UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
one)





[X]
            Quarterly
      Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934 for the quarterly period ended March 31, 2008,
  or





[   ]
            Transition
      Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
      1934 for the transitionperiod
      from ______________
              to
      _____________.





Commission
File No. 0-23862


Fonix
Corporation


(Exact
name of registrant as specified in its charter)





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





387
South 520 West, Suite 110


Lindon, Utah 84042


(Address
of principal executive offices with zip code)





(801)
553-6600


(Registrant's
telephone number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 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]   No[  ].





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer, or a smaller reporting
company.  (Check one):


Large
accelerated filer [  ]  Accelerated filer
[  ]  Non-accelerated filer
[  ]  Smaller reporting company [X]





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-25 of the Exchange Act).


Yes
__ No X





As of May
9, 2007, there were issued and outstanding 6,310,155,345 shares of our Class A
common stock.








FONIX
CORPORATION


FORM
10-Q








TABLE
OF CONTENTS





PART
      I - FINANCIAL INFORMATION
            PageItem
      1.
            Financial
      Statements (Unaudited)Condensed
      Consolidated Balance Sheets – As of March 31, 2008, and December 31,
      2007
            3Condensed
      Consolidated Statements of Operations and Comprehensive Loss for the Three
      Months Ended March 31, 2008 and 2007
            4Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended March 31,
      2008 and 2007
            5Notes
      to Condensed Consolidated Financial Statements (Unaudited)
            7Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            17Item
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            31Item
      4.
            Controls
      and Procedures
            32PART
      II - OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            32Item
      1A.
            Risk
      Factors
            33Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            34Item
      6.
            Exhibits
            34












Fonix
      Speech and SubsidiariesCONDENSED
      CONSOLIDATED BALANCE SHEETSMarch
      31,2008
            
            
            2007ASSETSCurrent
      assetsCash
      and cash equivalents
            
            $
            93,000
            
            
            $
            26,000Prepaid
      expenses and other current assets
            
            
            -
            
            
            
            61,000Total
      current assets
            
            
            93,000
            
            
            
            87,000Property and equipment,
      net of accumulated depreciation of $1,296,000 and $1,293,000,
      respectively
            
            
            13,000
            
            
            
            16,000Deposits
      and other assets
            
            
            -
            
            
            
            108,000Total
      assets
            
            $
            106,000
            
            
            $
            211,000LIABILITIES
      AND STOCKHOLDERS' DEFICITCurrent
      liabilitiesAccrued
      liabilities
            
            $
            5,252,000
            
            
            $
            4,505,000Accounts
      payable
            
            
            1,760,000
            
            
            
            1,532,000Derivative
      liability
            
            
            20,947,000
            
            
            
            20,742,000Accrued
      payroll and other compensation
            
            
            211,000
            
            
            
            211,000Accrued
      settlement obligation
            
            
            340,000
            
            
            
            540,000Deferred
      revenues
            
            
            445,000
            
            
            
            445,000Notes
      payable - related parties
            
            
            961,000
            
            
            
            902,000Series
      E debentures
            
            
            1,754,000
            
            
            
            1,754,000Current
      portion of notes payable
            
            
            4,368,000
            
            
            
            3,833,000Deposits
      and other
            
            
            7,000
            
            
            
            7,000Total
      current liabilities
            
            
            36,045,000
            
            
            
            34,471,000Long-term
      notes payable, net of current portion
            
            
            3,331,000
            
            
            
            3,556,000Total
      liabilities
            
            
            39,376,000
            
            
            
            38,027,000Commitments
      and contingenciesStockholders'
      deficitPreferred
      stock, $0.0001 par value;  50,000,000 shares
      authorized;Series
      A, convertible; 166,667 shares outstanding (aggregate liquidation
      preference of $6,055,000)
            
            
            500,000
            
            
            
            500,000Series
      L, convertible; 1,521 shares and 1,535 shares outstanding ,
      respectively
            
            
            -
            
            
            
            -Common
      stock, $0.0001 par value; 20,000,000,000 shares
authorized;Class
      A voting, 5,702,687,745 shares and 4,287,119,186 shares outstanding,
      respectively
            
            
            570,000
            
            
            
            429,000Class
      B non-voting, none outstanding
            
            
            -
            
            
            
            -Additional
      paid-in capital
            
            
            238,743,000
            
            
            
            238,714,000Outstanding
      warrants to purchase Class A common stock
            
            
            474,000
            
            
            
            474,000Cumulative
      foreign currency translation adjustment
            
            
            10,000
            
            
            
            10,000Accumulated
      deficit
            
            
            (279,567,000
            )
            
            
            (277,943,000
            )Total
      stockholders' deficit
            
            
            (39,270,000
            )
            
            
            (37,816,000
            )Total
      liabilities and stockholders' deficit
            
            $
            106,000
            
            
            $
            211,000




See
accompanying notes to condensed consolidated financial
statements.


3


Fonix
      Corporation and SubsidiariesCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONSAND
      COMPREHENSIVE LOSSThree
      Months Ended March 31,
            
            2008
            
            
            2007Revenues
            
            $
            286,000
            
            
            $
            360,000Cost
      of revenues
            
            
            25,000
            
            
            
            7,000Gross
      profit
            
            
            261,000
            
            
            
            353,000Expenses:Selling,
      general and administrative
            
            
            502,000
            
            
            
            807,000Product
      development and research
            
            
            218,000
            
            
            
            487,000Total
      expenses
            
            
            720,000
            
            
            
            1,294,000Other
      income (expense):Interest
      expense
            
            
            (508,000
            )
            
            
            (463,000
            )Gain
      (loss) on derivative liability
            
            
            (79,000
            )
            
            
            617,000Other
      income (expense), net
            
            
            (587,000
            )
            
            
            154,000Net
      loss from continuing operations
            
            
            (1,046,000
            )
            
            
            (787,000
            )Net
      loss
            
            
            (1,046,000
            )
            
            
            (787,000
            )Preferred
      stock dividends
            
            
            (578,000
            )
            
            
            (410,000
            )Loss
      attributable to common stockholders
            
            $
            (1,624,000
            )
            
            $
            (1,197,000
            )Basic
      and diluted loss per common share from continuing
    operations
            
            $
            (0.00
            )
            
            $
            (0.00
            )Net
      loss
            
            $
            (1,046,000
            )
            
            $
            (787,000
            )Other
      comprehensive (loss) income - foreign currency translation
            
            
            -
            
            
            
            -Comprehensive
      loss
            
            $
            (1,046,000
            )
            
            $
            (787,000
            )










4


Fonix
      Corporation and SubsidiariesCONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWSThree
      Months Ended March 31,
            
            2008
            
            
            2007Cash
      flows from operating activitiesNet
      income (loss)
            
            $
            (1,046,000
            )
            
            $
            (787,000
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Gain
      (loss) on derivative liability
            
            
            79,000
            
            
            
            (617,000
            )Accretion
      of discount on notes payable
            
            
            310,000
            
            
            
            239,000Depreciation
            
            
            3,000
            
            
            
            14,000Changes
      in assets and liabilitiesPrepaid
      expenses and other current assets
            
            
            61,000
            
            
            
            (3,000
            )Other
      assets
            
            
            108,000
            
            
            
            -Accounts
      payable
            
            
            228,000
            
            
            
            (456,000
            )Accrued
      payroll and other compensation
            
            
            -
            
            
            
            -Other
      accrued liabilities
            
            
            175,000
            
            
            
            213,000Deferred
      revenues
            
            
            -
            
            
            
            (13,000
            )Net
      cash used in operating activities
            
            
            (82,000
            )
            
            
            (1,410,000
            )Cash
      flows from investing activitiesNet
      cash used in investing activities
            
            
            -
            
            
            
            -Cash
      flows from financing activitiesProceeds
      from issuance of Class A common stock, net
            
            
            -
            
            
            
            -Proceeds
      from related party note payable
            
            
            59,000
            
            
            
            102,000Advance
      on Series B Preferred Stock
            
            
            -
            
            
            
            1,250,000Proceeds
      from issuance of Series O Preferred Stock
            
            
            290,000
            
            
            
            -Proceeds
      from notes payable
            
            
            -
            
            
            
            450,000Payments
      on accrued settlement obligation
            
            
            (200,000
            )
            
            
            -Net
      cash provided by financing activities
            
            
            149,000
            
            
            
            1,802,000Net
      increase (decrease) in cash and cash equivalents
            
            
            67,000
            
            
            
            392,000Cash
      and cash equivalents at beginning of year
            
            
            26,000
            
            
            
            5,000Cash
      and cash equivalents at end of year
            
            $
            93,000
            
            
            $
            397,000










5


Fonix
Corporation and Subsidiaries


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)


(Unaudited)








Supplemental
schedule of noncash investing and financing activities





For
the Three Months Ended March 31, 2008:





Issued
1,354,251,012 shares of Class A common stock upon conversion of 15 shares of
Series L Convertible Preferred Stock.





Issued
61,347,547 shares of Class A common stock upon conversion of $11,500 in accrued
interest.





Accrued
$481,000 of dividends on Series L Preferred Stock.





Accrued
$34,000 of dividends on Series M Preferred Stock.





Accrued
$31,000 of dividends on Series N Preferred Stock.





Accrued
$3,000 of dividends on Series O Preferred Stock.





Accrued
$28,000 of dividends on Fonix Speech Series B Preferred Stock.





For
the Three Months Ended March 31, 2007:





Issued
397,173,839 shares of Class A common stock in conversion of 64 shares of Series
L Convertible Preferred Stock.





Accrued
$370,000 of dividends on Series L Preferred Stock.


6


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





1.  SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES





Basis of
Presentation – The accompanying unaudited condensed consolidated
financial statements ofFonixCorporation and
subsidiaries (collectively, the “Company” or “Fonix”) have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission (the “SEC”).  Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America 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.  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 2007 Annual Report on Form 10-K.





These
condensed consolidated financial statements reflect all adjustments (consisting
only of normal recurring adjustments) that, in the opinion of management, are
necessary to present fairly the financial position and results of operations of
the Company for the periods presented.  The Company’s business
strategy is not without risk, and readers of these condensed consolidated
financial statements should carefully consider the risks set forth under the
heading “Certain Significant Risk Factors” in the Company’s 2007 Annual Report
on Form 10-K.





Operating
results for the three months ended March 31, 2008, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2008.





Nature of
Operations–Fonix
Corporation (“the Company”) provides value-added speech technologies through its
subsidiary, Fonix Speech, Inc. (“Fonix Speech”).  The Company offers
speech-enabling technologies including automated speech recognition (“ASR”) and
text-to-speech (“TTS”) through Fonix Speech to markets for wireless and mobile
devices, computer telephony, server solutions and personal software for consumer
applications.  The Company has received various patents for certain
elements of its core technologies and have filed applications for other patents
covering various aspects of its technologies.  The Company seeks to
develop relationships and strategic alliances with third-party developers and
vendors in telecommunications, computers, electronic devices and related
industries, including producers of application software, operating systems,
computers and microprocessor chips.  Revenues are generated through
licensing of speech-enabling technologies, maintenance contracts and
services.





Business
Condition-For
the quarters ended March 31, 2008 and 2007, we generated revenues of $286,000
and $360,000, respectively; incurred net losses of $1,046,000 and $787,000,
respectively; and had negative cash flows from operating activities of $82,000
and $1,410,000, respectively.  As of March 31, 2008, we had an
accumulated deficit of $279,567,000; negative working capital of $35,952,000;
derivative liabilities of $20,947,000 related to the issuance of Series L
Preferred Stock,  Series M Preferred Stock, Series N Preferred Stock,
Series O Preferred Stock,  Series E Convertible Debentures and Series
B Preferred Stock of our subsidiary; accrued liabilities and accrued settlement
obligation of $5,592,000; accounts payable of $1,760,000; and current portion of
notes payable of $4,368,000, Series E debentures of $1,754,000 and deferred
revenues of $445,000.  We expect to continue to incur significant
losses and negative cash flows from operating activities at least through
December 31, 2008, primarily due to expenditure requirements associated with
continued marketing and development of our speech-enabling
technologies.





The
Company’s cash resources, limited to collections from customers, sales of our
equity and debt securities and loans, have not been sufficient to cover
operating expenses.  As a result, some payments to vendors have been
delayed.  On March 15, 2007, the New York State trial court entered
judgment against the Company and in favor of the Breckenridge Fund in the amount
of $1,602,000.  In February 2008, the Company entered into an amended
settlement agreement with Breckenridge under which the Company agreed to pay
Breckenridge $540,000.  The Company has paid Breckenridge $242,500 and
is obligated to pay the balance of $297,500 at the rate of $42,500 per
month.





7


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





These
factors, as well as the risk factors set out elsewhere in the Annual Report on
Form 10-K,  raise substantial doubt about the Company’s ability to
continue as a going concern.  The accompanying financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.  Management plans to fund further operations of the
Company from cash flows from future license and royalty arrangements and with
proceeds from additional issuance of debt and equity
securities.  There can be no assurance that management’s plans will be
successful.





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.  As of March 31, 2008 and 2007, there
were outstanding common stock equivalents to purchase 153,793,797,205 and
12,395,755,010 shares of common stock, respectively, that were not included in
the computation of diluted net loss per common share as their effect would have
been anti-dilutive, thereby decreasing the net loss per common
share.





The
following table is a reconciliation of the net loss numerator of basic and
diluted net loss per common share for the three months ended March 31, 2008 and
2007:





Three
      Months Ended March 31,2008
            
            
            2007Per
            
            
            
            
            
            PerShare
            
            
            
            
            
            ShareAmount
            
            
            Amount
            
            
            Amount
            
            
            AmountNet
      loss
            
            $
            (1,046,000
            )
            
            
            
            
            $
            (787,000
            )Preferred
      stock dividends
            
            
            (578,000
            )
            
            
            
            
            
            (410,000
            )Loss
      attributable to common stockholders
            
            $
            (1,624,000
            )
            
            $
            (0.00
            )
            
            $
            (1,197,000
            )
            
            $
            (0.00
            )Weighted-average
      common shares outstanding
            
            
            4,845,833,564
            
            
            
            
            
            
            
            1,522,953,187





Imputed Interest
Expense–Interest
is imputed on long-term debt obligations where management has determined that
the contractual interest rates are below the market rate for instruments with
similar risk characteristics.





Comprehensive
Loss–Other
comprehensive loss as presented in the accompanying condensed consolidated
financial statements consists of cumulative foreign currency translation
adjustments.





Revenue
Recognition– The Company recognizes revenue when pervasive evidence of
an arrangement exists; services have been rendered or products have been
delivered; the price to the buyer is fixed and determinable; and collectibility
is reasonably assured.  Revenues are recognized by the Company based
on the various types of transactions generating the revenue.  For
software sales, the Company recognizes revenues in accordance with the
provisions of Statement of Position No. 97-2, “Software Revenue Recognition,”
and related interpretations.The Company
generates revenues from licensing the rights to its software products to end
users and from royalties.





For Fonix
Speech, revenue of all types is recognized when acceptance of functionality,
rights of return, and price protection are confirmed or can be reasonably
estimated, as appropriate.  Revenues from development and consulting
services are recognized on a completed-contract basis when the services are
completed and accepted by the customer.  The completed-contract method
is used because the Company’s contracts are typically either short-term in
duration or the Company is unable to make reasonably dependable estimates of the
costs of the contracts.  Revenue for hardware units delivered is
recognized when delivery is verified and collection assured.






8


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





Revenue
for products distributed through wholesale and retail channels and through
resellers is recognized upon verification of final sell-through to end users,
after consideration of rights of return and price
protection.  Typically, the right of return on such products has
expired when the end user purchases the product from the retail
outlet.  Once the end user opens the package, it is not returnable
unless the medium is defective.





When
arrangements to license software products do not require significant production,
modification or customization of software, revenue from licenses and royalties
are recognized when persuasive evidence of a licensing arrangement exists,
delivery of the software has occurred, the fee is fixed or determinable, and
collectibility is probable.  Post-contract obligations, if any,
generally consist of one year of support including such services as customer
calls, bug fixes, and upgrades.  Related revenue is recognized over
the period covered by the agreement.  Revenues from maintenance and
support contracts are also recognized over the term of the related
contracts.





Revenues
applicable to multiple-element fee arrangements are bifurcated among the
elements such as license agreements and support and upgrade obligations using
vendor-specific objective evidence of fair value.  Such evidence
consists primarily of pricing of multiple elements as if sold as separate
products or arrangements.  These elements vary based upon factors such
as the type of license, volume of units licensed, and other related
factors.





Deferred
revenue as of March 31, 2008, and December 31, 2007, consisted of the
following:





Description
            Criteria
      for Recognition
            
            Mar
      31, 2008
            
            
            Dec
      31, 2007Deferred
      unit royalties and license fees
            Delivery
      of units to end users or expiration of contract
            
            $
            445,000
            
            
            $
            445,000





Cost of Revenues– Cost of revenues from license, royalties, and maintenance consists of
costs to distribute the product, installation and support personnel
compensation, amortization and impairment of capitalized speech software costs,
licensed technology, and other related costs.  Cost of service
revenues consists of personnel compensation and other related
costs.





Software
Technology Development and Production Costs– All costs incurred to
establish the technological feasibility of speech software technology to be
sold, leased, or otherwise marketed are charged to product development and
research expense.  Technological feasibility is established when a
product design and a working model of the software product have been completed
and confirmed by testing.  Costs to produce or purchase software
technology incurred subsequent to establishing technological feasibility are
capitalized.  Capitalization of software costs ceases when the product
is available for general release to customers.  Costs to perform
consulting or development services are charged to cost of revenues in the period
in which the corresponding revenues are recognized.  The cost of
maintenance and customer support is charged to expense when related revenue is
recognized or when these costs are incurred, whichever occurs
first.





2.  NOTES
PAYABLE





In
connection with the acquisition of the capital stock of LTEL Holdings in 2004,
the Company issued a 5%, $10,000,000, secured, six-year note (the “Note”)
payable to McCormack Avenue, Ltd. (“McCormack”).  Under the terms of
the Note, quarterly interest-only payments were required through January 15,
2005, with quarterly principal and interest payments of $319,000 beginning April
2005 and continuing through January 2010.  Interest on the Note is
payable in cash or, at the Company’s option, in shares of the Company’s Class A
common stock.  The Note is secured by the capital stock and all of the
assets of LTEL Holdings and its subsidiaries.  The Note was originally
valued at $4,624,000 based on an imputed interest rate of 25 percent per
annum.





The
discount on the Note is based on an imputed interest rate of 25%.  The
carrying amount of the Note of $6,919,000 at March 31, 2008, was net of
unamortized discount of $1,814,000.  As of the date of this report,
the Company had not made any scheduled payments for 2007 or 2008.








9


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





On September 8, 2006, the Company
received a default notice (the “Default Notice”) from McCormack in respect of
the Note.  Under the terms of the Note, and a related Security
Agreement between the Company and McCormack dated February 24, 2004 (the
“Security Agreement”), McCormack was entitled to declare all liabilities,
indebtedness, and obligations of the Company to McCormack under the Security
Agreement and the Note immediately due and owing upon an event of
default.  The Note defines an event of default to include the
non-payment by the Company of a scheduled payment which is not cured within 60
days.





In the
Default Notice, McCormack stated that it intended to exercise its rights,
including any and all rights set forth in the Note, as amended. McCormack has
taken no action to collect amounts due under the note.





During
the fourth quarter of 2006, the Company entered into two promissory notes with
an unrelated third party in the aggregate amount of $330,000. These notes accrue
interest at 10% annually and were due and payable during the second quarter of
2007.  As of the date of this report, the Company had not made the
scheduled payments on these promissory notes, and the holder of the notes had
not declared a default under the notes.





During
the quarter ended March 31, 2007, the Company entered into five promissory notes
with an unrelated third party in the aggregate amount of
$450,000.  These notes accrue interest at 10% annually and were due
and payable during the third quarter of 2007.  As of the date of this
report, the Company had not made the scheduled payments on these promissory
notes, and the holder of the notes had not declared a default under the
notes.





The
following schedule summarizes the Company’s current debt obligations and
respective balances at March 31, 2008, and December 31, 2007:








Notes Payable
            
            March 31, 2008
            
            
            December 31, 20075%
      Note payable to a company, $8,733,000 face amount, due in quarterly
      installments of $319,000, matures January 2010, less unamortized discount
      based on interest imputed at 25% of $1,814,000 and $2,124,000,
      respectively
            
            $
            6,919,000
            
            
            $
            6,609,000Note
      payable to a company, interest at 10%, matured June 2007, due on
      demand
            
            
            235,000
            
            
            
            235,000Note
      payable to a company, interest at 10%, matured June 2007, due on
      demand
            
            
            95,000
            
            
            
            95,000Note
      payable to a company, interest at 10%, matured July 2007, due on
      demand
            
            
            450,000
            
            
            
            450,000Note
      payable to related parties, interest at 12%, matured September 2006,
      secured by intellectual property rights
            
            
            961,000
            
            
            
            902,000Total
      notes payable
            
            
            8,660,000
            
            
            
            8,291,000Less
      current maturities
            
            
            (5,329,000
            )
            
            
            (4,735,000
            )Long-Term
      Note Payable
            
            $
            3,331,000
            
            
            $
            3,556,000







10


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





3.  RELATED-PARTY
NOTES PAYABLE





During
2002, two executive officers of the Company (the “Lenders”) sold shares of the
Company’s Class A common stock owned by them and advanced the resulting proceeds
amounting to $333,000 to the Company under the terms of a revolving line of
credit and related promissory note.  The funds were advanced for use
in Company operations.  The advances bear interest at 12 percent per
annum, which interest is payable on a semi-annual basis.  The entire
principal, along with unpaid accrued interest and any other unpaid charges or
related fees, was originally due and payable on June 10, 2003.  The
Company and the Lenders have agreed to postpone the maturity date on several
occasions.  The note was due September 30, 2006.  As of
March 31, 2008, the Company had not made payment against the outstanding balance
due on the note.  All or part of the outstanding balance and unpaid
interest may be converted at the option of the Lenders into shares of Class A
common stock of the Company at any time.  The conversion price was the
average closing bid price of the shares at the time of the
advances.  To the extent the market price of the Company’s shares is
below the conversion price at the time of conversion, the Lenders are entitled
to receive additional shares equal to the gross dollar value received from the
original sale of the shares.  A beneficial conversion option of
$15,000 was recorded as interest expense in connection with this
transaction.  The Lenders may also receive additional compensation as
determined appropriate by the Board of Directors.





During
the year ended December 31, 2005, the Company received an additional advance of
$50,000 against the promissory note.  The balance due at December 31,
2005 was $486,000.  During the year ended December 31, 2006, the
Company received additional advances and other consideration from the Lenders in
the aggregate amount of $419,000 and made principal payments to the Lenders
against the note of $105,000.  During the year ended December 31,
2007, the Company received additional advances of $102,000.  During
the quarter ended March 31, 2008, the Company received additional advances of
$59,000.  The balance due at March 31, 2008, was
$961,000.





The
balance due of $961,000 is secured by the Company’s intellectual property
rights and common stock of Fonix Speech.  As of March 31, 2008, the
Lenders had not converted any of the outstanding balance into common
stock.  However, on March 24, 2008, the Lenders converted $10,000 of
accrued interest into 53,913,701 shares of common stock for the benefit of one
of the Lenders, Thomas A. Murdock a former officer and director of the
Company.





4.  PREFERRED
STOCK





The
Company’s certificate of incorporation allows for the issuance of preferred
stock in such series and having such terms and conditions as the Company’s board
of directors may designate.





Series A
Convertible Preferred Stock – As of March 31, 2007, there were 166,667
shares of Series A convertible preferred stock outstanding.  Holders
of the Series A convertible preferred stock have the same voting rights as
common stockholders, have the right to elect one person to the board of
directors and are entitled to receive a one time preferential dividend of $2.905
per share of Series A convertible preferred stock prior to the payment of any
dividend on any class or series of stock.  At the option of the
holders, each share of Series A convertible preferred stock is convertible into
one share of Class A common stock and in the event that the common stock price
has equaled or exceeded $10 per share for a 15 day period, the shares of Series
A convertible preferred stock will automatically be converted into Class A
common stock.  In the event of liquidation, the holders are entitled
to a liquidating distribution of $36.33 per share and a conversion of Series A
convertible preferred stock at an amount equal to .0375 shares of common stock
for each share of Series A convertible preferred stock.





Series L
Preferred Stock – On September 7, 2006, the Company entered into a Series
L 9% Convertible Preferred Stock Exchange Agreement (the "Exchange Agreement")
with McCormack and Kenzie Financial (“Kenzie”), a British Virgin Islands
company.  Pursuant to the Exchange Agreement, McCormack and Kenzie
exchanged all 2,000 shares of Series H Preferred Stock that they acquired
from the sale of LTEL Holdings, for 1,960.8 and 39.2 shares,
respectively,  of the Company's Series L 9% Convertible Preferred
Stock (the "Series L Preferred Stock").









11


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





Because
the shares of Series L Preferred Stock were issued in exchange for the remaining
outstanding shares of Series H Preferred Stock, the Company did not receive any
proceeds in connection with the issuance of the Series L Preferred
Stock.





The
Series L Preferred Stock entitles McCormack and Kenzie to receive dividends in
an amount equal to 9% of the then-outstanding balance of shares of Series L
Preferred Stock.  The dividends are payable in cash or shares of the
Company's Class A common stock, at the Company's option.





The
Series L Preferred Stock is convertible into common stock of the Company at the
option of the holder by using a conversion price which was 80% of the average of
the two (2) lowest closing bid prices for the twenty-day trading period prior to
the conversion date.





Redemption
of the Series L Preferred Stock, whether at the Company’s option or that of
McCormack or Kenzie, requires the Company to pay, as a redemption price, the
stated value of the outstanding shares of Series L Preferred Stock to be
redeemed, together with any accrued but unissued dividends thereon, multiplied
by one hundred ten percent (110%).





The
Company accounted for the exchange as redemption of the outstanding Series H
Preferred Stock as the Series H Preferred Stock was not convertible into shares
of common stock of the Company.  The Series L Preferred Stock is
convertible into shares of common stock of the Company.  The Company
followed the accounting treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the redemption of
$30,991,000 due to the value of the conversion feature of the Series L Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 140%, risk-free rate of 3.75% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
L Preferred Stock, no value was prescribed to the Series L Preferred
Stock.  Also in connection with the redemption, the Company recognized
a preferred stock dividend of $16,000,000, equal to the original discount the
Company had assigned to the Series H Preferred Stock.  At March 31,
2008, the fair value of the Series L Preferred Stock derivative liability was
$15,817,000.





For the
quarter ended March 31, 2008, the Company issued 1,354,251,012 shares of its
Class A common stock in conversion of 15 shares of its Series L Preferred
Stock.  At March 31, 2008, 1,521 shares of Series L Preferred Stock
remained outstanding.  (See Note 9 for discussion of conversions
subsequent to March 31, 2008.)





Series M
Preferred Stock– On April 4, 2007, the Company entered into a Series M
9% Convertible Preferred Stock Exchange Agreement with Sovereign Partners, LP
(“Sovereign”).  Pursuant to the exchange agreement, Sovereign
exchanged 150 shares of the Company’s Series L Preferred Stock for 150 shares of
the Company’s Series M 9% Convertible Preferred Stock (the “Series M Preferred
Stock”).





The
Series M Preferred Stock entitles Sovereign or its assignees to receive
dividends in an amount equal to 9% of the then-outstanding balance of shares of
Series M Preferred Stock.  The dividends are payable in cash or shares
of the Company’s Class A common stock, at the Company’s option.





The
Series M Preferred Stock may be converted into common stock of the Company at
the option of the holder by using a conversion price which shall be the lower of
(i) 80% of the average of the two lowest closing bid prices for the twenty-day
trading period prior to the conversion date, or (ii) $0.004.







12


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





Redemption
of the Series M Preferred Stock, whether at the Company’s option or that of
Sovereign, requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series M Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





Because
the shares of Series M were issued in exchange for the outstanding shares of
Series L Preferred Stock, the Company did not receive any proceeds in connection
with the issuance of the Series M Preferred Stock.





The
Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the redemption of
$1,603,000 due to the value of the conversion feature of the Series M Preferred
Stock, which was previously recorded as part of the Series L Preferred Stock
derivative liability.  The liability was calculated using the
Black-Scholes valuation model with the following assumptions: dividend yield of
0%, expected volatility of 134%, risk-free rate of 5% and expected life of 4
years.  As the value of the derivative liability was greater than the
face value of the Series M Preferred Stock, no value was prescribed to the
Series M Preferred Stock.  At March 31, 2008, the fair value of the
Series M Preferred Stock derivative liability was $1,560,000.





Series N
Convertible Preferred Stock – On August 24, 2007, the Company entered
into a Securities Purchase Agreement with Trillium Partners, LP and other
unnamed future investors relating to the issuance and sale of the Company’s
Series N 9% Convertible Preferred Stock.





Pursuant
to the agreement, the Company agreed to issue up to 2,400 shares of its Series N
9% Convertible Preferred Stock (the “Series N Preferred Stock”) at a per share
price of $1,000 to Trillium Partners, LP and other unnamed future investors, for
gross proceeds of up to $2,400,000.  As of the date of this report,
the Company had issued 1,350 shares of the Series N Preferred Stock, for cash
proceeds of $1,350,000.





The
Series N Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series N
Preferred Stock.  The dividends are payable in cash or shares of the
Company's Class A common stock, at the Company's option.





The
Series N Preferred Stock is convertible into Class A common stock of the Company
at the option of the holder by using a conversion price equal to 80% of the
average of the two lowest closing bid prices for the twenty-day trading period
prior to the conversion date.





Redemption
of the Series N Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series N Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





The
Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the redemption of
$957,000 due to the value of the conversion feature of the Series N Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 128%, risk-free rate of 5.0% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
N Preferred Stock, no value was prescribed to the Series N Preferred
Stock.  At March 31, 2008, the fair value of the Series N Preferred
Stock derivative liability was $1,404,000.









13


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





Series O
Convertible Preferred Stock – Between January 25, 2008, and May 5, 2008,
the Company received advances from three entities in connection with the
purchase agreements related to the Company’s Series O 9% Convertible Preferred
Stock (“Series O Preferred Stock”). On May 20, 2008, the Company entered into
Securities Purchase Agreements with Southridge Partners LP, Southshore Capital
Fund LTD, Sovereign Partners LP (collectively, the “Series O Purchasers”) for
the sale of an aggregate of 38.8 shares of Series O Preferred Stock for gross
proceeds of $373,000. The
material terms of the purchase agreements had been agreed upon prior to receipt
of the advances.  Therefore, the Series O Preferred Stock was
accounted for as discussed below on the dates cash proceeds were received by the
Company.  The Company also began accruing dividends upon receiving the
advances.





The
Series O Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series O
Preferred Stock. The dividends are payable in cash or shares of the Company's
Class A common stock, at the Company's option.





The
Series O Preferred Stock is convertible into common stock of the Company at the
option of the holder by using a conversion price, equal to 80% of the average of
the two lowest closing bid prices for the twenty-day trading period prior to the
conversion date.





Redemption
of the Series O Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series O Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





The
Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for
Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock.”The Company recognized a derivative liability upon
the redemption of $290,000 due to the value of the conversion feature of the
Series O Preferred Stock. The liability was calculated using the Black-Scholes
valuation model with the following assumptions: dividend yield of 0%, expected
volatility of 128%, risk-free rate of 5.0% and expected life of 4 years. As the
value of the derivative liability was greater than the face value of the Series
O Preferred Stock, no value was prescribed to the Series O Preferred Stock. At
March 31, 2008, the fair value of the Series O Preferred Stock derivative
liability was $302,000.





Fonix Speech,
Inc. Series B Convertible Preferred Stock – On April 4, 2007, the Company
entered into a Securities Purchase Agreement by and among the Company, Fonix
Speech, Inc. (“FSI”), and Sovereign Partners, LP (“Sovereign”).  FSI
is a wholly owned subsidiary of the Company.





Pursuant
to the FSI purchase agreement, FSI sold 125 shares of its Series B 9%
Convertible Preferred Stock (the “Series B Preferred Stock”) at a per share
price of $10,000 to Sovereign, for gross proceeds of $1,250,000.





The
shares of Series B Preferred Stock are convertible into shares of the Company’s
Class A common stock.  The Series B Preferred Stock may be converted
into common stock of the Company at the option of the holder by using a
conversion price which shall be the lower of (i) 80% of the average of the two
lowest closing bid prices for the twenty-day trading period prior to the
conversion date, or (ii) $0.004.





The
Series B Preferred Stock entitles Sovereign or its assignees to receive
dividends in an amount equal to 9% of the then-outstanding balance of shares of
Series B Preferred Stock.  The dividends are payable in cash or shares
of the Company's Class A common stock, at the Company's option





The
Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the issuance of
$1,336,207 due to the value of the conversion feature of the Series B Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 134%, risk-free rate of 5% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
B Preferred Stock, no value was prescribed to the Series B Preferred
Stock.  At March 31, 2008, the fair value of the Series B Preferred
Stock derivative liability was $1,300,000.









14


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





5.  CONVERTIBLE
DEBENTURES





On
December 7, 2006, the Company entered into a Securities Purchase Agreement,
dated as of December 1, 2006 (the “Agreement”), with Southridge Partners LP
("Southridge") relating to the purchase and sale of a Series E 9% Secured
Subordinated Convertible Debenture (the “Debenture”) in the principal amount of
$850,000.





Pursuant
to the Agreement, Southridge paid the purchase price by tendering a prior
debenture in the aggregate amount (including principal and interest) of
$641,000, and agreed that an advance to the Company in the amount of $75,000
made in November 2006 would also constitute part of the purchase
price.  Southridge agreed to fund the remaining $134,000 upon the
effectiveness of a registration statement, to be filed by the Company, to
register the resales of shares issuable to Southridge upon conversion of the
Debenture.  The
Company received no new capital in connection with the issuance and sale of the
Debenture.





The
Debenture is convertible into shares of our Class A common stock.  The
number of shares issuable is determined by dividing the amount of the Debenture
being converted by the conversion price, which is the average of the two lowest
per share market values for the twenty trading days immediately preceding the
conversion date multiplied by seventy percent. The conversion price is subject
to adjustment as set forth in the Debenture.  Southridge has agreed
not to convert the Debenture to the extent that such conversion would cause
Southridge to beneficially own in excess of 4.999% of the then-outstanding
shares of Class A common stock of the Company except in the case of a merger by
the Company or other organic change.





The
Company also entered into a Registration Rights Agreement (the “Registration
Agreement”) with Southridge pursuant to which the Company agreed to file a
registration statement to register the resale by Southridge of shares of the
Company’s Class A common stock issuable upon conversion of the
Debenture. As
of the date of this Report, no registration statement has been
filed.




In
addition to the Debenture issued to Southridge described above, on December 7,
2006, the Company entered into a Securities Purchase Agreement, dated as of
December 1, 2006 (the “McCormack Agreement”), with McCormack, relating to the
purchase and sale of a Series E 9% Secured Subordinated Convertible Debenture
(the “McCormack Debenture”) in the principal amount of $1,039,000.





Pursuant
to the McCormack Agreement, McCormack paid the purchase price by tendering
outstanding promissory notes in the amounts of $300,000 and $350,000, together
with combined interest thereon of $64,000, and agreed that advances to the
Company in the amount of $325,000, made in September, October, and November
2006, would also constitute part of the purchase price.





The
McCormack Debenture is convertible into shares of the Companay's Class A common
stock. on the same terms as the Debenture.




The
Company also entered into a Registration Rights Agreement (the “McCormack
Registration Agreement”) with McCormack pursuant to which the Company agreed to
file a registration statement to register the resale by McCormack of shares of
the Company’s common stock issuable upon conversion of the
Debenture.  As of the date of this Report, no registration statement
had been filed.









15


Fonix
Corporation and Subsidiaries


Notes
to Condensed Consolidated Financial Statements


(Unaudited)





6.  COMMON
STOCK, STOCK OPTIONS AND WARRANTS





Class A Common
Stock – During the three months ended March 31, 2008, 1,354,251,012
shares of Class A common stock were issued in conversion of 15 shares of Series
L Preferred Stock, 53,913,701 shares were issued in conversion of interest on
the related party note and 7,403,846 shares were issued in payment of interest
on the Series L Preferred Stock.





Stock Options
– As of March 31, 2008, the Company had a total of 204,000 options to
purchase Class A common stock outstanding.  During the three months
ended March 31, 2008 no options were granted.





Warrants –
As of March 31, 2008, the Company had warrants to purchase a total of 15,000
shares of Class A common stock outstanding that expire through
2010.





7.  LITIGATION,
COMMITMENTS AND CONTINGENCIES





Breckenridge
Complaint – On June 6, 2006, Breckenridge filed a complaint against the
Company in the Supreme Court of the State of New York, County of Nassau (the
“Court”), in connection with a settlement agreement between the Company and
Breckenridge entered into in September 2005. On
February 2, 2007, the Court granted Breckenridge’s motion for summary judgment,
denied the Company’s summary judgment motion, and directed that a hearing be
held to determine the amount owed by the Company to Breckenridge.  The
Company and Breckenridge entered into a stipulation that the Company owed
Breckenridge $1,530,000 plus interest at a rate of 9% from September 15, 2006 to
the date of entry of judgment.





The
Court’s judgment, dated as of March 15, 2007, states that the Company owes an
aggregate of $1,602,000 to Breckenridge.  The Company has accrued for
this settlement in the accompanying financial statements.  In February
2008, the Company entered into an amended settlement agreement with Breckenridge
under which the Company agreed to pay Breckenridge $540,000.  The
Company has paid Breckenridge $242,500 and is obligated to pay the balance of
$297,500 at the rate of $42,500 per month.





Hite Development
Corporation –  In January 2007, Hite Development Corporation
(“Hite”) brought a lawsuit against the Company claiming breach of contract and
breach of the covenant of good faith and fair dealing, alleging that the Company
failed to make certain payments under a settlement agreement with Hite dating
from March 2005.  The complaint seeks approximately $33,000 plus
interest.  The Company filed its answer in May 2007.  The
case is currently in the discovery phase.  On May 8, 2008, Hite filed
a motion for summary judgment.  As of the date of this Report, the
Company had not filed its response to the motion.  The Company intends
to defend against the claims in the complaint.





RR Donnelley
Receivables Inc– In July 2007, RR
Donnelley Receivables Inc. (“Donnelly”) brought a lawsuit against the Company
for alleged failure to pay for services provided.  The complaint seeks
approximately $21,000 plus interest.  The Company filed its answer in
August 2007, and filed a motion to dismiss the action in December
2007.  That motion is currently pending before the
court.  If the Company’s motion to dismiss is denied, the Company
intends to defend against the claims in the complaint.





8.  SUBSEQUENT
EVENTS





Subsequent
to March 31, 2008, the Company has issued 500,000,000 shares of its Class A
common stock in conversion of 5 shares of Series L Preferred Stock.





Subsequent
to March 31, 2008, the Company has issued 107,467,600 shares of its Class A
common stock in payment of interest on the Series L Preferred
Stock.








16


ITEM
      2.
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS





This
report on Form 10-Q contains, in addition to historical information,
forward-looking statements that involve substantial risks and
uncertainties.  All forward-looking statements contained herein are
deemed by Fonix to be covered by and to qualify for the safe harbor protection
provided by Section 21E of the Private Securities Litigation Reform Act of
1995.  When used in this report, words such as “believes,” “expects,”
“intends,” “plans,” “anticipates,” “estimates,” and similar expressions are
intended to identify forward-looking statements, although there may be certain
forward-looking statements not accompanied by such
expressions.  Statements relating to the future performance, business
strategies and implementation, availability of outside financing, financial
performance, market acceptance of our products, and similar statements may also
include forward looking statements.  Actual results could differ
materially from the results anticipated by Fonix 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, 2007.  The Company disclaims
any obligation or intention to update any forward-looking
statements.





To
date, we have earned only limited revenue from operations and intend to continue
to rely primarily on financing through the sale of our equity and debt
securities to satisfy future capital requirements.





The following Management’s Discussion
and Analysis of Financial Condition and Results of Operations (“MD&A”) is
intended to help the reader understand Fonix Corporation, our operations and our
present business environment.  MD&A is provided as a supplement
to, and should be read in conjunction with, our condensed consolidated financial
statements and the accompanying notes thereto.  This overview
summarizes MD&A, which includes the following sections:





·
            Overview
      – a general description of our business and the markets in which we
      operate; our objective; our areas of focus; and challenges and risks of
      our business.





·
            Significant
      Accounting Policies– a discussion of
      accounting policies that require critical judgments and
      estimates.





·
            Results of
      Operations– an analysis of
      our Company’s consolidated results of operations for the three years
      presented in our consolidated financial statements.  Except to
      the extent that differences among our operating segments are material to
      an understanding of our business as a whole, we present the discussion in
      the MD&A on a consolidated
basis.





·
            Liquidity
      and Capital Resources– an analysis of
      cash flows; off-balance sheet arrangements and aggregate contractual
      obligations; the impact of foregoing exchange; an overview of financial
      position; and the impact of inflation and changing
  prices.





We intend for this discussion to
provide the reader with information that will assist in understanding our
financial statements, the changes in certain key items in those financial
statements from year to year, and the primary factors that accounted for those
changes, as well as how certain accounting principles affect our financial
statements.  The discussion also provides information about the
financial results of the various segments of our business to provide a better
understanding of how those segments and their results affect the financial
condition and results of operations of the Company as a whole.  This
discussion should be read in conjunction with our financial statements as of
December 31, 2007, and the year then ended and the notes accompanying those
financial statements.





Overview





We are engaged in providing value-added
speech technologies through Fonix Speech, Inc. (“Fonix Speech”).  We
offer speech-enabling technologies including automated speech recognition
(“ASR”) and text-to-speech (“TTS”) through Fonix Speech.  We offer our
speech-enabling technologies to markets for wireless and mobile devices,
computer telephony, server solutions and personal software for consumer
applications.  We have received various patents for certain elements
of our core technologies and have filed applications for other patents covering
various aspects of our technologies.  We seek to develop relationships
and strategic alliances with third-party developers and vendors in
telecommunications, computers, electronic devices and related industries,
including producers of application software, operating systems, computers and
microprocessor chips.  Revenues are generated through licensing of
speech-enabling technologies, maintenance contracts and services.






17


For the quarters ended March 31, 2008
and 2007, we generated revenues of $286,000 and $360,000, respectively; incurred
net losses of $1,046,000 and $787,000, respectively; and had negative cash flows
from operating activities of $82,000 and $1,410,000, respectively.  As
of March 31, 2008, we had an accumulated deficit of $279,567,000; negative
working capital of $35,952,000; derivative liabilities of $20,947,000; related
to the issuance of Series L Preferred Stock,  Series M Preferred
Stock, Series N Preferred Stock, Series N Preferred Stock,  Series E
Convertible Debentures and Series B Preferred Stock of our subsidiary; accrued
liabilities and accrued settlement obligation of $5,592,000; accounts payable of
$1,760,000; and current portion of notes payable of $4,368,000, Series E
debentures of $1,754,000 and deferred revenues of $445,000.  We expect
to continue to incur significant losses and negative cash flows from operating
activities at least through December 31, 2008, primarily due to expenditure
requirements associated with continued marketing and development of our
speech-enabling technologies.





We are continually developing new
product offerings in the ASR businesses in an effort to increase our revenue
stream, and we are continuing to work with our existing customers to increase
sales.  We have also experienced operating expense decreases through
headcount reductions and overall cost reduction measures.  Through the
combination of increased recurring revenues and the overall operating cost
reduction strategies we have implemented, we hope to achieve positive cash flow
from operations in the next 18-24 months.  However, there can be no
assurance that we will be able to achieve positive cash flow from operations
within this time frame.





Historically, our cash resources,
limited to collections from customers, draws on equity lines of credit and
loans, have not been sufficient to cover operating expenses.  We
periodically engage in discussions with various sources of financing to
facilitate our cash requirements including buyers of both debt and equity
securities.  To date, no additional sources of funding offering terms
superior to those available under equity lines have been implemented, and we
rely on first, cash generated from operations, and second, cash provided through
convertible debt financing arrangements.  We will need to generate
approximately $2 to $3 million to continue operations for the next twelve
months.  There can be no assurance that we will be able to obtain such
financing or that, if we can obtain such financing, it will be on terms
favorable to us.





Significant
Accounting Policies





The discussion and analysis of our
financial condition and results of operations are based upon our consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States.  The preparation
of these financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of sales and expenses during the reporting
period.  Significant accounting policies and areas where substantial
judgments are made by management include:





Accounting
estimates-The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosures of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period.  Actual results could differ from those
estimates.





Valuation of
long-lived assets - The carrying values of our long-lived assets are
reviewed for impairment whenever events or changes in circumstances indicate
that they may not be recoverable.  When such an event occurs, we
project undiscounted cash flows to be generated from the use of the asset and
its eventual disposition over the remaining life of the asset.  If
projections indicate that the carrying value of the long-lived asset will not be
recovered, the carrying value of the long-lived asset, other than software
technology, is reduced by the estimated excess of the carrying value over the
projected discounted cash flows.





Goodwill
–
Goodwill represents the excess of the cost over the fair value of net assets of
acquired businesses. Goodwill is not amortized, but is tested for impairment
quarterly or when a triggering event occurs.  The testing for
impairment requires the determination of the fair value of the asset or entity
to which the goodwill relates (the reporting unit).  The fair value of
a reporting  unit is determined based upon a weighting of the quoted
market price of our common stock and present value techniques based upon
estimated future cash flows of the reporting unit, considering future revenues,
operating costs, the risk-adjusted discount rate and other
factors.  Impairment is indicated if the fair value of the reporting
unit is allocated to the assets and liabilities of that unit, with the excess of
the fair value of the reporting unit over the amounts assigned to its assets and
liabilities assigned to the fair value of goodwill.  The amount of
impairment of goodwill is measured by the excess of the goodwill’s carrying
value over its fair value.








18


Revenue
recognition – We recognize revenue when pervasive evidence of an
arrangement exists, services have been rendered or products have been delivered,
the price to the buyer is fixed and determinable and collectibility is
reasonable assured.  Revenues are recognized by us based on the
various types of transactions generating the revenue.  For software
sales, we recognize revenues in accordance with the provisions of Statement of
Position No. 97-2, “Software Revenue Recognition” and related
interpretations.We generate
revenues from licensing the rights to its software products to end users and
from royalties.





For Fonix
Speech, revenue of all types is recognized when acceptance of functionality,
rights of return, and price protection are confirmed or can be reasonably
estimated, as appropriate.  Revenues from development and consulting
services are recognized on a completed-contract basis when the services are
completed and accepted by the customer.  The completed-contract method
is used because our contracts are typically either short-term in duration or we
are unable to make reasonably dependable estimates of the costs of the
contracts.  Revenue for hardware units delivered is recognized when
delivery is verified and collection assured.





Revenue
for products distributed through wholesale and retail channels and through
resellers is recognized upon verification of final sell-through to end users,
after consideration of rights of return and price
protection.  Typically, the right of return on such products has
expired when the end user purchases the product from the retail
outlet.  Once the end user opens the package, it is not returnable
unless the medium is defective.





When
arrangements to license software products do not require significant production,
modification or customization of software, revenue from licenses and royalties
are recognized when persuasive evidence of a licensing arrangement exists,
delivery of the software has occurred, the fee is fixed or determinable, and
collectibility is probable.  Post-contract obligations, if any,
generally consist of one year of support including such services as customer
calls, bug fixes, and upgrades.  Related revenue is recognized over
the period covered by the agreement.  Revenues from maintenance and
support contracts are also recognized over the term of the related
contracts.





Revenues
applicable to multiple-element fee arrangements are bifurcated among the
elements such as license agreements and support and upgrade obligations using
vendor-specific objective evidence of fair value.  Such evidence
consists primarily of pricing of multiple elements as if sold as separate
products or arrangements.  These elements vary based upon factors such
as the type of license, volume of units licensed, and other related
factors.





Deferred
revenue as of March 31, 2008, and December 31, 2007, consisted of the
following:




Description
            
            Criteria
      for Recognition
            
            March
      31, 2008
            
            
            December
      31, 2007Deferred
      unit royalties and license fees
            
            Delivery
      of units to end users or expiration of contract
            
            $
            445,000
            
            
            $
            445,000





Cost of
revenues-  Cost of revenues from license, royalties, and maintenance
consists of costs to distribute the product, installation and support personnel
compensation, amortization and impairment of capitalized speech software costs,
licensed technology, and other related costs.  Cost of service
revenues consists of personnel compensation and other related
costs.





Software
Technology Development and Production Costs- All costs incurred to
establish the technological feasibility of speech software technology to be
sold, leased, or otherwise marketed are charged to product development and
research expense.  Technological feasibility is established when a
product design and a working model of the software product have been completed
and confirmed by testing.  Costs to produce or purchase software
technology incurred subsequent to establishing technological feasibility are
capitalized.  Capitalization of software costs ceases when the product
is available for general release to customers.  Costs to perform
consulting or development services are charged to cost of revenues in the period
in which the corresponding revenues are recognized.  Costs of
maintenance and customer support are charged to expense when related revenue is
recognized or when these costs are incurred, whichever occurs
first.





19


Capitalized software technology costs
were amortized on a product-by-product basis.  Amortization was
recognized from the date the product was available for general release to
customers as the greater of (a) the ratio that current gross revenue for a
product bears to total current and anticipated future gross revenues for that
product or (b) the straight-line method over the remaining estimated economic
life of the products.  Amortization was charged to cost of
revenues.





We assessed unamortized capitalized
software costs for possible write down on a quarterly basis based on net
realizable value of each related product.  Net realizable value was
determined based on the estimated future gross revenues from a product reduced
by the estimated future cost of completing and disposing of the product,
including the cost of performing maintenance and customer
support.  The amount by which the unamortized capitalized costs of a
software product exceeded the net realizable value of that asset was written
off.





Imputed Interest
Expense and Income - Interest is imputed on long-term debt obligations
and notes receivable where management has determined that the contractual
interest rates are below the market rate for instruments with similar risk
characteristics.





Foreign Currency
Translation-The
functional currency of our Korean subsidiary is the South Korean
won.  Consequently, assets and liabilities of the Korean operations
are translated into United States dollars using current exchange rates at the
end of the year.  All revenue is invoiced in South Korean won and
revenues and expenses are translated into United States dollars using
weighted-average exchange rates for the year.





Comprehensive
Income-Other
comprehensive income presented in the accompanying consolidated financial
statements consists of cumulative foreign currency translation
adjustments.





Recently Enacted
Accounting Standards





Business
Combinations - In December 2007, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standards No. 141 (revised
2007) (“SFAS 141”)“Business Combinations.” This accounting principle requires the
fundamental requirements of acquisition accounting (purchase accounting) be
applied to all business combinations in which control is obtained regardless of
consideration and for an acquirer to be identified for each business
combination. Additionally, this accounting principle requires
acquisition-related costs and restructuring costs at the date of acquisition to
be expensed rather than allocated to the assets acquired and the liabilities
assumed; minority interests, including goodwill, to be recorded at fair value at
the acquisition date; recognition of the fair value of assets and liabilities
arising from contractual contingencies and contingent consideration (payments
conditioned on the outcome of future events) at the acquisition date;
recognition of bargain purchase (acquisition-date fair value exceeds
consideration plus any noncontrolling interest) as a gain; and recognition of
changes in deferred taxes. This accounting principle will be adopted January
2009. The accounting requirements will be adopted prospectively. Earlier
adoption is prohibited. Adoption is not expected to have an impact on our
consolidated financial position, results of operations or cash
flows.





Noncontrolling
Interests in Consolidated Financial Statements - In December 2007, the
FASB issued Statement of Financial Accounting Standard No. 160,
“Noncontrolling Interests in Consolidated Financial Statements.”  This
accounting principle eliminates noncomparable accounting for minority interests.
Specifically, minority interests are presented as a component of shareholders’
equity; consolidated net income includes amounts attributable to both the parent
and minority interest and is disclosed on the face of the income statement;
changes in the ownership interest are accounted for as equity transactions if
ownership remains controlling; elimination of purchase accounting for
acquisitions of noncontrolling interests and acquisitions of additional
interests; and recognition of deconsolidated controlling interest based on fair
value consistent with SFAS No. 141 (revised 2007),Business Combinations. This
accounting principle will be adopted January 2009. The accounting requirements
will be adopted prospectively, however presentation and disclosure will be
adopted retrospectively for all periods presented. Earlier adoption is
prohibited. Adoption is not expected to have an impact on our consolidated
financial position, results of operations or cash flows.









20


Fair Value
Measurements-In September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements” (“SFAS 157”). SFAS 157 provides guidance for using fair value to
measure assets and liabilities. The standard also responds to investors’ request
for expanded information about the extent to which a company measures assets and
liabilities at fair value, the information used to measure fair value, and the
effect of fair value measurements on earnings. SFAS 157 took effect for the
Company’s fiscal year beginning January 1, 2008. We are currently reviewing the
effect that the adoption of SFAS 157 will have on our financial
statements.





Results
of Operations




Three
months ended March 31, 2008, compared with three months ended March 31,
2007




During
the three months ended March 31, 2008, we recorded revenues of $286,000, a
decrease of $74,000 from $360,000 in 2007. The decrease was primarily due to
decreased royalty revenues of $87,000, decreased non-recurring engineering
(“NRE”) speech revenues of $15,000 and decreased licensing revenue of $2,000,
partially offset by an increase in support fees of $30,000.





Selling,
general and administrative expenses were $502,000 for the three months ended
March 31, 2008, a decrease of $305,000 from $807,000 in 2007. The decrease is
primarily due to decreased salary and wage related expenses of $406,000,
decreased consulting expenses of $17,000, decreased legal and accounting fees of
$7,000, decreased depreciation expenses of $5,000 and decreased other expenses
of $3,000,partially offset by an increased occupancy related expenses of
$85,000, increased investor relations related expenses of $38,000, increased
travel expenses of $5,000, increased taxes, licenses and permits of
$3,000  and increased advertising expenses of $2,000.





We
incurred research and product development expenses of $218,000 for the three
months ended March 31, 2008, a decrease of $269,000 from $487,000 in 2007. The
decrease was primarily due to an overall decrease in wage related expenses of
$244,000, decreased consulting expenses of $14,000, decreased travel expenses of
$6,000, decreased depreciation expenses of $6,000 and decreased other expenses
of $1,000, partially offset by an increased occupancy related expenses of
$2,000.





Net other
income (expense) was $587,000 expense for the three months ended March 31, 200,
a change of $741,000 from the net other income of $154,000 in
2007.  The overall change was due to the loss recognized on the
derivative liability of $79,000, compared to the $617,000 gain in 2007, and the
increase in interest expense of $45,000.





Liquidity
and Capital Resources





We must raise additional funds to be
able to satisfy our cash requirements during the next 12 months.  It
is anticipated that we will need to raise approximately $2.5 to $5 million over
the next 12 months to meet obligations and continue our product development,
corporate operations and marketing expenses.  Because we presently
have only limited revenue from operations, we intend to continue to rely
primarily on financing through the sale of our equity and debt securities to
satisfy future capital requirements until such time as we are able to enter into
additional third-party licensing, collaboration, or co-marketing arrangements
such that we will be able to finance ongoing operations from license, royalty,
and sales revenue.  We are working with game developers and other
potential licensors of our speech product offerings to develop additional
revenue streams for our speech technologies.  There can be no
assurance that we will be able to enter into such
agreements.  Furthermore, the issuance of equity or debt securities
which are or may become convertible into equity securities of Fonix in
connection with such financing could result in substantial additional dilution
to the stockholders of Fonix.





Our cash resources are limited to
collections from customers, proceeds from the issuance of preferred stock, and
loan proceeds, and are not sufficient to cover current operating expenses and
payments of current liabilities.  At March 31, 2008, we had negative
working capital of $35,952,000 derivative liabilities of $20,947,000 related to
the issuance of Series L Preferred Stock,  Series M Preferred Stock,
Series N Preferred Stock, Series N Preferred Stock,  Series E
Convertible Debentures and Series B Preferred Stock of our subsidiary, accrued
liabilities and accrued settlement obligation of $5,592,000, accounts payable of
$1,760,000 and current portion of notes payable of $4,368,000, Series E
debentures of $1,754,000 and deferred revenues of $445,000.









21


We had $286,000 in revenue and a loss
of $1,046,000 for the quarter ended March 31, 2008.  Net cash used in
operating activities of $82,000 for the quarter ended March 31, 2008, resulted
principally from the net loss incurred of $1,046,000, non-cash accretion of
discount on notes payable of $310,000, increased accounts payable of $228,000,
increased accrued liabilities of $175,000, decreased other assets of $108,000,
non-cash loss recognized on the derivative liability of $79,000, decreased
prepaid expenses and other current assets of $61,000 and depreciation expense of
$3,000 We did not use any cash in investing activities for the quarter ended
March 31, 2008.  Net cash provided by financing activities of $149,000
consisting primarily of the proceeds on the Series O Preferred Stock of $290,000
and proceeds from the related party note of $59,000.





We had negative working capital of
$35,952,000 at March 31, 2008, compared to negative working capital of
$34,384,000 at December 31, 2007.  Current assets increased by $6,000
to $93,000 from $87,000 from December 31, 2007, to March 31,
2008.  Current liabilities increased by $1,574,000 to $36,045,000 from
$34,471,000 during the same period.  The change in working capital
from December 31, 2007, to March 31, 2008, reflects, in part, increased current
portion of notes payable of $535,000, increased accrued liabilities of $747,000,
increased accounts payable of $228,000, increased derivative liability of
$205,000 and increased notes payable to related parties of $59,000, partially
offset by a decrease in accrued settlement obligation of $200,000 and an
increased cash of $67,000.  Total assets were $106,000 at March 31,
2008, compared to $211,000 at December 31, 2007.





Notes
Payable - Related Parties





During 2002, two executive officers of
the Company (the “Lenders”) sold shares of the Company’s Class A common stock
owned by them and advanced the resulting proceeds amounting to $333,000 to the
Company under the terms of a revolving line of credit and related promissory
note.  The funds were advanced for use in Company
operations.  The advances bear interest at 12 percent per annum, which
interest is payable on a semi-annual basis.  The entire principal,
along with unpaid accrued interest and any other unpaid charges or related fees,
was originally due and payable on June 10, 2003.  The Company and the
Lenders have agreed to postpone the maturity date on several
occasions.  The note was due September 30, 2006.  As of
March 31, 2008, the Company had not made payment against the outstanding balance
due on the note.  All or part of the outstanding balance and unpaid
interest may be converted at the option of the Lenders into shares of Class A
common stock of the Company at any time.  The conversion price was the
average closing bid price of the shares at the time of the
advances.  To the extent the market price of the Company’s shares is
below the conversion price at the time of conversion, the Lenders are entitled
to receive additional shares equal to the gross dollar value received from the
original sale of the shares.  A beneficial conversion option of
$15,000 was recorded as interest expense in connection with this
transaction.  The Lenders may also receive additional compensation as
determined appropriate by the Board of Directors.





During the year ended December 31,
2005, the Company received an additional advance of $50,000 against the
promissory note.  The balance due at December 31, 2005 was
$486,000.  During the year ended December 31, 2006, the Company
received additional advances and other consideration from the Lenders in the
aggregate amount of $419,000 and made principal payments to the Lenders against
the note of $105,000.  During the year ended December 31, 2007, the
Company received additional advances of $102,000.  During the quarter
ended March 31, 2008, the Company received additional advances of
$59,000.  The balance due at March 31, 2008, was
$961,000.





The balance due of $961,000 is secured
by the Company’s intellectual property rights and common stock of Fonix
Speech.  As of March 31, 2008, the Lenders had not converted any of
the outstanding balance into common stock.  However, on March 24,
2008, the Lenders converted $10,000 of interest into 53,913,701 shares of our
common stock for the benefit of one of the Lenders, Thomas A. Murdock, a former
officer and director of the Company.





Notes
Payable





In connection with the acquisition of
the capital stock of LTEL Holdings in 2004, we issued a 5%, $10,000,000,
secured, six-year note (the “Note”) payable to McCormack Avenue, Ltd.
(“McCormack”).  Under the terms of the Note, quarterly interest-only
payments were required through January 15, 2005, with quarterly principal and
interest payments beginning April 2005 and continuing through January
2010.  Interest on the Note is payable in cash or, at our option, in
shares of our Class A common stock.  The Note is secured by the
capital stock and all of the assets of LTEL Holdings and its
subsidiaries.  The Note was valued at $4,624,000 based on an imputed
interest rate of 25 percent per annum.









22


The discount on the Note is based on an
imputed interest rate of 25%.  The carrying amount of the Note of
$5,542,000 at December 31, 2006, was net of unamortized discount of
$3,191,000.  As of the date of this Report, we had not made any
scheduled payments for 2006 or 2007.





On September 8, 2006, we received a
default notice (the “Default Notice”) from McCormack in respect of the
Note.  Under the terms of the Note, and a related Security Agreement
between us and McCormack dated February 24, 2004 (the “Security Agreement”),
McCormack was entitled to declare all liabilities, indebtedness, and obligations
of Fonix to McCormack under the Security Agreement and the Note immediately due
and owing upon an event of default.  The Note defines an event of
default to include the non-payment by us of a scheduled payment which is not
cured within 60 days.





In the
Default Notice, McCormack stated that it intended to exercise its rights,
including any and all rights set forth in the Note as amended. McCormack
has taken no action to collect amounts due under the note.




Also on
September 8, 2006, McCormack provided to us a Notice of Sale, stating
McCormack’s intention to sell at public auction all of the collateral referred
to in the Security Agreement, consisting of the capital stock and assets of
LecStar Telecom, LecStar DataNet and LTEL Holdings.  As of the date of
this report, no sale of the assets or capital stock of LecStar Telecom, LecStar
DataNet nor LTEL Holdings had occurred.





McCormack
notified us that notwithstanding the Series L Exchange Agreement between us and
McCormack discussed above, McCormack had not waived any of its rights in
connection with the Note, the Modification Agreement, the Security Agreement, or
the Supplemental Security Agreement.





During
the fourth quarter of 2006, we entered into two promissory notes with an
unrelated third party in the aggregate amount of $330,000. These notes accrue
interest at 10% annually and are due and payable during the second quarter of
2007.





During
the quarter ended March 31, 2007, we entered into five promissory notes with an
unrelated third party in the aggregate amount of $450,000.  These
notes accrue interest at 10% annually and are due and payable during the third
quarter of 2007.





Series A
Convertible Preferred Stock





As of March 31, 2007, there were
166,667 shares of Series A convertible preferred stock
outstanding.  Holders of the Series A convertible preferred stock have
the same voting rights as common stockholders, have the right to elect one
person to the board of directors and are entitled to receive a one time
preferential dividend of $2.905 per share of Series A convertible preferred
stock prior to the payment of any dividend on any class or series of
stock.  At the option of the holders, each share of Series A
convertible preferred stock is convertible into one share of Class A common
stock and in the event that the common stock price has equaled or exceeded $10
per share for a 15 day period, the shares of Series A convertible preferred
stock will automatically be converted into Class A common stock.  In
the event of liquidation, the holders are entitled to a liquidating distribution
of $36.33 per share and a conversion of Series A convertible preferred stock at
an amount equal to .0375 shares of common stock for each share of Series A
convertible preferred stock.





Series L
Preferred Stock





On September 7, 2006, the Company
entered into a Series L 9% Convertible Preferred Stock Exchange Agreement (the
"Exchange Agreement") with McCormack and Kenzie Financial (“Kenzie”), a British
Virgin Islands company.  Pursuant to the Exchange Agreement, McCormack
and Kenzie exchanged all 2,000 shares of Series H Preferred Stock that
they  acquired from the sale of LTEL Holdings, for 1,960.8 and 39.2
shares, respectively,  of the Company's Series L 9% Convertible
Preferred Stock (the "Series L Preferred Stock").





Because the shares of Series L
Preferred Stock were issued in exchange for the remaining outstanding shares of
Series H Preferred Stock, the Company did not receive any proceeds in connection
with the issuance of the Series L Preferred Stock.









23


The
Series L Preferred Stock entitles McCormack and Kenzie to receive dividends in
an amount equal to 9% of the then-outstanding balance of shares of Series L
Preferred Stock.  The dividends are payable in cash or shares of the
Company's Class A common stock, at the Company's option.





The
Series L Preferred Stock is convertible into common stock of the Company at the
option of the holder by using a conversion price which was 80% of the average of
the two (2) lowest closing bid prices for the twenty-day trading period prior to
the conversion date.





Redemption
of the Series L Preferred Stock, whether at the Company’s option or that of
McCormack or Kenzie, requires the Company to pay, as a redemption price, the
stated value of the outstanding shares of Series L Preferred Stock to be
redeemed, together with any accrued but unissued dividends thereon, multiplied
by one hundred ten percent (110%).




The Company accounted for the exchange
as redemption of the outstanding Series H Preferred Stock as the Series H
Preferred Stock was not convertible into shares of common stock of the
Company.  The Series L Preferred Stock is convertible into shares of
common stock of the Company.  The Company followed the accounting
treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the redemption of
$30,991,000 due to the value of the conversion feature of the Series L Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 140%, risk-free rate of 3.75% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
L Preferred Stock, no value was prescribed to the Series L Preferred
Stock.  Also in connection with the redemption, the Company recognized
a preferred stock dividend of $16,000,000, equal to the original discount the
Company had assigned to the Series H Preferred Stock.  At March 31,
2008, the fair value of the Series L Preferred Stock derivative liability was
$15,817,000.





For the quarter ended March 31, 2008,
the Company issued 1,354,251,012 shares of its Class A common stock in
conversion of 15 shares of its Series L Preferred Stock.  At March 31,
2008, 1,521 shares of Series L Preferred Stock remained
outstanding.





Series
M Preferred Stock





On April
4, 2007, the Company entered into a Series M 9% Convertible Preferred Stock
Exchange Agreement with Sovereign Partners, LP
(“Sovereign”).  Pursuant to the exchange agreement, Sovereign
exchanged 150 shares of the Company’s Series L Preferred Stock for 150 shares of
the Company’s Series M 9% Convertible Preferred Stock (the “Series M Preferred
Stock”).





The
Series M Preferred Stock entitles Sovereign or its assignees to receive
dividends in an amount equal to 9% of the then-outstanding balance of shares of
Series M Preferred Stock.  The dividends are payable in cash or shares
of the Company’s Class A common stock, at the Company’s option.





The
Series M Preferred Stock may be converted into common stock of the Company at
the option of the holder by using a conversion price which shall be the lower of
(i) 80% of the average of the two lowest closing bid prices for the twenty-day
trading period prior to the conversion date, or (ii) $0.004.





Redemption
of the Series M Preferred Stock, whether at the Company’s option or that of
Sovereign, requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series M Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).






24


Because
the shares of Series M were issued in exchange for the outstanding shares of
Series L Preferred Stock, the Company did not receive any proceeds in connection
with the issuance of the Series M Preferred Stock.





The Company followed the accounting
treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the redemption of
$1,603,000 due to the value of the conversion feature of the Series M Preferred
Stock, which was previously recorded as part of the Series L Preferred Stock
derivative liability.  The liability was calculated using the
Black-Scholes valuation model with the following assumptions: dividend yield of
0%, expected volatility of 134%, risk-free rate of 5% and expected life of 4
years.  As the value of the derivative liability was greater than the
face value of the Series M Preferred Stock, no value was prescribed to the
Series M Preferred Stock.  At March 31, 2008 the fair value of the
Series M Preferred Stock derivative liability was $1,560,000.





Series N
Convertible Preferred Stock





On August 24, 2007, the Company
entered into a Securities Purchase Agreement with Trillium Partners, LP and
other unnamed future investors relating to the issuance and sale of the
Company’s Series N 9% Convertible Preferred Stock.





Pursuant to the agreement, the Company
agreed to issue up to 2,400 shares of its Series N 9% Convertible Preferred
Stock (the “Series N Preferred Stock”) at a per share price of $1,000 to
Trillium Partners, LP and other unnamed future investors, for gross proceeds of
up to $2,400,000.  As of the date of this report, the Company had
issued 1,350 shares of the Series N Preferred Stock, for cash proceeds of
$1,350,000.





The
Series N Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series L
Preferred Stock.  The dividends are payable in cash or shares of the
Company's Class A common stock, at the Company's option.





The
Series N Preferred Stock is convertible into Class A common stock of the Company
at the option of the holder by using a conversion price equal to 80% of the
average of the two lowest closing bid prices for the twenty-day trading period
prior to the conversion date.





Redemption
of the Series N Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series N Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





The Company followed the accounting
treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the redemption of
$957,000 due to the value of the conversion feature of the Series N Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 128%, risk-free rate of 5.0% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
N Preferred Stock, no value was prescribed to the Series N Preferred
Stock.  At March 31, 2008, the fair value of the Series N Preferred
Stock derivative liability was $1,404,000.





Series O
Convertible Preferred Stock





Between
January 25, 2008, and May 5, 2008, the Company received advances from three
entities in connection with the purchase agreements related to the Company’s
Series O 9% Convertible Preferred Stock (“Series O Preferred Stock”). On May 20,
2008, the Company entered into Securities Purchase Agreements with Southridge
Partners LP, Southshore Capital Fund LTD, Sovereign Partners LP (collectively,
the “Series O Purchasers”) for the sale of an aggregate of 38.8 shares of Series
O Preferred Stock for gross proceeds of $373,000. The
material terms of the purchase agreements had been agreed upon prior to receipt
of the advances.  Therefore, the Series O Preferred Stock was
accounted for as discussed below on the dates cash proceeds were received by the
Company.  The Company also began accruing dividends upon receiving the
advances.


25


The
Series O Preferred Stock entitles the Purchasers to receive dividends in an
amount equal to 9% of the then-outstanding balance of shares of Series O
Preferred Stock. The dividends are payable in cash or shares of the Company's
Class A common stock, at the Company's option.





The
Series O Preferred Stock is convertible into common stock of the Company at the
option of the holder by using a conversion price, equal to 80% of the average of
the two lowest closing bid prices for the twenty-day trading period prior to the
conversion date.





Redemption
of the Series O Preferred Stock, whether at the Company’s option or that of the
Purchasers requires the Company to pay, as a redemption price, the stated value
of the outstanding shares of Series O Preferred Stock to be redeemed, together
with any accrued but unissued dividends thereon, multiplied by one hundred ten
percent (110%).





The
Company followed the accounting treatment in SFAS 150 “Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS
133 “Accounting for Derivative Instruments and Hedging Activities” and EITF
00-19 “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock.” The Company recognized a
derivative liability upon the redemption of $290,000 due to the value of the
conversion feature of the Series O Preferred Stock. The liability was calculated
using the Black-Scholes valuation model with the following assumptions: dividend
yield of 0%, expected volatility of 128%, risk-free rate of 5.0% and expected
life of 4 years. As the value of the derivative liability was greater than the
face value of the Series O Preferred Stock, no value was prescribed to the
Series O Preferred Stock. At March 31, 2008, the fair value of the Series O
Preferred Stock derivative liability was $302,000.





For a
more detailed discussion of the Series O Preferred Stock, see the “Recent
Developments” section below.





Fonix Speech,
Inc. Series B Convertible Preferred Stock





On April 4, 2007, the Company entered
into a Securities Purchase Agreement by and among the Company, Fonix Speech,
Inc. (“FSI”), and Sovereign Partners, LP (“Sovereign”).  FSI is a
wholly owned subsidiary of the Company.





Pursuant to the FSI purchase agreement,
FSI sold 125 shares of its Series B 9% Convertible Preferred Stock (the “Series
B Preferred Stock”) at a per share price of $10,000 to Sovereign, for gross
proceeds of $1,250,000.





The shares of Series B Preferred Stock
are convertible into shares of the Company’s Class A common
stock.  The Series B Preferred Stock may be converted into common
stock of the Company at the option of the holder by using a conversion price
which shall be the lower of (i) 80% of the average of the two lowest closing bid
prices for the twenty-day trading period prior to the conversion date, or (ii)
$0.004.





The Series B Preferred Stock entitles
Sovereign or its assignees to receive dividends in an amount equal to 9% of the
then-outstanding balance of shares of Series B Preferred Stock.  The
dividends are payable in cash or shares of the Company's Class A common stock,
at the Company's option





The Company followed the accounting
treatment in SFAS 150 “Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity,”SFAS
133 “Accounting for Derivative
Instruments and Hedging Activities”and EITF 00-19 “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”The Company recognized a derivative liability upon the issuance of
$1,336,207 due to the value of the conversion feature of the Series B Preferred
Stock.  The liability was calculated using the Black-Scholes valuation
model with the following assumptions: dividend yield of 0%, expected volatility
of 134%, risk-free rate of 5% and expected life of 4 years.  As the
value of the derivative liability was greater than the face value of the Series
B Preferred Stock, no value was prescribed to the Series B Preferred
Stock.  At March 31, 2008, the fair value of the Series B Preferred
Stock derivative liability was $1,300,000.






26


Stock Options and
Warrants





During
the three months ended March 31, 2008, we did not grant any stock
options.  As of March 31, 2008, we had a total of 204,000 options to
purchase Class A common stock outstanding.





As of March 31, 2007, we had warrants
to purchase a total of 15,000 shares of Class A common stock outstanding that
expire through 2010.





Other





We presently have no plans to purchase
new research and development.





Recent
Developments





Amendments
to Articles of Incorporation





On May
19, 2008, the Company filed with the State of Delaware a Certificate of
Designation and Series O 9% Convertible Stock Terms (the “Certificate of
Designation”), which become a part of the Company’s Certificate of
Incorporation, as amended.  The following is a description of the
material terms of the Series O Preferred Stock:





Dividends.  Holders
of Series O Preferred Stock shall be entitled to receive, when and as declared
by the Board of Directors either out of funds legally available therefore or
through the issuance of shares of the Company’s Class A common stock (the
“Common Stock”), and the Company shall accrue, quarterly in arrears on March 31,
June 30, September 30, and December 31 of each year, commencing on the earlier
of March 31, 2008, or any Conversion Date (as defined below), cumulative
dividends on the Preferred Stock at the rate per share (as a percentage of the
Stated Value per share) equal to nine percent (9%) per annum, payable in cash or
shares of Common Stock at the option of the Company.





Liquidation.  Upon
any liquidation, dissolution or winding-up of the Company, whether voluntary or
involuntary (a "Liquidation"), and subject to the rights of the holders of the
Company’s Series A Convertible Preferred Stock then outstanding, the holders of
the Series O Preferred Stock shall be entitled to receive out of the assets of
the Company, whether such assets are capital or surplus, for each share of
Series O Preferred Stock an amount equal to the Stated Value plus all accrued
but unpaid dividends per share, whether declared or not, and all other amounts
in respect thereof (including liquidated damages, if any) then due and payable
before any distribution or payment shall be made to the holders of any junior
securities (as defined in the Certificate of Designation), and if the assets of
the Company shall be insufficient to pay in full such amounts, then the entire
assets to be distributed to the holders of Series O Preferred Stock shall be
distributed among the holders of Series O Preferred Stock ratably in accordance
with the respective amounts that would be payable on such shares if all amounts
payable thereon were paid in full.  The Company shall mail written
notice of any such Liquidation, not less than 45 days prior to the payment date
stated therein, to each record holder of Series O Preferred Stock.





Conversion.  The Series O
Preferred Stock may be converted into common stock of the Company at the option
of the holder by using a conversion price which shall be 80% of the average of
the two (2) lowest closing bid prices for the twenty-day trading period prior to
the conversion date.





The Certificate of Designation imposes
certain restrictions on the conversion of the Series O Preferred Stock,
including that in no event (except (i) if the Company is in default of any of
its obligations under the Certificate of Designation or the Series O Purchase
Agreements, or (ii) except as otherwise set forth in the Certificate of
Designation) shall any Series O Purchaser be entitled to convert any Series O
Preferred Stock to the extent that, after such conversion, the sum of (1) number
of shares of Common Stock beneficially owned by such Series O Purchaser and its
affiliates (other than the shares of Common Stock which may be deemed
beneficially owned through the ownership of the unconverted portion of the
Series O Preferred Stock), and (2) the number of shares of Common Stock issuable
upon the conversion of the Series O Preferred Stock with respect to which the
determination of this proviso is being made, would result in beneficial
ownership by the Series O Purchaser and its affiliates of more than 4.99% of the
outstanding shares of Common Stock.






27


Voting
Rights.  Except as otherwise provided in the Certificate of
Designation and as otherwise required by law, the Series O Preferred Stock shall
have only the voting rights (the “Special Voting Rights”) as
follows:





(i)          The
holders of shares of Series O Preferred Stock shall be entitled to vote solely
on the issues set forth below, and, except to the extent specifically provided
herein, each holder shall be entitled to the number of votes equal to (i) the
largest number of full shares of Common Stock into which all shares of Series O
Preferred Stock held by such holder could be converted, pursuant to the
conversion provisions of the Certificate of Designation, at the record date for
the determination of the stockholders entitled to vote on such matter or, if no
record date is established, at the date such vote is taken or any written
consent of stockholders is first executed, multiplied (ii) by 5.





(ii)          The
Special Voting Rights set forth above shall be granted to the holders of shares
of Series O Preferred Stock only with respect to (a) an increase or decrease in
the number of authorized shares (“Share Change”) and/or (b) any proposed reverse
stock split of the Common Stock of the Company (the “Proposed Reverse Split”),
with the ratio of the Proposed Reverse Split(s) to be determined by the Company
in its sole discretion.





(iii)          The
Holders of the Series O Preferred Stock shall be entitled to exercise the
Special Voting Rights set forth above with respect to the Share Change and/or
Proposed Reverse Split only:





(A)      Following a recommendation by the
Company’s Board of Directors to its shareholders of the Share Change and/or
Proposed Reverse Split; and


(B)      Following the filing by the Company with
the United States Securities and Exchange Commission (the “SEC”) a Definitive
Proxy Statement or Definitive Information Statement, or other such statement
(the “Definitive Shareholder Statement”) filed with the SEC for the purpose,
among others, of communicating with the Company’s shareholders relating to the
Share Change and/or Proposed Reverse Split; and


(C)      Beginning on the tenth (10th) business
day (excluding weekends and national holidays) preceding the date on which the
shareholder meeting and vote are to be held (the “Voting Date”) or the date by
which shareholder written consents are to be provided (the “Consent Date”), as
applicable, and running through and including the Voting Date or the Consent
Date, as applicable, such period being the “Special Voting Period.”





(iv)          Upon
the ending of the Special Voting Period, the Special Voting Rights pertaining to
the Series O Preferred Stock with respect to the Share Change and/or Proposed
Reverse Split described in the applicable Definitive Shareholder Statement shall
terminate.





(v)          Except
as otherwise expressly provided in the Certificate of Designation or as required
by law, the holders of Series O Preferred Stock exercising the Special Voting
Rights with respect to the Share Change and/or Proposed Reverse Split shall vote
together as a single class with the holders of the Company’s Common Stock on the
Share Change and/or Proposed Reverse Split.





(vi)          Except
as otherwise set forth above with respect to the Special Voting Rights and as
otherwise required by law, the Series O Preferred Stock shall have no voting
rights.





Protective
Provisions.  So long as any shares of Series O Preferred Stock are
outstanding, the Company shall not and shall cause its subsidiaries not to,
without the affirmative vote of each of the holders of the Preferred Stock then
outstanding, (i) alter or change adversely the powers, preferences or rights
given to the Preferred Stock, (ii) alter or amend the Certificate of
Designation, (iii) authorize or create any class of stock ranking as to
dividends or distribution of assets upon a Liquidation (as defined in the
Certificate of Designation) or otherwise senior to or pari passu with the Series
O Preferred Stock, (iv) amend its certificate of incorporation, bylaws or other
charter documents so as to affect adversely any rights of any holders of the
Series O Preferred Stock, (v) increase the authorized or designated number of
shares of Series O Preferred Stock, (vi) issue any additional shares of Series O
Preferred Stock (including the reissuance of any shares of Series O Preferred
Stock converted for Common Stock) or (vii) enter into any agreement with respect
to the foregoing.








28


Redemption.  Redemption
of the Series O Preferred Stock, whether at our option or that of Sovereign,
requires us to pay, as a redemption price, the stated value of the outstanding
shares of Series O Preferred Stock to be redeemed, together with any accrued but
unissued dividends thereon, multiplied by one hundred ten percent
(110%).





This description of some of the terms
of the Series O Preferred Stock is meant as a summary only, and is not complete
and should be read in conjunction with the Certificate of Designation filed as
an exhibit to this Quarterly Report on Form 10-Q.





Entry
into a Material Definitive Agreement


Unregistered
Sale of Equity Securities





On May
20, 2008, the Company entered into Series O 9% Convertible Preferred Stock
Purchase Agreements (the “Series O Purchase Agreements”) with Southridge
Partners LP, Southshore Capital Fund LTD, and Sovereign Partners LP
(collectively, the “Series O Purchasers”). Pursuant to the Series O Purchase
Agreements, the Series O Purchasers purchased an aggregate of  38.8
shares of the Company’s Series ) 9% Convertible Preferred Stock (the “Series O
Preferred Stock”) for aggregate proceeds to the Company of
$373,000.





The shares of Series O Preferred Stock
per purchaser were as follows:


Southridge
Partners LP  268
 Southshore
Capital Fund LTD 55
 Sovereign
Partners LP    50





The Series O Preferred Stock entitles
the Series O Purchasers or their assignees to receive dividends in an amount
equal to 9% of the then-outstanding balance of shares of Series O Preferred
Stock. The dividends are payable in cash or shares of the Company’s Class A
common stock, at the Company’s option.





Under the Series O Purchase Agreements
and the Series O Terms, the Series O Purchasers or their assignees may convert
shares of Series O Preferred Stock into shares of our common stock. The sale of
the Series O Preferred Stock and the Company’s future issuances of shares of
common stock upon any conversion of the Series O Preferred Stock will be made
without registration under the securities Act of 1933 (the “1933 Act”) in
reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder, including Regulation D and Rule 506.  All of
the Series O Purchasers were accredited investors.  Additionally,
there was no public offering of the Series O Preferred Stock, and no general
solicitation or general advertising was made or done in connection with the
issuance of the Series O Preferred Stock.





Move
to New Headquarters Facilities





As previously disclosed in the
Company’s 10-K date December 31, 2007, we relocated our offices to a new
facility located at 387 South 520 West, Suite 110, Lindon, Utah
84042.  The facility consists of 3900 square feet of office
space.  We entered into a 5-year lease with lease payments of $6,131
per month.  We believe that the new facilities are suitable for our
needs for the foreseeable future.





Resignations
of Thomas A. Murdock and William A. Maasberg, Jr.





On
Wednesday, March 5, 2008, Thomas A. Murdock resigned as Chairman of the Board,
President, and Chief Executive Officer of the Company.  Additionally,
Mr. Murdock resigned all officer and director positions he held with Fonix
Speech, Inc., Fonix/AcuVoice, Inc., Fonix/Papyrus Corporation, Fonix UK, Ltd.,
and Fonix Sales, Korea Group, Ltd., all subsidiaries of the
Company.





Additionally, William A. Maasberg
resigned as director of the Company on Wednesday, March 5, 2008, and as Chief
Operating Officer on March 31, 2008.








29


Appointment
of New Chairman, President, and Chief Executive Officer





In
connection with the resignations of Messrs. Murdock and Maasberg, the Company
appointed Roger D. Dudley, who was serving as the Company’s Executive Vice
President and Chief Financial Officer, as the Company’s Chairman, President, and
Chief Executive Officer.  Mr. Dudley will continue to serve as Chief
Financial Officer.  Following the resignations of Messrs. Murdock and
Maasberg, Mr. Dudley is the sole director of the Company.








Corporate
Outlook








Fonix’s
focus on providing competitive and value-added solutions for customers and
partners requires a broad set of technologies, service offerings and channel
capabilities.  Management anticipates and expects further development
of complementary technologies, added product and application developments,
access to market channels and additional opportunities for strategic alliances
in other industry segments.





We will
continue to leverage our research and development of speech technologies to
deliver software applications and engines to device manufacturers looking to
incorporate speech interfaces into end-user products.  Fonix Speech’s
award-wining technologies provide competitive embedded speech solutions for
mobile/wireless devices, videogames, telephony systems and products for the
assistive market based on Fonix’s proprietary and patented TTS and ASR
technologies.





As we proceed to implement our strategy
and to reach our objectives, we anticipate further development of complementary
technologies, added product and applications development expertise, access to
market channels and additional opportunities for strategic alliances in other
industry segments.  The strategy adopted by us has significant risks,
and shareholders and others interested in Fonix and our Class A common stock
should carefully consider the risks set forth below and under the heading
“Certain Significant Risk Factors” in Item 1, Part I, of our annual report on
Form 10-K for the year ended December 31, 2007.





As noted above, as of March 31, 2008,
we had an accumulated deficit of $277,943,000; negative working capital of
$34,384,000; derivative liabilities of $20,742,000 related to the issuance of
Series L Preferred Stock,  Series M Preferred Stock, Series N
Preferred Stock,  Series E Convertible Debentures and Series B
Preferred Stock of our subsidiary; accrued liabilities and accrued settlement
obligation of $5,045,000; accounts payable of $1,532,000; and current portion of
notes payable of $3,833,000, Series E debentures of $1,754,000 and deferred
revenues of $445,000.  Further, on March 15, 2007, the New York State
trial court entered the Breckenridge Judgment in the amount of
$1,602,000.  However, we have entered into a settlement agreement to
pay the balance due Breckenridge under the Breckenridge Judgment of $297,500 at
the rate of $42,500 for seven consecutive months.  As of the date of
this report, the balance owed was $255,000.  Sales of products and
revenue from licenses based on our technologies have not been sufficient to
finance ongoing operations.  These matters raise substantial doubt
about our ability to continue as a going concern.  Our continued
existence is dependent upon several factors, including our success in (1)
increasing speech license, royalty and services revenues, (2) raising sufficient
additional funding, and (3) minimizing operating costs.  Until
sufficient revenues are generated from operating activities, we expected to
continue to fund our operations through debt instruments.  We are
currently pursuing additional sources of liquidity in the form of traditional
commercial credit, asset based lending, or additional sales of our equity
securities to finance our ongoing operations.  Additionally, we are
pursuing other types of commercial and private financing, which could involve
sales of our assets or sales of one or more operating divisions.  Our
sales and financial condition have been adversely affected by our reduced credit
availability and lack of access to alternate financing because of our
significant ongoing losses and increasing liabilities and
payables.  As we have noted in our previous annual reports and other
public filings, if additional financing is not obtained in the near future, we
will be required to more significantly curtail our operations or seek protection
under bankruptcy laws.








30


Information
Concerning Forward-Looking Statements





Certain of the statements contained in
this report (other than the historical financial data and other statements of
historical fact) are forward-looking statements.  These statements
include, but are not limited to our expectations with respect to the development
of a diversified revenue base; delivery of our VoiceDial application; the market
volume of educational electronic dictionary devices; our ability to capitalize
in markets including toys, appliances, and other devices; the market demand for
videogames; our growth strategies and the implementation of our Core
Technologies and potential results; our payment of dividends on our common
stock; our ability to meet customer demand for speech technologies and
solutions; development of complementary technologies, products, marketing, and
strategic alliance opportunities; profitability of language learning tools; the
status of  traditional operator systems; our ability to continue
operations in the event we do not receive approval to amend our articles of
incorporation; the comparability of our speech-enabled Speech Products to other
products; our intentions with respect to strategic collaborations and marketing
arrangements; our intentions with respect to use of licenses; our plans with
respect to development and acquisition of speech solutions; our goals with
respect to supplying speech solutions for OEMs; our expectations with respect to
continued financial losses; and our intentions with respect to financing our
operations in the future.  Additional forward-looking statements may
be found in the “Certain Significant Risk Factors” Section of our 10-K for the
year ended December 31, 2007, together with accompanying explanations of the
potential risks associated with such statements.





Forward-looking statements made in this
report, are made based upon management’s good faith expectations and beliefs
concerning future developments and their potential effect upon
Fonix.  There can be no assurance that future developments will be in
accordance with such expectations, or that the effect of future developments on
Fonix will be those anticipated by management.  Forward-looking
statements may be identified by the use of words such as “believe,” “expect,”
“plans,” “strategy,” “prospects,” “estimate,” “project,” “anticipate,” “intends”
and other words of similar meaning in connection with a discussion of future
operating or financial performance.





You are cautioned not to place undue
reliance on these forward looking statements, which are current only as of the
date of this Report.  We disclaim any intention or obligation to
update or revise any forward-looking statements, whether as a result of new
information, future events, or otherwise.  Many important factors
could cause actual results to differ materially from management’s expectations,
including those listed in the “Certain Significant Risk Factors” Section of our
10-K for the year ended December 31, 2007, as well as the
following:





•
            unpredictable
      difficulties or delays in the development of new products and
      technologies;





•
            changes
      in U.S. or international economic conditions, such as inflation, interest
      rate fluctuations, foreign exchange rate fluctuations or recessions in
      Fonix's markets;





•
            pricing
      changes to our supplies or products or those of our competitors, and other
      competitive pressures on pricing and
sales;





•
            difficulties
      in obtaining or retaining the management, engineering, and other human
      resource competencies that we need to achieve our business
      objectives;





•
            the
      impact on Fonix or a subsidiary from the loss of a significant customer or
      a significant number of customers;





•
            risks
      generally relating to our international operations, including
      governmental, regulatory or political
changes;





•
            transactions
      or other events affecting the need for, timing and extent of our capital
      expenditures; and





•
            the
      extent to which we reduce outstanding
debt.





Item
3.                      Quantitative
and Qualitative Disclosures About Market Risk






31


Foreign Currency
Exposure





To date, all of our revenues have been
denominated in United States dollars and received primarily from customers in
the United States.  Our exposure to foreign currency exchange rate
changes has been insignificant.  We expect, however, that future
product license and services revenue may also be derived from international
markets and may be denominated in the currency of the applicable
market.  As a result, operating results may become subject to
significant fluctuations based upon changes in the exchange rate of certain
currencies in relation to the U.S. dollar.  Furthermore, to the extent
that we engage in international sales denominated in U.S. dollars, an increase
in the value of the U.S. dollar relative to foreign currencies could make our
products less competitive in international markets.  Although we will
continue to monitor our exposure to currency fluctuations, we cannot assure that
exchange rate fluctuations will not adversely affect financial results in the
future.







Item
4.                      
Controls and Procedures




Management's Report on Internal
Control Over Financial Reporting




Evaluation of Disclosure
Controls and Procedures.  Our Chief Executive Officer who is
also our Chief Financial Officer, after evaluating the effectiveness of the
Company’s “disclosure controls and procedures” (as defined in the Securities
Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end
of the period covered by this annual  report, has concluded that our
disclosure controls and procedures are effective based on his evaluation of
these controls and procedures required by paragraph (b) of Exchange Act Rules
13a-15 or 15d-15.





Changes in Internal Control
Over Financial Reporting.  There were no changes in our
internal control over financial reporting identified in connection with the
evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that
occurred during our last fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.





Section 404
Assessment.  Section 404 of the Sarbanes-Oxley Act of 2002
required management’s annual review and evaluation of our internal controls
beginning with our Form 10-K for the fiscal year ending December 31, 2007, and
an attestation of the effectiveness of these controls by our independent
registered public accounting firm beginning with our Form 10-K for the fiscal
year ending on December 31, 2008.  We are dedicating significant
resources, including management time and effort, and incurring substantial costs
in connection with our ongoing Section 404 assessment.  We are
continue to document and test our internal controls and consider whether any
improvements are necessary for maintaining an effective control environment at
our company.  The evaluation of our internal controls is being
conducted under the direction of our senior management.  In addition,
our management is regularly discussing the results of our testing and any
proposed improvements to our control environment with our Board of
Directors.  We will continue to work to improve our controls and
procedures, and to educate and train our employees on our existing controls and
procedures in connection with our efforts to maintain an effective controls
infrastructure at our Company.





Limitations on Effectiveness
of Controls.  A system of controls, however well designed and
operated, can provide only reasonable, and not absolute, assurance that the
system will meet its objectives.  The design of a control system is
based, in part, upon the benefits of the control system relative to its
costs.  Control systems can be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the control.  In addition, over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate.  In addition, the design of any control
system is based in part upon assumptions about the likelihood of future
events.





PART
II - OTHER INFORMATION





Item
1.                      Legal
Proceedings





Breckenridge Complaint – On
June 6, 2006, Breckenridge filed a complaint against the Company in the Supreme
Court of the State of New York, County of Nassau (the “Court”), in connection
with a settlement agreement between the Company and Breckenridge entered into in
September 2005. In the Complaint, Breckenridge alleged that the Company failed
to pay certain amounts due under the settlement agreement in the amount of
$450,000. The Company denied the allegations of Breckenridge’s complaint and
filed a motion for summary judgment.  Breckenridge also filed for
summary judgment on its complaint.









32


On
February 2, 2007, the Court granted Breckenridge’s motion for summary judgment,
denied the Company’s summary judgment motion, and directed that a hearing be
held to determine the amount owed by the Company to Breckenridge.  The
Company and Breckenridge entered into a stipulation that the Company owed
Breckenridge $1,530,000 plus interest at a rate of 9% from September 15, 2006 to
the date of entry of judgment.





The
Court’s judgment, dated as of March 15, 2007, states that the Company owes an
aggregate of $1,602,000 to Breckenridge.  The Company has accrued for
this settlement in the accompanying financial statements.  In February
2008, the Company entered into an amended settlement agreement with Breckenridge
under which the Company agreed to pay Breckenridge $540,000.  The
Company has paid Breckenridge $242,500 and is obligated to pay the balance of
$297,500 at the rate of $42,500 per month.





Hite Development Corporation v. Fonix
Corporation,Third District Court, Salt Lake County (Civil No.
070900883).  In January 2007, Hite Development Corporation (“Hite”)
brought a lawsuit against the Company claiming breach of contract and breach of
the covenant of good faith and fair dealing, alleging that the Company failed to
make certain payments under a settlement agreement with Hite dating from March
2005.  The complaint seeks approximately $33,000 plus
interest.  The Company filed its answer in May 2007.  The
case is currently in the discovery phase.  On May 8, 2008, Hite filed
a motion for summary judgment.  As of the date of this Report, the
Company had not filed its response to the motion.  The Company intends
to defend against the claims in the complaint.





RR Donnelley Receivables Inc. v.
Fonix Corporartion,Third District Court, Salt Lake County (Civil No.
070412088).  In July 2007, RR Donnelley Receivables Inc. (“Donnelly”)
brought a lawsuit against the Company for alleged failure to pay for services
provided.  The complaint seeks approximately $21,000 plus
interest.  The Company filed its answer in August 2007, and filed a
motion to dismiss the action in December 2007.  That motion is
currently pending before the court.  If the Company’s motion to
dismiss is denied, the Company intends to defend against the claims in the
complaint.





Item
1A.                      Risk
Factors





We
attempt to identify, manage and mitigate the risks and uncertainties associated
with our business to the extent practical.  However, some level of
risk and uncertainty will always be present.  The section of our
Annual Report on Form 10-K for the fiscal year ended December 31, 2007, entitled
“Certain Significant Risk Factors” describes some of the risks and uncertainties
associated with our business. These risks and uncertainties have the potential
to materially affect our business, financial condition, results of operations,
cash flows, projected results and future prospects. We have revised the
following risk factors which were previously disclosed in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2007.





Our
substantial and continuing losses since inception, coupled with significant
ongoing operating expenses, raise doubt about our ability to continue as a going
concern.





Since inception, we have sustained
substantial losses.  Such losses continue due to ongoing operating
expenses and a lack of revenues sufficient to offset operating
expenses.  We have raised capital to fund ongoing operations by
private sales of our securities, some of which sales have been highly dilutive
and involve considerable expense.  In our present circumstances, there
is substantial doubt about our ability to continue as a going concern absent
significant sales of our products and telecommunication services, substantial
revenues from new licensing or co-development contracts, or continuing large
sales of our securities.





We had net income of $14,959,000 for
December 31, 2007, and net losses $21,943,000 and $22,631,000 for the years
ended December 31, 2006 and 2005, respectively.  We incurred a net
loss of $1,046,000 for the three months ended March 31, 2008.  As of
March 31, 2008, we had an accumulated deficit of $279,567,000; negative working
capital of $35,952,000; derivative liability of $20,947,000 related to the
issuance of Series L Preferred Stock,  Series M Preferred Stock,
Series N Preferred Stock, Series N Preferred Stock,  Series E
Convertible Debentures and Series B Preferred Stock of our subsidiary; accrued
liabilities and accrued settlement obligation of $5,592,000, accounts payable of
$1,760,000; and current portion of notes payable of $4,368,000, Series E
debentures of $1,754,000 and deferred revenues of $445,000.









33


We expect to continue to spend
significant amounts to enhance our Speech Products and technologies and fund
further Product development.  As a result, we will need to generate
significant additional revenue to achieve profitability.  Even if we
do achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis.  If we do not achieve
and maintain profitability, the market price for our common stock may further
decline, perhaps substantially, and we may have to curtail or cease our
operations.





Continuing
debt obligations could impair our ability to continue as a going
concern.





As of March 31, 2008, we had debt
obligations of $8,660,000, accrued liabilities and accrued settlement obligation
of $5,592,000 and vendor accounts payable of approximately
$1,760,000.  At present, our revenues from existing licensing
arrangements and Speech Product sales are not sufficient to offset our ongoing
operating expenses or to pay in full our current debt obligations.





There is substantial risk, therefore,
that the existence and extent of the debt obligations described above could
adversely affect our business, operations and financial condition, and we may be
forced to curtail our operations, sell part or all of our assets, or seek
protection under bankruptcy laws.  Additionally, there is substantial
risk that the current or former employees or our vendors could bring lawsuits to
collect the unpaid amounts.  In the event of lawsuits of this type, if
we are unable to negotiate settlements or satisfy our obligations, we could be
forced into bankruptcy.





Item
2.                      Unregistered
Sales of Equity Securities and Use of Proceeds





During
the three months ended March 31, 2008, we issued 1,354,251,012 shares of our
common stock in connection with conversions of 15 shares of our Series L
Preferred Stock for which we received no proceeds.    The
shares of common stock were issued without registration under the 1933 Act in
reliance on Section 4(2) of the 1933 Act and the rules and regulations
promulgated thereunder.





We
received no proceeds from the issuance of shares upon conversion of our series
of preferred stock.





Item
6.                      Exhibits





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







Exhibit
      No.
            
            Description of
      Exhibit3
            
            Certification
      of Designation of Series O Preferred Stock31
            
            Certification
      of President and Chief Financial Officer32
            
            Certification
      of President and Chief Financial Officer Pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002









34


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
      CorporationDate:
      May 20, 2008
            /s/  Roger
      D.  DudleyRoger
      D.  Dudley, Chief Executive Officer,
  President,Chief
      Financial Officer, and Director(Principal
      Executive Officer, Principal Financial
Officer)








35


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