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

                                   FORM 10-Q


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

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

                      COMMISSION FILE NUMBER    0-23862
                                              ------------

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

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

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

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

                         ------------------------------
                         (Former address of registrant)

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 November 9, 1998, 62,828,552 shares of the issuer's common stock, par
value $.0001 per share, were issued and outstanding.
<PAGE>
 
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.
<PAGE>
 
                               FONIX CORPORATION
                         (A DEVELOPMENT STAGE COMPANY)

                     CONDENSED CONSOLIDATED BALANCE SHEETS
                                  (Unaudited)
<TABLE> 
<CAPTION> 
ASSETS
                                                                                                     September 30,    December 31,
                                                                                                          1998           1997
                                                                                                     -------------   --------------
<S>                                                                                                  <C>             <C> 
Current assets:                                                                         
   Cash and cash equivalents                                                                         $  20,053,030     $ 20,501,676
   Notes receivable                                                                                        822,139          600,000
   Accounts receivable, net                                                                                257,186                -
   Interest and other receivables                                                                           91,722           14,919
   Inventory                                                                                                65,523                -
   Prepaid expense                                                                                         136,775           32,094
   Stock subscription receivable                                                                         2,000,000                -
                                                                                                     -------------   -------------- 
      Total current assets                                                                              23,426,375       21,148,689

Property and equipment, net of accumulated depreciation of $955,944 and $464,100, respectively           2,462,907        1,567,279

Intangible assets, net of accumulated amortization of $764,502 and $25,509, respectively                24,984,215          138,951

Other assets                                                                                               130,302           39,647
                                                                                                     -------------   --------------
      Total assets                                                                                   $  51,003,799   $   22,894,566
                                                                                                     =============   ==============
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Bank overdraft                                                                                    $     178,757   $            -
   Revolving notes payable                                                                              20,034,536       18,612,272
   Notes payable - related party                                                                         6,737,453          551,510
   Notes payable - other                                                                                   100,000                -
   Accounts payable                                                                                      2,868,670          291,638
   Accrued liabilities                                                                                   1,133,388          505,619
   Accrued liabilities - related party                                                                     492,636          459,502
   Deferred revenues                                                                                       931,816                -
   Capital lease obligation - current portion                                                               55,227           49,325
                                                                                                     -------------   --------------
      Total current liabilities                                                                         32,532,483       20,469,866

Capital lease obligation, net of current portion                                                            10,039           52,225
                                                                                                     -------------   --------------
      Total liabilities                                                                                 32,542,522       20,522,091
                                                                                                     -------------   --------------
Commitments and contingencies (Notes 11 and 12)

Stockholders' equity:
   Preferred stock                                                                                      25,697,414        5,812,444
   Common stock                                                                                              5,859            4,358
   Additional paid-in capital                                                                           82,266,674       38,637,059
   Outstanding warrants                                                                                  3,258,928        2,936,360
   Deferred consulting expense                                                                            (186,725)               -
   Deficit accumulated during the development stage                                                    (92,580,873)     (45,017,746)
                                                                                                     -------------   --------------
      Total stockholders' equity                                                                        18,461,277        2,372,475
                                                                                                     -------------   --------------
      Total liabilities and stockholders' equity                                                      $ 51,003,799   $   22,894,566
                                                                                                     =============   ==============
</TABLE> 
    See accompanying notes to condensed consolidated financial statements.

                                       3
<PAGE>
 
                               FONIX CORPORATION
                         (A DEVELOPMENT STAGE COMPANY)

                CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)


<TABLE> 
<CAPTION> 
                                                                                                       OCTOBER 1,
                                               THREE MONTHS ENDED            NINE MONTHS ENDED            1993
                                                  SEPTEMBER 30,                 SEPTEMBER 30,        (INCEPTION) TO
                                           --------------------------   ---------------------------   SEPTEMBER 30,
                                               1998           1997          1998           1997           1998
                                           ------------   -----------   ------------   ------------   ------------- 
<S>                                        <C>            <C>           <C>            <C>            <C>
Revenues                                   $    199,017   $       -     $  2,671,302   $        -     $  2,671,302
Cost of revenues                                 33,164           -           57,353            -           57,353
                                           ------------   -----------   ------------   ------------   ------------  
  Gross profit                                  165,853           -        2,613,949            -        2,613,949
                                           ------------   -----------   ------------   ------------   ------------  
Expenses:
 Purchased in-process research and
  development                                 5,500,000           -       23,339,840            -       23,339,840
 Product development and research             4,419,400     1,650,371     10,080,895      4,715,650     28,018,188
 Selling, general and administrative          4,048,834     2,185,169      7,769,085      5,935,838     30,015,755
                                           ------------   -----------   ------------   ------------   ------------  

    Total expenses                           13,968,234     3,835,540     41,189,820     10,651,488     81,373,783
                                           ------------   -----------   ------------   ------------   ------------  

Loss from operations                        (13,802,381)   (3,835,540)   (38,575,871)   (10,651,488)   (78,759,834)
                                           ------------   -----------   ------------   ------------   ------------  
Other income (expense):
 Interest income                                292,526       279,671        856,408        882,096      3,448,475
 Interest expense                              (378,636)   (1,697,550)      (973,537)    (3,203,735)    (4,826,080)
 Cancellation of common stock
  reset provisions                           (6,111,577)          -       (6,111,577)           -       (6,111,577)
                                           ------------   -----------   ------------   ------------   ------------  

    Total other expense, net                 (6,197,687)   (1,417,879)    (6,228,706)    (2,321,639)    (7,489,182)
                                           ------------   -----------   ------------   ------------   ------------  

Loss before extraordinary items             (20,000,068)   (5,253,419)   (44,804,577)   (12,973,127)   (86,249,016)

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

Net loss                                   $(20,000,068)  $(6,135,283)  $(44,804,577)  $(13,854,991)  $(87,100,332)
                                           ============   ===========   ============   ============   ============  
Basic and diluted net loss per
 common share                              $      (0.42)  $     (0.18)  $      (0.94)  $      (0.37)
                                           ============   ===========   ============   ============
</TABLE> 

    See accompanying notes to condensed consolidated financial statements.

                                      

                                       4
<PAGE>
 
                               fonix corporation
                         (A Development Stage Company)

                CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (Unaudited)
               Increase (Decrease) in Cash and Cash Equivalents
<TABLE> 
<CAPTION>                                                                                   
                                                                                            
                                                                                                                    October 1,     
                                                                                     Nine Months Ended                 1993        
                                                                                        September 30,             (Inception) to  
                                                                              --------------------------------     September 30,   
                                                                                   1998              1997              1998      
                                                                              ---------------   --------------   ----------------
<S>                                                                           <C>               <C>              <C> 
Cash flows from operating activities:
   Net loss                                                                   $   (44,804,577)  $  (13,854,991)   $   (87,100,332) 
   Adjustments to reconcile net loss to net cash
     used in operating activities:
     Issuance of common stock for services                                                  -        1,120,004          5,437,240  
     Issuance of common stock for patent                                              100,807                -            100,807
     Non-cash expense related to issuance of debentures,                                                           
       warrants, preferred stock and common stock                                   6,111,577        2,489,336         10,078,914  
     Non-cash compensation expense related to issuance                                                             
       of stock options                                                               133,375                -          2,416,275
     Non-cash expense related to issuance of notes payable and                                                     
       accrued expense for services                                                   857,000                -            857,000
     Non-cash expense related to exchange of notes receivable for services            150,000                -            150,000
     Non-cash expense related to purchased in-process research and development     22,839,608                -         22,839,608
     Gains (losses) on asset disposals                                                    (88)               -              1,193
     Depreciation and amortization                                                  1,210,935          237,784          1,700,544 
     Extraordinary loss on extinguishment of debt                                           -          881,864            881,864
     Extraordinary gain on forgiveness of debt                                              -                -            (30,548)
     Changes in assets and liabilities, net of acquisitions:                                                       
       Accounts receivable, net                                                      (183,418)               -           (183,418)
       Interest and other receivables                                                 (74,009)         157,643            (88,928)
       Inventory                                                                       (8,358)               -             (8,358)
       Prepaid expense                                                               (100,281)        (152,689)          (132,375) 
       Other assets                                                                   (80,212)         (18,420)          (119,859)
       Accounts payable                                                             2,381,610           40,870          4,453,448 
       Accrued liabilities                                                            482,568       (1,006,905)         1,116,168 
       Accrued liabilities - related party                                           (370,966)          (4,978)            88,536 
       Deferred revenues                                                                2,126                -              2,126
                                                                                -------------    -------------     -------------- 
     Net cash used in operating activities                                        (11,352,303)     (10,110,482)       (37,540,095)
                                                                                -------------    -------------     --------------  
CASH FLOWS FROM INVESTING ACTIVITIES, NET OF EFFECTS OF ACQUISITIONS:
   Acquisition of subsidiaries, net of cash acquired                              (14,738,495)               -        (14,738,495) 
   Purchase of property and equipment                                              (1,240,540)        (625,597)        (3,271,919)  
   Proceeds from sale of equipment                                                        500                -                500 
   Investment in intangible assets                                                    (94,789)         (75,035)          (259,249)
   Issuance of notes receivable                                                    (1,322,139)        (883,600)        (3,805,739) 
   Payments received on notes receivable                                                    -        1,633,600          1,883,600
                                                                                -------------    -------------     --------------  
     Net cash (used in) provided by investing activities                          (17,395,463)          49,368        (20,191,302)
                                                                                -------------    -------------     --------------  
CASH FLOWS FROM FINANCING ACTIVITIES:
   Bank overdraft                                                                     178,757                -            178,757
   Net proceeds from revolving note payable                                         1,422,264        3,352,637         20,034,536   
   Net (payments) proceeds on revolving note payable - related party                 (514,296)         760,000             37,214 
   Proceeds from notes payable - other                                                100,000                -          2,451,667
   Payments on notes payable - other                                                  (49,250)               -         (1,829,056)
   Principal payments on capital lease obligation                                     (36,284)               -            (79,665)
   Proceeds from issuance of convertible debentures, net                                    -        2,685,000          3,185,000 
   Proceeds from sale of warrants                                                     322,928                -            922,928
   Proceeds from sale of common stock, net                                         17,471,155          425,000         38,175,700  
   Proceeds from sale of Series B, C and D preferred stock, net                     9,403,846                -         14,707,346
                                                                                -------------    -------------     --------------  
     Net cash provided by financing activities                                     28,299,120        7,222,637         77,784,427 
                                                                                -------------    -------------     --------------  
Net increase (decrease) in cash and cash equivalents                                 (448,646)      (2,838,477)        20,053,030 

Cash and cash equivalents at beginning of period                                   20,501,676       22,805,786                  -
                                                                                -------------    -------------     --------------  
Cash and cash equivalents at end of period                                      $  20,053,030    $  19,967,309     $   20,053,030
                                                                                =============    =============     ==============

</TABLE> 
    See accompanying notes to condensed consolidated financial statements.

                                       5
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)

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

<TABLE> 
<CAPTION> 
                                                                                      
                                                                                      October 1,
                                                            Nine Months Ended            1993
                                                              September 30,         (Inception) to 
                                                           ----------------------    September 30,
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:              1998       1997           1998
                                                           ----------  ----------   --------------
<S>                                                        <C>         <C>          <C> 
   Cash paid during the period for interest                $  747,629   $ 771,037     $  2,784,648
</TABLE> 

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

   FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998:

   The Company has 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 (see Note 8).

   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 (see Note 8).

   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.

   FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997:

   A $500,000 Series A Convertible Debenture was converted into 166,667 shares 
       of Series A Preferred Stock.

   Series B Convertible Debentures in the amount of $850,000 and related 
       accrued interest of $7,850 were converted into 145,747 shares of common
       stock.

   Series B Convertible Debentures in the amount of $2,150,000 and related 
       accrued interest of $28,213 were converted into 108,911 shares of 
       Series B Preferred Stock.

   Preferred Stock Dividends of $2,647,171 were recorded related to the 
       beneficial conversion features and accretion of Series B and Series C
       Convertible Preferred Stock.

    See accompanying notes to condensed consolidated financial statements.

                                       6
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

These condensed consolidated financial statements reflect all adjustments
(consisting only of normal recurring adjustments) that, in the opinion of
management, are necessary to present fairly the financial position and results
of operations of the Company as of the balance sheet dates and for the periods
presented.

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

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

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

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

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

NET LOSS PER COMMON SHARE - Basic and diluted net loss per common share are
calculated by dividing net loss attributable to common stockholders by the
weighted average number of shares of common stock outstanding during the period.
At September 30, 1998 and 1997, there were outstanding common stock equivalents
to purchase 38,321,643 and 9,982,403 shares of common stock, respectively, that
were not included in the computation of diluted net loss per common share as
their effect would have been anti-dilutive, thereby decreasing the net loss per
common share.  Net loss per common share amounts have been restated for all
periods presented to reflect basic and diluted per share presentations.

                                       7
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


The following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the three and nine months ended 
September 30, 1998 and 1997:
<TABLE>
<CAPTION>
                                                             Three Months Ended September 30,
                                                    ---------------------------------------------------
                                                               1998                      1997
                                                    -------------------------  ------------------------
                                                                   Per Share                 Per Share
                                                        Loss         Amount        Loss        Amount
                                                    -------------  ----------  ------------  ----------
<S>                                                 <C>            <C>         <C>           <C>
Loss before extraordinary items                     $(20,000,068)              $(5,253,419)

Preferred stock dividends                             (2,626,890)               (1,660,718)
                                                    ------------               -----------
Loss attributable to common stockholders
 before extraordinary items                          (22,626,958)     $(0.42)   (6,914,137)     $(0.16)
 
Extraordinary loss on extinguishment of
 debt                                                          -           -      (881,864)      (0.02)
                                                    ------------   ---------   -----------   ----------

Net loss attributable to common
 stockholders                                       $(22,626,958)     $(0.42)  $(7,796,001)     $(0.18)
                                                    ============   =========   ===========   =========

Weighted average common shares
 outstanding                                          54,020,736                42,192,776
                                                    ============               ===========
</TABLE>

<TABLE>
<CAPTION>
                                                              Nine Months Ended September 30,
                                                    ----------------------------------------------------
                                                               1998                      1997
                                                    -------------------------  -------------------------
                                                                   Per Share                  Per Share
                                                        Loss         Amount        Loss         Amount
                                                    -------------  ----------  -------------  ----------
<S>                                                 <C>            <C>         <C>            <C>
Loss before extraordinary items                     $(44,804,577)              $(12,973,127)

Preferred stock dividends                             (2,758,550)                (1,660,718)
                                                    ------------               ------------
Loss attributable to common stockholders
 before extraordinary items                          (47,563,127)     $(0.94)   (14,633,845)     $(0.35)
                                                                      
 
Extraordinary loss on extinguishment of
 debt                                                          -           -       (881,864)      (0.02)
                                                    ------------      ------   ------------      ------
Net loss attributable to common
 stockholders                                       $(47,563,127)     $(0.94)  $(15,515,709)     $(0.37)
                                                    ============      ======   ============      ======

Weighted average common shares
 outstanding                                          50,385,468                 42,053,697
                                                    ============               ============
</TABLE>

                                       8
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


2.  ACQUISITIONS

The Company created a wholly-owned subsidiary ("fonix/Articulate") for the sole
purpose of acquiring Articulate Systems, Inc. ("ASI"), a Delaware corporation,
in September 1998. ASI was a provider of sophisticated voice recognition
products to specialized segments of the health care industry. Those same
products and services are now provided by the Company's HealthCare Solutions
Group. The acquisition was closed on September 2, 1998. The Company delivered to
the former ASI stockholders 5,140,751 shares of restricted common stock (having
a market value of $8,353,720 on that date), cash payment of $7,787,249 and 8.5
percent demand notes in the aggregate amount of $4,747,339. Additionally, the
Company has agreed in principle to issue stock options in exchange for all of
ASI's stock options outstanding on the date of acquisition (see Note 8).
Subsequent to the acquisition, the Company agreed to pay several ASI employees
incentive compensation for continued employment in the aggregate amount of
$857,000, in connection with which the Company issued 8.5 percent demand notes
for $452,900 and recorded an accrued liability of $404,100 for the balance. The
demand notes issued to both the ASI stockholders and the ASI employees are
payable after November 1, 1998. The $404,100 accrued liability is payable on or
before January 31, 1999. The ASI acquisition was accounted for as a purchase.

The excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of ASI was $23,584,256, of which $13,700,000 was
capitalized as the purchase cost of completed technology, $4,384,256 was
capitalized as goodwill and other intangibles and $5,500,000 was expensed as
purchased in-process research and development.  These allocations were based on
a third-party valuation of the relative fair values.

The Company also created a wholly-owned subsidiary for the sole purpose of
acquiring AcuVoice, Inc. ("AcuVoice"), a California corporation, in March 1998.
After the acquisition, the acquisition subsidiary changed its name to
fonix/AcuVoice, Inc. ("fonix/AcuVoice"). AcuVoice developed and marketed text-
to-speech or speech synthesis technologies and products directly to end-users,
systems integrators and original equipment manufacturers for use in the
telecommunications, multi-media, education and assistive technology markets.
Those same products and services are now provided by the Company's Interactive
Technologies Solutions Group.  The AcuVoice acquisition was closed on March 13,
1998.  The Company issued 2,692,216 shares of restricted common stock (having a
market value of $16,995,972 on that date) and paid a cash payment of
approximately $8,000,000 for all of the then outstanding common shares of
AcuVoice.  The acquisition was accounted for as a purchase.

The excess of the purchase price over the estimated fair market value of the
acquired tangible net assets of AcuVoice was $25,339,840, of which $6,750,000
was capitalized as the purchase cost of the completed technology, $750,000 was
capitalized as goodwill and $17,839,840 was expensed as purchased in-process
research and development.  These allocations were based on a third-party
valuation of the relative fair values.

The following unaudited pro forma financial statement data for the three and
nine months ended September 30, 1998 and 1997 present the results of operations
of the Company as if the acquisitions of AcuVoice and ASI had occurred at the
beginning of each three and nine-month period.  The pro forma results have been
prepared for comparative purposes only and do not purport to be indicative of
what would have occurred had the acquisitions been made at the beginning of the
applicable period or of future results. Expenses related to purchased in-process
research and development related to the acquisitions of AcuVoice and ASI of
$17,839,849 and $5,500,000, respectively, were recorded at the date of the
acquisitions and are not presented in the following pro forma financial
statement data since they are non-recurring charges directly attributable to the
acquisitions.

                                       9
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

<TABLE>
<CAPTION>
 
                                   Three Months Ended September 30,    Nine Months Ended September 30,
                                   ---------------------------------   -------------------------------
                                         1998              1997              1998            1997
                                   ----------------  ---------------   ---------------  --------------
<S>                                <C>               <C>               <C>              <C> 
Revenues                               $    239,980     $    195,517     $  3,233,621   $      755,191
                                                                        
Loss before extraordinary items         (15,583,360)      (6,966,077)     (31,373,544)     (18,152,534)
                                                                        
Net loss                                (15,583,360)      (7,847,941)     (31,373,544)     (19,034,398)
                                                                        
Basic and diluted net loss                                              
   per common share                           (0.32)           (0.20)           (0.63)           (0.44)
</TABLE>

3.  CERTIFICATE OF DEPOSIT

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

4.  NOTES RECEIVABLE

As of September 30, 1998, the Company had short-term, unsecured, demand notes
receivable from two unrelated entities in the amounts of $662,139 and $160,000
which notes were issued in connection with the Company's intended acquisition of
these entities.  Interest begins to accrue at an annual rate of six percent on
the date which is 90 days after the Company demands payment, which the Company
may do if both parties agree that the acquisition of any entity will not
proceed.

Previously, the Company had entered into short-term, unsecured, demand notes
receivable agreements with two unrelated entities in the amounts of $100,000 and
$50,000 which were issued in connection with the Company's intended acquisition
of these entities.  The Company no longer intends to pursue these acquisitions,
and has canceled these notes as consideration for product development and
research services rendered by these entities to the Company.

5.  INTANGIBLE ASSETS

Intangible assets consist of the purchase cost of completed technology, goodwill
and other intangibles in connection with the acquisitions of AcuVoice and ASI
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 of the completed technology, goodwill, other intangibles
and patents of four to eight years.

6.  NOTES PAYABLE

As of September 30, 1998, the Company had a revolving note payable to a bank in
the amount of $19,984,536.  Loaned amounts under the revolving note payable are
limited, in the aggregate at any time, to $20,000,000.  The weighted average
outstanding balance during the nine months ended September 30, 1998 was
$18,121,205.  This note was due October 29, 1998, bore interest at an annual
rate of 6.55 percent, and is secured by a certificate of deposit in the amount
of $20,000,000 (see Note 3).  This revolving note is renegotiated quarterly and
interest is payable monthly. As of September 30, 1998, the Company owed the bank
$309,457 in past due interest. Subsequently, all such amounts were paid to the
bank and the note has been negotiated to extend the maturity date of the note to
December 4, 1998. The Company plans to continue renewing the note indefinitely.


                                       10
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

As of September 30, 1998, the Company had an unsecured revolving note payable to
a bank in the amount of $50,000. Loaned amounts under the revolving note payable
are limited, in the aggregate at any time, to $50,000.  The weighted average
outstanding balance during the nine months ended September 30, 1998 was $2,390.
This note is payable on demand and bears interest at an annual rate of 10.5
percent.

As of September 30, 1998, the Company had an unsecured, non-interest bearing
demand note payable in the amount of $100,000 to  Synergetics, Inc.
("Synergetics"), a  research and development entity (see Note 11).  This note is
payable on demand.

7.  RELATED-PARTY NOTES PAYABLE

As of September 30, 1998, the Company had unsecured demand notes payable to ASI
stockholders in the aggregate amount of $4,747,339, which notes were issued in
connection with the ASI acquisition on September 2, 1998 (see Note 2).  These
demand notes bear interest at an annual rate of 8.5 percent and are payable
after November 1, 1998.

As of September 30, 1998, the Company had unsecured demand notes payable to
various ASI employees in the aggregate amount of $452,900.  The Company agreed
to pay several ASI employees incentive compensation for continued employment  in
the aggregate amount of $857,000, for which the Company issued demand notes for
$452,900 and recorded an accrued liability of $404,100 for the balance (see 
Note 2).  The demand notes bear interest at an annual rate of 8.5 percent and 
are payable after November 1, 1998.

In connection with the acquisition of certain liabilities of ASI pursuant to the
ASI merger (see Note 2), the Company executed and delivered a $1,500,000
unsecured demand note payable to a company which is a stockholder of the
Company. This demand note bears interest at an annual rate of 8.5 percent and is
payable after November 1, 1998.

As of September 30, 1998, the Company had a $37,214 unsecured revolving note
payable to a company owned by three individuals who are executive officers and
directors of the Company and who each beneficially own more than ten percent of
the Company's common stock.  The weighted average balance outstanding during the
nine months ended September 30, 1998 was $85,967.  This revolving note is
payable on demand and bears interest at an annual rate of 12 percent.  The
maximum amount outstanding under this revolving note was $551,510 during the
nine months ended September 30, 1998. The Company believes the terms of the
related-party revolving note payable are at least as favorable to the Company as
the terms that could have been obtained from an unrelated third party in a
similar transaction.

8.  STOCKHOLDERS' EQUITY

COMMON STOCK - During the nine months ended September 30, 1998, the Company
issued 15,002,758 shares of common stock.  Of such shares, 5,390,476 shares were
issued in connection with a private placement (see below), 7,832,967 shares 
were issued in connection with the acquisitions of AcuVoice and ASI (see 
Note 2), 1,489,501 shares were issued upon the conversion of Series B and C
Convertible Preferred Stock and related dividends, 265,000 shares were issued
upon the exercise of previously granted warrants and options and 24,814 shares
were issued for the purchase of a patent.

PRIVATE PLACEMENT - On March 12, 1998, the Company completed a private placement
(the "Offering") of up to 6,666,666 shares of its restricted common stock to
seven accredited investors (the "Investors"). The total purchase price to be
paid by the Investors pursuant to the Offering was $30,000,000. Of that amount,
$15,000,000 was received by the Company on March 12, 1998, in return for which
the Company issued a total of 3,333,333 shares of restricted common stock.
Finders' fees of $870,000 were paid in connection with the $15,000,000 received.
The remainder of the purchase price was to be paid by the Investors on July 27,
1998 (60 days after the effectiveness of a registration statement that the
Company filed with the Securities and Exchange Commission covering the common
stock issued and
                                       11
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


issuable to the investors) (the "Second Funding Date"), provided that, as of
such date, certain conditions were satisfied. Certain conditions precedent to
receiving the additional funding were not met as of the Second Funding Date. In
separate transactions in June and August 1998, certain Investors paid to the
Company $3,000,000 in return for which the Company issued 666,667 additional
shares under the terms and conditions set forth in the Offering documents.
Finders' fees of $163,846 have been accrued in connection with the $3,000,000
received. No other payment has been received by the Company pursuant to the
Offering, and the Company does not expect any further payment to be made.

The Investors acquired certain "reset rights" in connection with the Offering
pursuant to which the Investors would receive additional shares of restricted
common stock ("Reset Shares") if the average market price of the Company's
common stock for the 60-day period following the initial closing date did not
equal or exceed $5.40 per share.  On August 31, 1998, the Company and the
Investors in the Offering restructured the reset provision whereby the Company
issued 608,334 shares of Series D 4%  Convertible Preferred Stock ("Series D")
and 1,390,476 shares of common stock for (i) the relinquishment of the
Investors' contractual right to receive Reset Shares in connection with the
$15,000,000 received in March 1998, and the $3,000,000 received in June and
August 1998, and (ii) a financing cost in connection with the issuance of
500,000 shares of Series D.  In connection with the restructuring, the Company
recorded an expense of $6,111,577 for the difference between the Company's
original obligation to issue additional shares under the "reset rights"
provision in the Offering and the fair value of the shares that were actually
issued in settlement for the relinquishment of the reset provision, and recorded
a preferred stock dividend of $1,000,000 related to financing costs in
connection with the issuance of 500,000 shares of Series D (see Series D
Preferred Stock below).

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

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

SERIES D PREFERRED STOCK - On August 31, 1998, the Company entered into an
agreement with the Investors whereby the Company issued 500,000 shares of the
Company's Series D for $10,000,000.  Additionally, the Company issued to certain
of the Investors a total of 608,334 shares of Series D (i) in return for their
relinquishment of their contractual right to receive Reset Shares in connection
with the Offering (see Private Placement above), and as (ii) an additional cost
of raising the $10,000,000 from the Series D placement.  Dividends accrue on the
stated value ($20 per share) of Series D at the rate of 4 percent per year, are
payable annually or upon conversion, in cash or common stock, at the option of
the Company, and are convertible into shares of the Company's common stock at
the holder's option anytime after the earlier of November 29, 1998 or the date
the registration statement which the Company has agreed to file with the
Securities and Exchange Commission covering the common stock issuable upon the
conversion of the Series D is declared effective.  Each month the holders of the
Series D may not convert more than 25 percent of the total number of shares of
Series D originally issued to such holders on a cumulative basis.  For example,
during the first month a holder may convert up to 25% of the total preferred
stock issued to the holder, and during the following month that same holder may
convert, on an aggregate to date basis, up to 50% of the total number of shares
of Series D held by the holder. Additionally, each month, the holders may
convert up to 50 percent of the total number of shares of Series D originally
issued to such holders on a cumulative basis, if both of the following
conditions are satisfied: the average daily trading volume of the Company's
common stock is more than 500,000 shares for the 10-trading-day period before
the conversion; and the average per share closing bid price for such 10-trading-
day period has not decreased by more than 5 percent during that 10-trading-day
period. Any outstanding shares of Series D as of August 31, 2001 automatically
will be converted at the conversion price described below most beneficial to the
holders on such date. In the event of liquidation, the holders of the Series D
are entitled to an amount equal to the stated value ($20 per share) plus accrued
but unpaid dividends whether declared or not. The holders of Series D have no
voting rights. The Series D shares,
                                       12
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


together with dividends accrued thereon, may be converted into shares of the
Company's common stock at the lesser of: $3.50 per share; or the lesser of 110
percent of the average per share closing bid price for the 15 trading days
immediately preceding the date of issuance of the Series D shares; or 90 percent
of the average of the three lowest per share closing bid prices during the 22
trading days immediately preceding the conversion date. In the event that the
holders convert at the $3.50 per share price, the Company is obligated to issue
warrants to purchase 0.8 shares of common stock for each share of Series D
converted to common stock. Using the conversion terms most beneficial to the
holder, the Company is amortizing a beneficial conversion feature of $2,462,964
as a dividend over a 180 day-period.

SERIES E PREFERRED STOCK - Effective as of September 30, 1998, the Company
entered into an agreement with two of the Investors whereby the Company issued
100,000 shares of the Company's Series E 4% Convertible Preferred Stock ("Series
E") for $2,000,000.  Additionally, the Company issued to the purchasers of the
Series E a total of 150,000 additional shares of Series E in exchange for which
those purchasers surrendered a total of 150,000 shares of Series D. Dividends
accrue on the stated value ($20 per share) of Series E at a rate of 4 percent
per year, are payable annually or upon conversion, in cash or common stock, at
the option of the Company, and are convertible into shares of the Company's
common stock at anytime at the holder's option.  Any outstanding shares of
Series E as of September 30, 2001 are automatically converted at the conversion
price described below most beneficial to the holders on such date. In the event
of liquidation, the holders of the Series E are entitled to an amount equal to
the stated value ($20 per share) plus accrued but unpaid dividends whether
declared or not. The holders of Series E have no voting rights. The Series E,
together with dividends accrued thereon, may be converted into shares of the
Company's common stock at the lesser of: $3.50 per share; or the lesser of 110
percent of the average per share closing bid price for the 15 trading days
immediately preceding the date of issuance of the Series E shares; or 90 percent
of the average of the three lowest per share closing bid prices during the 22
trading days immediately preceding the conversion date. If the Investors convert
at the $3.50 per share price, the Company is obligated to issue warrants to
purchase 0.8 shares of common stock for each share of Series E converted to
common stock. Using the conversion terms most beneficial to the holder, the
Company recorded a preferred stock dividend of $968,047 for the beneficial
conversion feature of the Series E. As of September 30, 1998, no shares of
Series E had been converted to common stock. On November 4, 1998, 50,000 shares
of Series E and related dividends were converted into 1,130,805 shares of common
stock.

COMMON STOCK OPTIONS - During the nine months ended September 30, 1998, the
Company granted options to purchase 2,734,000 shares of common stock. Of such
options, 450,000 (having an exercise price of $5.16 per share) were granted to
three individuals who are executive officers and directors of the Company and
who each beneficially own more than ten percent of the Company's common stock;
355,000, 1,240,000, and 589,000 options were granted to various employees at
exercise prices of $3.34, $3.54, and $6.50 per share, respectively, and 100,000
options were granted to an unrelated party for services with an exercise price
of $3.75 per share. The term of all options granted during the nine months ended
September 30, 1998 is ten years from the date of grant. Additionally, the
Company has agreed in principle to issue stock options in exchange for the ASI
stock options in connection with the acquisition of ASI (see Note 2). These
options will have expiration dates ranging from January 1, 2001 to November 2,
2002. As of September 30, 1998, the Company had a total of 13,319,920 options
outstanding.

On June 1, 1998, the Company's board of directors approved the 1998 Stock Option
and Incentive Plan (the "Plan") for directors, employees and other persons
acting on behalf of the Company, under which the aggregate number of shares
authorized for issuance is 10,000,000.  On July 14, 1998, the Company's
shareholders approved the Plan.  The Plan is administered by a committee
consisting of two or more directors of the Company.  The exercise price for
these options is the closing market price of the stock on the date the options
are granted.  The option term is ten years from the date of grant.
                                       13
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


9.  RELATED-PARTY TRANSACTIONS

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

The Company subleases office space leased by a company owned by the three
individuals described above.  The rent and other related charges are passed
through without mark-up to the Company:

<TABLE>
<CAPTION>
                               Nine months Ended September 30,
                               -------------------------------
                                    1998             1997
                               ---------------  --------------
<S>                            <C>              <C>
Expenses:
     Base rent                         $83,788         $57,900
     Leasehold improvements             35,247               -
Liabilities:
     Accrued liabilities                44,846           5,772
</TABLE>

During 1996, disinterested members of the Company's Board of Directors
authorized the Company to reimburse three executive officers for all taxes
payable by them in conjunction with the 1995 exercise of 3,700,000 warrants by a
company owned by them.  The total authorized reimbursement was $1,150,000 in
1997 and $1,350,000 in 1996.  As of September 30, 1998, the Company had paid the
total authorized reimbursement of $2,500,000, $340,516 of which was paid during
the nine months ended September 30, 1998.

10.  STATEMENTS OF WORK

On February 11, 1998, the Company entered into a Restated First Statement of
Work and License Agreement with Siemens Semiconductor Group of Siemens
Aktiengesellschaft ("Siemens"). The Company and Siemens are jointly pursuing the
development of Siemens' integrated circuits incorporating the Company's
technologies for use in certain telecommunications applications. On February 20,
1998, the Company received $2,691,066 in cash from Siemens. Of that amount: (1)
$1,291,712 was paid to the Company as a non-refundable payment to license
certain automatic speech recognition technologies for which the Company has no
further obligation; (2) $322,928 was paid to purchase warrants to acquire
1,000,000 shares of the Company's restricted common stock at an average exercise
price of $20 per share with expiration dates ranging from December 31, 1998 to
December 31, 1999; and (3) $1,076,426 was paid to the Company to acquire, if
Siemens so elected, shares of the Company's restricted common stock or to become
a non-refundable license payment. In June 1998, Siemens elected to apply the
$1,076,426 portion as a non-refundable payment to license certain automatic
speech recognition technologies for which the Company has no further obligation.

The Company recorded the $1,291,712 and $1,076,426 license payments as revenue
during the nine months ended September 30, 1998.

11.  PRODUCT DEVELOPMENT AND RESEARCH

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

                                       14
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


acquired intellectual property rights, technologies and technology rights that
were developed by Synergetics and that pertained to the ASR technologies. The
Company agreed to provide all funding necessary for Synergetics to develop
commercially viable technologies. There was no minimum requirement or maximum
limit with respect to the amount of the funding to be provided by the Company.
However, under the terms of the Synergetics Agreement, the Company was obligated
to use its best efforts in raising the necessary funding for the engineering,
development and marketing of the ASR technologies. As part of the Synergetics
Agreement, the Company agreed to pay Synergetics a royalty of ten percent of
gross revenues from sales of its ASR technologies (the "Royalty"). Under the
terms of the Synergetics Agreement, the Company paid to Synergetics $125,995 and
$1,628,433 for the three and nine months ended September 30, 1998, respectively,
for product development and research efforts.

Until March 1997, Synergetics had compensated its engineers, employees, members
of its development team, and other financial backers (collectively, the
"Developers"), in part, with the issuance of "Project Shares" granting the
holders of such shares the right, within limits, to share pro rata in future
Royalty payments by the Company.  In addition to issuance of Project Shares,
Synergetics had made cash advances to some members of its project team (which
members are not employees of the Company) on a non-recourse basis.  Repayment
of those advances was secured by future disbursements, if any, under the
borrower's Project Shares.

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

12.  COMMITMENTS AND CONTINGENCIES

OPERATING LEASE AGREEMENT - In June 1998, the Company entered into a long-term
noncancellable operating lease agreement for a facility in Cupertino,
California, which houses its Silicon Valley operations.  Future aggregate
minimum obligations under this operating lease are as follows:
<TABLE>
<CAPTION>
Years ending December 31,
<S>                           <C>
          1998                         $  163,883
          1999                            292,899
          2000                            308,474
          2001                            320,531
          2002                            332,589
          Thereafter                      140,672
                                       ----------
 
            Total                      $1,559,048
                                       ==========
</TABLE>

The Company has a noncancellable operating lease agreement for a facility in
Woburn, Massachusetts, which houses its HealthCare Solutions and Interactive
Technologies Solutions Groups.  Future aggregate minimum obligations under this
operating lease for the years ended December 31, 1998 and 1999 are $89,373 and
$245,776, respectively.

                                       15
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


PROFESSIONAL SERVICES AGREEMENT - Effective May 7, 1998, the Company entered
into a one-year professional services agreement with a public relations firm.
The minimum monthly retainer is $15,000 per month.  In connection with this
agreement, the firm was granted options to purchase 100,000 shares of the
Company's common stock at $3.75 per share.  The options have a ten-year term and
are fully vested.  In connection with this transaction, the Company recorded
$320,100 of consulting expense, of which $186,725 is deferred as of 
September 30, 1998, and will be recognized ratably over the life of the 
agreement.

LITIGATION - 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 assert claims for breach of contract relating to certain
financing the Company received during 1998. Specifically, Clarke and Perpetual
Growth allege that they entered into a contract with the Company under which the
Company agreed to pay them a commission of 5 percent of all financing provided
to the Company 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, subject to the
right of Clarke and Perpetual Growth to produce additional evidence which would
establish jurisdiction of the New York court over the Company.  Even if such
evidence is available, the Company intends to vigorously defend the claims
asserted in that action.  However, Clarke and Perpetual Growth could prevail in
the lawsuit, in which case the Company may be required to pay significant
amounts of monetary damages or other amounts awarded by the court.  At a
minimum, the ongoing nature of this action will result in some diversion of
management time and effort from the operation of the business.

On March 11, 1998, an action (the "J&L Action") was filed against the Company in
the Supreme Court of the State of New York for the County of New York by Jesup &
Lamont Securities Corporation ("J&L").  The J&L Action alleged that the Company
was obligated to pay a fee in excess of $1,200,000 plus 30,000 shares of the
Company's restricted common stock in connection with the Offering (see Note 8).
The J & L Action was settled upon payment of $385,000 by the Company to J&L.
The J&L Action has been dismissed with prejudice.

On July 9, 1998, the Company settled a case brought by a shareholder of the
Company against certain directors of the Company and K.L.S. Enviro Resources,
Inc. ("KLSE"), a third party affiliated with certain of the director-defendants.
Pursuant to the settlement, and at no cost to the Company, the Company received
warrants to purchase 583,000 shares of KLSE common stock at a purchase price of
$0.40 per share.

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

13.  SUBSEQUENT EVENTS

NOTE PAYABLE - Subsequent to September 30, 1998, in connection with the
employment of a person as an officer of the Company, the Company issued a
$20,000 unsecured note payable to that officer.  This note bears interest at ten
percent and is due on December 31, 1998.

ACQUISITIONS - The Company created a wholly-owned subsidiary for the purpose of
acquiring Papyrus Associates, a Pennsylvania corporation and Papyrus
Development, a Massachusetts corporation, in October 1998.  Papyrus Associates

                                       16
<PAGE>
 
                               FONIX CORPORATION
                         (A Development Stage Company)
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)


is now marketed by the Company's Interactive Technologies Solutions Group.  On
October 29,1998, the Company acquired 100 percent of the outstanding common
stock of Papyrus Associates for the issuance of 1,076,926 shares of the
Company's restricted common stock (having a market value of $1,110,580 on that
date) and promissory notes to the shareholders of Papyrus Associates totaling
$360,000, due the fifth business day following the closing of the Company's next
equity funding, but no later than February 28, 1999 and notes totaling $180,000,
due April 30, 1999.  These notes bear interest at an annual rate of six percent.

Papyrus Development has developed and has expertise in embedded systems and
enhanced Internet applications.  Such activities are now conducted by the
Company's Interactive Technologies Solutions Group.  On October 29,1998, the
Company acquired 100 percent of the outstanding common stock of Papyrus
Development for the issuance of 2,034,188 shares of the Company's restricted
common stock (having a market value of $2,097,756 on that date) and promissory
notes to the shareholders of Papyrus Development totaling $490,000, due the
fifth business day following the closing of the Company's next equity funding,
but no later than February 28, 1999, notes totaling $340,000, due February 28,
1999 and notes totaling $340,000, due September 30, 1999.  These notes bear
interest at an annual rate of six percent. These acquisitions will be accounted
for as purchases.

                                       17
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

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

OVERVIEW
--------

fonix is a development stage company that aims to make commercially
available a comprehensive package of human-computer interaction technology
products and solutions.  The Company has developed proprietary automatic
computer voice recognition technologies and related technologies such as text-
to-speech, neural network design and data compression.  These technologies, as
developed to date, employ a proprietary phonetic speech modeling engine and a
linguistic and contextual process based on a proprietary neural network system
(artificial intelligence).

In November 1997, the Company entered into an agreement (the "Siemens
Agreement") with the Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens") pursuant to which the Company and Siemens agreed to pursue research
and development of certain of the Company's technologies and the
commercialization of such technologies for the telecommunications industry
through a strategic alliance.  Pursuant to the terms of the Siemens Agreement,
the Company and Siemens entered into the First Statement of Work and License
Agreement (see Note 10 to the condensed consolidated financial statements)
pursuant to which Siemens paid the Company a license fee for the development and
production of certain of its technologies in integrated circuits suitable for
certain telecommunications applications. The Siemens Agreement calls for the
payment to the Company of additional license fees when the Company and Siemens
have entered into further agreements for the development of specific
technologies, although there can be no assurance that the parties will enter
into such additional agreements.

In March 1998, the Company expanded its suite of human-computer interaction
technologies by acquiring the award-winning voice synthesis technologies of
AcuVoice, Inc. ("AcuVoice").  That acquisition was accomplished through a merger
of AcuVoice into a wholly-owned subsidiary of the Company now known as
fonix/AcuVoice, Inc ("fonix/AcuVoice").  The business operations previously
conducted by AcuVoice are now part of the Company's Interactive Technologies
Solutions Group.  AcuVoice was incorporated in 1984 and since that time has been
engaged in development of a software only text-to-human-speech synthesis
technology called "concatenative speech synthesis," now recognized in the speech
technology industry as a leading method of achieving natural sounding speech
from a computer.  Beginning in early 1996, AcuVoice began selling developer kits
based on its technology.  Companies that the Company believes to be developing
marketable products based on the fonix/AcuVoice technologies include IBM,
General Motors, Kurzweil Educational Systems, Pratt & Whitney, Octel
Communications, Andersen Consulting, NEC, Dialogic and Bell Atlantic.  Companies
that have developed products using fonix/AcuVoice developer kits, and now are
selling or using products containing fonix/AcuVoice text-to-speech technologies
include AT&T, Motorola, Northern Telecom, Lucky Goldstar (Korea), Smart Dial,
Signet, Concierge, Ultimate Technology, First Call, XL Vision, Applied Future
Technologies and Productivity Works.

In September 1998, the Company acquired Articulate Systems, Inc. ("ASI"), a
developer of leading voice recognition and systems software for specialized
applications in the health care industry.  That acquisition was accomplished
through a merger of ASI into a wholly-owned subsidiary of the Company now known
as fonix/Articulate, Inc. ("fonix/Articulate").  The business operations
previously conducted by Articulate are now conducted by the Company's HealthCare
Solutions Group based in Woburn, Massachusetts.

In October 1998, the Company acquired Papyrus Associates, Inc. ("PAI") and
Papyrus Development Corporation ("PDC").  PAI develops and markets printing and
cursive handwriting recognition software for personal digital assistants, pen
tablets and mobile phones. The Papyrus Recognizer is marketed under the
trademark "Allegro." PDC is a systems integration provider with expertise and
intellectual property related to embedded systems and enhanced Internet
applications. PDC has an ongoing partnership with e-Travel that resulted in the
first corporate travel management Web-

                                       18
<PAGE>
 
browser client software system. The acquisition of both PDC and PAI
(collectively "Papyrus") was accomplished through a merger of PDC and PAI into a
wholly-owned subsidiary of the Company, Papyrus Acquisition Corporation.
Following the acquisitions, the Company operates the business formerly operated
by Papyrus as part of its Interactive Technologies Solutions Group in Woburn,
Massachusetts.

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

The Company markets its voice recognition and systems software for specialized
applications in the health care industry through its HealthCare Solutions Group.
The HealthCare Solutions Group presently markets large vocabulary voice
recognition software for the rapid capture, transcription and management of
clinical information dictated by radiologists and emergency medical physicians.
The two products now being sold by the HealthCare Solutions Group, PowerScribe
Radiology and PowerScribeEM, are marketed to major hospitals and medical centers
by The MRC Group, Inc., an unaffiliated third party distributor.  The MRC Group
also supports and services the systems within the United States.

The Company presently intends to consummate other previously announced
acquisitions involving additional complementary technologies (see Note 13 to the
condensed consolidated financial statements).  There can be no assurance that
any other acquisitions will be consummated, however, or that the AcuVoice, ASI
or Papyrus acquisitions, or any other acquisition or merger already consummated
or that may be consummated in the future, will generate substantial revenues or
result in increased opportunities for the Company to enter into profitable
licensing arrangements or that such additional technologies can be successfully
integrated with the Company's existing technologies.  To the extent the Company
finances such acquisitions by issuances of its capital stock, additional, and
possibly substantial, dilution will result to existing shareholders.

RESULTS OF OPERATIONS
---------------------

THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THREE MONTHS ENDED 
SEPTEMBER 30, 1997

During the three months ended September 30, 1998, the Company recorded revenues
of $199,017 from the operations of its HealthCare Solutions and Interactive
Technologies Solutions Groups.

Prior to March 1997, the Company conducted its scientific research and
development activities solely through Synergetics, Inc.("Synergetics"), a
research and development entity, pursuant to product development and assignment
contracts between the Company and Synergetics (collectively, the "Synergetics
Agreement").  Under that arrangement, Synergetics provided personnel and
facilities and the Company financed scientific research and development of the
its technologies on an as-required basis.  There was no minimum requirement or
maximum limit with respect to the amount of funding the Company was obligated to
provide to Synergetics under the Synergetics Agreement, and the Company was
obligated to use its best efforts in raising all of the necessary funding for
the development of its technologies.  Synergetics submitted pre-authorized work
orders and budgets, which were then reviewed and approved by the Company.  All
funds paid to Synergetics have been accounted for by the Company as research and
development expense.  Under the Synergetics Agreement, the Company had also
agreed to pay a royalty to Synergetics equal to ten percent of revenues from
sales of the technologies developed by Synergetics or products incorporating
such technologies (the "Royalty"). On March 13, 1997, the Company and
Synergetics reached an agreement in principle to modify the Synergetics
Agreement with regard to the development and assignment of the technologies
developed by Synergetics. Most research and development activities previously
conducted by Synergetics were moved in-house to the Company in or about March
1997. On April 6, 1998, the parties finalized their understanding in a written
Royalty Modification Agreement (the "Modification Agreement"). Under the
Modification Agreement, the Company                                    
                                      19
<PAGE>
 
will issue warrants in exchange for a pro rata cancellation of its obligation to
pay the Royalty or any percentage of the revenues received from entering into
licensing or co-development agreements or otherwise from the manufacture of
products incorporating the technologies developed by Synergetics. Assignment to
the Company of all technology relating to the technologies developed by
Synergetics is confirmed by the Modification Agreement.

From inception on October 1, 1993 through September 30, 1998, the Company has
invested $28,018,188 in product development and research relating to its
technologies.  During the three months ended September 30, 1998, the Company
incurred product development and research expenses of $4,419,400, an increase of
$2,769,029 over the same period in the previous year.  This increase is due
primarily to the addition of product development and research personnel,
increased use of independent contractors, equipment, facilities and the
acquisitions of AcuVoice and ASI. Approximately $423,727 of such increase is for
development costs from the operations of  fonix/AcuVoice and fonix/Articulate.
The Company anticipates similar or increased product development and research
costs as it continues to expand, develop and market its technologies.
Additionally, the Company purchased in-process research and development totaling
$5,500,000 during the three months ended September 30, 1998, in connection with
the acquisition of fonix/Articulate.

Selling, general and administrative expenses were $4,048,834 and $2,185,169 for
the three months ended September 30, 1998 and 1997, respectively.  This increase
from the previous period was due primarily to the hiring of additional employees
and the resulting increases in salaries, wages and related costs, legal and
accounting and depreciation and amortization.  Salaries, wages and related costs
were $1,754,401 and $772,744 for the three months ended September 30, 1998 and
1997, respectively, an increase of $981,657 over the three months ended
September 30, 1997.  This increase is attributable to incentive compensation for
continue employment paid to employees of ASI of $857,000, and to increases in
personnel from recent acquisitions.  Legal and accounting expenses increased
$386,328 and depreciation and amortization increased $467,852.  The $467,852
increase in depreciation and amortization is primarily attributable to the
amortization of intangible assets acquired in connection with the acquisitions
of AcuVoice and ASI.

Due to significant product development and research and selling, general and
administrative expenses, the Company has incurred losses from operations since
inception totaling $78,759,834, of which $13,802,381 and $3,835,540 were
incurred during the three months ended September 30, 1998 and 1997,
respectively.   At September 30, 1998, the Company had an accumulated deficit of
$92,580,873 and stockholders' equity of $18,461,277. The Company anticipates
that its investment in ongoing scientific product development and research of
its technologies will continue at present or increased levels for at least the
remainder of fiscal 1998 assuming the availability of working capital.

Net other expense was $6,197,687 for the three months ended September 30, 1998,
an increase of $4,779,808 over the three months ended September 30, 1997. This
increase was due primarily to a $6,111,577 expense recorded in connection with
the cancellation of a reset provision associated with a private placement of the
Company's common stock (see Liquidity and Capital Resources).

NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS ENDED 
SEPTEMBER 30, 1997

During the nine months ended September 30, 1998, the Company recorded revenues
of $2,671,302, of which $2,368,138 was a non-refundable license fee from
Siemens, for which the Company has no further obligation.  The remainder of such
revenues were from sales and licensing fees.

During the nine months ended September 30, 1998, the Company incurred product
development and research expenses of $10,080,895, an increase of $5,365,245 over
the same period in the previous year.  This increase was due primarily to the
addition of product development and research personnel, increased use of
independent contractors, equipment, facilities and the operations of AcuVoice
and ASI.  Approximately $643,575 of such increase is for development costs from
the operations of the HealthCare Solutions and Interactive Technologies
Solutions Groups. The Company anticipates similar or increased product
development and research costs as it expands and continues to develop and market
the applications and products offered by its HealthCare Solutions and
Interactive Technologies Solutions Groups. Additionally, the Company purchased
in-process product development and research totaling $23,339,840 during the nine
months ended September 30, 1998, in connection with the acquisitions of AcuVoice
and ASI.


                                       20
<PAGE>
 
Selling, general and administrative expenses were $7,769,085 and $5,935,838,
respectively, for the nine months ended September 30, 1998 and 1997.  This
increase from the previous period was due primarily to the hiring of additional
employees and the resulting increases in salaries, wages and related costs,
legal and accounting and depreciation and amortization.  Salaries, wages and
related costs were $3,280,790 and $1,787,726 for the nine months ended 
September 30, 1998 and 1997, respectively, an increase of $1,493,064 over 
the nine months ended September 30, 1997.  This increase is attributable to 
incentive compensation for continued employment paid to employees of ASI of 
$857,000, and to increases in personnel from recent acquisitions.  Legal and 
accounting expenses increased $774,475 and depreciation and amortization 
increased $790,117.  The $790,117 increase in depreciation and amortization is 
primarily attributable to the amortization of intangible assets acquired in 
connection with the acquisitions of AcuVoice and ASI.  Additionally, consulting
and outside services decreased by $2,303,087.

The Company incurred losses from operations of $38,575,871 and $10,651,488
during the nine months ended September 30, 1998 and 1997, respectively.  The
significant increase in losses from operations is primarily due to purchased in-
process product development and research charges of $23,339,840 associated with
the acquisitions of AcuVoice and ASI. The Company anticipates that its
investment in ongoing scientific product development and research will continue
at present or increased levels for at least the remainder of fiscal 1998
assuming availability of working capital.

Net other expense was $6,228,706 for the nine months ended September 30, 1998,
an increase in net other expense of $3,907,067 over the nine months ended
September 30, 1997.  This increase was primarily due to a $6,111,577 expense
recorded in connection with the settlement of a reset provision associated with
a private placement of the Company's common stock (see Liquidity and Capital
Resources).  Additionally, interest expense decreased $2,230,198 from the nine
months ended September 30, 1997, primarily due to financing costs associated
with the issuance and extinguishment of debt instruments during the nine months
ended September 30, 1997.


LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

The Company had negative working capital of $9,106,108 at September 30, 1998
compared to positive working capital of $678,823 at December 31, 1997.  The
current ratio was 0.72 at September 30, 1998, compared to 1.03 at December 31,
1997.  Current assets increased by $2,277,686 to $23,426,375 from December 31,
1997 to September 30, 1998. Current liabilities increased by $12,062,617 to
$32,532,483 during the same period.  The decrease in working capital from
December 31, 1997 to September 30, 1998, was primarily attributable to an
increase in notes payable associated with the acquisition of ASI and increases
in accounts payable and notes payable of $859,000 as incentive compensation to
ASI employees to ensure continued employment, and accrued liabilities due to a
cash shortage. Total assets were $51,003,799 at September 30,1998 compared to
$22,894,566 at December 31, 1997.

From its inception, the Company's principal source of capital has been private
and other exempt sales of the Company's debt and equity securities.  During the
nine months ended September 30, 1998, the Company issued 15,002,758 shares of
common stock.  Of such shares, 5,390,476 shares were issued in connection with a
private placement (see below), 7,832,967 shares were issued in connection with
the acquisitions of AcuVoice and ASI, 1,489,501 shares were issued upon the
conversion of Series B and C Convertible Preferred Stock and related dividends,
265,000 shares were issued upon the exercise of previously granted warrants and
options and 24,814 shares were issued for the purchase of a patent.

On March 12, 1998, the Company completed a private placement (the "Offering") of
up to 6,666,666 shares of its restricted common stock to seven accredited
investors (the "Investors").  The total purchase price to be paid by the
Investors pursuant to the Offering was $30,000,000.  Of that amount, $15,000,000
was received by the Company on March 12, 1998, in return for which the Company
issued a total of 3,333,333 shares of restricted common stock. Finders' fees of
$870,000 were paid in connection with the $15,000,000 received.  The remainder
of the purchase price was to be paid by the Investors on July 27, 1998 (60 days
after the effectiveness of a registration statement that the 

Company filed with the Securities and Exchange Commission covering the common
stock issued and issuable to the investors) (the "Second Funding Date"),
provided that, as of such date, certain conditions were satisfied.  Certain
conditions precedent to receiving the additional funding were not met as of the
Second Funding Date.  In separate transactions in June and August 1998, certain
Investors paid to the Company $3,000,000 in return for which the Company issued
666,667 additional shares under the terms and conditions set forth in the
Offering documents.  Placement fees of $163,846 have been accrued in connection
with the $3,000,000 received.  No other payment has been received by the Company
pursuant to the Offering and the Company does not expect any further payment to
be made.

                                       21
<PAGE>

The Investors acquired certain "reset rights" in connection with the Offering
pursuant to which the Investors would receive additional shares of restricted
common stock ("Reset Shares") if the average market price of the Company's
common stock for the 60-day period following the initial closing date did not
equal or exceed $5.40 per share.  On August 31, 1998, the Company and the
Investors in the Offering restructured the reset provision whereby the Company
issued 608,334 shares of Series D 4%  Convertible Preferred Stock ("Series D")
and 1,390,476 shares of common stock for (i) the relinquishment of the
Investors' contractual right to receive Reset Shares in connection with the
$15,000,000 received in March 1998, and the $3,000,000 received in June and
August 1998, and (ii) a financing cost in connection with the issuance of
500,000 shares of Series D.  In connection with the restructuring, the Company
recorded an expense of $6,111,577 for the difference between the Company's
original obligation to issue additional shares under the "reset rights"
provision in the Offering and the fair value of the shares that were actually
issued in settlement for the relinquishment of the reset provision and recorded
a preferred stock dividend of $1,000,000 related to financing costs in
connection with the issuance of 500,000 shares of Series D (see Series D
Preferred Stock below).

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

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

On August 31, 1998, the Company entered into an agreement with the Investors
whereby the Company issued 500,000 shares of the Company's Series D for
$10,000,000.  Additionally, the Company issued to certain of the Investors a
total of 608,334 shares of Series D (i) in return for their relinquishment of
their contractual right to receive Reset Shares in connection with the Offering
(see Private Placement above), and as (ii) an additional cost of raising the
$10,000,000 from the Series D placement.  Dividends accrue on the stated value
($20 per share) of Series D at the rate of 4 percent per year, are payable
annually or upon conversion, in cash or common stock, at the option of the
Company, and are convertible into shares of the Company's common stock at the
holder's option anytime after the earlier of November 29, 1998 or the date the
registration statement which the Company has agreed to file with the Securities
and Exchange Commission covering the common stock issuable upon the conversion
of the Series D is declared effective.  Each month the holders of the Series D
may not convert more than 25 percent of the total number of shares of Series D
originally issued to such holders on a cumulative basis.  For example, during
the first month a holder may convert up to 25% of the total preferred stock
issued to the holder, and during the following month that same holder may
convert, on an aggregate to date basis, up to 50% of the total number of shares
of Series D held by the holder. Additionally, each month, the holders may
convert up to 50 percent of the total number of shares of Series D originally
issued to such holders on a cumulative basis, if both of the following
conditions are satisfied:  the average daily trading volume of the Company's
common stock is more than 500,000 shares for the 10-trading-day period before
the conversion; and the average per share closing bid price for such 10-trading-
day period has not decreased by more than 5 percent during that 10-trading-day
period. Any outstanding shares of Series D as of August 31, 2001 automatically
will be converted at the conversion price described below most beneficial to the
holders on such date. In the event of liquidation, the holders of the Series D
are entitled to an amount equal to the stated value ($20 per share) plus accrued
but unpaid dividends whether declared or not. The holders of Series D have no
voting rights. The Series D shares, together with dividends accrued thereon, may
be converted into shares of the Company's common stock at the lesser of: $3.50
per share; or the lesser of 110 percent of the average per share closing bid
price for the 15 trading days immediately preceding the date of issuance of the
Series D shares; or 90 percent of the average of the three lowest per share
closing bid prices during the 22 trading days immediately preceding the
conversion date. In the event that the holders convert at the $3.50 per share
price, the Company is obligated to issue warrants to purchase 0.8 shares of
common stock for each share of Series D converted to common stock. Using the
conversion terms most beneficial to the holder, the Company is amortizing a
beneficial conversion feature of $2,462,964 as a dividend over a 180 day-period.

Effective as of September 30, 1998, the Company entered into an agreement with
two of the Investors whereby the Company issued 100,000 shares of the Company's
Series E 4% Convertible Preferred Stock ("Series E") for $2,000,000.
Additionally, the Company issued to the purchasers of the Series E a total of
150,000 additional shares of Series E in exchange for which those purchasers
surrendered a total of 150,000 shares of Series D.  Dividends accrue on the
stated 
                       
                                      22
<PAGE>
 
value ($20 per share) of Series E at a rate of 4 percent per year, are payable
annually or upon conversion, in cash or common stock, at the option of the
Company, and are convertible into shares of the Company's common stock at
anytime at the holder's option. Any outstanding shares of Series E as of
September 30, 2001 are automatically converted at the conversion price described
below most beneficial to the holders on such date. In the event of liquidation,
the holders of the Series E are entitled to an amount equal to the stated value
($20 per share) plus accrued but unpaid dividends whether declared or not. The
holders of Series E have no voting rights. The Series E, together with dividends
accrued thereon, may be converted into shares of the Company's common stock at
the lesser of: $3.50 per share; or the lesser of 110 percent of the average per
share closing bid price for the 15 trading days immediately preceding the date
of issuance of the Series E shares; or 90 percent of the average of the three
lowest per share closing bid prices during the 22 trading days immediately
preceding the conversion date. If the Investors convert at the $3.50 per share
price, the Company is obligated to issue warrants to purchase 0.8 shares of
common stock for each share of Series E converted to common stock. Using the
conversion terms most beneficial to the holder, the Company recorded a preferred
stock dividend of $968,047 for the beneficial conversion feature of the Series
E. As of September 30, 1998, no shares of Series E had been converted to common
stock. On November 4, 1998, 50,000 shares of Series E and related dividends were
converted into 1,130,805 shares of common stock.

During the nine months ended September 30, 1998, the Company granted options to
purchase 2,734,000 shares of common stock.  Of such options, 450,000 (having an
exercise price of $5.16 per share) were granted to three individuals who are
executive officers and directors of the Company and who each beneficially own
more than ten percent of the Company's common stock; 355,000, 1,240,000, and
589,000 options were granted to various employees at exercise prices of $3.34,
$3.54, and $6.50 per share, respectively, and 100,000 options were granted to an
unrelated party for services with an exercise price of $3.75 per share.  The
term of all options granted during the nine months ended September 30, 1998 is
ten years from the date of grant. Additionally, the Company agreed in principle
to issue stock options in exchange for the ASI stock options in connection with
the acquisition of ASI. These options have expiration dates ranging from January
1, 2001 to November 2, 2002. As of September 30, 1998, the Company had a total
of 13,319,920 options outstanding.

Although the Company has signed its first Statement of Work with Siemens and the
Company anticipates that it will enter into additional third-party licenses or
co-development agreements for its technologies with Siemens during fiscal year
1998, there can be no assurance that this will occur.  Even with the Siemens
Agreement in place and taking into account expected revenues from the HealthCare
Solutions and Interactive Technologies Solutions Groups, the Company's ongoing
operating expenses will remain higher than revenues from operations at least
through the first half of 1999. Accordingly, the Company expects to incur
significant losses at least through the end of fiscal year 1998 and until such
time as it is able to enter into substantial licensing and co-development
agreements and receive substantial revenues from such arrangements or from the
operations of its recently acquired subsidiaries, of which there can be no
assurance.

As of September 30, 1998, the Company had a revolving note payable to a bank in
the amount of $19,984,536.  Loaned amounts under the revolving note payable are
limited, in the aggregate at any time, to $20,000,000.  The weighted average
outstanding balance during the nine months ended September 30, 1998 was
$18,121,205.  This note was due October 29, 1998, bore interest at an annual
rate of 6.55 percent, and is secured by a certificate of deposit in the amount
of $20,000,000. This revolving note is renegotiated quarterly and interest is
payable monthly. As of September 30, 1998, the Company owed the bank $309,457 in
past due interest. Subsequently, all such amounts were paid to the bank and the
note has been negotiated to extend the maturity date of the note to December 4,
1998. The Company plans to continue renewing the note indefinitely.

The Company will need to raise additional funds in the near term to satisfy its
cash requirements for operations and current liabilities. Scientific product
development and research, corporate operations and marketing expenses will
continue to require substantial additional capital.  In addition, the Company
recently has acquired AcuVoice and ASI and intends to complete other previously
announced acquisitions.  These and other acquisition transactions have required
and will require substantial additional capital resources, even if the Company
uses its securities in payment of all or part of the purchase price of such
acquisitions.  Because the Company presently has only limited revenue from
operations, the Company intends to continue to rely primarily on financing
through sales of its equity, convertible equity and debt securities to satisfy
future capital requirements until such time as the Company is able to generate
sufficient revenues to enable it to finance ongoing operations.  There can be no
assurance that the Company will be able to sell its equity 

                                       23
<PAGE>
 
and debt securities or enter into such arrangements, such that sufficient
operating capital will be available when and in the amounts needed. If such
financing is not available, the Company will have to significantly reduce or
suspend its operations. Furthermore, the issuance of equity securities or other
securities which are or may become convertible to the equity securities of the
Company in connection with such financing (or in connection with acquisitions)
will result in dilution to the stockholders of the Company which could be
substantial.

The Company presently has no plans to purchase any new plants or office
facilities.  The Company presently anticipates that it will incur approximately
$900,000 in capital expenditures for equipment Company-wide over the next twelve
months.

YEAR 2000 RISKS

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.

In the ordinary course of its business, the Company tests and evaluates its
technologies and software and hardware products.  The Company believes that all
of its technologies and products generally are Year 2000 compliant, meaning that
the use or occurrence of dates on or after January 1, 2000 will not materially
affect the performance of such technologies or products with respect to four
digit date dependent data or the ability of such products to correctly create,
store, process, and output information related to such data.  However, 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 the Company's technologies or
products experience Year 2000 problems, those persons could assert claims for
damages.

The Company uses third party equipment and software that may not be Year 2000
compliant.  The Company has implemented a review of key products provided by
outside vendors to determine if their products are Year 2000 compliant and
presently believes that all software provided by third parties that is critical
to its business is Year 2000 compliant or will be before the year 2000.  The
Company believes that all computer software and hardware acquired from third
parties after the 2nd quarter of 1997 is Year 2000 compliant. However, if
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, failed 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 have the potential to cause
a material adverse affect on the Company's business, operating results, or
financial condition by making it difficult to bill customers timely and
accurately, meet product development or production schedules, or pay obligations
and operating expenses timely.

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

The Company expects that its Year 2000 compliance efforts will cost 
approximately $70,000 per year through the year 2000.

                                       24
<PAGE>

OUTLOOK

CORPORATE OBJECTIVES, TECHNOLOGY VISION AND ACQUISITION STRATEGY

The Company has positioned itself as a developer of "next generation" speech and
human-computer interaction technologies that will provide multiple product
solutions for business, consumer and service applications.  The Company's
management team has assembled leading talents in the speech recognition, speech
synthesis, handwriting recognition and other arenas related to its two primary
business units; the HealthCare Solutions and Interactive Technologies Solutions
Groups.  The Board of Directors and management have developed a business
strategy that focuses on the health care and interactive systems markets,
outlines a vision of the next major market opportunities in these industries and
articulates a corporate and technology strategy that includes marketing of a
suite of fonix-branded products, strategic alliances, collaborative development
agreements and technology licenses.

The Company is determined to become a multi-market, multi-product enterprise
offering advanced speech and human-computer interaction technologies for health
care, embedded and interactive applications.  Advanced human-computer interface
technologies and multi-modal systems include:

     .    speech recognition
     .    speech synthesis
     .    speaker identification and verification
     .    handwriting recognition
     .    pen and touch screen input
     .    intelligent agents
     .    natural language understanding

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

     .    PCs and PDAs
     .    cellular phones
     .    automotive and home environment speech controls
     .    automated information and transaction kiosks
     .    telephone systems with natural dialogue and gesture controls
     .    medical transcription and reporting systems, including PowerScribe
           Radiology and PowerScribe EM
     .    smart consumer appliances and electronics
     .    speech and pen-based computers utilizing handwriting and cursive
           recognition
     .    interactive education and entertainment systems
     .    interactive advertising
     .    real-time translation systems

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

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

The Company has observed that there are numerous small "boutique" speech
technology vendors.  The Company has previously acquired several such vendors
including AcuVoice, ASI and Papyrus.  An alliance with other such vendors by
the Company can offer these small companies greater access to human and other
resources which, it is hoped, will lead to greater market share, improved
product development and support, and creation of additional product
opportunities. In turn, the Company believes that such alliances will provide it
with additional speech and human computer interaction 

                                       25
<PAGE>
technologies, including haptic (manual) input and output, face and gesture
recognition, pentop and wearable computers.

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

               SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained herein under, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Outlook,"
including statements concerning (i) the Company's strategy, (ii) the Company's
expansion plans, (iii) the market for and potential applications of the
Company's technologies, (iv) the results of product 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 for the year ended December 31, 1997.

                          PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

THE CLARK ACTION

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 assert
claims for breach of contract relating to certain financing the Company received
during 1998.  Specifically, Clarke and Perpetual Growth allege that they entered
into a contract with the Company under which the Company agreed to pay them a
commission of 5 percent of all financing provided to the Company 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, subject to the
right of Clarke and Perpetual Growth to produce additional evidence which would
establish jurisdiction of the New York court over the Company.  Even if such
evidence is available, the Company intends to vigorously defend the claims

asserted in that action.  However, Clarke and Perpetual Growth could prevail in
the lawsuit, in which case the Company may be required to pay significant
amounts of money damages or other amounts awarded by the court.  At a minimum,
the ongoing nature of this action will result in some diversion of management
time and effort from the operation of the business.

THE J&L ACTION

On March 11, 1998, an action (the "J&L Action") was filed against the Company in
the Supreme Court of the State of New York for the County of New York by Jesup &
Lamont Securities Corporation ("J&L").  The J&L Action alleged that the Company
was obligated to pay a fee in excess of $1,200,000 plus 30,000 shares of the
Company's restricted common stock in connection with the Offering (see Note 8).
The J & L Action was settled upon payment of $385,000 by the Company to J&L.
The J&L Action has been dismissed with prejudice.

On July 9, 1998, the Company settled a case brought by a shareholder of the
Company against certain directors of the Company and K.L.S. Enviro Resources,
Inc. ("KLSE"), a third party affiliated with certain of the director-defendants.
Pursuant to the settlement, and at no cost to the Company, the Company received
warrants to purchase 583,000 shares of KLSE common stock at a purchase price of
$0.40 per share.

                                      26
<PAGE>

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

ITEM 2.  CHANGES IN SECURITIES

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

During the quarter ended September 30, 1998, the Company issued equity
securities that were not registered under the Securities Act of 1933, as amended
(the "Act"), other than unregistered sales in reliance on Regulation S under the
Act as follows:

     On August 7, 1998, the Company issued 222,222 shares of common stock as
     part of the Offering upon the payment by some of the Investors of an
     advance of $1,000,000. The Company issued such shares without registration
     under the Act in reliance on Section 4(2) of the Act or Regulation D. Such
     shares of common stock were issued as restricted stock, but were covered,
     as of the date of their issuance for public resales by the Investors, by an
     effective registration statement filed with the Securities and Exchange
     Commission.

     On August, 31, 1998, the Company issued 1,390,476 shares of common stock
     for (i) the relinquishment of Investors' contractual right to receive Reset
     Shares in connection with $3,000,000 received in June and August 1998, and
     (ii) a financing cost in connection with the issuance of 500,000 shares of
     Series D 4% Convertible Preferred Stock. The Company issued such shares
     without registration under the Act in reliance on Section 4(2) of the Act
     or Regulation D. Such shares of common stock were issued as restricted
     stock, but were covered, as of the date of their issuance for public
     resales by the Investors, by an effective registration statement filed with
     the Securities and Exchange Commission.

     On September 2, 1998 the Company issued 5,140,751 shares of common stock to
     various shareholders of Articulate Systems, Inc. as part of the
     consideration for the merger of Articulate Systems, Inc. with and into a
     subsidiary of the Company.  The common stock was valued at $1.63 per share.
     The Company issued such shares without registration under the Act in
     reliance on Section 4(2) of the Act or Regulation D.  Such shares of common
     stock were issued as restricted securities and the certificates
     representing such shares were stamped with a restrictive legend to prevent
     any resale without registration under the Act or pursuant to an exemption.

     On August 31, 1998 the Company issued an aggregate of 1,108,334 shares of
     Series D 4% Convertible Preferred Stock to various unaffiliated Investors
     for the payment of $10,000,000 and (i) the relinquishment of investors'
     contractual right to receive Reset Shares in connection with $15,000,000
     received in March 1998, and (ii) a financing cost in connection with the
     issuance of 500,000 shares of Series D 4% Convertible Preferred Stock. See
     Part I, Item 2 -- Management's Discussion and Analysis -- Liquidity and
     Capital Resources. The Company issued the Series D without registration
     under the Act in reliance on Section 4(2) of the Act or Regulation D. The
     Series D were issued as restricted securities and the certificates
     representing such shares were stamped with a restrictive legend to prevent
     any resale without registration under the Act or pursuant to an exemption.

     On September 30, the Company issued an aggregate of 250,000 shares of
     Series E 4% Convertible Preferred Stock to various unaffiliated Investors
     in exchange for the payment of $2,000,000 which was received in October
     1998 and 150,000 shares of Series D 4% Convertible Preferred Stock. See
     Part I, Item 2 -- Management's Discussion and Analysis -- Liquidity and
     Capital Resources. The Company issued The Series E without registration
     under the Act in reliance on Section 4(2) of the Act or Regulation D. The
     Series E were issued as restricted securities and the certificates
     representing such shares were stamped with a restrictive legend to prevent
     any resale without registration under the Act or pursuant to an exemption.

                                      27
<PAGE>
ITEM 4.  SUBMISSION OF VOTE OF SECURITY HOLDERS

At its Annual Meeting of Shareholders on July 14, 1998, the following actions
were submitted and approved by vote of the majority of the issued and
outstanding shares of the Company:

     (1)  Election of directors;
     (2)  Approval of the Company's 1998 Stock Option and Incentive Plan;
     (3)  Ratification of the Company's adoption of the 1997 Stock Option and
          Incentive Plan;
     (4)  Approval of the issuance by the Company of up to 6,666,666 shares of
          restricted common stock to private investors, together with such
          additional amounts of common stock as may be issuable as a result of
          certain "reset" and "reset adjustment" provisions applicable to such
          shares;
     (5)  To approve the Board of Directors' selection of Arthur Andersen LLP,
          as the Company's independent public accountant for the fiscal year
          ended December 31, 1998.

     A total of 40,717,920 shares ( approximately 79.6%) of the issued and
outstanding shares of the Company were represented by proxy or in person at the
meeting.  These shares were voted on the matters described above as follows:

     1. For the directors as follows:
<TABLE>
<CAPTION>
 
                                                        # Shares Abstaining/
Name                   # Shares For  # Shares Against         Withheld
---------------------  ------------  ----------------   --------------------
<S>                    <C>           <C>                <C>
Stephen M. Studdert      40,353,825           364,095             0
Alan C. Ashton           40,459,965           257,955             0
Joseph Verner Reed       40,453,615           264,305             0
Reginald K. Brack        40,459,105           258,815             0
Rick D. Nydegger         40,431,379           286,541             0
John A. Oberteuffer      40,430,065           287,855             0
Thomas A. Murdock        40,375,625           342,295             0
Roger D. Dudley          40,356,225           361,695             0
 
</TABLE>
     2. For the approval of the Company's 1998 Stock Option and Incentive Plan
        as follows:
<TABLE>
<CAPTION>
 
# Shares For            # Shares Against  # Shares Abstaining
----------------------  ----------------  -------------------
<S>                     <C>               <C>
          30,208,251             865,933               31,320
</TABLE>
     3. For the ratification of the Company's approval of the 1997 Stock Option
        and Incentive Plan as follows:

 
                                    28     
<PAGE>
 
<TABLE>
<CAPTION>
 
# Shares For            # Shares Against  # Shares Abstaining
----------------------  ----------------  -------------------
<S>                     <C>               <C>
          30,144,438             888,446               72,620
 
</TABLE>
     4. For approval of the issuance by the Company of up to 6,666,666 shares of
        restricted common stock as follows:
<TABLE>
<CAPTION>
 
# Shares For            # Shares Against  # Shares Abstaining
----------------------  ----------------  -------------------
<S>                     <C>               <C>
          30,531,169             519,038               55,297
</TABLE>
     5. For approval of the Board of Directors' selection of Arthur Andersen as
        the independent certified accountants of the Company as follows:
<TABLE>
<CAPTION>
 
# Shares For            # Shares Against  # Shares Abstaining
----------------------  ----------------  -------------------
<S>                     <C>               <C>
          40,607,162              61,969               48,789
</TABLE>
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

a.   Exhibits: The following Exhibits are filed with this Form 10-K pursuant to
     Item 601(a) of Regulation S-K:

<TABLE>
<CAPTION>
Exhibit No.    Description of Exhibit
-------------  ----------------------
     <S>       <C>
     (2)(i)    Agreement and Plan of Reorganization among the Company, fonix
               Acquisition Corporation and AcuVoice dated as of January 13,
               1998, incorporated by reference from the Company's Current Report
               on Form 8-K, filed March 20, 1998

     (2)(ii)   Agreement and Plan of Merger among the Company, ASI Acquisition
               Corporation and Articulate Systems, Inc., dated as of July 31,
               1998, incorporated by reference from the Company's Current Report
               on Form 8-K, filed September 17, 1998

     (2)(iii)  Amendment No. 1 to Agreement and Plan of Merger Agreement and
               Plan of Merger among the Company, ASI Acquisition Corporation and
               Articulate Systems, Inc., dated as of September 2, 1998, 
               incorporated by reference from the Company's Current Report on 
               Form 8-K, filed September 17, 1998
 
     (3)(i)    Articles of Incorporation of the Company which are incorporated
               by reference from the Company's Registration Statement on 
               Form S-18 dated as of September 12, 1989

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

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

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

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


 
                                       29
<PAGE>

     (4)(i)     Certificate of Designation of Rights and Preferences of Series D
                4% Convertible Preferred Stock, filed with the Secretary of
                State of Delaware on August 27, 1998, filed herewith

     (4)(ii)    Certificate of Designation of Rights and Preferences of Series E
                4% Convertible Preferred Stock, filed with the Secretary of
                State of Delaware on October 15, 1998, filed herewith

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

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

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

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

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

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

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

     (10)(viii) Restated First Statement of Work and License Agreement between
                the Company and Siemens, dated February 11, 1998, filed 
                herewith *

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

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

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

                                      30
<PAGE>
     (10)(xii)   Royalty Modification Agreement among the Company and 
                 Synergetics, dated as of April 6, 1998, which is incorporated 
                 by reference from the Company's Annual Report on Form 10-K 
                 for the year ended December 31, 1997
               
     (10)(xiii)  Purchase Agreement with John Oberteuffer and the Company dated
                 April 9, 1998, which is incorporated by reference from the
                 Company's Annual Report on Form 10-K for the year ended 
                 December 31, 1997
               
     (10)(xiv)   Employment Agreement by and between the Company and John A.
                 Oberteuffer, which is incorporated by reference from the
                 Company's Annual Report on Form 10-K for the year ended 
                 December 31, 1997
               
     (10)(xv)    First Amendment to Master Agreement for Joint Collaboration
                 between the Company and Siemens, dated February 13, 1998, which
                 is incorporated by reference from the Company's Annual Report 
                 on Form 10-K for the year ended December 31, 1997
               
     (10)(xvi)   Second Amendment to Master Agreement for Joint Collaboration
                 between the Company and Siemens, dated March 13, 1998, which is
                 incorporated by reference from the Company's Annual Report on
                 Form 10-K for the year ended December 31, 1997
               
     (10)(xvii)  Series D Convertible Preferred Stock Purchase Agreement Among
                 fonix corporation, JNC Opportunity Fund, Ltd., Diversified
                 Strategies Fund, L.P., Dominion Capital Fund, Ltd., Sovereign
                 Partners, LP, Canadian Advantage Limited Partnership and 
                 Thomson Kernaghan & Co. (as agent) dated as of August 31, 
                 1998, filed herewith

     (10)(xviii) Series E Convertible Preferred Stock Exchange and Purchase
                 Agreement among fonix corporation, Sovereign Partners, LP and 
                 Dominion Capital Fund, Ltd., dated as of September 30, 1998, 
                 filed herewith

     (27)        Financial Data Schedule

     *    Originally filed as part of Annual Report on Form 10-K for fiscal year
          ended December 31, 1997 pursuant to Request for Confidential Treatment
          ("CTR").  Pursuant to subsequent correspondence with the staff of the
          Commission during the quarter ended September 30, 1998, the exhibit,
          as redacted, is filed herewith and is not subject to the pending CTR.
          Redacted portions are excluded pursuant to the CTR.

(b)  Reports filed on Form 8-K during the three-month period ended September 30,
     1998:

     (i)  On September 17, 1998, the Company filed a Current Report on Form 8-K,
          dated September 2, 1998, containing Item 2 disclosure pertaining to
          the Company's acquisition by merger of Articulate Systems, Inc.
 

 
                                      31
<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:  November 16, 1998                 /s/ Douglas L. Rex  
     ----------------------              ---------------------------------------
                                         Douglas L. Rex, Chief Financial Officer

 
                                      32