SEC Info - Fonix Corp - 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

[X]

Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2007, 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	22-2994719
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

9350 South 150 East, Suite 700

Sandy, Utah 84070

(Address of principal executive offices with zip code)

(801) 553-6600

(Registrant's telephone number, including area code)

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

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

Larger Accelerated Filer __ Accelerated Filer __ Non-Accelerated Filer X .

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

Yes __ No X

As of August 15, 2007, there were issued and outstanding 2,510,758,709 shares of our Class A common stock.

FONIX CORPORATION

FORM 10-Q

TABLE OF CONTENTS

		Page

PART I - FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets – As of June 30, 2007, and December 31, 2006	3

	Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended June 30, 2007 and 2006	4

	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006	5

	Notes to Condensed Consolidated Financial Statements (Unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29

Item 4.	Controls and Procedures	29


PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	30

Item 1A.	Risk Factors	31

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32

Item 6.	Exhibits	32

Fonix Corporation and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

	June 30,			December 31,
	2007			2006

ASSETS

Current assets
Cash and cash equivalents	$	7,000		$	5,000
Funds held in escrow		94,000			-
Prepaid expenses and other current assets		2,000			4,000

Total current assets		103,000			9,000

Property and equipment, net of accumulated depreciation of $1,286,000 and $1,261,000, respectively		23,000			48,000

Deposits and other assets		117,000			117,000

Goodwill		2,631,000			2,631,000

Total assets	$	2,874,000		$	2,805,000

LIABILITIES AND STOCKHOLDERS' DEFICIT

Current liabilities
Accrued liabilities	$	3,281,000		$	2,054,000
Accounts payable		1,283,000			1,504,000
Net liabilities of discontinued subsidiaries		20,819,000			20,819,000
Derivative liability		20,274,000			20,941,000
Accrued payroll and other compensation		214,000			214,000
Accrued settlement obligation		1,530,000			1,530,000
Deferred revenues		446,000			460,000
Notes payable - related parties		902,000			800,000
Series E debentures		1,754,000			1,754,000
Current portion of notes payable		3,185,000			2,883,000
Deposits and other		7,000			7,000

Total current liabilities		53,695,000			52,966,000

Long-term notes payable, net of current portion		3,633,000			2,988,000

Total liabilities		57,328,000			55,954,000

Commitments and contingencies

Stockholders' deficit
Preferred stock, $0.0001 par value; 50,000,000 shares authorized;
Series A, convertible; 166,667 shares outstanding (aggregate liquidation preference of $6,055,000)		500,000			500,000
Common stock, $0.0001 par value; 5,000,000,000 shares authorized;
Class A voting, 2,326,143,324 shares and 1,309,965,981 shares outstanding, respectively		232,000			131,000
Class B non-voting, none outstanding		-			-
Additional paid-in capital		238,222,000			236,936,000
Outstanding warrants to purchase Class A common stock		474,000			474,000
Cumulative foreign currency translation adjustment		10,000			10,000
Accumulated deficit		(293,892,000	)		(291,200,000	)

Total stockholders' deficit		(54,454,000	)		(53,149,000	)

Total liabilities and stockholders' deficit	$	2,874,000		$	2,805,000

See accompanying notes to condensed consolidated financial statements.

Fonix Corporation and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006


Revenues	$	644,000		$	367,000		$	1,004,000		$	639,000
Cost of revenues		72,000			1,000			79,000			6,000

Gross profit		572,000			366,000			925,000			633,000

Expenses:
Selling, general and administrative		654,000			1,253,000			1,464,000			2,419,000
Product development and research		437,000			590,000			924,000			1,160,000

Total expenses		1,091,000			1,843,000			2,388,000			3,579,000

Other income (expense):
Interest expense		(455,000	)		(374,000	)		(917,000	)		(751,000	)
Gain (loss) on derivative liability		(87,000	)		-			529,000			-

Other income (expense), net		(542,000	)		(374,000	)		(388,000	)		(751,000	)

Net loss from continuing operations		(1,061,000	)		(1,851,000	)		(1,851,000	)		(3,697,000	)
Net loss from discontinued operations		-			(2,655,000	)		-			(4,885,000	)

Net loss		(1,061,000	)		(4,506,000	)		(1,851,000	)		(8,582,000	)
Preferred stock dividends		(431,000	)		(254,000	)		(841,000	)		(2,103,000	)

Loss attributable to common stockholders	$	(1,492,000	)	$	(4,760,000	)	$	(2,692,000	)	$	(10,685,000	)


Basic and diluted loss per common share from continuing operations	$	(0.00	)	$	(0.00	)	$	(0.00	)	$	(0.01	)

Basic and diluted loss per common share from discontinued operations	$	(0.00	)	$	(0.01	)	$	(0.00	)	$	(0.01	)


Net loss	$	(1,061,000	)	$	(4,506,000	)	$	(1,851,000	)	$	(8,582,000	)
Other comprehensive (loss) income - foreign currency translation		-			7,000			-			7,000

Comprehensive loss	$	(1,061,000	)	$	(4,499,000	)	$	(1,851,000	)	$	(8,575,000	)

See accompanying notes to condensed consolidated financial statements.

Fonix Corporation and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

Six Months Ended June 30,	2007			2006
Cash flows from operating activities
Net loss	$	(1,851,000	)	$	(8,582,000	)
Adjustments to reconcile net loss to net cash used in operating activities:
Discontinued operations		-			4,885,000
Gain (loss) on derivative liability		(529,000	)		-
Accretion of discount on notes payable		494,000			368,000
Accretion of discount on legal settlement		-			82,000
Depreciation		25,000			29,000
Foreign exchange loss (gain)		-			(7,000	)
Changes in assets and liabilities
Funds held in escrow		(94,000	)		-
Prepaid expenses and other current assets		2,000			(46,000	)
Intercompany account		-			(150,000	)
Accounts payable		(218,000	)		200,000
Accrued payroll and other compensation		-			67,000
Other accrued liabilities		385,000			481,000
Deferred revenues		(14,000	)		25,000

Net cash used in operating activities		(1,800,000	)		(2,648,000	)

Cash flows from investing activities
Purchase of property and equipment		-			(12,000	)

Net cash used in investing activities		-			(12,000	)

Cash flows from financing activities
Proceeds from issuance of Class A common stock, net		-			3,168,000
Proceeds from related party note payable		102,000			-
Proceeds from Series B Preferred Stock		1,250,000			-
Proceeds from notes payable		450,000			55,000
Payments on related party note payable		-			(105,000	)
Payments of accrued settlement obligation		-			(440,000	)

Net cash provided by financing activities		1,802,000			2,678,000

Net increase in cash and cash equivalents		2,000			18,000

Cash and cash equivalents at beginning of period		5,000			28,000

Cash and cash equivalents at end of period	$	7,000		$	46,000

See accompanying notes to condensed consolidated financial statements.

Fonix Corporation and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

Supplemental schedule of noncash investing and financing activities

For the Six Months Ended June 30, 2007:

Issued 1,016,177,343 shares of Class A common stock upon conversion of 115 shares of Series L Convertible Preferred Stock.

Accrued $781,000 of dividends on Series L Preferred Stock Series M Preferred Stock and Fonix Speech Series B Preferred Stock.

Accrued $33,000 of dividends on Series M Preferred Stock.

Accrued $27,000 of dividends on Fonix Speech Series B Preferred Stock.

For the Six Months Ended June 30, 2006:

Issued 15,028,249 shares of Class A common stock upon conversion of 266 shares of Series J Convertible Preferred Stock.

Issued 109,300,000 shares of Class A common stock upon conversion of 1,093 shares of Series K Convertible Preferred Stock.

Issued 2,838,412 shares of Class A common stock as payment of $65,000 of dividends on Series H Preferred Stock.

Accrued $500,000 of dividends on Series H Preferred Stock.

See accompanying notes to condensed consolidated financial statements.

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation– The accompanying unaudited condensed consolidated financial statements of Fonix Corporation and subsidiaries (collectively, the “Company” or “Fonix”) have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the following disclosures are adequate to make the information presented not misleading. The Company suggests that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s 2006 Annual Report on Form 10-K.

The Company has not consolidated the assets, liabilities or operations related to its former telecom operations at June 30, 2007, as these assets are under the control of the court appointed bankruptcy trustee pursuant to the filing for protection under Chapter 7 of the Bankruptcy Code by LecStar Telecom, Inc., LecStar DataNet, Inc., LTEL Holdings and Fonix Telecom, Inc., on October 2, 2006. The accompanying footnotes do not include disclosures related to the operations of the aforementioned companies and represent solely the operations of Fonix Speech, Inc.

These condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary to present fairly the financial position and results of operations of the Company for the periods presented. The Company’s business strategy is not without risk, and readers of these condensed consolidated financial statements should carefully consider the risks set forth under the heading “Certain Significant Risk Factors” in the Company’s 2006 Annual Report on Form 10-K.

Operating results for the six months ended June 30, 2007, are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

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

The Company previously operated a telecommunications business, the results of which were included in prior SEC filings. On October 2, 2006, LecStar Telecom Inc., a Georgia corporation (“LecStar Telecom”), LecStar DataNet, Inc., a Georgia corporation (“LecStar DataNet”), LTEL Holdings Corporation (“LTEL Holdings”), a Delaware corporation, and Fonix Telecom Inc., a Delaware corporation (“Fonix Telecom”), each of which are direct or indirect subsidiaries of Fonix, filed for bankruptcy protection in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The case numbers are as follows: LTEL Holdings Corporation, 06-11081 (BLS); LecStar Telecom, Inc., 06-11082 (BLS); LecStar DataNet, Inc., 06-11083 (BLS); Fonix Telecom, Inc., 06-11084 (BLS).)

LecStar Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom sought protection under Chapter 7 of Title 11 of the U.S. Bankruptcy Code, 11 U.S.C ss 101 et seq. (the “Bankruptcy Code”). Pursuant to Bankruptcy Code Section 701, on October 3, 2006, Alfred Thomas Guliano was appointed the interim trustee for LecStar Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom. As these subsidiary companies were in Chapter 7 Bankruptcy proceedings as of the date of this Report, the results of their operations have been treated as discontinued operations.

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Business Condition - For the three months ended June 30, 2007 and 2006, the company generated revenues of $644,000 and $367,000, respectively and incurred net losses of $1,061,000 and $4,506,000, respectively. For the six months ended June 30, 2007 and 2006, the company generated revenues of $1,004,000 and $693,000, respectively, incurred net losses of $1,851,000 and $8,582,000, respectively, and had negative cash flows from operating activities of $1,800,000 and $2,648,000, respectively. As of June 30, 2007, the company had an accumulated deficit of $293,892,000; negative working capital of $53,592,000; accrued liabilities and accrued settlement liability of $4,811,000; derivative liabilities of $20,274,000 related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Series E Convertible Debentures and Series B Preferred Stock of our subsidiary, Fonix Speech; net liabilities of discontinued subsidiaries of $20,819,000 related to the telecom subsidiaries subject to bankruptcy (LecStar Telecom, LecStar DataNet, LTEL Holdings and Fonix Telecom); accounts payable of $1,283,000; and current portion of notes payable of $4,087,000. The company expects to continue to incur significant losses and negative cash flows from operating activities at least through December 31, 2007, primarily due to expenditure requirements associated with continued marketing and development of our speech-enabling technologies.

The Company’s cash resources, limited to collections from customers, sales of our equity and debt securities and loans, have not been sufficient to cover operating expenses. As a result, some payments to vendors have been delayed.

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

Net Loss Per Common Share– Basic and diluted net loss per common share are calculated by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. As of June 30, 2007 and 2006, there were outstanding common stock equivalents to purchase 19,639,705,706 and 49,919,168 shares of common stock, respectively, that were not included in the computation of diluted net loss per common share as their effect would have been anti-dilutive, thereby decreasing the net loss per common share.

The following table is a reconciliation of the net loss numerator of basic and diluted net loss per common share for the three and six months ended June 30, 2007 and 2006:

	Three Months Ended June 30,
	2007						2006
				Per						Per
				Share						Share
	Amount			Amount			Amount			Amount
Net loss from continuing operations	$	(1,061,000	)				$	(1,851,000	)
Net loss from discontinued operations		--			--			(2,655,000	)	$	(0.00	)
Net loss	$	(1,061,000	)				$	(4,506,000	)
Preferred stock dividends		(431,000	)					(254,000	)
Loss attributable to common stockholders	$	(1,492,000	)	$	(0.00	)	$	(4,760,000	)	$	(0.01	)
Weighted-average common shares outstanding		1,960,341,139						705,796,055

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

	Six Months Ended June 30,
	2007						2006
				Per						Per
				Share						Share
	Amount			Amount			Amount			Amount
Net loss from continuing operations	$	(1,851,000	)				$	(3,697,000	)
Net loss from discontinued operations		--			--			(4,885,000	)	$	(0.01	)
Net loss	$	(1,851,000	)				$	(8,582,000	)
Preferred stock dividends		(841,000	)					(2,103,000	)
Loss attributable to common stockholders	$	(2,692,000	)	$	(0.00	)	$	(10,685,000	)	$	(0.02	)
Weighted-average common shares outstanding		2,036,896,444						686,768,855

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

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

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

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

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

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

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

Deferred revenue as of June 30, 2007, and December 31, 2006, consisted of the following:

Description		Criteria for Recognition		June 30, 2007			Dec 31, 2006
Deferred unit royalties and license fees		Delivery of units to end users or expiration of contract		$	446,000		$	460,000

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

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

Stock-Based Employee Compensation– Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“FAS 123(R)”), an amendment of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) using the modified prospective transition method. Under this transition method, compensation costs are recognized beginning with the effective date: (a) based on the requirements of FAS 123(R) for all share-based awards granted after the effective date; and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of FAS 123(R) that remain unvested on the effective date. Accordingly, the Company did not restate the results of prior periods. The most notable change resulting from the adoption of FAS123(R) is that compensation expense associated with stock options is now recognized in the Company’s Statements of Operations, rather than being disclosed in a pro forma footnote to the Company’s financial statements.

The Company recognized compensation expense related to option grants and the vesting of previously unvested options for the six months ended June 30, 2007, of $0.

There were no option grants during the six months ended June 30, 2007.

2. GOODWILL

The carrying value of goodwill is assessed for impairment quarterly. An assessment was performed for the six months ended June 30, 2007, which resulted in no impairment, and the carrying value of goodwill remained unchanged at $2,631,000 at June 30, 2007.

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

3. NOTES PAYABLE

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

The discount on the Note is based on an imputed interest rate of 25%. The carrying amount of the Note of $6,038,000 at June 30, 2007, was net of unamortized discount of $2,695,000. As of the date of this report, the Company had not made any scheduled payments for 2006 or 2007.

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

In the Default Notice, McCormack stated that it intended to exercise its rights, including any and all rights set forth in the Note, as amended.

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

During the fourth quarter of 2005, the Company entered into two promissory notes with an unrelated third party in the aggregate amount of $650,000. These notes accrue interest at 10% annually and were due and payable during May and June of 2006. As of the date of this report, the Company had not made the scheduled payments on these promissory notes; the holder of the notes has not declared a default under the notes.

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

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

The following schedule summarizes the Company’s current debt obligations and respective balances at June 30, 2007, and December 31, 2006:

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Notes Payable	June 30, 2007			December 31, 2006

5% Note payable to a company, $8,733,000 and $8,733,000 face amount, respectively, due in quarterly installments of $319,000, matures January 2010, less unamortized discount based on interest imputed at 25% of $ 2,695,000 and $3,191,000, respectively	$	6,038,000		$	5,543,000

Note payable to a company, interest at 10%, matured June 2007		235,000			235,000

Note payable to a company, interest at 10%, matured June 2007		95,000			95,000

Note payable to a company, interest at 10%, matured July 2007		450,000			--

Note payable to related parties, interest at 12%, matured September 2006, secured by intellectual property rights		902,000			800,000

Total notes payable		7,720,000			6,671,000
Less current maturities		(4,087,000	)		(3,683,000	)

Long-Term Note Payable	$	3,633,000		$	2,988,000

4. RELATED-PARTY NOTES PAYABLE

During 2002, two executive officers of the Company (the “Lenders”) sold shares of the Company’s Class A common stock owned by them and advanced the resulting proceeds amounting to $333,000 to the Company under the terms of a revolving line of credit and related promissory note. The funds were advanced for use in Company operations. The advances bear interest at 12 percent per annum, which interest is payable on a semi-annual basis. The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, were originally due and payable on June 10, 2003. The Company and the Lenders have agreed to postpone the maturity date on several occasions. The note was due September 30, 2006 and no default had been declared. As of the date of this report, the Company had not made payment against the outstanding balance due on the note. All or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of the Company at any time. The conversion price was the average closing bid price of the shares at the time of the advances. To the extent the market price of the Company’s shares is below the conversion price at the time of conversion, the Lenders are entitled to receive additional shares equal to the gross dollar value received from the original sale of the shares. A beneficial conversion option of $15,000 was recorded as interest expense in connection with this transaction. The Lenders may also receive additional compensation as determined appropriate by the Board of Directors.

In October 2002, the Lenders pledged 30,866 shares of the Company's Class A common stock to Queen, LLC (the “Equity Line Investor”), in connection with an advance of $183,000 to the Company under the Third Equity Line. The Equity Line Investor subsequently sold the pledged shares and applied $82,000 of the proceeds as a reduction of the advance. The value of the pledged shares of $82,000 was treated as an additional advance from the Lenders.

During the fourth quarter of 2003, the Company made a principal payment of $26,000 against the outstanding balance of the promissory note. During 2004, the Company entered into an agreement with the holders of the promissory note to increase the balance of the note payable by $300,000 in exchange for a release of the $1,443,000 of accrued liabilities related to prior indemnity agreements between the Company and the note holders. The Company classified the release of $1,143,000 as a capital contribution in the Consolidated Financial Statements during the fourth quarter of 2004. The Company made principal payments against the note of $254,000 during the year ended December 31, 2004. During the year ended December 31, 2005, the Company received an additional advance of $50,000 against the promissory note. The balance due at December 31, 2005, was $486,000. During the year ended December 31, 2006, the Company received additional advances of $419,000 and made principal payments to the Lenders against the note of $105,000. During the quarter ended March 31, 2007, the Company received additional advances of $102,000. The balance due at June 30, 2007, was $902,000.

The aggregate advances of $902,000 are secured by the Company’s intellectual property rights. As of June 30, 2007, the Lenders had not converted any of the outstanding balance or interest into common stock.

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

5. PREFERRED STOCK

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

Series A Convertible Preferred Stock– As of June 30, 2007, there were 166,667 shares of Series A convertible preferred stock outstanding. Holders of the Series A convertible preferred stock have the same voting rights as common stockholders, have the right to elect one person to the board of directors and are entitled to receive a one time preferential dividend of $2.905 per share of Series A convertible preferred stock prior to the payment of any dividend on any class or series of stock. At the option of the holders, each share of Series A convertible preferred stock is convertible into one share of Class A common stock and in the event that the common stock price has equaled or exceeded $10 per share for a 15 day period, the shares of Series A convertible preferred stock will automatically be converted into Class A common stock. In the event of liquidation, the holders are entitled to a liquidating distribution of $36.33 per share and a conversion of Series A convertible preferred stock at an amount equal to .0375 shares of common stock for each share of Series A convertible preferred stock.

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

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

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

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

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

The Company accounted for the exchange as redemption of the outstanding Series H Preferred Stock as the Series H Preferred Stock was not convertible into shares of common stock of the Company. The Series L Preferred Stock is convertible into shares of common stock of the Company. The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the redemption of $30,991,000 due to the value of the conversion feature of the Series L Preferred Stock. The liability was calculated using the Black-Scholes valuation model with the following assumptions: dividend yield of 0%, expected volatility of 140%, risk-free rate of 3.75% and expected life of 4 years. As the value of the derivative liability was greater than the face value of the Series L Preferred Stock, no value was prescribed to the Series L Preferred Stock. Also in connection with the redemption, the Company recognized a preferred stock dividend of $16,000,000, equal to the original discount the Company had assigned to the Series H Preferred Stock. At June 30, 2007 the fair value of the Series L Preferred Stock derivative liability was $16,812,768.

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

For the six months ended June 30, 2007, the Company issued 1,016,177,343 shares of its Class A common stock in conversion of 115 shares of its Series L Preferred Stock. At June 30, 2007, 1,743 shares of Series L Preferred Stock remained outstanding.

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

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

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

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

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

The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the redemption of $1,603,448 due to the value of the conversion feature of the Series M Preferred Stock, which was previously recorded as part of the Series L Preferred Stock derivative liability. The liability was calculated using the Black-Scholes valuation model with the following assumptions: dividend yield of 0%, expected volatility of 134%, risk-free rate of 5% and expected life of 4 years. As the value of the derivative liability was greater than the face value of the Series M Preferred Stock, no value was prescribed to the Series M Preferred Stock. At June 30, 2007 the fair value of the Series M Preferred Stock derivative liability was $1,582,507.

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

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

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

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

The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the issuance of $1,336,207 due to the value of the conversion feature of the Series B Preferred Stock. The liability was calculated using the Black-Scholes valuation model with the following assumptions: dividend yield of 0%, expected volatility of 134%, risk-free rate of 5% and expected life of 4 years. As the value of the derivative liability was greater than the face value of the Series B Preferred Stock, no value was prescribed to the Series B Preferred Stock. At June 30, 2007 the fair value of the Series B Preferred Stock derivative liability was $1,318,756. .

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

6. CONVERTIBLE DEBENTURES

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

Pursuant to the Agreement, Southridge paid the purchase price by tendering a prior debenture in the aggregate amount (including principal and interest) of $641,000, and agreed that an advance to the Company in the amount of $75,000 made in November 2006 would also constitute part of the purchase price. Southridge agreed to fund the remaining $134,000 upon the effectiveness of a registration statement, to be filed by the Company, to register the resales of shares issuable to Southridge upon conversion of the Debenture.

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

The Company also entered into a Registration Rights Agreement (the “Registration Agreement”) with Southridge pursuant to which the Company agreed to file a registration statement to register the resale by Southridge of shares of the Company’s common stock issuable upon conversion of the Debenture. Under the Registration Agreement, the Company agreed to file a registration statement to register the resale by Southridge of up to 300,000,000 shares of Fonix Class A common stock

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

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

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

The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the issuance of $680,023 due to the value of the conversion feature of the Debenture. The liability was calculated using the Black-Scholes valuation model with the following assumptions: dividend yield of 0%, expected volatility of 139%, risk-free rate of 5% and expected life of 4 years. At June 30, 2007 the fair value of the Debenture derivative liability was $2,404,266, of which $1,754,464 reported as Series E Debenture, $89,916 reported as accrued interest and $559,886 reported as derivative liability.

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The Company also entered into a Registration Rights Agreement (the “McCormack Registration Agreement”) with McCormack pursuant to which the Company agreed to file a registration statement to register the resale by McCormack of shares of the Company’s common stock issuable upon conversion of the Debenture.

The Company received no new capital in connection with the issuance and sale of the Debenture.

7. EQUITY LINES OF CREDIT

Seventh Equity Line of Credit - On May 27, 2005, the Company entered into a seventh private equity line agreement (the "Seventh Equity Line Agreement") with the Equity Line Investor, on terms substantially similar to those of the Sixth Equity Line between Queen and the Company dated November 15, 2004.

Under the Seventh Equity Line Agreement, the Company had the right to draw up to $20,000,000 against an equity line of credit (the "Seventh Equity Line") from the Equity Line Investor. The Company was entitled under the Seventh Equity Line Agreement to draw certain funds and to put to the Equity Line Investor shares of the Company's Class A common stock in lieu of repayment of the draw. The Company was limited as to the amount of shares it may put to the Equity Line Investor in connection with each put; the Company could not put shares which would cause the Equity Line Investor to own more than 4.99% of its outstanding common stock on the date of the put notice. The number of shares to be issued in connection with each draw was determined by dividing the amount of the draw by 93% of the average of the two lowest closing bid prices of our Class A common stock over the ten trading days after the put notice is tendered. The Equity Line Investor was required under the Seventh Equity Line Agreement to tender the funds requested by the Company within two trading days after the ten-trading-day period used to determine the market price.

The Company granted registration rights to the Equity Line Investor and filed three registration statements which cover the resales of the shares to be issued under the Seventh Equity Line. All of the shares registered by the first registration statement had been sold as of October 24, 2005. The second registration statement filed in connection with the Seventh Equity Line was declared effective by the SEC on February 10, 2006. All of the shares registered by the second registration statement had been sold as of July 26, 2006. The Company filed a third registration statement on June 26, 2006, to register additional shares under the Seventh Equity Line. However, that registration statement was not declared effective, and no shares were sold under that registration statement.

In January, 2007, the Company terminated the Seventh Equity Line, and the Company has withdrawn the third registration statement related to the Seventh Equity Line. As such, as of the date of this Report, the Company did not have an equity line of credit financing available to it.

8. COMMON STOCK, STOCK OPTIONS AND WARRANTS

Class A Common Stock– During the six months ended June 30, 2007, 1,016,177,343 shares of Class A common stock were issued upon conversion of 115 shares of Series L Preferred Stock.

Stock Options – As of June 30, 2007, the Company had a total of 526,012 options to purchase Class A common stock outstanding. During the six months ended June 30, 2007 no options were granted.

Warrants– As of June 30, 2007, the Company had warrants to purchase a total of 15,000 shares of Class A common stock outstanding that expire through 2010.

Fonix Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

9. LITIGATION, COMMITMENTS AND CONTINGENCIES

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

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

The Court’s order, dated as of March 15, 2007, adjudged that the Company owes an aggregate of $1,602,000 to Breckenridge.

On April 26, 2007, Breckenridge filed a complaint in the United States District Court for the District of Utah, entitled “The Breckenridge Fund, LLC v. Fonix Corporation, Fonix Speech, Inc., Thomas A. Murdock, and Roger D. Dudley.” In the complaint, and allegations contained in an amended complaint, Breckenridge asserts statutory claims under the Uniform Fraudulent Transfers Act and a related equitable claim based on the conveyance of intellectual property and other assets made by the Company to Fonix Speech in February 2006 in connection with the incorporation of Fonix Speech as a wholly owned subsidiary of the Company. The complaint seek a judgment against all of the defendants in the amount of $1,601,735. The complaint also seeks to set aside alleged transfers between the Company and Dudley or Murdock, and for subordination of any security interest held by Dudley or Murdock. Allegations in an amended complaint assert claims against the company’s lawyers.

Concurrent with the filing of its complaint, Breckenridge brought a Motion for Prejudgment Writ of Attachment seeking to attach certain of the assets of Fonix Speech, including its intellectual property and cash, as necessary to satisfy the judgment of $1,602,000 that Breckenridge obtained in New York. In May 2007, the United States District ordered that Fonix Speech’s remaining $94,000 of operating capital be frozen immediately. The court ordered Breckenridge to post a bond of $90,000. Fonix Speech has taken steps to comply with the court’s order. The Company, Fonix Speech and Breckenridge have recently conducted discussions concerning settlement of all of Breckenridge’s claims

10. SUBSEQUENT EVENTS

Series L Convertible Preferred Stock– Subsequent to June 30, 2007 the Company issued 184,615,385 shares of Class A common stock in conversion of 12 shares of the Series L Convertible Preferred Stock.

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report on Form 10-Q contains, in addition to historical information, forward-looking statements that involve substantial risks and uncertainties. All forward-looking statements contained herein are deemed by Fonix to be covered by and to qualify for the safe harbor protection provided by Section 21E of the Private Securities Litigation Reform Act of 1995. When used in this report, words such as “believes,” “expects,” “intends,” “plans,” “anticipates,” “estimates,” and similar expressions are intended to identify forward-looking statements, although there may be certain forward-looking statements not accompanied by such expressions. Statements relating to the future performance, business strategies and implementation, availability of outside financing, financial performance, market acceptance of our products, and similar statements may also include forward looking statements. Actual results could differ materially from the results anticipated by Fonix and discussed in the forward-looking statements. Factors that could cause or contribute to such differences are discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The Company disclaims any obligation or intention to update any forward-looking statements.

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

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

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

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

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

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

We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of the Company as a whole. This discussion should be read in conjunction with our financial statements as of December 31, 2006, and the year then ended and the notes accompanying those financial statements.

Overview

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

We previously operated a telecommunications business, the results of which were included in prior SEC filings. On October 2, 2006, LecStar Telecom Inc., a Georgia corporation (“LecStar Telecom”), LecStar DataNet, Inc., a Georgia corporation (“LecStar DataNet”), LTEL Holdings Corporation (“LTEL Holdings”), a Delaware corporation, and Fonix Telecom Inc., a Delaware corporation (“Fonix Telecom”), each of which are direct or indirect subsidiaries of Fonix, filed for bankruptcy protection in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). The case numbers are as follows: LTEL Holdings Corporation, 06-11081 (BLS); LecStar Telecom, Inc., 06-11082 (BLS); LecStar DataNet, Inc., 06-11083 (BLS); Fonix Telecom, Inc., 06-11084 (BLS).)

LecStar Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom sought protection under Chapter 7 of Title 11 of the U.S. Bankruptcy Code, 11 U.S.C ss 101 et seq. (the “Bankruptcy Code”). Pursuant to Bankruptcy Code Section 701, on October 3, 2006, Alfred Thomas Guliano was appointed the interim trustee for LecStar Telecom, LecStar DataNet, LTEL Holdings, and Fonix Telecom. As these subsidiary companies were in Chapter 7 Bankruptcy proceedings, as of the date of this Report, the results of their operations have not been included.

For the three months ended June 30, 2007 and 2006, we generated revenues of $644,000 and $367,000, respectively and incurred net losses of $1,061,000 and $4,506,000, respectively. For the six months ended June 30, 2007 and 2006, we generated revenues of $1,004,000 and $639,000, respectively, incurred net losses of $1,851,000 and $8,582,000, respectively, and had negative cash flows from operating activities of $1,800,000 and $2,648,000, respectively. As of June 30, 2007, we had an accumulated deficit of $293,892,000; negative working capital of $53,592,000; accrued liabilities and accrued settlement liability of $4,811,000; derivative liabilities of $20,274,000 related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Series E Convertible Debentures and Series B Preferred Stock of our subsidiary, Fonix Speech; net liabilities of discontinued subsidiaries of $20,819,000 related to the telecom subsidiaries subject to bankruptcy (LecStar Telecom, LecStar DataNet, LTEL Holdings and Fonix Telecom); accounts payable of $1,283,000 and current portion of notes payable of $4,087,000. We expect to continue to incur significant losses and negative cash flows from operating activities at least through December 31, 2007, primarily due to expenditure requirements associated with continued marketing and development of our speech-enabling technologies.

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

Historically, our cash resources, limited to collections from customers, draws on equity lines of credit and loans, have not been sufficient to cover operating expenses. We periodically engage in discussions with various sources of financing to facilitate our cash requirements including buyers of both debt and equity securities. We rely on first, cash generated from operations, and second, cash provided through convertible debt financing and other financing arrangements. Except for payment of certain liabilities, we will need to generate approximately $1 to $3 million to continue operations for the next twelve months.

Significant Accounting Policies

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

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

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

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

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

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

Deferred revenue as of June 30, 2007, and December 31, 2006, consisted of the following:

Description		Criteria for Recognition		June 30, 2007			Dec 31, 2006
Deferred unit royalties and license fees		Delivery of units to end users or expiration of contract		$	446,000		$	460,000

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

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

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

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

Stock-Based Employee Compensation- Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“FAS 123(R)”), an amendment of SFAS No. 123, “Accounting for Stock-Based Compensation,” using the modified prospective transition method. Under this transition method, compensation costs are recognized beginning with the effective date: (a) based on the requirements of FAS 123(R) for all share-based awards granted after the effective date and (b) based on the requirements of FAS 123 for all awards granted to employees prior to the effective date of FAS 123(R) that remain unvested on the effective date. Accordingly, we did not restate the results of prior periods. The most notable change resulting from the adoption of FAS 123(R) is that compensation expense associated with stock options is now recognized in our Statements of Operations, rather than being disclosed in a pro forma footnote to our financial statements.

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

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

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

Recently Enacted Accounting Standards In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides related guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. FIN 48 is effective for the Company beginning January 1, 2007. The Company adopted FIN 48 at the beginning of fiscal year 2007 with no material impact to the financial condition, results of operations, or cash flows.In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This Statement provides companies with an option to report selected financial assets and liabilities at fair value. Generally accepted accounting principles have required different measurement attributes for different assets and liabilities that can create artificial volatility in earnings. The Statement’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 is effective for the Company beginning January 1, 2008. The Company is currently evaluating the impact of this standard.

The Company has reviewed all other recently issued, but not yet adopted, accounting standards in order to determine their effects, if any, on its consolidated results of operation, financial position or cash flows. Based on that review, the Company believes that none of these pronouncements will have a significant effect on its current or future earnings or operations.

Results of Operations (Continuing operations only)

Three months ended June 30, 2007, compared with three months ended June 30, 2006

During the three months ended June 30, 2007, we recorded revenues of $644,000, an increase of $277,000 from $367,000 in 2006. The increase was primarily due to increased royalty revenues of $255,000 and increased licensing revenue of $75,000, partially offset by decreased retail product sales of $13,000 and decreased non-recurring engineering (“NRE”) speech revenues of $40,000.

Selling, general and administrative expenses were $654,000 for the three months ended June 30, 2007, a decrease of $599,000 from $1,253,000 in 2006. The decrease is primarily due to decreased salary and wage related expenses of $177,000, decreased other expenses of $128,000, decreased consulting expenses $109,000, decreased travel expenses of $96,000, decreased investor relations related expenses of $52,000, decreased legal and accounting fees of $50,000, decreased advertising expenses of $2,000 and decreased depreciation expenses of $1,000 partially offset by increased taxes, licenses and permits of $14,000 and increased occupancy related expenses of $2,000.

We incurred research and product development expenses of $437,000 for the three months ended June 30, 2007, a decrease of $153,000 from $590,000 in 2006. The decrease was primarily due to an overall decrease in wage related expenses of $137,000, reduced occupancy expenses of $22,000, reduced other operating expenses of $3,000, reduced depreciation expenses of $2,000, partially offset by increased travel expenses of $7,000 and increased consulting expenses of $4,000.

Net interest and other expense was $542,000 for the three months ended June 30, 2007, an increase of $168,000 from net other expense of $374,000 in 2006. The overall increase was due to an increase in interest expense of $81,000 and a loss recognized on the derivative liability of $87,000.

Six months ended June 30, 2007, compared with six months ended June 30, 2006

During the six months ended June 30, 2007, we recorded revenues of $1,004,000, an increase of $365,000 from $639,000 in 2006. The increase was primarily due to increased royalty revenues of $367,000 and increased licensing revenue of $95,000 and increased retail product sales of $9,000, partially offset by decreased non-recurring engineering (“NRE”) speech revenues of $106,000.

Selling, general and administrative expenses were $1,464,000 for the six months ended June 30, 2007, a decrease of $955,000 from $2,419,000 in 2006. The decrease is primarily due to decreased salary and wage related expenses of $242,000, decreased other expenses of $236,000, decreased travel expenses of $162,000, decreased legal and accounting fees of $125,000, decreased consulting expenses $105,000, decreased investor relations related expenses of $82,000, decreased advertising expenses of $23,000 and decreased depreciation expenses of $2,000, partially offset by increased occupancy related expenses of $12,000 and increased taxes, licenses and permits of $10,000.

We incurred research and product development expenses of $924,000 for the six months ended June 30, 2007, a decrease of $236,000 from $1,160,000 in 2006. The decrease was primarily due to an overall decrease in wage related expenses of $204,000, reduced occupancy expenses of $27,000, by reduced travel expenses of $3,000 reduced other operating expenses of $2,000, reduced depreciation expenses of $2,000, partially offset and increased consulting expenses of $2,000.

Net interest and other expense was $388,000 for the six months ended June 30, 2007, a decrease of $363,000 from net other expense of $751,000 in 2006. The overall decrease was due to a gain recognized on the derivative liability of $529,000, partially offset by an increase in interest expense of $166,000.

Liquidity and Capital Resources

We must raise additional funds to be able to satisfy our cash requirements during the next 12 months. Except for payment of certain liabilities it is anticipated that we will need to raise approximately $1 to $3 million over the next 12 months to meet obligations and continue our product development, corporate operations and marketing expenses. Because we presently have only limited revenue from operations, we intend to continue to rely primarily on financing through the sale of our equity and debt securities to satisfy future capital requirements until such time as we are able to enter into additional third-party licensing, collaboration, or co-marketing arrangements such that we will be able to finance ongoing operations from license, royalty, and sales revenue. We are working with game developers and other potential licensors of our speech product offerings to develop additional revenue streams for our speech technologies. There can be no assurance that we will be able to enter into such agreements. Furthermore, the issuance of equity or debt securities which are or may become convertible into equity securities of Fonix in connection with such financing could result in substantial additional dilution to the stockholders of Fonix.

Our cash resources are limited to collections from customers, proceeds from the issuance of preferred stock, and loan proceeds, and are only sufficient to cover current operating expenses and payments of current liabilities. At June 30, 2007, we had negative working capital of $53,592,000; derivative liabilities of $20,274,000 related to the issuance of Series L Preferred Stock, of Series M Preferred Stock, of Series E Convertible Debentures, and of the Series B Preferred Stock of our subsidiary, Fonix Speech; net liabilities of discontinued subsidiaries of $20,819,000 related to the telecom assets subject to bankruptcy, accrued liabilities and accrued settlement obligation of $4,811,000; accounts payable of $1,283,000 and current portion of notes payable of $4,087,000.

We had $1,004,000 in revenue and a loss of $1,851,000 for the six months ended June 30, 2007. Net cash used in operating activities of $1,800,000 for the quarter ended June 30, 2007, resulted principally from the net loss incurred of $1,851,000, non-cash gain recognized on the derivative liability of $529,000, decreased accounts payable of $218,000, increased funds held in escrow of $94,000 and decreased deferred revenues of $14,000 partially offset by non-cash accretion of discount on notes payable of $494,000, increased accrued liabilities of $385,000, depreciation expense of $25,000 and increased prepaid expenses and other current assets of $2,000,. We did not use any cash in investing activities for the quarter ended June 30, 2007. Net cash provided by financing activities of $1,802,000 consisting primarily of proceeds from Series B Preferred Stock of our subsidiary, Fonix Speech; the Series B Preferred Stock of $1,250,000, proceeds from notes payable of $450,000 and proceeds from the related party note of $102,000.

We had negative working capital of $53,592,000 at June 30, 2007, compared to negative working capital of $52,957,000 at December 31, 2006. Current assets increased by $94,000 to $103,000 from $9,000 from December 31, 2006, to June 30, 2007. Current liabilities increased by $729,000 to $ 53,695,000 from $52,966,000 during the same period. The change in working capital from December 31, 2006, to June 30, 2007, reflects, in part, increased current portion of notes payable of $302,000, increased accrued liabilities of $1,227,000 and increased notes payable to related parties of $102,000, partially offset by decreased derivative liability of $667,000, decreased accounts payable of $218,000 and increased cash of $2,000. Total assets were $2,874,000 at June 30, 2007, compared to $2,805,000 at December 31, 2006.

Notes Payable - Related Parties

During 2002, two of our executive officers (the “Lenders”) sold shares of our Class A common stock owned by them and advanced the resulting proceeds amounting to $333,000 to us under the terms of a revolving line of credit and related promissory note. The funds were advanced for use in our operations. The advances bear interest at 12 percent per annum, which interest is payable on a semi-annual basis. The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, were originally due and payable on June 10, 2003. Fonix and the Lenders have agreed to postpone the maturity date on several occasions. The note was due September 30, 2006 and no default had been declared. As of August 20, 2007, we had not made payment against the outstanding balance due on the note. All or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of Fonix at any time. The conversion price was the average closing bid price of the shares at the time of the advances. To the extent the market price of our shares is below the conversion price at the time of conversion, the Lenders are entitled to receive additional shares equal to the gross dollar value received from the original sale of the shares. The Lenders may also receive additional compensation as determined appropriate by the Board of Directors.

In October 2002, the Lenders pledged 30,866 shares of our Class A common stock to Queen, LLC ( the “Equity Line Investor”), in connection with an advance of $183,000 to us under the Third Equity Line. The Equity Line Investor subsequently sold the pledged shares and applied $82,000 of the proceeds as a reduction of the advance. The value of the pledged shares of $82,000 was treated as an additional advance from the Lenders.

During the fourth quarter of 2003, we made a principal payment of $26,000 against the outstanding balance of the promissory note. During 2004, we entered into an agreement with the holders of the promissory note to increase the balance of the note payable by $300,000 in exchange for a release of the $1,443,000 of accrued liabilities related to prior indemnity agreements between us and the note holders. We classified the release of $1,143,000 as a capital contribution in the Consolidated Financial Statements during the fourth quarter of 2004. We made principal payments against the note of $253,000 during the year ended December 31, 2004. During the year ended December 31, 2005, we received an additional advance of $50,000 under the note from the Lenders. The balance due the Lenders at December 31, 2005, was $486,000. During the year ended December 31, 2006, we received additional advances of $419,000 and made principal payments to the Lenders against the note of $105,000. During the quarter ended March 31, 2007, we received additional advances of $102,000. The balance due at June 30, 2007 was $902,000.

The unpaid balance of $902,000 at June 30, 2007, is secured by our assets, including our stock of Fonix Speech. As of March 31, 2007, the Lenders had not converted any of the outstanding balance or interest into common stock.

Notes Payable

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

The discount on the Note is based on an imputed interest rate of 25%. The carrying amount of the Note of $6,038,000 at June 30, 2007, was net of unamortized discount of $2,695,000. As of the date of this Report, we had not made any scheduled payments for 2006 or 2007.

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

In the Default Notice, McCormack stated that it intended to exercise its rights, including any and all rights set forth in the Note as amended.

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

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

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

During the six months ended June 30, 2007, we entered into five promissory notes with an unrelated third party in the aggregate amount of $450,000. These notes accrue interest at 10% annually and are due and payable during the third quarter of 2007.

Seventh Equity Line of Credit

On May 27, 2005, we entered into a seventh private equity line agreement (the "Seventh Equity Line Agreement") with the Equity Line Investor, on terms substantially similar to those of the Sixth Equity Line between Queen and us dated November 15, 2004.

Under the Seventh Equity Line Agreement, we had the right to draw up to $20,000,000 against an equity line of credit (the "Seventh Equity Line") from the Equity Line Investor. We were entitled under the Seventh Equity Line Agreement to draw certain funds and to put to the Equity Line Investor shares of the Company's Class A common stock in lieu of repayment of the draw. We were limited as to the amount of shares we may put to the Equity Line Investor in connection with each put; we could not put shares which would cause the Equity Line Investor to own more than 4.99% of our outstanding common stock on the date of the put notice. The number of shares to be issued in connection with each draw was determined by dividing the amount of the draw by 93% of the average of the two lowest closing bid prices of our Class A common stock over the ten trading days after the put notice is tendered. The Equity Line Investor was required under the Seventh Equity Line Agreement to tender the funds requested by us within two trading days after the ten-trading-day period used to determine the market price.

We granted registration rights to the Equity Line Investor and filed three registration statements which cover the resales of the shares to be issued under the Seventh Equity Line. All of the shares registered by the first registration statement had been sold as of October 24, 2005. The second registration statement filed in connection with the Seventh Equity Line was declared effective by the SEC on February 10, 2006. All of the shares registered by the second registration statement had been sold as of July 26, 2006. We filed a third registration statement on June 26, 2006, to register additional shares under the Seventh Equity Line. However, that registration statement was not declared effective, and no shares were sold under that registration statement.

In January 2007, we terminated the Seventh Equity Line, and we have withdrawn the third registration statement related to the Seventh Equity Line. As such, as of the date of this report, we did not have an equity line of credit financing available to us.

Series A Convertible Preferred Stock

At June 30, 2007, there were 166,667 shares of Series A convertible preferred stock outstanding. Holders of the Series A convertible preferred stock have the same voting rights as common stockholders, have the right to elect one person to the board of directors and are entitled to receive a one time preferential dividend of $2.905 per share of Series A convertible preferred stock prior to the payment of any dividend on any class or series of stock. At the option of the holders, each share of Series A convertible preferred stock is convertible into one share of Class A common stock and in the event that the common stock price has equaled or exceeded $10 per share for a 15 day period, the shares of Series A convertible preferred stock will automatically be converted into Class A common stock. In the event of liquidation, the holders are entitled to a liquidating distribution of $36.33 per share and a conversion of Series A convertible preferred stock at an amount equal to .0375 shares of common stock for each share of Series A convertible preferred stock.

Series L Convertible Preferred Stock

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

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

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

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

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

In connection with the issuance of the Series L Preferred Stock, we filed with the State of Delaware a Certificate of Designation and Series L 9% Convertible Stock Terms (the “Series L Terms”), which become a part of our Certificate of Incorporation, as amended.

We accounted for the exchange as redemption of the outstanding Series H Preferred Stock as the Series H Preferred Stock was not convertible into shares of common stock of Fonix. The Series L Preferred Stock is convertible into shares of common stock of Fonix. We followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” We recognized a derivative liability upon the redemption of $30,991,000 due to the value of the conversion feature of the Series L Preferred Stock. The liability was calculated using the Black-Scholes valuation model. As the value of the derivative liability was greater than the face value of the Series L Preferred Stock, no value was prescribed to the Series L Preferred Stock. Also in connection with the redemption, the Company recognized a preferred stock dividend of $16,000,000, equal to the original discount we had assigned to the Series H Preferred Stock.

For the six months ended June 30, 2007, we issued 1,015,229,976 shares of our Class A common stock in conversion of 115 shares of its Series L Preferred Stock. At June 30, 2007, 1,743 shares of Series L Preferred Stock remained outstanding.

Series M Preferred Stock

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

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

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

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

Fonix Speech, Inc. Series B Convertible Preferred Stock

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

Pursuant to the FSI agreement, FSI sold 125 shares of its Series B 9% Convertible Preferred Stock (the “Series B Preferred Stock”) at a per share price of $10,000 to Sovereign. In anticipation of the transaction, Sovereign advanced the gross proceeds of $1,250,000 to the Company on March 30, 2007. The advance has been accounted for as a liability in the accompanying financial statements.

Stock Options and Warrants

During the six months ended June 30, 2007, we did not grant any stock options. As of June 30, 2007, we had a total of 526,012 options to purchase Class A common stock outstanding.

As of June 30, 2007, we had warrants to purchase a total of 15,000 shares of Class A common stock outstanding that expire through 2010.

Other

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

Corporate Outlook

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

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

As we proceed to implement our strategy and to reach our objectives, we anticipate further development of complementary technologies, added product and applications development expertise, access to market channels and additional opportunities for strategic alliances in other industry segments. The strategy adopted by us has significant risks, and shareholders and others interested in Fonix and our Class A common stock should carefully consider the risks set forth below and under the heading “Certain Significant Risk Factors” in Item 1, Part I, of our annual report on Form 10-K for the year ended December 31, 2006.

As noted above, as of June 30, 2007, we had an accumulated deficit of $292,892,000 negative working capital of $53,592,000, derivative liability of $20,274,000 related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Fonix Speech Series B Preferred Stock and Series E Convertible Debentures, net liabilities of discontinued subsidiaries of $20,819,000 related to the telecom assets (LecStar Telecom, LecStar DataNet, LTEL Holdings and Fonix Telecom) subject to bankruptcy, accrued liabilities and accrued settlement obligation of $4,811,000, accounts payable of $1,283,000 and current portion of notes payable of $4,087,000. Sales of products and revenue from licenses based on our technologies have not been sufficient to finance ongoing operations. These matters raise substantial doubt about our ability to continue as a going concern. Our continued existence is dependent upon several factors, including our success in (1) increasing speech license, royalty and services revenues, (2) raising sufficient additional funding, and (3) minimizing operating costs. Until sufficient revenues are generated from operating activities, we expected to continue to fund our operations through debt instruments. We are currently pursuing additional sources of liquidity in the form of traditional commercial credit, asset based lending, or additional sales of our equity securities to finance our ongoing operations. Additionally, we are pursuing other types of commercial and private financing, which could involve sales of our assets or sales of one or more operating divisions. Our sales and financial condition have been adversely affected by our reduced credit availability and lack of access to alternate financing because of our significant ongoing losses and increasing liabilities and payables. As we have noted in our previous annual reports and other public filings, if additional financing is not obtained in the near future, we will be required to more significantly curtail our operations or seek protection under bankruptcy laws.

Information Concerning Forward-Looking Statements

Certain of the statements contained in this report (other than the historical financial data and other statements of historical fact) are forward-looking statements. These statements include, but are not limited to our expectations with respect to the development of a diversified revenue base; delivery of our VoiceDial application; the market volume of educational electronic dictionary devices; our ability to capitalize in markets including toys, appliances, and other devices; the market demand for videogames; our growth strategies and the implementation of our Core Technologies and potential results; our payment of dividends on our common stock; our ability to meet customer demand for speech technologies and solutions; development of complementary technologies, products, marketing, and strategic alliance opportunities; profitability of language learning tools; the status of traditional operator systems; our ability to continue operations in the event we do not receive approval to amend our articles of incorporation; the comparability of our speech-enabled Speech Products to other products; our intentions with respect to strategic collaborations and marketing arrangements; our intentions with respect to use of licenses; our plans with respect to development and acquisition of speech solutions; our goals with respect to supplying speech solutions for OEMs; our expectations with respect to continued financial losses; and our intentions with respect to financing our operations in the future. Additional forward-looking statements may be found in the “Certain Significant Risk Factors” Section of our 10-K for the year ended December 31, 2006, together with accompanying explanations of the potential risks associated with such statements.

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

You are cautioned not to place undue reliance on these forward looking statements, which are current only as of the date of this Report. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Many important factors could cause actual results to differ materially from management’s expectations, including those listed in the “Certain Significant Risk Factors” Section of our 10-K for the year ended December 31, 2006, as well as the following:

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

the extent to which we reduce outstanding debt.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exposure

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

Item 4.

Controls and Procedures

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

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

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

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

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

The Court’s order, dated as of March 15, 2007, adjudged that the Company owes an aggregate of $1,602,000 to Breckenridge.

Item 1A.

Risk Factors

We attempt to identify, manage and mitigate the risks and uncertainties associated with our business to the extent practical. However, some level of risk and uncertainty will always be present. The section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, entitled “Certain Significant Risk Factors” describes some of the risks and uncertainties associated with our business. These risks and uncertainties have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results and future prospects. We have revised the following risk factors which were previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

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

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

We incurred net losses of $21,943,000, $22,631,000 and $15,148,000 for the years ended December 31, 2006, 2005 and 2004, respectively. We incurred a net loss of $1,061,000 for the three months ended June 30, 2007 and $1,851,000 for the six months ended June 30, 2006. As of June 30, 2007, we had an accumulated deficit of $293,892,000, negative working capital of $53,592,000, derivative liability of $20,274,000 related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Series B Preferred Stock and the Series E Debentures, net liabilities of unconsolidated subsidiaries of $20,819,000 related to the telecom assets subject to bankruptcy, accrued liabilities and accrued settlement obligation of $4,811,000 accounts payable of $1,283,000 and current portion of notes payable of $4,087,000.

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

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

As of June 30, 2007, we had debt obligations of $7,717,000, accrued liabilities and accrued settlement obligation of $4,811,000 and vendor accounts payable of approximately $1,283,000. At present, our revenues from existing licensing arrangements and Speech Product sales are not sufficient to offset our ongoing operating expenses or to pay in full our current debt obligations.

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

We currently do not have access to the Seventh Equity Line or other equity lines of credit, which could have a material adverse effect on our ability to continue operations.

Since 2000, we have relied substantially on equity lines of credit for financing our operations. Pursuant to these equity lines, we historically have drawn funds against the equity line and put shares of our Class A common stock to the equity line investor in repayment of the draws. In light of current SEC regulations and interpretations by the SEC, we terminated the Seventh Equity Line and as of the date of the Report, we did not have access to an equity line of credit or similar financing arrangements. Although we are seeking to negotiate additional financing sources and reviewing our options, there can be no guarantee that we will be able to enter into arrangements for financing that will be on terms that will be satisfactory to us. Any inability to enter into new financing arrangements could have a material adverse impact on our ability to continue our operations, and we may be required to seek protection under the bankruptcy laws.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

During the six months ended June 30, 2007, we issued 1,016,177,343 shares of our common stock in connection with conversions of 115 shares of our Series L Preferred Stock for which we received no proceeds. The shares of common stock were issued without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

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

Item 6.

Exhibits

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

Exhibit No.

Description of Exhibit

31.1

Certification of President

31.2

Certification of Chief Financial Officer

32.1

Certification of President Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

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

	Fonix Corporation



Date: August 20, 2007	/s/ Roger D. Dudley
	Roger D. Dudley, Executive Vice President,
	Chief Financial Officer
	(Principal financial officer)

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Fonix Corp · 10-Q · For 6/30/07

Filed On 8/20/07 4:16pm ET · SEC File 0-23862 · Accession Number 1096906-7-1182

Quarterly Report · Form 10-Q
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10-Q · Fonix Corporation Form 10-Q June 30, 2007

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Fonix Corp · 10-Q · For 6/30/07

Filed On 8/20/07 4:16pm ET · SEC File 0-23862 · Accession Number 1096906-7-1182

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10-Q · Fonix Corporation Form 10-Q June 30, 2007

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