<PAGE>

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

                                    FORM 10-Q/A

                                 (Amendment No. 2)



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

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

                          Commission file number 0-23862

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

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

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

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




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

As of November 9, 1998,  62,828,552  shares of the issuer's  common  stock,  par
value $.0001 per share, were issued and outstanding.





<PAGE>



                                   INTRODUCTION

This  Amendment  No. 2 to the  Quarterly  Report on Form 10-Q for the  quarterly
period ended  September  30,  1998,  of Fonix  Corporation  (the  "Company")  is
submitted to amend the following Items:

Part I - Financial Information
           Item 1.   Financial Statements


                          PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements.

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

                                        2

<PAGE>
                              Fonix Corporation
                        (A Development Stage Company)

                    CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (Unaudited)

<TABLE>
<CAPTION>
ASSETS
                                                                                      September 30,       December 31,
                                                                                          1998               1997
                                                                                    ------------------ ------------------
<S>                                                                                  <C>               <C>
Current assets:                                                                      (As restated
                                                                                     See Note 1)
       Cash and cash equivalents                                                         $ 20,053,030       $ 20,501,676
       Notes receivable                                                                       822,139            600,000
       Accounts receivable, net                                                               257,186                  -
       Interest and other receivables                                                          91,722             14,919
       Inventory                                                                               65,523                  -
       Prepaid expense                                                                        136,775             32,094
       Stock subscription receivable                                                        2,000,000                  -
                                                                                    ------------------ ------------------

            Total current assets                                                           23,426,375         21,148,689

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

Intangible assets, net of accumulated amortization of
   $1,356,381 and $25,509, respectively                                                    34,726,176            138,951

Other assets                                                                                  130,302             39,647
                                                                                    ------------------ ------------------

            Total assets                                                                 $ 60,745,760       $ 22,894,566
                                                                                    ================== ==================

LIABILITIES AND STOCKHOLDERS' EQUITY

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

            Total current liabilities                                                      32,532,483         20,469,866

Capital lease obligation, net of current portion                                               10,039             52,225
                                                                                    ------------------ ------------------

            Total liabilities                                                              32,542,522         20,522,091
                                                                                    ------------------ ------------------

Commitments and contingencies (Notes 11 and 12)

Stockholders' equity:
       Preferred stock                                                                     25,697,414          5,812,444
       Common stock                                                                             5,859              4,358
       Additional paid-in capital                                                          82,396,674         38,637,059
       Outstanding warrants                                                                 3,258,928          2,936,360
       Deferred consulting expense                                                           (186,725)                 -
       Deficit accumulated during the development stage                                   (82,968,912)       (45,017,746)
                                                                                    ------------------ ------------------

            Total stockholders' equity                                                     28,203,238          2,372,475
                                                                                    ------------------ ------------------

            Total liabilities and stockholders' equity                                   $ 60,745,760       $ 22,894,566
                                                                                    ================== ==================
</TABLE>


     See accompanying notes to condensed consolidated financial statements.


                                        3
<PAGE>

                             Fonix Corporation
                       (A Development Stage Company)

              CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                (Unaudited)

<TABLE>
<CAPTION>
                                                                                                                October 1,
                                                                                                                   1993
                                                  Three Months Ended                Nine Months Ended          (Inception) to
                                                     September 30,                    September 30,            September 30,
                                            ------------------------------------------------------------------
                                                 1998            1997             1998             1997             1998
                                            ---------------- -------------- ----------------- ---------------------------------
                                               (As restated                    (As restated                      (As restated
                                               See Note 1)                      See Note 1)                       See Note 1)
<S>                                        <C>               <C>            <C>               <C>               <C>
Revenues                                          $ 199,017            $ -       $ 2,671,302  $             -      $ 2,671,302
Cost of revenues                                     33,164              -            57,353                -           57,353
                                            ---------------- -------------- ----------------- ----------------- ---------------

       Gross profit                                 165,853              -         2,613,949                -        2,613,949
                                            ---------------- -------------- ----------------- ----------------- ---------------

Expenses:
    Purchased in-process research and
     development                                  3,821,000              -        13,136,000                -       13,136,000
    Product development and research              4,419,400      1,650,371        10,080,895        4,715,650       28,018,188
    Selling, general and administrative           4,320,891      2,185,169         8,360,964        5,935,838       30,607,634
                                            ---------------- -------------- ----------------- ----------------- ---------------

       Total expenses                            12,561,291      3,835,540        31,577,859       10,651,488       71,761,822
                                            ---------------- -------------- ----------------- ----------------- ---------------

Loss from operations                            (12,395,438)    (3,835,540)      (28,963,910)     (10,651,488)     (69,147,873)
                                            ---------------- -------------- ----------------- ----------------- ---------------

Other income (expense):
    Interest income                                 292,526        279,671           856,408          882,096        3,448,475
    Interest expense                               (378,636)    (1,697,550)         (973,537)      (3,203,735)      (4,826,080)
    Cancellation of common stock reset
      provisions                                 (6,111,577)             -        (6,111,577)               -       (6,111,577)
                                            ---------------- -------------- ----------------- ----------------- ---------------

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

Loss before extraordinary items                 (18,593,125)    (5,253,419)      (35,192,616)     (12,973,127)     (76,637,055)

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

Net loss                                    $   (18,593,125) $  (6,135,283) $    (35,192,616) $   (13,854,991)  $  (77,488,371)
                                            ================ ============== ================= ================= ===============


Basic and diluted net loss per
     common share                                   $ (0.39)       $ (0.18)          $ (0.75)         $ (0.37)
                                            ================ ============== ================= ================
</TABLE>

     See accompanying notes to condensed consolidated financial statements.

                                        4

                                Fonix Corporation
                          (A Development Stage Company)

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                Increase (Decrease) in Cash and Cash Equivalents
<TABLE>
<CAPTION>
                                                                                                          October 1,
                                                                                                             1993
                                                                                Nine Months Ended        (Inception) to
                                                                                  September 30,          September 30,
                                                                           -----------------------------
                                                                               1998           1997           1998
                                                                           -------------- -------------- --------------
Cash flows from operating activities:                                       (As restated                  (As restated
                                                                            See Note 1)                   See Note 1)
<S>                                                                        <C>            <C>            <C>
      Net loss                                                              $(35,192,616)  $(13,854,991) $ (77,488,371)
      Adjustments to reconcile net loss to net cash
        used in operating activities:
        Issuance of common stock for services                                          -      1,120,004      5,437,240
        Issuance of common stock for patent                                      100,807              -        100,807
        Non-cash expense related to issuance of debentures,
          warrants, preferred stock and common stock                           6,111,577      2,489,336     10,078,914
        Non-cash compensation expense related to issuance
          of stock options                                                       133,375              -      2,416,275
        Non-cash expense related to issuance of notes payable and
          accrued expense for services                                           857,000              -        857,000
        Non-cash expense related to exchange of notes receivable for
          services                                                               150,000              -        150,000
        Non-cash expense related to purchased in-process research and
          development                                                         12,635,768              -     12,635,768
        Gains (losses) on asset disposals                                            (88)             -          1,193
        Depreciation and amortization                                          1,802,814        237,784      2,292,423
        Extraordinary loss on extinguishment of debt                                   -        881,864        881,864
        Extraordinary gain on forgiveness of debt                                      -              -        (30,548)
        Changes in assets and liabilities, net of acquisitions:
           Accounts receivable, net                                             (183,418)             -       (183,418)
           Interest and other receivables                                        (74,009)       157,643        (88,928)
           Inventory                                                              (8,358)             -         (8,358)
           Prepaid expense                                                      (100,281)      (152,689)      (132,375)
           Other assets                                                          (80,212)       (18,420)      (119,859)
           Accounts payable                                                    2,381,610         40,870      4,453,448
           Accrued liabilities                                                   482,568     (1,006,905)     1,116,168
           Accrued liabilities - related party                                  (370,966)        (4,978)        88,536
           Deferred revenues                                                       2,126              -          2,126
                                                                           -------------- -------------- --------------

        Net cash used in operating activities                                (11,352,303)   (10,110,482)   (37,540,095)
                                                                           -------------- -------------- --------------

Cash flows from investing activities, net of effects of acquisitions:
      Acquisition of subsidiaries, net of cash acquired                      (14,738,495)             -    (14,738,495)
      Purchase of property and equipment                                      (1,240,540)      (625,597)    (3,271,919)
      Proceeds from sale of equipment                                                500              -            500
      Investment in intangible assets                                            (94,789)       (75,035)      (259,249)
      Issuance of notes receivable                                            (1,322,139)      (883,600)    (3,805,739)
      Payments received on notes receivable                                            -      1,633,600      1,883,600
                                                                           -------------- -------------- --------------

        Net cash (used in) provided by investing activities                  (17,395,463)        49,368    (20,191,302)
                                                                           -------------- -------------- --------------

Cash flows from financing activities:
      Bank overdraft                                                             178,757              -        178,757
      Net proceeds from revolving note payable                                 1,422,264      3,352,637     20,034,536
      Net (payments) proceeds on revolving note payable - related party         (514,296)       760,000         37,214
      Proceeds from notes payable - other                                        100,000              -      2,451,667
      Payments on notes payable - other                                          (49,250)             -     (1,829,056)
      Principal payments on capital lease obligation                             (36,284)             -        (79,665)
      Proceeds from issuance of convertible debentures, net                            -      2,685,000      3,185,000
      Proceeds from sale of warrants                                             322,928              -        922,928
      Proceeds from sale of common stock, net                                 17,471,155        425,000     38,175,700
      Proceeds from sale of Series B, C and D preferred stock, net             9,403,846              -     14,707,346
                                                                           -------------- -------------- --------------

        Net cash provided by financing activities                             28,299,120      7,222,637     77,784,427
                                                                           -------------- -------------- --------------

Net increase (decrease) in cash and cash equivalents                            (448,646)    (2,838,477)    20,053,030

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

Cash and cash equivalents at end of period                                   $20,053,030    $19,967,309   $ 20,053,030
                                                                           ============== ============== ==============
</TABLE>


     See accompanying ntoes to condensed consolidated financial statements.

                                        5

<PAGE>

                             Fonix Corporation
                       (A Development Stage Company)

        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
                                 (Unaudited)
<TABLE>
<CAPTION>
                                                                                                       October 1,
                                                                                                          1993
                                                                            Nine Months Ended        (Inception) to
                                                                              September 30,           September 30,
                                                                       ----------------------------
Supplemental disclosure of cash flow information:                          1998          1997             1998
                                                                       ------------- --------------  ----------------
                                                                       (As restated                   As restated
                                                                        See Note 1)                   See Note 1)
<S>                                                                       <C>            <C>             <C>
      Cash paid during the period for interest                            $ 747,629      $ 771,037       $ 2,784,648
</TABLE>

Supplemental Schedule of Non-cash Investing and Financing Activities:

      For the Nine Months Ended September 30, 1998:

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

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

      The   Company issued  1,390,476  shares of common stock and 608,334 shares
            of Series D 4% Convertible  Preferred  Stock in connection  with the
            cancellation of existing reset  provisions and costs associated with
            the issuance of Series D 4%  Convertible  Preferred  Stock (see Note
            8).

      Preferred Stock  Dividends  of  $1,000,000  were  recorded  related to the
            issuance of 1,390,476  common shares and 608,334  shares of Series D
            4% Convertible  Preferred Stock in connection with the  cancellation
            of existing reset provisions (see Note 8).

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

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

      The   Company  issued  5,140,751  shares of common stock  (having a market
            value of  $8,353,720)  and notes payable of $4,747,339 in connection
            with the  acquisition  of Articulate  Systems,  Inc. The Company has
            agreed to issue options to purchase 91,830 shares of common stock to
            the holders of Articulate Systems, Inc.
            (having a fair market value of approximately $130,000).

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

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

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

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

      For the Nine Months Ended September 30, 1997:

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

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

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

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

     See accompanying notes to condensed consolidated financial statements.

                                        6

<PAGE>

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



1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

Subsequent  to the  Company  filing  its  Quarterly  Report on Form 10-Q for the
period ended September 30, 1998 with the Securities and Exchange Commission, the
Company  reevaluated the appraisal of the fair value of the in-process  research
and  development  acquired with the purchases of AcuVoice,  Inc., and Articulate
Systems,  Inc.  (see Note 2). The amount  allocated to  in-process  research and
development for the AcuVoice,  Inc., acquisition was reduced from $17,839,840 to
$9,315,000.  The amount allocated to in-process research and development for the
Articulate Systems, Inc., acquisition was reduced from $5,500,000 to $3,821,000.
The  previously  issued  consolidated  financial  statements  as of and  for the
periods ended  September 30, 1998 have been restated to reflect these changes as
follows:


<TABLE>
<CAPTION>
                                                    As of September 30, 1998
                                  As Originally
                                   Reported                                     As Restated
<S>                               <C>                                           <C>
Intangible assets, net            $24,984,215                                   $34,726,176
Total assets                       51,003,799                                    60,745,760
Stockholders' equity               18,461,277                                    28,203,238
</TABLE>



                                        7

<PAGE>


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




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

                    Reported      As Restated           Reported          As Restated        Reported         As Restated
<S>             <C>                 <C>               <C>               <C>                <C>               <C>
Purchased in-
process
research and
develop ment    $      5,500,000    $    3,821,000    $   23,339,840    $    13,136,000    $   23,339,840    $  13,136,000
Loss from
operations           (13,802,381)      (12,395,438)      (38,575,871)       (28,963,910)      (78,759,834)     (69,147,873)

Net loss             (20,000,068)      (18,593,125)      (44,804,577)       (35,192,616)      (87,100,332)     (77,488,371)
Basic and
diluted net
loss per
common
share                     $(0.42)           $(0.39)           $(0.94)            $(0.75)
</TABLE>


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

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

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

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

Net Loss Per Common  Share - Basic and  diluted  net loss per  common  share are
calculated  by dividing  net loss  attributable  to common  stockholders  by the
weighted average number of shares of common stock outstanding during the period.
At September 30, 1998 and 1997, there were outstanding  common stock equivalents
to purchase 38,413,473

                                        8

<PAGE>


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


and 9,982,403  shares of common stock,  respectively,  that were not included in
the  computation of diluted net loss per common share as their effect would have
been  anti-dilutive,  thereby decreasing the net loss per common share. Net loss
per common share amounts have been restated for all periods presented to reflect
basic and diluted per share presentations.



                                        9

<PAGE>


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


The following table is a  reconciliation  of the net loss numerator of basic and
diluted net loss per common share for the three and nine months ended  September
30, 1998 and 1997:



<TABLE>
<CAPTION>
                                                                             Three Months Ended September 30,
                                                                   ------------------------------------------------------
                                                                        1998                                   1997
                                                            ---------------------------------        ------------------------------
                                                                                Per Share                               Per Share
                                                               Loss               Amount              Loss               Amount
                                                               ----               ------              ----               ------

<S>                                                           <C>               <C>                    <C>                <C>
Loss before extraordinary items                               $(18,593,125)                            $(5,253,419)
Preferred stock dividends                                       (2,626,890)                             (1,660,718)
                                                              -------------                            ------------
Loss attributable to common stockholders before
extraordinary items                                            (21,220,015)           $(0.39)           (6,914,137)          $(0.16)
Extraordinary loss on extinguishment of debt                        -                  -                  (881,864)           (0.02)
                                                              -------------      -----------           ------------        ---------

Net loss attributable to common
stockholders                                                  $(21,220,015)           $(0.39)          $(7,796,001)          $(0.18)
                                                              =============     =============          ============        =========

Weighted average common shares

outstanding                                                      54,020,736                              42,192,776
                                                              =============                            ============
</TABLE>




<TABLE>
<CAPTION>
                                                                              Nine Months Ended September 30,
                                                                   ------------------------------------------------------
                                                                        1998                                   1997
                                                            ---------------------------------        ------------------------------
                                                                                Per Share                               Per Share
                                                               Loss               Amount              Loss               Amount
                                                               ----               ------              ----               ------

<S>                                                           <C>               <C>                   <C>                  <C>
Loss before extraordinary items                               $(35,192,616)                           $(12,973,127)
Preferred stock dividends                                       (2,758,550)                             (1,660,718)
                                                              -------------                           -------------
Loss attributable to common stockholders before
extraordinary items                                            (37,951,166)           $(0.75)          (14,633,845)          $(0.35)
Extraordinary loss on extinguishment of debt                              -                 -             (881,864)           (0.02)
                                                              -------------      -----------           ------------        ---------

Net loss attributable to common
stockholders                                                  $(37,951,166)           $(0.75)         $(15,515,709)          $(0.37)
                                                              =============     =============          ============        =========

Weighted average common shares

outstanding                                                      50,385,468                              42,053,697
                                                              =============                            ============
</TABLE>




                                       10

<PAGE>


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


2.  ACQUISITIONS


The Company created a wholly owned subsidiary  ("fonix/Articulate") for the sole
purpose of acquiring Articulate Systems,  Inc. ("ASI"), a Delaware  corporation,
in  September  1998.  ASI was a  provider  of  sophisticated  voice  recognition
products  to  specialized  segments  of the  health  care  industry.  Those same
products and services are now  provided by the  Company's  HealthCare  Solutions
Group. The acquisition was closed on September 2, 1998. The Company delivered to
the former ASI stockholders  5,140,751 shares of restricted common stock (having
a quoted market value of $8,353,720 on that date),  a cash payment of $7,787,249
and  8.5  percent   demand  notes  in  the  aggregate   amount  of   $4,747,339.
Additionally,  the Company  agreed to issue stock options in exchange for all of
ASI's stock options  outstanding and unexercised on the date of acquisition at a
rate designed to allow the holders thereof to receive that amount of Fonix stock
as they would have received had they  exercised  their options before the merger
closed for  payment  of the same  exercise  price (see Note 8). The fair  market
value of the  options  to be  issued  to ASI  option  holders  is  approximately
$130,000  using  the  Black-Scholes  option  pricing  model.  Subsequent  to the
acquisition,   the  Company  agreed  to  pay  several  ASI  employees  incentive
compensation for continued employment in the aggregate amount of $857,000 (which
was not included in the purchase  price of ASI),  in  connection  with which the
Company  issued 8.5 percent  demand  notes for  $452,900 and recorded an accrued
liability of $404,100  for the balance.  The demand notes issued to both the ASI
stockholders  and the ASI  employees  are payable  after  November 1, 1998.  The
$404,100  accrued  liability is payable on or before  January 31, 1999.  The ASI
acquisition was accounted for as a purchase.


Purchase price allocations to tangible assets included $286,954 of cash, $62,835
of accounts  receivable,  $57,165 of inventory,  $14,043 of prepaid  expense and
$117,540 of fixed assets.  Purchase price  allocations  to  liabilities  assumed
included $310,008 of accounts payable and accrued expenses,  $1,900,000 of notes
payable and $929,690 of deferred  revenue.  The above purchase price allocations
were based upon the estimated  fair market values of the assets and  liabilities
acquired as of the date of acquisition.


The excess of the  purchase  price over the  estimated  fair market value of the
acquired  assets  and  liabilities  of ASI  was  $23,584,256,  including  direct
acquisition  costs of  $94,787,  of which  $13,945,000  was  capitalized  as the
purchase cost of completed  technology,  $5,818,256 was  capitalized as goodwill
and other  intangibles  and  $3,821,000  was  expensed as  purchased  in-process
research and development. The amount attributed to purchased in-process research
and  development  was expensed in connection  with the  acquisition  because the
purchased in-process  technology had not yet reached  technological  feasibility
and had no  alternative  future use.  The amounts  assigned  to  purchased  core
technology  and  goodwill  and  other  intangibles  are  being  amortized  on  a
straight-line  basis  over a  period  of  eight  years  (see  Note 5)  based  on
management's review of ASI's operating history, industry trends, the opinions of
industry experts,  market research reports,  analyst reports, and other industry
materials.


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

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

                                       11

<PAGE>


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


payable and accrued  expenses and $599,250 of notes payable.  The above purchase
price allocations were based upon the estimated fair market values of the assets
and liabilities acquired as of the date of acquisition.


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


The amount  attributed  to purchased  in-process  research and  development  was
expensed in connection  with the  acquisition  because the purchased  in-process
technology had not yet reached technological  feasibility and had no alternative
future use. The amounts  assigned to purchased core  technology and goodwill and
other intangibles are being amortized on a straight-line  basis over a period of
eight years (see Note 5) based on  management's  review of AcuVoice's  operating
history,  industry  trends,  the opinions of industry  experts,  market research
reports, analyst reports, and other industry materials.

The amount attributed to purchased  in-process research and development for each
acquisition  was determined by (1) estimating the costs to develop the purchased
in-process  technology into commercially  viable products  (expected  completion
dates of the end of calendar  year 1998 for ASI's  technology  and mid-year 1999
for  AcuVoices's  technology),  (2) estimating the resulting net cash flows from
the projects and (3)  discounting the net cash flows back to their present value
using a discount rate of 60 percent for the AcuVoice  technology  and 40 percent
for the ASI technology.

At the time of its acquisition by Fonix, ASI's research and development  focused
on  developing  a new  PowerScribe  platform  design  that will  support  as-yet
unproven  features  including an enhanced tool kit that supports  advanced voice
recognition  technology built on all-new language models, as well as new storage
and retrieval applications.  At the time of its acquisition by Fonix, AcuVoice's
research and development efforts were focused on the continued  development of a
completely   new   generation   of   proprietary    text-to-speech   technology.
Specifically,  the company was working to expand voice capacity to include other
voices  (including female and foreign language  voices).  Remaining  development
efforts for these projects  include  various phases of design,  development  and
testing.  Funding for the  projects  was  expected to be obtained  from  private
offerings of the Company's equity  securities.  Expenditures to complete each of
these  projects  were  expected  to  total  approximately  $1.0  million.  These
estimates  are subject to change,  given the  uncertainties  of the  development
process,  and no assurance can be given that  significant  deviations from these
estimates will not occur.

The net cash flows  resulting from the projects at ASI and AcuVoice,  which were
used to value the purchased in- process research and development,  were based on
management's estimates of revenues,  cost of revenues,  research and development
costs,  selling,  general and  administrative  costs, and income taxes from such
projects. These estimates are based on the following assumptions:  The potential
market size that the  projects are  addressing;  the  Company's  ability to gain
market share in these  segments;  and the life cycle of  in-process  technology.
Earnings before interest and taxes are estimated to be  approximately 35 percent
to 60  percent  for the sales  generated  from the ASI and  AcuVoice  in-process
technology. Estimated total revenues from the purchased in-process product areas
peak in calendar  years  2000-2001 and decline  rapidly  thereafter as other new
products  are  expected  to enter the  market.  In  addition,  a portion  of the
anticipated  revenues has been attributed to enhancements of the base technology
under  development,  and has been excluded from the net cash flow  calculations.
Existing  technology  was  valued at  $13,945,000  for ASI and  $11,192,000  for
AcuVoice. There can be no assurances that these assumptions will prove accurate,
or that the Company will realize the anticipated benefit of these acquisitions.

The rates  utilized to discount  the net cash flows to their  present  value are
based on cost of capital calculations. Due to the high risk nature of the growth
and  profitability  inherent in the forecast and the risks  associated  with the
developmental  projects,   venture  capital  rates  of  return  were  considered
appropriate for the acquired

                                       12

<PAGE>


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


companies. The discount rates used to derive the net present value of cash flows
from each purchased  in-process  technology were commensurate with each acquired
company's  i) early stage of  development;  ii) history of limited  revenues and
losses;  iii) the uncertainties in the economic  estimates  described above; iv)
the inherent uncertainty surrounding the successful development of the purchased
in-process  technology;  v)  the  useful  life  of  such  technology;   vi)  the
profitability  levels of the technology;  and, vii) the  uncertainty  associated
with technological advances inherent in the R&D.

If these  projects  are not  successfully  developed,  the  Company's  business,
operating results,  and financial  condition may be adversely affected in future
periods.  In addition,  the value of other intangible assets acquired may become
impaired.  To date,  results have not differed  significantly  from the forecast
assumptions.  These  releases  were within range of the  development  horizon in
terms of date of release and cost to  complete  anticipated  at each  respective
date of  acquisition.  Management  believes  the  value  allocated  to  acquired
developed  technology and in-process research and development is consistent with
these facts and circumstances.


The following  unaudited pro forma  financial  statement  data for the three and
nine months ended  September 30, 1998 and 1997 present the results of operations
of the Company as if the  acquisitions  of AcuVoice  and ASI had occurred at the
beginning of each three and nine-month  period.  The pro forma results have been
prepared for  comparative  purposes  only and do not purport to be indicative of
what would have occurred had the acquisitions  been made at the beginning of the
applicable period or of future results. Expenses related to purchased in-process
research  and  development  related to the  acquisitions  of AcuVoice and ASI of
$9,315,000  and  $3,821,000,  respectively,  were  recorded  at the  date of the
acquisitions  and  are  not  presented  in the  following  pro  forma  financial
statement data since they are non-recurring charges directly attributable to the
acquisitions.



                                       13

<PAGE>


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


<TABLE>
<CAPTION>
                                        Three Months Ended September 30,             Nine Months Ended September 30,
                                               1998           1997                      1998              1997

<S>                                 <C>              <C>                        <C>              <C>

Revenues                            $      239,980   $      195,517             $     3,233,621  $      755,191

Loss before extraordinary items       (15,875,374)       (7,258,091)                (26,749,586)   (19,028,576)

Net loss                              (15,875,374)       (8,139,955)                (26,749,586)   (19,910,440)

Basic and diluted net loss
   per common share                         (0.28)            (0.16)                      (0.48)         (0.40)
</TABLE>





3.  CERTIFICATE OF DEPOSIT

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

4.  NOTES RECEIVABLE

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

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


                                       14

<PAGE>


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


5.  INTANGIBLE ASSETS

Intangible assets consist of the purchase cost of completed technology, goodwill
and other  intangibles in connection  with the  acquisitions of AcuVoice and ASI
and direct costs  incurred by the Company in applying  for patents  covering its
technologies.  Amortization  is  computed  on a  straight-line  basis  over  the
estimated useful lives of the completed technology,  goodwill, other intangibles
and patents of five to eight years.

6.  NOTES PAYABLE

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

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

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

7.  RELATED-PARTY NOTES PAYABLE

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

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

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

As of September 30, 1998,  the Company had a $37,214  unsecured  revolving  note
payable to a company owned by three  individuals who are executive  officers and
directors of the Company and who each  beneficially own more than ten percent of
the Company's common stock. The weighted average balance  outstanding during the
nine months ended September 30, 1998 was $85,967. This revolving note is payable
on demand and bears interest at an annual rate of 12 percent. The maximum amount
outstanding under this revolving note was $551,510 during the nine

                                       15

<PAGE>


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


months  ended  September  30,  1998.  The  Company  believes  the  terms  of the
related-party revolving note payable are at least as favorable to the Company as
the terms that could  have been  obtained  from an  unrelated  third  party in a
similar transaction.

8.  STOCKHOLDERS' EQUITY

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

Private Placement - On March 12, 1998, the Company completed a private placement
(the  "Offering") of up to 6,666,666  shares of its  restricted  common stock to
seven  accredited  investors (the  "Investors").  The total purchase price to be
paid by the Investors pursuant to the Offering was $30,000,000.  Of that amount,
$15,000,000  was received by the Company on March 12, 1998,  in return for which
the Company  issued a total of  3,333,333  shares of  restricted  common  stock.
Finders' fees of $870,000 were paid in connection with the $15,000,000 received.
The remainder of the purchase  price was to be paid by the Investors on July 27,
1998 (60 days  after the  effectiveness  of a  registration  statement  that the
Company filed with the  Securities and Exchange  Commission  covering the common
stock  issued and  issuable  to the  investors)  (the  "Second  Funding  Date"),
provided  that, as of such date,  certain  conditions  were  satisfied.  Certain
conditions  precedent to receiving the additional funding were not met as of the
Second Funding Date. In separate  transactions in June and August 1998,  certain
Investors paid to the Company  $3,000,000 in return for which the Company issued
666,667  additional  shares  under  the terms  and  conditions  set forth in the
Offering  documents.  Finders'  fees of $163,846 have been accrued in connection
with the $3,000,000 received.  No other payment has been received by the Company
pursuant to the Offering, and the Company does not expect any further payment to
be made.

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

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

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

                                       16

<PAGE>


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


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

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

                                       17

<PAGE>


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


been converted to common stock.  On November 4, 1998,  50,000 shares of Series E
and related dividends were converted into 1,130,805 shares of common stock.

Common Stock  Options - During the nine months  ended  September  30, 1998,  the
Company  granted options to purchase  2,734,000  shares of common stock. Of such
options,  450,000  (having an exercise price of $5.16 per share) were granted to
three  individuals  who are executive  officers and directors of the Company and
who each  beneficially  own more than ten percent of the Company's common stock;
355,000,  1,240,000,  and 589,000  options were granted to various  employees at
exercise prices of $3.34, $3.54, and $6.50 per share, respectively,  and 100,000
options were granted to an unrelated  party for services with an exercise  price
of $3.75 per share. The term of all options granted during the nine months ended
September  30,  1998 is ten  years  from the date of  grant.  Additionally,  the
Company  agreed to issue 98,132 stock  options in exchange for ASI stock options
in connection  with the acquisition of ASI (see Note 2). These options will have
expiration  dates  ranging  from  January 1, 2001 to  November  2,  2002.  As of
September 30, 1998, the Company had a total of 13,411,750 options outstanding.

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

9.  RELATED-PARTY  TRANSACTIONS

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

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


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

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

10.  STATEMENTS OF WORK

                                       18

<PAGE>


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



On February 11, 1998,  the Company  entered into a Restated  First  Statement of
Work  and  License  Agreement  with  Siemens   Semiconductor  Group  of  Siemens
Aktiengesellschaft ("Siemens"). The Company and Siemens are jointly pursuing the
development  of  Siemens'  integrated   circuits   incorporating  the  Company's
technologies for use in certain telecommunications applications. On February 20,
1998, the Company received  $2,691,066 in cash from Siemens. Of that amount: (1)
$1,291,712  was paid to the  Company  as a  non-refundable  payment  to  license
certain automated speech  recognition  technologies for which the Company has no
further  obligation;  (2)  $322,928  was paid to  purchase  warrants  to acquire
1,000,000 shares of the Company's restricted common stock at an average exercise
price of $20 per share with  expiration  dates ranging from December 31, 1998 to
December 31, 1999;  and (3)  $1,076,426  was paid to the Company to acquire,  if
Siemens so elected, shares of the Company's restricted common stock or to become
a  non-refundable  license payment.  In June 1998,  Siemens elected to apply the
$1,076,426  portion as a  non-refundable  payment to license  certain  automated
speech recognition technologies for which the Company has no further obligation.
The Company  recorded the $1,291,712 and $1,076,426  license payments as revenue
during the nine months ended September 30, 1998.

11.  PRODUCT DEVELOPMENT AND RESEARCH

In October  1993,  the  Company  entered  into an  agreement  (the  "Synergetics
Agreement")  with  Synergetics,  whereby  Synergetics  was  to  develop  certain
technologies  related to the  Company's  automated  speech  recognition  ("ASR")
technologies.  The  Company's  president is one of seven members of the board of
directors  of  Synergetics,  and three  executive  officers,  directors  and ten
percent  beneficial  owners of the  Company  own less than five  percent  of the
common stock of Synergetics.  Under the terms of the Synergetics  Agreement,  as
subsequently  modified,  the  Company  acquired  intellectual  property  rights,
technologies  and technology  rights that were developed by Synergetics and that
pertained  to the ASR  technologies.  The Company  agreed to provide all funding
necessary for Synergetics to develop commercially viable technologies. There was
no  minimum  requirement  or  maximum  limit  with  respect to the amount of the
funding  to be  provided  by  the  Company.  However,  under  the  terms  of the
Synergetics  Agreement,  the Company was  obligated  to use its best  efforts in
raising the necessary funding for the engineering,  development and marketing of
the ASR technologies.  As part of the Synergetics Agreement,  the Company agreed
to pay  Synergetics a royalty of ten percent of gross revenues from sales of its
ASR technologies (the "Royalty").  Under the terms of the Synergetics Agreement,
the Company paid to  Synergetics  $125,995 and $1,628,433 for the three and nine
months ended  September  30, 1998,  respectively,  for product  development  and
research efforts.

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

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

                                       19

<PAGE>


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


will be canceled.

12.  COMMITMENTS AND CONTINGENCIES

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

<TABLE>
<CAPTION>
           Years ending December 31,

<S>                  <C>                                      <C>
                     1998                                     $   163,883
                     1999                                         292,899
                     2000                                         308,474
                     2001                                         320,531
                     2002                                         332,589
                     Thereafter                                   140,672
                                                              ------------

                               Total                          $ 1,559,048
</TABLE>

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

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

Litigation - On August 28,  1998,  John R. Clarke and  Perpetual  Growth Fund, a
company  Clarke's  spouse  purportedly  owns,  commenced  an action  against the
Company in  federal  court for the  Southern  District  of New York.  Clarke and
Perpetual  Growth  assert  claims for  breach of  contract  relating  to certain
financing the Company received during 1998.  Specifically,  Clarke and Perpetual
Growth allege that they entered into a contract with the Company under which the
Company  agreed to pay them a commission of 5 percent of all financing  provided
to the Company by Southridge  Capital  Management or its affiliates.  Clarke and
Perpetual  claim  that  they  are  entitled  to  commissions   with  respect  to
approximately  $3,000,000 of equity  financing to the Company in July and August
1998,  and the  Company's  offerings  of Series D and Series E  preferred  stock
(totaling together $12,000,000) in August and September 1998.

The Company believes that the Clarke lawsuit is without merit and filed a motion
to  dismiss  based  upon the  court's  lack of  personal  jurisdiction  over the
Company. The court granted the Company's motion to dismiss, subject to the right
of Clarke  and  Perpetual  Growth to produce  additional  evidence  which  would
establish  jurisdiction  of the New York  court over the  Company.  Even if such
evidence is  available,  the  Company  intends to  vigorously  defend the claims
asserted in that action.  However,  Clarke and Perpetual Growth could prevail in
the  lawsuit,  in which case the  Company  may be  required  to pay  significant
amounts of monetary damages or other amounts awarded by the court. At a minimum,
the ongoing  nature of this action will result in some  diversion of  management
time and effort from the operation of the business.

                                       20

<PAGE>


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


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

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

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


                                       21

<PAGE>


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



13.  SUBSEQUENT EVENTS

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

Acquisitions - The Company created a wholly owned  subsidiary for the purpose of
acquiring   Papyrus   Associates,   a  Pennsylvania   corporation   and  Papyrus
Development,  a Massachusetts  corporation,  in October 1998. Papyrus Associates
develops,  markets and supports handwriting  recognition software. Such software
is now marketed by the Company's  Interactive  Technologies  Solutions Group. On
October  29,1998,  the Company  acquired 100 percent of the  outstanding  common
stock  of  Papyrus  Associates  for the  issuance  of  1,076,926  shares  of the
Company's restricted common stock (having a quoted market value of $1,110,580 on
that  date) and  promissory  notes to the  shareholders  of  Papyrus  Associates
totaling  $360,000,  due the fifth  business  day  following  the closing of the
Company's  next equity  funding,  but no later than  February 28, 1999 and notes
totaling  $180,000,  due April 30, 1999.  These notes bear interest at an annual
rate of six percent.

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




                                       22

<PAGE>


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

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

Overview

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

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

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

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

In October 1998,  the Company  acquired  Papyrus  Associates,  Inc.  ("PAI") and
Papyrus Development  Corporation  ("PDC"). PAI develops and markets printing and
cursive handwriting  recognition  software for personal digital assistants,  pen
tablets  and  mobile  phones.  The  Papyrus  Recognizer  is  marketed  under the
trademark "Allegro."

                                       23

<PAGE>



PDC is a systems integration  provider with expertise and intellectual  property
related to  embedded  systems and  enhanced  Internet  applications.  PDC has an
ongoing  partnership  with e-Travel that resulted in the first corporate  travel
management  Web-browser  client software system. The acquisition of both PDC and
PAI  (collectively  "Papyrus") was accomplished  through a merger of PDC and PAI
into a wholly owned subsidiary of the Company,  Papyrus Acquisition Corporation.
Following the acquisitions,  the Company operates the business formerly operated
by Papyrus as part of its  Interactive  Technologies  Solutions Group in Woburn,
Massachusetts.

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

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

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

Acquisitions

During the nine months ended September 30, 1998, the Company acquired  AcuVoice,
and ASI,  for the  in-process  research and  development  (IPR&D) of each of the
respective companies.

AcuVoice (Acquired March 13, 1998)

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

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

                                       24

<PAGE>



Windows NT/Solaris environments.

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

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

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

ASI (Acquired September 2, 1998)

ASI focuses on  developing  and  marketing  speech  recognition  and  integrated
speech-oriented  software  applications  for  desk-top  and client  server-based
computer   environments.   In  1993,   the   company   focused   on   developing
large-vocabulary  speech  applications for the heath care market, with a primary
focus  on  medical  records  management.  In  1995,  ASI  began  development  of
PowerScribe,  which  converts  speech into text to create an electronic  medical
report. The first PowerScribe application focused on the radiology market.

At the date of  acquisition,  ASI's IPR&D  focused on (1)  enhancing its current
PowerScribe  Radiology  application to meet the needs of the health care market,
and (2) develop products addressing the needs of other health care segments. The
next generation of PowerScribe Radiology, identified as Version 2.5, will differ
from Version 1.0, in that it will have an enhanced tool kit,  providing a common
set of services including storage and retrieval,  and improved voice recognition
technology  using a different set of language models.  In addition,  Version 2.5
will also be developed with new version of SQL. SQL Version 7.0 is significantly
improved over Version 6.5, in that it  self-administers  more  effectively,  and
incorporates  technology supporting remote access via a virtual connection.  ASI
is also developing PowerScribe products for emergency, cardiology, and pathology
health care segments.

The   developmental   projects  at  the  time  of  the   acquisition   were  not
technologically  feasible and had no alternative future use. This conclusion was
attributable  to the fact that ASI had not  completed  a working  model that had
been tested and proven to work at  performance  levels which were expected to be
commercially viable, and that the technologies  constituting the projects had no
alternative use other than their intended use. The value is attributable  solely
to the development  efforts  completed as of the acquisition  date. The acquired
IPR&D  was  valued  at  approximately  $3.8  million  based  on an  analysis  of
forecasted income.

As of the date of acquisition,  ASI had invested  approximately  $3.4 million in
the IPR&D identified above.  Development of the acquired  in-process  technology
into  commercially  viable products and services  required  efforts  principally
related to the  completion  of all  planning,  designing,  coding,  prototyping,
scalability verification, and testing activities necessary to establish that the
proposed  technologies  would  meet  their  design   specifications,   including
functional,   technical,  and  economic  performance  requirements.   Management
estimates  that an  additional  $1.0 million  will be required  over the next 12
months to develop the aforementioned products to commercial viability.

Of the projects  deemed  IPR&D,  both  Radiology 2.5 and Emergency 1.0 achieving
technological feasibility and commercial viability subsequent to the acquisition
date, within range of the anticipated time of release and cost to

                                       25

<PAGE>



complete. Management confirms that remaining IPR&D projects are continuing to be
developed as anticipated.

Valuation Methodology

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

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

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

The rates  utilized to discount the net cash flows to their  present  value were
consistent  with the nature of the  forecast and the risks  associated  with the
projected growth,  profitability and developmental  projects.  Discount rates of
50% and 60% for AcuVoice and 35% and 40% for ASI were deemed appropriate for the
business  enterprises and for the acquired IPR&D,  respectively.  These discount
rates  were   consistent  with  the  acquired   companies'   various  stages  of
development;  the uncertainties in the economic  estimates  described above; the
inherent  uncertainty at the time of the acquisition  surrounding the successful
development  of the  purchased  in-process  technology;  the useful life of such
technology;  the  profitability  levels  of such  technology;  and the  inherent
uncertainties of the technological advances that were indeterminable at the time
of the acquisition.

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

Results of Operations

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

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

Prior  to  March  1997,  the  Company  conducted  its  scientific  research  and
development activities solely through

                                       26

<PAGE>



Synergetics, Inc.("Synergetics"), a research and development entity, pursuant to
product development and assignment contracts between the Company and Synergetics
(collectively, the "Synergetics Agreement"). Under that arrangement, Synergetics
provided personnel and facilities and the Company financed  scientific  research
and development of the its  technologies on an as-required  basis.  There was no
minimum  requirement  or maximum limit with respect to the amount of funding the
Company was obligated to provide to Synergetics under the Synergetics Agreement,
and the  Company  was  obligated  to use its best  efforts in raising all of the
necessary funding for the development of its technologies. Synergetics submitted
pre-authorized work orders and budgets, which were then reviewed and approved by
the  Company.  All funds  paid to  Synergetics  have been  accounted  for by the
Company as research and development  expense.  Under the Synergetics  Agreement,
the Company had also agreed to pay a royalty to Synergetics equal to ten percent
of revenues from sales of the technologies  developed by Synergetics or products
incorporating such technologies (the "Royalty").  On March 13, 1997, the Company
and  Synergetics  reached an agreement  in  principle to modify the  Synergetics
Agreement  with regard to the  development  and  assignment of the  technologies
developed by Synergetics.  Most research and development  activities  previously
conducted by  Synergetics  were moved  in-house to the Company in or about March
1997.  On April 6, 1998,  the Company  and  Synergetics  entered  into a Royalty
Modification  Agreement,   under  which  the  Company  agreed,  subject  to  its
compliance with applicable  securities laws, to make an offer to exchange common
stock  purchase  warrants  having  an  exercise  price of $10 per  share for the
Project  Shares  at the  rate of one  warrant  to  purchase  800  shares  of the
Company's  common  shares for each  Project  Share.  The  warrants,  if and when
issued,  will not be exercisable until the earlier of (1) the date the Company's
common stock has traded for a period of 15 consecutive trading days at a minimum
of $37.50 per share or (2) September 30, 2000.  The offer of warrants to holders
of Project Shares cannot be made by the Company until a  registration  statement
covering the total number of warrants issuable upon the exercise of the warrants
has been declared effective by the Securities and Exchange Commission.  Upon the
tender to the Company of any Project  Shares a  corresponding  percentage of the
Royalty will be canceled.  Assignment to the Company of all technology  relating
to the  technologies  developed by Synergetics is confirmed by the  Modification
Agreement.

From  inception on October 1, 1993 through  September 30, 1998,  the Company has
invested  $28,018,188  in  product  development  and  research  relating  to its
technologies.  During the three months  ended  September  30, 1998,  the Company
incurred product development and research expenses of $4,419,400, an increase of
$2,769,029  over the same  period in the  previous  year.  This  increase is due
primarily  to the  addition  of  product  development  and  research  personnel,
increased  use  of  independent  contractors,   equipment,  facilities  and  the
acquisitions of AcuVoice and ASI. Approximately $423,727 of such increase is for
development  costs from the operations of fonix/AcuVoice  and  fonix/Articulate.
The Company  anticipates  similar or increased product  development and research
costs  as  it  continues  to  expand,   develop  and  market  its  Technologies.
Additionally, the Company purchased in-process research and development totaling
$3,821,000  during the three months ended September 30, 1998, in connection with
the acquisition of fonix/Articulate.

Selling,  general and administrative expenses were $4,320,981 and $2,185,169 for
the three months ended September 30, 1998 and 1997, respectively.  This increase
from the previous period was due primarily to the hiring of additional employees
and the  resulting  increases in salaries,  wages and related  costs,  legal and
accounting and depreciation and amortization.  Salaries, wages and related costs
were  $1,754,401 and $772,744 for the three months ended  September 30, 1998 and
1997,  respectively,  an  increase  of  $981,657  over the  three  months  ended
September 30, 1997. This increase is attributable to incentive  compensation for
continue  employment  paid to employees of ASI of $857,000,  and to increases in
personnel  from recent  acquisitions.  Legal and accounting  expenses  increased
$386,328 and  depreciation  and amortization  increased  $739,909.  The $739,909
increase in  depreciation  and  amortization  is primarily  attributable  to the
amortization of intangible  assets acquired in connection with the  acquisitions
of AcuVoice and ASI.

Due to significant  product  development  and research and selling,  general and
administrative  expenses,  the Company has incurred losses from operations since
inception  totaling  $69,147,873,  of  which  $12,395,438  and  $3,835,540  were
incurred   during  the  three  months  ended   September   30,  1998  and  1997,
respectively.  At September 30, 1998, the Company had an accumulated  deficit of
$82,968,912 and  stockholders'  equity of $28,203,238.  The Company  anticipates
that its investment in ongoing  scientific  product  development and research of
its  Technologies  will continue at present or increased levels for at least the
remainder of fiscal 1998 assuming the availability of working capital.

                                       27

<PAGE>




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


                                       28

<PAGE>




Nine months ended  September 30, 1998 compared with nine months ended  September
30, 1997

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

During the nine months ended  September 30, 1998, the Company  incurred  product
development and research expenses of $10,080,895, an increase of $5,365,245 over
the same period in the previous  year.  This  increase was due  primarily to the
addition  of  product  development  and  research  personnel,  increased  use of
independent  contractors,  equipment,  facilities and the operations of AcuVoice
and ASI.  Approximately  $643,575 of such increase is for development costs from
the  operations  of  the  HealthCare  Solutions  and  Interactive   Technologies
Solutions  Groups.  The  Company   anticipates   similar  or  increased  product
development and research costs as it expands and continues to develop and market
the  applications   and  products  offered  by  its  HealthCare   Solutions  and
Interactive Technologies Solutions Groups.  Additionally,  the Company purchased
in-process product development and research totaling $13,136,000 during the nine
months ended September 30, 1998, in connection with the acquisitions of AcuVoice
and ASI.

Selling,  general and  administrative  expenses were  $8,360,964 and $5,935,838,
respectively,  for the nine  months  ended  September  30,  1998 and 1997.  This
increase from the previous  period was due primarily to the hiring of additional
employees  and the  resulting  increases in salaries,  wages and related  costs,
legal and accounting and  depreciation  and  amortization.  Salaries,  wages and
related costs were $3,280,790 and $1,787,726 for the nine months ended September
30, 1998 and 1997, respectively,  an increase of $1,493,064 over the nine months
ended   September  30,  1997.   This  increase  is   attributable  to  incentive
compensation for continued employment paid to employees of ASI of $857,000,  and
to  increases  in  personnel  from  recent  acquisitions.  Legal and  accounting
expenses  increased   $774,475  and  depreciation  and  amortization   increased
$1,381,996.   The  $1,381,996  increase  in  depreciation  and  amortization  is
primarily  attributable  to the  amortization  of intangible  assets acquired in
connection with the acquisitions of AcuVoice and ASI.  Additionally,  consulting
and outside services decreased by $2,303,087.

The Company  incurred  losses from  operations of  $28,963,910  and  $10,651,488
during the nine months  ended  September  30, 1998 and 1997,  respectively.  The
significant  increase in losses from  operations  is primarily  due to purchased
in-process  product  development and research charges of $13,136,000  associated
with the  acquisitions  of AcuVoice  and ASI. The Company  anticipates  that its
investment in ongoing scientific product  development and research will continue
at  present  or  increased  levels  for at least the  remainder  of fiscal  1998
assuming availability of working capital.

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

Liquidity and Capital Resources

The Company had negative  working  capital of  $9,106,108  at September 30, 1998
compared to positive  working  capital of $678,823  at December  31,  1997.  The
current ratio was 0.72 at September  30, 1998,  compared to 1.03 at December 31,
1997.  Current assets  increased by $2,277,686 to $23,426,375  from December 31,
1997 to September 30, 1998.  Current  liabilities  increased by  $12,062,617  to
$32,532,483  during  the same  period.  The  decrease  in working  capital  from
December  31, 1997 to September  30,  1998,  was  primarily  attributable  to an
increase in notes payable  associated  with the acquisition of ASI and increases
in accounts  payable and notes payable of $859,000 as incentive  compensation to
ASI employees to ensure continued  employment,  and accrued liabilities due to a
cash shortage.  Total assets were  $60,745,760 at September  30,1998 compared to
$22,894,566 at December 31, 1997.


                                       29

<PAGE>



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

On March 12, 1998, the Company completed a private placement (the "Offering") of
up to  6,666,666  shares  of its  restricted  common  stock to seven  accredited
investors  (the  "Investors").  The  total  purchase  price  to be  paid  by the
Investors pursuant to the Offering was $30,000,000.  Of that amount, $15,000,000
was received by the Company on March 12,  1998,  in return for which the Company
issued a total of 3,333,333 shares of restricted common stock.  Finders' fees of
$870,000 were paid in connection with the $15,000,000 received. The remainder of
the  purchase  price was to be paid by the  Investors  on July 27, 1998 (60 days
after the effectiveness of a registration  statement that the Company filed with
the  Securities  and  Exchange  Commission  covering the common stock issued and
issuable to the investors)  (the "Second  Funding  Date"),  provided that, as of
such date,  certain conditions were satisfied.  Certain conditions  precedent to
receiving the additional  funding were not met as of the Second Funding Date. In
separate  transactions  in June and August 1998,  certain  Investors paid to the
Company  $3,000,000 in return for which the Company  issued  666,667  additional
shares  under the  terms and  conditions  set forth in the  Offering  documents.
Placement  fees of $163,846 have been accrued in connection  with the $3,000,000
received.  No other  payment has been  received  by the Company  pursuant to the
Offering and the Company does not expect any further payment to be made.

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

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

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

On August 31, 1998,  the Company  entered into an agreement  with the  Investors
whereby  the  Company  issued  500,000  shares  of the  Company's  Series  D for
$10,000,000.  Additionally,  the  Company  issued to certain of the  Investors a
total of 608,334  shares of Series D (i) in return for their  relinquishment  of
their  contractual right to receive Reset Shares in connection with the Offering
(see Private  Placement  above),  and as (ii) an additional  cost of raising the
$10,000,000  from the Series D placement.  Dividends  accrue on the stated value
($20 per  share)  of Series D at the rate of 4 percent  per  year,  are  payable
annually  or upon  conversion,  in cash or common  stock,  at the  option of the
Company,  and are convertible  into shares of the Company's  common stock at the
holder's  option  anytime after the earlier of November 29, 1998 or the date the
registration  statement which the Company has agreed to file with the Securities
and Exchange  Commission  covering the common stock issuable upon the conversion
of the Series D is  declared  effective.  Each month the holders of the Series D
may not convert more than 25 percent of the

                                       30

<PAGE>



total  number  of  shares of Series D  originally  issued to such  holders  on a
cumulative basis. For example, during the first month a holder may convert up to
25% of the total preferred stock issued to the holder,  and during the following
month that same holder may convert,  on an aggregate to date basis, up to 50% of
the total  number of shares of Series D held by the holder.  Additionally,  each
month, the holders may convert up to 50 percent of the total number of shares of
Series D originally issued to such holders on a cumulative basis, if both of the
following  conditions  are  satisfied:  the average daily trading  volume of the
Company's common stock is more than 500,000 shares for the 10-trading-day period
before the  conversion;  and the  average  per share  closing bid price for such
10-trading-day  period  has not  decreased  by more than 5 percent  during  that
10-trading-day  period. Any outstanding shares of Series D as of August 31, 2001
automatically  will be converted at the conversion  price  described  below most
beneficial to the holders on such date. In the event of liquidation, the holders
of the Series D are  entitled  to an amount  equal to the stated  value ($20 per
share) plus accrued but unpaid dividends whether declared or not. The holders of
Series D have no voting  rights.  The Series D shares,  together with  dividends
accrued  thereon,  may be converted into shares of the Company's common stock at
the lesser of: $3.50 per share;  or the lesser of 110 percent of the average per
share closing bid price for the 15 trading days  immediately  preceding the date
of  issuance  of the Series D shares;  or 90 percent of the average of the three
lowest per share  closing  bid prices  during  the 22 trading  days  immediately
preceding  the  conversion  date.  In the event that the holders  convert at the
$3.50 per share price,  the Company is  obligated to issue  warrants to purchase
0.8 shares of common stock for each share of Series D converted to common stock.
Using the  conversion  terms  most  beneficial  to the  holder,  the  Company is
amortizing a beneficial  conversion  feature of  $2,462,964 as a dividend over a
180 day-period.

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

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

Although the Company has signed its first Statement of Work with Siemens and the
Company anticipates that it will enter into additional  third-party  licenses or
co-development  agreements for its technologies  with Siemens during fiscal year
1998,  there can be no  assurance  that this will  occur.  Even with the Siemens
Agreement in place and

                                       31

<PAGE>



taking  into  account  expected  revenues  from  the  HealthCare  Solutions  and
Interactive  Technologies  Solutions  Groups,  the Company's  ongoing  operating
expenses will remain  higher than revenues from  operations at least through the
first half of 1999. Accordingly, the Company expects to incur significant losses
at least  through  the end of fiscal year 1998 and until such time as it is able
to enter into substantial  licensing and  co-development  agreements and receive
substantial  revenues  from  such  arrangements  or from the  operations  of its
recently acquired subsidiaries, of which there can be no assurance.

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

The Company will need to raise  additional funds in the near term to satisfy its
cash  requirements for operations and current  liabilities.  Scientific  product
development  and research,  corporate  operations  and  marketing  expenses will
continue to require substantial  additional  capital.  In addition,  the Company
recently has acquired  AcuVoice and ASI and intends to complete other previously
announced acquisitions.  These and other acquisition  transactions have required
and will require substantial  additional capital resources,  even if the Company
uses its  securities  in  payment of all or part of the  purchase  price of such
acquisitions.  Because the  Company  presently  has only  limited  revenue  from
operations,  the  Company  intends to continue to rely  primarily  on  financing
through sales of its equity,  convertible  equity and debt securities to satisfy
future capital  requirements  until such time as the Company is able to generate
sufficient revenues to enable it to finance ongoing operations.  There can be no
assurance  that the Company will be able to sell its equity and debt  securities
or enter into such arrangements,  such that sufficient operating capital will be
available  when and in the amounts  needed.  If such financing is not available,
the  Company  will have to  significantly  reduce  or  suspend  its  operations.
Furthermore,  the issuance of equity securities or other securities which are or
may become  convertible  to the equity  securities  of the Company in connection
with such financing (or in connection with acquisitions) will result in dilution
to the stockholders of the Company which could be substantial.

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

Year 2000 Risks

Many computer  systems and software  products are coded to accept only two digit
entries in the date code field.  These date code fields will need to accept four
digit entries to distinguish  21st century dates from 20th century  dates.  As a
result,  many companies'  software and computer systems will need to be upgraded
or replaced in order to comply with such Year 2000 requirements.

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


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The Company uses third party  equipment  and software  that may not be Year 2000
compliant.  The Company has  implemented  a review of key  products  provided by
outside  vendors to determine  if their  products  are Year 2000  compliant  and
presently  believes that all software provided by third parties that is critical
to its  business  is Year 2000  compliant  or will be before the year 2000.  The
Company  believes  that all computer  software and hardware  acquired from third
parties after the 2nd quarter of 1997 is Year 2000 compliant.  However, if third
party  equipment or software  does not operate  properly with regard to the Year
2000 issue,  the Company may incur  unexpected  expenses to remedy any problems.
Such costs may materially  adversely  affect the Company's  business,  operating
results, and financial condition.  In addition, if the Company's key systems, or
a  significant  number of its systems,  failed as a result of Year 2000 problems
the Company could incur  substantial  costs and disruption of its business.  The
Company may also experience delays in implementing Year 2000 compliant  software
products.  Any of these problems have the potential to cause a material  adverse
affect on the Company's  business,  operating results, or financial condition by
making it  difficult  to bill  customers  timely and  accurately,  meet  product
development or production  schedules,  or pay obligations and operating expenses
timely.

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

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


Outlook

Corporate Objectives, Technology Vision and Acquisition Strategy

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

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

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

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

           o         PCs and PDAs
           o         cellular phones

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

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

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

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

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

                 Special Note Regarding Forward-Looking Statements

Certain statements contained herein under, "Management's Discussion and Analysis
of Financial  Condition  and Results of  Operations"  and  "Outlook,"  including
statements  concerning (i) the Company's strategy,  (ii) the Company's expansion
plans,  (iii)  the  market  for  and  potential  applications  of the  Company's
technologies,  (iv) the results of product development and research efforts, and
(v)  the  growth  of the  Company's  business  contain  certain  forward-looking
statements  concerning  the  Company's  operations,   economic  performance  and
financial  condition.  Because such statements  involve risks and uncertainties,
actual  results may differ  materially  from those  expressed or implied by such
forward-looking  statements.  Factors that could cause such differences include,
but are not  necessarily  limited to, those  discussed in the  Company's  Annual
Report on Form 10-K for the year ended December 31, 1997.





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                                    SIGNATURES

           In  accordance  with  the  requirements  of  the  Exchange  Act,  the
registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized.

                                Fonix Corporation




Date: June 18, 1999                                 /s/ Douglas L. Rex
                                                  ==============================
                                                  Chief Financial Officer