Preferred stock, $.0001 par value; 20,000,000 shares authorized;  Series A,
         convertible; 166,667 shares outstanding
            (aggregate liquidation preference of $6,055,012)                                     500,000          500,000
         Series D, 4% cumulative convertible; 876,667 and 958,334 shares
             outstanding, respectively
            (aggregate liquidation preference of $18,299,103)                                 20,705,530       22,200,936
         Series E, 4% cumulative convertible; 250,000 shares outstanding in 1998                       -        3,257,886
     Common stock, $.0001 par value; 100,000,000 shares authorized;
         83,750,179 and 64,324,480 shares outstanding, respectively                                8,375            6,432
     Additional paid-in capital                                                               99,217,980       88,517,711
     Outstanding warrants                                                                      3,585,399        3,323,258
     Deferred consulting expense                                                                       -         (106,700)
     Deficit accumulated during the development stage                                       (114,230,725)     (92,933,777)
                                                                                          ---------------     ------------

         Total stockholders' equity                                                            9,786,559       24,765,746
                                                                                          ---------------     ------------

         Total liabilities and stockholders' equity                                       $   22,398,082      $61,912,791
                                                                                          ===============     ============
</TABLE>

         See accompanying notes to condensed consolidated financial statements.

                                        3



<PAGE>
                       Fonix Corporation and Subsidiaries
                          [A Development Stage Company]

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                                                  October 1,
                                                                                                                     1993
                                                         Three Months Ended            Nine Months Ended          (Inception) to
                                                            September 30,                September 30,            September 30,
                                                      --------------------------   --------------------------
                                                         1999           1998           1999           1998           1999
                                                      ------------  -------------  -------------   ------------  -------------

<S>                                                   <C>           <C>            <C>            <C>            <C>
Revenues                                              $    65,707   $     95,500   $    351,083   $   2,567,785  $   2,955,807
Cost of revenues                                            7,919          7,372         21,159          31,561         56,599
                                                      ------------  -------------  -------------  -------------  -------------

    Gross margin                                           57,788         88,128        329,924       2,536,224      2,899,208
                                                      ------------  -------------  -------------  -------------  -------------

Expenses:
    Selling, general and administrative                 2,864,400      2,672,252      7,537,577       6,112,765     38,601,890
    Product development and research                    1,906,968      4,296,938      6,278,318       9,958,433     37,276,215
    Amortization of goodwill and purchased core
          technology                                      630,609        500,776      1,962,443       1,100,336      3,674,710
    Purchased in-process research and development               -              -              -       9,315,000      9,315,000
                                                      ------------  -------------  -------------  -------------  -------------

        Total expenses                                  5,401,977      7,469,966     15,778,338      26,486,534     88,867,815
                                                      ------------  -------------  -------------  -------------  -------------

Loss from operations                                   (5,344,189)    (7,381,838)   (15,448,414)    (23,950,310)   (85,968,607)
                                                      ------------  -------------  -------------  ------------   -------------

Other income (expense):
    Interest income                                        26,198        292,241         46,752         856,123      3,713,840
    Interest expense                                   (1,577,413)      (365,902)    (4,314,809)       (960,803)    (9,638,041)
    Other expense                                        (154,940)             -       (154,940)              -       (154,940)
    Cancellation of common stock reset provision                -     (6,111,577)             -      (6,111,577)    (6,111,577)
                                                      ------------  -------------  -------------  -------------  -------------

        Total other income (expense), net              (1,706,155)    (6,185,238)    (4,422,997)     (6,216,257)   (12,190,718)
                                                      ------------  -------------  -------------  -------------  -------------

Loss from continuing operations                        (7,050,344)   (13,567,076)   (19,871,411)    (30,166,567)   (98,159,325)

Discontinued operations:
    Operating loss of HealthCare
        Solutions Group                                (2,962,147)    (5,026,049)    (5,953,726)     (5,026,049)   (12,229,033)
    Gain on disposal of HealthCare Solutions Group,
        net of income taxes of $250,000                 6,616,646              -      6,616,646               -      6,616,646
                                                      ------------  -------------  -------------  -------------  -------------

Loss before extraordinary items                        (3,395,845)   (18,593,125)   (19,208,491)    (35,192,616)  (103,771,712)

Extraordinary items:
    Loss on extinguishment of debt                              -              -              -               -       (881,864)
    Gain on forgiveness of accounts payable and
        accrued interest                                  372,061              -        372,061               -        402,609
                                                      ------------  -------------  -------------  -------------  -------------

Net loss                                              $(3,023,784)  $(18,593,125)  $(18,836,430)  $ (35,192,616) $(104,250,967)
                                                      ============  ============   ===========    =============  =============


Basic and diluted net loss per common share           $     (0.05)      $ (0.39)      $ (0.31)       $ (0.75)
                                                      ============   ===========   ===========    ===========
</TABLE>


  See accompanying notes to condensed consolidated financial statements.

                                        4

<PAGE>
                       Fonix Corporation and Subsidiaries
                          [A Development Stage Company]

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Unaudited)
                Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
                                                                                                            October 1,
                                                                                                               1993
                                                                             Nine Months Ended            (Inception) to
                                                                               September 30,               September 30,
                                                                       -------------------------------
                                                                            1999             1998              1999
                                                                       --------------   --------------    --------------
<S>                                                                    <C>              <C>               <C>
Cash flows from operating activities:
     Net loss                                                          $ (18,836,430)   $(35,192,616)     $(104,250,967)
     Adjustments to reconcile net loss to net cash
       used in operating activities:
       Issuance of common stock for services                                 100,000               -          5,587,554
       Issuance of common stock for patent                                         -         100,807            100,807
       Non-cash expense related to issuance of notes payable,
          debentures, warrants, preferred and common stock                 2,270,000       6,111,577         12,348,914
       Non-cash compensation expense related to issuance
         of stock options                                                    119,240         133,375          2,615,540
       Non-cash expense related to issuance of notes payable
          and accrued expense for services                                        -          857,000            857,000
       Non-cash exchange of notes receivable for services                         -          150,000            150,000
       Non-cash portion of purchased in-process research and
          development                                                             -       12,635,768         13,136,000
       Loss on disposal of property and equipment                            154,940             (88)           154,940
       Gain on sale of HealthCare Solutions Group                         (6,616,646)              -         (6,615,365)
       Depreciation and amortization                                       4,423,595       1,802,814          8,199,049
       Extraordinary loss on extinguishment of debt                                -               -            881,864
       Extraordinary gain on forgiveness of accounts payable and
          accrued interest                                                  (372,061)              -           (402,609)
       Changes in assets and  liabilities,  net of effects of
        acquisitions and disposition:
          Accounts receivable                                               (391,982)       (183,418)          (540,480)
          Employee advances                                                     (755)              -            (67,986)
          Interest and other receivables                                      (4,436)        (74,009)            (9,919)
          Inventory                                                           (7,509)         (8,358)           (27,730)
          Prepaid assets                                                      40,465        (100,281)            (7,001)
          Other assets                                                           270         (80,212)          (119,575)
          Accounts payable                                                (1,558,666)      2,381,610          3,455,070
          Accrued liabilities                                              1,632,083         482,568          2,273,872
          Accrued liabilities - related party                              1,249,271        (370,966)         1,397,030
          Deferred revenues                                                  568,115           2,126            649,381
                                                                       --------------   -------------     --------------

       Net cash used in operating activities                             (17,230,506)    (11,352,303)       (60,234,611)
                                                                       --------------   -------------     --------------

Cash flows from investing activities, net of effects
  of acquisitions and disposition:
     Proceeds from sale of HealthCare Solutions Group                     21,305,982               -         21,305,982
     Acquisition of subsidiaries, net of cash acquired                             -     (14,738,495)       (15,323,173)
     Proceeds from sale of property and equipment                             50,000             500             50,000
     Purchase of property and equipment                                      (99,089)     (1,240,540)        (3,435,559)
     Investment in intangible assets                                               -         (94,789)          (164,460)
     Issuance of notes receivable                                                  -      (1,322,139)        (3,228,600)
     Payments received on notes receivable                                   245,000               -          2,128,600
                                                                       --------------   -------------     --------------

       Net cash provided by (used in) investing activities                21,501,893     (17,395,463)         1,332,790
                                                                       --------------   -------------     --------------

Cash flows from financing activities:
     Bank overdraft                                                         (138,034)        178,757                  -
     Net proceeds (payments) from revolving note payable                 (20,038,193)      1,422,264            (49,250)
     Net proceeds (payments) from revolving note payable -
          related parties                                                 (7,895,178)       (514,296)        (7,813,537)
     Net proceeds from other notes payable                                 6,953,760         100,000          9,865,427
     Payments on other notes payable                                      (7,788,000)        (49,250)        (9,567,806)
     Principal payments on capital lease obligations                         (55,504)        (36,284)          (148,210)
     Proceeds from issuance of convertible debentures, net                 6,254,240               -          9,439,240
     Proceeds from sale of warrants                                          438,240         322,928          1,511,168
     Proceeds from sale of common stock, net                                       -      17,471,155         38,175,700
     Proceeds from sale of preferred stock, net                                    -       9,403,846         17,707,346
     Proceeds from sale of common stock and related repricing rights
       subject to redemption, net                                                  -                -         1,830,000
                                                                       --------------   -------------     --------------

       Net cash (used in) provided by financing activities               (22,268,669)     28,299,120         60,950,078
                                                                       --------------   -------------     --------------

Net (decrease) increase in cash and cash equivalents                     (17,997,282)       (448,646)         2,048,257

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

Cash and cash equivalents at end of period                             $   2,048,257    $ 20,053,030      $   2,048,257
                                                                       ==============   =============     ==============
</TABLE>


       See accompanying notes to condensed consolidated financial statements.

                                        5
<PAGE>
                        Fonix Corporation and Subsidiaries
                           [A Development Stage Company]

            CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
                                  (Unaudited)


<TABLE>
<CAPTION>
                                                                                       October 1,
                                                                                          1993
                                                           Nine Months Ended          (Inception) to
                                                             September 30,             September 30,
                                                       ---------------------------
Supplemental disclosure of cash flow information:         1999          1998             1999
                                                       ------------  -------------    ------------

<S>                                                    <C>            <C>             <C>
      Cash paid during the period for interest         $ 1,068,882    $  747,629      $ 4,498,888
</TABLE>

Supplemental Schedule of Non-cash Investing and Financing Activities:

For the Nine Months Ended September 30, 1999:

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

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

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

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

     A total of  970,586  shares  of common  stock  previously  held by  certain
     shareholders  and  originally  valued at  $1,000,916  were  returned to the
     Company in settlement of litigation.

     The Company issued 6,000,000 shares of common stock valued at $3,278,893 to
     the  guarantors of the Series C convertible  debentures as  indemnification
     for the sale of their  shares by the  holders of the  Series C  convertible
     debentures  held as  collateral  for  these  debentures.  The  proceeds  of
     $3,278,893 received by the holders were used to pay liquidation damages and
     retire  Series C  convertible  debentures  in the amounts of  $750,000  and
     $2,528,893, respectively.

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

     Preferred stock dividends of $635,160 were accrued on Series D and Series E
     preferred stock.

     Dividends totaling $828,212 were accrued relating to the liquidation damage
     provisions  of  Series  D  and  Series  E  preferred  stock  and  Series  C
     convertible debentures.

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

     A total of 131,667 shares of Series D preferred stock and related dividends
     of $96,193 were converted into 8,468,129 shares of common stock.

     A total of 135,072 shares of Series E preferred stock and related dividends
     of $66,015 were converted into 5,729,156 shares of common stock.

     In connection with the sale of HealthCare  Solutions  Group,  $2,500,000 of
     the sales price was placed into an escrow account.

     A  revolving  note  payable in the  amount of $50,000  was paid by a former
     employee and is included as an account payable.

     Promissory notes held by certain  shareholders  were reduced by $414,991 in
     settlement of litigation.

For the Nine Months Ended September 30, 1998:

     The Company had a stock subscription receivable in the amount of $2,000,000
     in  connection  with  the  issuance  of  100,000  shares  of  Series  E  4%
     Convertible  Preferred Stock that was consummated as of September 30, 1998.
     This receivable was collected subsequent to period end.

     Preferred  Stock  Dividends  of  $1,553,001  were  recorded  related to the
     beneficial  conversion  features  of Series D and  Series E 4%  Convertible
     Preferred Stock.

     The Company issued  1,390,476  shares of common stock and 608,334 shares of
     Series D 4% Convertible Preferred Stock in connection with the cancellation
     of existing  reset  provisions  and costs  associated  with the issuance of
     Series D 4% Convertible Preferred Stock.

     Preferred  Stock  Dividends  of  $1,000,000  were  recorded  related to the
     issuance  of  1,390,476  common  shares and  608,334  shares of Series D 4%
     Convertible Preferred Stock in connection with the cancellation of existing
     reset provisions.

     Preferred   Stock  Dividends  of  $73,889  were  accrued  on  Series  D  4%
     Convertible Preferred Stock.

     The Company exchanged  150,000 shares of Series D 4% Convertible  Preferred
     Stock for 150,000 shares of Series E 4% Convertible Preferred Stock.

     The Company issued  5,140,751 shares of common stock (having a market value
     of  $8,353,720)  and notes payable of  $4,747,339  in  connection  with the
     acquisition of Articulate Systems, Inc.

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

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

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

     The Company issued  2,692,216 shares of common stock (having a 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 and Subsidiaries
                       (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" or "Fonix")  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 nine months ended September 30, 1999 are not
necessarily  indicative  of the results that may be expected for the year ending
December  31,  1999.  The Company  suggests  that these  condensed  consolidated
financial  statements be read in  conjunction  with the  consolidated  financial
statements and the notes thereto included in the Company's Annual Report on Form
10-K (Amendment No. 1) for the year ended December 31, 1998.

Recently Enacted Accounting  Standards - In June 1998, the Financial  Accounting
Standards Board issued Statement of Financial  Accounting Standards ("SFAS") No.
133,  "Accounting  for  Derivative  Instruments  and Hedging  Activities."  This
statement   establishes   accounting  and  reporting  standards  requiring  that
derivative  instruments  be recorded in the balance  sheet as either an asset or
liability  measured at its fair value and that changes in the derivative's  fair
value be  recognized  currently in earnings  unless  specific  hedge  accounting
criteria are met.  SFAS No. 133 is effective  for fiscal years  beginning  after
June 15, 2000. The adoption of this statement is not expected to have a material
effect on the Company's  consolidated  financial  statements as the Company does
not currently hold any derivative or hedging instruments.

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

Net Loss Per Common  Share - Basic and  diluted  net loss per  common  share are
calculated  by dividing  net loss  attributable  to common  stockholders  by the
weighted average number of shares of common stock outstanding during the period.
At September 30, 1999 and 1998, there were outstanding  common stock equivalents
to purchase 90,535,319 and 38,413,473 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.

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


                                       7

<PAGE>


                    Fonix Corporation and Subsidiaries
                       (A Development Stage Company)
           NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                (Unaudited)



<TABLE>
<CAPTION>
                                                            Three months ended September 30,
                                            -------------------------------------------------------------------------
                                                      1999                                      1998
                                            --------------------------------     ------------------------------------
                                                                Per share                             Per share
                                                     Loss         Amount                  Loss         Amount
                                            --------------------------------     ------------------------------------
<S>                                         <C>               <C>                <C>                <C>
Loss from continuing operations             $   (7,050,344)                      $  (17,388,076)
Preferred stock dividends                       (1,031,288)                          (2,626,890)
                                            ---------------                      ---------------
Net loss from continuing operations
    attributable to common stockholders         (8,081,632)   $    (0.11)           (20,014,966)    $    (0.37)
Discontinued operations                          3,654,499          0.05             (1,205,049)         (0.02)
Extraordinary items                                372,061          0.01                      -             -
                                            ----------------  ------------       ---------------    --------------------
Loss attributable to common stockholders    $   (4,055,072)   $    (0.05)        $  (21,220,015)    $    (0.39)
                                            ================  ============       ================   =====================

Weighted average common shares
    outstanding                                  76,479,555                          54,020,736
                                            ================                     ================
</TABLE>
<TABLE>
<CAPTION>
                                                             Nine months ended September 30,
                                            -------------------------------------------------------------------------------
                                                             1999                                     1998
                                            -------------------------------------     -------------------------------------
                                                                     Per share                                 Per share
                                                     Loss              Amount                  Loss             Amount
                                            -------------------------------------     -------------------------------------
<S>                                         <C>                <C>                    <C>                 <C>
Loss from continuing operations             $   (19,871,411)                          $   (33,987,567)
Preferred stock dividends                        (2,460,518)                               (2,626,890)
                                            -----------------                         -----------------
Net loss from continuing operations
    attributable to common stockholders         (22,331,929)   $    (0.33)                (36,614,457)    $    (0.73)
Discontinued operations                             662,920          0.01                  (1,205,049)         (0.02)
Extraordinary items                                 372,061          0.01                          -               -
                                           -----------------   -------------          ----------------    -----------------
Loss attributable to common stockholders   $    (21,296,948)   $    (0.32)            $   (37,819,506)    $    (0.75)
                                           =================   =============          ================    =================

Weighted average common shares
    outstanding                                  68,678,645                                50,385,468
                                            ================                          ================
</TABLE>



2.   SALE OF THE HEALTHCARE SOLUTIONS GROUP

In  September  1999,  the Company  completed  the sale of the  operations  and a
significant portion of the assets of its HealthCare  Solutions Group (the "HSG")
to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated third party, for
up to $28,000,000. At the closing of this transaction, $21,500,000, less certain
credits of  $194,018  was paid and  $2,500,000  was  deposited  into an 18-month
escrow account in connection  with the  representations  and warranties  made by
Fonix in the sales  transaction.  Any  remaining  amount up to  $4,000,000 is an
earnout contingent on the

                                       8

<PAGE>


                  Fonix Corporation and Subsidiaries
                     (A Development Stage Company)
         NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                              (Unaudited)


performance of the HSG over the next two years.  The Company will not record the
contingent earnout,  if any, until successful  completion of the earnout period.
The sale was approved by a majority of Fonix's  stockholders.  The proceeds from
the sale were used to reduce certain of the Company's liabilities and to provide
working   capital  to  allow  Fonix  to  focus  on  marketing  and   development
opportunities  for its Interactive  Technology  Solutions Group. The assets sold
include inventory,  property and equipment,  certain prepaid expenses, purchased
core  technology  and other  assets of the HSG.  Additionally,  L&H  assumed the
capital  lease  obligations  related to the HSG and the  obligations  related to
certain of the Company's deferred revenues.

On September 1, 1999, upon the closing of the Sale, the Company discontinued the
operations  of the HSG. The results of  operations of the HSG have been reported
separately as discontinued operations in the accompanying condensed consolidated
statements  of  operations.  Prior year  results  have been  restated to provide
comparability.  The net assets (liabilities) of the HSG in the December 31, 1998
condensed consolidated balance sheet consist of the following:

<TABLE>
<CAPTION>
<S>                                                           <C>
         Inventory                                            $      72,582
         Other receivables                                            4,554
         Deferred revenues                                         (675,997)
                                                              --------------
              Net current assets (liabilities)                $   (598,861)
                                                              =============

         Property and equipment, net of
            accumulated depreciation of $27,367               $     182,981
         Intangible assets, net of accumulated
            amortization of $828,886                             19,379,131
         Other assets                                                22,343
                                                              --------------

             Net long-term assets                             $  19,584,455
                                                              ==============
</TABLE>

Revenues from HSG's  operations  were  $1,726,262 for the period from January 1,
1999 to September 1, 1999 and $103,517 for the nine months ended  September  30,
1998.  These  amounts  have  not  been  included  in  revenues  reported  in the
accompanying condensed consolidated statements of operations.

3.  FORGIVENESS OF TRADE PAYABLES AND ACCRUED INTEREST

In September 1999, the Company negotiated  reductions of $221,376 in amounts due
various  trade  vendors.  Additionally,  the Company  negotiated  reductions  of
$150,685 in accrued  interest owed to certain note  holders.  These amounts have
been  accounted  for  as  extraordinary  items  in  the  accompanying  condensed
consolidated statements of operations.

4.  ACQUISITIONS

The  Company  acquired  AcuVoice,  Inc.  ("AcuVoice")  in March  1998.  AcuVoice
developed and marketed text-to-speech ("TTS") technologies and products directly
to end-users,  systems integrators and original equipment  manufacturers for use
in the  telecommunications,  multi-media,  education  and  assistive  technology
markets.  In  addition,   the  Company  acquired  PAI  and  Papyrus  Development
Corporation  ("PDC")  (together  with  PAI,  "Papyrus")  in  October  1998.  PAI
developed,  marketed and supported printing and cursive handwriting  recognition
software for "personal digital assistants",  pen tablets and mobile phones under
the  trademark,  Allegro(TM).  PDC  was  a  systems  integration  provider  with
expertise and intellectual  property in embedded  systems and enhanced  Internet
applications.  The  products  and  services  formerly  provided by AcuVoice  and
Papyrus are now provided by the  Company's  Interactive  Technologies  Solutions
Group ("ITSG").

The Company also acquired Articulate Systems,  Inc.  ("Articulate") in September
1998.  Articulate  was a provider of voice  recognition  products to specialized
segments of the healthcare industry under the PowerScribe(R) trade name. The

                                       9

<PAGE>


                     Fonix Corporation and Subsidiaries
                        (A Development Stage Company)
            NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 (Unaudited)


Company  operated the  Articulate  business  through the HSG. The operations and
substantially all the assets of the HSG were sold on September 2, 1999 (see Note
2). All of the acquisitions discussed above were accounted for as purchases.

The following  unaudited pro forma  financial  statement  data for the three and
nine months ended  September  30, 1998 present the results of  operations of the
Company as if the  acquisitions  of AcuVoice and Papyrus had occurred at January
1, 1998. The pro forma results have been prepared for comparative  purposes only
and do not  purport  to be  indicative  of  what  would  have  occurred  had the
acquisitions  been made at January 1, 1998, or of future results.  Purchased in-
process  research  and  development  related to the  acquisition  of AcuVoice of
$9,315,000  was  expensed  at the date of the  AcuVoice  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.  Pro  forma
financial information for the acquisition of Articulate has not been included in
the following pro forma financial  statement as the operations and substantially
all  the  assets  of  the  HSG  were  sold  September  2,  1999  (see  Note  2).
Additionally,  the historical  operating  results of Articulate from the date of
acquisition  through  September  30, 1998 have been  excluded from the pro forma
information.


<TABLE>
<CAPTION>
                                                     Three Months Ended      Nine Months Ended
                                                      September 30,1998     September 30, 1998
                                                     -------------------    -------------------
<S>                                                 <C>                      <C>
Revenues                                            $        145,185         $     2,804,667

Net loss from continuing operations                     (13,932,394)             (22,211,826)

Net loss from continuing operations
   attributable to common stockholders                  (16,559,284)             (24,970,376)

Basic and diluted net loss
   per common share                                           (0.31)                   (0.49)
</TABLE>

5. PAPYRUS SETTLEMENT

After the Papyrus  acquisition closed in October 1998, the Company  investigated
some of the representations and warranties made by Papyrus to induce the Company
to acquire the Papyrus  companies.  The Company  determined  that certain of the
representations  made by  Papyrus  and its  executive  officers  appeared  to be
inaccurate. On February 26, 1999, the Company filed an action against the former
shareholders of Papyrus alleging  misrepresentation  and breach of contract.  In
March and April 1999,  five of the former  shareholders of Papyrus filed actions
against the Company  alleging  default under the terms of the  promissory  notes
issued to them in  connection  with the Papyrus  acquisition  and certain  other
claims.  Subsequently,  the Company entered into agreements with the five former
Papyrus  shareholders  for  dismissal  of the  actions and  cancellation  of the
promissory  notes upon payment to the former  shareholders  of  $1,217,384  (the
"Settlement  Payment") and return of 970,586  shares of restricted  common stock
previously  issued  to the  five  former  shareholders  in  connection  with the
acquisition  of Papyrus.  The Company paid the  Settlement  Payment in September
1999 and the lawsuits described above have been dismissed.


6.  INTANGIBLE ASSETS

Intangible assets consist of purchased core technology and goodwill arising from
the  acquisitions  of  AcuVoice  and Papyrus  and direct  costs  incurred by the
Company in applying  for patents  covering  its  technologies.  Amortization  is
computed on a straight-line  basis over the estimated  useful lives ranging from
five  to  eight  years.  Total  accumulated   amortization  was  $3,757,780  and
$1,770,668 at September 30, 1999 and December 31, 1998, respectively,  excluding
amortization  of $828,886  related to HSG at December 31, 1998. The  unamortized
portion of the purchased core

                                       10

<PAGE>


                  Fonix Corporation and Subsidiaries
                     (A Development Stage Company)
         NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                              (Unaudited)


technology  and goodwill  related to the purchase of  Articulate  have been as a
result of the Sale.  Additionally,  the amount of goodwill  associated  with the
purchase of PAI was reduced by  $1,415,908  in  connection  with the  settlement
payment in September 1999 (see Note 5).

7.  RELATED-PARTY AND OTHER NOTES PAYABLE

As of September  30, 1999,  the Company had  unsecured  notes  payable to former
Papyrus stockholders in the aggregate amount of $77,625, which notes were issued
in connection with the  acquisition of Papyrus.  The holders of these notes have
not made demand for payment.

During the nine months ended  September 30, 1999, the Company paid, or otherwise
reduced through agreement (see Note 5), notes payable to various related parties
totaling $8,414,255, plus accrued interest.

In September  1999,  the Company paid other notes  payable to unrelated  parties
aggregating  $588,000  plus accrued  interest.  Additionally,  a revolving  note
payable in the amount of $50,000 was paid by a former  employee  and is included
as an account payable.

A revolving note payable in the amount of $19,988,193 at December 31, 1998, plus
accrued interest, was paid in full in January 1999.

8.  SERIES C 5% CONVERTIBLE DEBENTURES

On January 29, 1999, the Company  entered into a Securities  Purchase  Agreement
with  four  investors  pursuant  to which  the  Company  sold  its  Series C 5%,
Convertible  Debentures (the "Debentures") in the aggregate  principal amount of
$4,000,000. The outstanding principal amount of the Debentures is convertible at
any time at the option of the holders into shares of the Company's  common stock
at a conversion price, subject to adjustment, equal to the lesser of $1.25 or 80
percent of the average of the closing bid price of the  Company's  common  stock
for the five trading days immediately preceding the conversion date. The Company
recorded  $687,500 as interest  expense upon the issuance of the  Debentures  in
connection  with this  beneficial  conversion  feature.  The Company also issued
400,000 warrants to purchase an equal number of the Company's common shares at a
strike price of $1.25 per share in connection with this financing.  The warrants
are  exercisable  for a period  of three  years  from  the  date of  grant.  The
estimated  fair  value of the  warrants  of  $192,000,  as  computed  under  the
Black-Scholes  pricing model, was recorded as interest expense upon the issuance
of the  Debentures.  On March 3,  1999,  the  Company  executed  a  supplemental
agreement  pursuant  to which  the  Company  agreed to sell  another  $2,500,000
principal  amount of Debentures on the same terms and  conditions as the January
29, 1999  agreement,  except no  additional  warrants  were issued.  The Company
recorded  $1,062,500  as interest  expense upon the  issuance of the  additional
Debentures in connection with the beneficial conversion feature. The obligations
of the Company for  repayment of the  Debentures,  as well as its  obligation to
register the common stock underlying the potential  conversion of the Debentures
and the exercise of the warrants  issued in these  transactions,  are personally
guaranteed by the Guarantors (see Note 10). In connection with the March 3, 1999
funding, the Company agreed to grant a lien on the patent covering the Company's
Automated Speech Recognition ("ASR") technologies as collateral for repayment of
the  debentures.  However,  to date no lien on the patent has been granted.  The
Guarantors  guaranteed  the  obligations of the Company under the Debentures and
pledged  6,000,000 shares of common stock of the Company  beneficially  owned by
them as collateral security for their obligations under their guarantee.

The outstanding  principal  amount of the Debentures bears interest at a rate of
5%,  payable on March 31, June 30,  September  30, and  December 31, and on each
conversion  date, of each year during the term of the  Debentures.  In addition,
the interest on the outstanding  principal  amount of the Debentures may, at the
Company's  option,  be paid in  shares  of the  Company's  Class A common  stock
calculated based upon the Debenture Conversion Price on the date such

                                      11

<PAGE>


                    Fonix Corporation and Subsidiaries
                       (A Development Stage Company)
           NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                (Unaudited)


interest becomes due. The Company has not paid interest on the Debentures at any
time since they were issued.  Under the terms of the  Debentures,  the investors
could charge penalties for such failure.  However, the investors have waived all
such penalties accruing prior to October 1, 1999.

Under the terms of the  Debentures,  in the event that the Company fails to file
and have declared  effective the registration  statement  registering the shares
underlying  the  Debentures,  the holders of the  Debentures  may elect  penalty
provisions  to (a)  reduce  the  conversion  price by 2.5% per  month  until the
registration  statement  is  declared  effective,  or (b)  receive  2.5%  of the
outstanding  principal  amount of Debentures  per month,  in cash. To date,  the
Company has not filed the registration statement or had it declared effective as
required.  However,  all holders waived the penalty  provisions through June 30,
1999. Additionally, some holders of the Debentures agreed to a partial waiver of
their  penalty  provisions  through  September  30,  1999.  The  holders  of the
Debentures  have  agreed  to waive the  penalty  provisions,  contingent  on the
registration  statement  being  declared  effective by February 29, 2000. In the
event that the  registration  statement is not declared  effective by that date,
the penalty provisions automatically apply, retroactive to October 1, 1999.

Subsequent to the March 3, 1999, funding, the holders of the Debentures notified
the Company and the Guarantors  that the  Guarantors  were in default of certain
terms of the stock pledge  agreement  executed by the Guarantors in favor of the
holders  as a result of the  Company's  failure  to  register  the resale of the
shares  underlying the Debentures,  and that the holders may therefore  exercise
their  right to sell the shares  pledged by the  Guarantors.  The holders of the
Debentures  have  subsequently  informed  the  Company  that  they have sold the
6,000,000  shares  pledged by the  Guarantors and that proceeds from the sale of
the pledged shares has aggregated $3,278,893. Of this total, $406,250 related to
penalties  attributable to default  provisions of the stock pledge agreement and
recorded  was as interest  expense and  $343,750  related to  provisions  of the
Series D Preferred  Stock and has been  recorded as preferred  stock  dividends.
Both of these amounts were recorded  during the three months ended September 30,
1999. The remaining $2,528,893 of the proceeds was applied as a reduction of the
principal  balance  of the  Debentures  as of  September  30,  1999.  Additional
interest   payable  under  the  provisions  of  the  stock  pledge  and  related
indemnification  agreements  has been  recorded  by the  Company  as an  accrued
liability in the amount of $731,250.  Under its indemnity  agreement in favor of
the  Guarantors,  the Company  will issue  6,000,000  replacement  shares to the
Guarantors  for the shares sold by the holders and reimburse the  Guarantors for
any costs incurred as a result of the holders' sales of the  Guarantors'  shares
(see Note 10).

On December 3, 1999, the Company  received  notice that its Class A common stock
had been delisted from the Nasdaq SmallCap Market. The delisting was an event of
default under the terms of the Debentures.  Upon the occurrence of this event of
default,  the  outstanding  principal  amount of the  Debentures,  together with
accrued  interest,  became  immediately  due and payable in cash.  However,  the
holders of the Debentures waived this event of default.

9.  STOCKHOLDERS' EQUITY

Common Stock Subject to Redemption - On December 21, 1998,  the Company  entered
into a private placement securities  agreement.  Pursuant to the agreement,  the
Company received  $1,980,000 in net proceeds in exchange for 1,801,802 shares of
redeemable  common  stock,  an equal number of  "Repricing  Rights,"  Repurchase
Rights,  and warrants to purchase 200,000 shares of common stock. Each Repricing
Right  entitles  the holder to receive a number of  additional  shares of common
stock  for  no  additional  consideration  according  to a  formula  ("Repricing
Rights")  based on the lowest  closing bid price of the  Company's  common stock
during the 15 consecutive  trading days immediately  preceding the exercise date
and a repricing  price,  as defined,  ranging from $1.3875 to $1.4319  depending
upon the date of the exercise.  The repricing rights became exercisable on March
21, 1999.

Each holder of the Repurchase Rights has the right, based on certain conditions,
to require the Company to  repurchase  all or a portion of the  holder's  common
shares  or  Repricing  Rights.  The  Repurchase  Rights  may  only be  exercised
simultaneously with or after the occurrence of a major transaction or triggering
event. Major transactions and triggering

                                      12

<PAGE>


                      Fonix Corporation and Subsidiaries
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


events  consist  of,  among  others,  certain  consolidations,  mergers or other
business  combinations,  the sale or  transfer of all or  substantially  all the
Company's  assets,  a  purchase,  tender or  exchange  offering  of more than 40
percent of the Company's outstanding common stock made and accepted, the failure
to have a related  registration  statement  declared effective prior to June 19,
1999 or a suspension from listing or delisting of the Company's common stock for
a period of more than three days. As a registration  statement  registering  the
shares and the shares underlying the Repricing Rights was no declared  effective
by June 19, 1999, and the Company's  Class A common stock has been delisted from
the Nasdaq SmallCap Market, the holders had the right to exercise the Repurchase
Right.  However,  the holder has waived  its right to  exercise  the  repurchase
option as a result of the  delisting of the Class A common stock from the Nasdaq
SmallCap  Market  and  deferred  until  March 1,  2000,  its  right  to  require
repurchase  as a  result  of  the  Company's  failure  to  register  the  shares
underlying  the Repurchase  Rights and the Class A common stock.  If such shares
are not registered  before March 1, 2000, the holder may exercise the Repurchase
Rights.

The repurchase  price for the common stock is $1.3875 per share.  The repurchase
price for the Repricing  Rights is based on a formula  using the Repricing  Rate
and the last reported  sale price of the  Company's  common stock on the date of
the exercise of the repurchase right.

Series D and E Preferred  Stock - During the nine  months  ended  September  30,
1999,  131,667 shares of Series D preferred stock and 135,072 shares of Series E
preferred  stock,  together with related  dividends on each, were converted into
8,467,129  shares and 5,729,156  shares,  respectively,  of the Company's common
stock.  After the above  conversions  876,667 shares of Series D preferred stock
remain outstanding.

On December 3, 1999, the Company  received  notice that its Class A common stock
had been delisted  from the Nasdaq  SmallCap  Market,  in part because the stock
price had been below  $1.00 per share since  approximately  March 1999 (see Note
15). However, the Company's Class A common stock is currently trading on the OTC
Bulletin Board.

The  delisting of the  Company's  Class A common stock from the Nasdaq  SmallCap
Market was an event of default under the terms of the Series D preferred  stock.
Upon the  occurrence of an event of default,  the Company was required to pay to
each  holder of Series D preferred  stock a fee of two  percent of the  purchase
price of the Series D preferred  stock in cash for each month  during  which the
stock is  delisted.  However,  the holders of the Series D preferred  stock have
waived this event of default.

Common Stock - The Company  incurred an obligation to issue 6,000,000  shares of
common stock to two individuals who are executive officers and directors and one
individual who is a former  officer and director of the Company in  satisfaction
of an indemnification agreement wherein the Company was required to pay any sums
the three individuals paid for the benefit of the Company.  The shares are to be
issued to replace shares beneficially owned by the three individuals and sold by
the holders of the Debentures and Series D preferred stock (see Note 10).

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

In April 1999, five former PAI  shareholders  agreed to cancel 970,586 shares of
common stock to the Company reducing the total shares they had received from the
Company  in the 1998  acquisition  of PAI from  3,111,114  shares  to  2,140,528
shares.  The shares were  effectively  canceled in September  1999 in connection
with the  Settlement  Payment  (see Note 5). The  original  fair market value of
$1,000,917  associated  with the canceled  shares is reflected as a reduction to
goodwill associated with the purchase of PAI.


                                      13

<PAGE>


                      Fonix Corporation and Subsidiaries
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


As of September 30, 1999

Common Stock  Options - During the nine months  ended  September  30, 1999,  the
Company  granted  754,500 stock options to employees at exercise  prices ranging
from $0.59 to $1.78 per share. Additionally, 9,500 stock options were granted to
two consultants for services  provided to the Company.  The fair market value of
the  consultant  options  was $1.32 per share,  or  $12,540 in total,  using the
Black-Scholes  pricing model and was charged to product development and research
expense.  The term of all options  granted  during this nine month period is ten
years  from the date of  grant.  Of the stock  options  issued,  726,334  vested
immediately,  18,834  vest six months  after  issuance  and 18,832 vest one year
after  issuance.  The  weighted  average  fair value of the  options  granted to
employees  during the nine months ended  September  30, 1999 was $1.31 per share
using the Black-Scholes pricing model. Had compensation expense for the issuance
of these options been recorded in accordance with the method  prescribed by SFAS
No. 123, "Accounting for Stock-Based Compensation",  the Company's net loss from
continuing  operations  attributable  to  common  stockholders  would  have been
$22,281,723 or $0.32 per share for the nine months ended  September 30, 1999. As
of  September  30,  1999,  the  Company  had  a  total  of  15,536,582   options
outstanding.

Effective May 7, 1998, the Company entered into a one-year professional services
agreement with a public relations firm. The minimum monthly retainer was $15,000
per month. In connection  with this  agreement,  the firm was granted options to
purchase 100,000 shares of the Company's common stock at $3.75 per share. In May
1999, the Company  negotiated a termination of this agreement for a cash payment
of approximately $33,000 and the grant of options was rescinded.

Common Stock  Warrants - During the nine months ended  September  30, 1999,  the
Company granted  warrants to L&H in connection with loans made to the Company in
April and May 1999 totaling  $6,000,000.  These  warrants  allow L&H to purchase
850,000  shares of common stock of the Company at exercise  prices  ranging from
$0.60 to $0.70 per share.  Of these  warrants,  250,000 expired October 18, 1999
without being exercised. The remaining 600,000 warrants expire May 17, 2001. The
fair value of the  warrants  was $0.14 and $0.35 per share for the  250,000  and
600,000 warrants, respectively, using the Black-Scholes pricing model. The value
of the warrants totaled  $246,240 and was amortized as a financing  expense over
the term of the loans.

On February 11,  1998,  the Company  entered into a First  Statement of Work and
License Agreement with Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens")  under  which the Company  and  Siemens  are  jointly  pursuing  the
development of Siemens' integrated circuits  incorporating ASR and other related
technologies for use in certain telecommunications  applications.  In connection
with the license  agreement  Siemens  purchased  warrants  to acquire  1,000,000
shares of restricted  common stock at an average exercise price of $20 per share
with expiration dates ranging from December 31, 1998 to December 31, 1999. As of
September 30, 1999,  800,000 of the warrants  originally  issued had expired and
200,000 of the  warrants  remain  outstanding  at an average  exercise  price of
$30.00 per share.

As of  September  30,  1999,  the  Company  had a total  of  2,475,000  warrants
outstanding.

10.  RELATED-PARTY  TRANSACTIONS

Related-party  transactions  with  entities  owned  by two  individuals  who are
executive  officers and directors and one individual who is a former officer and
director of the Company for the nine months  ended  September  30, 1999 and 1998
were as follows:


<TABLE>
<CAPTION>
                                       1999                  1998
                                  -------------        ---------------
<S>                               <C>                  <C>
Expenses:
     Base rent                    $   93,312           $     83,788
     Leasehold improvements       $       -            $     35,247
</TABLE>

                                      14
<PAGE>


                    Fonix Corporation and Subsidiaries
                       (A Development Stage Company)
           NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                (Unaudited)

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

Guaranty of Company Obligations and Related Indemnity Agreement - The Guarantors
have guaranteed  certain  obligations of the Company (see Note 8), including the
Company's  obligations  under  the  Debentures.  As  security  for  some  of the
guarantees,  the Guarantors  pledged  shares of Fonix common stock  beneficially
owned by them. In September  1999, the Company paid in full a note payable to an
unrelated third party that had previously been guaranteed by the Guarantors. The
Guarantors  pledged 6,000,000 shares of the Company's common stock  beneficially
owned by them as collateral security for the Company's obligations regarding the
Debentures.

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

Subsequent to the March 3, 1999, funding, the holders of the Debentures notified
the Company and the Guarantors  that the  Guarantors  were in default of certain
terms of the stock  pledge  agreement  as a result of the  Company's  failure to
register in a timely manner the resale of the shares  underlying the Debentures,
and that the holders may exercise  their right to sell the shares pledged by the
Guarantors. The holders of the Debentures have subsequently informed the Company
that  proceeds  from the sale of the  6,000,000  pledged  shares has  aggregated
$3,278,893.  Under  its  indemnity  agreement  in favor of the  Guarantors,  the
Company is obligated to issue 6,000,000 replacement shares to the Guarantors for
the shares sold by the holders of the Debentures.  Additionally, the Company has
recorded a related  party  liability of  $1,296,600  as a  reimbursement  to the
Guarantors  for the income taxes  incurred by the  Guarantors as a result of the
holders' sales of the Guarantors' shares.

In December 1998, the Guarantors  guaranteed certain  additional  obligations of
the Company. As security for some of the guarantees, the Guarantors also pledged
shares of the Company's common stock  beneficially owned by them. In March 1999,
143,230 of the shares  previously  pledged by the Guarantors to a bank were sold
by the bank and the proceeds  were used to pay Company  credit card balances and
the related accrued interest in full totaling $244,824.  In May 1999, 100,000 of
the shares  previously  pledged by the  Guarantors  to another  creditor  of the
Company were sold by the creditor and the proceeds,  totaling $72,335, were used
to pay amounts owed by the Company.

As of September 30, 1999, no guarantees remain outstanding. However, the Company
anticipates  that in the future the  Guarantors  may  request  that the  Company
provide  indemnity  and/or  compensation  for the  guarantees,  advances  and/or
pledges by the  Guarantors  for the benefit of the  Company.  To the extent such
requests,  if any, are  reasonable  and of a nature  similar to what the Company
would grant to unrelated parties in similar transactions,  the Company presently
anticipates  that it will submit any such requests to the Board of Directors for
consideration.



                                      15

<PAGE>


                       Fonix Corporation and Subsidiaries
                          (A Development Stage Company)
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)

11.  PRODUCT DEVELOPMENT AND RESEARCH

Synergetics  - In October  1993,  the Company  entered  into an  agreement  with
Synergetics,  a research and development entity, to develop certain technologies
related to the Company's ASR  technologies.  Under the terms of the  Synergetics
agreement,  the Company expended $186,455 during the nine months ended September
30, 1999 for product  development and research efforts. No amounts were expended
during the three months ended September 30, 1999.

IMC2 - In March 1998, the Company entered into a professional services agreement
with IMC2, a research  and  development  entity,  to provide  assistance  to the
Company in the development of specific ASR  technologies.  The President of IMC2
is also the President of Synergetics. The professional services agreement is for
a term of 36 months  and  requires  the  Company  to make  monthly  payments  of
$22,000.  Under the terms of the  agreement,  the Company  expended  $66,000 and
$198,000   during  the  three  and  nine  months  ended   September   30,  1999,
respectively.

Adiva-  Beginning in 1998,  the Company  utilized  the research and  development
services of Adiva.  The president of Adiva is also the president of  Synergetics
and IMC2. The Company  expended  $63,395 during the nine months ended  September
30, 1999 for research and development  efforts.  No amounts were expended during
the three months ended September 30, 1999.

12.  COMMITMENTS AND CONTINGENCIES

Employment  Agreements - In January 1998,  the Company  entered into  employment
contracts  with two employees  which expire in January 2001.  The minimum annual
salary payments required by these contracts total $405,000. In January 1999, the
Company announced a cost reduction program for the Company's 1999 operating year
wherein the two employees referred to above agreed that their compensation would
be reduced 30 percent effective February 1999.

Executive Employment  Agreements - On November 1, 1996, the Company entered into
employment  contracts with three executive officers (one of whom is no longer an
executive  officer)  which expire on December  31, 2001.  The annual base salary
pursuant  to the  contracts  with  each  executive  officer  for the year  ended
December 31, 1999 is $425,000.  In January  1999,  the Company  announced a cost
reduction  program  for  the  Company's  1999  operating  year  wherein  the two
remaining  executive  officers  agreed that their annual  compensation  would be
reduced to  $297,500  commencing  February  1999.  At the same time,  Stephen M.
Studdert  resigned as the Company's  Chief  Executive  Officer.  His  employment
agreement  was canceled and he entered into a separation  agreement  pursuant to
which he will be paid  $250,000 per year  through  January 31, 2001 and $100,000
for the year ended January 31, 2002.

Sublease of Office Facilities - Effective May 14, 1999, the Company entered into
an agreement to sublease  10,224 square feet of its Draper,  Utah facility to an
unrelated third party.  The agreement  requires the sublessee to pay $13,961 per
month, or approximately 40 percent of the Company's monthly obligation under the
primary lease agreement  through December 31, 2000. The sublessee has the option
to extend the term by two additional three-month periods.

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

Operating  Lease - In March 1999, the Company entered into an agreement to lease
office space in Cleveland, Ohio for sales and installation personnel of the HSG.
The lease is for three  years at a monthly  rate of $4,260 and became  effective
May 1, 1999. Future aggregate minimum obligations under this operating lease are
$144,840.  Under the terms of the sale of the HSG,  L&H assumed  this  operating
lease obligation in September 1999.

                                      16

<PAGE>


                    Fonix Corporation and Subsidiaries
                       (A Development Stage Company)
           NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                (Unaudited)


Capital  Lease  Obligations  - In  January  1999,  the  Company  entered  into a
noncancelable  capital  lease  arrangement  for  telephone  equipment at its HSG
facility  in Woburn,  Massachusetts.  In May 1999,  the Company  entered  into a
noncancelable  capital  lease  arrangement  for  telephone  equipment at its HSG
facility in Cleveland,  Ohio. Future aggregate  minimum  obligations under these
capital leases, net of amounts representing  interest,  aggregate  approximately
$51,000. Under the terms of the sale of the HSG, L&H assumed these capital lease
obligations in September 1999.

Royalty  Agreements - The Company has entered into  various  technology  license
agreements.  Generally,  the agreements  require the Company to pay royalties at
specified  dollar  amounts in  connection  with each product sold that  utilizes
technologies licensed by the Company under these agreements.  Royalty expense is
accrued at the time product revenues incorporating the licensed technologies are
recognized.  There  were no  sales  of  products  incorporating  these  licensed
technologies  during the nine months ended September 30, 1998.  Royalty expenses
of $37,238 and $100,763,  all related to the HSG, were incurred during the three
and nine months ended September 30, 1999,  respectively,  and have been included
in the loss from discontinued operations.

13. LITIGATION

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

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

OGI - On July 28, 1999,  Oregon  Graduate  Institute  ("OGI")  filed a notice of
default,  demand for  mediation  and demand for  arbitration  with the  American
Arbitration  Association.  In its demand, OGI asserted that Fonix was in default
under three separate  agreements between the Company and OGI in the total amount
of $175,000.  On or about  September  23, 1999,  the Company  responded to OGI's
demand  and  denied  the  existence  of a default  under  the  three  agreements
identified by OGI. Moreover,  the Company asserted a counterclaim against OGI in
an amount not less than  $250,000.  The  arbitrator  appointed  by the  American
Arbitration  Association will conduct a scheduling conference in January 2000 to
set dates for the proceeding, including the date of the arbitration hearing.

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



                                      17

<PAGE>


                      Fonix Corporation and Subsidiaries
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


14.  REPORTABLE SEGMENTS

The  Company  has  adopted  SFAS No.  131,  "Disclosures  about  Segments  of an
Enterprise and Related Information". This statement requires disclosures related
to components of a company for which separate financial information is available
and evaluated  regularly by the Company's  chief  operating  decision  makers in
deciding how to allocate resources and in assessing performance.  As a result of
the sale of the HSG in September 1999 (see Note 2), management believes that the
Company has only one  operating  segment  because the Company's  remaining  core
business consists only of operations  derived from the Interactive  Technologies
Solutions Group.

15.  SUBSEQUENT EVENTS

Shareholders  Meeting - At the Company's annual shareholder meeting held October
29,  1999,  59,497,418  shares  were  represented  in person  or by  proxy.  The
shareholders  approved amendments to the Company's  certificate of incorporation
that (A) created a new class of common  stock  designated  as Class B Non-Voting
Common Stock with 1,985,000 Class B shares authorized;  and (B) redesignated the
Company's current common stock as Class A Common Stock and changed each share of
existing  common stock into a share of Class A Common Stock.  Additionally,  the
shareholders approved an amendment to the Company's certificate of incorporation
that  increased  the  number  of common  shares  authorized  to be  issued  from
100,000,000  to  300,000,000  and increased  the number of authorized  preferred
shares from  20,000,000  to  50,000,000.  The Class B shares were  authorized to
provide for the conversion of 1,935,000  common shares issued in the acquisition
of Articulate  Systems,  Inc., to a non-voting class of stock as provided in the
acquisition  agreement.  The  Company  does not intend to  register  its Class B
Non-Voting Common Stock. The shareholders also approved a series of transactions
pursuant to which the Company issued its Series D 4% preferred  stock and Series
E 4% preferred stock.

Appointment  of  Director -  Effective  October  29,  1999,  Mark S.  Tanner was
appointed as a member of the Company's  Board of Directors.  Mr. Tanner  becomes
the second  independent  member appointed to the Board of Directors during 1999.
Previously,  on September 2, 1999, William A. Maasberg,  Jr. was appointed as an
independent member of the Company's Board of Directors.

Conversion  of Series D Preferred  Stock - Subsequent  to September  30, 1999, a
total of 494,944  shares of Series D  preferred  stock,  together  with  related
dividends, were converted into 38,785,1425 shares of the Company's common stock.
After the above  conversions  381,723 shares of Series D preferred  stock remain
outstanding.

Delisting from the Nasdaq SmallCap Market - Until recently,  the Company's Class
A common  stock  traded  on the  Nasdaq  SmallCap  market  which  requires,  for
continued  listing, a minimum bid price of at least $1.00 per share. At June 29,
1999,  the  Company's  Class A common stock had traded below $1.00 for more than
thirty consecutive trading days. On June 29, 1999, the Company received a letter
from Nasdaq indicating that unless the minimum bid price for the Company's Class
A common stock returned to at least $1.00 per share for at least ten consecutive
trading days prior to September 29, 1999, the Company's shares would be delisted
from the  Nasdaq  SmallCap  Market on  October 1,  1999.  The  Company  appealed
Nasdaq's  notice and listing  determination  in  September  1999.  Nasdaq held a
hearing on the matter on October 28, 1999.

On December 3, 1999, the Company  received  notice that its Class A common stock
had been delisted  from the Nasdaq  SmallCap  Market,  in part because the stock
price had been below $1.00 per share since approximately March 1999. The Company
is currently evaluating its options,  including the possibility of appealing the
delisting  decision.  However,  the Company's  Class A common stock is currently
trading on the OTC Bulletin Board.

Additionally,  the  delisting  of the  Company's  Class A common  stock from the
Nasdaq  SmallCap  Market  was  an  event  of  default  under  the  terms  of the
Debentures.  Upon  the  occurrence  of an  event  of  default,  the  outstanding
principal  amount of all of the Debentures,  together with accrued  interest and
all other amounts owing in respect thereof,  became  immediately due and payable
in cash.  However,  the  holders of the  Debentures  have  waived  this event of
default.

                                      18

<PAGE>


                      Fonix Corporation and Subsidiaries
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


Finally,  the  delisting of the  Company's  Class A common stock from the Nasdaq
SmallCap Market was a triggering event giving rise to certain  repurchase rights
in connection  with the  Company's  Series D and Series E preferred  stock.  The
holders of the  Repurchase  Rights had the right to require  Fonix to repurchase
some or all of the  investor's  Class A  common  shares  and  Repricing  Rights.
However, the holders have waived this event of default.

Recent Financing  Activities  -Fonix has recently entered into an agreement with
four investors whereby Fonix intends to sell to the investors a total of 250,000
shares of its Series F 6% Convertible  Preferred  Stock (the "Series F Preferred
Stock"), in return for payment of $5,000,000.  It is anticipated that the Series
F Preferred  Stock will be  convertible  into  shares of Fonix's  Class A common
stock during the first six months  following the closing of the transaction at a
price of $0.75 per share,  and thereafter at a price equal to 90% of the average
of the three lowest closing bid prices in the twenty-day trading period prior to
the  conversion  of the Series F Preferred  Stock.  Fonix  anticipates  that the
investors  will receive  registration  rights which will require Fonix to file a
registration  statement  covering the shares  underlying  the Series F Preferred
Stock, and that Fonix will have the option of redeeming any outstanding Series F
Preferred  Stock.  Although  Fonix has received  approximately  $1,000,000 as an
advance in connection with this financing, the securities purchase agreement has
not been signed. Accordingly,  the terms may differ from those set forth in this
paragraph.





                                      19

<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, AS AMENDED,  FOR THE YEAR
ENDED DECEMBER 31, 1998.


Overview

Corporate Summary

Fonix is a  development  stage company  engaged in marketing  and  developing of
proprietary human/computer interaction technologies.  Specifically,  the Company
has developed neural network-based automated speech recognition ("ASR"), as well
as  text-to-speech   ("TTS"),   handwriting   recognition   ("HWR")  and  speech
compression  technologies  packaged  in  products  salable  to a wide  range  of
customers.  (ASR,  TTS, HWR and speech  compression  technologies  are sometimes
collectively  referred  to as  "core  technologies".)  The  Company  expects  to
continue to make commercially available products utilizing its core technologies
which enable  computers and electronic  devices to interact with people on human
terms  rather than humans  conforming  to the process of a machine.  The Company
believes  this new  efficient,  intuitive and natural  method of  human/computer
interaction will eventually  replace  traditional  interaction tools such as the
keyboard  and mouse in a broad range of mass  market,  industrial,  embedded and
server-based applications.

         Fonix  is  pursuing  revenue   opportunities   through   generation  of
non-recurring  engineering  fees,  product  and  technology  license  royalties,
product sales and product support maintenance contracts. The Company markets its
products  and core  technologies  to software  developers,  consumer  electronic
manufacturers (including producers of computer processors or chips), third party
product  developers,   operating  system  developers,   network  and  share-ware
developers and Internet and web related companies. The Company focuses marketing
toward  both  embedded  systems  applications  and  server-based  solutions  for
Internet and telephony voice activated applications.

         Manufacturers of consumer electronic products, software development and
Internet  content  use Fonix  core  technologies  to  simplify  the use of their
products  and  increase  product  functionality   resulting  in  broader  market
opportunities  and  significant   competitive   advantage.   Unlike  traditional
stand-alone consumer speech and language  technologies,  Fonix solutions support
multiple  platforms,  are environment and speaker  independent,  while providing
easy integration within a relatively small memory requirement.

Competitive Advantages of Core Technologies

         Fonix  core   technologies   have  key   competitive   advantages  that
differentiate them from other speech and handwriting technology companies.

         ASR.  Fonix  researchers  have  developed and patented what the Company
believes to be a fundamentally  new and unique approach to the analysis of human
speech  sounds  and  the  contextual   recognition  of  speech.   The  core  ASR
technologies  attempt  to  approximate  the  techniques  employed  by the  human
auditory system and language  understanding  centers in the human brain. The ASR
technologies  use  information  in speech sounds  perceptible  to humans but not
discernible  by current ASR systems.  The ASR  technologies  also employ  neural
network technologies (artificial intelligence techniques) for identifying speech
components  and  word  sequences  contextually,  similar  to the  way  in  which
scientists  believe  information  is processed by the human brain.  As presently
developed,  the  phonetic  sound  recognition  engine is  comprised  of  several
components  including audio signal processing,  a feature extraction  process, a
phoneme estimation process, and a linguistic process based on proprietary neural
net technologies that are designed to interpret human speech contextually.  This
development  has yielded a proprietary ASR system  utilizing a unique  front-end
analysis of the acoustic speech signal, a neural net-based  phoneme  identifier,
and a neural-net

                                      20

<PAGE>



architecture for back-end  language  modeling.  The latter component is known as
MULTCONS  or  multi-level  temporal  constraint   satisfaction  network.   These
developments  have been the subject of two issued  patents  and several  pending
patents.  In addition,  the Company has acquired a related  patent  covering the
front-end recognition process.

         The Company believes the reliable  recognition of natural,  spontaneous
speech spoken by one or more individuals in a variety of common  environments by
means  of a  conveniently  placed  microphone  will  significantly  improve  the
performance,  utility and convenience of applications  such as computer  command
and control,  voice  activated  navigation  of the  Internet,  data input,  text
generation, telephony transactions, continuous dictation, and other applications
in both embedded and server based applications.

         Fonix has pursued the development of these ASR  technologies to produce
salable  products  and  gain  market  share by  overcoming  the  limitations  of
currently available  commercial ASR systems and broadening the market acceptance
and use of human/computer interaction technologies.  Key benefits resulting from
Fonix proprietary ASR technologies  which  differentiate  Fonix ASR products and
technologies from other currently available competitive products include:

1.       Significantly  reduced  computer  memory  requirements  allowing speech
         recognition  to operate in embedded  system  environments,  or enabling
         server-based  systems to operate with  significantly  more simultaneous
         users because  memory  requirements  do not encumber as much  operating
         system resources as competitive traditional systems.
2.       Significantly  reduced  power  requirements  making Fonix  technologies
         available for use in a host of smaller computing solutions with limited
         battery/power   capacity  and  enabling  more  simultaneous   users  on
         server-based systems.
3.       Speaker  independence  allowing various speakers to use the same system
         without  the system  being  trained to a  particular  user's  voice and
         dialect.
4.       Excellent  noise  cancellation  qualities  allowing  the ASR  system to
         extract ambient  background  noise,  thus allowing  higher  recognition
         rates in noisy environments.
5.       Highly reduced need for headsets or tethered microphones.
6.       Rapid porting to multiple  computer chip  platforms and operating
         systems  to create  broad  product  demand.  7. The Fonix  Accelerated
         Applications  Speech  Technology  (FAAST)  product is a leading  edge,
         visual,  integrated development  environment which allows customers to
         build  applications  in a rapid time frame with a high rate of success
         and little  outside  resources  thereby  accelerating  product time to
         market.

         The Company  believes  that its ASR  technologies  offer unique  speech
processing techniques that will improve a broad range of computing solutions and
accelerate and enhance  integration of human/computer  interaction  technologies
into products, applications, solutions and devices.

         Although these plans represent  management's  beliefs and  expectations
based on its  current  understanding  of the  market and its  experience  in the
industry,  there  can be no  assurance  that  actual  results  will  meet  these
expectations.  See "Certain Significant Risk Factors." During 1998 and 1997, the
Company has expended $12,109,065, and $7,066,294,  respectively, on ASR research
and development  activities.  Since its inception (October 1, 1993), the Company
has  spent   $35,365,904  on  research  and  development   ("R&D")  of  its  ASR
technologies.  The  Company  expects  that a  substantial  part  of its  capital
resources  will  continue  to be  devoted to  research  and  development  of ASR
technologies and other proprietary technologies for the foreseeable future.

         TTS.  Fonix  text-to-speech  products  include  a  small,   proprietary
vocabulary-true human-quality synthetic voice with full prosody and an unlimited
vocabulary  text-to-speech  engine initially developed by AcuVoice and purchased
by Fonix in 1998. All TTS products are sold under the Fonix brand name.

         The  Company's  TTS  products  began as a new  approach to  synthesized
speech,  a system using actual  recordings of "units" of human speech (i.e., the
sound  pulsation).  Since the unit of  speech  often  consists  of more than one
phoneme (sound), Fonix's approach has been called a "large segment concatenative
speech  synthesis"  approach.  Other companies such as DEC and AT&T began in the
early 1960s and continue  until the present to use a method  called  "parametric
speech synthesis."  Parametric systems have problems of speech quality,  because
their unit is not an actual recording,

                                      21

<PAGE>



but a computer's  version of what a human voice sounds like. Poor speech quality
also occurs because the parametric unit consists, for the most part, of a single
phoneme,  such as the "t" in the word "time." Fonix  synthetic  speech  products
have been recognized as high quality,  human sounding engines which include full
voice inflection,  intonation and clarity. Fonix' large vocabulary TTS ("LVTTS")
engine won awards as "best  text-to-speech"  product at the Computer  Technology
Expo  '97 and '98 and the  best of show  award at  AVIOS  '97.  Presently  LVTTS
products   are   sold   to   end-users,   systems   integrators   and   OEMs  in
telecommunications, multi-media, educational and assistive technology markets.

         The products  include the Fonix AV 1700 TTS system for end-user desktop
and laptop system use. The Fonix AV 2001 SDK is a software  development  kit for
developers of telephony applications. Run-time software licenses for the AV 2001
are offered for  applications  developed  with the SDK. The SDK  supports  major
computer telephony platforms.

         During the nine months ended  September 30, 1999, the Company  received
in the  aggregate,  $348,726  in  revenue  from  licensing  or  sale  of the TTS
technologies  and  products  compared to  pro-forma  revenue of $246,382 for the
comparable nine month period of 1998.

         HWR.  In  October  1998,  Fonix  acquired  Papyrus   Associates,   Inc.
("Papyrus"), including its Allegro handwriting recognition software. The Allegro
handwriting  recognition software is a single letter recognition system like the
popular  Graffiti  handwriting  recognition  software  for  the  PalmPilot  PDA.
However,  Allegro's  alphabet is all natural in appearance  involving lower case
letter  making.  The Allegro  system is easy to use and requires  practically no
learning.  Allegro is sold by Purple  Software in England for the Psion Series 5
hand-held  PC. This  software has also been licensed to Philips for use with its
line of smart cell phones. Allegro is also the subject of a sales agreement with
Lucent  Technologies for use in its Inferno operating  system.  Papyrus has also
developed   cursive   handwriting    recognition   software   which   recognizes
naturally-written  whole words.  This cursive  technology is only available as a
licensed product to OEM customers.  Both the Allegro and the cursive handwriting
recognition  software  are user  independent  and  require  no  training  on the
software.

         During the nine months ended  September 30, 1999, the Company  received
$2,357  in  revenue  from  licensing  or  sale  of the  handwriting  recognition
technologies  compared to pro-forma  revenue of $190,147 for the comparable nine
month period of 1998.

Market Strategy

         The world-wide market for ASR, TTS and HWR technologies and products is
newly emerging.  Currently, only a small portion of prospective applications for
these human/computer  interaction technologies has reached the critical point of
commercial viability.  Among the largest current markets developing or employing
speech  technologies  are  applications  in  the  telephony  and  call  centers,
automatic   desktop   dictation   software,    telematic,   personal   hand-held
communication  solutions,  Internet  voice portals and research and  development
markets. Historically,  development of speech products in an emerging market has
been affected by declining margins,  large memory requirements,  non- extendable
technology,  operating  system  platform  dependence,  lack of  integration  and
non-recurring  engineering  dependence.  Recently,  several  forces  have driven
market  trends  toward  accelerated  demand  for  speech  including   technology
convergence (more speech products  companies and proliferation of the world wide
web),  explosive  growth  in mobile  personal  communications  and  organization
devices,  and  legislative  concerns for consumer  safety and handicap access to
technology.

         The Company has strategically  sought markets for its core technologies
with high margins,  broad use, rapid development and market  emergence/presence.
Fonix  has also  strategically  avoided  markets  with  low  margins  which  are
commodity  driven,  subject to continuous price compression and require massive,
costly customer support systems.

         The Company's current  marketing  strategy is governed by the following
general principles:

1.       Specific  focus on  markets  where  current  revenues  can be  realized
         through a market  driven  approach  and away from  markets  focusing on
         continued research and development.
2.       Pursuit of customers who enjoy dominant or significant  market share in
         their respective markets and who

                                      22

<PAGE>



         display financial ability and marketing organization to rapidly bring
         products to market.
3.       Pursuit of integration into customer products where Fonix technology is
         directly  compatible  and can go to  market  with  minimal  additional
         development  engineering.
4.       Partner with customers who have existing marketing  channels in place
         and leverage  product sales through those channels.
5.       Generally  position Fonix as a provider of second tiercustomer support,
         providing training and tools for Fonix customers who create  excellent
         front  line  support  systems  for  their  end-user customers.

         Because  the  Company  is  pursuing   integration   into  mass  market,
industrial,  general  business and personal  electronic  products and  computing
solutions,  lead time to revenue  generation  is longer than  retail,  commodity
driven  software  products.  The  Company's  products sold and  integrated  into
customer  applications  are subject to both  customer  production  schedules and
customer  success in marketing the products and generating  product  sales.  The
Company's  revenues  are  thus  subject  to  delays  and  possible  cancellation
resulting from customer integration delays.

         To bring the Company's  proprietary  technologies to market,  Fonix has
focused marketing and product development into embedded markets and server-based
markets.

Embedded Markets

         Increasingly  efficient and powerful  computing  solutions have rapidly
developed new markets by creating smaller, more convenient devices equipped with
personalized   functions.   These  devices   include  PDAs   (personal   digital
assistants),  cellular phones, web pads, wireless  communications  devices,  and
other consumer  electronics.  A significant  deterrent to full  functionality of
powerful yet small computing devices is the current need for a keyboard and/or a
mouse to interface  with the device.  Recent  integration  of HWR technology has
helped to increase the demand for natural, intuitive human/computer interactions
with  these  devices  and has helped  markets to emerge  ready to pay for speech
recognition  and  synthetic  speech  in  computing  solutions.  The next step to
greater  human/computer  interaction is to integrate speech into these products.
Other product  developments are driving  additional  interest in  human/computer
technologies  including new products  (electronic  books,  wearable  computers),
testing of smart appliances and toys (VCRs, answering machines, wireless phones,
climate control systems) and automotive applications (command and control, hands
free cellular phones and voice activated navigation systems).

         Historically,  micro  processors  did  not  contain  enough  memory  or
computing power (MIPS) to operate most ASR and TTS applications.  This created a
significant problem for embedded markets. Adding the hardware necessary to boost
memory and  computing  power  would  increase  the price of devices  higher than
consumer markets would tolerate.

         Because  of  proprietary  engineering  innovations,  Fonix  ASR and TTS
technologies have memory and power requirements that fall well within tolerances
needed  to  speech  enable  applications  using  existing  16  bit  and  32  bit
processors.  To  capitalize  on this distinct  competitive  advantage,  Fonix is
pursuing sales and partnership  relationships  with companies  offering embedded
products  for  mass  consumer  markets,  industrial  applications  and  business
computing solutions.

         Fonix has  identified  key embedded  market  segments which it believes
will provide long term,  sustainable revenue flow using proprietary ASR, TTS and
HWR technologies and which meet Fonix's general  business  strategy  objectives.
These strategically focused embedded markets include:

1.       Chip   Manufacturers.   Digital  signal  processor  ("DSP")  and  micro
         processor  manufacturers  are  currently  highly  focused on technology
         innovations  which will support and drive sales of chips  through third
         party vendors. Because Fonix ASR and TTS technologies have demonstrated
         the  ability  to  operate  in these  environments,  Fonix  is  pursuing
         relationships  with these  manufacturers  to  leverage  their  existing
         marketing channels.
2.       Design and Development Contractors. Firms designing reference platforms
         and real products and developing functions operating on those platforms
         through  contracts with major mass market product  suppliers  provide a
         strong  market for Fonix with  channels to major  consumer  electronics
         marketers.
3.       Software Developers. Many software developers in multiple markets
         provide opportunity for Fonix to enhance

                                                        23

<PAGE>



         software sales for these companies by enabling their software  products
         with one or more human/computer  interaction  technologies,  leading to
         leveraged product sales and royalty revenue for Fonix.
4.       Third Party Product  Developers.  Many companies are currently  seeking
         ASR,  TTS and HWR  technologies  to  integrate  into a host of consumer
         electronic  devices,  commercial  applications and business  solutions.
         Fonix evaluates each  prospective  opportunity and the tradeoff between
         revenue  potential and development  time required.  Primary markets for
         these   applications   are  in  automotive  and  aviation   telematics,
         industrial wearable computers, mobile communications devices and PDA's.

Server-Based Markets

         Telephony/call  center  solutions  and  shrink-wrap  desktop  dictation
software  sales are two of the most  advanced  emerging  markets  for  automated
speech.  Current industry revenue estimates  indicate that customized  automated
call centers, virtual operators,  packaged call center software, custom vertical
market  dictation  systems  and  general  desktop  dictation  systems  have  led
server-based speech  applications into the market.  Because speech products have
now  reached a point of both  acceptable  product  quality  and  initial  market
acceptance,   several  additional   industries  are  currently  researching  and
developing  plans for  integration  of ASR, TTS and HWR. These new product areas
including network systems,  telephone  company e-mail reader services,  software
document readers,  Internet  navigation and screenless Internet access, web site
text readers, mobile computing solutions and many more.

         The Company is addressing this market opportunity from the strengths of
its  core  technologies.  Fonix  has  released  version  1 of its  FAAST  (Fonix
Accelerated  Application  Speech  Technology)  for  Servers.  FAAST for  Servers
provides  application  developers with a tool enabling rapid  development of ASR
and TTS which can be quickly and cleanly  ported into their  product.  FAAST for
Servers is targeted to currently  emerging and newly developing markets expected
to utilize speech applications in the near and mid-term future.

         In addition,  the Company is focused on direct  product  development in
server-based markets. This focus is employed in three primary areas:

1.       Internet Voice  Portals.  Speech enabled access to the Internet and web
         site  navigation is a rapidly  emerging  need.  Fonix is developing and
         will soon  implement  products for voice portals to the Internet  which
         may be  purchased  for use by portal  companies,  web sites and content
         providers, Internet service providers, and browsers.
2.       TTS for Reading  Web Sites.  Since over 70% of all web content is text,
         demand  for  products  allowing  web  content to be read to the user is
         rapidly  growing.  Fonix has  developed a web page reader  which can be
         added to web sites.  Working in concert with established audio players,
         this  product is targeted  toward the  largest  web  content  providers
         worldwide in media, government, business and other industries.
3.       Network Systems  Command and Control and E-mail Reader.  Fonix provides
         both  ASR and TTS  which  can be  seamlessly  integrated  into  network
         software to speech-enable software applications.
4.       Video Captioning.  The Company has developed a means to effectively use
         ASR to create  automatic forced alignment and automatic closed and open
         captioning for video aftermarket  editing services.  Future versions of
         this product  will include  real-time  live closed  captioning  systems
         utilizing  Fonix  continuous  ASR. Major video software  developers and
         marketers and large scale video editing and  production  facilities are
         prime targets for this product.

Fonix Product Development and Delivery Focus

         The focus of Fonix  management is to  transition a technology  research
development  team  focused on  invention  and proof of concept into a team which
delivers quality products on schedule and within budget,  while at the same time
continuing  to achieve  technology  upgrades  to maintain  distinct  competitive
technology advantages.

         To  accelerate  the delivery of Fonix  technologies  into the market as
bona  fide  products,   Fonix   management  has  reconfigured  the  R&D-oriented
development  organization into a Product Delivery/R&D matrix  organization.  The
new structure consists of the traditional R&D-oriented  organization overlaid by
product  teams led by product  managers who are  marketing-oriented  and charged
with direct profit and loss responsibilities.  These responsibilities begin with
market

                                      24

<PAGE>



research and with product  definition and specification and end with delivery of
quality  products  which address real needs  identified by the  marketplace,  on
schedule and within  budget.  As  identified by industry  experience,  this is a
demanding  but  necessary   role,  and  has  been  found  industry  wide  to  be
indispensable  in  transforming  a company  from the R&D phase into the  product
delivery phase.

Year 2000 Issue

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

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

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

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

Results of Operations

Three months ended September 30, 1999 compared with three months ended September
30, 1998

During the three months ended September 30, 1999, the Company recorded  revenues
of  $65,707  from  the  sale of its  Interactive  Technologies  Solutions  Group
products,  a decrease of $29,793 over the same period in the previous  year. The
decrease is due to a  reorganization  and redirection of the sales and marketing
staff in the 1999 period.

Selling,  general and administrative expenses were $2,864,400 and $2,672,252 for
the three  months ended  September  30, 1999 and 1998,  respectively.  Salaries,
wages and related costs were $1,949,422 and $988,412 for the three months

                                      25

<PAGE>



ended September 30, 1999 and 1998,  respectively,  an increase of $961,010. This
increase  is  attributable  to  $1,296,600  in  additional  compensation  to two
executive officers and a former executive officer related to the indemnification
of income  taxes  resulting  from the sale of shares  beneficially  owned by the
three  individuals  for  payment  of  Company  obligations  offset  in  part  by
management's cost reduction initiatives  implemented in February 1999. Legal and
accounting expenses decreased $85,626.  This decrease is attributed primarily to
the  costs of legal  and  accounting  services  related  to the  acquisition  of
Articulate and Papyrus and the preparation of registration statements in 1998 in
addition  to a  reduction  in legal  fees  expended  for  litigation  and patent
registration  matters.  Marketing  expenses decreased $37,853 and consulting and
outside  services  decreased by $239,491.  These  decreases are  attributable to
management's  cost  reduction  initiatives  implemented  in February 1999. . The
Company incurred product  development and research expenses of $1,906,968 during
the three months ended  September  30, 1999, a decrease of  $2,389,970  over the
same  period  in  the  previous  year.   This  decrease  was  due  primarily  to
management's  cost  reduction  initiatives  implemented  in February  1999.  The
Company  anticipates similar decreases in product development and research costs
as it begins to complete the  development  of certain TTS  products.  During the
three months ended September 30, 1999 and 1998, the Company  expended a total of
approximately  $100,000  and  $50,000,  respectively,  in  connection  with  the
development  of the  AcuVoice  purchased  in-process  research  and  development
projects.

Amortization  of goodwill and  purchased  core  technologies  were  $630,609 and
$500,776 for the three months ended  September 30, 1999 and 1998,  respectively,
representing an increase of $129,833. This increase is primarily attributable to
the   amortization  of  intangible   assets  acquired  in  connection  with  the
acquisitions of Papyrus.

The Company incurred losses from operations of $5,344,189 and $11,202,838 during
the three months ended September 30, 1999 and 1998,  respectively.  The decrease
in losses from  operations  is due  primarily  to  management's  cost  reduction
initiatives  implemented in February 1999, and purchased in process research and
development costs incurred in the acquisition of Articulate in 1998. The Company
anticipates that its investment in ongoing  scientific  product  development and
research  will  continue at decreased  levels for the  remainder of fiscal 1999,
assuming availability of working capital.

Net other expense was $1,706,155 for the three months ended  September 30, 1999,
a decrease of $4,479,083  over the three months ended  September  30, 1998.  The
decrease was due  primarily to costs  attributed to the  cancellation  of common
stock reset  provisions  that  occurred  in 1998 and to a reduction  in interest
income of $266,043 from  certificates  of deposit that were converted to cash to
retire a bank line of credit in January  1999,  offset in part by an increase in
interest  expense of  $1,211,511  attributable  to the  issuance of the Series C
Convertible Debentures issued in January and March 1999.


Nine months ended  September 30, 1999 compared with nine months ended  September
30, 1998

During the nine months ended September 30, 1999, the Company  recorded  revenues
of $351,083, a decrease of $2,216,702 over the same period in the previous year.
In the 1998 period,  the Company received revenues of $2,368,138 from Siemens as
a non-refundable  license fee for which the Company had no further obligation of
any kind.  The 1999 revenues are primarily from sales and licensing fees related
to the TTS technologies and products.

Selling,  general and administrative expenses were $7,537,577 and $6,112,765 for
the nine months ended September 30, 1999 and 1998, respectively. Salaries, wages
and related  costs were  $4,090,525  and  $2,584,164  for the nine months  ended
September  30, 1999 and 1998,  respectively,  an increase  of  $1,506,361.  This
increase  is   attributable   to   $1,296,600   in   expenses   related  to  the
indemnification  of income  tax  liabilities  resulting  from the sale of shares
beneficially  owned by two executive  officers and one former executive  officer
for payment of Company  obligations  and to  management's  redirection  of labor
resources from core  development  and research  activities to selling,  business
development  and  marketing  activities,  offset  in part by  management's  cost
reduction  initiatives  implemented  in February 1999.  Additionally,  legal and
accounting expenses increased $207,505,  the increase is attributed primarily to
the costs of  services  related  to the sale of the HSG assets to L&H and to the
costs of securities filings.  Further,  marketing expenses decreased $20,837 and
consulting  and outside  services  decreased  by $98,178.  These  decreases  are
attributable to management's cost reduction initiatives  implemented in February
1999.

                                      26

<PAGE>



The Company  incurred  product  development and research  expenses of $6,278,318
during the nine months ended  September 30, 1999, a decrease of $3,680,115  over
the same  period in the  previous  year.  This  decrease  was due  primarily  to
management's  cost  reduction  initiatives  implemented  in February  1999.  The
Company  anticipates similar decreases in product development and research costs
as it begins to complete the  development  of certain TTS  products.  During the
nine months ended  September 30, 1999 and 1998, the Company  expended a total of
approximately  $250,000  and  $80,000,  respectively,  in  connection  with  the
development  of the AcuVoice  purchased  in-process  R&D  projects.  The Company
anticipates that its investment in ongoing product development and research will
continue  at  decreased  levels  for the  remainder  of 1999 and 2000,  assuming
availability of working capital.

Amortization  of goodwill and purchased  core  technologies  was  $1,962,443 and
$1,100,336 for the nine months ended September 30, 1999 and 1998,  respectively,
representing an increase of $862,107. This increase is primarily attributable to
the   amortization  of  intangible   assets  acquired  in  connection  with  the
acquisitions of AcuVoice and Papyrus.

Net other expense was $4,422,997 for the nine months ended September 30, 1999, a
decrease of  $1,793,260  over the nine months ended  September  30,  1998.  This
decrease was due primarily to $6,111,577 in costs attributed to the cancellation
of common  stock reset  provisions  that  occurred in 1998 and to a reduction in
interest income of $809,371 from  certificates of deposit that were converted to
cash to  retire a bank  line of credit  in  January  1999,  offset in part by an
increase  in  interest  expense of  $3,354,006  attributable  to the Series C 5%
convertible debentures issued in January and March 1999.

In-Process Research and Development

At the date of acquisition of AcuVoice,  management  estimated that the acquired
in-process  research and development  projects of AcuVoice were approximately 75
percent  complete  and that an  additional  $1.0  million  would be  required to
develop  these  projects  to  commercial  viability.  Additionally,   management
anticipated  release  dates  of the  fourth  quarter  of 1999  for the  AcuVoice
projects.  As of  September  30,  1999,  the  Company  has  expended  a total of
approximately  $380,000 in  connection  with the  AcuVoice  acquired  in-process
research and  development  projects,  and  management  estimates that a total of
approximately  $620,000  will be  required to complete  the  AcuVoice  projects.
Management also estimates that the AcuVoice  projects are 85 percent complete as
of September 30, 1999,  and that the release dates will be in the second quarter
of 2000.

Liquidity and Capital Resources

         The Company must raise  additional funds to be able to satisfy its cash
requirements during the next 12 months. The research and development,  corporate
operations and marketing expenses will continue to require  additional  capital.
Because the Company  presently  has only limited  revenue from  operations,  the
Company  intends to continue to rely primarily on financing  through the sale of
its equity and debt  securities or sales of existing  technologies or businesses
to satisfy future capital requirements until such time as the Company is able to
enter into additional third-party licensing or co-development  arrangements such
that it will be able to finance ongoing  operations out of license,  royalty and
sales revenue.  There can be no assurance that the Company will be able to enter
into such agreements.  Furthermore,  the issuance of equity  securities or other
securities  which are or may become  convertible  into equity  securities of the
Company in  connection  with such  financing  would  result in  dilution  to the
stockholders of the Company which could be substantial.

         The Company had negative working capital of $4,400,201 at September 30,
1999 compared to negative  working  capital of $14,678,975 at December 31, 1998.
The  current  ratio was  0.35:1 at  September  30,  1999  compared  to 0.59:1 at
December 31, 1998.  Current assets  decreased by $18,277,855 to $2,410,215  from
December  31, 1998 to  September  30,  1999.  Current  liabilities  decreased by
$28,506,629  to  $6,810,416  during the same  period.  The  increase  in working
capital from December 31, 1998 to September 30, 1999, was primarily attributable
to decreases in accounts and notes payable and notes payable to related parties,
offset in part by increases  in accrued  liabilities,  income taxes  payable and
decreases  in cash and  notes  receivable.  Total  assets  were  $22,398,084  at
September 30,1999 compared to $61,912,791 at December 31, 1998.



                                      27

<PAGE>

Delisting of the Company's Common Stock by Nasdaq

         Until recently, the Company's Class A common stock traded on the Nasdaq
SmallCap Market which requires, for continued listing, a minimum bid price of at
least $1.00 per share.  At June 29, 1999, the Company's Class A common stock had
traded below $1.00 for more than 30 consecutive  trading days. On June 29, 1999,
the Company received a letter from Nasdaq indicating that unless the minimum bid
price for the  Company's  Class A common  stock  returned  to at least $1.00 per
share for at least 10 consecutive  trading days prior to September 29, 1999, the
Company's shares would be delisted from the Nasdaq SmallCap Market on October 1,
1999.  The Company  appealed the Nasdaq notice and a hearing was held on October
28, 1999.

         On December 3, 1999,  the  Company  received  notice that its stock had
been  delisted from the Nasdaq  SmallCap  Market as of December 3, 1999, in part
because the stock price had been below $1.00 per share since approximately March
1999. The Company is currently evaluating its options, including the possibility
of appealing the delisting decision. However, the Company's Class A common stock
is currently trading on the OTC Bulletin Board.

         The result of  delisting  from the Nasdaq  SmallCap  Market  could be a
reduction in the liquidity of any  investment  in the  Company's  Class A common
stock, even if the Company's shares continue to trade on the OTC Bulletin Board.
Further,  delisting could reduce the ability of holders of the Company's Class A
common stock to purchase or sell shares as quickly and as  inexpensively as they
have done historically.

         The  delisting of the Company's  common stock from the Nasdaq  SmallCap
Market  was an event of  default  under  the  terms  of the  Debentures  and the
Repurchase  Rights.  Upon the  occurrence  of this event of default,  the unpaid
principal amount of the Debentures,  together with accrued interest thereon, was
immediately  due and payable.  However,  the holders of the  Debentures  and the
Repurchase Rights have waived this event of default.

Sale of the HealthCare Solutions Group

         In September 1999, the Company completed the sale of the operations and
a  significant  portion of the assets (the "Sale") of its  HealthCare  Solutions
Group  (the  "HSG") to  Lernout &  Hauspie  Speech  Products  N.V.  ("L&H"),  an
unrelated third party, for up to $28,000,000.  Of this sales price, $21,500,000,
less certain credits of $194,018, was paid at closing,  $2,500,000 is being held
in an 18  month  escrow  account  in  connection  with the  representations  and
warranties made by the Company at the time of the Sale. Any remaining  amount up
to $4,000,000 is an earnout  contingent on the  performance  of the HSG over the
next two years.  The Company  will not record the  contingent  earnout,  if any,
until  successful  completion of the earnout period.  The proceeds from the Sale
were used to reduce a significant  portion of the Company's  liabilities  and to
provide   working   capital  for  the  Company's   marketing  and   distribution
opportunities  for its Interactive  Technology  Solutions Group. The assets sold
include inventory,  property and equipment,  certain prepaid expenses, purchased
core technology and other assets of HSG.  Additionally,  L&H assumed the capital
and operating lease obligations  related to the HSG and the obligations  related
to certain of the Company's deferred revenues.

Notes Payable

         After the  Papyrus  acquisition  closed in October  1998,  the  Company
investigated  some of the  representations  and  warranties  made by  Papyrus to
induce the Company to acquire the Papyrus companies. The Company determined that
certain  of the  representations  made by  Papyrus  and its  executive  officers
appeared to be  inaccurate.  On February 26, 1999,  the Company  filed an action
against the former stockholders of Papyrus alleging misrepresentation and breach
of contract. In March and April 1999, five of the former stockholders of Papyrus
filed  actions  against  the  Company  alleging  default  under the terms of the
promissory  notes issued to them in connection with the Papyrus  acquisition and
certain other claims. Subsequently, the Company entered into agreements with the
five former Papyrus  stockholders  for dismissal of the actions and cancellation
of the promissory  notes upon payment to the former  stockholders  of $1,217,384
(the  "Settlement  Payment") and return of 970,586  shares of restricted  common
stock previously  issued to the five former  stockholders in connection with the
acquisition  of Papyrus.  The Company paid the  Settlement  Payment in September
1999 and the lawsuits  described above have been  dismissed.  The 970,586 shares
were  effectively  canceled in September 1999 in connection  with the Settlement
Payment.  The  original  fair market  value of  $1,000,917  associated  with the
canceled  shares was  reflected as a reduction to goodwill  associated  with the
purchase of Papyrus  Associates,  Inc. As of September 30, 1999, the Company had
unsecured notes payable to former Papyrus stockholders in the

                                      28

<PAGE>



aggregate  amount of $77,625,  which notes were  issued in  connection  with the
acquisition  of  Papyrus.  The  holders of these  notes have not made demand for
payment.

         During the nine months ended  September 30, 1999,  the Company paid, or
otherwise  reduced  through  agreement  notes payable to various related parties
totaling $8,818,355, plus accrued interest. Additionally, the Company paid other
notes payable to unrelated parties  aggregating  $560,000 plus accrued interest.
Additionally,  a revolving  note  payable in the amount of $50,000 was paid by a
former employee and is included as an account payable.  A revolving note payable
in the amount of $19,988,193 at December 31, 1998,  plus accrued  interest,  was
paid in full in January 1999 with the  proceeds  from a  certificate  of deposit
that secured the note and $22,667 in cash.

         In September  1999,  the Company  negotiated  reductions of $221,376 in
amounts  due  various  trade  vendors.   Additionally,  the  Company  negotiated
reductions of $150,685 in accrued  interest owed to certain note holders.  These
amounts have been  accounted for as  extraordinary  items in the 1999  condensed
consolidated statements of operations.

December 1998 Equity Offering

         In connection with the Company's  Equity Offering in December 1998, the
holder of the 1,801,802 Class A common shares and the Repricing Rights may, upon
the  occurrence of certain  events,  require the Company to repurchase  all or a
portion of the holder's  Class A common shares or repricing  rights  received in
the Equity Offering, as follows:

         o        For each Class A common  share  with a  repricing  right,  the
                  greater of $1.3875 or the sum of $1.11 plus the product of the
                  Repricing Rate multiplied by the last reported sale price.

         o        For each Repricing Right without the associated Class A common
                  share,  the product of the  Repricing  Rate  multiplied by the
                  last reported sale price.

         o         For each Class A common share without the associated
                   Repricing Right, $1.3875.

         For each of the above  examples,  the  Repricing  Rate is determined by
calculating the following fraction:

                       (Repricing Price - Market Price)
                       --------------------------------
                                 Market Price

As of December 13, 1999, the Repricing  Price was $1.4319,  and the market price
was $0.30.

         The events which trigger the Repurchase Rights include a failure by the
Company to have a registration  statement  registering the Class A common shares
and the shares  underlying the Repricing Rights in the Equity Offering  declared
effective  by June 19, 1999,  or the  delisting of the Class A common stock from
the Nasdaq  SmallCap  Market.  Because both of these events have  occurred,  the
investor in the Equity Offering had the right to exercise the repurchase option.
However,  the  Equity  Offering  investor  waived  its  right  to  exercise  the
repurchase  option as a result of the delisting of the Class A common stock from
the  Nasdaq  SmallCap  Market and  deferred  until  March 1, 2000,  its right to
require  repurchase as a result of the Company's  failure to register the shares
underlying  the Repurchase  Rights and Class A common stock.  If such shares are
not registered  before March 1, 2000, the Equity Offering  investor may exercise
the Repurchase Rights.  Presently,  the Company does not have sufficient cash or
other  liquid  assets to pay the amount  which would be due if the holder of the
Class A common shares and the Repricing Rights exercised its Repurchase Rights.

Series C 5% convertible debentures

         On January 29, 1999,  the Company  entered  into a securities  purchase
agreement with four investors pursuant to which the Company sold its Series C 5%
convertible  debentures in the aggregate  principal  amount of  $4,000,000.  The
outstanding principal amount of the Debentures is convertible at any time at the
option of the holders into shares of the Company's  common stock at a conversion
price  equal to the lesser of (1) $1.25 or (2) 80% of the average of the closing
bid price of the  Company's  common stock for the five trading days  immediately
preceding the conversion date.

                                      29

<PAGE>



However, in the event that the Company fails to file and have declared effective
the registration statement registering the shares underlying the Debentures, the
holders  of the  Debentures  may elect  penalty  provisions  to (a)  reduce  the
conversion price by 2.5% per month until the registration  statement is declared
effective, or (b) receive 2.5% of the outstanding principal amount of Debentures
per  month,  in cash.  To date,  the  Company  has not  filed  the  registration
statement or had it declared effective as required.  However, all holders waived
the penalty provisions through June 30, 1999. Additionally,  some holders of the
Debentures  agreed  to a  partial  waiver of their  penalty  provisions  through
September  30,  1999.  The  holders of the  Debentures  have agreed to waive the
penalty  provisions,  contingent on the  registration  statement  being declared
effective by February 29, 2000. In the event that the registration  statement is
not declared effective by that date, the penalty provisions automatically apply,
retroactive to October 1, 1999.

         The outstanding  principal amount of the Debentures bears interest at a
rate of 5%, payable on March 31, June 30,  September 30, and December 31, and on
each  conversion  date,  of each  year  during  the term of the  Debentures.  In
addition,  the interest on the  outstanding  principal  amount of the Debentures
may, at the Company's  option, be paid in shares of the Company's Class A common
stock  calculated  based upon the  Debenture  Conversion  Price on the date such
interest becomes due. The Company has not paid interest on the Debentures at any
time since they were issued.  Under the terms of the  Debentures,  the investors
could charge penalties for such failure.  However, the investors have waived all
such penalties accruing prior to October 1, 1999.

         The Company recorded  $687,500 as interest expense upon the issuance of
the  Debentures in  connection  with this  beneficial  conversion  feature.  The
Company  also  issued  400,000  warrants  to  purchase  an equal  number  of the
Company's  common shares at a strike price of $1.25 per share in connection with
this  financing.  The warrants are  exercisable for a period of three years from
the date of grant.  The  estimated  fair value of the warrants of  $192,000,  as
computed under the Black-Scholes pricing model, was recorded as interest expense
upon the issuance of the  Debentures.  On March 3, 1999, the Company  executed a
supplemental  agreement  pursuant  to which the Company  agreed to sell  another
$2,500,000  principal  amount of the Debentures on the same terms and conditions
as the January 29, 1999  agreement,  except no additional  warrants were issued.
The Company  recorded  $1,062,500  as interest  expense upon the issuance of the
supplemental  Debentures in connection with the beneficial  conversion  feature.
The obligations of the Company for repayment of the  Debentures,  as well as its
obligation to register the common stock  underlying the potential  conversion of
the  Debentures and the exercise of the warrants  issued in these  transactions,
were  personally  guaranteed by two officers and directors and a former  officer
and director of the Company (the "Guarantors").  In connection with the March 3,
1999  funding,  the Company  agreed to grant a lien on the patent  covering  the
Company's  ASR  technologies  as  collateral  for  repayment of the  Debentures.
However,  to date no  lien  on the  patent  has  been  granted.  The  Guarantors
guaranteed  the  obligations  of the Company  under the  Debentures  and pledged
6,000,000  shares of common stock of the Company  beneficially  owned by them as
collateral security for their obligations under their guarantees.

         Subsequent to the March 3, 1999 funding,  the holders of the Debentures
notified  the Company and the  Guarantors  that the  Guarantors  were in default
under the terms of the stock pledge  agreement and that the holders  intended to
exercise  their  rights  to  sell  some  or  all of the  pledged  shares  of the
Guarantors. The holders of the Debentures have subsequently informed the Company
that they have sold the  6,000,000  shares  pledged by the  Guarantors  and that
proceeds  from the sale of the pledged  shares  aggregated  $3,278,893.  Of this
total, $406,250 was allocated to penalties attributable to default provisions of
the stock pledge agreement and recorded as interest expense and $343,750 related
to penalty  provisions of the Series D preferred stock and recorded as preferred
stock  dividends.  Both of these amounts were recorded by the Company during the
three months ended September 30, 1999. The remaining  $2,528,893 of the proceeds
was applied as a reduction  of the  principal  balance of the  Debentures  as of
September  30, 1999.  Under its indemnity  agreement  with the  Guarantors,  the
Company will issue 6,000,000 replacement shares to the Guarantors for the shares
sold by the holders and reimburse  the  Guarantors  for any costs  incurred as a
result of the holders' sales of the Guarantors' shares. Accordingly, the Company
recorded an expense of  $1,296,600  during the nine months ended  September  30,
1999.

Guarantors

         In addition to guaranteeing obligations relating to the Debentures, the
Guarantors  guaranteed certain other obligations of the Company. As security for
some of the guarantees, the Guarantors pledged shares of the Company's

                                      30

<PAGE>



common stock  beneficially  owned by them. In March 1999,  143,230 of the shares
previously  pledged  by the  Guarantors  to a bank were sold by the bank and the
proceeds were used to pay Company  credit card balances and the related  accrued
interest  in  full  totaling  $244,824.  In May  1999,  100,000  of  the  shares
previously  pledged by the  Guarantors  to another  creditor of the Company were
sold by the  creditor  and the  proceeds,  totaling  $72,335,  were  used to pay
amounts owed by the Company.  In September 1999, the Company paid a note payable
to an unrelated  third party in the amount of $560,000 that had previously  been
guaranteed by the  Guarantors.  As of September  30, 1999, no guarantees  remain
outstanding.

Series D and Series E preferred stock

         During the nine months  ended  September  30, 1999,  131,667  shares of
Series D  preferred  stock  and  135,072  shares of  Series E  preferred  stock,
together with related  dividends on each,  were converted into 8,468,129  shares
and 5,729,156 shares, respectively, of the Company's Class A common stock. After
the above  conversions,  876,667  shares of Series D  preferred  stock  remained
outstanding as of September 30, 1999.  Subsequent to September 30, 1999, a total
of 494,944 shares of Series D preferred stock,  together with related dividends,
were converted into 34,591,946  shares of the Company's Class A common stock. As
of  December  13,  1999,  381,723  shares of  Series D  preferred  stock  remain
outstanding.

Class A common stock, stock options, and warrants

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

         During the nine months ended  September 30, 1999,  the Company  granted
754,500  stock  options to  employees at exercise  prices  ranging from $0.59 to
$1.78  per  share.  Additionally,  9,500  stock  options  were  granted  to  two
consultants for services  provided to the Company.  The fair market value of the
consultant  options  was  $1.30  per  share,  or  $12,540  in  total,  using the
Black-Scholes  pricing model and was charged to product development and research
expense.  The term of all options  granted  during this nine month period is ten
years  from the date of  grant.  Of the stock  options  issued,  726,334  vested
immediately,  18,834  vest six months  after  issuance  and 18,832 vest one year
after issuance.  As of September 30, 1999, the Company had a total of 15,536,582
options outstanding.

         During the nine months ended  September 30, 1999,  the Company  granted
warrants  to L&H in  connection  with loans made to the Company in April and May
1999 totaling $6,000,000. These warrants allow L&H to purchase 850,000 shares of
Class A common  stock of the Company at exercise  prices  ranging  from $0.60 to
$0.70 per share.  Of these warrants,  250,000 expired October 18, 1999,  without
being exercised. The remaining 600,000 warrants expire May 17, 2001.

         On February 11,  1998,  the Company  entered into a First  Statement of
Work and License  Agreement with Siemens under which the Company and Siemens are
jointly pursuing the development of Siemens' integrated  circuits  incorporating
ASR  and  other  related  technologies  for  use in  certain  telecommunications
applications.  In  connection  with  the  license  agreement  Siemens  purchased
warrants to acquire  1,000,000  shares of restricted  common stock at an average
exercise price of $20 per share with expiration  dates ranging from December 31,
1998 to December 31, 1999.  As of  September  30, 1999,  800,000 of the warrants
originally issued had expired and 200,000 of the warrants remain  outstanding at
an average exercise price of $30 per share.

         As of September 30, 1999, the Company had a total of 2,475,000 warrants
outstanding.

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

              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 product

                                      31

<PAGE>



development and research efforts,  and (v) the growth of the Company's  business
contain certain forward-looking  statements concerning the Company's operations,
economic  performance and financial  condition.  Because such statements involve
risks and  uncertainties,  actual  results  may  differ  materially  from  those
expressed  or implied by such  forward-looking  statements.  Factors  that could
cause such  differences  include,  but are not  necessarily  limited  to,  those
discussed in the Company's  Annual Report on Form 10-K (as amended) for the year
ended December 31, 1998.









                                      32

<PAGE>




PART II - OTHER INFORMATION

Item 1.  Legal Proceedings

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

The Company believes that the Clarke lawsuit is without merit and filed a motion
to  dismiss  based  upon the  court's  lack of  personal  jurisdiction  over the
Company. The court granted the Company's motion to dismiss. Clarke and Perpetual
Growth have appealed the dismissal, and such appeal has been denied. The Company
has filed a suit against  Clarke and  Perpetual  Growth in federal court for the
Central District of Utah seeking a declaratory judgment that it does not owe any
money to Clarke and Perpetual  Growth.  Now that the action in New York has been
dismissed, the Company intends to vigorously pursue the Utah action.

Papyrus - After the  Papyrus  acquisition  closed in October  1998,  the Company
investigated  some of the  representations  and  warranties  made by  Papyrus to
induce the Company to acquire  Papyrus.  The Company  determined that certain of
the representations  made by Papyrus and their executive officers appeared to be
inaccurate. On February 26, 1999, the Company filed an action against Papyrus in
the United States  District  Court for the District of Utah,  Central  Division,
wherein   the   Company   alleged   claims  for   misrepresentation,   negligent
misrepresentation,  breach of contract,  breach of the implied  covenant of good
faith and fair dealing and  rescission.  On March 11, 1999,  three of the former
shareholders of Papyrus filed an action against the Company in the United States
District Court for the District of  Massachusetts,  alleging a default under the
terms of the  promissory  notes  issued to them in  connection  with the Papyrus
acquisition.  On April 2, 1999, the three former Papyrus  shareholders  filed an
amended  complaint  against the Company seeking  additional  remedies  including
violation of Massachusetts  unfair and deceptive acts and practices statutes and
copyright  infringement.  On April 8, 1999, a fourth former Papyrus  shareholder
filed an action  against the Company  alleging a default  under the terms of the
promissory  notes issued to him in connection  with the Papyrus  acquisition and
seeking  additional  remedies  including  violation of Massachusetts  unfair and
deceptive acts and practices statutes and copyright  infringement.  On April 13,
1999,  a  fifth  former   Papyrus   shareholder   filed  a  similar   action  in
Massachusetts.  Subsequently,  the Company has entered into  agreements with the
five former Papyrus  shareholders  for dismissal of the actions and cancellation
of the promissory  notes upon payment to the former  shareholders  of $1,188,909
(the "Settlement Payment") and return for cancellation by the Company of 970,586
shares of  restricted  common  stock issued to the five former  shareholders  in
connection  with the  acquisition.  The  Company  agreed  to pay the  Settlement
Payment on or before  August 31,  1999 or, if the  definitive  proxy  soliciting
consents from the  shareholders  of the Company is effective prior to August 31,
1999, upon the closing of the sale of the HSG assets or the Company and the five
former Papyrus shareholders are free to pursue their respective claims.

OGI - On July 28, 1999,  Oregon  Graduate  Institute  ("OGI")  filed a notice of
default,  demand for  mediation  and demand for  arbitration  with the  American
Arbitration  Association.  In its demand, OGI asserted that Fonix was in default
under three separate  agreements between the Company and OGI in the total amount
of $175,000.00.  On or about September 23, 1999, the Company  responded to OGI's
demand  and  denied  the  existence  of a default  under  the  three  agreements
identified by OGI. Moreover,  the Company asserted a counterclaim against OGI in
an amount not less than $250,000.00.  The Company  anticipates that the American
Arbitration  Association  will conduct a scheduling  conference  within the next
twenty  days of  which  dates  for the  proceeding,  including  the  arbitration
hearing, will be set.

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

                                      33

<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:   December 29, 1999                  /s/ Douglas L. Rex
     ---------------------------------  ----------------------------------------
                                        Douglas L. Rex, Chief Financial Officer


                                      34