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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

(Mark one)

[X]  Annual Report  pursuant to Section 13 or 15(d) of the  Securities  Exchange
     Act of 1934 for the fiscal year ended December 31, 1999, or

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

Commission File No. 0-23862

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


         Delaware                                           87-0380088
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

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

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

Securities registered pursuant to
          Section 12(b) of the Act:  None

Securities registered pursuant to
          Section 12(g) of the Act:  Class A Common Stock ($0.0001 par value per
                                     share)

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

The  aggregate  market value of the voting stock held by  non-affiliates  of the
registrant is  approximately  $247,408,499  calculated  using a closing price of
$1.59  per  share on April 10,  2000.  For  purposes  of this  calculation,  the
registrant has included only the number of shares  directly held by its officers
and directors as of April 10, 2000, (and not counting shares  beneficially owned
on that date) in determining the shares held by non-affiliates.  As of April 10,
2000,  there were issued and  outstanding  163,994,614  shares of the  Company's
Class A common stock.

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best  of  the  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K. [ ]




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                          1999 FORM 10-K ANNUAL REPORT

                                TABLE OF CONTENTS

                                     Part I

                                                                            Page

Item  1.   Business............................................................3
Item  2.   Properties.........................................................22
Item  3.   Legal Proceedings..................................................23
Item  4.   Submission of Matters to a Vote of Security Holders................23

                                     Part II

Item  5.   Market for Registrant's Common Equity and Related
           Stockholder Matters................................................23
Item  6.   Selected Financial Data............................................25
Item  7.   Management's Discussion and Analysis of Financial Condition and
           Results of Operations..............................................26
Item  8.   Financial Statements and Supplementary Data........................34
Item  9.   Changes in and Disagreements with Accountants on Accounting and
           Financial Disclosure...............................................34

                                    Part III

Item 10.   Directors and Executive Officers of the Registrant.................34
Item 11.   Executive Compensation.............................................37
Item 12.   Security Ownership of Certain Beneficial Owners and Management.....42
Item 13.   Certain Relationships and Related Transactions.....................44

                                     Part IV

Item 14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K....47





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ITEM 1.               BUSINESS

General

           Fonix Corporation,  a Delaware corporation ("Fonix" or the "Company")
is a development  stage company engaged in marketing and developing  proprietary
human-computer interface ("HCI") technologies and solutions.  Specifically,  the
Company has developed neural network-based automated speech recognition ("ASR"),
text-to-speech  ("TTS"),  handwriting recognition ("HWR") and speech compression
technologies  that are  integrated  into products for  commercial and industrial
applications and customers.  (ASR, TTS, HWR and speech compression  technologies
are  sometimes  collectively  referred to as "Core  Technologies".)  The Company
expects to continue to make  commercially  available  applications  and products
utilizing its Core  Technologies  which enable people to interact with computers
and electronic devices on human terms rather than conforming to the process of a
machine. The Company believes its efficient, intuitive and natural method of HCI
will enhance  traditional  interaction tools such as the keyboard and mouse in a
broad range of mass market,  consumer,  industrial,  embedded  and  server-based
applications and products.

           Fonix  is  pursuing  revenue   opportunities  through  generation  of
non-recurring engineering fees, product and technology license and royalty fees,
product sales and product support maintenance  contracts.  The Company currently
markets its  products and Core  Technologies  to software  developers,  consumer
electronics manufacturers,  micro-processor  manufacturers,  third-party product
developers,  operating system developers,  network and share-ware developers and
Internet and web-related  companies.  The Company focuses its marketing  efforts
toward both embedded  systems  applications  for mobile  electronic  devices and
consumer  products,  and  server-based  solutions  for  Internet  and  telephony
voice-activated applications.

           Manufacturers of consumer electronics products,  software development
and Internet content  developers use Fonix Core Technologies to simplify the use
of their products and increase product functionality resulting in broader market
opportunities  and significant  competitive  advantage.  Fonix solutions support
multiple  platforms,  are environment  and speaker  independent and provide easy
integration within a relatively small memory requirement.

Core Technologies

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

           ASR. Fonix  researchers  have developed and patented what the Company
believes to be a  fundamentally  unique approach to the analysis of human speech
sounds and the contextual recognition of speech. The ASR technologies attempt to
approximate  the techniques  employed by the human auditory  system and language
understanding,  based upon the use of a series of neural networks. The Fonix ASR
technologies  use  information  in speech sounds  perceptible  to humans but not
discernible  by other ASR systems.  The ASR  technologies  employ neural network
technologies   (artificial   intelligence  techniques)  for  identifying  speech
components and word sequences contextually. As presently developed, the phonetic
sound  recognition  engine is comprised of several  components,  including audio
signal processing,  a feature extraction  process, a phoneme estimation process,
and a linguistic process based on the neural net technologies.  This development
has yielded a proprietary ASR system utilizing a unique method of extracting the
fundamental  mathematical  elements from the acoustic  speech  signal,  a neural
net-based phoneme (speech sound) identifier,  and a neural-net  architecture for
modeling the many complex  elements of human language.  The latter  component is
known as MULTCONSTM or multi-level  temporal  constraint  satisfaction  network.
These  developments  have been the subject of two issued  patents and 13 pending
patent  applications.  In addition,  the Company has  acquired a related  patent
covering the front-end recognition process.

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


                                  Page 3 of 47

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

1.         Significantly reduced computer memory requirements that allows speech
           recognition to operate in embedded system  environments,  or enabling
           server-based  systems to operate with significantly more simultaneous
           users due to lower memory requirements.
2.         Significantly   reduced   power   requirements   that   makes   Fonix
           technologies  available  for  use  in a  host  of  smaller  computing
           solutions  with limited  battery/power  capacity  and  enabling  more
           simultaneous users on server-based systems.
3.         Speaker  independence  that allows  various  speakers to use the same
           system without the system being trained to a particular  user's voice
           and dialect.
4.         Excellent noise cancellation  qualities that allows the ASR system to
           extract ambient background noise, permitting higher recognition rates
           in  noisy   environments   and  reduces  the  need  for  direct-wired
           microphones or headsets.
5.         Rapid  porting to multiple  computer  chip  platforms  and  operating
           systems that creates broad embedded product demand.
6.         Leading edge, visual,  integrated  development  environment using the
           Fonix Accelerated  Applications  Speech  Technology  (FAAST) software
           developer kit ("SDK"), that allows customers to build applications in
           a rapid  time  frame  with a high  rate of  success  and few  outside
           resources, thereby accelerating product time to market.

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

           The Company  expended  $6,823,612 in 1999,  $12,109,065  in 1998, and
$7,066,294 in 1997 on ASR research and development ("R&D") activities. Since its
inception  (October 1, 1993),  the Company has spent  $36,869,970  on R&D of ASR
technologies.  The Company  recognized  revenue of $2,368,138 in 1998  resulting
from a licensing  agreement for ASR technology with an  international  microchip
manufacturer.  Otherwise,  no ASR-related revenue has been generated to date and
the  Company  expects  that a  substantial  part of its capital  resources  will
continue  to be  devoted  to  product  development  and  marketing  R&D  of  ASR
technologies in the future.

           TTS. Fonix  text-to-speech  products  include a defined,  proprietary
vocabulary-true human-quality synthetic voice with full prosody and an unlimited
vocabulary text-to-speech engine.

           The Company's TTS products use actual  recordings of "units" of human
speech (i.e., the sound  pulsation).  Since the unit of speech often consists of
more than one phoneme (sound), Fonix's approach has been called a "large segment
concatenative  speech  synthesis"  approach.   Since  the  early  1960's,  other
companies  such as DEC and AT&T have  used a method  called  "parametric  speech
synthesis." In contrast to these  parametric  systems,  Fonix  synthetic  speech
products  produce a high quality,  human sounding voice that includes full voice
inflection, intonation and clarity. Fonix' large vocabulary TTS ("LVTTS") engine
won awards as "best text-to-speech"  product at the Computer Technology Expo '97
and '98 and the best of show award at AVIOS '97.  Presently  LVTTS  products are
sold to  end-users,  systems  integrators  and  OEMs in call  centers,  Internet
applications,   telecommunications,   multi-media,   educational  and  assistive
technology markets.

           TTS  products  include  the  Fonix AV 1700 TTS  system  for  end-user
desktop and laptop system use. The Fonix AV 2001 SDK is a tool for developers of
telephony  applications.  Run-time software licenses for the AV 2001 are offered
for  applications  developed  with  the SDK.  The SDK  supports  major  computer
telephony platforms, including Microsoft Windows 95m, Windows 98 and Windows NT,
Solaris Sparc and Solaris X86, and AIX.

           During  1999,  the  Company  recognized   $397,873  in  revenue  from
licensing or sale of the TTS technologies and products.


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           HWR. Fonix  handwriting  recognition  products are marketed under the
Allegro  brand name.  The Allegro HWR  software is a single  letter  recognition
system like the Graffiti  handwriting  recognition software for the PalmPilot(R)
PDA. However,  Allegro's  alphabet is all natural in appearance  involving lower
case letter.  The Allegro  system is easy to use and requires  little  training.
Allegro is sold by Purple  Software,  under  license from the  Company,  for the
Psion Series 5(R)  hand-held PC. It has also been  integrated  into  NuvoMedia's
Rocketbook(R)  for  handwriting  features in its electronic  book program.  This
software  has also been  licensed to Philips for use with its smart cell phones.
Fonix also offers cursive HWR software which recognizes  naturally-written whole
words. The cursive HWR technology is only available as a licensed product to OEM
customers. Both the Allegro and the cursive handwriting recognition software are
user independent and require no training on the software.

           During  1999,  the  Company  received  $41,634  in  revenue  from the
licensing of the HWR technologies.

           Integration of HCI  Technologies.  During 1999,  the Company  created
SDK's for developing  applications  that utilize some or all Core  Technologies.
FAAST for Embedded and FAAST for Server allows the rapid development of ASR, TTS
and HWR programs into a single application.  One such product development effort
that has been undertaken by the Company is a pen/voice  application that permits
simultaneous  input and  editing of both  handwriting  and speech for  hand-held
devices.

Market Strategy

           The world-wide  market for HCI technologies and products is emerging.
Currently, only a small portion of prospective applications for HCI technologies
has  reached  the  critical  point of  commercial  viability.  Among the largest
current markets  developing or employing  speech  technologies  are embedded and
server-based  applications  in telephony  and call  centers,  automatic  desktop
dictation software,  personal hand-held  communication  devices,  Internet voice
portals and R&D  markets.  Historically,  development  of speech  products in an
emerging   market  has  been  affected  by  declining   margins,   large  memory
requirements,  non-extendable technology,  operating system platform dependence,
lack of integration and non-recurring engineering dependence.  Recently, several
market  trends  have  accelerated  demand  for  speech  applications   including
technology  convergence (more speech products companies and proliferation of the
world  wide  web),  explosive  growth  in  mobile  personal  communications  and
organization devices, and legislative concerns for consumer safety and access to
technology by handicapped or disabled individuals.

           The  Company   has   strategically   sought   markets  for  its  Core
Technologies  with  high  margins,  broad  use,  rapid  development  and  market
emergence/presence.  Fonix  has  also  strategically  avoided  markets  with low
margins which are commodity driven,  subject to continuous price compression and
require  costly  customer  support  systems.  The  Company's  current  marketing
strategy is governed by the following general principles:

1.         Focus on revenues - Pursue  specific  markets  where  revenues can be
           realized in the short term through a market driven  approach and away
           from markets  focusing on continued  R&D.  Also pursue  opportunities
           that  represent   recurring  revenue  streams  rather  than  one-time
           development or engineering fees.
2.         Integration with minimal additional development  engineering - Pursue
           integration into customer products where Fonix technology is directly
           compatible  and can go to market as part of existing or new  products
           with minimal additional development engineering.
3.         Existing  marketing  channels and significant  market share - Partner
           with  customers  who have  existing  marketing  channels in place and
           leverage product sales through those channels. Also, pursue customers
           who enjoy  dominant or significant  market share in their  respective
           markets and who display the financial  ability and marketing power to
           rapidly bring products to market.
4.         Second tier customer support - Position Fonix generally as a provider
           of second tier  customer  support,  providing  training and tools for
           Fonix customers who operate  excellent front line support systems for
           their end-user customers.

           Because  the  Company  is  pursuing  integration  into  mass  market,
industrial,  general  business and personal  electronics  products and computing
solutions, lead time to revenue recognition is longer than for retail, commodity
driven  software  products.  The  Company's  products sold and  integrated  into
customer applications are subject to both


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customer production schedules and customer success in marketing the products and
generating  product sales. The Company's revenues are thus subject to delays and
possible cancellation resulting from customer integration delays.

Embedded Markets
           Increasingly  efficient and powerful computing solutions have rapidly
developed new markets by creating smaller, more convenient devices equipped with
personalized   functions.   These  devices   include  PDAs   (personal   digital
assistants),  cellular phones, web pads, wireless  communications  devices,  and
other consumer  electronics.  A significant  deterrent to full  functionality of
these powerful,  yet small computing  devices is the current need for a keyboard
and/or  a  mouse  to  interface  with  the  device.  Recent  integration  of HWR
technology  has helped to increase  the demand for natural,  intuitive  HCI with
these  devices  and has  prepared  markets  to pay for  speech  recognition  and
synthetic speech in computing solutions.  Other product development  initiatives
that may drive additional  interest in HCI include  electronic  books,  wearable
computers,  testing of smart  appliances  and toys  (VCRs,  answering  machines,
wireless   phones,   and  climate  control  systems)  and  command  and  control
applications  (automotive,  hands  free  cellular  phones  and  voice  activated
navigation systems).

           Historically,  micro processors for mobile computing  devices did not
contain  enough  memory or  computing  power  (MIPS) to operate most ASR and TTS
applications.  Adding the hardware necessary to boost memory and computing power
increased the price of such devices to unacceptable levels.  However,  Fonix ASR
and TTS technologies  have memory and power  requirements  that fall well within
tolerances needed to speech enable applications using existing 16 bit and 32 bit
processors.  To  capitalize  on this distinct  competitive  advantage,  Fonix is
pursuing sales and partnership  relationships  with companies  offering embedded
products  for  mass  consumer  markets,  industrial  applications  and  business
computing solutions. Currently, Fonix has ported its HCI technologies to several
RISC  processors  including  ARM,  Epson EOC  33A104 and 204,  and the  Infineon
TriCore,  and  to  Microsoft  Windows  CE  hardware  platforms  including  Intel
StrongARM, Hitachi SH3 and SH4, and MIPs core.

           The Company has  addressed  these market  opportunities  by releasing
FAAST 1.0 for Embedded.  FAAST for Embedded provides application developers with
a tool  enabling  rapid  development  of ASR and TTS  applications  that  can be
quickly and efficiently ported into their product.

           Fonix has identified key embedded  market  segments which it believes
will provide long term, sustainable revenue and earnings flow as follows:

1.         Chip  Manufacturers.  Digital  signal  processor  ("DSP")  and  micro
           processor  manufacturers  are currently  highly focused on technology
           innovations  which  will  support  and drive  sales of chips  through
           third-party vendors. Fonix ASR and TTS technologies have demonstrated
           ability to operate in these environments.
2.         Design Developers.  Firms designing  reference platforms and products
           and  developing   functions  operating  on  those  platforms  through
           contracts with major mass market product  suppliers  provide a strong
           market  opportunity  for Fonix  because  they are  channels  to major
           consumer electronics marketers.
3.         Software   Developers.   Software   developers  in  multiple  markets
           increasingly  enable  their  software  products  with one or more HCI
           technologies,  resulting in  leveraged  product  sales and  potential
           royalty revenue for Fonix.
4.         Third-Party Product Developers.  Many companies are currently seeking
           HCI  technologies  to integrate  into a host of consumer  electronics
           devices,  commercial  applications  and business  solutions.  Primary
           markets  for  these  applications  are  in  automotive  and  aviation
           telematics,  industrial  wearable  computers,  mobile  communications
           devices and PDAs.

Server-Based Markets
           Telephony/call  center  solutions and shrink-wrap  desktop  dictation
software  sales are two of the most  advanced  emerging  markets  for  automated
speech.  Current industry revenue estimates  indicate that customized  automated
call centers, virtual operators,  packaged call center software, custom vertical
market  dictation  systems  and  general  desktop  dictation  systems  have  led
server-based  speech  applications  into the market.  Additionally,  new product
areas for automated  speech include network  systems,  telephone  company e-mail
reader services,  software document readers,  Internet navigation and screenless
Internet access, web site text readers and mobile computing solutions.


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           The Company has  addressed  these market  opportunities  by releasing
FAAST 1.0 for Servers.  FAAST for Servers provides application developers with a
tool enabling rapid  development of ASR and TTS applications that can be quickly
and efficiently ported into their product.

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

1.         Internet Voice Portals. Speech enabled access to the Internet and web
           site navigation is a rapidly  emerging need.  Fonix is developing and
           will soon implement  products for voice portals to the Internet which
           may be purchased for use by portal  companies,  web sites and content
           providers, Internet service providers and browsers.
2.         TTS for Reading Web Sites. Since over 70% of all web content is text,
           demand for  products  allowing  web content to be read to the user is
           rapidly  growing.  Fonix has developed a web page reader which can be
           added to web sites.  This   voice  solution  is  targeted  toward the
           largest  web  content  providers  worldwide  in  media,   government,
           business and other industries.
3.         Network Systems Command and Control and E-mail Reader. Fonix provides
           both ASR and TTS  which can be  seamlessly  integrated  into  network
           software to speech-enable software applications.

Fonix Product Development and Delivery Focus

           To  accelerate  the  delivery  of  Fonix   technologies,   Fonix  has
transitioned  from an R&D-oriented  organization  into a product delivery matrix
organization.  Company focus and  organization  consists of product teams led by
product managers who are  marketing-oriented  and charged with direct profit and
loss  responsibilities.  These  responsibilities begin with market research, and
product  definition and  specification and end with delivery of quality products
which  address  needs  identified  by the  marketplace,  on schedule  and within
budget.

           Fonix  has  organized  its  product   development  efforts  into  the
following product management teams to facilitate delivery of its products to the
embedded and server markets described above:

1.         FAAST 1.0 for  Embedded  Markets  includes  a  Graphical  Development
           Environment  that will allow  customers to create and optimize speech
           applications  and  generate  the code that will run  directly  on the
           target  embedded  platform.   Fonix  is  initially   delivering  this
           technology on the Intel StrongArm(R), MIPs Core, Epson EOC 33A104 and
           208,  Hitachi SH3 and SH4, and Infineon  TriCore with  standalone and
           Microsoft Windows CE versions.
2.         FAAST 1.0 for Server Markets is an SDK targeted to tightly  integrate
           Fonix ASR and TTS  technologies  on large platforms that will service
           hundreds of concurrent users.  This technology is primarily  targeted
           to applications that provide voice in and out for the Internet.
3.         TTS  Solutions   focus  on  both  small  and   unlimited   vocabulary
           applications  using  Fonix  AV1700 and AV2001 for the  telephony  TTS
           market.
4.         Embedded   Command  and  Control   Solutions   work   directly   with
           manufacturers  of products to integrate HCI into PDA's,  cell phones,
           automobile command and control and other applications.
5.         Internet Voice Portal Solutions  utilize the FAAST for Server product
           to provide the  technology to  voice-enable  the Internet for devices
           which may not have a screen or keyboard,  such as PDA's, cell phones,
           or  automotive  applications.  A prime  market  for this  product  is
           providing Internet access to the handicapped.
6.         Integrated  Pen/Voice Solution provide simultaneous HWR and ASR input
           for hand-held, mobile computing devices.

Employees

           As of April 10, 2000, the Company employed 89 people.  Of this total,
46 were employed in product development and delivery,  15 were employed in sales
and marketing and 28 were employed in strategic development,  administration and
support.




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                               RECENT DEVELOPMENTS

Changes in the Company's Board of Directors and Executive Officers

           Stephen M. Studdert resigned as the Company's chief executive officer
on January 26, 1999, as chairman of the board of directors on April 10, 1999 and
as a director on July 31, 1999.  In  connection  with his  resignation  as chief
executive  officer,  the Company  entered into a separation  agreement  with Mr.
Studdert pursuant to which Mr. Studdert released the Company from all claims and
obligations  under his employment  agreement,  and the Company agreed to pay Mr.
Studdert $250,000 in 1999, $250,000 in 2000 and $100,000 in 2001.

           Joseph Verner Reed, Reginald K. Brack and Rick D. Nydegger resigned
from the board of directors effective September 3, 1999.

           William A. Maasberg Jr. became a member of Fonix's board of directors
on September 3, 1999. From December 1997 through February 1999, Mr. Maasberg was
a Vice President and General Manager of the AMS Division of Eyring  Corporation.
The AMS Division manufactures  multi-media  electronic work instruction software
applications.  He was also a co-founder  and principal in  Information  Enabling
Technologies,  Inc.  ("IET"),  and LIBRA  Corporation  ("LIBRA"),  two companies
focusing  on  software  application  development,  and  served  in  several  key
executive positions with both IET and LIBRA from May 1976 through November 1997.
Mr.  Maasberg  worked for IBM  Corporation  from July 1965  through  May 1976 in
various  capacities.  He received  his BS Degree  from  Stanford  University  in
Electrical  Engineering and his MS in Electrical Engineering from the University
of Southern California. Mr. Maasberg was re-elected to the board of directors at
the Company's 1999 Annual  Meeting of  Stockholders  and became chief  operating
officer for the Company on March 21, 2000.

           Mark S. Tanner was  appointed to Fonix's  board of directors on
November 9, 1999. Mr. Tanner is currently the chief financial officer and senior
vice president of finance and  administration for Mrs. Fields' Original Cookies,
Inc.  Mr.  Tanner  spent nine  years at  PepsiCo,  where he was chief  financial
officer for Pepsi  International's  operations  in Asia,  the Middle  East,  and
Africa. He was vice president of strategic planning for Pepsi North America,  as
well as chief financial officer for Pepsi North America's Pepsi East Operations.
Mr. Tanner also spent ten years with United Technologies  Corporation in various
capacities,  including director of corporate development.  Mr. Tanner holds a BA
in  economics  from  Stanford  University  and an MBA  from  the  University  of
California at Los Angeles.

Sale of HealthCare Solutions Group

           On September 1, 1999,  Fonix completed the sale of the operations and
a significant portion of the assets of its HealthCare Solutions Group to Lernout
& Hauspie Speech Products N.V., an unrelated third party, for up to $28,000,000.
At the  closing  of this  transaction,  $21,500,000,  less  certain  credits  of
$194,018 was paid, and $2,500,000 was deposited into an 18-month  escrow account
in connection with the representations and warranties made by Fonix in the sales
transaction.  The  remaining  $4,000,000  of the sales  price is  payable  as an
earnout contingent on the performance of the HealthCare Solutions Group over the
next two years.  Through December 31, 1999,  $500,000 had been released from the
escrow. The Company will not record the contingent  earnout, if any, until it is
earned.  The sale was  approved  by a  majority  of  Fonix's  stockholders.  The
proceeds from the sale were used to reduce certain of the Company's  liabilities
and to  provide  working  capital  to allow  Fonix to  focus  on  marketing  and
development opportunities.

1999 Annual Meeting of Stockholders

           Fonix held its 1999  Annual  Meeting of  Stockholders  on October 29,
1999, at which  59,497,418  shares were  represented in person or by proxy.  The
stockholders  approved amendments to the Company's  Certificate of Incorporation
that (1) created a new class of common  stock  designated  as Class B Non-Voting
Common Stock (the "Class B Shares") with  1,985,000  Class B shares  authorized;
and (2) redesignated the Company's  then-current  common stock as Class A Common
Stock and changed each share of then-outstanding


                                  Page 8 of 47

<PAGE>



common  stock  into  a  share  of  Class  A  Common  Stock.  Additionally,   the
stockholders approved an amendment to the Company's Certificate of Incorporation
that  increased  the number of  authorized  common  shares from  100,000,000  to
300,000,000  and  increased  the  number of  authorized  preferred  shares  from
20,000,000 to 50,000,000.  The Class B shares were authorized to provide for the
conversion of 1,985,000  common shares issued in connection with the acquisition
of Articulate  Systems,  Inc.  ("Articulate")  to a non-voting class of stock as
provided in the Articulate acquisition agreement. The Company does not intend to
register  its  Class B  shares.  The  stockholders  also  approved  a series  of
transactions in which the Company issued its Series D preferred stock and Series
E preferred stock. Finally, the stockholders elected Thomas A. Murdock, Roger D.
Dudley,  John A.  Oberteuffer,  and William A.  Maasberg Jr. to Fonix's board of
directors,  and approved the board's selection of Arthur Andersen LLP as Fonix's
independent public accountants for the year ended December 31, 1999.

Delisting of the Company's Class A common stock from the Nasdaq SmallCap Market

           On June 29, 1999, the Company received a letter from Nasdaq notifying
the Company  that unless the minimum bid price for the  Company's  common  stock
returned to $1.00 per share or more for at least ten  consecutive  trading  days
before September 29, 1999, the Company's common stock would be delisted from the
Nasdaq  SmallCap  Market on October 1, 1999.  In  September  1999,  the  Company
appealed the Nasdaq decision to delist the Company's common stock. Nasdaq held a
hearing on the Company's  appeal on October 28, 1999.  On December 3, 1999,  the
Company  received  notice  that its  stock  had been  delisted  from the  Nasdaq
SmallCap Market as of December 3, 1999. The Company's  common stock is currently
trading on the OTC Bulletin Board. See "Risk Factors - Delisting from the Nasdaq
SmallCap  Market could have an adverse  effect on the liquidity of the Company's
Class A common  stock and has  triggered  certain  rights of the  holders of the
Company's Debentures and Repurchase Rights."

Financing Activities

           Series D and Series E Preferred Stock During 1999,  626,611 shares of
Series D  preferred  stock  and  135,072  shares of  Series E  preferred  stock,
together with related  dividends on each, were converted into 47,252,275  shares
and 5,729,156  shares,  respectively,  of Class A common stock.  After the above
conversions,  381,723 shares of Series D preferred stock and no shares of Series
E preferred  stock remained  outstanding as of December 31, 1999.  Subsequent to
December  31,  1999,  a total of  217,223  shares of Series D  preferred  stock,
together with related dividends,  were converted into 15,436,378 shares of Class
A common stock. As of April 10, 2000, 164,500 shares of Series D preferred stock
remain  outstanding.  In connection  with the sales of the Series D and Series E
preferred stock, the Company agreed to register the sale of shares received on a
conversion of the Series D and Series E preferred stock. If the number of shares
of the Company's  Class A common stock  currently  issuable upon a  hypothetical
conversion of the remaining  Series D preferred  stock exceeds those  authorized
for issuance,  the Company would be required to file an additional  registration
statement to cover the remaining shares.

           December 1998 Private Placement of Common Stock In connection with  a
private offering of Class A common stock completed in December 1998 (the "Equity
Offering"),  the purchaser of 1,801,802  Class A common shares received an equal
number of  Repricing  Rights as well as warrants to purchase  200,000  shares of
Class A common  stock at an exercise  price of $1.665 per share.  The  Repricing
Rights  provide for the  issuance  of shares of Class A common  stock based upon
agreed upon rates that vary depending  upon the market price of the stock.  Also
included were certain Repurchase Rights that may, upon the occurrence of certain
events, require the Company to repurchase all or a portion of the holder's Class
A  common  shares  or  Repricing  Rights  received  in the  Equity  Offering.  A
registration  statement  covering the shares  underlying the Equity Offering was
declared  effective February 11, 2000.  Subsequently,  the Repricing Rights were
exercised, resulting in the issuance of 4,568,569 shares of Class A common stock
on February  14, 2000.  The Equity  Offering  shares and the shares  issued upon
exercise of the Repricing Rights were sold, thereby  extinguishing the Company's
obligation to repurchase the shares or the Repricing Rights.

           Series C  Convertible  Debentures  On January 29,  1999,  the Company
entered into a Securities  Purchase  Agreement with four  investors  pursuant to
which the Company  agreed to issue its Series C  convertible  debentures  in the
aggregate  principal amount of $4,000,000.  The outstanding  principal amount of
the debentures is convertible at


                                  Page 9 of 47

<PAGE>



any time at the option of the holder  into  shares of Class A common  stock at a
conversion  price equal to the lesser of $1.25 or the average of the closing bid
price of Class A common stock for the five trading  days  immediately  preceding
the conversion date multiplied by 80%,  subject to adjustment.  The Company also
issued  warrants  to  purchase  400,000  shares  of Class A  common  stock at an
exercise  price of $1.25  per  share in  connection  with  this  financing.  The
warrants have an exercise  period of three years.  On March 3, 1999, the Company
executed a Supplemental  Agreement  pursuant to which the Company agreed to sell
another  $2,500,000  principal  amount of the  debentures  on the same terms and
conditions as the January 29, 1999 agreement, except no additional warrants were
issued.  Interest  on the  Debentures  is  payable  quarterly  in  shares of the
Company's  Class A common stock or cash, at the Company's  option.  (The January
and March 1999 offerings of debentures are collectively referred to as the "Debt
Offering.")

           In connection with the Debt Offering,  two officers and directors and
one former  officer and  director of the Company  (together,  the  "Guarantors")
pledged  6,000,000  shares of the  Company's  Class A common stock  beneficially
owned by them as  collateral  security for the Company's  obligations  under the
debentures.  Subsequent to the March 1999 funding, the holders of the debentures
notified  the Company and the  Guarantors  that the  Guarantors  were in default
under the terms of the pledge and that the holders  intended  to exercise  their
rights to sell some or all of the pledged shares.  The holders of the debentures
subsequently  informed the Company and the Guarantors that the 6,000,000 pledged
shares were sold,  and that  proceeds  from the sale of the pledged  shares were
used to pay  penalties  attributable  to default  provisions of the stock pledge
agreement and to reduce the principal  balance of the debentures.  The aggregate
proceeds  from the sale of the pledged  shares was  $3,278,893.  Of this amount,
$406,250 was allocated to penalties  attributable  to default  provisions of the
stock pledge  agreement and recorded as interest expense and $343,750 related to
penalty  provisions of the Series D preferred  stock (held by a related group of
investors) and recorded as preferred stock dividends. Both of these amounts were
recorded by the Company during 1999.  The remaining  $2,528,893 was applied as a
reduction of the principal  balance of the  Debentures as of September 30, 1999.
As of April 10, 2000,  the  remaining  principal  balance of the  debentures  of
$3,971,107  plus interest had been converted into  10,385,364  shares of Class A
common stock.

           Series F  Convertible  Preferred  Stock  Effective  February 1, 2000,
Fonix entered into an agreement  with four  investors  whereby Fonix sold to the
investors a total of 290,000 shares of its Series F convertible preferred stock,
in return for cash of $2,750,000.  The Series F preferred  stock was convertible
into shares of Fonix's  Class A common stock during the first 90 days  following
the closing of the transaction at a price of $0.75 per share,  and thereafter at
a price  equal to 85% of the average of the three  lowest  closing bid prices in
the 20-day  trading  period  prior to the  conversion  of the Series F preferred
stock. A registration statement describing the Class A common stock to be issued
upon conversion of the Series F preferred stock was declared  effective February
11, 2000.

           Through  April 10,  2000,  all  290,000  shares of Series F preferred
stock together with related  dividends  were converted into 7,764,948  shares of
Class A common stock and the Company recorded a beneficial conversion feature in
the amount of $2,750,000 at the date of issuance.

           Registration  on Form  S-2 In  compliance  with  registration  rights
granted in  connection  with the Equity  Offering,  Debt  Offering  and Series F
Preferred Stock transactions described above, Fonix registered 56,864,399 shares
of its Class A common stock. The registration statement filed on Form S-2 became
effective February 11, 2000.

           Series G Convertible  Preferred Stock Fonix has recently entered into
an agreement with  investors  whereby Fonix intends to sell up to 250,000 shares
of its Series G 5% convertible  preferred  stock, in return for cash payments of
up to $5,000,000.  Although the terms of the sale have not been finalized, it is
anticipated that the Series G preferred stock will be convertible into shares of
Fonix's  Class A common  stock at a price of $1.50 per share during the first 90
days following the closing of the  transaction,  and thereafter at a price equal
to 85% of the average of the three lowest  closing bid prices in the  twenty-day
trading  period prior to the  conversion  of the Series G preferred  stock.  The
purchasers  of the Series G preferred  stock will  receive  registration  rights
which will require Fonix to file a registration  statement  covering the Class A
common stock underlying the Series G preferred  stock.  Fonix will also have the
option of redeeming  outstanding  Series G preferred  stock.  Through  April 10,
2000,  Fonix received  approximately  $1,250,000 as advances in connection  with
this financing,


                                  Page 10 of 47

<PAGE>



although the  securities  purchase  agreement has not been signed.  Accordingly,
final terms may differ from those described above.

Addition of Shares to 1998 Stock Option and Incentive Plan

           At a meeting of the board of directors on January 31, 2000, the board
voted to increase  the number of shares of Class A common  stock  subject to the
1998 Stock Option and Incentive Plan (the "Plan") by 10,000,000 shares. The Plan
was adopted on June 1, 1998, and approved by the  shareholders of the Company on
July 14, 1998. As initially  approved by the  shareholders,  the Plan  contained
10,000,000 shares.  Prior to increasing the number of shares available under the
Plan on January 31,  2000,  a total of  7,708,782  options  had been  granted to
employees, directors, and other eligible participants. The additional 10,000,000
shares were registered on Form S-8 effective February 15, 2000.

Grants of Stock Options

           During 1999,  Fonix granted options to purchase  1,294,000  shares of
Class A common stock as follows:

<TABLE>
<CAPTION>

Grantee                 Number of Shares            Exercise Price
--------                ----------------            --------------
<S>                               <C>                      <C>
Directors                         400,000                  $0.406
Employee                          100,000                  $3.250
Employee                           25,000                  $1.531
Employees                          25,000                  $1.630
Employees                         673,000                  $1.531
Employees                           5,000                  $1.781
Employees                          50,000                  $1.281
Employees                           1,500                  $0.594
Employees                           5,000                  $1.375
Unrelated consultants               9,500                  $1.531
</TABLE>

           The term of all of these stock  options is ten years from the date of
grant. During 1999,  2,815,882 options expired without exercise.  As of December
31, 1999, the Company had a total of 14,355,900  options  outstanding,  of which
13,484,237 were exercisable on or before December 31, 1999.

The Synergetics Transaction

           Prior  to  March  1997,   the  Company's   scientific   research  and
development activities were conducted solely by a third party, Synergetics, Inc.
("Synergetics"),  pursuant  to  product  development  and  assignment  contracts
(collectively, the "Synergetics Agreement"). Under that arrangement, Synergetics
provided  personnel  and  facilities,  and the Company  financed the Synergetics
research and development  activities on an as-required basis and the Company was
obligated to pay to Synergetics a royalty of 10% (the "Royalty") of net revenues
from sales of products incorporating  Synergetics' "VoiceBox" technology as well
as technology  derivatives thereof.  Synergetics  compensated its developers and
others  contributing to the development  effort,  in part, by granting  "Project
Shares" to share in a portion of the Royalty  received by Synergetics.  On April
6,  1998,  the  Company  and  Synergetics  entered  into a Royalty  Modification
Agreement  whereby  the  Company  agreed  to offer  an  aggregate  of  4,800,000
non-transferable  common stock  purchase  warrants to the holders of the Project
Shares in  consideration  for which  Synergetics  agreed to cancel  any  further
obligation on the part of the Company to pay the Royalty.  The exercise price of
the warrants was to be $10 per share and the warrants  would not be  exercisable
until the first to occur of (1) the date that the per share closing bid price of
the Class A common  stock was equal to or  greater  than  $37.50 per share for a
period of 15 consecutive trading days, or (2) September 30, 2000.

           Effective March 31, 2000, the Company and Synergetics entered into a
Restated  Royalty  Modification  Agreement  whereby  the  Company  agreed to pay
Synergetics $28,000 (the "Cancellation  Amount") to cancel the obligation of the
Company to pay the  Royalty.  The  Company has paid the  Cancellation  Amount to
Synergetics  and teh  Royalty  has been  canceled.  The  Company  has no further
obligations to  Synergetics,  including the prior  obligation to issue 4,800,000
warrants.

Termination of Financing Relationship

           For several years, the Company  maintained a relationship with a bank
pursuant to which the Company borrowed against its own funds on deposit with the
bank. Borrowings under this arrangement accrued interest at a


                                  Page 11 of 47

<PAGE>



rate approximately 1% greater than the rate of interest earned by the Company on
its funds on deposit with the bank.  In order to reduce  interest  expenses,  on
January  8, 1999,  the  Company  applied  its  deposit  account in the amount of
$20,024,109  against the unpaid loan  balance of  $20,046,776,  resulting  in an
unpaid  loan  balance of  $22,667,  which  amount  subsequently  was paid by the
Company.




                        CERTAIN SIGNIFICANT RISK FACTORS

The short- and  long-term  success of the  Company is subject to certain  risks,
many of which are  substantial in nature and outside the control of the Company.
You should consider  carefully the following risk factors,  in addition to other
information  contained herein. All forward-looking  statements  contained herein
are deemed by the  Company to be covered by and to qualify  for the safe  harbor
protection provided by the Private Securities Litigation Reform Act of 1995 (the
"1995 Act").  You should  understand  that several  factors  govern  whether any
forward-looking  statement contained herein will or can be achieved.  Any one of
those  factors  could  cause  actual  results  to differ  materially  from those
projected herein. These forward-looking  statements include plans and objectives
of  management  for  future  operations,  including  the  strategies,  plans and
objectives  relating to the products and the future economic  performance of the
Company  and its  subsidiaries  discussed  above.  In light  of the  significant
uncertainties  inherent in the  forward-looking  statements included herein, the
inclusion of any such statement  should not be regarded as a  representation  by
the Company or any other person that the objectives or plans of the Company will
be achieved.

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

           Since its inception, Fonix has sustained losses. Such losses continue
due to acquisitions  made in 1998,  ongoing  operating  expenses,  and a lack of
revenues  sufficient to offset  operating  expenses.  Fonix had negative working
capital of  $4,804,796  at December 31, 1999.  Fonix has raised  capital to fund
ongoing  operations by private sales of its securities,  some of which have been
highly dilutive and involve considerable expense. Furthermore, in recent months,
the  financial  condition  of the Company has  required the Company to negotiate
with its  creditors  to reduce  the  amount or  extend  the due date of  certain
obligations.  In its present  circumstances,  there is  substantial  doubt about
Fonix's ability to continue as a going concern absent  immediate and significant
sales of its  existing  products,  substantial  revenues  from new  licensing or
co-development  contracts or a relatively  large sale of its  securities  in the
near term.

           Fonix incurred net losses of $21,662,419, $43,118,782 and $22,453,948
for the years  ended  December  31,  1999,  1998 and 1997,  respectively.  As of
December 31, 1999, Fonix had an accumulated deficit of $116,706,803 For the year
ended  December 31, 1999,  Fonix  recorded  revenues of $439,507.  For the years
ended  December 31, 1999 and 1998,  Fonix  recorded  combined  revenues from the
operations of the TTS and HWR businesses in the amount of $439,507 and $236,586,
respectively.  Other than these revenues, Fonix's only revenues to date resulted
from  non-refundable  license  fees  totaling  $2,368,138  paid  in  1998  by an
international  microchip  manufacturer  for the use of certain  technologies  in
integrated circuits suitable for telecommunications  applications, and for which
Fonix has no further obligation whatsoever.

           Fonix expects continuing losses from operations until such time as:

           o         current and  additional  co-development  arrangements  with
                     third parties produce revenues sufficient to offset Fonix's
                     ongoing operating expenses; and/or

           o         revenues  from  the  licensing  of  Core  Technologies  and
                     products  increase to levels  sufficient to exceed  Fonix's
                     operating expenses.



                                 Page 12 of 47

<PAGE>



           Until that time,  the Company must rely on funds raised  through debt
and equity placements.

Continuing debt obligations  could impair Fonix's ability to continue as a going
concern.

           As of April 10, 2000, Fonix owed trade payables in the aggregate
amount  of  approximately  $789,774,  of which  $755,454  are more  than 90 days
overdue. At present,  Fonix's revenues from existing licensing  arrangements and
products are not sufficient to offset Fonix's ongoing  operating  expenses or to
pay  Fonix's  current  debt as  described  above.  There  is  substantial  risk,
therefore, that the existence and extent of the debt obligations described above
could adversely affect Fonix, its operations and financial condition.

If Fonix does not receive  additional  capital when and in the amounts needed in
the near future,  its ability to continue as a going  concern is in  substantial
doubt.

           Fonix anticipates incurring substantial sales and marketing,  product
development and research and general operating  expenses in the future that will
require  substantial  amounts of additional  capital on an ongoing basis.  These
capital  needs  are in  addition  to the  amounts  required  to  repay  the debt
discussed  above.  Fonix will most likely have to obtain such capital from sales
of  its  equity,  convertible  equity  and  debt  securities.  Obtaining  future
financing may be costly and will likely be dilutive to existing stockholders. If
Fonix is not able to obtain  financing  when and in the amounts  needed,  and on
terms that are acceptable to it,  Fonix's  operations,  financial  condition and
prospects could be materially and adversely affected,  and Fonix could be forced
to curtail its operations or sell part or all of its assets,  including its Core
Technologies.

Holders of Fonix  Class A common  stock are  subject  to the risk of  additional
dilution to their  interests as a result of the  conversion of presently  issued
preferred stock.

           Introduction



                                  Page 13 of 47

<PAGE>



           Fonix currently has two series of preferred stock outstanding: Series
A and  Series  D.  All of  Fonix's  presently  outstanding  preferred  stock  is
convertible  into shares of Fonix Class A common  stock.  The Series A preferred
stock was issued in October 1995 and is  convertible,  one-for-one  into 166,667
shares  of Class A common  stock  at the  option  of the  holder.  The  Series D
preferred  stock is  convertible  into Class A common stock  according to one of
three  separate  conversion  formulas,  one of which is based,  in part,  on the
market  price of Fonix  Class A common  stock  during the  several  week  period
leading up to the  conversion  date.  Fonix  previously  had two other series of
preferred stock  outstanding,  Series E and Series F preferred stock, with terms
similar  to those of the  Series D, but all  shares of the Series E and Series F
preferred stock have been converted into shares of Class A common stock.

           At April 10, 200, the remaining 164,500 shares of Series D preferred
stock would convert into 2,333,333 shares of Class A common stock,  representing
1.40% of all shares of Class A common  stock  then  outstanding.  However,  this
calculation  excludes  the issuance of shares of Class A common stock as payment
of dividends  accrued on the Series D preferred stock at the date of conversion,
as well as shares of Class A common stock issued upon conversion of the Series D
preferred stock prior to April 10, 2000.

           The following  table describes the number of shares of Class A common
stock that would be issuable as of April 10, 2000,  assuming all 164,500  shares
of the Series D preferred  stock presently  issued and  outstanding  shares were
converted,  and further  assuming  that the  applicable  conversion  or exercise
prices at the time of such  conversion or exercise  were the following  amounts.
The table  excludes the effect of the issuance of shares of Class A common stock
upon  payment of  accrued  dividends  and also  excludes  differences  among the
various methods of calculating the applicable conversion or exercise price.




                 ------------------      ------------------------
                                          Shares of Class A
                                             Common Stock
                                            Issuable Upon
                 Hypothetical              Conversion or
                 Conversion/              Exercise of Series
                 Exercise Price            D Preferred Stock
                 ------------------      ------------------------
                       $0.25                       13,160,000
                       $0.75                        4,386,667
                       $1.50                        2,193,333
                       $2.25                        1,462,222
                       $3.00                        1,096,667


Given the  structure  of the  conversion  formulas  applicable  to the  Series D
preferred stock, there effectively


                                  Page 14 of 47

<PAGE>



is no limitation on the number of shares of Class A common stock into which such
convertible securities may be converted or exercised. As the market price of the
Class A common  stock  decreases,  the number of shares of Class A common  stock
underlying  the Series D preferred  stock  continues to increase.

           Overall Dilution to Market Price and Relative Voting Power of
           Previously  Issued Common Stock

           The  conversion  of the  Series  D  preferred  stock  may  result  in
substantial  dilution to the equity interests of other holders of Class A common
stock. Specifically,  the issuance of a significant amount of additional Class A
common stock would result in a decrease of the relative  voting control of Class
A common stock issued and  outstanding  prior to the  conversion of the Series D
preferred stock.  Furthermore,  public resales of Class A common stock following
the  conversion  of the  Series D  preferred  stock  likely  would  depress  the
prevailing  market  price  of Class A common  stock.  Even  prior to the time of
actual  conversions,   exercises  and  public  resales,  the  market  "overhang"
resulting  from  the  mere  existence  of  Fonix's   obligation  to  honor  such
conversions or exercises could depress the market price of Class A common stock.

           Increased Dilution With Decreases in Market Price of Class A Common
           Stock

           The outstanding shares of Series D preferred stock are convertible at
a floating  price that may and likely will be below the market  price of Class A
common stock prevailing at the time of conversion or exercise.  As a result, the
lower the market price of Class A common stock at and around the time the holder
converts  or  exercises,  the  more  Class A common  stock  the  holder  of such
convertible securities receives. Any increase in the number of shares of Class A
common stock issued upon  conversion or exercise as a result of decreases in the
prevailing  market price would  compound the risks of dilution  described in the
preceding paragraph of this risk factor.

           Increased Potential for Short Sales

           Downward  pressure on the market  price of Fonix Class A common stock
that likely  would  result from sales of Fonix  Class A common  stock  issued on
conversion of the Series D preferred  stock could encourage short sales of Class
A common  stock  by the  holders  of the  Series D  preferred  stock or  others.
Material amounts of such short selling could place further downward  pressure on
the market price of Fonix Class A common stock.

           Limited Effect of Restrictions on Extent of Conversions

           The  holders  of the Series D  preferred  stock are  prohibited  from
converting  their preferred stock into more than 4.999% of the then  outstanding
Fonix Class A common stock.  This  restriction,  however,  does not prevent such
holders from either  waiving such  limitation or  converting  or exercising  and
selling some of their convertible security position and thereafter converting or
exercising the rest or another  significant  portion of their  holding.  In this
way,  individual holders of Series D preferred stock could sell more than 4.999%
of the outstanding  Fonix Class A common stock in a relatively  short time frame
while never holding more than 4.999% at a time.

           Payment of dividends and interest in shares of Class A common stock
           may result in further dilution

           Under the terms of the Series D preferred  stock, the Company has the
option to pay dividends on the preferred  stock in shares of the Company's Class
A common stock.  Dividends  accrue from the date of the purchase of the Series D
preferred  stock.  As such,  a decision by the Company to pay such  dividends in
shares of Class A common  stock could  result in a  substantial  increase in the
number of shares  issued and  outstanding  and could result in a decrease of the
relative  voting  control of Fonix Class A common stock  issued and  outstanding
prior to such payment of dividends.

If Fonix  has  difficulty  capitalizing  on  acquisitions,  its  operations  and
financial prospects could be adversely affected.


                                 Page 15 of 147

<PAGE>



           In 1998,  Fonix completed the  acquisitions of AcuVoice, Inc.,
("AcuVoice")  Articulate,  and the Papyrus Companies  (collectively  "Papyrus").
Notwithstanding  the sale in 1999 of the HealthCare  Solutions Group (consisting
principally of the assets  acquired from  Articulate),  Fonix's  acquisitions of
AcuVoice and Papyrus present risks including at least the following:

               o    Fonix may have difficulty  financing  ongoing  operations of
                    acquired  businesses to the extent such  businesses  are not
                    generating positive cash flows;

               o    Fonix  may have  difficulty  combining  or  integrating  the
                    technology,  operations,  management  or work  force  of the
                    acquired businesses with Fonix's existing operations;

               o    Fonix may have difficulty retaining the key personnel of the
                    acquired businesses;

               o    Fonix may have  difficulty  maintaining  uniform  standards,
                    controls,   procedures,   and  policies  across  its  entire
                    organization, including the acquired businesses; and

               o    There may be increased  commitment of  management  resources
                    and related expenses resulting from efforts to integrate and
                    manage  acquired  businesses  located  at  a  distance  from
                    Fonix's principal executive offices and research facilities.

Fonix has a limited product  offering and many of its key technologies are still
in the product development stage.

           There presently are only a limited number of  commercially  available
applications or products incorporating the Core Technologies.  Fonix markets its
HCI  technologies  and  products  for  embedded  applications,  and Internet and
telephony  applications.  However,  the  marketing  of  these  technologies  and
products is in its initial start-up phase with no material  funding  commitments
or meaningful sales.  These product  offerings are still relatively  limited and
have not  generated  significant  revenues  to date.  An  additional  element of
Fonix's business strategy is to achieve revenues through  appropriate  strategic
alliances,  co-development  arrangements,  and license  arrangements  with third
parties. In addition to a master  collaboration  agreement with an international
microchip  manufacturer,  the Company has recently  entered into  licensing  and
joint-marketing  agreements with Intel and Microsoft.  These agreements  provide
for  joint  marketing  and  application  development  for  Intel  and  Microsoft
end-users  or  customers.  There can be no  assurance  that these  collaboration
agreements will produce license or other agreements which will generate material
revenues for Fonix.

The market for many of Fonix's  technologies  is largely  unproven and may never
develop  sufficiently  to  allow  Fonix  to  capitalize  on its  technology  and
products.

           The market for HCI technologies,  including ASR technologies, TTS and
HWR, is relatively new. Additionally,  Fonix's technologies are new and, in many
instances,  represent a significant  departure from  technologies  which already
have  found a  degree  of  acceptance  in the  HCI  marketplace.  The  financial
performance of Fonix will depend,  in part, on the future  development,  growth,
and ultimate size of the market for HCI applications and products generally, and
applications and products  incorporating  Fonix's technologies and applications.
The applications and products which  incorporate  Fonix's  technologies  will be
competing with more  conventional  means of information  processing such as data
entry,  access by keyboard or touch-tone  telephone,  or professional  dictation
services.  Fonix  believes  that  there is a  substantial  potential  market for
applications  and products  incorporating  advanced HCI  technologies  including
speech recognition, speech synthesis, speech compression, speaker identification
and  verification,  handwriting  recognition,  pen and touch screen  input,  and
natural  language  understanding.   Nevertheless,  such  a  market  for  Fonix's
technologies  or for  products  incorporating  Fonix's  technologies  may  never
develop to the point that profitable operations can be achieved or sustained.


Competition  from other industry  participants  and rapid  technological  change
could impede Fonix's ability to achieve profitable operations.


                                 Page 16 of 147

<PAGE>



           The  computer  hardware  and  software   industries  are  highly  and
intensely competitive. In particular, the HCI market sector and specifically the
ASR,  computer voice and  communications  industries are  characterized by rapid
technological  change.  Competition  in the  HCI  market  is  based  largely  on
marketing ability and resources,  distribution channels,  technology and product
superiority and product  service and support.  The development of new technology
or material  improvements to existing  technologies  by Fonix's  competitors may
render Fonix's technologies less attractive or even obsolete.  Accordingly,  the
success  of Fonix  will  depend  upon its  ability to  continually  enhance  its
technologies  and interactive  solutions and products to keep pace with or ahead
of  technological  developments  and  to  address  the  changing  needs  of  the
marketplace.  Some of Fonix's competitors have greater experience in developing,
manufacturing  and marketing HCI  technologies,  applications and products,  and
some have far greater financial and other resources than Fonix, or its potential
licensees   and   co-developers,    as   well   as   broader   name-recognition,
more-established  technology  reputations,  and mature distribution channels for
their products and technologies.  Barriers to entry in the software industry are
low,  and as the market for various HCI  products  expands  and  matures,  Fonix
expects more entrants into this already competitive arena.

Fonix's independent public accountants have included a "going concern" paragraph
in their reports for the years ended December 31, 1999, 1998 and 1997.

           The independent  public  accountants'  reports for Fonix's  financial
statements  for the years ended  December  31, 1999,  1998,  and 1997 include an
explanatory  paragraph  regarding  substantial  doubt about  Fonix's  ability to
continue as a going  concern.  This may have an adverse  effect on the Company's
ability to obtain financing.

Delisting  from the Nasdaq  SmallCap  Market could have an adverse effect on the
liquidity of the Company's Class A common stock.

           Until  recently,  the  Company's  Class A common  stock traded on the
Nasdaq SmallCap  market.  On December 3, 1999, the Company  received notice that
its Class A common stock had been delisted from the Nasdaq SmallCap Market.  The
Company's Class A common stock is currently trading on the OTC Bulletin Board.

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


Fonix's  operations  and  financial  condition  could be  adversely  affected by
Fonix's failure or inability to protect its intellectual  property or if Fonix's
technologies are found to infringe the intellectual property of a third party.

           Dependence on proprietary technology

           Fonix's success is heavily dependent upon its proprietary technology.
On June 17, 1997,  the United  States  Patent and  Trademark  Office issued U.S.
Patent No. 5,640,490 entitled "A User Independent,  Real-time Speech Recognition
System and  Method"  (the  "'490  Patent").  The 490  patent has a 20-year  life
running from the November 4, 1994 filing date,  and has been  assigned to Fonix.
This patent covers  certain  elements of the Fonix ASR  technologies.  Fonix has
acquired two other patents and has filed 13 additional United States and foreign
patent applications.  In addition to its patents,  Fonix relies on a combination
of copyright and trademark laws, trade secrets,  confidentiality  procedures and
contractual  provisions  to  protect  its  proprietary  rights.  Such  means  of
protecting  Fonix's  proprietary  rights may not be adequate  because  such laws
provide only limited protection. Despite precautions that Fonix takes, it may be
possible  for  unauthorized  third  parties  to  duplicate  aspects of the Fonix
technologies  or the current or future  products or technologies of its business
units or to obtain  and use  information  that  Fonix  regards  as  proprietary.
Additionally,  Fonix's competitors may independently develop similar or superior
technology.  Policing  unauthorized use of proprietary rights is difficult,  and
some international laws do not protect  proprietary rights to the same extent as
United States laws. Litigation periodically may be necessary to enforce


                                  Page 17 of 47

<PAGE>



Fonix's  intellectual  property  rights,  to  protect  its trade  secrets  or to
determine the validity and scope of the proprietary rights of others.

           Risks of infringement by Fonix upon the technology of unrelated
           parties or entities

           Fonix is not aware and does not believe that any of its  technologies
or products  infringe the  proprietary  rights of third  parties.  Nevertheless,
third  parties  may claim  infringement  with  respect to its  current or future
technologies or products or products  manufactured  by others and  incorporating
Fonix's  technologies.  Fonix  expects  that  participants  in the HCI  industry
increasingly  will be subject to  infringement  claims as the number of products
and  competitors  in the  industry  grows and the  functionality  of products in
different  industry segments overlaps.  Any such claims,  with or without merit,
could be time consuming, result in costly litigation,  cause development delays,
or require  Fonix to enter  into  royalty or  licensing  agreements.  Royalty or
license  agreements  may not be  available on  acceptable  terms or at all. As a
result,  infringement  claims  could have a material  adverse  affect on Fonix's
business, operating results, and financial condition.

Fonix  is  subject  to the  risk  that  certain  key  personnel,  including  key
scientific  employees and  independent  contractors  named below,  on whom Fonix
depends, in part, for its operations, will cease to be involved with Fonix.

           Fonix is dependent on the  knowledge,  skill and expertise of several
key  scientific  employees,  including  John A.  Oberteuffer,  Ph.D.,  Dale Lynn
Shepherd,   R.  Brian  Moncur,  Mark  Hamilton  and  Doug  Jensen;   independent
contractors  including C. Hal Hansen,  Tony R. Martinez,  Ph.D.,  and Kenneth P.
Hite; and executive  officers,  including Thomas A. Murdock and Roger D. Dudley.
The loss of any of the key personnel listed above could materially and adversely
affect  Fonix's future  business  efforts.  Although Fonix has taken  reasonable
steps  to  protect  its  intellectual   property  rights   including   obtaining
non-competition  and  non-disclosure  agreements  from all of its  employees and
independent  contractors,  if one or more of Fonix's key  scientific,  executive
employees or independent contractors resigns from Fonix to join a competitor, to
the extent not prohibited by such person's  non-competition  and  non-disclosure
agreement,  the loss of such personnel and the employment of such personnel by a
competitor  could  have a  material  adverse  effect  on Fonix.  Fonix  does not
presently have any key man life insurance on any of its employees.

Fonix  has  no  dividend  history  and no  intention  to  pay  dividends  in the
foreseeable future.

           Fonix has never paid dividends on or in connection  with any class of
its common stock and does not intend to pay any dividends to common stockholders
for the foreseeable future.

There may be  additional  unknown  risks which  could have a negative  effect on
Fonix.

           The risks and  uncertainties  described  in this  section are not the
only ones facing Fonix.  Additional risks and  uncertainties not presently known
to Fonix or that Fonix currently  deems  immaterial may also impair its business
operations.  If any of the foregoing  risks actually  occur,  Fonix's  business,
financial  condition,  or results of operations  could be  materially  adversely
affected.  In such case,  the trading  price of Fonix Class A common stock could
decline.

ITEM 2.              PROPERTIES

The Company  owns no real  property.  Commencing  in October  1996,  the Company
leased a 25,600 square foot facility in Draper, Utah, from an unaffiliated third
party  at  which  it  conducts  its  principal  scientific   research,   product
development  and sales and marketing  activities.  The  Company's  lease of that
facility is for a term of 8 years,  with a right to terminate  after five years,
at the Company's  option.  Provided that the Company is not in default under the
lease,  the Company has the option to extend the lease for 5  additional  years.
The average  base  monthly  lease  payment over the 8-year life of the lease for
that  facility  is  $28,389.  Beginning  in  May  1999,  the  Company  subleased
approximately 10,240 square feet of this space to an unrelated third party for a
monthly rental of $13,961.



                                  Page 18 of 47

<PAGE>



The sublease  expires December 2000, but may be renewed for up to two additional
three-month periods at the option of the sublessee.

The Company  also leases  approximately  10,000  square feet of office  space in
Cupertino,  California.  The  lease on this  space is for 5 years,  with rent of
$24,412 per month.  Beginning June, 1999, the Company subleased this space to an
unaffiliated  party who  assumed  the terms and  payments  under the lease.  Two
executive  officers of the Company have  personally  guaranteed  payment on this
lease until the assignment is effective.

In addition to the Draper facility, the Company subleases office space at market
rates for its corporate headquarters and administrative  operations in Salt Lake
City, Utah, under subleases from Studdert Companies  Corporation ("SCC"). SCC is
owned and controlled by three  individuals,  two of whom are executive  officers
and  directors  of  the  Company.   [See  "Certain   Relationships  and  Related
Transactions,"  and  "Security   Ownership  of  Certain  Beneficial  Owners  and
Management"].  The two executive  officers and a former executive officer of the
Company have personally guaranteed these leases in favor of SCC's landlord.  The
leases  expire  December  2002 and  February  2003 and  require  monthly  rental
payments of $10,369.

The Company leases approximately 1,377 square feet of office space in Lexington,
Massachusetts,  where it conducts  sales and marketing for its HWR  technologies
and product development for pen/voice products.  This lease expires November 30,
2002 and requires monthly rental payments of $2,754.

The Company  believes that the facilities  described  above are adequate for its
current needs.



ITEM 3.              LEGAL PROCEEDINGS

           On July 28, 1999, Oregon Graduate Institute ("OGI") filed a notice of
default,  demand for  mediation,  and demand for  arbitration  with the American
Arbitration  Association.  In its demand,  OGI asserted  that the Company was in
default under three separate agreements between the Company and OGI in the total
amount of $175,000. On September 23, 1999, the Company responded to OGI's demand
and denied the existence of a default under the three  agreements  identified by
OGI.  Moreover,   the  Company  asserted  a  counterclaim  before  the  American
Arbitration Association against OGI in an amount not less than $250,000. Neither
OGI nor the Company have yet undertaken any discovery.  However,  a hearing date
has been set for August 8, 2000. The Company believes the OGI arbitration  claim
is without merit,  and management  intends to vigorously  press its counterclaim
against OGI.

           In addition to the proceeding commenced by OGI, the Company is
involved in various lawsuits,  claims,  and proceedings  arising in the ordinary
course of business. Management believes the ultimate disposition of such matters
will not materially  affect the  consolidated  financial  position or results of
operations of the Company.


ITEM 4.              SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On October 29, 1999, the Company held its 1999 Annual  Meeting of  Stockholders.
The following matters were submitted to a vote of security holders:

          Election of Thomas A. Murdock,  Roger D. Dudley,  John A  Oberteuffer,
          and  William A.  Maasberg  Jr. to the  Company's  Board of  Directors,
          approved  as follows:

                                   Number of        Number of         Number of
           Name of Director        Shares For     Shares Against      Not Voted
          -----------------        ----------     --------------      ----------
          William A. Maasberg Jr.  47,381,620       7,831,673          4,284,125
          John A. Oberteuffer      47,411,770       7,783,378          4,302,270
          Thomas A. Murdock        47,356,820       8,562,673          3,577,925
          Roger D. Dudley          47,045,370       8,579,348          3,872,700


          Appointment of Arthur Andersen LLP as the Company's independent public
          accountants for the fiscal year ended December 31, 1999, approved by a
          vote of 59,101,639  shares for,  298,317  shares  against,  and 97,462
          shares withheld.

          Amendment to the Company's certificate of incorporation that created a
          new class of common  stock  designated  as Class B  Non-Voting  Common
          Stock (the "Class B Shares") with 1,985,000 Class B Shares authorized;
          approved by a vote of 57,192,593 shares for, 1,015,071 shares against,
          and 1,289,754 shares  withheld.  The Class B shares were authorized to
          provide for the  conversion  of 1,985,000  common shares issued in the
          acquisition  of Articulate to a non-voting  class of stock as provided
          in the acquisition agreement.

          Redesignation  of the Company's  then-current  common stock as Class A
          Common Stock and changed each share of  then-outstanding  common stock
          into a share of Class A Common Stock  approved by a vote of 57,192,593
          shares for, 1,015,071 shares against, and 1,289,754 shares withheld.

          Amendment to the Company's certificate of incorporation that increased
          the  number of Class A common  shares  authorized  to be  issued  from
          100,000,000  to  300,000,000  and  increased  the number of authorized
          preferred shares from 20,000,000 to 50,000,000,  approved by a vote of
          20,086,173  shares for,  12,969,230  shares against,  1,261,492 shares
          abstaining, and 25,180,523 brokler non-votes.

          A series of  transactions  in which the Company issued its Series D 4%
          preferred stock and Series E 4% preferred stock, approved by a vote of
          20,779,723  shares for,  12,397,825  shares against,  1,139,347 shares
          abstaining and 25, 180,523 shares not voted.


                                  Page 19 of 47

<PAGE>




                                     PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

           Fonix Class A common stock is listed on the OTC Bulletin  Board under
the trading  symbol FONX.  The  following  table shows the range of high and low
sales price  information for Class A common stock as quoted on the Nasdaq (until
December 3, 1999) and on the OTC Bulletin Board thereafter for the four quarters
of calendar 1999 and 1998. The quotations reflect inter-dealer  prices,  without
retail  mark-up,   mark-down  or  commissions  and  may  not  represent   actual
transactions.

<TABLE>
<CAPTION>
                            Calendar Year 1999           Calendar Year 1998
                          -----------------------      ----------------------
                          High          Low            High          Low
                          ----          -----          -----         ----
<S>                       <C>           <C>            <C>           <C>
First Quarter             $ 3.31        $ 0.69         $ 6.50        $ 3.50
Second Quarter            $ 0.94        $ 0.25         $ 6.34        $ 3.00
Third Quarter             $ 1.19        $ 0.28         $ 4.00        $ 1.12
Fourth Quarter            $1.00         $ 0.27         $ 2.63        $ 0.94
</TABLE>


           As of April 10, 2000, there were 164,194,614  shares of Fonix Class A
common stock outstanding, held by approximately 564 holders of record and 10,820
beneficial holders.  This number of beneficial holders represents an estimate of
the number of actual holders of the Company's stock, including beneficial owners
of shares held in "nominee" or "street"  name.  The actual  number of beneficial
owners is not known to the Company.

           The Company  has never  declared  any  dividend on its Class A common
stock and it is  expected  that  earnings,  if any,  in future  periods  will be
retained to further the development  and sale of the Company's HCI  technologies
and  products.  No dividends  can be paid on the Class A common stock until such
time as all accrued and unpaid dividends on outstanding preferred stock, if any,
have been paid.

                 Recent Sales of Unregistered Equity Securities

           On January 29, 1999,  the Company sold  debentures  in the  aggregate
principal  amount of $4,000,000 to four  investors.  The  outstanding  principal
amount of the debentures is convertible at any time at the option of the holders
into shares of Class A common stock at a conversion price equal to the lesser of
$1.25 or 80% of the average of the closing bid price of the Class A common stock
for the five trading days immediately preceding the conversion date. The Company
also  issued  warrants  to purchase  400,000  shares of Class A common  stock in
connection with this financing. The warrants are exercisable at a price of $1.25
per share and have a three-year  term. On March 3, 1999, the Company  executed a
Supplemental  Agreement  with the same  four  investors,  pursuant  to which the
Company sold  $2,500,000  principal  amount of  debentures on the same terms and
conditions as the January 29, 1999 agreement, except no additional warrants were
issued. The Company issued all of the debentures without  registration under the
Securities Act of 1933, as amended (the "1933 Act"), in reliance on Section 4(2)
or Regulation D. The  debentures  were issued as restricted  securities  and the
debentures were stamped with a restrictive  legend to prevent any resale without
registration under the 1933 Act or pursuant to an exemption.

           On February 1, 2000, the Company issued 290,000 shares of Series F
preferred stock, par value $20 per share, to five investors for $2,750,000.  The
Company issued such shares without  registration  under the 1933 Act in reliance
on  Section  4(2) of the  1933 Act and the  rules  and  regulations  promulgated
thereunder.  The shares of Series F preferred  stock were  issued as  restricted
securities and the  certificates  representing the Series F preferred stock were
stamped with a  restrictive  legend to prevent any resale  without  registration
under the 1933 Act or pursuant to an exemption.

           The Class A common shares  underlying the debentures and the Series F
preferred  stock  were  subsequently  registered  on Form S-2 that was  declared
effective February 11, 2000.

           On June 2, 1999,  the Company issued 200,000 shares of Class A common
stock to an unrelated individual


                                  Page 20 of 47

<PAGE>



in payment for  consulting  services  rendered.  The Company  issued such shares
without  registration  under  the  1933  Act in  reliance  on  Section  4(2)  or
Regulation  D. Such  shares of Class A common  stock were  issued as  restricted
securities,  and the certificates  representing  such shares were stamped with a
restrictive legend to prevent any resale without registration under the 1933 Act
or pursuant to an exemption.

           In two  separate  transactions,  on December 2 and December 29, 1999,
the  Company  issued  500,000  shares of Class A common  stock each to  separate
entities  not  affiliated  with the Company in payment for  consulting  services
rendered. The Company issued such shares without registration under the 1933 Act
in reliance on Section 4(2) or Regulation D. Such shares of Class A common stock
were registered on Form S-8 effective February 14, 2000.


ITEM 6.   SELECTED FINANCIAL DATA

The  selected  consolidated  financial  data set forth below is derived from the
Company's consolidated balance sheets and statements of operations as of and for
the years ended December 31, 1999, 1998, 1997, 1996 and 1995. The data set forth
below should be read in conjunction with  "Management's  Discussion and Analysis
of Financial Condition and Results of Operations" and the consolidated financial
statements and related notes thereto included in this Report.



<TABLE>
<CAPTION>
                                                                        For the Year Ended December 31,
                                             -------------- -------------- ------------ ------------- --------------
                                                 1999           1998          1997          1996          1995
                                             -------------- -------------- ------------ ------------- --------------
Statement of Operations Data:
<S>                                          <C>            <C>            <C>          <C>           <C>
Revenues                                     $     439,507  $   2,604,724  $        --  $         --  $           -
General and administrative expenses              9,498,753      8,817,643   12,947,112     3,530,400      3,553,665
Research and development expenses                7,909,228     13,060,604    7,066,294     4,758,012      2,704,165
Purchase of in-process research and                     --      9,315,000           --            --             --
development
Amortization of goodwill and purchased                          1,712,267
core technology                                  2,588,896                          --            --             --
Other income (expense)                         (3,698,789)    (6,507,245)  (1,558,678)       458,904       (88,067)
Loss from continuing operations               (19,949,196)   (36,843,475)  (21,572,084)  (7,829,508)    (6,345,897)
Loss from discontinued operations              (2,187,080)    (6,275,307)           --            --             --
Gain (loss) on extraordinary items                 473,857             --    (881,864)            --         30,548
Net loss                                      (21,662,419)   (43,118,782)  (22,453,948)  (7,829,508)    (6,315,349)
Basic and diluted net loss per common share  $      (0.31)  $      (0.91)  $    (0.59)  $     (0.21)  $      (0.30)

Weighted average number of common shares
outstanding                                     76,753,709     52,511,185   42,320,188    36,982,610     21,343,349
</TABLE>


                                  Page 21 of 47

<PAGE>



<TABLE>
<CAPTION>
                                                              As of December 31,
                                     ---------------------------------------------------------------------
                                        1999          1998           1997          1996          1995
                                     ------------ -------------- ------------- ------------- -------------
Balance Sheet Data:
<S>                                  <C>          <C>            <C>           <C>           <C>
Current assets                       $   480,885  $  20,638,070  $ 21,148,689  $ 23,967,601  $  7,912,728
Total assets                          19,173,147     61,912,791    22,894,566    25,331,270     7,984,306
Current liabilities                    5,285,681     35,317,045    20,469,866    19,061,081     6,674,572
Long-term debt, net of current         3,971,107             --        52,225            --            --
portion
Stockholders' equity                   8,086,359     24,765,746     2,372,475     6,270,189     1,309,734
</TABLE>




ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

THIS  REPORT ON FORM 10-K  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  BELOW IN THE SECTION
ENTITLED  "FACTORS  AFFECTING  FUTURE  OPERATING  RESULTS" AND UNDER THE HEADING
"CERTAIN SIGNIFICANT RISK FACTORS" IN ITEM 1 PART I OF THIS REPORT, ABOVE.

The following  discussion of the results of operations  and financial  condition
should be read in conjunction  with the  consolidated  financial  statements and
notes thereto included elsewhere in this report.

             Overview

           Since inception, Fonix has devoted substantially all of its resources
to research,  development and acquisition of software  technologies  that enable
intuitive human  interaction  with computers,  consumer  electronics,  and other
intelligent  devices.  Through  December  31,  1999,  the Company  has  incurred
cumulative  losses amounting to $98,237,110,  excluding  cumulative  losses from
discontinued  operations of $8,462,387 and net extraordinary  items. Such losses
are expected to continue until the effects of recent marketing and sales efforts
begin to take effect, if ever.

           In 1999,  Fonix  management  began to transition its strategic  focus
from technology  research,  development and acquisition into sales and marketing
and product  delivery.  In 1999,  the Company  expended  $1,125,611 in sales and
marketing  efforts.  The Company has made this  transition  while  continuing to
achieve  technology  upgrades  to  maintain  distinct   competitive   technology
advantages.

           In  its  current  marketing  efforts,   the  Company  seeks  to  form
relationships with third parties who can incorporate HCI technologies into new
or existing  products.  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  Fonix  presently  has such  relationships  and with which it may have
similar  relationships in the future include developers of application software,
operating  systems,  computers,   microprocessor  chips,  consumer  electronics,
automobiles, telephony and other technology products.




                                  Page 22 of 47

<PAGE>

           In February  1999,  in  connection  with its  transition in strategic
focus, the Company undertook an aggressive program of cost reduction  emphasized
in four areas of operations:

          1.   Salaries, wages and related costs - Salaries greater than $50,000
               per year were reduced 20 to 30 percent;

          2.   Third-party consultants - Reliance on third-party consultants was
               reduced in the areas of research and  development,  marketing and
               public relations;

          3.   Occupancy costs - Office space was reduced to accommodate current
               operating needs;

          4.   Asset  acquisition  -  Acquisition  of new  operating  assets was
               significantly restricted.

           Implementation  of these measures has reduced the monthly  deficit in
cash flows from operating  activities from $3 million in early 1999 to less than
$1 million  in  December  1999.  Additional  reductions  are  expected  as these
measures  reach full effect,  but will be offset by increased  expenses in sales
and marketing and ongoing product development.

           On May 19, 1999, Fonix signed an agreement to sell the operations and
a significant  portion of the assets of its HealthCare  Solutions Group ("HSG"),
which  consisted  primarily  of  the  operations  of  Articulate  Systems,  Inc.
("Articulate"),  to Lernout & Hauspie Speech Products N.V. ("L&H"), an unrelated
third party.  The sale closed September 1, 1999. The proceeds from the sale were
used to reduce certain of the Company's liabilities and provided working capital
to allow Fonix to focus on marketing and developing technologies and products.

Results of Operations

           The results of operations  disclosed below give effect to the sale of
the HSG and the  classification  of its net assets and  operating  activities as
discontinued operations.

1999 Compared to 1998

           During 1999, the Company recorded revenues of $439,507, a decrease of
$2,165,217 from $2,604,724 for 1998.  Revenue in 1998 included licensing fees of
$2,368,138 from an  international  microchip  manufacturer for which the Company
had no further obligation, and product sales and licensing fees of $236,586 from
other  customers.  The 1999 revenues are primarily  from licensing fees from TTS
and HWR technologies and products.

           Selling, general and administrative expenses were $9,498,753 for 1999
and  $8,817,643  for  1998,  an  increase  of  $681,110. A  one-time  charge  to
compensation  expense in 1999 in the amount of  $1,443,300  for  obligations  to
certain  executives  for  expenses  incurred on behalf of the Company  more than
offsets reductions achieved in other areas. Absent this charge, selling, general
and  administrative  expenses  decreased by $762,490,  due primarily to the cost
reduction  measures  undertaken  by the Company in February  1999.  Decreases in
salaries and related costs of $85,613 and in consulting  expenses of $61,842 are
direct results of such measures.  Also, a reduction in acquisition activity from
1998 to 1999  resulted in a decrease of $213,346 in legal and  investor-related
expenses.

           The Company  incurred  product  development and research  expenses of
$7,909,228  during 1999, a decrease of $5,151,376  from 1998.  This decrease was
due primarily to management's cost reduction initiatives implemented in February
1999 and the transition of emphasis from research and development  towards sales
and marketing.  The Company anticipates further decreases in product development
and research costs as it nears  completion of development of certain TTS and ASR
products.  During 1999 and 1998, the Company  expended a total of  approximately
$303,000 and $130,000,  respectively,  in connection with ongoing development of
the AcuVoice purchased in-process R&D projects. The Company anticipates that its
investment in product development and research will continue at decreased levels
for 2000, assuming availability of working capital.

           Amortization  of  goodwill  and  purchased  Core   Technologies   was
$2,588,896 for 1999 and  $1,712,267  for 1998. The increase of $876,629  results
from  amortization  for one full year in 1999 compared to  amortization  for the
portion of 1998 from the respective acquisition dates of AcuVoice and Papyrus to
the end of the year.



                                  Page 23 of 47

<PAGE>



           Net other expense was  $3,698,789  for 1999, a decrease of $2,808,456
from 1998, resulting from changes in several areas. Interest income decreased by
$979,998 primarily due to certificates of deposit that were converted to cash to
retire a bank line of credit in January  1999.  Cancellation  of certain  common
stock reset provisions  resulted in an expense of $6,111,577 in 1998 but did not
affect 1999.  Finally,  interest expense increased by $2,165,778  primarily as a
result of beneficial  conversion  features  recorded on  convertible  securities
issued in 1999,  interest charges incurred on advances from the purchaser of the
HSG and  interest  charges  on the  Series C  convertible  debentures  issued in
January and March 1999.

1998 Compared to 1997

           During 1998, the Company  recorded  revenues of $2,604,724,  of which
  $2,368,138 was a non-refundable license fee from Siemens for which the Company
  has no further  obligation of any kind. The balance of revenues  reflect sales
  and licensing fees related to TTS voice synthesis technology.

           During 1998, the Company  incurred  product  development and research
  expenses  of  $13,060,604,  an  increase  of  $5,994,310  over the  $7,066,294
  incurred in 1997.  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  Papyrus.
  Additionally,   the  Company  expensed   purchased   in-process  R&D  totaling
  approximately  $9,315,000  during 1998, in connection  with the acquisition of
  AcuVoice.

           Selling,  general and administrative expenses were $8,817,643 in 1998
  representing  a decrease  of  $4,129,469  from 1997.  This  decrease  resulted
  primarily  from a reduction in consulting  and outside  services  amounting to
  $6,739,461,  offset by an increase in salaries,  wages and related benefits of
  $858,713,  due to the  increased  workforce  from  the  AcuVoice  and  Papyrus
  acquisitions,  and an  increase  in  legal  fees of  $1,169,770,  incurred
  primarily in connection with acquisitions of AcuVoice, Articulate and Papyrus.

           Goodwill  and   purchased   core   technology   resulting   from  the
  acquisitions of AcuVoice and Papyrus was amortized to operations for the first
  time in 1998. An expense of $1,712,267 reflects  amortization from the date of
  acquisitions to the end of the year.

           Net other expense was  $6,507,245 for 1998, an increase of $4,948,567
  over the  previous  year.  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 Class A common stock. This increase was
  offset in part by a reduction  in interest  expense of  $1,287,599  from 1998,
  primarily due to extinguishment of certain debt instruments.

In-Process Research and Development

           At the date of acquisition of AcuVoice, management estimated that the
  acquired  in-process  R&D projects of AcuVoice were  approximately  75 percent
  complete  and that an  additional  $1.0  million  would be required to develop
  these projects to commercial  viability.  As of December 31, 1999, the Company
  has expended a total of approximately $433,000 in connection with the AcuVoice
  acquired  in-process  research  and  development   projects,   and  management
  estimates that a total of approximately  $567,000 will be required to complete
  the AcuVoice  projects.  Management also estimates that the AcuVoice  projects
  are 88 percent  complete as of December 31, 1999,  and that the release  dates
  will be in the second quarter of 2000.

Liquidity and Capital Resources

           The  Company  must raise  additional  funds to be able to satisfy its
  cash  requirements  during  the  next 12  months.  Research  and  development,
  corporate   operations  and  marketing   expenses  will  continue  to  require
  additional  capital.  Because the Company  presently has only limited  revenue
  from  operations,  the  Company  intends  to  continue  to rely  primarily  on
  financing through the sale of its equity and debt securities to satisfy future
  capital  requirements  until  such time as the  Company  is able to enter into
  additional  third-party licensing or co-development  arrangements such that it
  will be able to finance ongoing  operations out of license,  royalty and sales
  revenue. There can be no assurance that the Company will be able to enter into
  such agreements.


                                  Page 24 of 47

<PAGE>



  Furthermore, the issuance of equity or debt securities which are or may become
  convertible  into equity  securities  of the Company in  connection  with such
  financing  could result in substantial dilution to the stockholders of the
  Company.

           The Company had negative  working  capital of  $4,804,796 at December
  31, 1999,  compared to negative working capital of $14,678,975 at December 31,
  1998. The current ratio was 0.09:1 at December 31, 1999, compared to 0.58:1 at
  December 31, 1998.  Current  assets  decreased by $20,157,185 to $480,885 from
  December  31, 1998 to December  31,  1999.  Current  liabilities  decreased by
  $30,031,364 to $5,285,681  during the same period.  The improvement in working
  capital  reflects  the  payoff  of the  revolving  line  of  credit  with  the
  certificates  of deposit that occurred in January  1999,  and the reduction in
  notes payable to related parties and accounts payable from the proceeds of the
  sale of the HSG that was  completed on  September  1, 1999.  Total assets were
  $19,173,147 at December 31,1999, compared to $61,912,791 at December 31, 1998.

Delisting of the Company's Common Stock by Nasdaq

           Until  recently,  the  Company's  Class A common  stock traded on the
Nasdaq SmallCap  Market.  On December 3, 1999, the Company  received notice that
its stock had been  delisted from the Nasdaq  SmallCap  Market as of December 3,
1999.  Consequently,  the Company's Class A common stock is currently trading on
the OTC Bulletin Board.

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

Sale of the HealthCare Solutions Group

           On  September  1,  1999,  the  Company  completed  the  Sale  of  the
HSG to L&H for up to $28,000,000. Of this sales price, $21,500,000, less certain
credits of  $194,018,  was paid at closing,  $2,500,000  was held in an 18 month
escrow account in connection with the representations and warranties made by the
Company  at the time of the  Sale.  Of the  amount  originally  held in  escrow,
$500,000 was released to the Company  prior to December 31, 1999.  Any remaining
amount up to $4,000,000 is payable as an earnout  contingent on the  performance
of the HSG over the next two years.  The Company will not record the  contingent
earnout, if any, until successful  completion of the earnout  requirements.  The
proceeds  from  the  Sale  were  used to  reduce a  significant  portion  of the
Company's liabilities and to provide working capital for the Company's marketing
and  distribution  opportunities  for  its HCI  technologies.  The  assets  sold
included inventory,  property and equipment, certain prepaid expenses, purchased
technology  and other assets of the HSG.  Additionally,  L&H assumed the capital
and operating lease obligations  related to the HSG and the obligations  related
to certain of the Company's deferred revenues.

Notes Payable

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


                                  Page 25 of 47

<PAGE>



Papyrus.  The Company  paid the  Settlement  Payment in  September  1999 and the
lawsuits   described  above  have  been  dismissed.   The  970,586  shares  were
effectively  canceled  in  September  1999 in  connection  with  the  Settlement
Payment.  The  original  fair market  value of  $1,000,917  associated  with the
canceled  shares was  reflected as a reduction to goodwill  associated  with the
purchase of Papyrus  Associates,  Inc. As of December 31, 1999,  the Company had
unsecured notes payable to former Papyrus  stockholders in the aggregate  amount
of $77,625,  which  notes were  issued in  connection  with the  acquisition  of
Papyrus. The holders of these notes have not made demand for payment.

           During 1999, the Company paid, or otherwise reduced through agreement
notes  payable to various  related  parties  totaling  $8,482,946,  plus accrued
interest.  Additionally,  the Company paid other notes  payable to other parties
aggregating  $560,000,  plus accrued  interest.  Additionally,  a revolving note
payable in the amount of $50,000 was paid by a former  employee  and is included
as an account payable.  A revolving note payable in the amount of $19,988,193 at
December 31, 1998, plus accrued interest,  was paid in full in January 1999 with
the proceeds from a certificate  of deposit that secured the note and $22,667 in
cash.

           In the fourth quarter of 1999, the Company  negotiated  reductions of
$526,697  in amounts  due  various  trade  vendors.  Additionally,  the  Company
negotiated  reductions  of $229,055  in accrued  interest  owed to certain  note
holders.  These  amounts  were  considered  forgiveness  of debt and  have  been
accounted  for as  extraordinary  items in the 1999  consolidated  statement  of
operations.

December 1998 Equity Offering

           In connection with a private offering of Class A common stock
completed in December 1998 (the "Equity  Offering"),  the purchaser of 1,801,802
Class A common  shares  received an equal number of Repricing  Rights as well as
warrants to purchase 200,000 shares of Class A common stock at an exercise price
of $1.665 per share.  The Repricing Rights provide for the issuance of shares of
Class A common stock based upon rates that vary  depending upon the market price
of the stock.  Also included were certain  Repurchase  Rights that may, upon the
occurrence of certain events, require the Company to repurchase all or a portion
of the holder's Class A common shares or Repricing Rights received in the Equity
Offering.  A registration  statement  covering the shares  underlying the Equity
Offering was declared effective February 11, 2000.

           Subsequently, the Repricing Rights were exercised, resulting in the
issuance of 4,568,569  shares of Class A common stock on February 14, 2000.  The
Equity  Offering  shares and the shares  issued upon  exercise of the  Repricing
Rights were sold, thereby  extinguishing the Company's  obligation to repurchase
the shares or the Repricing Rights.

Series C convertible debentures

           On January 29, 1999, the Company  entered into a securities  purchase
agreement  with four  investors  pursuant to which the Company sold its Series C
convertible  debentures in the aggregate  principal  amount of  $4,000,000.  The
outstanding  principal  amount of the debentures was  convertible at any time at
the option of the holders into shares of the Company's Class A common stock at a
conversion  price  equal to the lesser of (1) $1.25 or (2) 80% of the average of
the closing bid price of the Company's Class A common stock for the five trading
days immediately preceding the conversion date. The Company recorded $687,500 as
interest  expense upon the issuance of the  debentures  in  connection  with the
beneficial  conversion  feature.  The Company  also issued  400,000  warrants to
purchase an equal number of the Company's Class A common shares at a strike


                                  Page 26 of 47

<PAGE>



price of $1.25 per share in  connection  with this  financing.  The warrants are
exercisable  for a period of three years from the date of grant.  The  estimated
fair value of the  warrants of  $192,000,  as computed  under the  Black-Scholes
pricing  model,  was  recorded  as  interest  expense  upon the  issuance of the
debentures.

           On March 3,  1999,  the  Company  executed a  supplemental  agreement
pursuant to which the Company agreed to sell another $2,500,000 principal amount
of the  debentures  on the same terms and  conditions  as the  January  29, 1999
agreement,  except no  additional  warrants  were issued.  The Company  recorded
$1,062,500 as interest expense upon the supplemental issuance in connection with
the beneficial conversion feature.

           The  obligations of the Company for repayment of the  debentures,  as
well as its  obligation  to register  the Class A common  stock  underlying  the
potential  conversion of the debentures and the exercise of the warrants  issued
in these transactions,  were personally guaranteed by two officers and directors
and a former  officer  and  director  of the  Company  (the  "Guarantors").  The
Guarantors pledged 6,000,000 shares of common stock of the Company  beneficially
owned  by  them  as  collateral  security  for  their  obligations  under  their
guarantees.

          Subsequent to the March 3, 1999 funding, the holders of the debentures
notified  the Company and the  Guarantors  that the  Guarantors  were in default
under the terms of the  guarantee  and the stock pledge  agreement and that they
had sold the 6,000,000 shares pledged by the Guarantors.  The aggregate proceeds
from the sale of the pledged shares were $3,278,893. Of this total, $406,250 was
allocated to penalties  attributable  to default  provisions of the stock pledge
agreement  and  recorded as interest  expense  and  $343,750  related to penalty
provisions  of the  Series  D  preferred  stock  (held  by a  related  group  of
investors) and recorded as preferred stock dividends.  The remaining  $2,528,893
was applied as a reduction  of the  principal  balance of the  debentures  as of
September  30, 1999.  Under its indemnity  agreement  with the  Guarantors,  the
Company  agreed to issue 6,000,00  replacement  shares to the Guarantors for the
shares sold by the holders of the  debentures  and reimburse the  Guarantors for
any costs incurred as a result of the holders' sales of the Guarnators'  shares.
In 1999,  the Company  estimated and recorded  expenses  amounting to $1,296,600
pursuant to the indemnity agreement.

           As of December 31, 1999,  the  remaining  outstanding  balance on the
debentures was  $3,971,107.  As of April 10, 2000,  all remaining  principal and
interest due on the debentures  have been converted to 10,385,364  shares of the
Company's Class A common stock.


                                  Page 27 of 47

<PAGE>



Guarantors

           In addition to guaranteeing  obligations  relating to the debentures,
the Guarantors  guaranteed certain other obligations of the Company. As security
for some of the guarantees, the Guarantors pledged shares of the Company's Class
A common stock  beneficially owned by them. In March 1999, 143,230 of the shares
previously  pledged  by the  Guarantors  to a bank were sold by the bank and the
proceeds were used to pay Company  credit card balances and the related  accrued
interest  in  full  totaling  $244,824.  In May  1999,  100,000  of  the  shares
previously  pledged by the  Guarantors  to another  creditor of the Company were
sold by the  creditor  and the  proceeds,  totaling  $72,335,  were  used to pay
amounts owed by the Company.  In September 1999, the Company paid a note payable
to an unrelated  third party in the amount of $560,000 that had previously  been
guaranteed  by the  Guarantors.  As of December  31, 1999,  guarantees  remained
outstanding in respect of certain real property subleases.

Series D and Series E Preferred Stock

           During 1999,  626,611 shares of Series D preferred  stock and 135,072
shares of Series E preferred  stock,  together  with related  dividends on each,
were converted into 47,252,275 shares and 5,729,156 shares, respectively, of the
Company's Class A common stock. After the above  conversions,  381,723 shares of
Series D  preferred  stock and no shares of Series E  preferred  stock  remained
outstanding as of December 31, 1999. Subsequent to December 31, 1999, a total of
217,223  shares of Series D preferred  stock,  together with related  dividends,
were converted into  15,436,378  shares of Class A common stock. As of April 10,
2000,  164,500  shares of Series D  preferred  stock  remained  outstanding.  In
connection  with the sales of the Series D and  Series E  preferred  stock,  the
Company  entered into  registration  rights  agreements  with the holders of the
Series D and Series E preferred  stock and agreed to register the sale of shares
received on a conversion  of the Series D and Series E preferred  stock.  If the
number  of shares  currently  issuable  upon a  hypothetical  conversion  of the
remaining  Series D preferred  stock  exceeds  those  authorized  for sale,  the
Company will be required to file an additional  registration  statement to cover
the remaining shares.

Class A common stock, stock options, and warrants

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

           On  December  23,  1999,  the  Company  issued  warrants  to purchase
1,000,000 shares of the Company's Class A common stock to professional  advisors
and  consultants.  The  warrants  were  valued  at $0.26  per  share  using  the
Black-Scholes  pricing model and the resulting charge was recorded as a deferred
consulting  expense in  stockholders'  equity to be  amortized  as  general  and
administrative  expense over the subsequent period of service.  Also in December
1999,  1,000,000  shares of Class A common  stock  were  issued to other
advisors and consultants as consideration for services rendered. The shares were
valued at  $375,000  based  upon the  market  value of the shares on the date of
issuance and recorded as general and administrative expenses.

           During 1999, the Company  granted  884,500 stock options to employees
at  exercise  prices  ranging  from  $0.59 to $3.25 per  share.  The term of all
options  granted  during  the year was ten years from the date of grant.  Of the
stock options  granted,  698,000  vested  immediately  and 186,500 vest over the
subsequent  three-year  period. As of December 31, 1999, the Company had a total
of 14,355,900 options outstanding.

           The Company's option plans provide for stock appreciation rights that
allow the  grantee  to  receive  shares of the  Company's  Class A common  stock
equivalent in value to the difference between the designated  exercise price and
the fair  market  value of the  Company's  stock  at the  date of  exercise.  At
December  31,  1999,  there were stock  appreciation  rights  related to 400,000
shares  outstanding with a weighted average exercise price of $1.18.  Subsequent
to December 31, 1999, these stock appreciation rights were exercised at weighted
average exercise price of $1.18

           During 1999, the Company  granted  warrants to L&H in connection with
loans  made to the  Company  in April and May 1999  totaling  $6,000,000.  These
warrants allow L&H to purchase 850,000 shares of Class A


                                  Page 28 of 47

<PAGE>



common stock of the Company at exercise  prices  ranging from $0.60 to $0.70 per
share.  The warrants  were valued at $246,240  using the  Black-Scholes  pricing
model and were  recorded as a charge to  interest  expense.  Of these  warrants,
250,000 expired October 18, 1999, without being exercised. The remaining 600,000
warrants expire May 17, 2001.

           As of  December  31,  1999,  the  Company  had a total  of  3,025,000
warrants outstanding.

                                     Outlook

Corporate Objectives and Technology Vision

           The Company believes that its Core  Technologies will be the platform
for the next  generation of automated  speech  technologies  and products.  Most
speech recognition products offered by other companies are based on technologies
that are largely in the public domain and represent nothing  particularly  "new"
or creative.  The Fonix Core  Technologies  are based on  proprietary,  patented
technology.  The Company  will  continue to seek patent  protection  of the Core
Technologies as well as technologies  and inventions  derived from the know how,
assets and rights  acquired from AcuVoice and Papyrus.  Management  believes the
Company's HCI  technologies  provide a  competitive  advantage  vis-a-vis  other
technologies available in the marketplace.

         As the Company  proceeds to  implement  its  strategy  and to reach its
objectives,   the  Company  anticipates  further  development  of  complementary
technologies,  added product and applications  development expertise,  access to
market channels and additional  opportunities  for strategic  alliances in other
industry  segments.  The  strategy  described  above is not  without  risk,  and
shareholders  and others  interested  in the Company and its common stock should
carefully  consider the risks set forth under the heading  "Certain  Significant
Risk Factors" in Item 1, Part I, above.




ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

           Index to Consolidated Financial Statements:

           Report of Independent Public Accountants (Arthur
               Andersen LLP)                                                 F-2

           Report of Independent Public Accountants (Pritchett,
               Siler & Hardy, P.C.)                                          F-3

           Consolidated Balance Sheets as of December 31, 1999
               and 1998                                                      F-4


                                  Page 29 of 47

<PAGE>



           Consolidated Statements of Operations for the Years
               Ended December 31, 1999, 1998 and 1997 and for
               the Period from October 1, 1993 (Date of Inception)
               to December 31, 1999                                          F-5

           Consolidated Statements of Stockholders' Equity for
               the Years Ended December 31, 1999, 1998 and 1997
               and for the Period from October 1, 1993 (Date of
               Inception) to December 31, 1999                               F-6

           Consolidated Statements of Cash Flows for the Years
               Ended December 31, 1999, 1998 and 1997 and for
               the Period from October 1, 1993 (Date of Inception)
               to December 31, 1999                                          F-9

           Notes to Consolidated Financial Statements                       F-11


ITEM 9.              CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
                     AND FINANCIAL DISCLOSURE

           During the years ended December 31, 1999, 1998, and 1997, and through
the date  hereof,  there  have been no  reportable  events  (as  defined in Item
304(a)(1)(v) of Regulation S-K).




                                  Page 30 of 47

<PAGE>



                                    PART III

ITEM 10.             DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

           The following  table sets forth certain  information  concerning  the
executive officers and directors of the Company as of April 10, 1999:

<TABLE>
<CAPTION>
 Name                                     Age                 Position

<S>                                       <C>                 <C>
Thomas A. Murdock                         56                  Director, President and Chief Executive Officer
Roger D. Dudley                           47                  Director, Executive Vice President, Chief Financial Officer
John A. Oberteuffer, Ph.D.                59                  Director, Vice President, Technology
William A. Maasberg, Jr.                  60                  Director, Chief Operating Officer
Mark S. Tanner                            45                  Director
</TABLE>

           All  directors  hold  office  until the next  annual  meeting  of the
stockholders  of the Company or until  their  successors  have been  elected and
qualified.  The  officers of the Company are elected  annually  and serve at the
pleasure of the Board of Directors.

          THOMAS A. MURDOCK is a co-founder  of the Company and has served as an
          executive officer and member of the Company's board of directors since
          June 1994. He has been the  Company's  chief  executive  officer since
          January 26, 1999. Mr. Murdock also has served as president of Studdert
          Companies  Corporation  ("SCC"), a related party, since 1992. For much
          of his  career,  Mr.  Murdock  was a  commercial  banker  and a senior
          corporate  executive  with  significant   international  emphasis  and
          experience.   Mr.   Murdock   also   serves  as  a  director   of  KLS
          Enviro Resources,  Inc., of Advocast,  Inc., an Internet research and
          development company, and SCC.

          ROGER D.  DUDLEY is a  co-founder  of the Company and has served as an
          executive officer and member of the Company's board of directors since
          June 1994. Mr. Dudley currently serves as the Company's executive vice
          president and chief financial  officer.  After several years at IBM in
          marketing  and sales,  he began his career in the  investment  banking
          industry. He has extensive experience in corporate finance, equity and
          debt private  placements and asset management.  Mr. Dudley also serves
          as a director of KLS Enviro Resources, Inc. and SCC.

          JOHN A.  OBERTEUFFER,  Ph.D.  has been a director of the Company since
          March 1997 and vice  president  technology  since  January 1998. He is
          also the founder and president of Voice Information  Associates,  Inc.
          ("VIA"),  a consulting  group providing  strategic  technical,  market
          evaluation,  product  development  and  corporate  information  to the
          automated speech recognition industry. In addition,  VIA publishes the
          monthly  newsletter,   ASRNews.  Dr.  Oberteuffer  also  is  executive
          director of the American Voice Input/Output Society ("AVIOS").  He was
          formerly vice  president of Voice  Processing  Corp.  (now merged with
          Voice  Control  Systems,  Inc.),  and also was founder and CEO of Iris
          Graphics,  which was acquired by Seitex Corp. Dr. Oberteuffer received
          his bachelor's  and master's  degrees from Williams  College,  and his
          Ph.D. in Physics from Northwestern University.  He was a member of the
          research  staff at  Massachusetts  Institute  of  Technology  for five
          years.

          WILLIAM A. MAASBERG, Jr. became a director of the Company in September
          1999 and was named chief  operating  officer  February  1, 2000.  From
          December 1997 through  February 1999, Mr.  Maasberg was vice president
          and general manager of the AMS Division of Eyring Corporation. The AMS
          Division manufactures multi-media electronic work instruction software
          application.  He was also a co-founder  and  principal in  Information
          Enabling Technologies,  Inc. ("ETI"), and LIBRA Corporation ("LIBRA"),
          two companies focusing on software application development, and served
          in several key  executive  positions  with both ETI and LIBRA from May
          1976 through  November 1997. Mr.  Maasberg  worked for IBM Corporation
          from July 1965 through May 1976 in various capacities. He received his
          B.S. Degree from Stanford University in Electrical Engineering and his
          M.S. in Electrical Engineering from the University of


                                  Page 31 of 47

<PAGE>



          Southern  California.  Mr.  Maasberg  was  re-elected  to the Board of
          Directors at the Company's 1999 Annual Meeting of Stockholders.

          MARK S. TANNER became a director of the Company in November  1999. Mr.
          Tanner is  currently  the chief  financial  officer  and  senior  vice
          president  of finance  and  administration  for Mrs.  Fields  Original
          Cookies,  Inc. Mr.  Tanner  spent nine years at PepsiCo,  where he was
          chief financial officer for Pepsi International's  operations in Asia,
          the Middle  East,  and  Africa.  He was vice  president  of  strategic
          planning for Pepsi North America,  as well as chief financial  officer
          for Pepsi North America's Pepsi East Operations. Mr. Tanner also spent
          ten years with United Technologies  Corporation in various capacities,
          including director of corporate  development.  Mr. Tanner holds a B.A.
          in  economics  from  Stanford   University  and  an  M.B.A.  from  the
          University of California at Los Angeles.


                      Significant Employees and Consultants

           In addition to the  officers  and  directors  identified  above,  the
Company expects the following  individuals to make significant  contributions to
the Company's business during 2000.

          PAUL  S.  CLAYSON,   43,  is  Vice  President  of  Strategic  Business
          Development  and has been employed by the Company since June 1998. Mr.
          Clayson's  career  experience has focused on  strategically  assessing
          markets, products and services, opening and establishing those markets
          and building  organizations and management structures to support their
          growth. His work has spanned multiple products,  services and markets.
          He also  served as a senior  officer  and  partner in a private  asset
          management business in charge of general management, marketing, sales,
          planning  and product  development  functions.  His work  included the
          creation of mutual  funds,  private  asset funds for  publicly  traded
          securities,  and private  investment  portfolios.  He also served as a
          senior  corporate  officer  for the Red Chip  Review  which  publishes
          research on small cap  publicly  traded  companies.  He  received  his
          education from the University of Utah and the University of Michigan.

          DALE LYNN SHEPHERD,  40, is vice president of engineering and has been
          employed by the Company  since 1997.  He was  employed by  Synergetics
          from 1992 to March 13, 1997.  Before his employment with  Synergetics,
          he was  employed  with  Mentorgraphics  where he  acted as a  software
          systems   architect  in   automatic   semiconductor   design.   Before
          Mentorgraphics, he worked on a contract basis with Signetics, Inc. Mr.
          Shepherd  graduated from Brigham Young  University  with a Bachelor of
          Science Degree in Electrical  Engineering.  He also received a Masters
          of Business Administration from Brigham Young University.

          R. BRIAN MONCUR,  40, is director of core technologies  implementation
          and has been with the Company since 1997. He was  previously  employed
          by Synergetics from 1992 to March 13, 1997. Before his employment with
          Synergetics,  he was employed by Signetics,  Inc. and  Mentorgraphics,
          where  he was a  senior  process  engineer  and  software  development
          engineer.  Mr. Moncur  graduated from Brigham Young  University with a
          Bachelor of Science degree in chemical engineering.

          JAMES MARK  HAMILTON,  40, is  director  of  engineering  and has been
          employed by the Company  since 1997.  Previously,  he was  employed by
          Synergetics  from 1996 to March 13, 1997. He has been a project leader
          in developing the Company's SDK System and has worked on the Company's
          portable voice project. Before his employment with Synergetics, he was
          employed by Intelligent  Technologies,  Inc., where he helped form the
          company and designed and developed the  educational  software  product
          called  IntelliBots for Macintosh and Windows.  Mr. Hamilton graduated
          from Brigham Young University with a Bachelor of Science in Electrical
          Engineering.

          DOUG JENSEN,  39, is director of embedded product  development and has
          been with the  Company  since  1997.  Previously,  he was  employed by
          Novell as strategic engineer between Novell and Intel. He also


                                  Page 32 of 47

<PAGE>



          worked for North American  Philips.  Mr. Jensen graduated from Brigham
          Young  University  with a  Bachelor  of Science  Degree in  Electrical
          Engineering.

          CARL HAL HANSEN,  50, is an independent  consultant and is co-inventor
          of the Company's automated speech recognition  technologies  ("ASRT").
          He is chairman and CEO of  Synergetics,  IMC2, and Adiva  Corporation.
          For  approximately  14 years,  he was employed by  Signetics,  Inc. in
          various    capacities,     including    test    equipment    engineer,
          characterization    engineer,   product   engineer,   and   electronic
          specialist. He was involved in the design,  fabrication and release of
          layout  design  for PC boards  and  interfaces.  In 1991,  Mr.  Hansen
          founded Synergetics,  were he continues to have direct leadership with
          respect to new product  development  and  engineering.  IMC2 currently
          provides  consulting in research and development to the Company in the
          area of ASR. Mr.  Hansen holds a degree in  electronics  from the Utah
          Trade Technical Institute of Provo, Utah.

          TONY R. MARTINEZ,  Ph.D., 42, is a senior consulting scientist for the
          Company's neural network development.  He is an associate professor of
          Computer  Science at Brigham Young  University and currently  heads up
          the Neural  Network and  Machine  Learning  Laboratory  in the Brigham
          Young University Ph.D./MS program. His principal research is in neural
          networks,  machine learning, ASOCS,  connectionist systems,  massively
          parallel  algorithms and  architectures,  and non-von Neuman computing
          methods.  He is associate  editor of the Journal of Artificial  Neural
          Networks.  Dr.  Martinez  received  his Ph.D.  in computer  science at
          University of California at Los Angeles in 1986.

          KENNETH P. HITE, 34, is a consultant for the Company. He is developing
          the  pen-voice  user  interface  for the  Windows  98  platform  which
          involves  integrating  Fonix's HWR and ASR technologies for use in pen
          tablet  computers.  He has 14 years  programming  experience.  and has
          worked  on  a  contract   assignment   for  Modis  Inc.   He  attended
          Northeastern  University  and has taken several  courses in management
          information systems.

None of the  executive  officers or  directors  of the Company is related to any
other officer or director of the Company.


ITEM 11.             EXECUTIVE COMPENSATION

           The   following   table  sets  forth   information   concerning   the
compensation  paid to all  persons  serving  as the  Company's  chief  executive
officer and the Company's most highly compensated  executive officers other than
its chief executive  officer who were serving as executive  officers at December
31,  1999,  and whose annual  compensation  exceeded  $100,000  during such year
(collectively the "Named Executive Officers"):




                                  Page 33 of 47

<PAGE>


                           Summary Compensation Table

<TABLE>
<CAPTION>
                                                Annual Compensation                            Long-Term Compensation
                                        -----------------------------------------------      ----------------------------
                                                                                                        Securities
                                                                                Other                   Underlying
                                                                               Annual                   Options/
Name and Principal Position               Year                  Salary          Bonus                     SARs(2)
                                        ---------           ------------     -----------     ----------------------------
<S>                                       <C>                 <C>                  <C>                   <C>
Thomas A. Murdock (1)                     1997                $305,385             -                     400,000/0
CEO (6/94 to 4/96 and                     1998                $425,000             -                     550,000/0
1/26/99 - present) and                    1999                $316,574             -                           0/0
President

Roger D. Dudley (1)                       1997                $305,385             -                     400,000/0
Executive Vice President, Chief           1998                $425,000             -                     550,000/0
   Financial Officer (Effective 3/21/00)  1999                $317,764             -                           0/0

Douglas L. Rex                            1998                $157,685             -                     200,000/0
Chief Financial officer                   1999                $166,322             -                           0/0
(Through 3/21/00)

John A. Oberteuffer                       1998                $203,941             -                     580,000/0
Vice President Technology                 1999                $199,238             -                           0/0
</TABLE>




           (1)       The  Company  has  executive  employment   agreements  with
                     Messrs.  Murdock and  Dudley.  The  material  terms of each
                     executive  employment  agreement  with Messrs.  Murdock and
                     Dudley are identical  and are as follows:  The term of each
                     employment  contract  is  from  November  1,  1996  through
                     December  31,  2001.  Annual  base  compensation  for  each
                     executive  for  the  first  three  years  of  such  term is
                     $250,000 from  November 1, 1996 through  December 31, 1996;
                     $325,000  from January 1, 1997  through  December 31, 1997;
                     and  $425,000  from  January 1, 1998  through  December 31,
                     1999. The annual base  compensation for the final two years
                     of the  employment  agreement  is $550,000  from January 1,
                     2000 through  December 31, 2000;  and $750,000 from January
                     1, 2001 through December 31, 2001. However, for these final
                     two  contract  years,  annual  base  compensation  and  the
                     performance-based incentive compensation will be subject to
                     review  by the  Company's  board of  directors  based  upon
                     either or both of the market price of the Company's  common
                     stock  and  profits  derived  by the  Company  from  annual
                     revenues from  operations.  Notwithstanding  the foregoing,
                     Messrs.  Murdock and Dudley voluntarily  reduced their base
                     compensation to $297,500 commencing January 1, 1999 as part
                     of the Company's  overall  efforts to reduce  expenses.  On
                     January 31,  2000,  these  contracts  were  extended at the
                     current base compensation through December 2005, subject to
                     subsequent   adjustments   as  approved  by  the  board  of
                     directors.

                     Each such  executive  officer also is entitled to customary
                     insurance benefits, office and support staff and the use of
                     an automobile.  In addition, if any executive is terminated
                     without cause during the contract term then all salary then
                     and thereafter due and owing under the executive employment
                     agreement shall, at the executive's  option, be immediately
                     paid in a lump sum payment to the executive officer and all
                     stock options, warrants and other similar rights granted by
                     the Company and then vested or earned shall be  immediately
                     granted to the executive  officer  without  restriction  or
                     limitation  of any kind.


                                  Page 34 of 47

<PAGE>



                     Each   executive    employment    agreement    contains   a
                     non-disclosure,   confidentiality,   non-solicitation   and
                     non-competition    clause.   Under   the   terms   of   the
                     non-competition  clause, each executive has agreed that for
                     a  period  of  one  year  after  the   termination  of  his
                     employment  with the Company that the  executive not engage
                     in any capacity in a business  which  competes  with or may
                     compete with the Company.

           (2)       All options granted in 1999 and 1998 were granted  pursuant
                     to the  Company's  1998  Stock  Option  Plan.  All  options
                     granted in 1997 were granted pursuant to the Company's 1997
                     Stock Option Plan.


        Board of Directors Meetings, Committees and Director Compensation

           The  Company's  board of  directors  took action at six duly  noticed
meetings  of the  Board  during  1999.  Each  director  attended  (in  person or
telephonically)  at  least  75%  of  the  meetings  of the  Company's  board  of
directors.  During 1999,  the  Company's  board of directors  had the  following
committees:  Audit  Committee,  comprised  of Messrs.  Dudley,  Maasberg  (as of
September  3,  1999) and Tanner  (as of  November  9,  1999);  and  Compensation
Committee,  comprised of Messrs. Murdock, Maasberg (as of September 3, 1999) and
Tanner (as of November 9, 1999). These standing committees conducted meetings in
conjunction with meetings of the full board of directors.


                                  Page 35 of 47

<PAGE>


             Compensation Committee Report on Executive Compensation

           Preliminary Note:  Notwithstanding anything to the contrary set forth
in any of the  previous  filings  made by the Company  under the 1933 Act or the
1934 Act that might incorporate future filings,  including,  but not limited to,
this Annual  Report on Form 10-K, in whole or in part,  the following  Executive
Compensation  Report and the  performance  graph  appearing  herein shall not be
deemed to be incorporated by reference into any such future filings.

           This Executive  Compensation Report discusses the Company's executive
compensation  policies  and the  basis  for the  compensation  paid to the Named
Executive Officers, including the persons serving as its chief executive officer
during the year ended December 31, 1999.

Compensation   Policy.   The  Committee's   policy  with  respect  to  executive
compensation has been designed to:

               o    Adequately  and  fairly  compensate  executive  officers  in
                    relation  to  their   responsibilities,   capabilities   and
                    contributions  to  the  Company  and  in a  manner  that  is
                    commensurate   with   compensation   paid  by  companies  of
                    comparable size or within the Company's industry;

               o    Reward executive  officers for the achievement of short-term
                    operating  goals and for the  enhancement  of the  long-term
                    value of the Company; and

               o    Align the interests of the executive  officers with those of
                    the  Company's   shareholders  with  respect  to  short-term
                    operating goals and long-term  increases in the price of the
                    Company's common stock.

           The components of compensation paid to executive officers consist of:
(a) base salary, (b) incentive compensation in the form of annual bonus payments
and stock options  awarded by the Company under the  Company's  Stock  Incentive
Plans  and (c)  certain  other  benefits  provided  to the  Company's  executive
officers.  The Company's Compensation Committee is responsible for reviewing and
approving cash  compensation  paid by the Company to its executive  officers and
members of the Company's senior  management  team,  including annual bonuses and
stock options awarded under the Company's Stock Incentive  Plans,  selecting the
individuals  who will be  awarded  bonuses  and  stock  options  under the Stock
Incentive Plans, and for determining the timing, pricing and amount of all stock
options  granted  thereunder,  each  within  the  terms of the  Company's  Stock
Incentive Plans.

           The  Company's  executive   compensation   program  historically  has
emphasized  the use of  incentive-based  compensation  to reward  the  Company's
executive officers and members of senior management for the achievement of goals
established by the board of directors. The Company uses stock options to provide
an incentive for a substantial  number of its officers and employees,  including
selected  members of  management,  and to reward such officers and employees for
achieving goals that have been established for the Company. The Company believes
its  incentive  compensation  plan rewards  management  when the Company and its
shareholders  have  benefitted  from achieving the Company's  goals and targeted
research and development  objectives,  all of which the  Compensation  Committee
feels will dictate,  in large part, the Company's future operating results.  The
Compensation  Committee  believes that its policy of  compensating  officers and
employees with  incentive-based  compensation fairly and adequately  compensates
those  individuals  in  relation  to their  responsibilities,  capabilities  and
contribution  to  the  Company,  and  in a  manner  that  is  commensurate  with
compensation  paid by  companies  of  comparable  size or within  the  Company's
industry.

           Components of  Compensation.  The primary  components of compensation
paid by the Company to its executive  officers and senior management  personnel,
and the  relationship  of  such  components  of  compensation  to the  Company's
performance, are discussed below:

               o    Base Salary. The Compensation Committee periodically reviews
                    and  approves  the base  salary  paid by the  Company to its
                    executive  officers  and  members of the  senior  management
                    team. Adjustments to base salaries are determined based upon
                    a number of factors, including the


                                  Page 36 of 47

<PAGE>



                    Company's  performance  (to the extent such  performance can
                    fairly  be  attributed   or  related  to  each   executive's
                    performance),  as well  as the  nature  of each  executive's
                    responsibilities,   capabilities   and   contributions.   In
                    addition,  the Compensation  Committee  periodically reviews
                    the base salaries of its senior  management  personnel in an
                    attempt to ascertain  whether those salaries  fairly reflect
                    job  responsibilities  and prevailing  market conditions and
                    rates of pay. The Compensation  Committee believes that base
                    salaries  for  the   Company's   executive   officers   have
                    historically  been  reasonable  in relation to the Company's
                    size and  performance  in comparison  with the  compensation
                    paid by similarly  sized  companies or companies  within the
                    Company's industry.

               o    Incentive  Compensation.  As discussed  above, a substantial
                    portion of each executive officer's  compensation package is
                    in the form of incentive compensation designed to reward the
                    achievement  of  short-term  operating  goals and  long-term
                    increases  in  shareholder   value.   The  Company's   Stock
                    Incentive   Plans  allow  the  Board  of  Directors  or  the
                    Compensation  Committee to grant stock  options to executive
                    officers  and  employees  for the  purchase of shares of the
                    Company's  common  stock.  Under  the  terms  of  the  Stock
                    Incentive Plans, the Board of Directors and the Compensation
                    Committee  have  authority,  within  the  terms of the Stock
                    Incentive  Plans,  to  select  the  executive  officers  and
                    employees who will be granted stock options and to determine
                    the  timing,  pricing  and  number  of stock  options  to be
                    awarded. The Compensation  Committee believes that the stock
                    options  granted  under the  Stock  Incentive  Plans  reward
                    executive officers only to the extent that shareholders have
                    benefitted  from  increases  in the  value of the  Company's
                    common stock.

               o    Other Benefits.  The Company  maintains  certain other plans
                    and arrangements  for the benefit of its executive  officers
                    and members of senior management. The Company believes these
                    benefits  are   reasonable  in  relation  to  the  executive
                    compensation practices of other similarly sized companies or
                    companies within the Company's industry.

           Compensation of the Chief Executive Officer.  As described  elsewhere
in this Report, the Company has entered into an executive  employment  agreement
with Mr. Murdock.  The material terms of this executive employment agreement are
described  above.  The   Compensation   Committee   believes  that  the  monthly
compensation  under  such  contract   adequately  and  fairly  compensates  this
executive officer in relation to his respective responsibilities,  capabilities,
contributions  and  dedication  to the  Company  and secures for the Company the
benefit of his  leadership,  management and financial  skills and  capabilities.
Moreover, the Compensation Committee believes that the salary and other benefits
are reasonable in relation to the responsibilities,  capabilities, contributions
and  dedication of Mr.  Murdock to the Company and are warranted to keep them in
line  with the  compensation  earned by chief  executive  officers  employed  by
companies of comparable size or within the Company's industry.

           Conclusion.  The  Compensation  Committee  believes that the concepts
discussed above further the  shareholders'  interests because a significant part
of executive  compensation  is based upon the Company  achieving its  marketing,
sales and product development goals and other specific goals set by the board of
directors.  At the same  time,  the  Compensation  Committee  believes  that the
program encourages responsible management of the Company in the short-term.  The
Compensation Committee regularly considers plan design so that the total program
is as effective as possible in furthering shareholder interests.

           The Compensation  Committee bases its review on the experience of its
own  members,  on  information  requested  from  management  personnel,  and  on
discussions  with and information  compiled by various  independent  consultants
retained by the Company.

                                          Respectfully submitted,

                                          Compensation Committee:
                                          Thomas A. Murdock
                                          William A. Maasberg, Jr.
                                          Mark S. Tanner


                                  Page 37 of 47

<PAGE>




                            Compensation of Directors

           Prior to April 1996, the Company's directors received no compensation
for their  service.  The Company  historically  has reimbursed its directors for
actual  expenses  incurred  in  traveling  to and  participating  in  directors'
meetings,  and the Company  intends to continue that policy for the  foreseeable
future.  On March 30, 1996, the Company's  board of directors  adopted,  and the
Company's  shareholders  subsequently  approved,  the Company's 1996  Directors'
Stock Option Plan (the "Directors' Plan"). Under the Directors' Plan, members of
the Board as  constituted on the date of adoption  received  options to purchase
200,000  shares  of the  Company's  Class A common  stock  for each year (or any
portion thereof consisting of at least six months) during which such persons had
served  on the board for each of  fiscal  years  1994 and 1995 and were  granted
200,000 shares for each of fiscal years 1996 through 1999,  which options vested
after  completion  of at least six  months'  service on the board  during  those
fiscal years.  These options have terms of ten years.  Similar  grants have been
made to the  Company's  directors  under the  Company's  1998 Stock Option Plan.
Under the Directors Plan and the 1998 Stock Option Plan, the Company  granted no
stock options to members of the board during 1999.

           Stock Options Granted to Directors During Fiscal Year 1999

<TABLE>
<CAPTION>
                                  Shares            Date             Exercise               Shares Vested
Name(1)                           Granted           Granted          Price Per Share        at December 31, 1999
----                              -------           -------          ---------------        --------------------

<S>                               <C>               <C>                    <C>                 <C>
William A. Maasberg, Jr.          200,000           09/03/99               $0.406              200,000
Mark S. Tanner                    200,000           11/09/99               $0.406              200,000
</TABLE>

(1)  Directors who are also Named  Executive  Officers also received  options as
     set forth in the table above.


                Compliance With Section 16(a) of the Exchange Act

           Section  16(a) of the  Securities  Exchange Act of 1934  requires the
Company's officers and directors, and persons who beneficially own more than 10%
of a registered  class of the Company's  equity  securities,  to file reports of
ownership and changes in ownership with the Securities and Exchange  Commission.
Officers,  directors  and  greater  than  10  %  shareholders  are  required  by
regulation of the Securities and Exchange Commission to furnish the Company with
copies of all Section 16(a) forms which they file. Based solely on its review of
the copies of such forms  furnished to the Company  during the fiscal year ended
December 31, 1999 the Company is aware of the following untimely filings:

           Thomas A. Murdock,  Roger D. Dudley,  and Stephen M. Studdert
(the  "Guarantors")  are in the process of preparing and filing year-end Forms 5
for 1999. The transactions to be reported include the sales by holders of shares
pledged by the Guarantors,  as described below,  about which the Guarantors were
not aware until after the Form 4 reporting  deadline for such  transactions  had
expired.

           The Guarantors pledged shares of Fonix Class A common stock to
guarantee payment by the Company of certain  expenses.  Such pledged shares were
sold in the second quarter of 1999. The sales by the pledgee will be reported on
the Forms 5 to be filed by the Guarantors.

           The Guarantors also pledged shares in connection with the Company's
offering of its Series C 5%  Convertible  Debentures.  Such pledged  shares were
sold  during the second and third  quarters of 1999.  The sales by the  pledgees
will be reported on Forms 5 to be filed by the Guarantors.

           All sales of such pledged shares were conducted by third party
pledgees  beyond the control of the  Guarantors.  As of the date of this report,
the Guarantors have not received a complete accounting of such sales.

                             Stock Performance Graph

           The following graph compares the yearly cumulative total returns from
the  Company's  Class A common  stock  during the five fiscal year period  ended
December 31, 1999 with the  cumulative  total return on the Media  General Index
and the  Standard  Industrial  Classification  (SIC)  Code  Index  for that same
period.  The  comparison  assumes $100 was  invested on January 1, 1994,  in the
Company's  Class A common stock and in the common stock of the  companies in the
referenced Indexes and further assumes reinvestment of dividends.

[GRAPH OMITTED]

<TABLE>
<CAPTION>
                                         1994       1995       1996        1997       1998       1999
                                        ------     ------      ------     ------     ------     ------
<S>                                     <C>        <C>         <C>        <C>         <C>        <C>
FONIX CORPORATION                       100.00     236.97      527.61     185.13      79.38      17.77
SIC CODE INDEX                          100.00      91.12       94.57     126.42     119.91     216.68
NASDAQ MARKET INDEX                     100.00     129.71      161.18     197.16     278.08     490.46
</TABLE>


                                  Page 38 of 47

<PAGE>




ITEM 12.    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following  table sets forth,  as of April 10, 2000,  the number of shares of
common  stock  of the  Company  beneficially  owned by all  persons  known to be
holders  of more than 5% of the  Company's  common  stock  and by the  executive
officers  and  directors  of the  Company  individually  and as a group.  Unless
indicated  otherwise,  the address of the shareholder is the Company's principal
executive offices, 60 East South Temple Street, Suite 1225, Salt Lake City, Utah
84111.

<TABLE>
<CAPTION>
                                               Number of
                                                Shares
Name and Address of 5% Beneficial Owners,     Beneficially       Percent of
Executive Officers and Directors                 Owned            Class(1)
-----------------------------------------    ---------------     ------------

<S>                                           <C>                     <C>
 Thomas A. Murdock                           10,099,084(2)(6)         6.1%
 Chairman f the Board and Chief
 Executive Officer

 Alan C. Ashton, Ph.D.                        9,624,167(3)(4)         5.9%
 c/o Beesmark Investments, L.C.
 5% Beneficial Owner
 261 East 1200 South
 Orem, Utah 84097

 Beesmark Investments, L.C.                   9,624,167(4)            5.9%
 5% Beneficial Owner
 261 East 1200 South
 Orem, Utah  84097

 Roger D. Dudley,                             4,398,723(5)(6)         2.7%
 Executive Vice President,
 Chief Financial Officer,
 Director

 John A. Oberteuffer, Ph.D.,                    710,000 (7)              *
 Vice President, Director
 600 West Cummings Park, Suite 4650
 Woburn, MA  01801

 Douglas L. Rex,                                457,900(8)               *
 Chief Financial Officer(8)

 William A. Maasberg Jr.,                       200,000(7)               *
 Chief Operating Officer,
 Director

 Mark S. Tanner, Director                       200,000(7)               *

 Officers and Directors as a
  Group (6 persons)                          14,054,305               8.4%
-----------------------
</TABLE>

*        Less than 1 percent.

(1)  Percentages  rounded to nearest 1/10th of one percent.  Except as indicated

                                 Page 39 of 47
<PAGE>


     in the footnotes  below,  each of the persons listed  exercises sole voting
     and  investment  power over the shares of Common Stock listed for each such
     person in the table.

(2)  Includes  8,706,771 shares of Common Stock deposited in a voting trust (the
     "Voting  Trust") as to which Mr.  Murdock is the sole trustee.  Persons who
     have  deposited  their  shares of Common  Stock into the Voting  Trust have
     dividend and liquidation  rights  ("Economic  Rights") in proportion to the
     number of shares of Common Stock they have  deposited in the Voting  Trust,
     but have no voting  rights with respect to such shares.  All voting  rights
     associated with the shares  deposited into the Voting Trust are exercisable
     solely and exclusively by the Trustee of the Voting Trust. The Voting Trust
     expires,  unless  extended  according  to  its  terms,  on the  earlier  of
     September  30,  2002,  or any of the  following  events:  (i)  the  Trustee
     terminates it; (ii) the participating  shareholders  unanimously  terminate
     it; or (iii) the Company is dissolved or  liquidated.  Although as the sole
     trustee of the Voting Trust Mr. Murdock  exercises the voting rights of all
     of the shares  deposited into the Voting Trust,  and accordingly has listed
     all shares in the table above, he has no economic or pecuniary  interest in
     any of the shares  deposited  into the Voting  Trust  except for  2,848,415
     shares as to which he directly owns Economic Rights, and 185,793 shares the
     Economic Rights as to which are owned by Studdert Companies Corp.  ("SCC"),
     a corporation  of which Mr.  Murdock is a 1/3 equity  owner.  Also includes
     2,813  shares  owned  directly by Mr.  Murdock,  11,400  shares  owned by a
     limited  liability  company of which Mr.  Murdock  is a 1/3  equity  owner,
     28,099  shares  (including  shares  issuable  upon the exercise of options)
     beneficially owned by members of Mr. Murdock's immediate family residing in
     the same household and 1,350,000  shares of Common Stock  underlying  stock
     options owned by Mr. Murdock and exercisable presently or within 60 days of
     April 10, 2000.

(3)  Includes all Common Stock beneficially owned by Beesmark Investments,  L.C.
     ("Beesmark"),  but  only to the  extent  that  Dr.  Ashton  is one of three
     managers of Beesmark,  and, as such,  is deemed to share  investment  power
     with respect to shares beneficially owned by Beesmark.

(4)  Beesmark's  beneficial  ownership  includes  166,667 shares of Common Stock
     presently  issuable  upon the  conversion  of shares of Series A  Preferred
     Stock.  The owners of  Beesmark  are Alan C.  Ashton and Karen  Ashton.  As
     owners of  Beesmark,  they each are  deemed to share  voting  control  over
     shares beneficially owned by Beesmark.  Mrs. Ashton is beneficially owns no
     shares  other  those  deemed  to be owned  by her as a  control  person  of
     Beesmark,  and,  consequently,  her beneficial  ownership is not separately
     reported.

(5)  Includes (i) 2,848,417 shares owned by Mr.  Dudley and  deposited  into the
     Voting  Trust,  (ii)  185,793  shares  owned by SCC as to which Mr.  Dudley
     shares  investment  power because of his  management  position with and 1/3
     ownership of SCC, which shares are deposited  into the Voting Trust;  (iii)
     2,813 shares  owned  directly by Mr.  Dudley;  (iv) 300 shares owned by Mr.
     Dudley's  minor  children;  (v) 11,400 shares owned by a limited  liability
     company  of which Mr.  Dudley is a 1/3  equity  owner;  and (vi)  1,350,000
     shares underlying stock options exercisable  presently or within 60 days of
     April 10, 2000. Mr. Dudley became Chief Financial Officer of the Company on
     March 21, 2000.

(6)  During 1999, Messrs.  Murdock and Dudley pledged their beneficial  interest
     in  4,000,000 of their shares of the Class A common stock of the Company in
     connection with certain obligations of the Company, and such pledged shares
     were sold by the pledgees. The Company has an obligation to issue 4,000,000
     replacement  shares to Messrs.  Murdock and Dudley in connection with those
     pledged shares sold.

(7)  Consisting of options which are presently exercisable.

(8)  Includes (i) 2,400 shares owned by Mr. Rex's spouse;  (ii)500  shares owned
     by an  entity  owned  and  controlled  by him;  and  (iii)  455,000  shares
     underlying  presently  exercisable  stock options.  Mr. Rex is no longer an
     officer of the Company.



                                  Page 40 of 47

<PAGE>


ITEM 13.             CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Studdert Companies Corp. (SCC)

           SCC is a Utah  corporation  that provides  investment  and management
services.  The officers,  directors  and owners of SCC are Stephen M.  Studdert,
former  chairman  and CEO of the  Company,  and Thomas A.  Murdock  and Roger D.
Dudley, each of whom is a director and executive officer of the Company.

           The Company subleases from SCC its corporate  headquarters located at
60 East South Temple Street, Salt Lake City, Utah. The sublease is from month to
month  pursuant to which the Company has agreed to pay the actual monthly rental
of  $10,368  and all  common  area  charges  payable  under the lease with SCC's
landlord.

Indemnity Agreement Related to Debenture Offering

         In connection with the Company's January and March 1999 offering of its
debentures,  Stephen M. Studdert,  Thomas A. Murdock and Roger D. Dudley entered
into stock pledge agreements, whereby each personally guaranteed the performance
and  obligations  of the Company  under the  Debentures,  and pledged  6,000,000
shares  of  common  stock of the  Company  owned by them as  security  for their
obligations under the guaranty.  The Company entered into an Indemnity Agreement
under which it agreed that,  in the event of a default by the Company  under the
terms of the debenture offering, if any or all of Messrs. Studdert,  Murdock, or
Dudley were  required to pay money or forfeit any of their pledged  shares,  the
Company would replace shares so forfeited and repay the obligation and liability
of each of Messrs. Studdert,  Murdock, or Dudley by paying cash in amounts equal
to  the  out-of-pocket  expenses  of  Messrs.  Studdert,  Murdock,  and  Dudley.
Additionally,  the  disinterested  members of the  Company's  board of directors
agreed that, in consideration of the pledge,  the Company would issue to each of
Messrs.  Studdert,  Murdock and Dudley  warrants to purchase  666,666  shares of
common  stock at an  exercise  price of $1.59 per  share.  The  warrants  have a
10-year  term.  Subsequently,  Messrs.  Studdert,  Murdock and Dudley  agreed to
indefinitely suspend their rights to receive these warrants.


                                  Page 41 of 47

<PAGE>

           However, subsequent to the March 1999 funding, the holders of the
debentures  notified the Company and the Guarantors  that the Guarantors were in
default under the terms of the pledge and that the holders  intended to exercise
their  rights to sell some or all of the  pledged  shares.  The  holders  of the
debentures  subsequently  informed  the  Company  and the  Guarantors  that  the
6,000,000  pledged  shares were sold.  Under its  indemnity  agreement  with the
Guarantors,  the Company  agreed to issue  6,000,000  replacement  shares to the
Guarantors for the shares sold by the holders of the debentures and to reimburse
the  Guarantors  for any costs incurred as a result of the holders' sales of the
Guarantors'  shares.  In 1999,  the  Company  estimated  and  recorded  expenses
amounting to $1,296,600 pursuant to the indemnity agreement.


John A. Oberteuffer

           In February 2000, the Company entered into an agreement to purchase
from John A.  Oberteuffer,  who is an  executive  officer  and  director  of the
Company,  all of Dr.  Oberteuffer's  rights and interests in certain methods and
apparatus for  integrated  voice and pen input for use in computer  systems.  In
payment for Dr.  Oberteuffer's  technology,  the Company granted Dr. Oberteuffer
600,000  warrants to purchase the Company's  Class A common stock at an exercise
price of $1.00 per share.  The warrants  expire  February 10,  2010.  Also,  the
Company granted Dr.  Oberteuffer the right to repurchase the technology from the
Company at fair  market  value if the  Company  subsequently  determines  not to
commercialize the pen/voice technologies or products.


Loans and Advances to the Company

           During 1999, Messrs.  Murdock,  Dudley and Studdert advanced funds in
the aggregate  amount of $317,159  related to sales of the Company's stock owned
by them that was pledged as collateral under certain borrowing  agreements.  The
balance was subsequently repaid in full. Also, Mr. Dudley advanced an additional
$68,691 to the Company for  operating  expenses,  all of which was  subsequently
repaid to him.  There were no amounts owed to these  individuals at December 31,
1999.

Stock Pledges for Payment of Legal Fees

The Company and Messrs.  Murdock and Dudley entered into an agreement with a New
York law firm regarding  payment of the Company's  legal fees owed to that firm.
Under the  agreement,  Mr.  Murdock,  as trustee,  entered  into a stock  pledge
agreement  pledging  100,000 shares of the Company's  common stock  beneficially
owned by Messrs.  Murdock and Dudley, and Messrs.  Murdock and Dudley guaranteed
the full payment of the Company's legal fees to the law firm,  together with any
other  indebtedness of the Company to the law firm. At the time Messrs.  Murdock
and  Dudley  agreed to  guarantee  the  payment,  the  Company  owed fees in the
approximate amount of $142,875 to the law firm. Subsequently,  the law firm sold
the shares held as collateral  to satisfy the  outstanding  obligation.  Messrs.
Murdock  and Dudley were  reimbursed  in cash for the value of the shares at teh
time of the sale by the law firm.


                                     PART IV

ITEM 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(A) Documents filed as part of this Form 10-K:

          1.   Consolidated Financial Statements (included in Part II, Item 8)


                                  Page 42 of 47

<PAGE>




               Consolidated Balance Sheets as of December 31, 1999 and 1998

               Consolidated   Statements  of  Operations  for  the  Years  Ended
               December 31, 1999,  1998 and 1997 and for the Period from October
               1, 1993 (Date of Inception) to December 31, 1999

               Consolidated  Statements  of  Stockholders'  Equity for the Years
               Ended  December 31,  1999,  1998 and 1997 and for the Period from
               October 1, 1993 (Date of Inception) to December 31, 1999

               Consolidated  Statements  of  Cash  Flows  for  the  Years  Ended
               December 31, 1999,  1998 and 1997 and for the Period from October
               1, 1993 (Date of Inception) to December 31, 1999

               Notes to Consolidated Financial Statements

          2.   Financial Statement Schedules: None

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

           Exhibit No.         Description of Exhibit

            (2)(i)       Agreement  and  Plan  of  Reorganization  among  the
                         Company,  Fonix  Acquisition  Corporation  and AcuVoice
                         dated as of January 13, 1998, incorporated by reference
                         from the Company's  Current  Report on Form 8-K,  filed
                         March 20, 1998

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

            (2)(iii)     Agreement  and Plan of Merger among Fonix,  Papyrus
                         Acquisition Corporation,  and Papyrus Associates, Inc.,
                         dated  as  of  September  10,  1998,   incorporated  by
                         reference  from the  Company's  Current  Report on Form
                         8-K, filed November 13, 1998

            (3)(i)       Articles of  Incorporation  of the Company  which are
                         incorporated    by   reference   from   the   Company's
                         Registration   Statement  on  Form  S-18  dated  as  of
                         September 12, 1989

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

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

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

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

            (4)(i)       Description  of the Company's  common stock and other
                         securities and specimen certificates  representing such
                         securities which are incorporated by reference from the
                         Company's  Registration Statement on Form S-18 dated as
                         of September 12, 1989, as amended


                                  Page 43 of 47

<PAGE>





            (4)(ii)      Certificate of Designation of Rights and Preferences
                         of Series A Preferred  Stock,  filed with the Secretary
                         of State of Delaware on September  24,  1997,  which is
                         incorporated by reference from the Company's  Quarterly
                         Report on Form 10-Q for the period ended  September 30,
                         1997

            (4)(iii)     Certificate   of   Designation   of  Rights   and
                         Preferences  of Series B Convertible  Preferred  Stock,
                         filed  with  the  Secretary  of State  of  Delaware  on
                         October 27, 1997,  which is  incorporated  by reference
                         from the  Company's  Quarterly  Report on Form 10-Q for
                         the period ended September 30, 1997

            (4)(iv)      Certificate of Designation of Rights and Preferences
                         of 5% Series C Convertible  Preferred Stock, filed with
                         the Secretary of State of Delaware on October 24, 1997,
                         which is  incorporated  by reference from the Company's
                         Quarterly  Report  on Form  10-Q for the  period  ended
                         September 30, 1997

            (4)(v)       Certificate of Designation of Rights and  Preferences
                         of Series D 4% Convertible  Preferred Stock, filed with
                         the  secretary of State of Delaware on August 27, 1998,
                         which is  incorporated  by reference from the Company's
                         Quarterly  Report  on Form  10-Q for the  period  ended
                         September 30, 1998

            (4)(vi)      Certificate of Designation of Rights and Preferences
                         of Series E 4% Convertible  Preferred Stock, filed with
                         the secretary of State of Delaware on October 15, 1998,
                         which is  incorporated  by reference from the Company's
                         Quarterly  Report  on Form  10-Q for the  period  ended
                         September 30, 1998

            (9)(i)       Voting Trust  Agreement dated as of December 10, 1993
                         by and among  Phonic  Technologies,  Inc.,  Stephen  M.
                         Studdert,  Thomas A. Murdock and Roger D. Dudley, which
                         is incorporated by reference from the Company's Current
                         Report on Form 8-K dated as of June 17, 1994

            (9)(ii)      Amendment of Voting Trust Agreement by and among the
                         Company, Stephen M. Studdert,  Thomas A. Murdock, Roger
                         D.  Dudley,   Beesmark   Investments,   L.C.,  Studdert
                         Companies   Corporation,   and  Thomas  A.  Murdock  as
                         Trustee, dated as of October 23, 1995,  incorporated by
                         reference from the Company's Current Report on Form 8-K
                         dated as of October 23, 1995

            (9)(iii)     Second  Amendment of Voting Trust  Agreement by and
                         among  the  Company,  Stephen  M.  Studdert,  Thomas A.
                         Murdock, Roger D. Dudley,  Beesmark Investments,  L.C.,
                         Studdert Companies  Corporation,  and Thomas A. Murdock
                         as Trustee,  dated as of July 2, 1996,  incorporated by
                         reference from the Annual Report on Form 10-KSB for the
                         fiscal year ended December 31, 1996

            (9)(iv)      Third  Amendment  of Voting  Trust  Agreement by and
                         among  the  Company,  Stephen  M.  Studdert,  Thomas A.
                         Murdock, Roger D. Dudley,  Beesmark Investments,  L.C.,
                         Studdert Companies  Corporation,  and Thomas A. Murdock
                         as   Trustee,   dated  as  of   September   20,   1996,
                         incorporated  by  reference  from the Annual  Report on
                         Form 10-KSB for the fiscal year ended December 31, 1996

            (9)(v)       Fourth  Amendment  of Voting  Trust  Agreement by and
                         among  the  Company,  Stephen  M.  Studdert,  Thomas A.
                         Murdock, Roger D. Dudley,  Beesmark Investments,  L.C.,
                         Studdert Companies  Corporation,  and Thomas A. Murdock
                         as   Trustee,   dated  as  of   September   20,   1996,
                         incorporated  by  reference  from the Annual  Report on
                         Form 10-KSB for the fiscal


                                  Page 44 of 47

<PAGE>



                         year ended December 31, 1996

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

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

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

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

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

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

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

            (10)(viii)   Restated  First  Statement  of Work and  License
                         Agreement  between  the  Company  and  Siemens,   dated
                         February 11, 1998, as revised, which is incorporated by
                         reference from the Company's Annual Report on Form 10-K
                         for the year ended December 31, 1997

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

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

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

            (10)(xii)    Royalty  Modification  Agreement among the Company
                         and  Synergetics,  dated as of April 6, 1998,  which is
                         incorporated  by reference  from the  Company's  Annual
                         Report on Form  10-K for the year  ended  December  31,
                         1997

            (10)(xiii)   Purchase  Agreement with John Oberteuffer and the
                         Company dated April 9, 1998, which


                                                              Page 45 of 47

<PAGE>



                         is   incorporated  by  reference  from the  Company's
                         AnnualReport on Form 10-K for the year ended December
                         31, 1997

            (10)(xiv)    Employment  Agreement  by and between the Company
                         and  John A.  Oberteuffer,  which  is  incorporated  by
                         reference from the Company's Annual Report on Form 10-K
                         for the year ended December 31, 1997

            (10)(xv)     First  Amendment  to  Master  Agreement  for Joint
                         Collaboration  between the Company and  Siemens,  dated
                         February 13, 1998,  which is  incorporated by reference
                         from the  Company's  Annual Report on Form 10-K for the
                         year ended December 31, 1997

            (10)(xvi)    Second  Amendment  to Master  Agreement  for Joint
                         Collaboration  between the Company and  Siemens,  dated
                         March 13, 1998, which is incorporated by reference from
                         the  Company's  Annual Report on Form 10-K for the year
                         ended December 31, 1997

            (10)(vii)    Series D  Convertible  Preferred  Stock  Purchase
                         Agreement  Among  Fonix  corporation,  JNC  Opportunity
                         Fund, Ltd., Diversified Strategies Fund, L.P., Dominion
                         Capital Fund, Ltd.,  Sovereign  Partners,  LP, Canadian
                         Advantage  Limited  Partnership and Thomson Kernaghan &
                         Co.   (as  agent)   dated  as  of  August   31,   1998,
                         incorporated by reference from the Company's  Quarterly
                         Report on Form 10-Q for the period ended  September 30,
                         1998

            (10)(xviii)  Series E Convertible  Preferred  Stock  Exchange
                         and  Purchase   Agreement   among  Fonix   corporation,
                         Sovereign Partners, LP and Dominion Capital Fund, Ltd.,
                         dated  as  of  September  30,  1998,   incorporated  by
                         reference from the Company's  Quarterly  Report on Form
                         10-Q for the period ended September 30, 1998

            (10)(xix)    Securities   Purchase   Agreement   among  Fonix
                         Corporation and JNC Strategic Fund,  dated December 21,
                         1998 for 1,801,802 shares of common stock and Repricing
                         Rights,  incorporated by reference from Amendment No. 1
                         to  Registration   Statement  on  Form  S-3  (File  No.
                         333-67573)

            (10)(xx)     Securities   Purchase   Agreement   among   Fonix
                         Corporation and the investors  identified therein dated
                         January 29,  1999,  as  supplemented  on March 3, 1999,
                         concerning  sales of  $6,500,000  principal  amount  of
                         Series C 5%  Convertible  Debentures,  incorporated  by
                         reference   from   Amendment  No.  1  to   Registration
                         Statement on Form S-3 (File No. 333- 67573)

            (10)(xxi)    Asset  Purchase  Agreement -  Acquisition  of Certain
                         Assets of Fonix Corporaion and Fonix/ASI  Corporation
                         by Lernout & Hauspie Speech  Products N.V.,  dated as
                         of May 19,  1999,which is  incorporated  by reference
                         from the Company's  Current Report on Form 8-K, filed
                         with the  Commission  on September  16, 1999 (therein
                         designated as Exhibit 10(a))

            (10)(xxii)   Escrow Agreement, dated as of September 1, 1999,which
                         is  incorporated  by  reference  from  the  Company's
                         Current Report on Form 8-K, filed with the Commission
                         on September 16, 1999 (therein  designated as Exhibit
                         10(b))

            (10)(xxiii)  Technology  Option  Agreement,  dated  as of May  19,
                         1999,which  is  incorporated  by  reference  from the
                         Company's  Current Report on Form 8-K, filed with the
                         Commission on September 16, 1999 (therein  designated
                         as Exhibit 10(c))

            (10)(xxiv)   Assignment  and  Assumption  Agreement,  dated  as of
                         September 1,  1999,which is incorporated by reference
                         from the Company's  Current Report on Form 8-K, filed
                         with the  Commission  on September  16, 1999 (therein
                         designated as Exhibit 10(d))

            (10)(xxv)    License    Agreement   by   and   between   Fonix/ASI
                         Corporation  and  Lernout & Hauspie  Speech  Products
                         N.V., dated as of May 19,  1999,which is incorporated
                         by reference  from the  Company's  Current  Report on
                         Form 8-K,  filed with the Commission on September 16,
                         1999 (therein designated as Exhibit 10(e))

            (10)(xxvi)   Loan Agreement,  dated as of April 22,  1999,which is
                         incorporated by reference from the Company's  Current
                         Report  on Form 8-K,  filed  with the  Commission  on
                         September  16, 1999  (therein  designated  as Exhibit
                         10(f))

            (10)(xxvii)  Amendment  to  Loan  Agreement,  dated  as of May 12,
                         1999,which  is  incorporated  by  reference  from the
                         Company's  Current Report on Form 8-K, filed with the
                         Commission on September 16, 1999 (therein  designated
                         as Exhibit 10(g))

            (10)(xxviii) Second  Amendment to Loan Agreement,  dated as of May
                         19,  1999,which is incorporated by reference from the
                         Company's  Current Report on Form 8-K, filed with the
                         Commission on September 16, 1999 (therein  designated
                         as Exhibit 10(h))

            (10)(xxix)   Loan  Agreement,  dated as of May 19,  1999,which  is
                         incorporated by reference from the Company's  Current
                         Report  on Form 8-K,  filed  with the  Commission  on
                         September  16, 1999  (therein  designated  as Exhibit
                         10(i))

            (10)(xxx)    First Amendment to Loan Agreement, dated as of August
                         12,  1999,which is incorporated by reference from the
                         Company's  Current Report on Form 8-K, filed with the
                         Commission on September 16, 1999 (therein  designated
                         as Exhibit 10(j))

            (10)(xxxi)   Agreement,   dated  as  of  July  31,  1999,which  is
                         incorporated by reference from the Company's  Current
                         Report  on Form 8-K,  filed  with the  Commission  on
                         September  16, 1999  (therein  designated  as Exhibit
                         10(k))

            (10)(xxxii)  Series F. Convertible Preferred Stock Purchase
                         Agreement, Among Fonix Corporation, Sovereign
                         Partners, LP, Dominion Capital Fund, LTD., Dominion
                         Investment Fund, LLC, Canadian Advantage, L.P., and
                         Queen LLC, dated as of February 1, 2000

            (22)         Subsidiaries of Registrant

            (23)(i)      Consent of Arthur Andersen LLP

            (23)(ii)     Consent of Pritchett Siler & Hardy, P.C.

            (27)         Financial Data Schedule



(B) Reports  filed on Form 8-K during the last  quarter of the fiscal year ended
December 31, 1999:

           On November 15, 1999, the Company filed  Amendment No. 1 to a Current
           Report filed on Form 8-K on September 16, 1999 pertaining to the sale
           and a significant  portion of the assets of the Company's  HealthCare
           Solutions  Group. The amendment was filed to submit certain pro forma
           financial information required by Item 7 of Form 8-K.



                                  Page 46 of 47

<PAGE>



                                   SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  registrant  has duly  caused  this report to be signed on its
behalf by the undersigned,  thereunto duly authorized, on this 14th day of April
2000.

                                        Fonix Corporation


Date: April 14, 2000                    By:   /s/ Thomas A. Murdock
     --------------------               ---------------------------------------
                                        Thomas A. Murdock, President and
                                        Chief Executive Officer


Date: April 14, 2000                    By:    /s/ Roger D. Dudley
     --------------------               ---------------------------------------
                                        Roger D. Dudley, Executive Vice
                                        President Finance and Chief Financial
                                        Officer (Principal Financial and
                                        Accounting Officer)



In  accordance  with the Exchange  Act, this report has been signed below by the
following  persons on behalf of the  registrant and in the capacities and on the
dates indicated:


/s/ Thomas A. Murdock                   /s/ William A. Maasberg, Jr.
---------------------------------       ----------------------------------------
Thomas A. Murdock, President and        William A. Maasberg, Jr., Director
           Chief Executive Officer

  April 14, 2000                          April 14, 2000
------------------------------          --------------------------------------
Date                                    Date



/s/ Roger D. Dudley                     /s/ Mark S. Tanner
---------------------------------       ----------------------------------------
Roger D. Dudley, Executive Vice         Mark S. Tanner, Director
President, Director

  April 14, 2000                          April 14, 2000
------------------------------          --------------------------------------
Date                                    Date


/s/ John A. Oberteuffer
------------------------------
John A. Oberteuffer, Ph.D., Director

  April 14, 2000
------------------------------
Date






                                  Page 47 of 47

<PAGE>

                                TABLE OF CONTENTS



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS  (ARTHUR ANDERSEN LLP)              F-2

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS (PRITCHETT, SILER &
     HARDY, P.C.)                                                            F-3

CONSOLIDATED FINANCIAL STATEMENTS:

  Consolidated Balance Sheets as of December 31, 1999 and 1998               F-4

  Consolidated Statements of Operations for the Years Ended December 31,
       1999, 1998 and 1997 and for the Period from October 1, 1993 (Date
       of Inception) to December 31, 1999                                    F-5

  Consolidated  Statements of  Stockholders'  Equity for the Years Ended
       December 31, 1999,  1998 and 1997 and for the Period from October
       1, 1993 (Date of Inception) to December 31, 1999                      F-6

 Consolidated Statements of Cash Flows for the Years Ended December 31,
      1999, 1998 and 1997 and for the Period from October 1, 1993 (Date
      of Inception) to December 31, 1999                                     F-9

  Notes to Consolidated Financial Statements                                F-11








<PAGE>



                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Fonix Corporation:

We  have  audited  the  accompanying   consolidated   balance  sheets  of  Fonix
Corporation (a Delaware  corporation in the development  stage) and subsidiaries
as of  December  31, 1999 and 1998 and the related  consolidated  statements  of
operations,  stockholders'  equity and cash flows for each of the three years in
the period ended December 31, 1999 and for the period from inception (October 1,
1993) to December 31, 1999. These financial statements are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
financial statements based on our audits. The consolidated  financial statements
of the Company for the period from  inception  (October 1, 1993) to December 31,
1995 were audited by other auditors whose report, dated March 4, 1996, expressed
an unqualified opinion on those statements and included an explanatory paragraph
regarding the Company's ability to continue as a going concern. The consolidated
financial statements for the period from inception (October 1, 1993) to December
31, 1995 reflect a net loss of  $12,012,299  of the total  inception to date net
loss of  $107,076,956.  The other auditors' report has been furnished to us, and
our  opinion,  insofar  as it  relates to the  amounts  included  for such prior
periods, is based solely on the report of such other auditors.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable  assurance about whether the financial  statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We  believe  that our  audits  and the  report of other  auditors
provide a reasonable basis for our opinion.

In our  opinion,  based on our audits and the report of other  auditors  for the
cumulative  information  for the  period  from  inception  (October  1, 1993) to
December 31,  1995,  the  consolidated  financial  statements  referred to above
present fairly, in all material respects, the consolidated financial position of
Fonix  Corporation  and  subsidiaries  as of December  31, 1999 and 1998 and the
results of their  operations and their cash flows for each of the three years in
the period ended December 31, 1999,  and for the period from inception  (October
1, 1993) to December 31, 1999 in conformity with accounting principles generally
accepted in the United States.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated  financial  statements,  the Company has not generated  significant
revenues through December 31, 1999 and has incurred significant losses since its
inception.  The  Company  expects  these  losses to  continue  at least  through
December 31,  2000.  As of December  31,  1999,  the Company has an  accumulated
deficit of $116,706,803, negative working capital of $4,804,796, and $981,301 of
accounts  payable over 60 days past due. These matters raise  substantial  doubt
about the Company's ability to continue as a going concern.  Management's  plans
with respect to these  matters are also  described  in Note 1. The  accompanying
consolidated  financial  statements  do not include any  adjustments  that might
result from the outcome of this uncertainty.


/s/ Arthur Andersen LLP

ARTHUR ANDERSEN LLP

Salt Lake City, Utah
April 10, 2000



<PAGE>




                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS




To the Board of Directors
Fonix Corporation
Salt Lake City, Utah


We have audited the consolidated statements of operations,  stockholders' equity
and cash flows of Fonix Corporation and subsidiary [a development stage company]
for the period from  October 1, 1993 (date of  inception)  to December  31, 1995
(these  financial  statements  are  not  presented  separately  herein).   These
consolidated  financial  statements  are  the  responsibility  of the  Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards  require that we plan and perform the audit to obtain reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects,  the consolidated results of operations and cash flows of
Fonix  Corporation  and subsidiary (a development  stage company) for the period
from October 1, 1993 (date of inception) to December 31, 1995 in conformity with
generally accepted accounting principles.

The  consolidated  financial  statements  referred  to above have been  prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated  financial  statements,  the Company is in the development
stage and has suffered  recurring losses which raise substantial doubt about its
ability to continue as a going  concern.  Management's  plans in regard to these
matters are also described in Note 1. The consolidated  financial  statements do
not  include  any  adjustments  that  might  result  from  the  outcome  of this
uncertainty.


/s/ Pritchett, Siler & Hardy, P.C.

PRITCHETT, SILER & HARDY, P.C.

Salt Lake City, Utah
March 4, 1996


<PAGE>
                                Fonix Corporation
                          (A Development Stage Company)

                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

ASSETS
                                                                                         December 31,          December 31,
                                                                                            1999                  1998
                                                                                     ---------------------  -----------------
<S>                                                                                  <C>                    <C>
Current assets:
     Cash and cash equivalents                                                       $           232,152    $     20,045,539
     Notes receivable                                                                                  -             245,000
     Accounts receivable, net of allowance for doubtful accounts of
           $20,000 and $8,000, respectively                                                      184,901             219,908
     Prepaid expenses                                                                             51,747              51,866
     Interest and other receivables                                                                1,546               3,722
     Inventory                                                                                    10,539               4,804
     Employee advances                                                                                 -              67,231
                                                                                     ---------------------  -----------------

          Total current assets                                                                   480,885          20,638,070

Funds held in escrow                                                                           2,038,003                   -

Property and equipment, net of accumulated depreciation of $1,938,494
     and $1,168,023, respectively                                                              1,148,802           2,145,031

Intangible assets, net of accumulated amortization of $ 4,392,457
     and $1,770,668, respectively                                                             15,399,593          19,437,290

Other assets                                                                                     105,864             107,945

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

          Total assets                                                               $        19,173,147    $     61,912,791
                                                                                     =====================  =================

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Bank overdraft                                                                  $                 -    $        138,034
     Advances                                                                                  1,000,000                   -
     Revolving notes payable                                                                           -          20,038,193
     Notes payable - related parties                                                              77,625           8,491,880
     Notes payable - other                                                                             -             560,000
     Accounts payable                                                                          1,359,040           3,536,074
     Accrued liabilities                                                                         857,033             981,774
     Accrued liabilities - related parties                                                     1,814,134             900,004
     Income taxes payable                                                                         50,000                   -
     Deferred revenues                                                                           127,849              20,000
     Capital lease obligation                                                                          -              52,225
     Net current liabilities of discontinued operations                                                -             598,861
                                                                                     ---------------------  -----------------

          Total current liabilities                                                            5,285,681          35,317,045

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

          Total liabilities                                                                    9,256,788          35,317,045
                                                                                     ---------------------  -----------------

Common stock and related repricing rights subject to redemption;
     1,801,802 shares and repricing rights outstanding in 1999
     and 1998 (aggregate redemption value of $2,500,000)                                       1,830,000           1,830,000
                                                                                     ---------------------  -----------------

Commitments and contingencies (Notes 1, 12, 14, 16, 17 and 20)

Stockholders' equity:
     Preferred stock, $.0001 par value; 50,000,000 shares authorized;
          Series A, convertible; 166,667 shares outstanding
              (aggregate liquidation preference of $6,055,012)                                   500,000             500,000
          Series D, 4% cumulative convertible; 381,723 and 1,008,334
              shares outstanding in 1999 and 1998, respectively
              (aggregate liquidation preference of $8,043,579)                                 9,095,910          22,200,936
          Series E, 4% cumulative convertible; 135,072 shares
              outstanding in 1998                                                                      -           3,257,886
     Common stock, $0.0001 par value; 300,000,000 shares authorized
          Class A voting, 123,535,325 and 64,324,480 shares
          outstanding in 1999 and 1998, respectively                                              12,353               6,432
          Class B non-voting, none outstanding                                                         -                   -
     Additional paid-in capital                                                              112,769,420          88,517,711
     Outstanding warrants                                                                      2,850,530           3,323,258
     Deferred consulting expense                                                                (435,051)           (106,700)
     Deficit accumulated during the development stage                                       (116,706,803)        (92,933,777)
                                                                                     ---------------------  -----------------

          Total stockholders' equity                                                           8,086,359          24,765,746
                                                                                     ---------------------  -----------------

          Total liabilities and stockholders' equity                                 $        19,173,147    $     61,912,791
                                                                                     =====================  =================
</TABLE>




          See accompanying notes to consolidated financial statements.


                                      F-4

<PAGE>
                                Fonix Corporation
                          (A Development Stage Company)

                      CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                                               October 1,
                                                                                                  1993
                                                                                              (Inception) to
                                                          Years Ended December 31,             December 31,
                                                 ------------------------------ -------------
                                                     1999           1998           1997           1999
                                                 -------------- --------------- ------------- --------------

<S>                                              <C>            <C>             <C>           <C>
Revenues                                         $     439,507  $   2,604,724   $          -  $   3,044,231
Cost of revenues                                        24,932         35,440              -         60,372
                                                 -------------- --------------- ------------- --------------

     Gross margin                                      414,575      2,569,284              -      2,983,859
                                                 -------------- --------------- ------------- --------------

Expenses:
     Selling, general and administrative             9,498,753      8,817,643     12,947,112     40,563,066
     Product development and research                7,909,228     13,060,604      7,066,294     38,907,125
     Amortization of goodwill and purchased
          core technology                            2,588,896      1,712,267              -      4,301,163
     Purchased in-process research and
          development                                        -      9,315,000              -      9,315,000
                                                 -------------- --------------- ------------- --------------

         Total expenses                             19,996,877     32,905,514     20,013,406     93,086,354
                                                 -------------- --------------- ------------- --------------

Loss from operations                               (19,582,302)   (30,336,230)   (20,013,406)   (90,102,495)
                                                 -------------- --------------- ------------- --------------

Other income (expense):
     Interest income                                    95,023      1,075,021      1,199,610      3,762,111
     Interest expense                               (3,636,467)    (1,470,689)    (2,758,288)    (8,959,699)
     Other                                            (157,345)             -              -       (157,345)
     Cancellation of common stock reset
          provision                                          -     (6,111,577)             -     (6,111,577)
                                                 -------------- --------------- ------------- --------------

         Total other income (expense), net          (3,698,789)    (6,507,245)    (1,558,678)   (11,466,510)
                                                 -------------- --------------- ------------- --------------

Loss from continuing operations before
     income tax benefit                            (23,281,091)   (36,843,475)   (21,572,084)  (101,569,005)

 Income tax benefit                                  3,331,895              -              -      3,331,895
                                                 -------------- --------------- ------------- --------------

Loss from continuing operations                    (19,949,196)   (36,843,475)   (21,572,084)   (98,237,110)

Discontinued operations:
     Operating loss of HealthCare Solutions
          Group                                     (5,953,726)    (6,275,307)             -    (12,229,033)
     Gain on disposal of HealthCare Solutions
          Group, net of income taxes of
          $3,100,000                                 3,766,646              -              -      3,766,646
                                                 -------------- --------------- ------------- --------------

Loss before extraordinary items                    (22,136,276)   (43,118,782)   (21,572,084)  (106,699,497)

Extraordinary items:
     Loss on extinguishment of debt                          -              -       (881,864)      (881,864)
     Gain on forgiveness of debt, net of
          income taxes of $281,895                     473,857              -              -        504,405
                                                 -------------- --------------- ------------- --------------

Net loss                                         $ (21,662,419) $ (43,118,782)  $(22,453,948) $(107,076,956)
                                                 ============== =============== ============= ==============


Basic and diluted net loss per common share      $       (0.31) $       (0.91)  $      (0.59)
                                                 ============== =============== =============
</TABLE>


          See accompanying notes to consolidated financial statements.


                                      F-5

<PAGE>

                               Fonix Corporation
                         (A Development Stage Company)

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                                                        Series A                         Series B
                                                                      Preferred Stock                 Preferred Stock
                                                                ---------------------------    ----------------------------
                                                                    Shares       Amount            Shares         Amount
                                                                ------------   ------------    ------------    ------------
<S>                                                             <C>            <C>             <C>             <C>
Balance, October 1, 1993 (date of inception)                              -    $         -               -     $         -

Net loss for the period October 1, 1993                                   -              -               -               -
  (date of inception) to December 31, 1993
                                                                ------------   ------------    ------------    ------------
Balance, December 31, 1993                                                -              -               -               -

Acquisition of Taris, Inc.                                                -              -               -               -

Shares issued for services at $.14 to $.18 per share                      -              -               -               -

Shares issued for services at $.25 per share                              -              -               -               -

Shares issued for conversion of notes payable
  and interest payable at $.04 per share                                  -              -               -               -

Shares issued for cash at $1.19 to $3.13 per
  share, less offering costs of $368,450                                  -              -               -               -

Net loss for the year ended December 31, 1994                             -              -               -               -
                                                                ------------   ------------    ------------    ------------
Balance, December 31, 1994                                                -              -               -               -

Shares issued during the year for cash at $.45 to
    $2.50 per share, less offering costs of $267,714                      -              -               -               -

Shares issued during the year for services rendered
    and cancellation of accounts payable at $.55 to
    $1.55 per share                                                       -              -               -               -

Warrants issued during the year for  cancellation
    of accounts  payable at $.033 per warrant
    (additional  compensation  expense of $2,282,900
    or $.62 per share was recorded)                                       -              -               -               -

Shares issued during the year upon  conversion of
    warrants for  cancellation  of accounts payable
    at $.35 per share                                                     -              -               -               -

Warrants  issued  during the year for cash at $.0033
    to $.10 per  warrant,  less offering costs of $5,040                  -              -               -               -

Shares issued during the year upon conversion of
  warrants for cash at $.50 to $1.00 per share                            -              -               -               -

Forgiveness of debt with related parties                                  -              -               -               -

Net loss for the year ended December 31, 1995                             -              -               -               -
                                                                ------------   ------------    ------------    ------------
Balance, December 31, 1995                                                -              -               -               -

Shares issued during the year for finders' fees
  at $1.52 to $2.72 per share                                             -              -               -               -

Shares issued during the year upon conversion
  of warrants for cash at $.50 per share                                  -              -               -               -

Shares issued during the year for cash at $.48 to
    $3.38 per share, less offering costs of $2,033,286                    -              -               -               -

Net loss for the year ended December 31, 1996                             -              -               -               -
                                                                ------------   ------------    ------------    ------------
Balance, December 31, 1996                                                -              -               -               -

Shares issued for services at $3.75 to $5.31 per share                    -              -               -               -

Shares issued for services at $6.50 to $8.38 per share                    -              -               -               -

Warrants issued during the year for services                              -              -               -               -

Shares issued upon the exercise of warrants
  for services at $2.00 per share                                         -              -               -               -

Shares issued during the year for cash at $2.50
  per share                                                               -    $         -               -     $         -

Warrants issued during the year in connection with
    the issuance of a convertible debenture and
    convertible preferred stock                                           -              -               -               -

Shares issued upon conversion of convertible
  debenture to common shares                                              -              -               -               -

Series B preferred shares issued for extinguishment
    of convertible  debenture at $20 stated value
    per share                                                             -              -         108,911       2,178,213

Sale of Series C preferred shares  and warrants,
  less cash fees of $201,500                                              -              -               -               -

Sale of Series B preferred shares for cash, less cash
  fees of $145,000                                                        -              -         125,000       2,355,000

Capital contribution in connection with put options                       -              -               -               -

Beneficial conversion features of Series B convertible
   debenture                                                              -              -               -               -

Series A preferred shares issued upon conversion
  of convertible debenture at $3 per share                          166,667        500,000               -               -

Conversion of Series B and Series C preferred shares
  to common shares                                                        -              -        (206,411)     (4,828,488)

Shares issued during the year in connection with
  exercise of options at $2.97 per share                                  -              -               -               -

Shares issued during the year in connection with the
  exercise of warrants at $.50 per share                                  -              -               -               -

Accretion of Series C preferred stock                                     -              -               -               -

Dividends on preferred stock                                              -              -               -         962,934

Net loss for the year ended December 31, 1997                             -              -               -               -
                                                                ------------   ------------    ------------    ------------
Balance, December 31, 1997                                          166,667        500,000          27,500         667,659

Shares issued for debt costs at $1.44 per share                           -              -               -               -

Options issued during the year for services                               -              -               -               -

Shares issued during the year for patent                                  -              -               -               -

Warrants issued during the year for cash                                  -              -               -               -

Shares issued upon the exercise of options and warrants                   -              -               -               -

Shares issued during the year for cash at $4.50
  per share, less issuance costs of $1,033,846                            -              -               -               -

Shares issued for acquisition of AcuVoice, Articulate
    and Papyrus                                                           -              -               -               -


Sale of Series D preferred shares, less issuance costs
  of $546,154                                                             -              -               -               -

Sale of Series E preferred shares, less issuance costs
  of $50,000                                                              -              -               -               -

Exchange of Series D for Series E preferred stock                         -              -               -               -

Conversions of preferred stock to common stock                            -              -         (27,500)       (676,190)

Shares issued for relinquishment of a reset provision                     -              -               -               -

Expiration of warrants                                                    -              -               -               -

Amortization of deferred consulting expense                               -    $         -               -     $         -

Dividends on preferred stock                                              -              -               -           8,531

Net loss for the year ended December 31, 1998                             -              -               -               -
                                                                ------------   ------------    ------------    ------------
Balance, December 31, 1998                                          166,667        500,000               -               -

Options issued during the year for services                               -              -               -               -

Extension of option expiration dates                                      -              -               -               -

Conversions of preferred stock                                            -              -               -               -

Common stock issued for services                                          -              -               -               -

Common stock issued for principal reduction on
    debentures                                                            -              -               -               -

Common stock returned and canceled                                        -              -               -               -

Warrants issued with Series C debentures                                  -              -               -               -

Warrants issued for services                                              -              -               -               -

Warrants expired                                                          -              -               -               -

Amortization of deferred consulting expense                               -              -               -               -

Beneficial conversion features on Series C debentures                     -              -               -               -

Preferred stock dividends                                                 -              -               -               -

Reduction of accrued offering costs                                       -              -               -               -

Net loss for the year ended December 31, 1999                             -              -               -               -
                                                                ------------   ------------    ------------    ------------

Balance, December 31, 1999                                          166,667    $   500,000               -     $         -
                                                                ============   ============    ============    ============
</TABLE>


<TABLE>
<CAPTION>
                                                                           Series C                      Series D
                                                                         Preferred Stock              Preferred Stock
                                                                  ---------------------------    ----------------------------
                                                                      Shares        Amount           Shares         Amount
                                                                  ------------   ------------    ------------    ------------
<S>                                                               <C>            <C>             <C>             <C>
Balance, October 1, 1993 (date of inception)                                -    $         -               -     $         -

Net loss for the period October 1, 1993
  (date of inception) to December 31, 1993                                  -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1993                                                  -              -               -               -

Acquisition of Taris, Inc.                                                  -              -               -               -

Shares issued for services at $.14 to $.18 per share                        -              -               -               -

Shares issued for services at $.25 per share                                -              -               -               -

Shares issued for conversion of notes payable
  and interest payable at $.04 per share                                    -              -               -               -

Shares issued for cash at $1.19 to $3.13 per
  share, less offering costs of $368,450                                    -              -               -               -

Net loss for the year ended December 31, 1994                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1994                                                  -              -               -               -

Shares issued during the year for cash at $.45 to
    $2.50 per share, less offering costs of $267,714                        -              -               -               -

Shares issued during the year for services rendered
    and cancellation of accounts payable at $.55 to
    $1.55 per share                                                         -              -               -               -

Warrants issued during the year for  cancellation of
    accounts  payable at $.033 per warrant (additional
    compensation  expense of $2,282,900 or $.62 per
    share was recorded)                                                     -              -               -               -

Shares issued during the year upon  conversion of
    warrants for  cancellation  of  accounts payable
    at $.35 per share                                                       -              -               -               -

Warrants  issued  during the year for cash at $.0033
    to $.10 per  warrant,  less offering costs of $5,040                    -              -               -               -

Shares issued during the year upon conversion of
  warrants for cash at $.50 to $1.00 per share                              -              -               -               -

Forgiveness of debt with related parties                                    -              -               -               -

Net loss for the year ended December 31, 1995                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1995                                                  -              -               -               -

Shares issued during the year for finders' fees
  at $1.52 to $2.72 per share                                               -              -               -               -

Shares issued during the year upon conversion
  of warrants for cash at $.50 per share                                    -              -               -               -

Shares issued during the year for cash at $.48 to
    $3.38 per share, less offering costs of $2,033,286                      -              -               -               -

Net loss for the year ended December 31, 1996                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1996                                                  -              -               -               -

Shares issued for services at $3.75 to $5.31 per share                      -              -               -               -

Shares issued for services at $6.50 to $8.38 per share                      -              -               -               -

Warrants issued during the year for services                                -              -               -               -

Shares issued upon the exercise of warrants
  for services at $2.00 per share                                           -              -               -               -

Shares issued during the year for cash at $2.50
  per share                                                                 -    $         -               -     $         -

Warrants issued during the year in connection with
    the issuance of a convertible debenture and
    convertible preferred stock                                             -              -               -               -

Shares issued upon conversion of convertible
  debenture to common shares                                                -              -               -               -

Series B preferred shares issued for extinguishment
    of convertible  debenture at $20 stated value per
    share                                                                   -              -               -               -

Sale of Series C preferred shares  and warrants,
  less cash fees of $201,500                                          187,500      2,948,500               -               -

Sale of Series B preferred shares for cash, less cash
  fees of $145,000                                                          -              -               -               -

Capital contribution in connection with put options                         -              -               -               -

Beneficial conversion features of Series B convertible
   debenture                                                                -              -               -               -

Series A preferred shares issued upon conversion
  of convertible debenture at $3 per share                                  -              -               -               -

Conversion of Series B and Series C preferred shares
  to common shares                                                     (2,500)       (62,772)              -               -

Shares issued during the year in connection with
  exercise of options at $2.97 per share                                    -              -               -               -

Shares issued during the year in connection with the
  exercise of warrants at $.50 per share                                    -              -               -               -

Accretion of Series C preferred stock                                       -        600,000               -               -

Dividends on preferred stock                                                -      1,159,057               -               -

Net loss for the year ended December 31, 1997                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1997                                            185,000      4,644,785               -               -

Shares issued for debt costs at $1.44 per share                             -              -               -               -

Options issued during the year for services                                 -              -               -               -

Shares issued during the year for patent                                    -              -               -               -

Warrants issued during the year for cash                                    -              -               -               -

Shares issued upon the exercise of options and warrants                     -              -               -               -

Shares issued during the year for cash at $4.50
  per share, less issuance costs of $1,033,846                              -              -               -               -

Shares issued for acquisition of AcuVoice, Articulate
    and Papyrus                                                             -              -               -               -


Sale of Series D preferred shares, less issuance costs
  of $546,154                                                               -              -         550,000      10,453,846

Sale of Series E preferred shares, less issuance costs
  of $50,000                                                                -              -               -               -

Exchange of Series D for Series E preferred stock                           -              -        (150,000)     (3,079,167)

Conversions of preferred stock to common stock                       (185,000)    (4,767,913)              -               -

Shares issued for relinquishment of a reset provision                       -              -         608,334      11,166,678

Expiration of warrants                                                      -              -               -               -

Amortization of deferred consulting expense                                 -    $         -               -     $         -

Dividends on preferred stock                                                -        123,128               -       3,659,579

Net loss for the year ended December 31, 1998                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1998                                                  -              -       1,008,334      22,200,936

Options issued during the year for services                                 -              -               -               -

Extension of option expiration dates                                        -              -               -               -

Conversions of preferred stock                                              -              -        (626,611)    (14,831,523)

Common stock issued for services                                            -              -               -               -

Common stock issued for principal reduction on debentures                   -              -               -               -

Common stock returned and canceled                                          -              -               -               -

Warrants issued with Series C debentures                                    -              -               -               -

Warrants issued for services                                                -              -               -               -

Warrants expired                                                            -              -               -               -

Amortization of deferred consulting expense                                 -              -               -               -

Beneficial conversion features on Series C debentures                       -              -               -               -

Preferred stock dividends                                                   -              -               -       1,726,497

Reduction of accrued offering costs                                         -              -               -               -

Net loss for the year ended December 31, 1999                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------

Balance, December 31, 1999                                                  -    $         -         381,723     $ 9,095,910
                                                                  ============   ============    ============    ============
</TABLE>


<TABLE>
<CAPTION>
                                                                             Series E                     Class A
                                                                          Preferred Stock                 Common Stock
                                                                  ---------------------------    ----------------------------
                                                                      Shares        Amount           Shares         Amount
                                                                  ------------   ------------    ------------    ------------
<S>                                                               <C>            <C>             <C>             <C>
Balance, October 1, 1993 (date of inception)                                -    $         -      10,395,249     $     1,040

Net loss for the period October 1, 1993
  (date of inception) to December 31, 1993                                  -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1993                                                  -              -      10,395,249           1,040

Acquisition of Taris, Inc.                                                  -              -         411,611              41

Shares issued for services at $.14 to $.18 per share                        -              -       1,650,000             165

Shares issued for services at $.25 per share                                -              -          20,000               2

Shares issued for conversion of notes payable
  and interest payable at $.04 per share                                    -              -       3,900,000             390

Shares issued for cash at $1.19 to $3.13 per
  share, less offering costs of $368,450                                    -              -       1,819,293             181

Net loss for the year ended December 31, 1994                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1994                                                  -              -      18,196,153           1,819

Shares issued during the year for cash at $.45 to
    $2.50 per share, less offering costs of $267,714                        -              -       6,442,538             645

Shares issued during the year for services rendered
    and cancellation of accounts payable at $.55 to
    $1.55 per share                                                         -              -         516,630              52

Warrants issued during the year for  cancellation of
    accounts  payable at $.033 per warrant
    (additional  compensation  expense of $2,282,900
    or $.62 per share was recorded)                                         -              -               -               -

Shares issued during the year upon  conversion of
    warrants for  cancellation  of accounts payable
    at $.35 per share                                                       -              -       3,700,000             370

Warrants  issued  during the year for cash at $.0033
    to $.10 per  warrant,  less offering costs of $5,040                    -              -               -               -

Shares issued during the year upon conversion of
  warrants for cash at $.50 to $1.00 per share                              -              -         550,000              55

Forgiveness of debt with related parties                                    -              -               -               -

Net loss for the year ended December 31, 1995                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1995                                                  -              -      29,405,321           2,941

Shares issued during the year for finders' fees
  at $1.52 to $2.72 per share                                               -              -         420,000              42

Shares issued during the year upon conversion
  of warrants for cash at $.50 per share                                    -              -          60,000               6

Shares issued during the year for cash at $.48 to
    $3.38 per share, less offering costs of $2,033,286                      -              -      11,741,242           1,174

Net loss for the year ended December 31, 1996                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1996                                                  -              -      41,626,563           4,163

Shares issued for services at $3.75 to $5.31 per share                      -              -          87,500               9

Shares issued for services at $6.50 to $8.38 per share                      -              -         505,000              50

Warrants issued during the year for services                                -              -               -               -

Shares issued upon the exercise of warrants
  for services at $2.00 per share                                           -              -         150,000              15

Shares issued during the year for cash at $2.50
  per share                                                                 -    $         -         150,000     $        15

Warrants issued during the year in connection with
    the issuance of a convertible debenture and
    convertible preferred stock                                             -              -               -               -

Shares issued upon conversion of convertible
  debenture to common shares                                                -              -         145,747              15

Series B preferred shares issued for extinguishment
    of convertible  debenture at $20 stated value per
    share                                                                   -              -               -               -

Sale of Series C preferred shares  and warrants,
  less cash fees of $201,500                                                -              -               -               -

Sale of Series B preferred shares for cash, less cash
  fees of $145,000                                                          -              -               -               -

Capital contribution in connection with put options                         -              -               -               -

Beneficial conversion features of Series B convertible
   debenture                                                                -              -               -               -

Series A preferred shares issued upon conversion
  of convertible debenture at $3 per share                                  -              -               -               -

Conversion of Series B and Series C preferred shares
  to common shares                                                          -              -         804,065              80

Shares issued during the year in connection with
  exercise of options at $2.97 per share                                    -              -          15,000               1

Shares issued during the year in connection with the
  exercise of warrants at $.50 per share                                    -              -         100,000              10

Accretion of Series C preferred stock                                       -              -               -               -

Dividends on preferred stock                                                -              -               -               -

Net loss for the year ended December 31, 1997                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1997                                                  -              -      43,583,875           4,358

Shares issued for debt costs at $1.44 per share                             -              -          35,000               4

Options issued during the year for services                                 -              -               -               -

Shares issued during the year for patent                                    -              -          24,814               3

Warrants issued during the year for cash                                    -              -               -               -

Shares issued upon the exercise of options and warrants                     -              -         265,000              27

Shares issued during the year for cash at $4.50
  per share, less issuance costs of $1,033,846                              -              -       4,000,000             400

Shares issued for acquisition of AcuVoice,
    Articulate and Papyrus                                                  -              -      10,944,081           1,094

Sale of Series D preferred shares, less issuance costs
  of $546,154                                                               -              -               -               -

Sale of Series E preferred shares, less issuance costs
  of $50,000                                                          100,000      1,950,000               -               -

Exchange of Series D for Series E preferred stock                     150,000      3,079,167               -               -

Conversions of preferred stock to common stock                       (114,928)    (2,777,292)      4,081,234             407

Shares issued for relinquishment of a reset provision                       -              -       1,390,476             139

Expiration of warrants                                                      -              -               -               -

Amortization of deferred consulting expense                                 -            $ -               -     $         -

Dividends on preferred stock                                                -      1,006,011               -               -

Net loss for the year ended December 31, 1998                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------
Balance, December 31, 1998                                            135,072      3,257,886      64,324,480           6,432

Options issued during the year for services                                 -              -               -               -

Extension of option expiration dates                                        -              -               -               -

Conversions of preferred stock                                       (135,072)    (3,298,247)     52,981,431           5,298

Common stock issued for services                                            -              -       1,200,000             120

Common stock issued for principal reduction on debentures                   -              -       6,000,000             600

Common stock returned and canceled                                          -              -        (970,586)            (97)

Warrants issued with Series C debentures                                    -              -               -               -

Warrants issued for services                                                -              -               -               -

Warrants expired                                                            -              -               -               -

Amortization of deferred consulting expense                                 -              -               -               -

Beneficial conversion features on Series C debentures                       -              -               -               -

Preferred stock dividends                                                   -         40,361               -               -

Reduction of accrued offering costs                                         -              -               -               -

Net loss for the year ended December 31, 1999                               -              -               -               -
                                                                  ------------   ------------    ------------    ------------

Balance, December 31, 1999                                                  -    $         -     123,535,325     $    12,353
                                                                  ============   ============    ============    ============
</TABLE>


<TABLE>
<CAPTION>
                                                                                                                  Deficit
                                                                                                                Accumulated
                                                                  Additional                    Deferred        During the
                                                                   Paid-in      Outstanding    Consulting       Development
                                                                   Capital       Warrants        Expense           Stage
                                                                ------------   ------------    ------------    --------------
<S>                                                             <C>            <C>             <C>             <C>
Balance, October 1, 1993 (date of inception)                    $    (1,040)   $         -     $         -     $         -

Net loss for the period October 1, 1993
  (date of inception) to December 31, 1993                                -              -               -        (1,782,611)
                                                                ------------   ------------    ------------    --------------
Balance, December 31, 1993                                           (1,040)             -               -        (1,782,611)

Acquisition of Taris, Inc.                                            1,240              -               -               -

Shares issued for services at $.14 to $.18 per share                249,835              -               -               -

Shares issued for services at $.25 per share                          4,998              -               -               -

Shares issued for conversion of notes payable
  and interest payable at $.04 per share                            156,515              -               -               -

Shares issued for cash at $1.19 to $3.13 per
  share, less offering costs of $368,450                          3,315,874              -               -               -

Net loss for the year ended December 31, 1994                             -              -               -        (3,914,339)
                                                                ------------   ------------    ------------    --------------
Balance, December 31, 1994                                        3,727,422              -               -        (5,696,950)

Shares issued during the year for cash at $.45 to
    $2.50 per share, less offering costs of $267,714              4,509,542              -               -               -

Shares issued during the year for services rendered
    and cancellation of accounts payable at $.55 to
    $1.55 per share                                                 355,319              -               -               -

Warrants issued during the year for  cancellation of
    accounts  payable at $.033 per warrant (additional
    compensation  expense of $2,282,900 or $.62 per
    share was recorded)                                                   -      2,405,000               -               -

Shares issued during the year upon  conversion of
    warrants for  cancellation  of accounts payable
    at $.35 per share                                             3,699,630     (2,405,000)              -               -

Warrants  issued  during the year for cash at $.0033
    to $.10 per  warrant,  less offering costs of $5,040                  -         45,360               -               -

Shares issued during the year upon conversion of
  warrants for cash at $.50 to $1.00 per share                      519,945        (45,000)              -               -

Forgiveness of debt with related parties                            506,874              -               -               -

Net loss for the year ended December 31, 1995                             -              -               -        (6,315,349)
                                                                ------------   ------------    ------------    --------------
Balance, December 31, 1995                                       13,318,732            360               -       (12,012,299)

Shares issued during the year for finders' fees
  at $1.52 to $2.72 per share                                       901,478              -               -               -

Shares issued during the year upon conversion
  of warrants for cash at $.50 per share                             29,994              -               -               -

Shares issued during the year for cash at $.48 to
    $3.38 per share, less offering costs of $2,033,286           11,857,269              -               -               -

Net loss for the year ended December 31, 1996                             -              -               -        (7,829,508)
                                                                ------------   ------------    ------------    --------------
Balance, December 31, 1996                                       26,107,473            360               -       (19,841,807)

Shares issued for services at $3.75 to $5.31 per share              386,710              -               -               -

Shares issued for services at $6.50 to $8.38 per share            3,426,202              -               -               -

Warrants issued during the year for services                              -      1,165,500               -               -

Shares issued upon the exercise of warrants
  for services at $2.00 per share                                   689,085       (389,100)              -               -

Shares issued during the year for cash at $2.50
  per share                                                     $ 1,256,235    $         -     $         -     $         -

Warrants issued during the year in connection with
    the issuance of a convertible debenture and
    convertible preferred stock                                           -      1,559,600               -               -

Shares issued upon conversion of convertible
  debenture to common shares                                        857,835              -               -               -

Series B preferred shares issued for extinguishment
    of convertible  debenture at $20 stated value per
    share                                                                 -              -               -               -

Sale of Series C preferred shares  and warrants,
  less cash fees of $201,500                                              -        600,000               -               -

Sale of Series B preferred shares for cash, less cash
  fees of $145,000                                                        -              -               -               -

Capital contribution in connection with put options                 500,000              -               -               -

Beneficial conversion features of Series B convertible
   debenture                                                        427,850              -               -               -

Series A preferred shares issued upon conversion
  of convertible debenture at $3 per share                                -              -               -               -

Conversion of Series B and Series C preferred shares
  to common shares                                                4,891,180              -               -               -

Shares issued during the year in connection with
  exercise of options at $2.97 per share                             44,499              -               -               -

Shares issued during the year in connection with the
  exercise of warrants at $.50 per share                             49,990              -               -               -

Accretion of Series C preferred stock                                     -              -               -          (600,000)

Dividends on preferred stock                                              -              -               -        (2,121,991)

Net loss for the year ended December 31, 1997                             -              -               -       (22,453,948)
                                                                ------------   ------------    ------------    --------------
Balance, December 31, 1997                                       38,637,059      2,936,360               -       (45,017,746)

Shares issued for debt costs at $1.44 per share                      50,310              -               -               -

Options issued during the year for services                         320,100              -        (320,100)              -

Shares issued during the year for patent                            100,804              -               -               -

Warrants issued during the year for cash                                  -        472,928               -               -

Shares issued upon the exercise of options and warrants             505,333           (360)              -               -

Shares issued during the year for cash at $4.50
  per share, less issuance costs of $1,033,846                   16,965,754              -               -               -

Shares issued for acquisition of AcuVoice,
    Articulate and Papyrus                                       28,686,933              -               -               -

Sale of Series D preferred shares, less issuance costs
  of $546,154                                                             -              -               -               -

Sale of Series E preferred shares, less issuance costs
  of $50,000                                                              -              -               -               -

Exchange of Series D for Series E preferred stock                         -              -               -               -

Conversions of preferred stock to common stock                    8,220,988              -               -               -

Shares issued for relinquishment of a reset provision            (5,055,240)             -               -               -

Expiration of warrants                                               85,670        (85,670)              -               -

Amortization of deferred consulting expense                     $         -    $         -     $   213,400     $         -

Dividends on preferred stock                                              -              -               -        (4,797,249)

Net loss for the year ended December 31, 1998                             -              -               -       (43,118,782)
                                                                ------------   ------------    ------------    -------------
Balance, December 31, 1998                                       88,517,711      3,323,258        (106,700)      (92,933,777)

Options issued during the year for services                          12,540              -               -               -

Extension of option expiration dates                                241,375              -               -               -

Conversions of preferred stock                                   18,124,472              -               -               -

Common stock issued for services                                    474,880              -        (375,000)              -

Common stock issued for principal reduction on debentures         3,278,293              -               -               -

Common stock returned and canceled                               (1,000,819)             -               -               -

Warrants issued with Series C debentures                                  -        438,240               -               -

Warrants issued for services                                              -        260,000        (127,500)              -

Warrants expired                                                  1,170,968     (1,170,968)              -               -

Amortization of deferred consulting expense                               -              -         174,149               -

Beneficial conversion features on Series C debentures             1,750,000              -               -               -

Preferred stock dividends                                                 -              -               -        (2,110,607)

Reduction of accrued offering costs                                 200,000              -               -               -

Net loss for the year ended December 31, 1999                             -              -               -       (21,662,419)
                                                                ------------   ------------    ------------    -------------

Balance, December 31, 1999                                      $112,769,420   $ 2,850,530     $  (435,051)    $(116,706,803)
                                                                ============   ============    ============    =============
</TABLE>


<TABLE>
<CAPTION>
                                                                                      Total
                                                                                   ------------
<S>                                                                                <C>
Balance, October 1, 1993 (date of inception)                                       $         -

Net loss for the period October 1, 1993
  (date of inception) to December 31, 1993                                          (1,782,611)
                                                                                   ------------
Balance, December 31, 1993                                                          (1,782,611)

Acquisition of Taris, Inc.                                                               1,281

Shares issued for services at $.14 to $.18 per share                                   250,000

Shares issued for services at $.25 per share                                             5,000

Shares issued for conversion of notes payable
  and interest payable at $.04 per share                                               156,905

Shares issued for cash at $1.19 to $3.13 per
  share, less offering costs of $368,450                                             3,316,055

Net loss for the year ended December 31, 1994                                       (3,914,339)
                                                                                   ------------
Balance, December 31, 1994                                                          (1,967,709)

Shares issued during the year for cash at $.45 to $2.50 per share, less offering
  costs of $267,714                                                                  4,510,187

Shares issued during the year for services rendered and cancellation of accounts
  payable at $.55 to $1.55 per share                                                   355,371

Warrants issued during the year for  cancellation  of accounts  payable at $.033
  per warrant (additional  compensation  expense of $2,282,900 or $.62 per share
  was recorded)                                                                      2,405,000

Shares issued during the year upon  conversion of warrants for  cancellation  of
  accounts payable at $.35 per share                                                 1,295,000

Warrants  issued  during the year for cash at $.0033 to $.10 per  warrant,  less
  offering costs of $5,040                                                              45,360

Shares issued during the year upon conversion of
  warrants for cash at $.50 to $1.00 per share                                         475,000

Forgiveness of debt with related parties                                               506,874

Net loss for the year ended December 31, 1995                                       (6,315,349)
                                                                                   ------------
Balance, December 31, 1995                                                           1,309,734

Shares issued during the year for finders' fees
  at $1.52 to $2.72 per share                                                          901,520

Shares issued during the year upon conversion
  of warrants for cash at $.50 per share                                                30,000

Shares issued during the year for cash at $.48 to $3.38 per share, less offering
  costs of $2,033,286                                                               11,858,443

Net loss for the year ended December 31, 1996                                       (7,829,508)
                                                                                   ------------
Balance, December 31, 1996                                                           6,270,189

Shares issued for services at $3.75 to $5.31 per share                                 386,719

Shares issued for services at $6.50 to $8.38 per share                               3,426,252

Warrants issued during the year for services                                         1,165,500

Shares issued upon the exercise of warrants
  for services at $2.00 per share                                                      300,000

Shares issued during the year for cash at $2.50
  per share                                                                        $ 1,256,250

Warrants issued during the year in connection with the issuance of a convertible
  debenture and convertible preferred stock                                          1,559,600

Shares issued upon conversion of convertible
  debenture to common shares                                                           857,850

Series B preferred shares issued for extinguishment of convertible  debenture at
  $20 stated value per share                                                         2,178,213

Sale of Series C preferred shares  and warrants,
  less cash fees of $201,500                                                         3,548,500

Sale of Series B preferred shares for cash, less cash
  fees of $145,000                                                                   2,355,000

Capital contribution in connection with put options                                    500,000

Beneficial conversion features of Series B convertible
   debenture                                                                           427,850

Series A preferred shares issued upon conversion
  of convertible debenture at $3 per share                                             500,000

Conversion of Series B and Series C preferred shares
  to common shares                                                                           -

Shares issued during the year in connection with
  exercise of options at $2.97 per share                                                44,500

Shares issued during the year in connection with the
  exercise of warrants at $.50 per share                                                50,000

Accretion of Series C preferred stock                                                        -

Dividends on preferred stock                                                                 -

Net loss for the year ended December 31, 1997                                      (22,453,948)
                                                                                   ------------
Balance, December 31, 1997                                                           2,372,475

Shares issued for debt costs at $1.44 per share                                         50,314

Options issued during the year for services                                                  -

Shares issued during the year for patent                                               100,807

Warrants issued during the year for cash                                               472,928

Shares issued upon the exercise of options and warrants                                505,000

Shares issued during the year for cash at $4.50
  per share, less issuance costs of $1,033,846                                      16,966,154

Shares issued for acquisition of AcuVoice, Articulate and Papyrus                   28,688,027


Sale of Series D preferred shares, less issuance costs
  of $546,154                                                                       10,453,846

Sale of Series E preferred shares, less issuance costs
  of $50,000                                                                         1,950,000

Exchange of Series D for Series E preferred stock                                            -

Conversions of preferred stock to common stock                                               -

Shares issued for relinquishment of a reset provision                                6,111,577

Expiration of warrants                                                                       -

Amortization of deferred consulting expense                                        $   213,400

Dividends on preferred stock                                                                 -

Net loss for the year ended December 31, 1998                                      (43,118,782)
                                                                                   ------------
Balance, December 31, 1998                                                          24,765,746

Options issued during the year for services                                             12,540

Extension of option expiration dates                                                   241,375

Conversions of preferred stock                                                               -

Common stock issued for services                                                       100,000

Common stock issued for principal reduction on debentures                            3,278,893

Common stock returned and canceled                                                  (1,000,916)

Warrants issued with Series C debentures                                               438,240

Warrants issued for services                                                           132,500

Warrants expired                                                                             -

Amortization of deferred consulting expense                                            174,149

Beneficial conversion features on Series C debentures                                1,750,000

Preferred stock dividends                                                             (343,749)

Reduction of accrued offering costs                                                    200,000

Net loss for the year ended December 31, 1999                                      (21,662,419)
                                                                                   ------------

Balance, December 31, 1999                                                         $ 8,086,359
                                                                                   ============
</TABLE>


          See accompanying notes to consolidated financial statements.


                                      F-6

<PAGE>

                                Fonix Corporation
                          (A Development Stage Company)

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                                   October 1,
                                                                                                      1993
                                                                                                 (Inception) to
                                                              Years Ended December 31,            December 31,
                                                     -------------------------------------------
                                                         1999           1998           1997            1999
                                                     -------------- -------------- -------------- ----------------
Cash flows from operating activities:
<S>                                                  <C>            <C>            <C>             <C>
     Net loss                                        $ (21,662,419) $ (43,118,782) $ (22,453,948)  $ (107,076,956)
     Adjustments to reconcile net loss to net cash
       used in operating activities:
       Issuance of common stock for services               158,600        50,314       4,112,970        5,646,154
       Issuance of common stock for patent                       -       100,807               -          100,807
       Non-cash expense related to issuance of
          debentures,warrants, preferred and
          common stock                                   2,411,349     6,111,577       3,967,337       12,490,263
       Non-cash compensation expense related to
          issuance and extension of stock options          360,615       213,400               -        2,856,915
       Non-cash expense related to issuance of
          notes payable and accrued expense for
          services                                               -       857,000               -          857,000
       Non-cash exchange of notes receivable for
          services                                               -       150,000               -          150,000
       Non-cash portion of purchased in-process
          research and development                               -    13,136,000               -       13,136,000
       Loss on disposal of property and equipment          154,940             -               -          154,940
       Gain on sale of HealthCare Solutions Group       (3,766,646)            -               -       (3,766,646)
       Write-off of assets received in acquisition               -             -               -            1,281
       Depreciation and amortization                     5,256,532     3,285,845         405,209        9,031,986
       Income tax benefit                               (3,331,895)            -               -       (3,331,895)
       Extraordinary loss on extinguishment of debt              -             -         881,864          881,864
       Extraordinary gain on forgiveness of debt          (473,857)            -               -         (504,405)
       Changes in assets and liabilities, net of
          effects of acquisitions:
         Accounts receivable                              (245,432)     (148,498)              -         (393,930)
         Employee advances                                   7,245       (67,231)              -          (59,986)
         Interest and other receivables                     (2,263)        9,436         142,724           (7,746)
         Inventory                                          (7,161)      (20,221)              -          (27,382)
         Prepaid assets                                     (3,381)      (15,372)        (27,922)         (50,847)
         Cash held in escrow                               (38,003)            -               -          (38,003)
         Other assets                                          944       (80,198)         (8,735)        (118,901)
         Accounts payable                               (1,650,337)    2,941,898         128,638        3,363,399
         Accrued liabilities                               514,312         8,189        (922,367)       1,156,101
         Accrued liabilities - related party             1,143,185      (311,743)         47,759        1,290,944
         Deferred revenues                                 632,242        81,266               -          713,508
                                                     -------------- -------------- -------------- ----------------

       Net cash used in operating activities           (20,541,430)  (16,816,313)    (13,726,471)     (63,545,535)
                                                     -------------- -------------- -------------- ----------------

Cash flows from investing activities, net of
          effects of acquisitions:
     Proceeds from sale of HealthCare Solutions
          Group                                         21,805,982             -               -       21,805,982
     Acquisition of subsidiaries, net of cash
          acquired                                               -   (15,323,173)              -      (15,323,173)
     Proceeds from sale of property and equipment           50,000             -               -           50,000
     Purchase of property and equipment                    (99,090)   (1,305,091)       (671,401)      (3,435,560)
     Investment in intangible assets                             -             -        (107,281)        (164,460)
     Issuance of notes receivable                                -      (745,000)     (1,483,600)      (3,228,600)
     Payments received on notes receivable                 245,000             -       1,883,600        2,128,600
                                                     -------------- -------------- -------------- ----------------

       Net cash provided by (used in) investing
          activities                                    22,001,892   (17,373,264)       (378,682)       1,832,789
                                                     -------------- -------------- -------------- ----------------

Cash flows from financing activities:
     Bank overdraft                                       (138,034)      138,034               -                -
     Advance                                             1,000,000             -               -        1,000,000
     Net proceeds from revolving note payable          (20,038,193)    1,376,671       2,234,914          (49,250)
     Net proceeds (payments) from revolving note
          payable - relatedparties                      (7,895,178)     (469,869)        551,510       (7,813,537)
     Proceeds from other notes payable                   6,953,760       560,000               -        9,865,427
     Payments on other notes payable                    (7,788,000)            -               -       (9,567,806)
     Principal payments on capital lease obligation        (60,684)      (49,325)        (43,381)        (153,390)
     Proceeds from issuance of convertible
          debentures, net                                6,254,240             -       2,685,000        9,439,240
     Proceeds from sale of warrants                        438,240       472,928         600,000        1,511,168
     Proceeds from sale of common stock, net                     -    17,471,155         469,500       38,175,700
     Proceeds from sale of preferred stock, net                  -    12,403,846       5,303,500       17,707,346
     Proceeds from sale of common stock and
          related repricing rights subject to
          redemption, net                                        -     1,830,000               -        1,830,000
                                                     -------------- -------------- -------------- ----------------

       Net cash provided by (used in ) financing
          activities                                   (21,273,849)   33,733,440      11,801,043       61,944,898
                                                     ----------------------------- -------------- ----------------

Net (decrease) increase in cash and cash
     equivalents                                       (19,813,387)     (456,137)     (2,304,110)         232,152

Cash and cash equivalents at beginning of period        20,045,539    20,501,676      22,805,786                -
                                                     -------------- -------------- -------------- ----------------

Cash and cash equivalents at end of period           $     232,152  $ 20,045,539   $  20,501,676  $       232,152
                                                     ============== ============== ============== ================
</TABLE>

          See accompanying notes to consolidated financial statements.


                                      F-9

<PAGE>

                                Fonix Corporation
                          (A Development Stage Company)

                CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

<TABLE>
<CAPTION>
                                                                                                    October 1, 1993
                                                                                                    (Inception) to
                                                               Years Ended December 31,             December 31,
                                                         ------------------------------------------
Supplemental disclosure of cash flow information:           1999          1998           1997           1999
                                                         ------------  -------------  -------------  ------------

<S>                                                      <C>           <C>            <C>            <C>
     Cash paid during the period for interest            $ 1,075,882   $ 1,392,987    $ 1,148,553    $ 4,505,888
</TABLE>

Supplemental Schedule of Non-cash Investing and Financing Activities:

     For the Year Ended December 31, 1999:

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

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

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

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

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

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

     Preferred  stock  dividends  of  $997,148  were  recorded  related  to  the
beneficial conversion features of Series D and Series E preferred stock.

     Preferred stock dividends of $769,710 were accrued on Series D and Series E
preferred stock.

     Dividends  totaling  $343,749  were  recorded  relating to the  liquidation
damage  provisions  of  Series  D and  Series E  preferred  stock  and  Series C
convertible debentures.

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

     A total of 626,611 shares of Series D preferred stock and related dividends
of $587,388 were converted into 47,252,275 shares of Class A common stock.

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

     Of the sales  proceeds  from the sale of the  HealthCare  Solutions  Group,
$2,500,000 was placed in an escrow account,  $500,000 of which was  subsequently
released.

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

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

     The  Company  issued  1,000,000  shares  of  Class A  common  stock  to two
unrelated  parties for consulting  fees valued at $375,000 of which $316,400 has
been deferred at December 31, 1999.

     The Company issued 1,000,000  warrants to three unrelated parties for legal
services  valued at $260,000 of which $118,651 has been deferred at December 31,
1999.

     For the Year Ended December 31, 1998:

     Preferred  stock  dividends  of  $3,461,543  were  recorded  related to the
beneficial conversion features of convertible preferred stock.

     Preferred stock dividends of $335,706 were accrued on convertible preferred
stock.

     A total of  27,500  shares  of  Series B  convertible  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  convertible  preferred  stock and
related  dividends of $123,129 were converted  into  1,295,919  shares of common
stock.

     TheCompany  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
an existing reset  provision and costs  associated with the issuance of Series D
4% convertible preferred stock.

     Preferred  stock  dividends  of  $1,000,000  were  recorded  related to the
issuance  of  1,390,476  common  shares  and  608,334  shares  of  Series  D  4%
convertible  preferred stock in connection with the  cancellation of an existing
reset provision.

     The Company exchanged  150,000 shares of Series D 4% convertible  preferred
stock for 150,000 shares of Series E 4% convertible preferred stock.

     A total of  114,928  shares of  Series E  convertible  preferred  stock and
related  dividends of $15,969 were  converted  into  2,591,733  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.

     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 issued  3,111,114 shares of common stock (having a market value
of  $3,208,336)   and  notes  payable  of  $1,710,000  in  connection  with  the
acquisition of Papyrus.

     The  Company  issued  notes  payable of  $348,145  in  connection  with the
acquisition of certain assets of The MRC Group, Inc.

     For the Year Ended December 31, 1997:

     A $500,000 Series A convertible debenture was converted into 166,667 shares
of Series A preferred stock.

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

     Series B convertible  debentures  in the amount of  $2,150,000  and related
accrued  interest of $28,213  were  converted  into  108,911  shares of Series B
convertible preferred stock.

     Dividends of $2,721,991 were recorded related to the beneficial  conversion
features and accretion of Series B and Series C convertible preferred stock.

     206,411  shares  of  Series  B  convertible  preferred  stock  and  related
dividends of $13,422 were converted into 786,867 shares of common stock.

     2,500 shares of Series C convertible  preferred stock and related dividends
of $472 were converted into 17,198 shares of common stock.

     Accounts  payable of $144,931 was converted into a capital lease obligation
of the same amount.


          See accompanying notes to consolidated financial statements.


                                      F-10




<PAGE>


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


 1.  NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations  -Fonix  Corporation (the "Company") is a development stage
company   engaged   in   developing,   acquiring   and   marketing   proprietary
human/computer  interface  technologies.  The  core  technologies  developed  or
acquired to date include automated speech  recognition  ("ASR"),  text-to-speech
("TTS"), and handwriting recognition ("HWR") technologies for embedded (original
equipment  manufacturer,  hereafter  "OEM") and server markets.  The Company has
received a patent for certain  elements of its core  technologies  and has filed
applications for other patents  covering various aspects of its technology.  The
Company seeks to develop  relationships and strategic alliances with third-party
developers  and vendors that are  participants  in the  computer and  electronic
devices  industry  (including  producers  of  application  software,   operating
systems,  computers  and  microprocessor  chips).  As of December 31, 1999,  the
Company  has  entered  into one  strategic  partnership  and  license  agreement
relating to its ASR technologies. Other revenues are generated through licensing
of its TTS and HWR technologies.  Although the Company has completed development
of the key components of its core  technologies,  there can be no assurance that
it will be able to sell,  license or otherwise  market its technologies to third
parties in order to generate sufficient  recurring revenues to pay its operating
costs and complete the development of its technologies.

Fonix  Corporation  (known as Taris,  Inc.  prior to its  acquisition  of Phonic
Technologies,  Inc. ("PTI"), as described below) was organized under the laws of
the state of Delaware on September 12, 1985.  Taris,  Inc. was a public  company
with no operations. Prior to June 17, 1994, Taris, Inc. effected a reverse stock
split of one share for 90 shares. The financial statements have been adjusted to
reflect the stock split as though it had happened  January 1, 1993.  PTI, a Utah
corporation  and the Company's  predecessor  in interest with respect to some of
the Company's ASR  technology,  was organized on October 1, 1993 (the  Company's
date of inception) for the purpose of developing  proprietary ASR  technologies.
On June 17, 1994,  Fonix  Corporation  entered into a merger  agreement with PTI
whereby Fonix issued 10,395,249 shares of its common stock for all of the issued
and  outstanding  common  shares of PTI.  Upon  completion  of the  merger,  PTI
stockholders  owned in excess of 90 percent of the  outstanding  common stock of
Fonix. The transaction was accounted for as a reverse  acquisition as though PTI
acquired Fonix. The financial statements,  therefore,  reflect the operations of
Fonix since the acquisition on June 17, 1994 and PTI since October 1, 1993.

Development  Stage  Presentation - The Company is in the  development  stage and
generated  revenues  of  $439,507  and  incurred  a  net  loss  from  continuing
operations  totaling  $19,949,196  for the year ended  December  31,  1999.  The
Company has incurred cumulative losses from continuing operations of $98,237,110
for the  period  from  inception  to  December  31,  1999.  The  Company  has an
accumulated deficit of $116,706,803, negative working capital of $4,804,796, and
$981,301 of accounts  payable over 60 days past due as of December 31, 1999. The
Company  expects  to  continue  to incur  significant  losses  through  at least
December  31,  2000,  primarily  due  to  significant  expenditure  requirements
associated   with  the  marketing  and   development  of  its  ASR  and  related
technologies.  These  factors,  as well as the risk factors set out elsewhere in
the Company's  Annual  Report on Form 10-K,  raise  substantial  doubt about the
Company's  ability to continue as a going concern.  The  accompanying  financial
statements do not include any adjustments  that might result from the outcome of
this uncertainty. Management plans to fund the operations of the Company through
proceeds  from  sales of its debt and  equity  securities  and cash  flows  from
license and royalty  arrangements.  There can be no assurance that  management's
plans will be successful.

Consolidation - The accompanying  consolidated  financial statements include the
accounts of the Company and its wholly owned subsidiaries, Fonix/AcuVoice, Inc.,
and Fonix/Papyrus,  Inc. All significant  intercompany balances and transactions
have  been  eliminated  in  consolidation.   During  1999,  other  wholly  owned
subsidiaries, Fonix Systems Corporation and Fonix/Articulate,  Inc., were merged
into the Company. As discussed more thoroughly in


                                      F-11

<PAGE>


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


Note 2, the  HealthCare  Solutions  Group ("HSG"),  consisting  primarily of the
assets and operations of  Fonix/Articulate,  Inc., is presented as  discontinued
operations.

Cash and Cash Equivalents - The Company considers all highly liquid,  short-term
investments with a maturity of three months or less to be cash equivalents.

Funds Held in Escrow - Funds held in escrow pursuant to terms of the sale of the
HSG (see Note 2) are held in  interest-bearing  accounts and become available to
the Company at the end of the 18-month period  following the closing of the sale
(March 2001).

Inventory  -  Inventory,   consisting   primarily  of  microphones  and  related
accessories,  is stated at the lower of cost  (first-in,  first -out  method) or
market value.

Property and Equipment - Property and equipment are stated at cost. Depreciation
is computed on a  straight-line  basis over the  estimated  useful  lives of the
assets as follows:

           Furniture and fixtures            5 years
           Computer equipment                3 to 5 years
           Leasehold improvements            18 months to 8 years

Leasehold  improvements are amortized over the shorter of the useful life of the
applicable  asset or the  remaining  lease  term.  Maintenance  and  repairs are
charged to expense as incurred and major improvements are capitalized.  Gains or
losses on sales or retirements  are included in the  consolidated  statements of
operations in the year of disposition.

Intangible  Assets - Intangible assets consist of the purchase cost of completed
technology and goodwill in connection with the  acquisitions of AcuVoice,  Inc.,
Papyrus Development Corporation,  and Papyrus Associates,  Inc. (see Note 2) 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 and patents ranging
from five to eight years.

Valuation of Long-lived Assets - The carrying value of the Company's  long-lived
assets is reviewed for impairment  whenever  events or changes in  circumstances
indicate that it may not be recoverable.  If such an event occurred, the Company
would  project  cash  flows to be  generated  from the use of the  asset and its
eventual  disposition  over the remaining life of the asset. If such projections
indicate that the cost in excess of the net asset would not be recoverable,  the
Company's  carrying value of such asset would be reduced by the estimated excess
of such value over the projected cash flows.

Revenue  Recognition - The Company  recognizes  revenues in accordance  with the
provisions of Statement of Position No. 97-2,  "Software  Revenue  Recognition".
The  Company  generates  revenues  from  licensing  the  rights to its  software
products to end users and from  royalties.  The Company also  generates  service
revenues from the sale of consulting and development services.

Revenues from software  license  agreements are recognized  upon shipment of the
software if there are no significant


                                      F-12

<PAGE>


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


postcontract  obligations.  If  postcontract  obligations  exist,  revenues  are
recognized when those obligations have been satisfied. Revenues from development
and consulting services are recognized as the services are completed.

Cost of revenues consists of costs to distribute the product (including the cost
of the  media on which it is  delivered),  installation  and  support  personnel
salaries and licensed technology and related costs.

Research and  Development - All  expenditures  for research and  development are
charged to  expense  as  incurred.  The  Company  incurred  total  research  and
development expenses of $ 7,909,228 in 1999,  $13,060,604 in 1998 and $7,066,294
in 1997. In 1998,  the Company also recorded  $9,315,000 of in-process  research
and development  purchased in connection with the acquisition of AcuVoice,  Inc.
The Company also  recorded  $3,821,000 of  in-process  research and  development
costs in connection with the acquisition of Articulate Systems,  Inc. ("ASI") in
1998. However,  as a result of the subsequent  disposition of the operations and
assets of ASI, these costs are reflected in  discontinued  operations  (see Note
2).

Income Taxes - The Company recognizes  deferred income tax assets or liabilities
for the expected future tax  consequences of events that have been recognized in
the  financial  statements  or  tax  returns.  Deferred  income  tax  assets  or
liabilities are determined  based upon the difference  between the financial and
income tax bases of assets and  liabilities  using enacted tax rates expected to
apply when differences are expected to be settled or realized.

Concentration  of Credit Risks - The  Company's  cash and cash  equivalents  are
maintained in bank deposit accounts which exceed federally insured limits.  Cash
equivalents  consist of highly liquid securities with maturities of three months
or less when purchased.  The Company has not experienced any losses with respect
to these deposits. In the normal course of business, the Company provides credit
terms to its  customers.  Accordingly,  the  Company  performs  on-going  credit
evaluations of its customers and maintains allowances for possible losses, which
when realized, have been within the range of management's expectations.

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

Fair Value of Financial  Instruments - The book values of the  Company's  assets
and liabilities  approximate  their fair values.  The estimated fair values have
been   determined   using   appropriate   market   information   and   valuation
methodologies.

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 year.
At  December  31,  1999,  1998 and 1997,  there were  outstanding  common  stock
equivalents to purchase  56,869,449,  38,319,638 and 13,395,948 shares of common
stock,  respectively,  that were not included in the  computation of diluted net
loss per common  share as their effect  would have been  anti-dilutive,  thereby
decreasing the net loss per common share.

The following table is a  reconciliation  of the net loss numerator of basic and
diluted net loss per common share for the years ended  December  31, 1999,  1998
and 1997.


                                      F-13

<PAGE>


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

<TABLE>
<CAPTION>
                                                1999                           1998                             1997
                                        ---------------------------    --------------------------    --------------------------
                                                          Loss                          Loss                          Loss
                                        Loss              Per Share    Loss             Per Share    Loss             Per Share
                                        ----              ---------    ----             ---------    ----             ---------

<S>                                     <C>               <C>          <C>              <C>          <C>              <C>
Loss from continuing operations         $(19,949,196)                  $(36,843,475)                 $(21,572,084)
Preferred stock dividends                 (2,110,607)                    (4,797,249)                   (2,721,991)
                                        -------------                  -------------                 -------------
Net loss from continuing operations
     attributable to common
     stockholders                        (22,059,803)     $ (0.29)      (41,640,724)    $ (0.79)      (24,294,075)    $ (0.57)
Discontinued operations, net of taxes     (2,187,080)       (0.03)       (6,275,307)      (0.12)                -           -
Extraordinary items, net of taxes            473,857         0.01               -             -          (881,864)      (0.02)
                                        --------------    ---------    -------------    ----------   --------------   ---------
Net loss attributable to common
        stockholders                    $(23,773,026)     $ (0.31)     $(47,916,031)    $ (0.91)     $(25,175,939)    $ (0.59)
                                        ==============    =========    =============    ==========   ==============   =========
Weighted average common shares
         outstanding                      76,753,709                     52,511,185                    42,320,188
                                        ==============                 =============                 ==============
</TABLE>

Stock-based  Compensation  - The  Company  uses the  intrinsic  value  method to
account for stock-based compensation plans. Under this method, compensation cost
is recognized for stock option awards only if the quoted market price is greater
than  the  amount  the  optionee  must  pay to  acquire  the  stock.  Pro  forma
disclosures using the fair value-based method required by Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation"
are presented in Note 11.

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

2.  ACQUISITIONS AND DISCONTINUED OPERATIONS

AcuVoice,  Inc. - In March 1998, the Company  created a wholly owned  subsidiary
(Fonix/AcuVoice,  Inc.) that  acquired  AcuVoice,  Inc.  ("AcuVoice").  AcuVoice
developed  and marketed  TTS  technologies  and products  directly to end users,
systems  integrators  and  original  equipment  manufacturers  for  use  in  the
telecommunications,  multi-media,  education and assistive  technology  markets.
These same  products and  services are now provided by the Company.  The Company
issued  2,692,216  shares of  restricted  Class A common stock  (having a market
value of $16,995,972 on that date) and paid cash of approximately $8,000,000 for
all of the then  outstanding  common  shares of AcuVoice.  The  acquisition  was
accounted for as a purchase.

Of the  2,692,216  shares of Class A common  stock  issued,  80,000  shares were
placed in escrow  against  which any claims for breach of  warranty  against the
former  shareholders of AcuVoice could be asserted by the Company.  On March 12,
1999,  the Company  submitted a claim for the shares  deposited  into the escrow
account  based on the  Company's  assertion  of  misrepresentations  made to the
Company  (see Note 16).  The shares held in escrow have been  excluded  from the
calculation  of basic net loss per common share for the years ended December 31,
1999 and 1998.


                                      F-14

<PAGE>


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



The purchase  price  allocation to tangible  assets  included  $253,881 of cash,
$13,728 of accounts  receivable,  $9,902 of property and  equipment  and $800 of
prepaid expenses. The purchase price allocations to liabilities assumed included
$22,929 of accounts  payable and accrued expenses and $599,250 of notes payable.
The excess of the  purchase  price over the  estimated  fair market value of the
acquired  tangible net assets of AcuVoice 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 in-process  research and
development.

The valuation of the acquired in-process research and development included,  but
was not  limited to, an analysis  of (1) the market for  AcuVoice  products  and
technologies;  (2) the completion costs for the projects;  (3) the expected cash
flows  attributed to the projects;  and (4) the risks  associated with achieving
the expected cash flows.  The value of the in-process  research and  development
was based upon  assumptions the Company believed to be reasonable but which were
inherently uncertain and unpredictable.  At the date of acquisition of AcuVoice,
management  estimated  that the acquired  in-process  research  and  development
projects  of  AcuVoice  were  approximately  75  percent  complete  and  that an
additional  $1.0  million  would  be  required  to  develop  these  projects  to
commercial viability.  As of December 31, 1999, the Company has expended a total
of approximately  $433,000 in connection with the AcuVoice  acquired  in-process
research and development  projects,  and management estimates that an additional
amount of  approximately  $567,000  will be required to  complete  the  AcuVoice
projects.  Management  currently  estimates  that the  AcuVoice  projects are 88
percent complete as of December 31, 1999, and anticipates  release in the second
quarter of 2000.

Papyrus Associates,  Inc. and Papyrus Development Corporation - In October 1998,
the  Company  created  a wholly  owned  subsidiary  (Fonix/Papyrus,  Inc.)  that
acquired Papyrus Associates,  Inc. ("PAI") and Papyrus  Development  Corporation
("PDC,"  together with PAI,  "Papyrus").  PAI developed,  marketed and supported
printing and cursive  handwriting  recognition  software for  "personal  digital
assistants", pen tablets and mobile phones under the trademark, Allegro(TM). PDC
was a systems integration  provider with expertise and intellectual  property in
embedded systems and enhanced  Internet  applications.  Fonix now provides these
products and  technologies.  The Company issued  3,111,114  shares of restricted
Class A common  stock  (having a market  value of  $3,208,336  on that date) and
promissory notes aggregating $1,710,000, in connection with this purchase.

Of the  3,111,114  shares of Class A common stock  issued,  311,106  shares were
placed in escrow  against  which any claims for breach of  warranty  against the
former  shareholders of Papyrus could be asserted by the Company. As of December
31, 1999,  15,482 shares  remain in escrow.  The shares held in escrow have been
excluded from the  calculation  of basic net loss per common share for the years
ended  December  31,  1999 and 1998.  The  acquisition  was  accounted  for as a
purchase.

The purchase price  allocation to tangible assets  included  $10,342 of cash and
$7,629 of accounts  receivable.  The purchase  price  allocation to  liabilities
assumed  included  $118,293 of accounts  payable  and accrued  liabilities.  The
excess  of the  purchase  price  over the  estimated  fair  market  value of the
acquired  tangible net assets of Papyrus was $5,018,658  and was  capitalized as
goodwill.

Articulate  Systems,  Inc.  - In  1998,  the  Company  created  a  wholly  owned
subsidiary   ("Fonix/Articulate")   that  acquired  Articulate   Systems,   Inc.
("Articulate")  in September  1998.  Articulate was a provider of  sophisticated
voice recognition  products to specialized segments of the health care industry.
The  Company  delivered  5,140,751  shares of  restricted  Class A common  stock
(having a 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  for all of
the then  outstanding  common shares of  Articulate.  Additionally,  the Company
issued  98,132  stock  options in  exchange  for all  Articulate  stock  options
outstanding on the date of acquisition at an exchange rate based on the relative
fair value of


                                      F-15

<PAGE>


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


the  companies'  stocks.  The  estimated  fair value of the  options  issued was
$130,000  using the  Black-Scholes  option  pricing model with weighted  average
assumptions  of a risk-free  rate of 5.1  percent,  expected  life of 2.5 years,
expected  volatility of 85 percent and an expected  dividend yield of 0 percent.
Subsequent  to the  acquisition,  the Company  agreed to pay several  Articulate
employees  incentive  compensation  for  continued  employment  in the aggregate
amount of $857,000. The Company issued 8.5 percent demand notes for $452,900 and
recorded an accrued  liability of $404,100  for the balance of this  obligation,
both of which were paid in 1999. The Articulate acquisition was accounted for as
a purchase.

Of the  5,140,751  shares of Class A common stock  issued,  315,575  shares were
placed in escrow  against  which any claims for breach of  warranty  against the
former shareholders of Articulate could be asserted by the Company and 1,985,000
shares  were  placed  in  escrow  to be  converted  at a later  date to  Class B
Non-Voting common stock, subject to approval by the shareholders of the Company.
By vote of the  shareholders  at the annual  meeting held October 29, 1999,  the
issuance of 1,985,000 share of Class B Non-Voting common stock was approved. The
Class B  shares  are  authorized,  but  have  not  yet  been  exchanged  for the
corresponding Class A shares held in escrow. The shares held in escrow have been
excluded  from the  calculation  of basic net loss per common share for the year
ended December 31, 1999 and 1998.

The purchase  price  allocation to tangible  assets  included  $286,954 of cash,
$62,835  of  accounts  receivable,  $57,165  of  inventory,  $14,043  of prepaid
expenses and $117,540 of property and equipment.  The purchase price  allocation
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 excess of the  purchase  price over the  estimated  fair market value of the
acquired tangible net assets of Articulate was $23,584,256, 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
in-process  research and development.  The valuation of the acquired  in-process
research and development was based upon  assumptions the Company  believed to be
reasonable at the time.

Effective  September 1, 1999, the Company sold the operations and certain assets
of the HSG, of which Articulate was a part (see below).

The MRC Group,  Inc. - On December 31, 1998, the Company acquired certain assets
of the MRC  Group,  Inc.  ("MRC")  relating  to  MRC's  selling,  marketing  and
servicing of certain of Articulate's  products. In consideration for the assets,
the Company  agreed to pay MRC $219,833  less  certain  amounts then owed to the
Company,  plus  $133,333  per  month for each of the  three  months  immediately
following  the closing,  less  certain  credits.  As of December  31, 1998,  the
remaining amount owing related to this acquisition was $216,666,  which was paid
in 1999.

The purchase price  allocation to tangible assets included  $142,852 of accounts
receivable and $40,000 of property and equipment.  The purchase price allocation
to liabilities  assumed  included  $311,588 of accrued  expenses and $849,742 of
deferred revenue. Additionally,  $152,839 of accounts receivable and $987,531 of
deferred  revenue from Articulate were  eliminated in purchase  accounting.  The
excess  of the  purchase  price  over the  estimated  fair  market  value of the
acquired  tangible  net  assets of MRC was  $314,761  which was  capitalized  as
goodwill.

Effective  September 1, 1999, the Company sold the operations and certain assets
of HSG, of which MRC was a part (see below).

Sale of the  HealthCare  Solutions  Group - On  September  1, 1999,  the Company
completed the sale of the  operations  and a  significant  portion of the assets
(the "Sale") of HSG to Lernout & Hauspie Speech Products N.V.


                                      F-16

<PAGE>


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


("L&H"),  an unrelated third party, for up to $28,000,000.  Of this sales price,
$21,500,000,  less  certain  credits  of  $194,018,  was  received  at  closing,
$2,500,000  was  held in an 18  month  escrow  account  in  connection  with the
representations  and  warranties  made by the Company in the sales  transaction.
Subsequent  to the  closing,  $500,000  was  released  from the escrow.  Another
$4,000,000  of the sales price is to be  contingently  paid as an earnout in two
installments of $2,000,000 each over the next two years based on the performance
of HSG. The proceeds  received  from the sale were used to reduce a  significant
portion of the  Company's  liabilities  and to provide  working  capital for the
Company's  marketing  and  development  opportunities.  The assets sold included
inventory,  property and equipment,  certain  prepaid  expenses,  purchased core
technology and other assets. Additionally, L&H assumed the capital and operating
lease obligations related to HSG and the obligations related to certain deferred
revenues.

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

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

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

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

Revenues from HSG's  operations  were  $284,960 for the period from  acquisition
through December 31, 1998 and $1,726,262 from January 1, 1999 through  September
1, 1999, the date of the Sale.  These amounts have not been included in revenues
in the accompanying  consolidated statements of operations,  but are included in
the operating loss from discontinued operations.

Proforma Financial  Statement Data - The following unaudited pro forma financial
statement  data for the years  ended  December  31,  1998 and 1997  present  the
results of  operations  of the Company as if the  acquisitions  of AcuVoice  and
Papyrus had occurred at the  beginning of each year.  The pro forma results have
been prepared for comparative  purposes only and do not purport to be indicative
of future results or what would have occurred had the acquisitions  been made at
the  beginning  of  the  applicable  year.  Purchased  in-process  research  and
development of $9,315,000 related to the acquisition of AcuVoice was recorded at
the date of the acquisition and is not presented in the following  unaudited pro
forma  financial  statement  data since it is a  non-recurring  charge  directly
attributable to the acquisition.  Historical and pro forma financial information
for the  acquisition  of  Articulate  and MRC  have  not  been  included  in the
following pro forma financial statement data as the operations and substantially
all assets  related to Articulate  were sold  September 1, 1999.  The results of
operations  of MRC  are  not  included  in the  unaudited  pro  forma  financial
statement data as the acquisition did not constitute the purchase of a business.



                                      F-17

<PAGE>


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


<TABLE>
<CAPTION>
                                                  For the Year  Ended December 31,
                                                  ---------------------------------------
                                                          1998                  1997
                                                  -----------------   -------------------
<S>                                               <C>                       <C>
Revenues                                          $     2,692,916           $  1,134,590

Loss before extraordinary items                       (31,462,937)           (15,939,441)

Net loss                                              (31,462,937)           (16,821,305)

Basic and diluted net loss per common share                 (0.55)                 (0.34)
</TABLE>

3.  CERTIFICATE OF DEPOSIT

Included  in cash and cash  equivalents  at December  31, 1998 is a  $20,000,000
short-term bank  certificate of deposit.  The certificate  earned interest at an
annual  rate  of  four  percent  at  December  31,1998,   payable  monthly.  The
certificate  was pledged as collateral on a revolving note payable (see Note 6).
On January 8, 1999, the certificate  matured and was not renewed.  Proceeds from
the  certificate  were  applied to reduce the  related  revolving  note  payable
balance.

4.  NOTES RECEIVABLE

At December  31,  1998,  the Company had a note  receivable  from a research and
development entity in the amount of $20,000 which was repaid on January 5, 1999.

As of December 31, 1998,  the Company had a six percent  short-term,  unsecured,
demand note receivable from an unrelated  entity in the amount of $225,000.  The
note was issued in connection  with the Company's  intended  acquisition  of the
entity.  Because the  acquisition  was not  consummated,  the  Company  demanded
payment and received $225,000 on March 4, 1999.


5.  PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at December 31, 1999 and 1998:

<TABLE>
<CAPTION>
                                                                      1999                 1998
                                                                 --------------      ----------------
<S>                                                              <C>                 <C>
           Computer equipment                                    $  2,294,766        $      2,329,755
              Furniture and fixtures                                  673,909                 778,479
           Leasehold improvements                                     118,621                 204,820
                                                                 -------------       -----------------
                                                                    3,087,296               3,313,054

           Less accumulated depreciation and amortization          (1,938,494)             (1,168,023)
                                                                 -------------       -----------------
           Net property and equipment                            $  1,148,802        $      2,145,031
                                                                 =============       =================
</TABLE>

 6.  REVOLVING AND OTHER NOTES PAYABLE

At December 31, 1998, the Company had a revolving note payable to a bank bearing
interest  at six  percent in the amount of  $19,988,193.  The  weighted  average
outstanding balance was $18,590,642 and the weighted average


                                      F-18

<PAGE>


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


interest rate was 6.40 percent  during 1998.  The Company paid the note in full,
including  accrued  interest,  on  January  8,  1999,  with  proceeds  from  the
certificate of deposit that secured the note and $22,667 in cash.

At December 31, 1998,  the Company had an unsecured  revolving note payable to a
bank in the amount of $50,000.  The weighted average  outstanding balance during
1998 was $14,384,  and the weighted  average  interest rate was 9.4 percent.  On
September 20, 1999, this note and related interest were paid in full by a former
employee and the related  amounts are  included in accounts  payable at December
31, 1999.

At December 31,  1998,  the Company had a note payable to a lender in the amount
of $560,000 which bore interest at 18 percent,  payable  monthly.  In connection
with the issuance of the note payable, the Company issued 35,000 shares of Class
A common  stock  (having a fair  value of $50,314  on the date of  issuance)  in
payment for a loan  origination fee. This amount is included in interest expense
in the accompanying consolidated statements of operations.  The note payable was
due January 2, 1999,  but was extended  from month to month by paying the lender
accrued  interest  plus a fee of $5,600.  On  September  1,  1999,  the note and
related interest were paid in full.

7.  RELATED-PARTY NOTES PAYABLE

At December  31, 1998,  the Company had  unsecured  demand notes  payable to the
former  Articulate  stockholders  in the aggregate  amount of $4,708,980.  These
notes were issued in connection with the Articulate acquisition (see Note 2). On
September 30, 1999, all  outstanding  amounts and related  interest were paid in
full.

Subsequent  to the  Articulate  acquisition,  the Company  agreed to pay several
Articulate  employees  incentive  compensation  for continued  employment in the
aggregate  amount of $857,000.  The Company issued demand notes for $452,900 and
recorded an accrued  liability  of $404,100  for the balance of this  obligation
(see Note 2). On September 3, 1999,  these notes,  the related  interest and the
accrued liability were paid in full.

In connection  with the  acquisition of certain  liabilities of Articulate  (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
bore  interest at an annual rate of 10 percent and was payable upon demand after
November 1, 1998.  The Company  obtained an  extension  of the due date from the
holder of the note and on February 2, 1999, this note and related  interest were
paid in full.

At December 31, 1998,  the Company had unsecured  demand notes payable to former
Papyrus  stockholders  in the aggregate  amount of $1,710,000,  which notes were
issued in connection  with the Papyrus  acquisition.  Demands for payment on the
notes were made as follows:  $1,190,000 on February 28, 1999,  $180,000 on April
30, 1999 and $340,000 on September  30, 1999,  and bore  interest at six percent
after their due date. The Company did not make payments on the due dates pending
the result of certain  legal  actions  undertaken  by the Company.  In September
1999, the actions were settled resulting in cancellation of the promissory notes
upon payment to the former Papyrus  shareholders of $1,217,384 and the return of
970,586  shares  of  restricted  Class  A  common  stock  previously  issued  in
connection with the acquisition of Papyrus.  The 970,586 shares were effectively
canceled in September  1999 in  connection  with the  settlement of the lawsuits
then pending and the original  fair market value of $1,000,917  associated  with
the canceled shares was reflected as a reduction to goodwill associated with the
purchase of Papyrus  Associates,  Inc. Of the notes  payable,  $77,625  remained
unpaid as of December 31, 1999.  The holders of these notes have not made demand
for payment.

The Company had an unsecured  revolving  note payable to a company  owned by two
executive  officers and directors and a former executive officer and director of
the Company. The Company believes the terms of the related-party  revolving note
payable were at least as  favorable  as the terms that could have been  obtained
from an unrelated third


                                      F-19

<PAGE>


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


party in a similar transaction.

At December 31, 1998, the Company had an unsecured,  non-interest bearing demand
note  payable in the amount of $100,000 to  Synergetics,  Inc.,  a research  and
development  entity (see Note 12). On September  2, 1999,  this note and related
interest were paid in full.

At December 31, 1998, the Company had an unsecured note payable to an officer of
the Company in the amount of $20,000,  which bore  interest at an annual rate of
10 percent.  On September 2, 1999,  this note and related  interest were paid in
full.

During 1999,  two  executive  officers of the company  advanced  funds  totaling
$317,159  related to sales of the Company's stock owned by them that was pledged
as collateral under certain borrowing  agreements.  The balance was subsequently
repaid in full. Also, an executive officer of the Company advanced an additional
$68,691 to the Company for  operating  expenses,  all of which was  subsequently
repaid to him.  There were no amounts owed to these  individuals at December 31,
1999.

8.  CONVERTIBLE DEBENTURES

Series A Convertible  Debentures - On October 23, 1995, the Company entered into
an agreement with Beesmark  Investments,  L.C., a Utah limited liability company
controlled  by an individual  who assumed a position on the  Company's  board of
directors in connection  with the execution of the agreement.  He later resigned
from the board.  Under the  agreement,  the Company  issued Series A convertible
debentures  in the amount of  $500,000.  The  debentures  bore  interest at five
percent and were originally due October 23, 1996. The debentures were ultimately
converted  into  166,667  shares  of  Series A  convertible  preferred  stock on
September 25, 1997 (see Note 9).

Series B Convertible  Debentures - On June 18, 1997, the Company  entered into a
convertible  debenture purchase agreement whereby an unrelated investment entity
agreed to purchase up to an aggregate  principal amount of $10,000,000 of Series
B convertible  debentures.  The debentures were due June 18, 2007, bore interest
at five percent and were  convertible  into shares of the Company's common stock
at the  holders'  option at the lesser of $6.81 or the  average of the per share
market value for the five trading days immediately preceding the conversion date
multiplied  by 90 percent for any  conversion on or prior to the 120th day after
the original  issue date and 87.5  percent for any  conversion  thereafter.  The
Company  received  $3,000,000  in proceeds  related to the  issuance of Series B
convertible  debentures.  Using the  conversion  terms  most  beneficial  to the
holders of the debentures, the Company recorded a debt discount of approximately
$427,900  which was  amortized as additional  interest  expense over the 120 day
period  commencing June 18, 1997. As part of the same  transaction,  the Company
also issued to the investors a warrant to purchase up to 250,000 shares of Class
A common  stock at any time prior to June 18,  2002,  at the  exercise  price of
$8.28 per share. The Company  recorded the fair value of the warrants,  totaling
$897,750,  as a charge to interest  expense.  The fair value of the warrants was
determined  as of the  date of  grant  using  the  Black-Scholes  pricing  model
assuming the following:  dividend yield of 0 percent;  expected volatility of 65
percent; risk free interest rate of 5.9 percent and an expected life to exercise
of five years. On July 31, 1997 and September 26, 1997, $500,000 and $350,000 of
the Series B convertible  debentures  together with interest earned thereon were
converted into 87,498 and 58,249 shares of Class A common stock, respectively.

Effective September 30, 1997, the Company and the Series B convertible debenture
holders  modified the  agreement  such that the holders  exchanged  all the then
outstanding  debentures in the amount of $2,150,000 and accrued interest thereon
in the amount of $28,213 into 108,911  shares of Series B convertible  preferred
stock which had essentially the same terms as the debentures and agreed that any
additional  purchases  under the  agreement  would be for  Series B  convertible
preferred stock. In connection with the extinguishment of the


                                      F-20

<PAGE>


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


Series B  convertible  debentures  and the  issuance  of  Series  B  convertible
preferred stock (see Note 9), the Company recorded all unamortized debt discount
as a loss on  extinguishment of debt.  However,  prior to the actual issuance of
the Series B preferred stock in exchange for the  outstanding  balance under the
debentures,  the  holders  converted  the  balance  of  $2,150,000  and  related
dividends into 431,769 shares of Class A common stock.  Also in connection  with
this  modification,  the Company issued an additional  warrant to purchase up to
175,000 shares of Class A common stock at any time prior to October 24, 2002, at
an exercise  price of $7.48 per share.  In connection  with the issuance of that
warrant,  the Company recorded the fair value of the warrant,  totaling $661,850
as an additional loss on  extinguishment of debt. The fair value of the warrants
was determined as of the date of the grant using the Black-Scholes pricing model
assuming the following:  dividend yield of 0 percent;  expected volatility of 65
percent; risk free interest rate of 5.8 percent and expected life to exercise of
5 years.

Series C Convertible  Debentures - On January 29, 1999, the Company entered into
an agreement with four investors pursuant to which the Company sold its Series C
convertible  debentures in the aggregate  principal  amount of  $4,000,000.  The
outstanding  principal  amount of the debentures was  convertible at any time at
the option of the holders  into shares of Class A common  stock at a  conversion
price  equal to the lesser of $1.25 or 80 percent of the  average of the closing
bid price of the  Class A common  stock for the five  trading  days  immediately
preceding the conversion date. The Company recorded $687,500 as interest expense
upon the issuance of the debentures in connection with the beneficial conversion
feature.  The Company  also issued  400,000  warrants  in  connection  with this
financing.  The  warrants are  exercisable  for a period of three years from the
date of grant. The estimated fair value of the warrants of $192,000, as computed
under the Black-Scholes pricing model, was recorded as interest expense upon the
issuance  of  the  debentures.   On  March  3,  1999,  the  Company  executed  a
supplemental  agreement  pursuant  to which the Company  agreed to sell  another
$2,500,000 principal amount of Series C convertible debentures on the same terms
and conditions as the January 29, 1999 agreement,  except no additional warrants
were issued. The obligations of the Company for repayment of the debentures,  as
well as its  obligation  to register the common stock  underlying  the potential
conversion of the  debentures  and the exercise of the warrants  issued in these
transactions, were personally guaranteed by two executive officers and directors
and one former executive officer and director (the "Guarantors"). These personal
guarantees were secured by a pledge of 6,000,000  shares of Fonix Class A common
stock  beneficially  owned  by the  Guarantors.  The  Company  entered  into  an
indemnity  agreement with the Guarantors  relating to this and other  guarantees
and pledges (see Note 12).

Subsequent to the March 3, 1999 funding, the holders of the Series C convertible
debentures  notified the Company and the Guarantors  that a default had occurred
under certain  terms of the stock pledge  agreement as a result of the Company's
failure to register in a timely manner the resale of the shares  underlying  the
debentures,  and that the holders had  exercised  their right to sell the shares
pledged by the Guarantors.  The Company was informed that proceeds from the sale
of the 6,000,000 pledged shares amounted to $3,278,893.  Of this total, $406,250
was  allocated  to penalties  attributable  to default  provisions  of the stock
pledge  agreement  and recorded by the Company as interest  expense and $343,750
related to penalty provisions of the Series D preferred stock (held by a related
group of investors)  and recorded by the Company as preferred  stock  dividends.
The remaining  $2,528,893 was applied as a reduction of the principal balance of
the debentures.  As of December 31, 1999, the remaining  balance of the Series C
convertible  debentures  was  $3,971,107.  Subsequent to December 31, 1999,  the
remaining  balance,  together with interest accrued thereon,  was converted into
10,385,364 shares of Class A common stock.

Under  its  indemnity  agreement  in favor of the  Guarantors,  the  Company  is
obligated to issue 6,000,000 replacement shares to the Guarantors for the shares
sold by the holders of the debentures.  Additionally, the Company has recorded a
related party liability of $1,296,600 as a  reimbursement  to the Guarantors for
the expenses incurred by the Guarantors as a result of the holders' sales of the
Guarantors' shares.

Certain  events  of  default  outlined  in the  Series C  convertible  debenture
agreement provided the holders the right to


                                      F-21

<PAGE>


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


declare  the  outstanding   balance  immediately  due  and  payable  and  impose
additional  penalties and interest until the default is cured.  Specified events
of default included  suspension from listing or delisting of the Company's Class
A common  stock from The Nasdaq  SmallCap  Market for a period of three  trading
days and failure to register the underlying common stock with the Securities and
Exchange  Commission by June 30, 1999.  In March 1999,  trading in the Company's
common stock was temporarily halted for five days. Following a series of notices
and  appeals,  the  Company was  notified on December 3, 1999,  that its Class A
common stock had been  delisted from the Nasdaq  SmallCap  Market (see Note 10).
The  Company's  Class A common  stock is  currently  trading on the OTC Bulletin
Board. Furthermore,  the Company had not registered the underlying shares by the
date  specified.  The holders of the  debentures  agreed to waive their right to
additional  penalties  and  interest  and their right to declare the balance due
provided the underlying  shares were registered with the Securities and Exchange
Commission  on or before  February 29, 2000. A  registration  statement  for the
shares was declared effective February 11, 2000, thereby satisfying the terms of
the waiver.

9. PREFERRED STOCK

In August  1997,  a majority  of the  shareholders  of the  Company  approved an
amendment  to  the  Company's  certificate  of  incorporation   authorizing  and
approving  the issuance of preferred  stock in such series and having such terms
and conditions as the Company's board of directors may designate.  The amendment
became  effective  September  24,  1997.  Thereafter,  the  Company's  board  of
directors adopted resolutions  establishing various series of preferred stock in
connection  with  certain  capital  fund-raising  in  1999,  1998 and  1997,  as
described below.

Series A Convertible  Preferred Stock - In September 1997,  Series A convertible
debentures  totaling  $500,000 were  converted  into 166,667  shares of Series A
convertible preferred stock. Holders of the Series A convertible preferred stock
have the same voting rights as common stockholders,  have the right to elect one
person  to the  board  of  directors  and are  entitled  to  receive  a one time
preferential  dividend  of $2.905  per share of Series A  convertible  preferred
stock prior to the payment of any  dividend on any class or series of stock.  At
the option of the holder, each share of Series A convertible  preferred stock is
convertible  into one share of Class A common  stock  and in the event  that the
common stock price has equaled or exceeded $10 for a 15 day period, the Series A
convertible  preferred  stock shares are  automatically  converted  into Class A
common  stock.  In the  event  of  liquidation,  the  holder  is  entitled  to a
liquidating  distribution  of  $36.33  per share  and a  conversion  of Series A
convertible preferred stock at an amount equal to 1.5 shares of common stock for
each share of Series A convertible preferred stock.

Series B Convertible Preferred Stock - Effective September 30, 1997, the Company
and the Series B  convertible  debenture  holders  agreed to  exchange  all then
outstanding  Series B  debentures  in the  aggregate  amount of  $2,150,000  and
accrued  interest thereon in the amount of $28,213 into 108,911 shares of Series
B convertible  preferred stock.  Dividends  accrued on the stated value ($20 per
share) of Series B  convertible  preferred  stock at a rate of five  percent per
year,  were payable  quarterly in cash or Class A common stock, at the option of
the  Company,  and were  convertible  into shares of Class A common stock at any
time after issuance at the holders'  option.  In the event of  liquidation,  the
holders of the Series B convertible  preferred  stock were entitled to an amount
equal to the stated value plus accrued but unpaid dividends  whether declared or
not. The holders of Series B convertible  preferred  stock had no voting rights.
The Series B  convertible  preferred  stock,  together  with  dividends  accrued
thereon, could be converted into shares of Class A common stock at the lesser of
$6.81 or the average of the per share  market  value for the five  trading  days
immediately  preceding  the  conversion  date  multiplied  by 90 percent for any
conversion  on or prior to the 120th day after the original  issue date and 87.5
percent  for  any  conversion  thereafter.   Using  the  conversion  terms  most
beneficial  to the holders,  the Company  recorded a dividend of $219,614  which
represented  a discount of 10 percent,  which was  available to the holders upon
issuance.  The  additional  2.5 percent  discount of $68,509 was  amortized as a
dividend over the remaining  days in the original 120 day vesting  period of the
Series B convertible  debentures.  Prior to the actual  issuance of the Series B
convertible


                                      F-22

<PAGE>


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


preferred  stock in exchange for the  outstanding  balance under the debentures,
the holders converted the balance of  $2,150,000,  and related  dividends,  into
431,679 shares of Class A common stock.

On October 24, 1997,  the Company sold an additional  125,000 shares of Series B
convertible  preferred  stock for $2,500,000  less $145,000 in related  offering
costs.  Using the conversion  terms most beneficial to the holders,  the Company
recorded a dividend  of  $576,667  which  represented  a discount of 10 percent,
which was available to the holders on or before 120 days  subsequent to closing.
A 2.5 percent  discount of $87,905 was amortized as a dividend over 120 days. As
a condition for issuing  preferred  stock, the holders were granted a put option
by SMD, L.L.C.  ("SMD"), a company which is controlled by three shareholders who
are current or former  officers and  directors  of the  Company.  The put option
required  SMD to  purchase  the Series B  convertible  preferred  stock from the
holders  at the  holders'  option  but only in the event that the Class A common
stock of the Company was removed  from listing on the NASDAQ Small Cap Market or
any other  national  securities  exchange.  The holders did not exercise the put
option.  In connection  with this put option,  the Company  recorded a financing
expense and a corresponding capital contribution of $125,000. As of December 31,
1997,  97,500 of the Series B convertible  preferred stock and dividends  earned
thereon had been  converted  into  355,188  shares of Class A common  stock.  In
January  1998,  the remaining  27,500  shares of Series B convertible  preferred
stock and dividends earned thereon were converted into 193,582 shares of Class A
common stock. As of December 31, 1999 and 1998,  there are no shares of Series B
convertible preferred stock outstanding.

Series C Convertible Preferred Stock - Effective September 30, 1997, the Company
entered  into an  agreement  with an unrelated  investment  entity  whereby that
entity agreed to purchase  187,500 shares of the Company's  Series C convertible
preferred  stock for $3,750,000,  which was received in October 1997.  Dividends
accrued on the stated  value ($20 per share) of Series C  convertible  preferred
stock at a rate of five  percent per year,  were  payable  quarterly  in cash or
Class A common stock, at the option of the Company,  and were  convertible  into
shares of Class A common stock at anytime after issuance at the holders' option.
In the event of liquidation,  the holders of the Series C convertible  preferred
stock were  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 C
convertible  preferred  stock had no voting  rights.  The  Series C  convertible
preferred stock,  together with dividends  accrued  thereon,  could be converted
into shares of Class A common stock at the lesser of $5.98 or the average of the
five lowest closing bid prices for the 15 trading days preceding the date of any
conversion notice multiplied by 91 percent for any conversion on or prior to the
120th day after the original issue date, 90 percent for any  conversion  between
121 and 180  days  and 88  percent  for any  conversion  thereafter.  Using  the
conversion terms most beneficial to the holder,  the Company recorded a dividend
of $1,060,718 which represented a discount of nine percent,  which was available
to the holder on or before 120 days subsequent to closing.  The additional three
percent  discount of $164,002 was  amortized as a dividend  over 180 days.  As a
condition for issuing  preferred  stock,  the holder of the Series C convertible
preferred  stock was granted a put option by SMD. The put option required SMD to
purchase  the  Series C  convertible  preferred  stock  from the  holder  at the
holder's option but only in the event that Class A common stock was removed from
listing  on the  NASDAQ  Small  Cap  Market  or any  other  national  securities
exchange.  In connection with this put option,  the Company recorded a financing
expense and a corresponding  capital  contribution of $375,000.  Associated with
the issuance of the Series C convertible  preferred  stock, the Company issued a
warrant to  purchase  up to 200,000  shares of Class A common  stock at any time
prior to October 24, 2000, at the exercise price of $7.18 per share. The Company
recorded the fair value of the warrant of $600,000 as  determined  as of October
24,1997 using the Black-Scholes  pricing model assuming the following:  dividend
yield of 0 percent;  expected volatility of 65 percent;  risk free interest rate
of 5.8 percent and expected  life to exercise of 3 years.  During the year ended
December 31, 1997, the Company issued 17,198 shares of Class A common stock upon
conversion of 2,500 shares


                                      F-23

<PAGE>


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


of Series C convertible  preferred stock and related accrued  dividends.  During
1998, the remaining  185,000 shares of Series C convertible  preferred stock and
related  dividends were converted into 1,295,919 shares of Class A common stock.
As of December 31, 1999,  there are no shares of Series C convertible  preferred
stock outstanding.

Series D Convertible  Preferred  Stock - On August 31, 1998, the Company entered
into an agreement  with  investors  whereby the Company issued 500,000 shares of
Series D convertible preferred stock for $10,000,000.  Additionally, the Company
issued to certain  investors a total of 608,334  shares of Series D  convertible
preferred  stock (i) in return  for their  relinquishment  of their  contractual
right to receive  Reset Shares in  connection  with the March 1998 offering (see
Note 10), and as (ii) an  additional  cost of raising the  $10,000,000  from the
Series D convertible  preferred stock placement.  Dividends accrue on the stated
value ($20 per  share) of Series D  convertible  preferred  stock at the rate of
four percent per year, are payable annually or upon conversion, in cash or Class
A common stock, at the option of the Company, and are convertible into shares of
Class A common stock at the holders'  option any time. Each month the holders of
the Series D convertible preferred stock may not convert more than 25 percent of
the total number of shares of Series D convertible  preferred  stock  originally
issued to such holders,  on a cumulative  basis.  For example,  during the first
month,  a holder may convert up to 25 percent of the total Series D  convertible
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 percent of the total
number of shares of Series D  convertible  preferred  stock held by the  holder.
Additionally, each month thereafter a holder may convert up to 50 percent of the
total number of shares of Series D convertible preferred stock originally issued
to such holder on a cumulative  basis,  if both of the following  conditions are
satisfied: the average daily trading volume of Class A 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 five  percent  during that  10-trading-day  period.  Any
outstanding shares of Series D convertible preferred stock as of August 31, 2001
automatically  will be converted at the conversion  price most beneficial to the
holders on such date. In the event of  liquidation,  the holders of the Series D
convertible  preferred stock 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  convertible  preferred  stock have no voting  rights.  The
Series D convertible  preferred stock,  together with dividends accrued thereon,
may be converted into shares of Class A 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 fifteen trading days  immediately  preceding the date of issuance of the
shares of Series D convertible  preferred stock; 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  Class A common  stock  for  each  share  of  Series D
convertible  preferred  stock  converted to common stock.  Using the  conversion
terms most  beneficial  to the  holders,  the  Company  amortized  a  beneficial
conversion  feature of $3,638,147 as a dividend over a 180 day-period.  In 1998,
150,000  shares of Series D  convertible  preferred  stock  were  exchanged  for
150,000  shares of Series E convertible  preferred  stock (see below).  In 1999,
626,611  shares of Series D convertible  preferred  stock and related  dividends
were converted into  47,252,275  shares of Class A common stock.  As of December
31,  1999,  381,723  shares  of  Series D  convertible  preferred  stock  remain
outstanding.

In  connection  with the sales of the  Series D  preferred  stock,  the  Company
entered into  registration  rights  agreements  with the Series D investors  and
agreed to register the sale of shares  received on a conversion  of the Series D
preferred  stock.  If the  number of shares  of Class A common  stock  currently
issuable upon a  hypothetical  conversion  of the  remaining  shares of Series D
preferred  stock exceed those registered  for  issuance,  the Company  would be
required to file an  additional  registration  statement to cover the  remaining
shares.

Subsequent to December 31, 1999 through April 10, 2000, 217,223 shares of Series
D preferred stock,  together with dividend accrued thereon,  were converted into
15,436,378 shares of Class A common stock.



                                      F-24

<PAGE>


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


Series E Convertible  Preferred  Stock - Effective as of September 30, 1998, the
Company  entered into an agreement  with two of the  purchasers  of the Series D
convertible  preferred  stock whereby the Company  issued  100,000 shares of the
Company's Series E convertible preferred stock for $2,000,000. Additionally, the
Company issued to the purchasers of the Series E convertible  preferred  stock a
total of 150,000  additional  shares of Series E convertible  preferred stock in
exchange for a total of 150,000 shares of Series D convertible  preferred stock.
Dividends  accrued on the stated  value ($20 per share) of Series E  convertible
preferred  stock at a rate of four percent per year,  were  payable  annually or
upon conversion, in cash or common stock, at the option of the Company, and were
convertible  into  shares  of Class A common  stock at any time at the  holders'
option.  In the event of  liquidation,  the holders of the Series E  convertible
preferred  stock were  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  convertible  preferred  stock  had no  voting  rights.  The  Series E
convertible  preferred  stock,  together with  dividends  accrued  thereon,  was
convertable  into  shares of Class A 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 convertible  preferred stock; 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 holders had converted at the $3.50 per share price,
the Company was  obligated  to issue  warrants to purchase 0.8 shares of Class A
common stock for each share of Series E convertible preferred stock converted to
common stock.  Using the conversion  terms most  beneficial to the holders,  the
Company  recorded a preferred  stock  dividend of  $968,047  for the  beneficial
conversion feature of the Series E convertible preferred stock. In 1998, 114,928
shares of  Series E  convertible  preferred  stock and  related  dividends  were
converted into 2,591,733  shares of Class A common stock. In 1999, the remaining
135,072  shares of Series E convertible  preferred  stock and related  dividends
were converted into 5,729,156 shares of Class A common stock. As of December 31,
1999, no shares of Series E convertible preferred stock remained outstanding.

Series F Convertible  Preferred Stock - Effective  February 1, 2000, the Company
entered into an agreement with four investors whereby it sold a total of 290,000
shares of its Series F  convertible  preferred  stock to a group of investors in
return for payment of $2,750,000. Dividends accrued on the stated value ($20 per
share) of Series F  convertible  preferred  stock at a rate of six  percent  per
year, were payable annually or upon conversion,  in cash or common stock, at the
option of the Company,  and were convertible into shares of Class A common stock
at any time at the holders' option. The Series F convertible preferred stock was
convertible  into  shares of Class A common  stock at a price of $0.75 per share
during the first 90 days following the close of the transaction,  and thereafter
at a price  equal to 85 percent of the average of the three  lowest  closing bid
prices in the 20-day  trading  period  prior to the  conversion  of the Series F
convertible preferred stock. Through December 31, 1999, the Company had received
$1,000,000 in cash advances in connection with this financing.

Subsequent  to February 1, 2000,  all shares of Series F  convertible  preferred
stock,  together with related  dividends  accrued  thereon,  were converted into
7,764,948  shares of Class A common  stock.  Using  the  conversion  terms  most
beneficial to the holder,  the Company  recorded a preferred  stock  dividend of
$2,750,000 for the beneficial  conversion feature related to these shares on the
date the Series F convertible preferred stock was issued.


10.  COMMON STOCK AND COMMON STOCK SUBJECT TO REDEMPTION

Common  Stock - During 1999,  the Company  issued  60,181,431  shares of Class A
common stock. Of such shares,  52,981,431 shares were issued upon the conversion
of preferred stock and related  dividends,  6,000,000 were issued as replacement
shares under an indemnification  agreement in favor of the Guarantors (see Notes
8 and 12) and 1,200,000 were issued to consultants as consideration for services
rendered. The Company canceled 970,586 shares


                                      F-25

<PAGE>


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


of Class A common  stock  that were  returned  in  connection  with the  Papyrus
settlement (see Note 16). At the annual meeting of shareholders  held on October
29,  1999,  issuance  of Class B  non-voting  common  stock was  approved by the
shareholders  of the  Company.  Also  approved  was an increase in the number of
common shares  authorized  from  100,000,000 to 300,000,000 and in the number of
preferred shares authorized from 20,000,000 to 50,000,000.

During 1998, the Company issued  20,740,605  shares of Class A common stock.  Of
such shares, 4,000,000 shares were issued in connection with a private placement
transaction,  10,944,081  shares were issued in connection with the acquisitions
of AcuVoice,  Articulate and Papyrus (see Note 2),  4,081,234 shares were issued
upon the  conversion of Series B and C convertible  preferred  stock and related
dividends,  1,390,476 shares were issued in connection with the restructuring of
reset rights, 265,000 shares were issued upon the exercise of previously granted
warrants and options, 35,000 shares were issued in payment of a loan origination
fee (see Note 6) and 24,814 shares were issued for the purchase of a patent.

On March 12, 1998, the Company agreed to a private  placement of up to 6,666,666
shares of its  restricted  Class A common  stock for a total  purchase  price of
$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  Class A  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 subject to the effectiveness of
a registration  statement  covering the Class A common stock issued and issuable
in the offering.  As of the July 27, 1998, the conditions precedent to receiving
the additional funding were not met. In separate transactions in June and August
1998,  certain investors paid to the Company a total of $3,000,000 in return for
which the Company issued 666,667 additional shares of Class A common stock under
the terms and  conditions  set forth in the offering.  Finders' fees of $163,846
were incurred in connection with the $3,000,000 received. No other proceeds have
been received by the Company pursuant to the offering,  and the Company does not
expect any further proceeds to be received.

The investors  acquired  certain "reset rights" in connection  with the offering
pursuant to which the investors would receive  additional shares of common stock
("Reset Shares") for no additional  consideration if the average market price of
the Company's Class A common stock for the 60-day period following the effective
date of the  registration  statement or the second funding 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 convertible  preferred stock and 1,390,476  shares of Class A
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  convertible
preferred  stock.  The  Company  recorded  an  expense  of  $6,111,577  for  the
difference between the Company's  original  obligation to issue Reset Shares and
the fair value of the shares that were  actually  issued in  settlement  for the
relinquishment  of the reset rights 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 convertible preferred stock.

Registration  Rights  and  Reserved  Shares - During  1999,  1998 and 1997,  the
Company entered into  registration  rights agreements with investors under which
the  Company  agreed to  register  the Class A common  stock  issuable  upon the
conversion of all series of preferred  stock and  debentures and the exercise of
warrants.  The Company  covenanted to reserve out of its authorized and unissued
shares of Class A common  stock no less than 200% of that  number of shares that
would be  issuable  upon the  conversion  of all series of  preferred  stock and
debentures  and any dividends and interest then payable in stock thereon and the
exercise  of  warrants.   As  of  April  10,  2000,  the  Company  has  reserved
approximately 5,000,000 shares of Class A common stock for this purpose.


                                      F-26

<PAGE>


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


Voting  Trust - As of  December  31,  1999, 10,306,772  shares of the  Company's
outstanding  Class A common  stock  were  held in a voting  trust  (the  "Voting
Trust") as to which the president and chief executive  officer of the Company is
the sole trustee. Persons who have deposited their shares of the Company's Class
A common stock into the Voting Trust have  dividend  and  liquidation  rights in
proportion  to the number of shares of the  Company's  Class A common stock they
have  deposited in the Voting  Trust,  but have no voting rights with respect to
such shares.  All voting rights  associated  with the shares  deposited into the
Voting Trust are exercisable solely and exclusively by the trustee of the Voting
Trust. The Voting Trust expires,  unless extended according to its terms, on the
earlier of September  30, 2002 or any of the following  events:  (i) the trustee
terminates it; (ii) the participating  stockholders unanimously terminate it; or
(iii) the Company is dissolved or liquidated.

Common Stock Subject to Redemption - On December 21, 1998,  the Company  entered
into a private  placement  agreement.  Pursuant  to the  agreement,  the Company
received  $1,980,000 in net proceeds in exchange for 1,801,802 shares of Class A
common  stock,  an equal number of "Repricing  Rights",  both subject to certain
Repurchase  Rights,  and warrants to purchase  200,000  shares of Class A common
stock.

Each  Repricing  Right  entitled  the holder to  receive a number of  additional
shares of Class A common stock for no  additional  consideration  according to a
formula based on the lowest  closing bid price of the  Company's  Class A common
stock,  as quoted by the  NASDAQ  SmallCap  Market,  during  the 15  consecutive
trading days  immediately  preceding the exercise date and a repricing price, as
defined,  ranging  from  $1.3875  to  $1.4319  depending  upon  the  date of the
exercise. The Repricing Rights became exercisable on March 21, 1999.

Each  holder  of the  Class  A  common  stock  described  above  had  the  right
("Repurchase  Right"),  based on certain  conditions,  to require the Company to
repurchase all or a portion of the holder's common shares and Repricing  Rights.
The Repurchase Rights could only be exercised  simultaneously  with or after the
occurrence of a major  transaction or triggering event as defined in the private
placement  securities  agreement.  Such events included certain  consolidations,
mergers or other business combinations, sale or transfer of all or substantially
all the Company's assets, purchase,  tender or exchange offering of more than 40
percent of the  Company's  outstanding  Class A common stock made and  accepted,
failure to have a  registration  statement  describing  the Class A common stock
declared  effective  prior to 180 days after the closing date or suspension from
listing or delisting of the Company's Class A common stock for a period of three
days. The repurchase price for the Class A common stock was $1.3875 per share.

On February 14, 2000,  the holder of the Repricing  Rights  converted its rights
into  4,568,569  shares of Class A common  stock and  subsequently  sold all the
shares. Simultaneously, the initial shares subject to the Repurchase Rights were
sold.  Consequently,  the Company has no further  obligation under the Repricing
Rights or the Repurchase Rights.

The  warrants  issued in this  transaction  have an exercise  price of $1.67 per
share and a term of three years.  The Company  assigned a fair value of $150,000
to the  warrants  as  determined  on December  21, 1998 using the  Black-Scholes
pricing model assuming a dividend yield of 0 percent,  expected volatility of 85
percent,  a risk free  interest  rate of 4.5 percent  and an expected  life of 3
years.

During 1997, the Company  issued  1,957,312  shares of Class A common stock.  Of
such shares, 150,000 were issued to an unrelated private investor,  265,000 were
issued upon the exercise of  previously  granted  warrants and options,  145,747
were issued upon conversion of convertible debentures,  804,065 were issued upon
the  conversion  of  preferred  stock and 592,500  were  issued to  unaffiliated
individuals for services  rendered valued at $3,812,971 based on the fair market
value of the shares at the time of issuance.


                                      F-27

<PAGE>


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


Delisting  from  the  Nasdaq  SmallCap  Market - Until  December  3,  1999,  the
Company's  Class A common  stock  traded on the  Nasdaq  SmallCap  Market  which
requires,  for  continued  listing,  a minimum  bid price of at least  $1.00 per
share.  At June 29, 1999,  the  Company's  Class A common stock had traded below
$1.00 for more than 30  consecutive  trading days. On June 29, 1999, the Company
received a letter from Nasdaq  indicating  that unless the minimum bid price for
the Company's  Class A common stock  returned to at least $1.00 per share for at
least 10  consecutive  trading days prior to September  29, 1999,  the Company's
shares would be delisted from the Nasdaq SmallCap Market on October 1, 1999. The
Company  appealed  Nasdaq's notice and listing  determination in September 1999.
Nasdaq held a hearing on the matter on October 28, 1999.

On December 3, 1999, the Company  received  notice that its Class A common stock
had been delisted from the Nasdaq SmallCap Market.  The Company's Class A common
stock is currently trading on the OTC Bulletin Board.

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

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


11. STOCK OPTIONS AND WARRANTS

Common Stock Options -On June 1, 1998, the Company's board of directors approved
the 1998 Stock Option and  Incentive  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.  The  Company's  shareholders
approved  the plan on July 14,  1998.  The plan is  administered  by a committee
consisting  of two or more  directors  of the Company.  The  exercise  price for
options granted under the plan is the closing market price of the Class A common
stock on the date the options are granted.  The option term is 10 years from the
date of grant. As of December 31, 1999, the number of shares available for grant
under this plan was 4,216,441.

In December 1998, the Company  granted options to purchase  2,800,000  shares of
Class A common  stock to members  of the board of  directors.  Of the  2,800,000
shares,  1,400,000  were for services  performed in 1998 and 1,400,000  were for
services to be performed in 1999  providing  the  directors served six months in
1999. In 1999, the Company  granted  400,000 options to new members of the board
of directors,  waiving the  requirement  that they serve for six months prior to
such granting.

On March 10, 1997,  the  Company's  board of  directors  approved the 1997 Stock
Option and Incentive Plan for  directors,  employees and other persons acting on
behalf of the Company, under which the aggregate number of shares authorized for
issuance is 7,500,000. The plan is administered by a committee consisting of two
or more  directors  of the Company.  The  exercise  price of such options is the
closing  market  price of the Class A common  stock on the date the  options are
granted.  The option term is 10 years from the date of grant. As of December 31,
1999, the number of shares available for grant under this plan was 2,238,993.

In April 1996,  the Company's  board of directors  approved the 1996  Directors'
Stock Option Plan,  under which the aggregate number of shares of Class A common
stock authorized for issuance is 5,400,000. The shareholders of the


                                      F-28

<PAGE>


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


Company  approved  the plan at their  annual  meeting in July 1996.  The plan is
administered by a committee  consisting of two or more directors of the Company.
The plan provides that each director shall receive  options to purchase  200,000
shares of Class A common stock for services  rendered as a director  during each
entire calendar year or portion of a calendar year in excess of six months.  The
exercise price of such options is the closing market price of the Class A common
stock on the date the options are granted. The option term is 10 years from date
of grant.  As of December 31,  1999,  the number of shares  available  for grant
under this plan was 2,200,000.

In April 1996,  the  Company's  board of  directors  approved a Long-Term  Stock
Investment  and  Incentive  Plan for  officers,  key employees and other persons
acting on behalf  of the  Company  under  which the  aggregate  number of shares
authorized  for issuance is 900,000.  The exercise price of these options is the
closing  market  price of the Class A common  stock on the date the  options are
granted.  The  term  of the  plan is 10  years  and  options  are  subject  to a
three-year vesting schedule,  pursuant to which one-third of the total number of
options  granted may be exercised each year. As of December 31, 1999, the number
of shares available for grant under this plan was 788,666.

A summary of options granted under the Company's  various stock option plans for
the years ended December 31, 1999, 1998 and 1997 is presented below:



<TABLE>
<CAPTION>
                                             1999                          1998                          1997
                                   ------------------------      ------------------------      -----------------------
                                                  Weighted                      Weighted                      Weighted
                                                  Average                       Average                       Average
                                   Stock          Exercise       Stock          Exercise       Stock          Exercise
                                   Options         Price         Options         Price         Options         Price
                                   -----------    ---------      -----------    ---------      ------------   --------
     Total options outstanding
<S>                                <C>            <C>            <C>            <C>            <C>            <C>
       at beginning of year         15,877,782    $  4.10         10,565,000    $  5.38          4,626,000    $  4.07
         Granted                     1,294,000       1.31          6,414,782       2.08          6,009,000       6.38
         Exercised                          -          -             (35,000)      6.00            (15,000)      2.97
         Forfeited                  (2,815,882)      3.01         (1,067,000)      4.56            (55,000)      6.45
                                   -----------                   -----------                   ------------
     Total options outstanding
       at end of year               14,355,900       4.06         15,877,782       4.10         10,565,000       5.38
                                   ===========                   ===========                   ============
     Total options exercisable
       at end of year               13,484,237       4.20          9,524,766       5.11          5,392,675       5.05
                                   ===========                   ===========                   ============
     Weighted average fair
       value of options granted
         during the year                          $  1.31                       $  1.98                       $  6.38
</TABLE>



                                      F-29

<PAGE>


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


A summary of options  outstanding  and options  exercisable  under the Company's
various stock option plans at December 31, 1999 is presented below:




<TABLE>
<CAPTION>
                    Options Oustanding                           Options Exercisable
-----------------------------------------------------       --------------------------
                              Weighted
                              Average        Weighted                      Weighted
Range of                      Remaining      Average                       Average
Exercise       Number         Contractual    Exercise       Number         Exercise
 Prices        Outstanding      Life          Price         Exercisable     Price
----------     -----------    -----------    --------       ------------   -----------
<S>             <C>           <C>            <C>            <C>            <C>
$0.40-1.18      3,932,157     9.0 years      $  1.05          3,332,158    $   1.03
 1.28-1.78        592,834     9.1 years         1.52            547,835        1.53
 2.97-4.06      3,755,334     6.6 years         3.96          3,570,335        3.99
 5.06-6.50      5,755,575     7.7 years         6.28          5,713,909        5.97
 7.13-8.50        320,000     7.2 years         7.17            320,000        7.17
               -----------                                  ------------
$0.40-8.50     14,355,900     7.8 years      $  4.06         13,484,237    $   4.20
               ===========                                  ============
</TABLE>


The Company  accounts for its stock option plans as they relate to employees and
directors under Accounting  Principles  Board Opinion No. 25, and therefore,  no
compensation  expense  has  been  recognized  in the  accompanying  consolidated
statements  of  operations.  Had  compensation  expense for these  options  been
determined in accordance with the method prescribed by SFAS No. 123, "Accounting
for  Stock-Based  Compensation",  the  Company's net loss per common share would
have been increased to the pro forma amounts indicated below for the years ended
December 31, 1999, 1998 and 1997:

<TABLE>
<CAPTION>
                                                       1999                1998                1997
                                                  --------------      -------------       --------------
Net loss attributable to common stockholders:
<S>                                               <C>                 <C>                 <C>
     As reported                                  $  23,773,026       $  47,916,031       $   25,175,939
     Pro forma                                       28,567,009          56,576,232           48,870,670

Basic and diluted net loss per common share:
     As reported                                  $      (0.31)       $      (0.91)       $       (0.59)
     Pro forma                                           (0.37)              (1.08)               (1.15)
</TABLE>

The fair value of options and warrants is  estimated  on the date granted  using
the Black-Scholes pricing model with the following weighted-average  assumptions
used for grants  during  1999,  1998 and 1997:  Risk-free  interest  rate of 5.7
percent,  4.8 percent and 5.6  percent  for 1999,  1998 and 1997,  respectively;
expected dividend yield of 0 percent for 1999, 1998 and 1997;  expected exercise
lives of 5 years for 1999, 1998 and 1997, ; expected  volatility of 102 percent,
85 percent and 75 percent for 1999, 1998 and 1997,  respectively.  The estimated
fair value of options  granted is subject to the  assumptions  made,  and if the
assumptions   were  to  change  the  estimated   fair  value  amounts  could  be
significantly different.



                                      F-30

<PAGE>


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


Warrants - A summary of warrants  granted by the Company  during the years ended
December 31, 1999, 1998 and 1997 is presented below:

<TABLE>
<CAPTION>

                                                  1999                          1998                          1997
                                        -------------------------     ------------------------      -------------------------
                                                        Weighted                      Weighted                      Weighted
                                                        Average                       Average                       Average
                                                        Exercise                      Exercise                      Exercise
                                          Shares        Price            Shares       Price             Shares      Price
                                        -----------    ----------     -----------    ---------      -----------    ----------
<S>                                      <C>           <C>             <C>           <C>               <C>         <C>
Total outstanding at beginning of year   1,925,000     $ 13.08         1,175,000     $  6.39           450,000     $  1.63
    Granted                              2,250,000        0.66         1,200,000       16.94           975,000        6.92
    Exercised                                   -           -           (230,000)       1.28          (250,000)       1.40
    Forfeited                           (1,150,000)      16.06          (220,000)       9.14                -
                                        -----------                   -----------                   -----------
Total outstanding at end of year         3,025,000        2.71         1,925,000       13.08         1,175,000        6.39
                                        ===========                   ===========                   ===========

Total exercisable at end of year         2,525,000     $  3.16         1,925,000     $ 13.08         1,175,000     $  6.39
                                        ===========                   ===========                   ===========
</TABLE>


Stock  Appreciation  Rights - The option plans  described above also provide for
stock  appreciation  rights that allow the grantee to receive  shares of Class A
common  stock  equivalent  in value to the  difference  between  the  designated
exercise  price and the fair market value of Class A common stock at the date of
exercise.  At December 31, 1999, there were stock appreciation rights related to
400,000  outstanding  stock options with a weighted  average  exercise  price of
$1.18.  Subsequent to December 31, 1999,  these stock  appreciation  rights were
exercised  resulting  in the  recording  of  $628,000  of  selling,  general and
administrative expense.

12.  RELATED-PARTY  TRANSACTIONS

Guarantee of Company  Obligations and Related Indemnity Agreement -Two executive
officers  and  directors  and a former  executive  officer  and  director of the
Company (the "Guarantors") have guaranteed obligations of the Company, including
obligations under the Series C debentures and certain real estate leases.

The Guarantors  pledged  6,000,000  shares of Class A common stock as collateral
security for the Series C  convertible  debentures.  In  consideration  for this
pledge,  the board of  directors  authorized  the  issuance  of  warrants to the
Guarantors  to purchase one share of Class A common stock for every three shares
pledged.  The  purchase  warrants  would have a term of 10 years and an exercise
price of 125 percent of the closing bid price of the  Company's  common stock on
January 29, 1999, the date of issuance of the  debentures.  The warrants are not
exercisable  for at least six months after the date of issuance.  The Guarantors
subsequently deferred receipt of the warrants,  but retained the right to accept
them at some later date. Accordingly,  no warrants have yet been issued pursuant
to this transaction. The Company also agreed to indemnify the Guarantors if they
are required to pay any sums for the benefit of the Company under their guaranty
of the Series C convertible  debentures.  The indemnity  agreement provides that
the Company  will issue shares of Class A common  stock of  sufficient  value to
reimburse the guarantors in full, plus interest at 10 percent per annum, for all
costs  associated  with meeting the guarantee  commitment,  including any income
taxes resulting therefrom.

Subsequent to the March 3, 1999 funding, the holders of the Series C convertible
debentures  notified the Company and the Guarantors  that a default had occurred
under certain terms of the stock pledge  agreement and that the holders sold the
6,000,000  shares pledged by the  Guarantors.  The proceeds from the sale of the
pledged  shares  were  applied to  certain  penalties  incurred  on the Series D
preferred  stock (held by a related  group of  investors)  and the remainder was
applied to reduce the principal  balance of the Series C convertible  debentures
as of September 30,


                                      F-31

<PAGE>


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


1999 (see Note 8).  Under  its  indemnity  agreement  with the  Guarantors,  the
Company  issued  6,000,000  replacement  shares to the Guarantors for the shares
sold and reimbursed the Guarantors for resulting costs. Accordingly, the Company
recorded an expense of $1,296,600 during 1999.

In December 1998, the Guarantors  guaranteed certain  additional  obligations of
the Company. As security for some of the guarantees, the Guarantors also pledged
shares of the Class A  common  stock  beneficially owned by them. In March 1999,
143,230 of the shares  pledged to a bank were sold by the bank and the  proceeds
were used to pay Company credit card balances and the related  accrued  interest
in full totaling $244,824. In May 1999, 100,000 of the shares pledged to another
creditor of the Company  were sold by the creditor  and the  proceeds,  totaling
$72,335,  were used to pay amounts owed by the Company.  The Company recorded an
expense of  $146,700  during  1999 to  reimburse  the  Guarantors  for  expenses
resulting from these sales.

Studdert   Companies  Corp.  -  Studdert  Companies  Corp.  ("SCC")  is  a  Utah
corporation that previously  provided  investment and management services to the
Company.  Two of the  officers,  directors  and owners of SCC are  directors and
executive  officers of the Company.  A third officer,  director and owner of SCC
was a director and executive  officer of the Company.  In June 1994, the Company
entered into an Independent  Consulting Agreement (the "SCC Agreement") with SCC
pursuant to which SCC rendered services to the Company.

Under the terms of the SCC Agreement  from June 1994 to April 1996,  the Company
paid a monthly fee of $50,000 to SCC for management and other services  rendered
on  behalf  of the  Company,  including  compensation  and  benefits  for  three
executive officers of the Company who were also officers and directors of SCC at
the time. The Company did not pay or award any form of compensation  directly to
these executive officers.  Through this period, the Company incurred charges for
services  rendered  and  reimbursable  expenses  payable  to  SCC  amounting  to
$2,554,405,  all of which  was paid on or  before  February  10,  1997.  Of this
amount,  $1,417,000 was paid by issuance of Class A common stock.  The stock was
issued  through  exercise  of a warrant for  3,700,000  shares of Class A common
stock  purchased  by SCC for $.033 per share with an exercise  price of $.35 per
share.  The $122,100  purchase  price and the  $1,295,000  exercise price of the
warrants  were  satisfied  by the  cancellation  of the amounts owed to SCC. The
balance of $1,137,405 was paid in cash during 1995, 1996 and 1997, as agreed.

Beginning May 1, 1996, the SCC Agreement was modified to cover only reimbursable
expenses incurred by SCC on behalf of the Company. Thereafter,  compensation and
benefits were paid directly to the executive  officers according to the terms of
their respective employment contracts with the Company. The Company continues to
rent  office  space  under  subleases  from SCC.  Payments  under the leases are
guaranteed  by three  officers,  owners and  directors  of SCC,  two of whom are
executive  officers and directors of the Company.  The subleases require monthly
payments of $10,368.  The Company  believes  the terms of the  subleases  are at
least as favorable as terms that could be obtained  from an  unaffiliated  third
party in a similar transaction. Accordingly, SCC was reimbursed for expenses and
lease  payments in the amount of $124,416 in 1999,  $117,228 in 1998 and $77,203
in 1997.

SMD,  L.L.C.  - From  September 4, 1997,  through  October 15, 1997 and again on
December 31, 1997, the Company, borrowed funds from SMD, L.L.C., a company owned
by two  directors  and  executive  officers and a former  director and executive
officer of the  Company  pursuant to a  revolving,  unsecured  promissory  note,
bearing  interest  at the rate of 12 percent  per annum.  The  aggregate  of all
amounts loaned under the note was $2,000,000 and the highest outstanding balance
at any one time was $1,550,000. All amounts were repaid, together with $5,542 in
interest  in 1998.  The loan and its  terms  were  approved  by the  independent
members of the board of directors of the Company.



                                      F-32

<PAGE>


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


Synergetics - Through December 1998, a director and the chief executive  officer
of the  Company  was also a director  of  Synergetics,  Inc.  In  addition,  two
executive  officers and directors and a former director and executive officer of
the Company owned shares of the common stock of Synergetics, although such share
ownership in the aggregate  constituted  less than 5 percent of the total shares
of Synergetics common stock issued and outstanding. Effective December 31, 1998,
the chief executive  officer and director of the Company resigned from the board
of Synergetics and the three executive  officers and directors  relinquished all
ownership  of  Synergetics  shares.   Until  March  1999,  the  Company  engaged
Synergetics  to  provide  assistance  to  Fonix  in the  development  of its ASR
technologies (see Note 14).

Voice  Information  Associates,  Inc. - A director and executive  officer of the
Company is also the founder and president of Voice Information Associates,  Inc.
("VIA"), a consulting group providing  strategic  technical,  market evaluation,
product  development  and  corporate   information  to  the  speech  recognition
industry.  During 1997,  the Company paid  approximately  $110,000 in consulting
fees to VIA for services  provided to the Company.  No payments were made by the
Company to VIA in 1999 and 1998.

Other Transactions - During 1996,  disinterested  members of the Company's board
of directors  authorized the Company to reimburse certain officers for all taxes
payable by the  officers in  conjunction  with the 1995  exercise  of  3,700,000
warrants by SCC, a company owned by the officers. The total amount authorized to
be reimbursed was  $1,150,000 in 1997 and  $1,350,000 in 1996. No  reimbursement
was paid in 1999, $340,516 was paid in 1998 and $2,159,484 was paid in 1997.

On December 23, 1999, the Company issued 250,000 warrants to a law firm having a
weighted average exercise price of $0.31 and a term of five years.  During 1999,
1998, and 1997, the Company paid approximately $902,000,  $746,000 and $394,000,
respectively, to the law firm for services provided to the Company.

13. STATEMENT OF WORK

On February 11,  1998,  the Company  entered into a First  Statement of Work and
License Agreement with Siemens Semiconductor Group of Siemens Aktiengesellschaft
("Siemens")  under  which the  Company and Siemens  were  jointly  pursuing  the
development of Siemens' integrated circuits  incorporating ASR and other related
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 ASR  technologies for which the Company has no further  obligation;  (2)
$322,928 was paid to purchase warrants to acquire 1,000,000 shares of restricted
Class A  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
restricted Class A 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 ASR technologies for which the Company
has no further obligation.  The Company recorded the $2,368,138 license payments
as revenue during the year ended December 31, 1998. No amounts were owed or paid
by Siemens in 1999.

14.  PRODUCT DEVELOPMENT AND RESEARCH

Synergetics  - Prior  to March  1997,  the  Company's  scientific  research  and
development  activities  were  conducted  solely by a third party,  Synergetics,
Inc.,  pursuant to product development and assignment  contracts  (collectively,
the  "Synergetics  Agreement").  Under that  arrangement,  Synergetics  provided
personnel and facilities,  and the Company financed the Synergetics research and
development  activities on an as-required basis and the Company was obligated to
pay to Synergetics a royalty of 10 percent (the  "Royalty") of net revenues from
sales of products


                                      F-33

<PAGE>


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


incorporating   Synergetics'   "VoiceBox"   technology  as  well  as  technology
derivatives   thereof.   Synergetics   compensated  its  developers  and  others
contributing to the development effort, in part, by granting "Project Shares" to
share in a portion of the Royalty received by Synergetics. On April 6, 1998, the
Company and Synergetics  entered into a Royalty  Modification  Agreement whereby
the Company  agreed to offer an aggregate of 4,800,000  non-transferable  common
stock purchase  warrants to the holders of the Project  Shares in  consideration
for which Synergetics agreed to cancel any further obligation on the part of the
Company to pay the Royalty. The exercise price of the warrants was to be $10 per
share and the warrants would not be exercisable  until the first to occur of (1)
the date that the per share  closing  bid price of the Class A common  stock was
equal to or greater than $37.50 per share for a period of 15 consecutive trading
days,  or (2)  September  30, 2000.  Effective  March 31, 2000,  the Company and
Synergetics entered into a Restated Royalty  Modification  Agreement whereby the
Company agreed to pay Synergetics $28,000 (the "Cancellation  Amount") to cancel
the  obligation  of the  Company to pay the  Royalty.  The  Company has paid the
Cancellation  Amount to  Synergetics  and the  Royalty  has been  canceled.  The
Company has no further  obligations to Synergetics,  including prior obligations
to issue 4,800,000 warrants.

Under the terms of the Synergetics Agreement,  as modified, the Company incurred
expenses totaling $50,455 in 1999,  $1,128,433 in 1998 and $2,819,427,  in 1997,
for research and development efforts.

Adiva- During 1998, the Company  utilized the research and development  services
of Adiva. The president of Adiva is also the president of Synergetics and IMC-2.
The  Company  incurred  expenses  of  $63,395 in 1999 and  $600,174  in 1998 for
services provided by Adiva.

IMC-2  - In  March  1998,  the  Company  entered  into a  professional  services
agreement with IMC-2, a research and development  entity, to provide  assistance
to the Company in the continuing  development of specific ASR technologies.  The
president of IMC-2 is also the president of Synergetics and Adiva. The agreement
is for a term of 36 months and requires the Company to make monthly  payments of
$22,000.  Future  noncancellable  payments under this agreement are $264,000 and
$44,000 for the years ended  December 31, 2000 and 2001.  Under the terms of the
agreement,  the  Company  expended  $264,000 in 1999 and  $220,000 in 1998,  for
research and development efforts.

Advocast - In July 1997, the Company entered into an arrangement  with Advocast,
Inc. ("Advocast"), an Internet research and development entity, whereby Advocast
assisted  the  Company  in  development  of  technologies  to create  and locate
searchable data bases on the Internet  through the use of interactive  video and
voice  technologies.  Under the terms of the  arrangement the Company paid $0 in
1999,  $816,750  in 1998  and  $705,005  in  1997,  for  Advocast  research  and
development efforts.

On November 25, 1998, in consideration for the research and development payments
received from Fonix through that date, Advocast issued 60,200 shares of Advocast
Series A 6% convertible  preferred stock to the Company. The Advocast shares, if
converted to Advocast common stock,  represent less than 20 percent of the total
outstanding  shares of Advocast  voting common stock.  Advocast is a development
stage company with minimal operations and there is substantial uncertainty as to
the value of the Advocast  shares.  The Company has  therefore  determined  that
there is not  sufficient  marketability  in Advocast  shares to determine  their
value. As a result, the Company has not recorded a value for the Advocast shares
in the accompanying consolidated financial statements.

15.  INCOME TAXES

At  December  31,  1999  and  1998,  net  deferred  income  tax  assets,  before
considering  the  valuation  allowance,  totaled  $25,104,947  and  $21,031,633,
respectively.  The amount of and ultimate  realization  of the benefits from the
deferred  income tax assets is dependent,  in part, upon the tax laws in effect,
the Company's  future  earnings,  and other future events,  the effects of which
cannot be determined. The Company has established a valuation allowance


                                      F-34

<PAGE>


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


for all deferred income tax assets not offset by deferred income tax liabilities
due to the uncertainty of their realization. The benefit for income taxes in the
accompanying  consolidated  statement  of  operations  for 1999  represents  net
operating  loss   carryforwards   utilized  to  offset  income  tax  liabilities
associated with the sale of the HSG and the gain on forgiveness of debt. The net
change in the valuation allowance was an increase of $4,202,930 for 1999.

At  December  31,  1999,  the  Company has unused  federal  net  operating  loss
carryforwards  available  of  approximately  $59,898,000  and  unused  state net
operating loss  carryforwards of approximately  $62,581,000 which may be applied
against  future taxable  income,  if any, and which expire in various years from
2008 through 2019. The Internal  Revenue Code contains  provisions  which likely
could reduce or limit the  availability  and  utilization of these net operating
loss carryforwards.  For example,  limitations are imposed on the utilization of
net operating loss  carryforwards if certain  ownership changes have taken place
or will take  place.  The  Company has not  performed  an analysis to  determine
whether any such limitations have occurred.

The  temporary  differences  and  carryforwards  which give rise to the deferred
income tax assets (liabilities) as of December 31, 1999 and 1998 are as follows:

<TABLE>
<CAPTION>


Deferred income tax assets:                                                  1999                     1998
                                                                      -------------------      -----------------
<S>                                                                   <C>                      <C>
      Net operating loss carryforwards:
                  Federal                                             $        20,365,190      $    18,526,707
                  State                                                         2,065,175            1,810,687
      Research and development credits                                          1,818,176              694,239
      Accrued liabilities                                                         811,892                   -
      Other                                                                        44,514                   -
                                                                      -------------------      -----------------
      Total deferred income tax assets before valuation allowance              25,104,947           21,031,633
      Valuation allowance                                                     (25,085,947)         (20,883,017)
                                                                      -------------------      -----------------
      Net deferred income tax assets                                               19,000              148,616
                                                                      -------------------      -----------------

Deferred income tax liabilities:
       Depreciation                                                               (19,000)            (148,316)
       Intangibles                                                                     -                  (300)
                                                                      -------------------      -----------------
    Total deferred income tax liabilities                                         (19,000)            (148,616)
                                                                      -------------------      -----------------
                                                                      $                -        $           -
                                                                      ===================      =================
</TABLE>

A reconciliation  of income taxes at the federal statutory rate to the Company's
effective rate is as follows:


<TABLE>
<CAPTION>

                                                   1999       1998      1997
                                                   ----       ----      ----
<S>                                               <C>        <C>       <C>
         Federal statutory income tax rate         34.0%      34.0%     34.0%
         State and local income tax rate,
            net of federal benefit                  3.3        3.3       3.3
         Permanent differences                     (9.0)     (11.2)        -
         Valuation allowance                      (14.0)     (26.1)    (37.3)
                                                  ------     ------    ------
         Effective income tax rate                 14.3%         -%        -%
                                                  ======     ======    ======
</TABLE>

                                      F-35

<PAGE>


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



16.  COMMITMENTS AND CONTINGENCIES

Employment  Agreements - In January 1998,  the Company  entered into  employment
contracts with two employees which expire in January 2001. The aggregate minimum
annual salary payments required by these contracts total $405,000. In connection
with these  agreements,  these  individuals  were  granted  options to  purchase
360,000 shares of the Company's  Class A common stock at $3.34 per share.  These
options have a 10-year life and are subject to a  three-year  vesting  schedule,
pursuant  to which  one-third  of the total  number of  options  granted  may be
exercised  each year.  One-third of the options are vested on the date of grant.
In the event that,  during the contract term,  both a change of control  occurs,
and within  six months  after such  change in  control  occurs,  the  employee's
employment is  terminated by the Company for any reason other than cause,  death
or retirement, the employee shall be entitled to receive an amount in cash equal
to all base salary then and thereafter payable within 30 days of termination. In
January  1999,  the  Company  announced a major cost  reduction  program for the
Company's 1999 operating year wherein the compensation of two employees referred
to above was reduced 30 percent effective February 1999.

Executive Employment  Agreements - On November 1, 1996, the Company entered into
employment  contracts with three executive officers (one of whom is no longer an
executive  officer)  which  expire on December 31, 2001.  In January  1999,  the
contracts  were modified as a part of a major cost reduction  program  announced
for the Company. At the same time, one of the execitive officers resigned as the
Company's chief executive officer, his employment agreement was canceled, and he
entered into a separation  agreement  pursuant to which he will be paid $250,000
per year for the years  ending  January 31, 2000 and 2001,  and $100,000 for the
year ending  January 31,  2002.  Under the January 1999  modifications,  the two
remaining  officers' salaries were reduced to $297,500 commencing February 1999.
In January 2000, the board of directors extended the two remaining  contracts at
the reduced base compensation until December 31, 2005. Subsequent adjustments in
base compensation, if any, will be approved by the board of directors.

In the event that,  during the contract term,  both a change of control  occurs,
and within  six months  after such  change in control  occurs,  the  executive's
employment is terminated by the Company for any reason other than cause,  death,
or  retirement,  the  executive  shall be  entitled to receive an amount in cash
equal  to all  base  salary  then  and  thereafter  payable  within  30  days of
termination.

Professional  Services  Agreements - Effective May 7, 1998, the Company  entered
into a one-year  professional  services  agreement with a public relations firm.
The minimum  monthly  retainer was $15,000 per month.  In  connection  with this
agreement,  the firm was granted  options to purchase  100,000 shares of Class A
common  stock at $3.75 per share.  The options have a 10-year term and are fully
vested. In connection with this transaction, the options were valued at $320,100
using the  Black-Scholes  pricing  model and the  resulting  charge  recorded as
consulting  expense,  of which $106,700 is deferred as of December 31, 1998, and
was subsequently recognized over the life of the agreement in 1999.

In December 1999, the Company  entered into a  professional  services  agreement
with two consulting  firms.  In connection  with these  agreements,  the Company
issued  1,000,000  shares  of Class A common  stock.  The  stock  was  valued at
$375,000  using  the fair  value of the  Class A common  stock on the date  each
contract  commenced.  The resulting  charge was recorded as deferred  consulting
expense which is a reduction in stockholders'  equity and will be amortized into
general and  administrative  expense  over the  subsequent  period of service in
2000.

On December 23, 1999, the Company issued warrants to purchase  1,000,000  shares
of Class A common stock to professional  advisors and consultants.  The warrants
were valued at $0.26 per share using the Black-Scholes  pricing model assuming a
risk-free  interest rate of 6.33 percent,  expected dividend yield of 0 percent;
expected exercise life


                                      F-36

<PAGE>


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


of five years, and expected volatility of 130 percent.  The resulting charge was
recorded as deferred  consulting  expense which is a reduction in  stockholders'
equity and will be amortized  into general and  administrative  expense over the
subsequent period of service in 2000.

Operating Lease Agreements - The Company leases certain facilities and equipment
used in its operations.  The amount of commitments for  noncancelable  operating
leases in effect at December 31, 1999, were as follows:


Years ending December 31,

          2000                $   847,272
          2001                    857,532
          2002                    851,697
          2003                    512,700
          2004                    293,664
               Total          $ 3,362,865

The Company  incurred  rental expense of $764,930,  $829,523 and $416,798 during
1999, 1998 and 1997, respectively, related to these leases.

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

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

AcuVoice - In connection with the AcuVoice acquisition, AcuVoice and its founder
made  certain  representations  and  warranties  to the  Company.  One of  those
representations  focused on the scope of a license agreement  previously entered
into by  AcuVoice  and  General  Magic for use by  General  Magic of  AcuVoice's
text-to-speech software in General Magic's Serengeti product. After the AcuVoice
acquisition  closed,  the Company  determined  that AcuVoice and its founder had
breached the  representation  concerning  the General Magic  license  agreement.
Under the terms of the AcuVoice  acquisition  agreement,  on March 12, 1999, the
Company  submitted  a claim for the  80,000  shares  deposited  into the  escrow
account by the former  stockholders of AcuVoice.  The founder,  as agent for the
former  stockholders  of  AcuVoice,  denied the claim.  The Company is presently
preparing  a  response  to the  founder's  denial of the claim.  If the  founder
continues to deny the claim after review of the Company's response,  the Company
will  seek  to  arbitrate  its  claim  pursuant  to the  terms  of the  AcuVoice
acquisition  agreement.  The Company is  presently  considering  other  possible
remedies against the founder and the other former directors of AcuVoice.

Forgiveness  of Trade  Payables and Accrued  Interest - During 1999, the Company
negotiated  reductions  of  $526,697  in  amounts  due  various  trade  vendors.
Additionally,  the Company negotiated reductions of $229,055 in accrued interest
owed  to  certain  note  holders.  These  amounts  have  been  accounted  for as
extraordinary items in the


                                      F-37

<PAGE>


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


accompanying consolidated statements of operations.

 17. LITIGATION

Oregon Graduate  Institute - On July 28, 1999, Oregon Graduate Institute ("OGI")
filed a notice of default,  demand for mediation and demand for arbitration with
the American  Arbitration  Association.  In its demand,  OGI  asserted  that the
Company was in default under three separate  agreements  between the Company and
OGI in the total  amount  of  $175,000.  On  September  23,  1999,  the  Company
responded to OGI's demand and denied the  existence of a default under the three
agreements  identified by OGI.  Moreover,  the Company  asserted a  counterclaim
before the American  Arbitration  Association  against OGI in an amount not less
than  $250,000.  Neither  OGI nor the Company  have  undertaken  any  discovery.
However,  a hearing date has been set for August 8, 2000.  The Company  believes
the OGI arbitration claim is without merit, and management intends to vigorously
press its counterclaim against OGI.

Papyrus - After the Papyrus acquisition closed, the Company investigated some of
the  representations  and  warranties  made by Papyrus to induce the  Company to
acquire Papyrus. The Company determined that certain of the representations made
by Papyrus and their executive officers were inaccurate. At about the same time,
the Company began  negotiations  with the former executive  officers of Papyrus,
which  negotiations,   among  other  things,   included  discussions   regarding
rescission of the Papyrus  acquisition.  On February 26, 1999, the Company filed
an action against  Papyrus in the United States  District Court for the District
of Utah,  Central Division (the "Utah Action").  In the Utah Action, the Company
alleged claims for  misrepresentation,  negligent  misrepresentation,  breach of
contract,  breach of the  implied  covenant  of good faith and fair  dealing and
rescission. On March 11, 1999, three of the former shareholders of Papyrus filed
an action  against  the  Company in the  United  States  District  Court for the
District of Massachusetts (the "Massachusetts Action"), alleging a default under
the terms of the promissory  notes issued to them in connection with the Papyrus
Acquisition.  On April 2, 1999, the three former Papyrus  shareholders  filed an
amended  complaint  against the Company seeking  additional  remedies  including
violation of Massachusetts  unfair and deceptive acts and practices statutes and
copyright  infringement.  On April 8, 1999, a fourth former Papyrus  shareholder
filed an action  against the Company  alleging a default  under the terms of the
promissory  notes issued to him in connection  with the Papyrus  acquisition and
seeking  additional  remedies  including  violation of Massachusetts  unfair and
deceptive acts and practices statutes and copyright infringement.  Subsequently,
the  Company  has  entered  into   agreements   with  the  four  former  Papyrus
shareholders  for dismissal of the actions and  cancellation  of the  promissory
notes upon payment to the former  shareholders  of $1,122,209  (the  "Settlement
Payment")  an amount equal to  approximately  73 percent of the balance due them
under the notes  issued  to them in the  Papyrus  acquisition,  and  return  for
cancellation by the Company of 970,586 shares of restricted Class A common stock
issued to them in the Papyrus  acquisition.  Payment was made in September 1999,
the shares were returned and canceled and the lawsuits have been dismissed.  The
cancellation  of returned shares is reflected in the  accompanying  consolidated
financial statements as a reduction of goodwill.

Other - In addition to the proceeding  commenced by OGI, the Company is involved
in various  lawsuits,  claims and proceedings  arising in the ordinary course of
business.  Management believes the ultimate disposition of such matters will not
materially affect the consolidated  financial  position or results of operations
of the Company.

18.  EMPLOYEE PROFIT SHARING PLAN

The Company has a 401(k)  profit  sharing plan covering  essentially  all of its
full-time  employees.  Under the plan,  employees may reduce their salaries,  in
amounts allowed by law, and contribute the salary  reduction  amount to the plan
on a pretax basis.  The plan also allows the Company to make matching and profit
sharing  contributions  as  determined  by the board of  directors.  To date, no
matching or profit sharing contributions have been made by the


                                      F-38

<PAGE>


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

Company.

19.  SIGNIFICANT CUSTOMERS

All of the  Company's  revenues  for 1999 and 1998 were  sourced from the United
States.  Of the $439,507 in revenues for 1999,  $209,401 was from one  customer,
General Magic.  Of the $2,604,724 in revenues for 1998,  $2,368,138 was from one
customer,  Siemens.  The remaining revenues in 1998 were primarily from the sale
of TTS and HWR applications and licenses,  with no single customer  representing
more than 10 percent of the Company's total revenues.

20.  SUBSEQUENT EVENTS

Series F  Convertible  Preferred  Stock - Subsequent  to December 31, 1999,  the
Company received an additional $1,750,000 in cash in connection with the sale of
290,000 shares of Series F preferred stock,  bringing the total cash received to
$2,750,000 (see Note 9).

Series G Convertible  Preferred Stock -The Company has recently  entered into an
agreement  with  investors  whereby it intends  to sell to the  investors  up to
250,000  shares of its  Series G  convertible  preferred  stock,  in return  for
payment of up to $5,000,000. It is anticipated that the Series G preferred stock
will be convertible  into shares of Class A common stock at a price of $1.50 per
share during the first 90 days  following  the closing of the  transaction,  and
thereafter  at a price equal to 85% of the average of the three  lowest  closing
bid prices in the 20-day  trading period prior to the conversion of the Series G
preferred  stock.  The  Company  anticipates  that the  investors  will  receive
registration  rights  which will  require  the  Company  to file a  registration
statement  covering the shares underlying the Series G preferred stock, and that
the Company will have the option of redeeming any outstanding Series G preferred
stock. Although the Company has received approximately  $1,250,000 through April
10, 2000 as advances in connection with this financing,  the securities purchase
agreement has not been signed. Accordingly, the terms may ultimately differ from
those described.

Issuance and Exercise of Stock  Options - Subsequent  to December 31, 1999,  the
Company granted a total of 2,529,400  stock options to various  employees of the
Company.  These  options  have 10-year  lives and  exercise  prices of $0.28 per
share,  except 1,500 options at $0.88 per share and 250,000 options at $0.55 per
share.  Of these options,  2,339,000 vest on March 31, 2000 and the balance vest
over the three years  subsequent  to issuance.  Subsequent  to December 31, 1999
through April 10, 2000,  502,228 shares of Class A common stock have been issued
pursuant  to the  exercise  of stock  options  and  stock  appreciation  rights.

In February  2000,  the Company  entered into an  agreement  to purchase  froman
executive officer and director of the Company all of his rights and interests in
certain  methods and  apparatus  for  integrated  voice and pen input for use in
computer  systems.  In payment  for this  technology,  the  Company  granted the
executive  officer  600,000  warrants to purchase the  Company's  Class A common
stock at an exercise price of $1.00 per share.  The warrants expire February 10,
2010.  Also, the Company  granted the executive  officer the right to repurchase
the technology from the Company at fair market value if the Company subsequently
determines not to commercialize the pen/voice technologies or products.

Issuance of Warrants - On January 19, 2000, the Company issued  warrants for the
purchase of 300,000  shares of Class A common stock for  services  rendered by a
professional  services  firm.  The warrants  have a three year life, an exercise
prices  ranging  from  $0.28 to $1.50  per share  and vest as  follows:  100,000
warrants on March 21, 2000,  100,000 warrants on September 30, 2000, and 100,000
warrants on December 31, 2000.


                                      F-39