fonix10k123107.htm

F-6

Fonix Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

	Years Ended December 31,
	2007		2006		2005
Supplemental Disclosure of Cash Flow Information

Cash paid during the year for interest	$	29,000	$	22,000	$	310,000
Cash paid during the year for income taxes		–		–		–

Supplemental Schedule of Non-cash Investing and Financing Activities

For the Year Ended December 31, 2007

Issued 2,777,153,205 shares of Class A common stock upon conversion of 173 shares of Series L Convertible Preferred Stock.

Accrued $1,481,000 of dividends on Series L Preferred Stock.

Accrued $102,000 of dividends on Series M Preferred Stock.

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

Accrued $85,000 of dividends on Fonix Speech Series B Preferred Stock.

Issued 150 shares of Series M Convertible Preferred Stock with a face value of $1,500,000 in exchange for 150 shares of Series L Preferred Stock with a face value of $1,500,000.

Issued 1,349.85 shares of Series N Convertible Preferred Stock with a face value of $1,349,850.

For the Year Ended December 31, 2006

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

Issued 109,300,000 shares of Class A common stock in 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 $692,000 of dividends on Series H Preferred Stock.

Issued 2,000 shares of Series L Convertible Preferred Stock with a face value of $20,000,000 in exchange for 2,000 shares of Series H Preferred Stock with a face value of $20,000,000.

Issued 489,870,090 shares of Class A common stock in conversion of 142 shares of Series L Preferred Stock.

For the Year Ended December 31, 2005

Issued 18,482,083 shares of Class A common stock in conversion of 1,078 shares of Series I Convertible Preferred Stock.

Issued 3,795,918 shares of Class A common stock in conversion of 93 shares of Series J Convertible Preferred Stock.

Issued 27,275,299 shares of Class A common stock as payment of $1,113,000 of dividends on Series H Preferred Stock.

Issued 29,417,578 shares of Class A common stock as payment of $1,248,000 of principal and interest on long-term debt.

Accrued $137,000 of dividends on Series H Preferred Stock.

Issued 1,452 shares of Series J Preferred Stock with a value of $1,452,000 in exchange for 1,172 shares of Series I Preferred Stock with a value of $1,172,000, a placement fee of $250,000 and settlement expense of $30,000.

Issued 2,277,000 shares of Class A common stock for a legal settlement expense valued at $73,000, or $0.03 per share.

See accompanying notes to consolidated financial statements.

F-7

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

NOTE 1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

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.

Business Condition - For the years ended December 31, 2007, 2006 and 2005, we generated revenues of $1,838,000, $1,329,000 and $1,358,000, respectively; net income of $14,959,000, net losses $21,943,000 and $22,631,000, respectively, and had negative cash flows from operating activities of $2,312,000, $4,048,000 and $8,643,000, respectively. As of December 31, 2007, we had an accumulated deficit of $277,943,000, negative working capital of $34,384,000, derivative liabilities of $20,742,000 related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Series N Preferred Stock, Series E Convertible Debentures and Series B Preferred Stock of our subsidiary, accrued liabilities and accrued settlement obligation of $5,045,000, accounts payable of $1,532,000 and current portion of notes payable of $3,833,000, Series E debentures of $1,754,000 and deferred revenues of $445,000.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.

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

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.

F-8

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

Consolidation - The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

The Company has not consolidated the assets, liabilities or operations related to the discontinued subsidiaries 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.

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

Fair Value of Financial Instruments - The carrying values of the Company’s liabilities approximate their fair values. The estimated fair values have been determined using appropriate market information and valuation methodologies. The carrying values of the accrued settlement obligation and note payable approximate fair value because the stated or imputed interest rates approximate the Company’s borrowing rate.

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

Valuation of Long-lived Assets - The carrying values of the Company's 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, the Company projects 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. The determination of whether the carrying value of software technology is recoverable is discussed below in the section titled “Software Technology Development and Production Costs” within this note.

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 the Company’s 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. As of December 31, 2006 and 2005, the fair value of goodwill was greater than the carrying value. At December 31, 2007, the Company determined that the carrying value of goodwill was in excess of its fair value and the balance of $2,631,000 was fully impaired.

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.

F-9

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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.

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 December 31, 2007, consisted of the following:

Description		Criteria for Recognition			Amount
Deferred unit royalties and license fees		Delivery of units to end users or expiration of contract			$	445,000

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

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

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.

F-10

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

The Company 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.

During 2003, the Company modified its estimate of future cash flows to be provided by its software technology and determined that the carrying amount of the technology was in excess of future cash flows provided by the technology. Accordingly, the Company recorded a charge of $1,124,000 during the year ended December 31, 2003, to fully impair the carrying value of the speech software technology. $822,000 of the impairment was charged to cost of revenues and $302,000 was charged to operating expenses, based on the use of the software.

Stock-based Compensation Plans - Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 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 SFAS 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 SFAS 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 SFAS123(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.

Prior to January 1, 2006, the Company accounted for stock options granted under its Stock Option Plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees) and related interpretations, as permitted by SFAS 123. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company’s net loss would have been increased to the pro forma amounts indicated below for years ended December 31, 2005.

Year Ended December 31,	2005
Net loss, as reported	$	(22,631,000	)
Add back: Total stock-based employee compensation		-
Deduct: Total stock-based employee compensation determined under fair value based method for all awards		(74,000	)

Pro forma net loss	$	(22,705,000	)

Basic and diluted net loss per common share:
As reported	$	(0.09	)
Pro forma		(0.09	)

Advertising Costs - Advertising costs are expensed when incurred. Total advertising expense was $13,000, $40,000 and $80,000 for the years ended December 31, 2007, 2006 and 2005, respectively.

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

Net Loss Per Common Share - Basic and diluted net loss per common share are calculated by dividing net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the year. At December 31, 2007, 2006 and 2005, there were outstanding common stock equivalents to purchase or receive 98,211,685,667, 5,647,746,872 and 97,634,670 shares of common stock, respectively. At December 31, 2007, 558,167 common stock equivalents were excluded in the computation of diluted net income per common share as their effect would have been anti-dilutive. All common stock equivalents at December 31, 2006 and 2005 were excluded 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.

F-11

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

The following table is a reconciliation of the net income or loss numerator of basic and diluted net income or loss per common share for the years ended December 31, 2007, 2006, and 2005:

	Years Ended December 31,
	2007					2006						2005
					Per				Per						Per
					Share				Share						Share
	Amount				Amount	Amount			Amount			Amount			Amount
Net income (loss) from continuing operations	$	14,959,000				$	(10,696,000	)				$	(8,794,000	)
Net loss from discontinued operations							(11,247,000	)	$	(0.01	)		(13,837,000	)	$	(0.05	)

Net income (loss)		14,959,000					(21,943,000	)					(22,631,000	)

Preferred stock dividends		(1,702,000	)				(18,735,000	)					(1,265,000	)
Net income (loss) attributable to common stockholders	$	13,257,000				$	(40,678,000	)				$	(23,896,000	)
Basic weighted-average common shares outstanding		2,417,708,937		$	0.01		768,076,936		$	(0.05	)		261,894,849		$	(0.09	)
Diluted weighted-average common shares outstanding		100,628,836,437		$	0.00		768,076,936		$	(0.05	)		261,894,849		$	(0.09	)

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 (see Notes 2 and 6).

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

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

Recently Enacted Accounting Standards

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

F-12

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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

Fair Value Measurements - In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides guidance for using fair value to measure assets and liabilities. The standard also responds to investors’ request for expanded information about the extent to which a company measures assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 will be effective for the Company’s fiscal year beginning January 1, 2008. In February 2008 the FASB Staff Position No. 157-2 which extended the effective date for certain nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. The Company is currently reviewing the effect that the adoption of SFAS 157 will have on its financial statements.

NOTE 2. PROPERTY AND EQUIPMENT

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

Computer equipment and software		3 to 5 years
Furniture and fixtures		5 years

Maintenance and repairs are charged to expense as incurred and major improvements are capitalized. Gains or losses on sales or retirements are included in the consolidated statements of operations in the year of disposition. Depreciation expense was $32,000, $58,000 and $59,000 for the years ended December 31, 2007, 2006, and 2005, respectively. Property and equipment consisted of the following at December 31, 2007 and 2006:

	2007			2006
Computer equipment	$	980,000		$	980,000
Software		201,000			201,000
Furniture and fixtures		128,000			128,000
		1,309,000			1,309,000
Less accumulated depreciation and amortization		(1,293,000	)		(1,261,000	)
Net Property and Equipment	$	16,000		$	48,000

NOTE 3. GOODWILL AND INTANGIBLE ASSETS

The carrying value of goodwill is assessed for impairment quarterly. The Company tested goodwill for impairment at December 31, 2007 and determined that goodwill had been fully impaired. The Company recorded an impairment charge of $2,631,000 in the accompanying financial statements.

F-13

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

NOTE 4. NOTES PAYABLE

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

The discount on the Note is based on an imputed interest rate of 25%. The carrying amount of the Note of $6,609,000 at December 31, 2007, was net of unamortized discount of $2,124,000. 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 relating to 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 may 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. To date, no sale of the assets or capital stock of LecStar Telecom, LecStar DataNet nor LTEL Holdings has occurred. On October 2, 2006, LecStar Telecom, LecStar DataNet and LTEL Holdings filed for protection under Chapter 7 of the Bankruptcy Code. As of the date of this Report, the results of their operations have been treated as discontinued operations.

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 the second quarter of 2006. The notes, along with accrued interest of $64,000 and additional advances of $325,000 were exchanged for the McCormack Debenture (described in Note 8).

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

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

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

F-14

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

Notes Payable	December 31, 2007			December 31, 2006

5% Note payable to a company, $8,733,000 face amount, due in quarterly installments of $319,000, matures January 2010, less unamortized discount based on interest imputed at 25% of $2,124,000 and $3,191,000, respectively	$	6,609,000		$	5,541,000

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		8,291,000			6,671,000
Less current maturities		(4,735,000	)		(3,683,000	)

Long-Term Note Payable	$	3,556,000		$	2,988,000

The following table shows the schedule of principal payments under notes payable and related party notes payable as of December 31, 2007:

Year ending December 31,	Payments
2008	$	5,280,000
2009		1,036,000
2010		4,098,000
	$	10,414,000

NOTE 5. RELATED-PARTY NOTES PAYABLE

During 2002, two executive officers of the Company (the “Lenders”) sold shares of the Company’s Class A common stock owned by them and advanced the resulting proceeds amounting to $333,000 to the Company under the terms of a revolving line of credit and related promissory note. The funds were advanced for use in Company operations. The advances bear interest at 12 percent per annum, which interest is payable on a semi-annual basis. The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, was originally due and payable on June 10, 2003. The Company and the Lenders have agreed to postpone the maturity date on several occasions. The note was due September 30, 2006. As of March 31, 2008, the Company had not made payment against the outstanding balance due on the note. All or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of the Company at any time. The conversion price is 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.

F-15

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

During the year ended December 31, 2005, the Company received an additional advance of $50,000 against the promissory note. The balance due at December 31, 2005 was $486,000. During the year ended December 31, 2006, the Company received additional advances and other consideration from the Lenders in the aggregate amount of $419,000 and made principal payments to the Lenders against the note of $105,000. During the year ended December 31, 2007, the Company received additional advances of $102,000. The balance due at December 31, 2007, was $902,000.

The aggregate advances of $902,000 are secured by the Company’s intellectual property rights and common stock of Fonix Speech. As of December 31, 2007, the Lenders had not converted any of the outstanding balance or interest into common stock. However, on March 24, 2008, the Lenders converted $10,000 into 53,913,701shares of our common stock for the benefit of one of the Lenders, Thomas A. Murdock.

NOTE 6. DEBENTURES

Series E Debentures - On December 7, 2006, the Company entered into a Securities Purchase Agreement, dated as of December 1, 2006 (the “Agreement”), with Southridge Partners, LP (“Southridge”) relating to the purchase and sale of a Series E 9% Secured Subordinated Convertible Debenture (the “Southridge 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 Southridge Debenture. The registration statement was filed in January 2007, but as of the date of the Report, had not been declared effective.

The Southridge Debenture is convertible into shares of the Company’s Class A common stock. The number of shares issuable is determined by dividing the amount of the Southridge 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 Southridge Debenture. Southridge has agreed not to convert the Southridge 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 Southridge 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 Southridge Debenture, on December 7, 2006, the Company entered into a Securities Purchase Agreement, dated as of December 1, 2006 (the “McCormack Agreement”), with McCormack Avenue, Ltd. (“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.

F-16

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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 also entered into a Registration Rights Agreement (the “McCormack Registration Agreement”) with McCormack pursuant to which the Company agreed to file a registration statement to register the resale by McCormack of shares of the Company’s common stock issuable upon conversion of the Debenture. As of the date of this Report, the registration statement had not been filed.

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

As the Series E Debentures are 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 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 December 31, 2007, the fair value of the Debenture derivative liability was $2,502,000, of which $1,754,000 is reported as Series E Debenture, $171,000 is reported as accrued interest and $577,000 is reported as part of the derivative liability.

NOTE 7. 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 - At December 31, 2007, there were 166,667 shares of Series A convertible preferred stock outstanding. Holders of the Series A convertible preferred stock have the same voting rights as common stockholders, have the right to elect one person to the board of directors and are entitled to receive a one time preferential dividend of $2.905 per share of Series A convertible preferred stock prior to the payment of any dividend on any class or series of stock. At the option of the holders, each share of Series A convertible preferred stock is convertible into one share of Class A common stock and in the event that the common stock price has equaled or exceeded $10 per share for a 15 day period, the shares of Series A convertible preferred stock will automatically be converted into Class A common stock. In the event of liquidation, the holders are entitled to a liquidating distribution of $36.33 per share and a conversion of Series A convertible preferred stock at an amount equal to .0375 shares of Class A common stock for each share of Series A convertible preferred stock.

Series H Preferred Stock - The Company issued 2,000 shares of 5% Series H nonvoting, nonconvertible Preferred Stock on February 24, 2004, in connection with the acquisition of LTEL. Dividends on the $20,000,000 stated value of the outstanding Series H Preferred Stock were payable at the rate of 5% per annum as and when declared by the Board of Directors. The annual dividend requirement was $1,000,000. If dividends were declared on Fonix's common stock, as a condition of that dividend, Fonix was required to pay three percent of the aggregate amount of such dividend to the Series H Preferred Stock. Dividends on the Series H Preferred Stock were payable in cash or, at the option of Fonix, in shares of Class A common stock. The Company has accrued for the March 31, 2006, June 30, 2006 and the period from July 1, 2006 through September 7, 2006 dividend payments under the Series H Preferred Stock, but has not paid the dividends to the holders of the Series H Preferred Stock as of the date of this report.

F-17

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

On September 7, 2006, the Company entered into an agreement to exchange the 2,000 shares of Series H Preferred Stock for shares of the Company’s Series L Preferred Stock. (See discussion below under “Series L Preferred Stock.”) As of December 31, 2007, no shares of Series H Preferred Stock remained outstanding.

Series I Convertible Preferred Stock - On October 24, 2003, the Company entered into a private placement of shares of its Class A common stock with The Breckenridge Fund, LLC, a New York limited liability company (“Breckenridge”). Under the terms of the private placement, the Company agreed to issue 1,043,478 shares of its Class A common stock to Breckenridge for $240,000 (the “Private Placement Funds”).

Subsequent to the Company’s receiving the Private Placement Funds, but before any shares were issued in connection with the private placement, the Company agreed with Breckenridge to rescind the private placement of the shares and to restructure the transaction. The Company retained the Private Placement Funds as an advance in connection with the restructured transaction. The Company paid no interest or other charges to Breckenridge for use of the Private Placement Funds.

Following negotiations with Breckenridge, on January 29, 2004, the Company issued to Breckenridge 3,250 shares of 8% Series I Convertible Preferred Stock (the “Series I Preferred Stock”), for an aggregate purchase price of $3,250,000, including the Private Placement Funds which the Company had already received. The Preferred Stock was issued under a purchase agreement dated as of December 31, 2003. The Series I Preferred Stock had a stated value of $1,000 per share.

In connection with the offering of the Series I Preferred Stock, the Company also issued to Breckenridge warrants to purchase up to 965,839 shares of the Company’s Class A common stock at $0.50 per share through December 31, 2008, and issued 2,414,596 shares of our Class A common stock.

The Series I Preferred Stock entitled Breckenridge to receive dividends in an amount equal to 8% of the then-outstanding shares of Preferred Stock. The dividends were payable in cash or shares of the Company’s Class A common stock, at the Company’s option.

On September 27, 2005, the Company agreed with Breckenridge to settle and discontinue the pending legal actions with Breckenridge. The three actions pending in the Supreme Court of New York, Nassau County, involved (i) the Company’s claims against Breckenridge for the improper transfer to and subsequent sale of shares of the Company’s common stock by Breckenridge; (ii) Breckenridge’s claims against the Company for failure to honor conversion notices or properly issue shares upon conversion of the Series I Preferred Stock by Breckenridge; and (iii) Breckenridge’s claims that the Company breached agreements in connection with the Series I Preferred Stock, and that pursuant to a security agreement, Breckenridge was entitled to damages and possession of the pledged collateral (collectively, the “Breckenridge Lawsuits”).

Pursuant to the settlement of the Breckenridge Lawsuits, the Company entered into a Mutual Release of Claims Agreement (the “Mutual Release”), pursuant to which the Company and Breckenridge agreed to settle and dismiss the Breckenridge Lawsuits, and to release any and all claims against each other relating to any prior transactions between the Company and Breckenridge. Pursuant to the Mutual Release, Breckenridge agreed to assign the remaining shares of Series I Preferred to Southridge Partners, LP, to release its security interest in the Company’s intellectual property, and to stipulate to the discontinuance with prejudice of the Breckenridge Lawsuits. The Company agreed to the release of the 2,777,777 Unauthorized Shares of Class A common stock that occurred in March 2004, which shares were valued at $73,000 and recognized as a legal settlement expense, and to pay to Breckenridge installment payments (the “Periodic Payments”) consisting of monthly payments of $130,000 from November 2005 through April 2006, and monthly payments of $165,000 from May 2006 through December 2006, as well as approximately $397,000 which the Company had previously paid into an escrow account in connection with the Breckenridge Lawsuits.

The Company also entered into an agreement with Breckenridge and Southridge Partners, LP (“Southridge”) whereby Breckenridge agreed to assign to Southridge all remaining shares of the Company’s Series I Preferred, consisting of approximately 1,172 shares, together with all of Breckenridge’s rights, interests, duties, and obligations which Breckenridge received in connection with the purchase from the Company of the Series I Preferred Stock. Southridge paid approximately $1,203,000 for Breckenridge’s rights to the Series I Preferred Stock and accepted the assignment of the shares of Series I Preferred Stock and all assigned rights, interests, duties, and obligations, and the Company consented to the assignment.

F-18

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

Southridge is not affiliated with Fonix Corporation or its subsidiaries. Southridge Partners, LP, is an entity managed by Southridge Capital Management.

The effect of the Assignment Agreement was to terminate the Company’s rights, duties, and obligations relating to the Series I Preferred Stock with respect to Breckenridge, and to enter into a new agreement relating to such rights, duties, and obligations with Southridge.

Additionally, the Company entered into a Security Agreement with Breckenridge relating to certain of its obligations in connection with the agreement with Breckenridge to discontinue the Breckenridge Lawsuits. Pursuant to the settlement agreement between the parties, the Company is required to make the Periodic Payments to Breckenridge. To secure those payments, the Company granted to Breckenridge a security interest in the proceeds that it receives in connection with draws on the Seventh Equity Line of Credit and any subsequent equity line-type financings in the event that we do not make a Periodic Payment when due. Specifically, the Company granted to Breckenridge the right to receive proceeds from its draws on the Seventh Equity Line and any subsequent equity line-type financings to the extent that we do not make a payment as required and after the applicable grace period or cure period has run. With respect to future equity line-type financings, the Company agreed to include in the documentation of such financings provisions granting to Breckenridge the right to make draws and to receive funds directly from the equity line provider in the event that we fail to make a payment as required, and then only to the extent of the amount of the payment.

For the year ended December 31, 2004, the Company issued 8,435,869 shares of the Company’s Class A common stock in response to conversion requests for 1,000 shares of Series I Preferred Stock. For the year ended December 31, 2005, the Company issued 18,482,083 shares of the Company’s Class A common stock in response to conversion request for 1,078 shares of Series I Preferred Stock. As of December 31, 2007, no shares of Series I Preferred Stock remained outstanding.

Series J Preferred Stock – On October 6, 2005, the Company entered into a Series J 5% Convertible Preferred Stock Exchange Agreement (the "Exchange Agreement") with Southridge Partners, LP ("Southridge"), a Delaware limited partnership. Pursuant to the Exchange Agreement, Southridge exchanged all of the shares of Series I Preferred Stock that it acquired from Breckenridge, for 1,452 shares of the Company's Series J 5% Convertible Preferred Stock (the "Series J Preferred Stock").

Because the shares of Series J were issued in exchange for the remaining outstanding shares of Series I Preferred Stock, we did not receive any proceeds in connection with the issuance of the Series J Preferred Stock. The Company issued 1,452 shares of Series J Preferred Stock in exchange for 1,172 shares of Series I Preferred Stock. Of the 280 additional shares that were issued to Southridge, 250 were issued as a placement fee and were accounted for in the selling, general and administrative expense in the accompanying financial statements. The remaining 30 shares were issued as additional litigation expense and were accounted for as legal settlement expense.

The Series J Preferred Stock entitles Southridge to receive dividends in an amount equal to 5% of the then-outstanding balance of shares of Series J 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 J 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 90% 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 J Preferred Stock, whether at our option or that of Southridge, requires us to pay, as a redemption price, the stated value of the outstanding shares of Series J Preferred Stock to be redeemed, together with any accrued but unissued dividends thereon, multiplied by one hundred ten percent (110%).

F-19

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

For the year ended December 31, 2005, the Company issued 3,795,918 shares of its Class A common stock upon conversion of 93 shares of its Series J Preferred Stock. For the year ended December 31, 2006, the Company issued 15,028,249 shares of its Class A common stock upon conversion of 266 shares of Series J Preferred Stock. As of December 31, 2007, no shares of Series J Preferred Stock remained outstanding.

Series K Preferred Stock – On February 3, 2006, the Company’s Board of Directors approved the designation and issuance of Series K 5% Convertible Preferred Stock (the “Series K Preferred Stock”). The Series K Preferred Stock entitled the holder to receive dividends in an amount equal to 5% of the stated value of the then-outstanding balance of shares of Series K Preferred Stock. The dividends were payable in cash or shares of the Company’s Class A common stock, at the Company’s option.

The shares of Series K Preferred Stock were issued pursuant to a Series K 5% Convertible Preferred Stock Exchange Agreement (the “Series K Agreement”), in connection with which Southridge exchanged 1,093 shares of Series J Convertible Preferred Stock for 1,093 shares of Series K Convertible Preferred Stock.

The Series K Preferred Stock were convertible into common stock of the Company at the option of the holder by using a conversion price of $0.01 per share.

For year ended December 31, 2006, the Company issued 109,300,000 shares of its Class A common stock upon conversion of all 1,093 shares of its Series K Preferred Stock. As of December 31, 2007, no shares of Series K Preferred Stock remained outstanding.

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

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

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

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

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

In connection with the issuance of the Series L Preferred Stock, the Company 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 the Company’s Certificate of Incorporation, as amended.

F-20

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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 December 31, 2007, the fair value of the Series L Preferred Stock derivative liability was $16,148,000.

For the year ended December 31, 2006, the Company issued 489,870,090 shares of our Class A common stock in conversion of 142 shares of its Series L Preferred Stock. For the year ended December 31, 2007, the Company issued 2,777,153,205 shares of our Class A common stock in conversion of 173 shares of its Series L Preferred Stock. The Company exchanged 150 shares of Series L Preferred Stock for 150 shares of Series M Preferred Stock as discussed below. At December 31, 2007, 1,535 shares of Series L Preferred Stock remained outstanding. Subsequent to December 31, 2007 and through March 31, 2008, the Company issued 1,404,251,012 shares of our Class A common stock in conversion of 16 shares of Series L Preferred Stock.

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

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

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

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

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

The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the redemption of $1,603,000 due to the value of the conversion feature of the Series M Preferred Stock, which was previously recorded as part of the Series L Preferred Stock derivative liability. The liability was calculated using the Black-Scholes valuation model with the following assumptions: dividend yield of 0%, expected volatility of 134%, risk-free rate of 5% and expected life of 4 years. As the value of the derivative liability was greater than the face value of the Series M Preferred Stock, no value was prescribed to the Series M Preferred Stock. At December 31, 2007 the fair value of the Series M Preferred Stock derivative liability was $1,577,000.

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

F-21

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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

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

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

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

The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the redemption of $957,000 due to the value of the conversion feature of the Series N Preferred Stock. The liability was calculated using the Black-Scholes valuation model with the following assumptions: dividend yield of 0%, expected volatility of 128%, risk-free rate of 5.0% and expected life of 4 years. As the value of the derivative liability was greater than the face value of the Series N Preferred Stock, no value was prescribed to the Series N Preferred Stock. At December 31, 2007, the fair value of the Series N Preferred Stock derivative liability was $1,109,000.

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

Pursuant to the FSI 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 December 31, 2007, the fair value of the Series B Preferred Stock derivative liability was $1,314,000.

F-22

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

NOTE 8. EQUITY LINES OF CREDIT

Sixth Equity Line of Credit – On November 15, 2004, the Company entered into a sixth private equity line agreement (the “Sixth Equity Line Agreement”) with the Equity Line Investor, on terms substantially similar to those of the previous equity lines. Under the Sixth Equity Line Agreement, the Company has the right to draw up to $20,000,000 against an equity line of credit (“the Sixth Equity Line”) from the Equity Line Investor. The Company is entitled under the Sixth 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 number of shares to be issued is determined by dividing the amount of the draw by 90% of the average of the two lowest closing bid prices of the Company’s Class A common stock over the ten trading days after the put notice is tendered. The Equity Line Investor is required under the Sixth 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.

In connection with the Sixth Equity Line Agreement, the Company granted registration rights to the Equity Line Investor and filed a registration statement on Form S-2, which covered the resales of the shares to be issued under the Sixth Equity Line. The Company is obligated to maintain the effectiveness of the registration statement.

For the year ended December 31, 2005, the Company received $4,263,000 in funds drawn under the Sixth Equity Line, less commissions and fees of $141,000. The Company issued 75,000,000 shares of Class A common stock to the Equity Line Investor as puts under the Sixth Equity Line, totaling $4,138,000.

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.

For the year ended December 31, 2005, the Company received $3,127,000 in funds drawn under the Seventh Equity Line, less commissions and fees of $106,000. The Company issued 100,000,000 shares of Class A common stock to the Equity Line Investor as puts under the Seventh Equity Line totaling $3,127,000.

For the year ended December 31, 2006, the Company received $3,378,000 in funds drawn under the Seventh Equity Line, less commissions and fees of $114,000. The Company issued 300,000,000 shares of Class A common stock to the Equity Line Investor as puts under the Seventh Equity Line totaling $3,378,000.

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.

F-23

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

NOTE 9. COMMON STOCK

Common Stock – During 2007, the Company issued 2,977,153,205 shares of Class A common stock. Of such shares, 2,777,153,205 shares were issued in conversion of 173 shares of Series L Preferred Stock and 200,000,000 shares were issued for consulting services.

During 2006, the Company issued 917,036,751 shares of Class A common stock. Of such shares, 300,000,000 were issued in connection with draws on the Seventh Equity Line, 15,028,249 shares were issued in conversion of 266 shares of Series J Preferred Stock, 109,300,000 shares were issued in conversion of 1,093 shares of Series K Preferred Stock, 2,838,412 shares were issued in payment of dividends on Series H Preferred Stock and 489,870,090 shares were issued in conversion of 142 shares of Series L Preferred Stock.

During 2005, the Company issued 261,157,897 shares of Class A common stock. Of such shares, 180,480,405 were issued upon conversion of draws on the equity lines, 29,417,578 were issued in payment of principal and interest on long-term debt, 27,275,299 were issued in payment of dividends on Series H Preferred Stock, 18,482,083 were issued in connection with conversions of Series I Preferred Stock, 3,795,918 were issued in connection with conversions of Series J Preferred Stock and 2,277,777 were issued in connection with legal settlement.

NOTE 10. STOCK OPTIONS AND WARRANTS

Common Stock Options - In 1998, the Company’s board of directors and shareholders approved the 1998 Stock Option and Incentive Plan (“the “1998 Plan”) for directors, employees and other persons acting on behalf of the Company, under which the aggregate number of shares authorized for issuance was 250,000. The Company subsequently determined that it had issued 253,581 options in excess of the aggregate number authorized under the plan. In 2004, the Company’s board of directors approved an increase in the number of shares under the Plan from 250,000 to 550,000 to cover the additional options issued. In November 2004, the Board of Directors again amended the 1998 Plan to increase the aggregate number of shares under the 1998 Plan from 550,000 to 20,000,000. The purpose of this amendment is to cover any additional issuances of shares made in excess of the number authorized under the 1998 Plan and to enable the Company to issue additional incentive stock options to key employees and non-qualified stock options, stock appreciation rights, cash and stock bonuses and other incentive grants to directors, employees and certain non-employees who have important relationships with the Company or its subsidiaries. At a meeting of shareholders held on December 30, 2004, the amendments to the 1998 Plan were approved. As of December 31, 2007, there were 19,092,358 shares available for grant under this plan.

In 1997, the Company’s board of directors approved the 1997 Stock Option and Incentive Plan for directors, employees and other persons acting on behalf of the Company, under which the aggregate number of shares authorized for issuance is 187,500. As of December 31, 2007, there were 187,500 shares available for grant under this plan.

In 1996, the Company’s board of directors and shareholders approved the 1996 Directors’ Stock Option Plan, under which the aggregate number of shares of Class A common stock authorized for issuance is 135,000. The plan provides that each director shall receive options to purchase 5,000 shares of Class A common stock for services rendered as a director during each entire calendar year or portion of a calendar year in excess of six months. The exercise price of such options is the closing market price of the Class A common stock on the date the options are granted. The option term is 10 years from date of grant. As of December 31, 2007, shares available for grant under this plan were 135,000.

In 1996, the Company’s board of directors approved a Long-Term Stock Investment and Incentive Plan for officers, key employees and other persons acting on behalf of the Company under which the aggregate number of shares authorized for issuance is 22,500. The exercise price of these options is the closing market price of the Class A common stock on the date the options are granted. The term of the plan is 10 years and options are subject to a three-year vesting schedule, pursuant to which one-third of the total number of options granted may be exercised each year. As of December 31, 2007, shares available for grant under this plan were 22,500.

F-24

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

On January 19, 2005 the Company entered into an option exchange program with its employees, wherein the Company gave eligible Fonix employees the opportunity to exchange outstanding stock options for the same number of new options to be issued at least six months and one day from the expiration of the offer. As a result of the option exchange program, the Company cancelled 414,450 options to purchase shares of our Class A common stock effective February 22, 2005. On August 23, 2005 the Company granted 414,450 options to employees participating in the option exchange program at $0.04 per share.

During 2005, the Company granted options to purchase 746,505 shares of Class A common stock in addition to the options granted in connection with the option exchange program described above. The options were granted at exercise prices ranging from $0.04 to $0.12. All options were granted at the quoted market price on the date of grant. All options granted vest over three years following issuance. If not exercised, all options expire within ten years from the date of grant.

During 2006, the Company granted options to purchase 58,000 shares of Class A common stock at exercise prices ranging from $0.01 to $0.02. All options were granted at the quoted market price on the date of grant. All options granted vest over three years following issuance. If not exercised, all options expire within ten years from the date of grant.

During 2007, the Company granted no options to employees.

A summary of options granted under the Company’s various stock option plans for the years ended December 31, 2007, 2006, and 2005, is presented below:

	2007					2006					2005
	Stock Options			Weighted Average Exercise Price		Stock Options			Weighted Average Exercise Price		Stock Options			Weighted Average Exercise Price
Outstanding at beginning of the year		907,642		$	0.13		1,331,205		$	0.132		818,920		$	42.42
Granted		-			-		58,000			0.01		1,160,955			0.09
Exercised		-			-		-			-		-			-
Forfeited		(531,142	)		0.15		(481,563	)		0.13		(647,810	)		59.11
Outstanding at end of the year		376,500			0.10		907,642			0.13		1,331,205			0.13
Exercisable at the end of the year		363,834		$	0.11		776,774		$	0.13		635,303		$	0.13

A summary of options outstanding and options exercisable under the Company’s various stock option plans at December 31, 2007, is presented below:

Options Outstanding							Options Exercisable
Range of Exercise Prices		Number Outstanding		Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable		Weighted Average Exercise Price
$	0.01 – 0.04		339,313	3.1 years	$	0.04		332,647	$	0.04
	0.12		18,000	7.8 years		0.12		12,000		0.12
	0.26		17,000	6.5 years		0.26		17,000		0.26
	3.60 – 61.24		2,187	3.7 years		8.76		2,187		8.76
$	0.01 – 61.24		376,500	6.2 years		0.10		363,834		0.11

F-25

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

The weighted average fair value of options granted during the years ended December 31, 2006, and 2005 were $0.01 and $0.09 per share, respectively. The options outstanding at December 31, 2007 had an aggregate intrinsic value of zero.

The fair value of options and warrants is estimated on the date granted using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants during 2006, and 2005:

	2006	2005
Risk-free interest rate	3.75%	3.75%
Expected dividend yield	0.0%	0.0%
Expected exercise lives	5 years	5 years
Expected volatility	143%	143%

The estimated fair value of options granted is subject to the assumptions made, and if the assumptions were to change the estimated fair value amounts could be significantly different.

Warrants - A summary of warrants granted by the Company during the years ended December 31, 2007, 2006, and 2005, is presented below:

	2007				2006				2005
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price		Shares			Weighted Average Exercise Price
Outstanding at beginning of the year		15,000	$	40.00		15,000	$	40.00		980,389		$	1.10
Granted		—		—		—		—		—			—
Forfeited		—		—		—		—		(965,389	)		0.51
Outstanding at end of the year		15,000		40.00		15,000		40.00		15,000			40.00
Exercisable at end of the year		15,000		40.00		15,000		40.00		15,000			40.00

NOTE 11. RELATED-PARTY TRANSACTIONS

The secretary of the Company is a partner in a law firm that the Company uses to provide legal services. During 2007, 2006 and 2005, the Company incurred expenses of approximately $207,000, $368,000 and $533,000, respectively, to the law firm for services provided to the Company.

NOTE 12. INCOME TAXES

At December 31, 2007 and 2006, net deferred income tax assets, before considering the valuation allowance, totaled $58,731,000 and $64,313,000, respectively. The amount and ultimate realization of the benefits from the deferred income tax assets are dependent, in part, upon the tax laws in effect, the Company’s future earnings, and other future events, the effects of which cannot be determined. The Company has established a valuation allowance for all deferred income tax assets not offset by deferred income tax liabilities due to the uncertainty of their realization. The net change in the valuation allowance was an decrease of $5,582,000 for 2007, an increase of $8,187,000 for 2006 and a decrease of $8,249,000 for 2005.

At December 31, 2007, the Company has unused federal net operating loss carryforwards available of approximately $142,985,000 and unused state net operating loss carryforwards of approximately $134,265,000 which may be applied against future taxable income, if any, and which expire in various years from 2011 through 2027. The Internal Revenue Code contains provisions which likely will reduce or limit the availability and utilization of these net operating loss carryforwards. For example, limitations are imposed on the utilization of net operating loss carryforwards if certain ownership changes have taken place or will take place. The Company has not performed an analysis to determine whether any such limitations have occurred.

F-26

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

The temporary differences and carryforwards which give rise to the deferred income tax assets as of December 31, 2007 and 2006 are as follows:

Deferred income tax assets:	2007			2006
Net operating loss carryforwards:
Federal	$	48,614,944		$	54,163,000
State		4,430,748			4,969,000
Research expenditures credits		2,511,887			2,487,000
Accrued liabilities		115,548			86,000
Deferred revenues		166,133			172,000
Amortization of intangible assets		2,891,700			2,437,000
Total deferred income tax assets		58,730,960			64,313,000
Valuation allowance		(58,730,960	)		(64,313,000	)
Deferred income tax liability – intangible telecommunications assets		–			–
Net deferred income tax assets	$	–		$	–

A reconciliation of income taxes at the federal statutory rate to the Company’s effective rate is as follows:

	Year Ended December 31,
	2007			2006			2005
Federal statutory income tax rate		34.0%			34.0%			34.0%
State and local income tax rate, net of federal benefit		3.3			3.3			3.3
Non-deductible items		(0.5	)		(0.5	)		(0.5	)
Valuation allowance		(37.2	)		(37.2	)		(37.2	)
Effective income tax rate		0.0%			0.0%			0.0%

NOTE 13. COMMITMENTS AND CONTINGENCIES

Executive Employment Agreements – As of December 31, 2007, the Company had employment agreements with two executive officers that were initiated November 1, 1996 and amended effective January 31, 2000 to extend the term of the agreements and reduce the base compensation. The current annual base salary for each executive officer was $309,400. During 2002, the executive officers agreed to accept reduced cash compensation pursuant to the Company’s 2002 Employee Compensation Plan. The current expiration date of the agreements is December 31, 2010.

In the event that, during the contract term, both a change of control occurs, and within six months after such change in control occurs, the executive’s employment is terminated by the Company for any reason other than cause, death, or retirement, the executive shall be entitled to receive an amount in cash equal to all base salary then and thereafter payable within 30 days of termination.

On March 5, 2008 Mr. Murdock resigned as President, Chairman, and Chief Executive Officer.

F-27

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

In connection with his resignation from the Company and its subsidiaries, Mr. Murdock entered into a Separation and Release of Claims Agreement (the “Separation Agreement”) with the Company. Under the Separation Agreement, the parties agreed that the Company is not obligated to pay to Mr. Murdock approximately $320,000 in deferred salary owed to Mr. Murdock unless and until (i) the occurrence of a Liquidity Event (as defined in the Agreement), and then in proportion to the amount that Mr. Dudley is paid for salary that he also deferred during the deferred salary period or (ii) the Company begins to make payments to Dudley for salary which he has deferred for the deferred salary period, and then in proportion to the amount that Mr. Dudley is paid for salary that he deferred during the deferred salary period, or (ii) the conversion by Murdock into shares of the Company's Common Stock at any time or times on or after the date of the Agreement, at Mr. Murdock’s sole option, any portion of the outstanding and unpaid deferred salary into fully paid and nonassessable shares of the Company’s Common Stock, with the number of shares issuable being determined by dividing the salary amount being converted by the conversion price (which is equal to the average of the closing bid prices over the ten (10) trading days prior to the conversion date). Additionally, the parties agreed that Mr. Murdock was not entitled to any severance under his Employment Agreement, except that upon the occurrence of a Liquidity Event, then the Company is required to pay to Mr. Murdock an amount which is equal to the lower of (i) his annual base salary or (ii) the severance paid to Mr. Dudley in connection with such Liquidity Event.

The Company also agreed (i) to provide COBRA medical coverage for Mr. Murdock through December 31, 2009; (ii) that all of Mr. Murdock’s stock options, warrants, and other similar rights would immediately vest; (iii) that the Company would maintain life insurance, disability insurance, and 401(k) plan for Mr. Murdock through December 31, 2009; (iv) to indemnify Mr. Murdock against claims relating to his service as an officer and director of Fonix, as well as in connection with the lawsuits by The Breckenridge Fund LLC; (v) that unpaid expenses of approximately $25,000 owed to Mr. Murdock would be paid to Mr. Murdock at the time of a Liquidity Event (as defined in the Agreement); and (vi) to pay as and when due in regular monthly installments the balance of approximately $24,000 under the terms a loan from the Company’s 401(k) plan, as lender, to Mr. Murdock, as borrower.

Under the Separation Agreement, Mr. Murdock agreed, among other this, (i) to release the Company and its officers, directors, and employees from any claims; and (ii) that he would not make us of or disclose any proprietary business or trade secret information.

Mr. Dudley’s executive employment agreement, as described above remained in force as the date of this Report.

Operating Lease Agreements - The Company leases certain facilities and equipment used in its operations. The amounts of commitments for non-cancelable operating leases in effect at December 31, 2007, were as follows:

Year ending December 31,
2008	$	312,000
2009		312,000
2010		208,000
	$	832,000

The Company incurred rental expense of $382,000, $350,000, $829,000 during 2007, 2006 and 2005, respectively, related to these leases.

Forgiveness of Trade Payables and Accrued Interest - The Company negotiated reductions in amounts due various trade vendors amounting to $199,000, $0 and $142,000 during 2007, 2006 and 2005 respectively.

NOTE 14. LITIGATION

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

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

F-28

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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

Hite Development Corporation v. Fonix Corporation, Third District Court, Salt Lake County (Civil No. 070900883). In January 2007, Hite Development Corporation (“Hite”) brought a lawsuit against the Company claiming breach of contract and breach of the covenant of good faith and fair dealing, alleging that the Company failed to make certain payments under a settlement agreement with Hite dating from March 2005. The complaint seeks approximately $33,000 plus interest. The Company filed its answer in May 2007. The case is currently in the discovery phase. The Company intends to defend against the claims in the complaint.

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

NOTE 15. EMPLOYEE PROFIT SHARING PLAN

The Company has a 401(k) profit sharing plan covering essentially all of its full-time employees. Under the plan, employees may reduce their salaries, in amounts allowed by law, and contribute the salary reduction amount to the plan on a pretax basis. The plan also allows the Company to make matching and profit sharing contributions as determined by the board of directors. To date, no matching or profit sharing contributions have been made by the Company.

NOTE 16. SIGNIFICANT CUSTOMERS

The Company’s revenues by geographic region for the years ended December 31, 2006, 2005 and 2004 were:

	2007			2006			2005

United States	$	913,000	50%	$	546,000	41%	$	898,000	66%
Asia Pacific		830,000	45%		591,000	44%		352,000	26%
Other		95,000	5%		192,000	15%		108,000	8%
	$	1,838,000		$	1,329,000		$	1,358,000

For the year ended December 31, 2007, four customer accounted for 20%, 15%, 12% and 10% of total revenues. For the year ended December 31, 2006, one customer accounted for 31% of total revenues and another customer accounted for 10% of total revenues. For the year ended December 31, 2005, one customer accounted for 17% of total revenues and another customer accounted for 15% of total revenues.

NOTE 17. SUBSEQUENT EVENTS

Through March 31, 2008, the Company has issued 1,404,251,012 shares of its Class A common stock in conversion of 16 shares of Series L Preferred Stock.

Through March 31, 2008, the Company has issued 7,403,846 shares of its Class A common stock in payment of interest on the Series L Preferred Stock.

F-29

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

Through March 31, 2008, the Company has issued 53,913,701shares of its Class A common stock in conversion of interest on the related party note.

As discussed above, in February 2008, the Company entered into an amended settlement agreement with Breckenridge under which the Company agreed to pay Breckenridge $540, 000. The Company has paid Breckenridge $242,500 and is obligated to pay the balance of $297,500 at the rate of $42,500 per month.

Mr. Murdock resigned as Chief Executive Officer, President, and Chairman of Fonix on March 5, 2008. Additionally, Mr. Maasberg resigned as a director on March 5, 2008 and as Chief Operating Officer on March 31, 2008.

Between December 31, 2007 and March 31, 2008, the Company received an aggregate of $250,000 from two investors in connection with an investment in the Company. The Company and the investors are negotiating the terms of the investment, which will be disclosed once the terms have been finalized and documents have been signed.

F-30

Part I
		Page

Item 1.	Business	3
Item 1A.	Risk Factors	9
Item 2.	Properties	18
Item 3.	Legal Proceedings	18
Item 4.	Submission of Matters to a Vote of Security Holders	19

Part II

Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	19
Item 6.	Selected Financial Data	24
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	26
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 8.	Financial Statements and Supplementary Data	41
Item 9A.	Controls and Procedures	42

Part III

Item 10.	Directors, Executive Officers and Corporate Governance	43
Item 11.	Executive Compensation	44
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	50
Item 13.	Certain Relationships and Related Transactions, and Director Independence	50
Item 14.	Principal Accountant Fees and Services	51

Part IV

Item 15.	Exhibits and Financial Statement Schedules	52

Types of Microprocessors	Types of Operating Systems
	Win32	WinCE	QNX	Linux	Solaris	Apple OS 10+	Symbian Nokia Series 60	No OS Support Required
Analog Devices Blackfin								X
ARM 7 ARM 9		X X		X			X	X
Epson S1C33 Family								X
Renasas SH-3 SH-4		X X	X					X
Intel SA-1110 XScale X86	X	X X	X X	X X
MIPS MIPS R4XXX		X
Motorola PPC 5100/5200			X	X
NeoMagic MiMagic3 (NMS7210) MiMagic5		X
TI OMAP1510 (ARM core)		X
Sun Sparc					X
Freescale iMXL (ARM)		X
Samsung S3C ARM		X
FreeScale mCore								X
Power PC						X

Hypothetical Conversion Price		Shares issuable upon Conversion of Southridge Debenture (Principal amount of $850,000)		Shares issuable upon Conversion of McCormack Debenture (Principal amount of $1,039,000)		Total shares issuable upon conversion of outstanding Debentures
$	0.0001		8,500,000,000		10,390,000,000		18,890,000,000
$	0.0002		4,250,000,000		5,195,000,000		9,445,000,000
$	0.0003		2,833,333,333		3,463,333,333		6,296,666,666
$	0.0005		1,700,000,000		2,078,000,000		3,778,000,000
$	0.001		850,000,000		1,039,000,000		1,889,000,000
$	0.002		425,000,000		519,500,000		944,500,000
$	0.005		170,000,000		207,800,000		377,800,000

Hypothetical Conversion Price		Shares issuable upon Conversion of Series L Preferred Stock (1,519 shares outstanding)		Shares issuable upon Conversion of Series M Preferred Stock (150 shares outstanding)		Shares issuable upon Conversion of Series N Preferred Stock (1,350 shares outstanding)		Shares issuable upon Conversion of Fonix Speech Series B Preferred Stock* (125 shares outstanding)		Total shares issuable upon conversion of outstanding Preferred Stock
$	0.0001		151,900,000,000		15,000,000,000		13,500,000,000		12,500,000,000		192,900,000,000
$	0.0002		75,950,000,000		7,500,000,000		6,750,000,000		6,250,000,000		96,450,000,000
$	0.0003		50,633,333,333		5,000,000,000		4,500,000,000		4,166,666,666		64,299,999,999
$	0.0005		30,380,000,000		3,000,000,000		2,700,000,000		2,500,000,000		38,580,000,000
$	0.001		15,190,000,000		1,500,000,000		1,350,000,000		1,250,000,000		19,290,000,000
$	0.002		7,595,000,000		750,000,000		675,000,000		625,000,000		9,645,000,000
$	0.005		3,038,000,000		300,000,000		270,000,000		250,000,000		3,858,000,000

DIRECTOR	SHARES VOTED IN FAVOR	SHARES VOTED AGAINST
Thomas A. Murdock	1,694,934,207	951,079,468
Roger D. Dudley	1,704,021,903	941,991,772
William A. Maasberg, Jr.	1,705,404,363	940,609,312

Calendar Year
	2008				2007				2006
	High		Low		High		Low		High		Low

First Quarter	$	0.0004	$	0.0001	$	0.0028	$	0.0013	$	0.003	$	0.015
Second Quarter					$	0.0025	$	0.0009	$	0.002	$	0.008
Third Quarter					$	0.0013	$	0.0004	$	0.009	$	0.005
Fourth Quarter					$	0.0016	$	0.0002	$	0.005	$	0.003

Current Assets	$	2,390,000
Investments		237,000
Property and equipment		148,000
Deposits and other assets		984,000
Intangible assets		18,500,000
Total assets acquired		22,259,000
Current liabilities		(8,923,000	)
Long-term portion of notes payable		(536,000	)
Total liabilities assumed		(9,459,000	)
Net Assets Acquired	$	12,800,000

	For the Year Ended December 31,
	2007			2006			2005			2004			2003
Statement of Operations Data:
Revenues	$	1,838,000		$	1,329,000		$	1,358,000		$	1,229,000		$	2,384,000
Cost of Revenues		141,000			18,000			70,000			33,000			1,029,000
Selling, general and administrative expenses		2,479,000			5,356,000			4,762,000			4,706,000			7,004,000
Legal settlement expense		–			–			2,080,000			–			–
Product development and research		1,572,000			2,143,000			2,196,000			2,559,000			5,141,000
Impairment loss on goodwill		2,631,000			–			–			–			302,000
Other expense, net		19,944,000			(4,508,000	)		(1,044,00	)		(543,000	)		(2,451,000	)
Gain (loss) from continuing operations, before equity in net loss of affiliate		14,959,000			(10,696,000	)		(8,794,000	)		(6,612,000	)		(13,183,000	)
Equity in loss of affiliate		–			–			–			–			(360,000	)
Net gain (loss) from continuing operations		14,959,000			(10,696,000	)		(8,794,000	)		(6,612,000	)		(13,543,000	)
Net loss from discontinued operations		–			(11,247,000	)		(13,837,000	)		(8,536,000	)		–
Net gain (loss)		14,959,000			(21,943,000	)		(22,631,000	)		(15,148,000	)		(13,543,000	)
Preferred stock dividends		(1,702,000	)		(18,735,000	)		(1,265,000	)		(3,927,000	)		–
Net gain (loss) attributable to common stockholders		13,257,000			(40,678,000	)		(23,896,000	)		(19,075,000	)		(13,543,000	)
Basic net income (loss) per common share from continuing operations	$	0.01		$	(0.04	)	$	(0.04	)	$	(0.12	)	$	(0.50	)
Basic and diluted net loss per common share from discontinued operations		–		$	(0.01	)	$	(0.05	)	$	(0.10	)		–
Basic weighted average number of common shares outstanding		2,417,708,937			768,076,936			261,894,849			89,795,728			26,894,005
Diluted net income per common share from continuing operations	$	0.00			–			–			–			–
Diluted weighted average number of common shares outstanding		100,629,394,604			768,076,936			261,894,849			89,795,728			26,894,005

	As of December 31,
	2007			2006			2005			2004			2003
Balance Sheet Data:
Current assets	$	87,000		$	9,000		$	1,465,000		$	2,120,000		$	342,000
Total assets		211,000			2,805,000			9,293,000			19,000,000			3,173,000
Current liabilities		34,471,000			52,966,000			20,469,000			15,700,000			13,530,000
Long-term debt, net of current portion		3,556,000			2,988,000			4,050,000			5,358,000			40,000
Stockholders’ (deficit)		(37,816,000	)		(53,149,000	)		(15,226,000	)		(2,058,000	)		(10,397,000	)

	For the Quarter Ended
	Mar 31, 2007			Jun 30, 2007			Sep 30, 2007			Dec 31, 2007
	(Unaudited)
Net sales	$	360,000		$	644,000		$	339,000		$	495,000
Gross profit		353,000			572,000			285,000			487,000
Net gain/loss from continuing operations		(787,000	)		(1,061,000	)		(585,000	)		17,392,000
Preferred stock dividends		(410,000	)		(431,000	)		(434,000	)		(427,000	)
Net gain/loss attributable to common stockholders		(1,197,000	)		(1,492,000	)		(1,019,000	)		16,965,000
Basic gain (loss) per common share	$	(0.00	)	$	(0.00	)	$	(0.00	)	$	0.01
Diluted gain per common share		--			--			--		$	0.00

	For the Quarter Ended
	Mar 31, 2006			Jun 30, 2006			Sep 30, 2006			Dec 31, 2006
	(Unaudited)
Net sales	$	272,000		$	366,000		$	386,000		$	305,000
Gross profit		267,000			365,000			380,000			299,000
Net loss from continuing operations		(1,851,000	)		(1,849,000	)		(4,486,000	)		(2,510,000	)
Net loss from discontinued operations		(2,230,000	)		(2,656,000	)		(6,361,000	)		--
Preferred stock dividends		(1,849,000	)		(254,000	)		(16,192,000	)		(440,000	)
Net loss attributable to common stockholders		(5,930,000	)		(4,759,000	)		(27,039,000	)		(2,950,000	)
Basic and diluted loss per common share	$	(0.01	)	$	(0.01	)	$	(0.01	)	$	(0.01	)

	Total		Less Than One		One to Three		Three to Five		More than Five
Notes payable	$	11,166,000	$	4,735,000	$	6,431,000	$	--		--
Operating lease obligations		832,000		312,000		520,000		--		--
Series E debentures		1,755,000		-- --		--		1,755,000		--
Preferred stock dividends		8,900,000		1,780,000		3,560,000		3,560,000		**
Total contractual cash obligations	$	22,653,000	$	6,827,000	$	10,511,000	$	5,315,000

Index to Consolidated Financial Statements:

Report of Independent Registered Public Accounting Firm	F-2

CONSOLIDATED FINANCIAL STATEMENTS:

Consolidated Balance Sheets as of December 31, 2007 and 2006	F-3

Consolidated Statements of Operations and Comprehensive Loss for the Years Ended December 31, 2007, 2006 and 2005	F-4

Consolidated Statements of Stockholders’ Deficit for the Years Ended December 31, 2005, 2006 and 2007	F-5

Consolidated Statements of Cash Flows for the Years Ended December 31, 2007, 2006 and 2005	F-6

Notes to Consolidated Financial Statements	F-8

Name	Age	Position

Roger D. Dudley	55	Director, Chief Executive Officer & Chief Financial Officer

Name and Principal Position	Year	Salary ($)			Bonus ($)		Stock Awards ($)		Option Grants ($)		Non-Equity Incentive Plan Compensation ($)		Change in Pension Value and Nonqualified Deferred Compensation Earnings ($)		All Other Compensation			Total ($)
Thomas A. Murdock Chief Executive Officer & President (2)	2007	$	309,400	(1)		--		--		--		--		--	$	10,210	(4)	$	319,610
Roger D. Dudley Executive vice President & Chief Financial Officer (2)	2007	$	309,400	(1)		--		--		--		--		--	$	5,283	(4)	$	314,683
William A. Maasberg, Jr. Chief Operating Officer (5)	2007	$	61,129			--		--		--		--		--		--		$	61,129

Name	Grant Date	Estimated Future Payouts Under Non-Equity Incentive Plan Awards			Estimated Future Payouts Under Equity Incentive Plan Awards			All Other Stock Awards: Number of Shares of Stock or Units (#)	All Other Option Awards: Number of Securities Underlying Options (#)	Exercise Price or Base Price of Option Awards ($/Sh)
		Threshold ($)	Target ($)	Maximum ($)	Threshold (#)	Target (#)	Maximum (#)
Thomas A. Murdock	N/A	--	--	--	--	--	--	--	--	--
Roger D. Dudley	N/A	--	--	--	--	--	--	--	--	--
William A. Maasberg, Jr.	N/A	--	--	--	--	--	--	--	--	--

	Option Awards					Stock Awards
Name	Number of Securities Underlying Unexercised Options (#) Exercisable	Number of Securities Underlying Unexercised Options (#) Unexercisable	Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#)	Option Exercise Price ($)	Option Expiration Date	Number of Shares or Units of Stock That Have Not Vested (#)	Market Value of Shares or Units of Stock That Have Not Vested ($)	Equity Incentive Plan Awards: Number of Unearned Shares, Units, or Other Rights That Have Not Vested (#)	Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units, or Other Rights That Have Not Vested ($)
Thomas A. Murdock	101,250	--	--	$0.04	2010	--	$19	--	--
Roger D. Dudley	101,250	--	--	$0.04	2010	--	$19	--	--
William A. Maasberg, Jr.	27,500	--	--	$0.04	2010	--	$5	--	--

	Option Awards		Stock Awards
Name of Executive Officer	Number of Shares Acquired on Exercise (#)	Value Realized on Exercise ($)	Number of Shares Acquired on Vesting (#)	Value Realized on Vesting ($)
Thomas A.. Murdock	--	--	--	--
Roger D. Dudley	--	--	--	--
William A. Maasberg, Jr.	--	--	--	--

Name	Plan Name	Number of Years Credited Service (#)	Present Value of Accumulated Benefit ($)	Payments During Last Fiscal Year ($)
Thomas A. Murdock	N/A	--	--	--
Roger D. Dudley	N/A	--	--	--
William A. Maasberg, Jr.	N/A	--	--	--

Name	Executive Contributions in Last FY ($)	Registrant Contributions in Last FY ($)	Aggregate Earnings in Last FY ($)	Aggregate Withdrawals/ Distributions ($)	Aggregate Balance at Last FYE ($)
Thomas A. Murdock	--	--	--	--	--
Roger D. Dudley	--	--	--	--	--
William A. Maasberg, Jr.	--	--	--	--	--

Name	Fees Earned or Paid in Cash ($)	Stock Awards ($)	Option Awards ($)	Non-Equity Incentive Plan Compensation ($)	Change in Pension Value and Nonqualified Deferred Compensation Earnings ($)	All Other Compensation ($)	Total ($)
Thomas A. Murdock	--	--	--	--	--	--	--
Roger D. Dudley	--	--	--	--	--	--	--
William A. Maasberg, Jr.	--	--	--	--	--	--	--

	2002	2003	2004	2005	2006	2007
FONIX CORPORATION	100.00	27.81	12.06	1.23	0.18	0.01
NASDAQ MARKET INDEX	100.00	150.36	163.00	166.58	183.68	201.91
SIC CODE INDEX - 7373	100.00	177.58	222.58	223.04	202.33	186.83

Name and Address of 5% Beneficial Owners, Executive Officers, and Directors	Number of Shares Beneficially Owned	Percent of Class (1)
Roger D. Dudley Chairman of the Board, Chief Executive Officer, Chief Financial Officer, Director	3,577,419,398(3)	38.34%
Thomas A. Murdock (2) Former Chairman of the Board & Former Chief Executive Officer	1,123,379,815(4)	13.34%
Officer and Director as a Group (1 person)	3,577,419,398	38.34%

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants, and rights	Weighted average exercise price of outstanding options, warrants, and rights	Number of securities remaining available for future issuance under equity compensation plans
Equity compensation plans approved by shareholders	376,500	$0.11	19,437,358
Equity compensation plans not approved by shareholders	--	--	--
Total	376,500	$0.11	19,437,358

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

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

		Consolidated Balance Sheets as of December 31, 2007 and 2006

		Consolidated Statements of Operations for the Years Ended December 31, 2007, 2006 and 2005

		Consolidated Statements of Stockholders’ Deficit for the Years Ended December 31, 2007, 2006 and 2005

		Consolidated Statements of Cash Flows for the Years Ended December 31, 2007, 2006 and 2005

		Notes to Consolidated Financial Statements


	2.	Financial Statement Schedules: None


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

	Exhibit No. Description of Exhibit

	9	Amended and Restated Voting

	10.1	Separation Agreement between Fonix Corporation and Thomas A. Murdock

	22	Subsidiaries of Registrant

	31	Certification of President and Chief Financial Officer

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

		Fonix Corporation



Date: April 15, 2008	By:	/s/ Roger D. Dudley
		Roger D. Dudley, President, Chief Executive Officer
		and Chief Financial Officer
		(Principal Executive Officer, Principal Financial and
		Accounting Officer)

	HANSEN, BARNETT & MAXWELL. P.C.
Salt Lake City, Utah
April 14, 2008

	December 31, 2007			December 31, 2006
ASSETS

Current assets
Cash and cash equivalents	$	26,000		$	5,000
Prepaid expenses and other current assets		61,000			4,000

Total current assets		87,000			9,000

Property and equipment, net of accumulated depreciation of $1,293,000 and $1,261,000, respectively		16,000			48,000

Deposits and other assets		108,000			117,000

Goodwill		-			2,631,000

Total assets	$	211,000		$	2,805,000

LIABILITIES AND STOCKHOLDERS' DEFICIT

Current liabilities
Accrued liabilities	$	4,505,000		$	2,054,000
Accounts payable		1,532,000			1,504,000
Net liabilities of discontinued subsidiaries		-			20,819,000
Derivative liability		20,742,000			20,941,000
Accrued payroll and other compensation		211,000			214,000
Accrued settlement obligation		540,000			1,530,000
Deferred revenues		445,000			460,000
Notes payable - related parties		902,000			800,000
Series E debentures		1,754,000			1,754,000
Current portion of notes payable		3,833,000			2,883,000
Deposits and other		7,000			7,000

Total current liabilities		34,471,000			52,966,000

Long-term notes payable, net of current portion		3,556,000			2,988,000

Total liabilities		38,027,000			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
Series L, convertible; 1,535 shares and 1,858 shares outstanding , respectively		-			-
Common stock, $0.0001 par value; 20,000,000,000 shares authorized;
Class A voting, 4,287,119,186 shares and 1,309,965,981 shares outstanding, respectively		429,000			131,000
Class B non-voting, none outstanding		-			-
Additional paid-in capital		238,714,000			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		(277,943,000	)		(291,200,000	)

Total stockholders' deficit		(37,816,000	)		(53,149,000	)

Total liabilities and stockholders' deficit	$	211,000		$	2,805,000

Fonix Corporation and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS


	Years Ended December 31,
	2007			2006			2005


Revenues
Speech licenses, royalties and maintenance	$	1,838,000		$	1,329,000		$	1,358,000

Total Revenue		1,838,000			1,329,000			1,358,000

Cost of revenues
Speech licenses, royalties and maintenance		141,000			18,000			70,000

Total cost of revenues		141,000			18,000			70,000

Gross profit		1,697,000			1,311,000			1,288,000

Operating expenses:
Selling, general and administrative		2,479,000			5,356,000			4,762,000
Impairment of goodwill		2,631,000			-			-
Legal settlement expense		-			-			2,080,000
Product development and research		1,572,000			2,143,000			2,196,000

Total operating expenses		6,682,000			7,499,000			9,038,000

Other income (expense):
Interest and other income		-			-			8,000
Interest expense		(1,887,000	)		(1,737,000	)		(1,298,000	)
Gain (loss) on derivative liability		813,000			(2,771,000	)		-
Gain on sale of investments		-			-			104,000
Gain on forgiveness of liabilities		21,018,000			-			142,000

Other income (expense), net		19,944,000			(4,508,000	)		(1,044,000	)

Income (loss) from continuing operations		14,959,000			(10,696,000	)		(8,794,000	)
Loss from discontinued operations		-			(11,247,000	)		(13,837,000	)

Net income (loss)		14,959,000			(21,943,000	)		(22,631,000	)
Preferred stock dividends		(1,702,000	)		(18,735,000	)		(1,265,000	)

Income (loss) attributable to common stockholders	$	13,257,000		$	(40,678,000	)	$	(23,896,000	)


Basic income (loss) per common share from continuing operations	$	0.01		$	(0.04	)	$	(0.04	)

Basic and diluted income (loss) per common share from discontinued operations	$	-		$	(0.01	)	$	(0.05	)

Diluted income per common share from continuing operations	$	0.00		$	-		$	-

Net income (loss)	$	14,959,000		$	(21,943,000	)	$	(22,631,000	)
Other comprehensive income - foreign currency translation		-			8,000			10,000

Comprehensive income (loss)	$	14,959,000		$	(21,935,000	)	$	(22,621,000	)

Fonix Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007

													Outstanding			Cumulative
													Warrants			Foreign
											Additional		to Purchase			Currency
	Preferred Stock						Common Stock				Paid-in		Common			Translation			Accumulated
	Shares			Amount			Shares		Amount		Capital		Stock			Adjustment			Deficit			Total

BALANCE, DECEMBER 31, 2004		170,917		$	6,750,000			131,200,170	$	13,000	$	217,061,000	$	735,000		$	8,000		$	(226,625,000	)	$	(2,058,000	)

Issuance of common stock under equity lines of credit		-			-			180,480,405		18,000		7,809,000		-			-			-			7,827,000

Shares issued for payment of principal and interest on long-term debt		-			-			29,417,578		3,000		1,248,000		-			-			-			1,251,000

Shares issued for payment of dividends on Series H Preferred		-			-			27,275,299		3,000		1,123,000		-			-			-			1,126,000

Conversion of Series I Preferred into common stock		(1,078	)		(1,078,000	)		18,482,083		2,000		1,076,000		-			-			-			-

Exchange of Series I Preferred for Series J Preferred		280			280,000			-		-		-		-			-			-			280,000

Series J Preferred Stock beneficial conversion dividend		-			-			-		-		161,000		-			-			(161,000	)		-

Conversion of Series J Preferred into common stock		(93	)		(93,000	)		3,795,918		-		93,000		-			-			-			-

Shares issued in conection with legal settlement		-			-			2,277,777		-		73,000		-			-			-			73,000

Cumulative foreign currency translation adjustment		-			-			-		-		-		-			10,000			-			10,000

Cancellation of warrants		-			-			-		-		261,000		(261,000	)		-			-			-

Dividend on Series H Preferred		-			-			-		-		-		-			-			(1,000,000	)		(1,000,000	)

Dividend on Series I Preferred		-			-			-		-		-		-			-			(86,000	)		(86,000	)

Dividend on Series J Preferred		-			-			-		-		-		-			-			(18,000	)		(18,000	)

Net loss for year ended December 31, 2005		-			-			-		-		-		-			-			(22,631,000	)		(22,631,000	)

BALANCE, DECEMBER 31, 2005		170,026		$	5,859,000			392,929,230	$	39,000	$	228,905,000	$	474,000		$	18,000		$	(250,521,000	)	$	(15,226,000	)

Issuance of common stock under equity lines of credit		-			-			300,000,000		30,000		3,250,000		-			-			-			3,280,000

Shares issued for payment of dividends on Series H Preferred		-			-			2,838,412		-		65,000		-			-			-			65,000

Exchange of Series J Preferred for Series K Preferred					-			-		-		-		-			-			-			-

Series J Preferred Stock beneficial conversion dividend		-			-			-		-		1,587,000		-			-			(1,587,000	)		-

Exchange of Series H Preferred for Series L Preferred					-			-		-		-		-			-			-			-

Series L Preferred Stock beneficial conversion dividend		-			(4,000,000	)		-		-		-		-			-			(16,000,000	)		(20,000,000	)

Conversion of Series J Preferred into common stock		(266	)		(266,000	)		15,028,249		2,000		264,000		-			-			-			-

Conversion of Series K Preferred into common stock		(1,093	)		(1,093,000	)		109,300,000		11,000		1,082,000		-			-			-			-

Conversion of Series L Preferred into common stock		(142	)		-			489,870,090		49,000		1,783,000		-			-			-			1,832,000

Cumulative foreign currency translation adjustment		-			-			-		-		-		-			(8,000	)		-			(8,000	)

Dividend on Series H Preferred		-			-			-		-		-		-			-			(693,000	)		(693,000	)

Dividend on Series J Preferred		-			-			-		-		-		-			-			(5,000	)		(5,000	)

Dividend on Series K Preferred		-			-			-		-		-		-			-			(11,000	)		(11,000	)

Dividend on Series L Preferred		-			-			-		-		-		-			-			(440,000	)		(440,000	)

Net loss for year ended December 31, 2006		-			-			-		-		-		-			-			(21,943,000	)		(21,943,000	)

BALANCE, DECEMBER 31, 2006		168,525		$	500,000			1,309,965,981	$	131,000	$	236,936,000	$	474,000		$	10,000		$	(291,200,000	)	$	(53,149,000	)

Shares issued in conection with investor relations		-			-			200,000,000		20,000		42,000		-			-			-			62,000

Conversion of Series L Preferred into common stock		(173	)		-			2,777,153,205		278,000		1,736,000		-			-			-			2,014,000

Dividend on Series L Preferred		-			-			-		-		-		-			-			(1,481,000	)		(1,481,000	)

Dividend on Series M Preferred		-			-			-		-		-		-			-			(102,000	)		(102,000	)

Dividend on Series N Preferred		-			-			-		-		-		-			-			(34,000	)		(34,000	)

Dividend on Series B Preferred		-			-			-		-		-		-			-			(85,000	)		(85,000	)

Net income for year ended December 31, 2007		-			-			-		-		-		-			-			14,959,000			14,959,000

BALANCE, DECEMBER 31, 2007		168,352		$	500,000			4,287,119,186	$	429,000	$	238,714,000	$	474,000		$	10,000		$	(277,943,000	)	$	(37,816,000	)

Fonix Corporation and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Years Ended December 31,
	2007			2006			2005
Cash flows from operating activities
Net income (loss)	$	14,959,000		$	(21,943,000	)	$	(22,631,000	)
Adjustments to reconcile net loss to net cash used in operating activities:
Discontinued operations		-			11,644,000			13,977,000
Gain / (Loss) on derivative liability		(813,000	)		2,772,000			-
Accretion of discount on notes payable		1,068,000			832,000			741,000
Non-cash expense related to the issuance of preferred stock		-			-			250,000
Stock issued for interest expense on long-term debt		-			-			500,000
Accretion of discount on legal settlement		-			117,000			-
Impairment of goodwill		2,631,000			-			-
Write down of intercompany receivable		-			1,214,000
Legal settlement expense		-			-			2,011,000
Gain on sale of investment		-			-			(104,000	)
Gain on forgiveness of liabilities		(21,018,000	)		-			(142,000	)
Depreciation		32,000			58,000			59,000
Foreign exchange loss (gain)		-			(8,000	)		10,000
Changes in assets and liabilities
Accounts receivable		-			1,000			-
Prepaid expenses and other current assets		5,000			135,000			(65,000	)
Intercompany account		-			-			(1,119,000	)
Other assets		9,000			(93,000	)		(33,000	)
Accounts payable		28,000			549,000			(128,000	)
Accrued payroll and other compensation		(3,000	)		(9,000	)		(1,433,000	)
Other accrued liabilities		805,000			689,000			(544,000	)
Deferred revenues		(15,000	)		(6,000	)		8,000

Net cash used in operating activities		(2,312,000	)		(4,048,000	)		(8,643,000	)

Cash flows from investing activities
Proceeds from sale of long term investments		-			-			104,000
Purchase of property and equipment		-			(12,000	)		(29,000	)

Net cash provided by (used in) investing activities		-			(12,000	)		75,000

Cash flows from financing activities
Proceeds from issuance of Class A common stock, net		-			3,504,000			7,827,000
Proceeds from related party note payable		102,000			419,000			50,000
Proceeds from debentures		-			650,000			650,000
Proceeds from credit advance		-			75,000			-
Proceeds from issuance of Series N Preferred Stock		1,350,000			-			-
Proceeds from issuance of Series B Preferred Stock		1,250,000			-
Proceeds from notes payable		450,000			330,000			-
Payments on related party note payable		-			(105,000	)		-
Payments on accrued settlement obligation		(819,000	)		(440,000	)		-
Discontinued operations		-			(536,000	)		-
Principal payments on notes payable		-			-			(100,000	)

Net cash provided by financing activities		2,333,000			3,897,000			8,427,000

Net increase (decrease) in cash and cash equivalents		21,000			(163,000	)		(141,000	)

Cash and cash equivalents at beginning of year		5,000			168,000			309,000

Cash and cash equivalents at end of year	$	26,000		$	5,000		$	168,000