UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2008, or

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

Commission File No. 0-23862

Fonix Corporation

(Exact name of registrant as specified in its charter)

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

387 South 520 West, Suite 110

Lindon, Utah 84042

(Address of principal executive offices with zip code)

(801) 553-6600

(Registrant's telephone number, including area code)

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

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

Indicate by check mark if the registrant is a well-know seasoned issuer, as defined in Rule 405 of the Securities Act

Yes [  ] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d)

Required [X] Not Required [  ]

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

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2008, was approximately $2,000,393, calculated using a closing price of $1.00 per share on June 30, 2008.  For purposes of this calculation, the registrant has included only the number of shares directly held by its officers and directors as of (and not counting shares beneficially owned on that date), in determining the shares held by non-affiliates.  

As of March 16, 2009, there were issued and outstanding 5,818,536 shares of our Class A common stock.

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company.  See definition of “accelerated filer and large accelerated filer,”  and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

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

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act).  Yes [  ]  No [X].

Fonix Corporation

2008 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

Part I

		Page
Item 1.	Business	3
Item 1A.	Risk Factors	13
Item 2.	Properties	19
Item 3.	Legal Proceedings	20
Item 4.	Submission of Matters to a Vote of Security Holders	20
Part II
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	21
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	24
Item 8.	Financial Statements and Supplementary Data	38
Item 9A.	Controls and Procedures	38
Part III
Item 10.	Directors, Executive Officers and Corporate Governance	40
Item 11.	Executive Compensation	42
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	46
Item 13.	Certain Relationships and Related Transactions, and Director Independence	47
Item 14.	Principal Accountant Fees and Services	48
Part IV
Item 15.	Exhibits and Financial Statement Schedules	49

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FORWARD LOOKING STATEMENTS

THIS ANNUAL REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION, FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES.  OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY FONIX AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.  FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” IN THE SECTION ENTITLED “FORWARD-LOOKING STATEMENTS,” AND ELSEWHERE IN THIS ANNUAL REPORT.  WE DISCLAIM ANY INTENTION OR OBLIGATION TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENT, WHETHER AS A RESULTOF NEW INFORMATION, FUTURE EVENTS, OR OTHERWISE.  THE FOLLOWING DISCUSSION SHOULD BE READ TOGETHER WITH OUR FINANCIAL STATEMENTS AND RELATED NOTES THERETO INCLUDED ELSEWHERE IN THIS DOCUMENT.

PART I

ITEM 1.                      BUSINESS

History and Development of the Company

Fonix Corporation (the “Company,” “Fonix,” or “we”) was incorporated in Delaware in 1985, and, pursuant to a merger transaction in 1994, the Company’s name was changed to Fonix Corporation. The Company’s operations are managed through its two wholly owned subsidiaries, Fonix Speech, Inc. (“Fonix Speech”) and Fonix GS Acquisition Co., Inc. (“Fonix GS”).

Fonix Speech

Fonix Speech provides value-added speech-enabling technologies, speech interface development tools, and speech solutions and applications, including automated speech recognition (“ASR”) and text-to-speech (“TTS”, together with ASR, the “Core Technologies”) that empower consumers to interact conversationally with information systems and devices.  We offer our speech-enabling technologies to markets for personal software for consumer applications including video games, e.Dictionaries and mobile navigation devices with GPS, wireless and mobile devices, computer telephony, and server solutions. The Company’s Speech Products enhance user productivity, ease of use and efficiency in a broad range of market segments, including mobile and wireless devices; videogame consoles; electronic devices for the assistive and language learning markets, robots, appliances; automotive telematics, computer telephony and server applications.

We have received various patents for certain elements of our Core Technologies and have filed applications for other patents covering various aspects of our technologies. We seek to develop relationships and strategic alliances with third-party developers and vendors in telecommunications, computers, electronic devices and related industries, including producers of application software, operating systems, computers and microprocessor chips. Revenues are generated through licensing of speech-enabling technologies, unit royalties, maintenance contracts and services.

Prior to 2002, the Company focused on research and development (“R&D”) projects for customized applications.  R&D and prototype development used the Core Technologies to develop applications and engines marketed for multiple operating systems and hardware platforms.  Today, Fonix Speech serves markets that are adopting speech-enabled interfaces, solutions and applications.  As memory requirements, noise robustness, speech recognition accuracy and efficiency of speech interface solutions become increasingly critical, Fonix Speech anticipates that its Core Technologies and solutions will meet customer demand for simple, convenient user interfaces.

Fonix GS

Fonix GS was formed on June 27, 2008 to facilitate the acquisition of Shanghai Gaozhi Software Systems Limited (“GaozhiSoft”).  GaozhiSoft is a leading Chinese software developer and solutions provider in 2G (second-generation) and 3G (third-generation) telecommunication operation support systems in China and throughout the Asian Pacific region. Gaozhisoft is a qualified competitor for telecommunication operation supports systems.

GaozhiSoft’s products are designed to increase data transferring speed, reduce telecommunications data loss and provide network management, billing accuracy and improved implementation techniques to telecom carriers.

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GaozhiSoft’s software products are divided into two main categories: (1) MOSS series and (2) MDtrac series. MOSS products provide service providers with integrated electronic management platforms for peer-to-peer business operation and automatic management.  MDtrac products provide data collection solutions.  GaozhiSoft has received various copyrights and patents for certain of its products and has filed applications for other copyrights and patents covering various aspects of its products.

Gaozhisoft has an outstanding management team with extensive industrial knowledge and experience with system developing, marketing and sales.  Since completion of the acquisition of GaozhiSoft, Fonix GS, through its wholly owned foreign entities, has been working with the management team to transition the business with a focus on creating synergies among the Company’s existing technologies and GoazhiSoft’s products.  Upon completion of the transition, we expect GaozhiSoft to continue its rapid growth and market penetration based on the implementation of the 3G mobile network service with these professional partners.

Fonix Corporation

We are continually developing new product offerings utilizing our Core Technologies in an effort to increase our revenue stream, and we are continuing to work with our existing customers to increase sales. We have also experienced operating expense decreases through headcount reductions and overall cost reduction measures. Through the combination of increased recurring revenues, operating cost reduction strategies and accretive acquistions, we hope to achieve positive cash flow from operations within the next 2-3 years. . However, there can be no assurance that we will be able to achieve positive cash flow from operations within this time frame.

Our cash resources, limited to loans, collections from customers and sales of our equity and debt securities, have not been sufficient to cover operating expenses.  We periodically engage in discussions with various sources of financing to facilitate our cash requirements including buyers of both debt and equity securities. To date, no additional sources of funding offering terms superior to those available under equity lines and convertible debentures have been implemented, and we rely on, first, cash generated from operations and second, convertible debt financing arrangements.  In addition to anticipated revenues generated from current and future customers, we will need to generate approximately $2 to $3 million to continue operations for the next twenty-four months.  There can be no assurance that we will be able to obtain such financing or that the terms will be favorable to the Company.

The acquisition of GaozhiSoft provides the Company a significant platform for growth which we expect will eventually provide a gateway to the Chinese market for our Core Technologies.  Additionally, we envision that through our foreign subsidiaries we will pursue opportunities to expand in Asia and pursue additional accretive acquisitions.

Company Internet addresses are as follows:

Fonix Corporation – www.fonix.com

Fonix Speech, Inc. – www.fonixspeech.com

Shanghai GaozhiSoft Co. Ltd -- www.gaozhisoft.com

VALUE-ADDED SPEECH TECHNOLOGIES

Fonix Speech, Inc.

On January 1, 2006, Fonix Speech, was incorporated and now operates as a wholly owned subsidiary of Fonix Corporation.  Fonix Speech provides value-added embedded speech technology development tools, applications and solutions for multiple market segments comprising mobile and wireless devices, video game consoles, electronic devices for the assistive and language learning markets, robots, appliances, automotive telematics, computer telephony and server applications.

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Original Equipment Manufacturers (“OEMs”) or Original Design Manufacturers (“ODMs”) of consumer electronics devices and products, software developers, wireless operators, telephony distributors, system integrators and value-added resellers (“VARs”) can simplify the use and increase the functionality of their electronic products and services by integrating Fonix speech interfaces, resulting in broader market opportunities and significant competitive advantages.  Fonix Speech development tools and solutions support multiple hardware and software platforms, are environment and speaker independent, optimize cost and power efficiencies, are easily integrated with relatively small memory requirements for embedded applications, and enhance scalability for high channel capacity for computer telephony and server-based systems.

Fonix Speech Market Focus

Fonix Speech delivers speech solutions in the following markets:

§ Electronic Devices

Fonix speech solutions make everyday life easier for people who are blind or have visual, vocal or mobility impairments, and for non-English speakers who are learning the English language.  FonixTalk® and  Fonix DECtalk®, recognized TTS technology for the assistive market, transforms ordinary text into highly intelligible speech.  Fonix VoiceIn™ is Fonix Speech’s proprietary neural network-based ASR technology.  Fonix Speech has taken its intuitive Core Technologies and applied them to everyday speech solutions for PCs and other consumer devices such as cordless phones, electronic dictionaries, MP3s and toys.

Fonix Speech Solutions for Electronic Devices

Fonix Speech offers a variety of speech solutions for the assistive and language learning markets.

o The Assistive Market

Fonix speech solutions make everyday life easier for people who are blind, have visual, vocal or mobility impairments or have learning disabilities.  Fonix DECtalk is the assistive industry’s premier text-to-speech engine, offering nine highly intelligible TTS voices and six languages.  Many users rely on Fonix DECtalk to read their email, the daily news or other documents, or to function as their voice to the outside world.  Current OEM partners in the assistive market include Dynavox, GW Micro, Prentke-Romich, Kurzweil Education Systems and Toby Churchill.

o PDA, PC and Electronic Devices

Fonix solutions apply speech interfaces to tasks that users perform everyday.  Many of these solutions are appropriate for multiple markets — assistive, mobile and wireless, and business and home users.  The Speech Products enable users to listen to documents, have email read aloud, access programs and launch applications with speech commands.  Historical partners include Microsoft, Intel, Hitachi, O2, Code Factory, Casio and HTC. Currently, the primary distribution of our Speech Products for electronic  devices is Apple through their iTunes AppStore for the iPhone 3G.

o The Language Learning Market – e.Dictionaries

Fonix Speech solutions are particularly useful for non-English speakers who are learning the language.  In the speech-enabled language learning (also known as “language acquisition” ) market, Fonix has capitalized on (i) FonixTalk and Fonix DECTalk’s small memory footprint and high intelligibility and (ii) Fonix VoiceIn’s high-recognition-rate capabilities.  Speech-enabled language learning is an emerging market, especially in Asia.  Multiple OEMs currently sell handheld electronic dictionaries in Japan and Korea that allow individuals to type a word in their native language (like Japanese) and have the word read or spoken back to them in English.  Non-English speakers can look up words in an English dictionary and have the device speak the word correctly in English.  Educational electronic dictionary devices are growing in popularity in Japan and are expected to exceed a market volume of more than 500,000 units per quarter.  Fonix Speech’s goal is to become the primary supplier of speech solutions for OEMs providing language learning devices and systems.  Fonix Speech has partnered with Epson and other chip manufacturers to provide an integrated solution including Fonix speech technology. Current OEMs marketing e.Dictionary devices featuring Fonix technology include Casio, Casio Soft, Canon, Huapu, Seiko Instruments, Inventec Besta, AOne Pro and Brilliant Systems.

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Speech applications are also becoming increasingly popular for day-to-day use.  Fonix Speech is working with OEM partners to capitalize on market opportunities for toys, appliances and other devices where speech applications may be applicable.  Fonix Speech has partnered with Epson to provide an integrated chip with Fonix speech technology to various OEMs manufacturing toys and appliances.

Fonix Speech’s primary competitors in the electronic device markets include Nuance, Voice Signal, Premier Assistive Technology and others.

§ Video Game Consoles

Fonix VoiceIn®Game Edition is Fonix Speech’s award-winning software solution for voice command and control in Xbox, Xbox 360, PlayStation2, PlayStation3 and PC video games.  We believe that Fonix VoiceIn is the industry’s most memory-efficient voice interface.  Game developers worldwide can now build games that utilize a common version across Xbox, Xbox 360, PlayStation2, PlayStation3 and PC platforms.  In 2006, Fonix added specialized tools for game developers including Fonix VoiceIn Karaoke Edition and Fonix VoiceIn Phonetic Edition. In 2008, Fonix completed Fonix VoiceIn 5.1 for the above referenced consoles and added Apple 3G.  Fonix VoiceIn is optimized for game development where memory and processing power are at a premium.

Fonix Speech Video Game Solutions

Fonix Speech’s voice command software is available for cross-platform game developers who wish to employ speech interfaces in videogames.  In March 2004, Fonix Speech made Fonix VoiceIn Game Edition commercially available to developers that produce videogames on multiple gaming platforms.  Fonix voice command technology has been available in the Microsoft Xbox developer’s kit (XDK) since February 2003.  In May 2005, Fonix announced a continuation of its agreement with Microsoft to deliver Fonix VoiceIn in the new Microsoft Xbox 360 developer’s kit.  Cross-platform game developers can use the same voice command software for PlayStation2, PlayStation3, PC games and Apple 3G.  Game developers worldwide can now build games that utilize a common application program interface across Xbox, Xbox 360, PlayStation2, PlayStation3, Apple 3G and PC platforms.  Fonix VoiceIn voice command software is available to game developers in multiple languages, including English and UK English, German, French, Spanish, Japanese and Italian.  Currently, Fonix VoiceIn is included on more than 20 video game titles on retail shelves.

Fonix Speech Video Game Market Opportunities

In the video games market, Fonix VoiceIn® Game Edition is a compelling feature for today’s game developers.  Gamers seek enhancements that add excitement, interaction and realism.  Fonix VoiceIn allows developers to take voice command and control to a new level.  The product gives players new access to games features, command and control functions and menu navigation.  Fonix expects this exciting new interface to expand market demand for videogames.  In November 2008 Ubisoft released Endwar on PS/3 and Xbox, and in March 2009 EndWar was released for the PC.  EndWar is a virtual video game that is played with FonixVoiceIn, a first-to-market video game that is played with voice commands.

Fonix VoiceIn Karaoke Edition is a new Fonix speech solution specifically designed for karaoke game developers. Fonix technology compares the timing, pitch and voice of the karaoke singer to the reference song and reports on the accuracy of the karaoke singing. Karaoke singers can better enjoy the experience, and improve future performances, by accurately measuring their talent against a professional song track.

Fonix VoiceIn Phonetic Edition is a new Fonix technology for videogame developers and animators. Fonix VoiceInPE speech technology aligns word phonetics with audio data, allowing animators to more precisely synchronize an animated characters’ facial movements with the phonetic components of speech. The technology utilizes input text to break down the phonetic components of words. The result is more realistic facial movement as animated characters “speak.”

Fonix Speech’s competitor in the video game market is primarily Nuance,  Fonix Speech’s partners also have competitors.  For example, Intel competes with IBM and Epson.  However, Fonix Speech is not precluded from working with its partners’ competitors.

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§ Mobile / Wireless

Fonix Speech provides embedded speech interface solutions for mobile phones, Smartphones, PDAs and wireless communication devices.  The award-winning Fonix VoiceDial™ is a totally interactive, hands-free software application that enables users to place calls and navigate device menus and applications simply by speaking.  Fonix VoiceCentral™ is a hands-free software application for Pocket PC that allows users to access Personal Information Management (“PIM”) tools, navigate through the device software, and access song and movie lists simply by speaking.  Fonix iSpeak™ is embedded on the Apple 3G phone and is sold through Apple’s iTunes App Store.  Fonix iSpeak is now available in English, Spanish, French, German and Italian.

Fonix Mobile/Wireless Solutions:

o Fonix VoiceDial

Fonix VoiceDialis a totally interactive, hands-free software application for Windows Mobile Pocket PC, Smartphone and Symbian devices that enables users to access mobile phone contacts simply by speaking.  VoiceDial is speaker independent, so no voice training is involved, including both contact names and digit dialing.  Fonix speech recognition is highly accurate, even in noisy environments like cars or airports.  VoiceDial offers several prompting voices; users choose which voices to download to their device.  All TTS voices are highly intelligible and will handle an unlimited vocabulary, even with difficult contact names.  VoiceDial is available in multiple languages — English, French, German and Spanish.  Current phones supported by Fonix VoiceDial include: Cingular (now AT&T Wireless) 2125, T-Mobile SDA, SDA II, Audiovox SMT 5600, i-mate SP3, i-mate SP3i, i-mate SP5, Motorola i930, Motorola MPx220, SPV C500, SPV C600, TSM 520, T-Mobile MDA, Cingular 8125, PPC 6700, Audiovox PPC 6600, i-mate PDA2k, i-mate JASJAR, i-mate K-JAM, MDA Pro, SPV M5000, and Qtek 9100.

o Fonix VoiceCentral

 Fonix VoiceCentral is a totally interactive, hands-free software application for Windows Mobile Pocket PC and Smartphone devices that enables users to access PIM tools, navigate through the device software and access song and movie lists simply by speaking.  VoiceCentral incorporates the award-winning Fonix VoiceDial software, while adding several other significant capabilities.  VoiceCentral allows users to manage email (listen to email, then choose to delete, reply with a .wav file or save); access calendar and tasks; launch or close any application simply by speaking; dial names directly from the contact list (users do not have to navigate multiple menu trees; they just say the name of the person they want to call); and dial a number directly using a continuous string of numbers.

o Fonix iSpeak

Fonix ISpeak is a voice dial application for the Apple 3G.  the user can voice command the phone dialing by stating the contact name or telephone number.  Fonix ISpeak is available in US Englsih, French, German, Spanish and Italian.

Fonix Mobile / Wireless Market Opportunities:

Fonix Speech’s partners, OEMs and ODMs provide significant potential to reach users in many market areas.  Fonix Speech has already seen significant market response to VoiceDial and expects to deliver in the following channels:

o OEMs & ODMs: The first Fonix VoiceDial contract delivered the solution on the Hewlett Packard (HP) Journada ® 928 WDA.  To date, VoiceDial has shipped with these additional devices: Hitachi G1000, i-mate PDA2k, T-Mobile MDA III and the O2 XDA IIs.  Fonix also has partnerships with Microsoft, Intel, Texas Instruments, Hitachi, O2 and HTC and is aggressively pursuing additional OEM opportunities with Nokia, Motorola, Sony-Ericsson, Siemens, Palm and Samsung.

o Mobile Operators: Fonix markets VoiceDial and VoiceCentral through mobile operators such as AT&T Wireless (formerly Cingular), T-Mobile, Orange, Vodafone and Verizon. VoiceDial can be delivered several ways, including loading software directly on the device or over-the-air activation.

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o Embedded Solutions: Other complementary solutions are also channels for distribution for the Speech Products. Companies like ALK CodeFactory have integrated Fonix Speech’s solutions into their applications.  Fonix Speech foresees partners shipping the full VoiceDial and VoiceCentral functionality as a complement to their applications and devices.  Fonix iSpeak is distributed through Apple iTunes AppStore.  Through the AppStore, the user downloads Fonix iSpeak which is embedded on the device.

Fonix Speech has several competitors offering a variety of speech technologies and products.  Companies like Nuance, Voice Signal and Neuvoice deliver speaker-dependent and speaker-independent solutions.  Other speech companies like IBM may introduce competitive products.

§ Customer Self-Service Solutions for Computer Telephony

Fonix ConnectMe™ is an innovative solution for computer telephony integration and server systems.  Fonix ConnectMe is a voice-automated telephone operator that provides anefficient, professional means of routing incoming, outgoing and internal calls.  Fonix also offers a voice interface solution for 511 system integrators.  511 is the designated three-digit phone number for national travel information within the United States.  Fonix ASR and TTS products are designed to give developers easy-to-use tools with which to build call center speech enabled solutions that lower costs and increase customer satisfaction.

Fonix Speech Customer Self-Service Solutions

Fonix Speech provides telephony and server-based solutions for automated phone directory and database information systems.  Fonix Speech believes that traditional operator systems and other means of accessing information are becoming antiquated.  Significant time is lost trying to access information through keypad directories or because calls are blocked after hours.  Also, information stored or transferred through servers, PBXs or databases may not easily be accessed through non-integrated platforms.  Voice-automated systems are capable of integrating these platforms and meeting customer expectations of competitive costs, easy installation with minimal change to their existing infrastructure and a simple user interface.

o Fonix ConnectMe

Fonix ConnectMe is a voice-automated telephone operator that provides an efficient, professional means of routing incoming, outgoing and internal calls.  Customers and employees dial one number, speak the name of a person or a department and are quickly connected to the person or department they want to reach.  Whether during peak business hours or late at night, ConnectMe’s 24-hour high-tech customer service capabilities ensure that all calls reach their intended destinations.  ConnectMe handles all incoming calls simultaneously, so callers are never put on hold.  Employees can create, maintain and access their own phone lists and can customize the delivery of calls.

o 511 Traffic Information System

In July 2000, the FCC assigned “511” as the number for nationwide access to traveler information. 511 was designated as a free service and when fully implemented will cover the majority of roads in the U.S., helping travelers avoid congested routes and safety hazards.  By dialing 5-1-1, callers can access information about route-specific weather and road conditions.  Fonix and partner Meridian Environmental Technology, Inc. provide a 511 system in North Dakota, South Dakota, Nebraska, Kansas and Montana.  Other states are scheduled to deploy the system in the near future.  Competition in the 511 market includes TellMe and IBM’s WebSphere.

Fonix Speech Customer Self-Service Market Opportunities

Fonix Speech is well positioned to be a primary competitor in telephony products with ConnectMe.  Benefits of ConnectMe include increased customer satisfaction, immediate ROI, user convenience, easy installation and maintenance, and its ability to bring a professional “voice” to companies’ telephone operator systems.  Fonix Speech’s market strategy is to sell ConnectMe through VARs and distributors.  Potential competitors in the telephony/server market include Nuance and Avaya.

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Fonix Speech Marketing and Sales Activities

Fonix Speech expects to expand sales through partners, OEMs, ODMs, VARs, direct sales and existing sales channels, both domestically and internationally.  Fonix Speech will focus on wireless and mobile devices, telephony and server phone solutions, assistive and language learning devices, the videogame market, robots and appliances.

To address global opportunities, Fonix Speech plans to develop and expand sales and marketing teams in Asia, Europe and the United States.  Fonix has partnered with companies like A.I. Corporation, a high-tech Japanese product distributor and engineering company specializing in embedded system software, to capitalize on sales and marketing efforts outside the United States.

Fonix Speech Strategic Relationships

Fonix Speech currently has a number of strategic collaboration, distribution and marketing arrangements with OEMs, software developers and VARs.  Fonix Speech intends to expand such relationships and add similar relationships, specifically in markets related to wireless and mobile devices, assistive and language learning devices and customer self-service solutions.  When Fonix Speech identifies “first mover” speech-enabling applications that can integrate Fonix Speech Products and Core Technologies, Fonix Speech intends to investigate investment opportunities to obtain preferred or priority collaboration rights.

Fonix Speech Continued Development

Fonix Speech plans to continue to invest resources in the development and acquisition of standard speech solutions and enhancements to its Core Technologies, developer tools and development frameworks to maintain competitive advantages.

Fonix Speech Platforms, Ports, and Processors

Fonix Speech supports multiple microprocessors ("Chips"); including Win32, WinCE, QNX, Linux, Solaris Palm, Apple OS 10+, Symbian Nokia Series 60 (operating systems).  Supported operating systems (“OSs”) (these are the chips) include: Analog Devices’ Blackfin, ARM 7, ARM 9, Epson S1C33 Family, Renesas, Intel, MIPS, Motorola, NeoMagic’s MiMagic3, MiMagic5, TI OMAP1510, Sun Sparc, FreeScale iMXL, Samsung S3C, FreeScale mCore and Power PC.

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

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RECENT DEVELOPMENTS

Exchange Agreement

In March 2009, the Company announced that it had closed a previously announced transaction whereby its subsidiary Fonix GS Acquisition Corporation, Inc. (“Fonix GS”) acquired 80% of the issued and outstanding shares of G-Soft Limited, a Hong Kong corporation (“G-Soft”), which is the ultimate parent of Shanghai Gaozhi Software Systems Limited ("GaozhiSoft"), a Chinese software developer and solutions provider in 2G (second-generation) and 3G (third-generation) mobile networks in China and throughout the Asian Pacific region.

In a Current Report filed with the SEC on August 12, 2008, the Company announced that it had formed Fonix GS for the purpose of acquiring the GaozhiSoft shares.

On June 27, 2008, the Company and Fonix GS entered into an exchange agreement (the “Exchange Agreement”), with Southridge LLC, a Connecticut limited liability company (“Southridge”), G-Soft and the shareholders of G-Soft (the “Sellers”).  G-Soft, through its wholly owned subsidiary, owns 100% of the outstanding equity of GaozhiSoft. Pursuant to the Exchange Agreement, Fonix GS agreed to purchase 80% of the issued and outstanding shares of G-Soft from the Sellers, and Southridge agreed to purchase the remaining 20% of the issued and outstanding G-Soft shares, thereby making Fonix GS and Southridge the ultimate shareholders of GaozhiSoft.

The Exchange Agreement was amended by that certain First Amendment to the Exchange Agreement, dated as of December 12, 2008 (the “First Amendment”), modifying the consideration for the purchase of the G-Soft shares and certain other closing conditions, as set forth therein.  Pursuant to the Exchange Agreement, as amended, in exchange for 20% of the outstanding shares of G-Soft, Southridge agreed to transfer shares of the Company’s Series L Convertible Preferred Stock (the “Series L Preferred Stock”) in the amounts set forth in the First Amendment.  In return for the purchase of 80% of the outstanding shares of G-Soft, the Company agreed to issue an aggregate of one hundred and twenty shares (120) of a new series of preferred stock (the “Series P Preferred Stock”) to the Sellers.  Additionally, subject to the terms of the First Amendment, the Sellers are entitled to annual earn-out payments equal to fifty percent (50%) of the prior year’s net income of GaozhiSoft, to be paid in the form of Series P Preferred Stock (the “Earn-Out Payments”).  The aggregate of the Earn-Out Payments is limited to three hundred and eighty (380) shares of Series P Preferred.  The First Amendment also amended and restated section 6.1 of the Exchange Agreement, relating to additional closing conditions, and section 8.2 of the original agreement relating to indemnification.

The Sellers and Fonix entered into an Escrow Agreement (the “Escrow Agreement”) with Adam L. Goldberg, whereby Mr. Goldberg agreed to act as escrow agent and hold the Series P Preferred Stock issued or issuable to the Sellers to purchase their interests in G-Soft.  The Escrow Agreement outlined Mr. Goldberg’s duties and obligations as Escrow Agent.

The First Amendment and the Escrow Agreement were described in more detail in, and attached as exhibits to, the Current Report on Form 8K, filed with the SEC on December 19, 2008.

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Additionally, Fonix GS and the Sellers entered into a side letter agreement, dated February 18, 2009 (the “Side Letter”), attached hereto as an exhibit, modifying certain closing conditions of the Exchange Agreement, as amended by the First Amendment.  The Side Letter establishes certain conditions regarding: (1) management and directorships of GaozhiSoft; (2) filing of certain administrative government documents in China; and (3) operations of GaozhiSoft.

The final closing conditions have been met, and the share exchange transaction closed as of March 27, 2009.

The foregoing summaries of the terms and conditions of the Exchange Agreement, First Amendment, Escrow Agreement and Side Letter do not purport to be complete and are qualified in their entirety by reference to the full text of the Exchange Agreement, First Amendment, Escrow Agreement and Side Letter, which were filed as exhibits to Current Reports previously filed with the SEC.

Issuance of Series P 9% Convertible Preferred Stock in G-Soft Transaction

As disclosed in a Current Report filed with the Commission on March 27, 2009, Fonix Corporation (the “Company”) issued an aggregate of one hundred and twenty shares (120) of the Company’s Series P 9% Convertible Preferred Stock (the “Series P Preferred Stock”) to G-Soft Limited, a Hong Kong corporation (“G-Soft”), which is the ultimate parent of Shanghai Gaozhi Software Systems Limited ("GaozhiSoft"), and the shareholders of G-Soft (collectively, the “Sellers”).  The Shares of Series P Preferred Stock were issued pursuant to an exchange agreement (the “Exchange Agreement”), with Southridge LLC, a Connecticut limited liability company (“Southridge”), and the Sellers.  Additionally, subject to the terms of the amended agreement with the Sellers, the Sellers are entitled to annual earn-out payments equal to fifty percent (50%) of the prior year’s net income of GaozhiSoft, to be paid in the form of Series P Preferred Stock (the “Earn-Out Payments”).  The aggregate of the Earn-Out Payments is limited to three hundred and eighty (380) shares of Series P Preferred, which were issued into an escrow account.

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

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

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

On September 26, 2008, the Company filed with the State of Delaware a Certificate of Designation and Series P 9% Convertible Stock Terms (the “Series P Terms”), which become a part of the Company’s Certificate of Incorporation, as amended.

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Under the G-Soft Agreement and the Series P Terms, the holders of the Series P Preferred Stock may convert shares of Series P Preferred Stock into shares of the Company’s common stock.  The Company’s issuances of shares of common stock upon any conversion of the Series P Preferred Stock will be made without registration under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.  The Company’s sale and issuance of the Series P Preferred Stock to the Sellers was made without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

Issuance of Shares of Series P 9% Convertible Preferred Stock to Acquire Remaining 20% of G-Soft

In connection with the G-Soft transaction described above, on March 27, 2009, the Company entered into a Series P Convertible Preferred Stock Purchase Agreement (the “Preferred Stock Purchase Agreement”), with Southridge Partners LP (“Southridge”).  Pursuant to the Preferred Stock Purchase Agreement, the Company issued 189 shares of Series P Preferred Stock in exchange for the 20% of G-Soft shares which Southridge had purchased in the G-Soft Transaction described above.

The Series P Preferred Stock issued to Southridge has the same terms as described above.

Under the Preferred Stock Purchase Agreement and the Series P Terms, Southridge may convert shares of Series P Preferred Stock into shares of the Company’s common stock.  The Company’s issuances of shares of common stock upon any conversion of the Series P Preferred Stock will be made without registration under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.  The Company’s sale and issuance of the Series P Preferred Stock to Southridge was made without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

The foregoing summaries of the terms and conditions of the Exchange Agreement and the Preferred Stock Purchase Agreement do not purport to be complete and are qualified in their entirety by reference to the full text of the Exchange Agreement and the Preferred Stock Purchase Agreement, filed previously with the Commission.

Reverse Stock Split

On December 19, 2008, Fonix Corporation (the “Company”) filed an amendment (the “Amendment”) to its Certificate of Incorporation, as amended to date, to provide for a reverse stock split (the “Reverse Split”) of the Company’s Class A common stock at a ratio of one new share for each 5,000 old shares, or one-for-5,000.  The Reverse Stock Split had previously been approved by the shareholders of the Company at the Company’s Annual Meeting on December 2, 2008.

The Amendment provided that the Reverse Stock Split would take effect on December 23, 2008.  However, due to scheduling issues between the Company’s transfer agent and FINRA, the effective date of the Reverse Stock Split was delayed.  The market effective date of the Reverse Stock Split will be as of the open of business on December 26, 2008.

Beginning December 26, 2008, Fonix's common stock trades under the symbol FNXC.

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 ITEM 1A.                           RISK FACTORS

The short- and long-term success of Fonix is subject to certain risks, many of which are substantial in nature and outside the control of Fonix.  You should consider carefully the following risk factors, in addition to other information contained herein.  When used in this Report, words such as “believes,” “expects,” “intends,” “plans,” “anticipates,” “estimates,” and similar expressions are intended to identify forward-looking statements, although there may be certain forward-looking statements not accompanied by such expressions.  Additionally, statements that relate to future business development, financial projections, capital raising, capital requirements, growth of markets or customer bases, or future business combinations may also include forward-looking statements.  You should understand that several factors govern whether any forward-looking statement contained herein will or can be achieved.  Any one of those factors could cause actual results to differ materially from those projected herein.  These forward-looking statements include plans and objectives of management for future operations, including the strategies, plans and objectives relating to the products and the future economic performance of Fonix and its subsidiaries discussed above.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of any such statement should not be regarded as a representation by Fonix or any other person that the objectives or plans of Fonix will be achieved.  Fonix disclaims any intention or obligation to update any forward-looking statement contained herein.

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

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

We had net loss of $6,169,000 for December 31, 2008, and net income of $14,959,000 for the year ended December 31, 2007 and a net loss of $21,943,000 for the year ended December 31, 2006, respectively. As of December 31, 2008, we had an accumulated deficit of $286,367,000, negative working capital of $44,471,000, derivative liabilities of $34,582,000 related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Series N Preferred Stock, Series O Preferred Stock, Series P Preferred Stock and Series B Preferred Stock of our subsidiary, accrued liabilities of $6,510,000, accounts payable of $1,801,000 and deferred revenues of $445,000.

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

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

As of December 31, 2008, we had debt obligations of $917,000, accrued liabilities of $6,510,000 and vendor accounts payable of approximately $1,801,000.  At present, our revenues from existing licensing arrangements and Speech Product sales are not sufficient to offset our ongoing operating expenses or to pay in full our current debt obligations.

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

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Holders of Fonix Class A common stock are subject to the risk of additional and substantial dilution to their interests as a result of the issuances of Class A common stock in connection with conversions of the outstanding series of preferred stock.

The following table describes the number of shares of Class A common stock that would be issuable, assuming that the full principal amount of the various series of preferred stock listed were converted into shares of our Class A common stock as of March 16, 2009 (irrespective of the availability of registered shares or conversion limitations imposed by the applicable certificates of designation), and further assuming that the applicable conversion price at the time of such put were the following amounts:

Hypothetical Conversion Price	Shares issuable upon Conversion of Series L Preferred Stock (1,494 shares outstanding)	Shares issuable upon Conversion of Series M Preferred Stock (150 shares outstanding)	Shares issuable upon Conversion of Series N Preferred Stock (1,755 shares outstanding)	Shares issuable upon Conversion of Series O Preferred Stock (730 shares outstanding)	Shares issuable upon Conversion of Series P Preferred Stock (1,305 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
$0.01	1,494,000,000	150,000,000	175,500,000	73,000,000	13,005,000,000	125,000,000	3,322,500,000
$0.02	747,000,000	75,000,000	87,750,000	36,500,000	652,500,000	62,500,000	1,661,250,000
$0.03	498,000,000	50,000,000	58,500,000	24,333,333	435,000,000	41,666,666	1,107,500,000
$0.05	298,800,000	30,000,000	35,100,000	14,600,000	261,000,000	25,000,000	664,500,000
$0.10	149,400,000	15,000,000	17,550,000	7,300,000	130,500,000	12,500,000	332,250,000
$0.20	74,700,000	7,500,000	8,775,000	3,650,000	65,250,000	6,250,000	166,125,000
$0.50	29,880,000	3,000,000	3,510,000	1,460,000	26,100,000	2,500,000	66,450,000

*           The Fonix Speech Series B Preferred Stock is convertible into shares of Fonix Corporation Class A common stock.

Given the formulas for calculating the shares to be issued in connection with conversions of the various series of preferred stock, there effectively is no limitation on the number of shares of Class A common stock which may be issued in connection with conversions of the outstanding shares of preferred stock, except for the number of shares available for issuance under the Company’s Certificate of Incorporation.  As such, shareholders are subject to the risk of substantial dilution to their interests as a result of our issuance of shares in connection with conversions of the series of preferred stock listed above.

We have no dividend history and have no intention to pay dividends in the foreseeable future.

We have never paid dividends on or in connection with any class of our common stock and do not intend to pay any dividends to common stockholders for the foreseeable future.

Competition from other industry participants and rapid technological change could impede our ability to achieve profitable operations.  Additionally, our current and potential competitors, some of whom have greater resources and experience than we do, may develop products and technologies that may cause a decline in demand for, and the prices of, our Speech Products.

The speech-enabled technologies market sector and telecommunications industry are characterized by rapid technological change.  Competition in the speech-enabled technologies market is based largely on marketing ability and resources, distribution channels, technology and product superiority and product service and support.  A number of companies have developed, or are expected to develop, products that compete with our Speech Products and Core Technologies.  Competitors in the speech technology software market include IBM, SpeechWorks International, Nuance, and VoiceSignal.  We expect additional competition from other companies, including Microsoft.  Furthermore, our competitors may combine with each other, and other companies may enter our markets by acquiring or entering into strategic relationships with our competitors.  Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to increase the abilities of their speech and language technology products to address the needs of our prospective customers.

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Many of our current and potential competitors have competitive advantages over us, including substantially greater financial, technical, personnel and other resources, including brand name recognition and long-standing relationships with customers.  These resources may place us at competitive disadvantage in our existing speech and telecommunications markets and may impair our ability to expand into new markets, which could adversely affect our business.  If we fail to grow rapidly or obtain additional capital we may not be able to compete with larger, more well established companies.  There can be no assurance that we will be able to successfully compete in our existing markets or in new markets.

We may incur a variety of costs to engage in future acquisitions of companies, products or technologies to grow our customer base, to expand into new markets, or to provide new services.  As such, the anticipated benefits of those acquisitions may never be realized.

We may acquire other businesses to grow our customer base, to expand into new markets, or to provide new services.  We may make acquisitions of, or significant investments in, complementary companies, products or technologies, although no additional material acquisitions or investments are currently pending.  Acquisitions may be accompanied by risks such as:

• difficulties in assimilating the operations and employees of acquired companies;

• diversion of our management's attention from ongoing business concerns;

• our potential inability to maximize our financial and strategic position through the successful incorporation of acquired technology and rights into our products and services;

• additional expense associated with amortization of acquired assets;

• additional expense associated with understanding and development of acquired business;

• maintenance and implementation of uniform standards, controls, procedures and policies; and

• impairment of existing relationships with employees, suppliers and customers as a result of the integration of new management employees.

We must attract and retain skilled personnel.  If we are unable to hire and retain technical, sales and marketing and operational employees, our business could be harmed.

Our ability to manage our growth will be particularly dependent on our ability to develop and retain an effective sales force and qualified technical and managerial personnel.  We intend to hire additional employees, including software engineers, sales and marketing employees and operational employees.  The competition for qualified sales, technical, and managerial personnel in the communications industry, as well as the speech technology industry, is intense, and we may not be able to hire and retain sufficient qualified personnel.  In addition, we may not be able to maintain the quality of our operations, control our costs, maintain compliance with all applicable regulations, and expand our internal management, technical, information and accounting systems in order to support our desired growth, which could have an adverse impact on our operations.

We are subject to the risk that certain key personnel, including key scientific employees named below, on whom we depend, in part, for our operations, will cease to be involved with us.

We are dependent on the knowledge, skill and expertise of several key scientific and business development employees, including Dale Lynn Shepherd and Ron Lowe; and executive officers, including Roger D. Dudley.  The loss of any of the key personnel listed above could materially and adversely affect our future business efforts.  Although we have taken reasonable steps to protect our intellectual property rights including obtaining non-competition and non-disclosure agreements from all of our employees and independent contractors, if one or more of our key scientific employees, executive employees or independent contractors resigns from Fonix to join a competitor, to the extent not prohibited by such person's non-competition and non-disclosure agreement, the loss of such personnel and the employment of such personnel by a competitor could have a material adverse effect on us.  We do not presently have any key man life insurance on any of our employees.

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As of the date of this Report, our board of directors consisted of one individual, and we had only one executive officer.  As such, management of the Company is consolidated in one individual.

On Wednesday, March 5, 2008, Thomas A. Murdock resigned as Chairman of the Board, President, and Chief Executive Officer of the Company.  Mr. Murdock also resigned all officer and director positions he held with Fonix Speech, Inc., Fonix/AcuVoice, Inc., Fonix/Papyrus Corporation, Fonix UK, Ltd., and Fonix Sales, Korea Group, Ltd., all subsidiaries of the Company.  Additionally, on Wednesday, March 5, 2008, William A. Maasberg resigned as director of the Company, although he continued to serve as our Chief Operating Officer until March 31, 2008.  In connection with the resignation of Messrs. Murdock and Maasberg, the Company appointed Roger D. Dudley, who was serving as the Company’s Executive Vice President and Chief Financial Officer, as the Company’s Chairman, President, and Chief Executive Officer.  Mr. Dudley will continue to serve as Chief Financial Officer.  Following the resignations of Messrs. Murdock and Maasberg, Mr. Dudley is the sole director of the Company.

Although our bylaws and Delaware corporate law permit the continuation of business with a sole director, this situation results in an absence of the typical checks and balances that are present where a board of directors consists of even two individuals.  Additionally, although we have in place controls and procedures relating to the operation of the Company, the positions of Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal accounting officer) are held by one individual, again resulting in the absence of checks and balances.  Such consolidation of management roles may also subvert certain of our operational controls and procedures.

An inability to market and develop additional services may adversely affect our ability to retain existing customers or attract new customers.

Through Fonix Speech, we offer speech technology solutions and products.  In order to address the future needs of our customers, we will be required to market and develop additional products and services.  We may not be able to continue to provide the range of speech products or telecommunication services that our customers need or desire.  We may lose some of our customers or be unable to attract new customers if we cannot offer the products and services our customers need or desire.

Our common stock is considered a penny stock.  Penny stocks are subject to special regulations, which may make them more difficult to trade on the open market.

Securities in the OTC market are generally more difficult to trade than those on the NASDAQ National Market, the NASDAQ SmallCap Market or the major stock exchanges.  In addition, accurate price quotations are also more difficult to obtain.  The trading market for our common stock is subject to special regulations governing the sale of penny stock.

A “penny stock” is defined by regulations of the Securities and Exchange Commission as an equity security with a market price of less than $5.00 per share.  The market price of our Class A common stock has been less than $5.00 for several years.

If you buy or sell a penny stock, these regulations require that you receive, prior to the transaction, a disclosure explaining the penny stock market and associated risks.  Furthermore, trading in our common stock would be subject to Rule 15g-9 of the Exchange Act, which relates to non-NASDAQ and non-exchange listed securities.  Under this rule, broker-dealers who recommend our securities to persons other than established customers and accredited investors must make a special written suitability determination for the purchaser and receive the purchaser's written agreement to a transaction prior to sale.  Securities are exempt from this rule if their market price is at least $5.00 per share.

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Penny stock regulations will tend to reduce market liquidity of our common stock, because they limit the broker-dealers' ability to trade, and a purchaser's ability to sell the stock in the secondary market.  The low price of our common stock will have a negative effect on the amount and percentage of transaction costs paid by individual shareholders.  The low price of our common stock may also limit our ability to raise additional capital by issuing additional shares.  There are several reasons for these effects.  First, the internal policies of many institutional investors prohibit the purchase of low-priced stocks.  Second, many brokerage houses do not permit low-priced stocks to be used as collateral for margin accounts or to be purchased on margin.  Third, some brokerage house policies and practices tend to discourage individual brokers from dealing in low-priced stocks.  Finally, broker's commissions on low-priced stocks usually represent a higher percentage of the stock price than commissions on higher priced stocks.  As a result, our shareholders will pay transaction costs that are a higher percentage of their total share value than if our share price were substantially higher.

We have a limited Speech Product offering, and many of our key technologies are still in the product development stage.

Presently, there are a limited number of commercially available Speech Products incorporating our Core Technologies.  For Fonix to be ultimately successful, sales from these Speech Products must be substantially greater.  An additional element of our business strategy is to achieve revenues through strategic alliances, co-development arrangements, and license arrangements with third parties.  For example, we have entered into licensing and joint-marketing agreements with Sony, Electronic Arts, Microsoft, Epson, Casio, Canon, Ubisoft, OC3, Harmonix, and others.  These agreements provide for joint marketing and application development for end-users or customers.  To date, these agreements have not produced significant revenues.  There can be no assurance that these collaboration agreements will produce license or other agreements which will generate significant revenues for us.

The market for many of our Core Technologies and Speech Products is largely unproven and may never develop sufficiently to allow us to capitalize on our Core Technology and Speech Products.

The market for speech-enabled Speech Products is rapidly evolving.  Additionally, our Speech Products are new and, in many instances, represent a significant departure from technologies which already have found a degree of acceptance in the speech-enabled technologies marketplace.  Our financial performance will depend, in part, on the future development, growth and ultimate size of the market for speech-enabled applications and Speech Products generally, and applications and products incorporating our Speech Products.  If the potential users of speech-enabled software in general and our products in particular do not perceive appropriate benefits, or if speech-enabled software platforms do not achieve commercial acceptance, our business could be harmed or even fail.

The Speech Products which incorporate our Core Technologies will be competing with more conventional means of information processing such as data entry, access by keyboard, mouse or touch-tone telephone.  We believe that there is a substantial potential market for applications and products incorporating advanced speech-enabled technologies.  Nevertheless, such a market for our Speech Products may never develop to the point that profitable operations can be achieved or sustained.

Our Speech Products may not achieve widespread acceptance by businesses or telecommunications carriers, which could limit our ability to grow our business.

Our ability to increase revenue in the future depends on the acceptance of speech-enabling products and applications by both our customers and end users.  The adoption and integration of speech-enabling products and applications could be hindered by the perceived costs of these new products and applications, as well as the reluctance of enterprises that have invested substantial resources in existing applications to replace their current systems with these new products and applications.  Accordingly, in order to achieve commercial acceptance, we will have to educate prospective customers, including large, established companies, about the uses and benefits of speech-enabling products and applications in general and our Speech Products in particular.  If these efforts fail, or if speech-enabling products and technology platforms do not achieve commercial acceptance, our business will not develop or may subsequently fail.

Continued development of the market for our Speech Products also will depend upon the following factors over which we have little or no control:

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• widespread deployment of speech-enabling applications by third parties, which is driven by consumer demand for services having a voice user interface;

• demand for new uses and applications of speech-enabling technology, including adoption of speech-enabled interfaces by companies that operate web sites;

• adoption of industry standards for speech-enabling and related technologies; and

• continuing improvements in hardware technology that may reduce the costs of speech-enabling technology solutions.

In many cases, the delivery of our Speech Products to end users is dependent upon third-party integration and may be subject to delays and cancellations that are beyond our control.

Generally, we are pursuing third-party integration of our Speech Products into mass market, general business, personal electronics products, and computing solutions.  Thus, lead time to revenue recognition will be longer than software products directly released into consumer channels.  Purchase of our Speech Products often requires a significant expenditure by a customer.  Accordingly, the decision to purchase our Speech Products typically requires significant pre-purchase evaluation.  We spend significant time educating and providing information to prospective customers regarding the use and benefits of our Speech Products.  During this evaluation period, we may expend substantial sales, marketing and management resources.

Further, our Speech Products sold and integrated into customer applications and products are subject to both customer production schedules and customer success in marketing their own products and generating product sales.  Our revenues are thus subject to delays and possible cancellation resulting from customer integration risks and delays.

In cases where our contract with our customers specifies milestones or acceptance criteria, we may not be able to recognize license or services revenue until these conditions are met.  We have in the past and may in the future experience unexpected delays in recognizing revenue.  Consequently, the length of our sales and implementation cycles and the varying order amounts for our Speech Products make it difficult to predict the quarter in which revenue recognition may occur and may cause license and services revenue and operating results to vary significantly from period to period.  These factors could cause our stock price to be volatile or to decline.

Our Speech Products can have a long sales cycle and, as a result, our quarterly operating results and our stock price may fluctuate.

The sales cycles for our Speech Products are generally six to twelve months but may be shorter or longer depending on the size and complexity of the order, the amount of services to be provided and whether the sale is made directly by us or indirectly through an OEM, VAR, or systems integrator.  The length of the sales cycles could adversely impact our operating results.

Our failure to respond to rapid change in the speech-enabled technologies market could cause us to lose revenue and could harm our business.

Our success will depend substantially upon our ability to enhance our existing Speech Products and to develop and introduce, on a timely and cost-effective basis, new technologies, Speech Products and features that meet changing end-user requirements and incorporate technological advancements.  If we are unable to develop new Speech Products and enhanced functionalities or technologies to adapt to these changes, or if we cannot offset a decline in revenue from existing Speech Products with sales of new Speech Products, our business will suffer.

Commercial acceptance of our Speech Products will depend, among other things, on:

• the ability of our Speech Products to meet and adapt to the needs of our target markets;

• the performance and price of our Speech Products and our competitors' products; and

• our ability to deliver customer services directly and through our resellers, VARs and OEM partners.

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In order to increase our international sales, we must increase the foreign language capacities of our Speech Products.  If we are unable to do so, we may be unable to grow our revenue and execute our business strategy.

We intend to expand our international sales, which requires a significant investment to create and refine different language models for each particular language or dialect.  These language models are required to create versions of products that allow end users to speak the local language or dialect and be understood.  If we fail to develop additional foreign language capacity of our Speech Products, our ability to benefit from international market opportunities and to grow our business will be limited.

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

Dependence on proprietary technology

Our success is heavily dependent upon our proprietary technology.  Certain elements of our Core Technologies are the subject of nine patents issued and allowed by the United States Patent and Trademark Office and seven other patent applications which are pending.  In addition to our patents, we rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights.  Such means of protecting our proprietary rights may not be adequate because such laws provide only limited protection.  Despite precautions that we take, it may be possible for unauthorized third parties to duplicate aspects of our technologies or the current or future products or technologies of our business units or to obtain and use information that we regard as proprietary.  Additionally, our competitors may independently develop similar or superior technology.  Policing unauthorized use of proprietary rights is difficult, and some international laws do not protect proprietary rights to the same extent as United States laws.  Litigation periodically may be necessary to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others.

Risks of our infringement upon the technology of unrelated parties or entities

We are not aware and do not believe that any of our technologies or products infringe the proprietary rights of third parties.  Nevertheless, third parties may claim infringement with respect to our current or future technologies or products or products manufactured by others and incorporating our technologies.  We expect that developers of speech-enabled technologies increasingly will be subject to infringement claims as the number of products and competitors in the industry grows and the functionality of products in different industry segments overlaps.  Responding to any such claims, whether or not they are found to have merit, could be time consuming, result in costly litigation, cause development delays, or require us to enter into royalty or license agreements.  Royalty or license agreements may not be available on acceptable terms or at all.  As a result, infringement claims could have a material adverse affect on our business, operating results, and financial condition.

There may be additional unknown risks, which could have a negative effect on our business.

The risks and uncertainties described in this section are not the only ones facing us.  Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.  If any of the foregoing risks actually occur, our business, financial condition, or results of operations could be materially adversely affected.

ITEM 2. PROPERTIES

We own no real property.  We lease approximately 3,900 square feet of office space in Lindon, Utah, where Fonix Speech conducts its principal scientific research, product development and sales and marketing activities.  Our lease of that facility expires April 30, 2013.  The average base monthly lease payment over the five-year life of the lease is $6,000.

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ITEM 3. LEGAL PROCEEDINGS

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.  On October 2, 2008, a judgment was entered against the Company in the amount of $28,050.

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

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

Annual Meeting of Shareholders

Annual Shareholder Meeting Results

On December 2, 2008, Fonix Corporation held its Annual Meeting of Shareholders in Salt Lake City, Utah.  The record date for the meeting was October 20, 2008, on which date there were 14,963,757,642 pre-split shares of our class A common stock outstanding.

The first matter voted upon at the meeting was the election of a director.  The following director was elected:

DIRECTOR	SHARES VOTED IN FAVOR	SHARES WITHHELD
Roger D. Dudley	7,679,501,871	1,211,813,436

The second matter voted upon at the meeting was the approval of the Board of Directors’ selection of Hansen, Barnett & Maxwell as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2008.  The results of the voting were 7,834,674,657 shares in favor, 582,334,490 shares against, and 474,306,159 shares abstaining.

The third matter voted upon at the meeting was the approval of an amendment to the Company’s Certificate of Incorporation to provide for a reverse stock split at one of the following ratios: 1-for-1,000; 1-for-2,500; 1-for-5,000; or 1-for-7,500.  The results of the voting were 5,394,860,190 common shares in favor, 3,450,924,914 shares against and 45,530,202 shares abstaining.  There were also an additional 39,500,000,000 votes from the holders of the Company’s Series O Preferred Stock, which was entitled to vote on this issue, which were voted in favor of this proposal.  By way of background, the Company’s Series O Preferred Stock granted its holders the right to vote on certain limited matters that could be proposed to the shareholders of the Company, including the proposed reverse stock split.  The Series O Preferred Stock certificate of designation provided that the holders of the Series O Preferred Stock would be entitled to that number of votes equal to the number of shares of common stock into which the preferred stock would be converted, multiplied by five.

The Company’s Board of Directors and management determined that it was in the best interest of the Company to implement a reverse stock split at a ratio of 1-for-5,000, or one (1) new share for each 5,000 old shares, which took effect in December 2008.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market information

Our Class A common stock is listed on the OTC Bulletin Board under the trading symbol FNIX.  The following table shows the range of high and low sales price information for our Class A common stock as quoted on the OTC Bulletin Board for the calendar years 2007 and 2008 and for the first quarter of 2009.  The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.  As noted above, in December 2008, we implemented a 1 for 5000 share reverse stock split.  The prices below have been adjusted to reflect the effect of the reverse split.

Calendar Year

	2009		2008		2007
	High	Low	High	Low	High	Low
First Quarter	$0.21	$0.026	$2.00	$0.50	$14.00	$6.50
Second Quarter			$1.50	$0.50	$12.50	$4.50
Third Quarter			$1.50	$0.50	$6.50	$2.00
Fourth Quarter			$1.00	$0.18	$8.00	$1.00

The high and low sales prices for our Class A common stock on March 31, 2009, were $0.085 and $0.07, respectively.  As of March 16, 2009, there were 5,818,536 shares of Fonix Class A common stock outstanding, held by approximately 1,400 holders of record and approximately 26,000 beneficial holders.  This number of beneficial holders represents an estimate of the number of actual holders of our stock, including beneficial owners of shares held in "nominee" or "street" name.  The actual number of beneficial owners is not known to us.

We have never declared any dividends on our Class A common stock and it is expected that earnings, if any, in future periods will be retained to further the development and sale of our Core Technologies and products.  No dividends can be paid on our common stock until such time as all accrued and unpaid dividends on our preferred stock have been paid.

Recent Sales of Unregistered Equity Securities

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

For the year ended December 31, 2008, we issued 705,696 shares of our Class A common stock upon conversion of 37 shares of our Series L Preferred Stock

Subsequent to December 31, 2008 and through March 16, 2009, we issued 1,078,393 shares of our Class A common stock upon conversion of 4 shares of our Series L Preferred Stock.

As of December 31, 2008, there were 1,498 shares of Series L Preferred Stock outstanding.

Series M Preferred Stock – On April 4, 2007, the Company entered into a Series M 9% Convertible Preferred Stock Exchange Agreement (the “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”).

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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 is the lower of (A) 80% of the average of the two (2) lowest closing bid prices for the twenty-day trading period prior to the conversion date, or (B) $0.004.

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

Under the Exchange Agreement and the Series M Terms, Sovereign or its assignees may convert shares of Series M Preferred Stock into shares of our common stock. The Company’s issuances of shares of common stock upon any conversion of the Series M Preferred Stock will be made without registration under the securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

During the year ended December 31, 2008 and through March 31, 2009 there were no conversions of Series M Preferred Stock.

As of December 31, 2008, there were 150 shares of Series M Preferred Stock outstanding.

Series N Preferred Stock – On August 24, 2007, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) by and among the Company, Trillium Partners, LP (“Trillium”), and other unnamed future investors relating to the purchase and sale of the Company’s Series N 9% Convertible Preferred Stock (the “Series N Preferred Stock”) in the amount of $2,400,000.

Pursuant to the Purchase Agreement, the Company agreed to sell up to 2,400 shares of the Preferred Stock at a per share price of $1,000, to the various investors.  The gross proceeds to the Company, if all shares of the Series N Preferred Stock are sold, will be $2,400,000.  Trillium purchased 1,755 shares between August 24, 2007 and December 31, 2008 of Preferred Stock pursuant to the Purchase Agreement, yielding gross proceeds to the Company of $1,755,000.  The Company anticipates that there will be additional sales to various investors of the Preferred Stock pursuant to the Purchase Agreement.

The shares of Preferred Stock are convertible into shares of the Company’s Class A common stock.  The shares may be converted into common stock of the Company at the option of the holder by using a conversion price which shall be eighty percent (80%) of the two (2) lowest closing bid prices over the twenty trading days prior to the conversion date.

The sale of the Preferred Stock was made without registration under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.  The Company’s issuances of shares of common stock upon any conversion of the Preferred Stock will be made without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

During the year ended December 31, 2008, there were no conversions of Series N Preferred Stock.  Subsequent to December 31, 2008 and through March 31, 2009, there were no conversions of our Series N Preferred Stock.

As of December 31, 2008, there were 1,755 shares of Series N Preferred Stock outstanding.

Series O Convertible Preferred Stock – Between January 25, 2008, and December 31, 2008, the Company received advances from three entities in connection with the purchase agreements related to the Company’s Series O 9% Convertible Preferred Stock (“Series O Preferred Stock”). On May 20, 2008, the Company entered into Securities Purchase Agreements with Southridge Partners LP, Southshore Capital Fund LTD, Sovereign Partners LP (collectively, the “Series O Purchasers”) for the sale of an aggregate of 730 shares of Series O Preferred Stock for gross proceeds of $730,000.  The material terms of the purchase agreements had been agreed upon prior to receipt of the advances.  Therefore, the Series O Preferred Stock was accounted for as discussed below on the dates cash proceeds were received by the Company.  The Company also began accruing dividends upon receiving the advances.

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

The shares of Preferred Stock are convertible into shares of the Company’s Class A common stock.  The shares may be converted into common stock of the Company at the option of the holder by using a conversion price which shall be eighty percent (80%) of the two (2) lowest closing bid prices over the twenty trading days prior to the conversion date.

The sale of the Preferred Stock was made without registration under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.  The Company’s issuances of shares of common stock upon any conversion of the Preferred Stock will be made without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

During the year ended December 31, 2008, there were no conversions of Series O Preferred Stock.  Subsequent to December 31, 2008 and through March 31, 2009, there were no conversions of our Series O Preferred Stock.

As of December 31, 2008, there were 730 shares of Series O Preferred Stock outstanding.

Series P Convertible Preferred Stock – On September 30, 2008, Fonix Corporation (the “Company”) entered into a Series P 9% Convertible Preferred Stock Exchange Agreement (the “Exchange Agreement”) with Sovereign Partners, LP (“Sovereign”), and McCormack Avenue Ltd. (“McCormack”).  Pursuant to the Exchange Agreement, Sovereign and McCormack exchanged certain debt obligations, discussed more fully below, for shares of the Company’s Series P 9% Convertible Preferred Stock (the “Series P Preferred Stock”).

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

The shares of Preferred Stock are convertible into shares of the Company’s Class A common stock.  The shares may be converted into common stock of the Company at the option of the holder by using a conversion price which shall be eighty percent (80%) of the two (2) lowest closing bid prices over the twenty trading days prior to the conversion date.

Redemption of the Series P Preferred Stock, whether at our option or that of the holder, requires us to pay, as a redemption price, the stated value of the outstanding shares of Series P 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 P were issued in exchange for certain outstanding debt obligations of the Company, we did not receive any proceeds in connection with the issuance of the Series P Preferred Stock to McCormack and Sovereign.

In connection with the issuance of the Series P Preferred Stock, on September 26, 2008, we filed with the State of Delaware a Certificate of Designation and Series P 9% Convertible Stock Terms (the “Series P Terms”), which become a part of our Certificate of Incorporation, as amended.

During the year ended December 31, 2008, there were no conversions of Series P Preferred Stock.  Subsequent to December 31, 2008 and through March 31, 2009, there were no conversions of our Series P Preferred Stock.

As of December 31, 2008, there were 1,305 shares of Series P Preferred Stock outstanding.

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Fonix Speech, Inc., Series B Convertible Preferred Stock – On April 4, 2007, the Company entered into a Securities Purchase Agreement (the “FSI Agreement”) by and among the Company, Fonix Speech, Inc. (“FSI”), and 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 “FSI Preferred Stock”), at a per share price of $10,000, to Sovereign. The gross proceeds to FSI were $1,250,000.

The shares of FSI Preferred Stock are convertible into shares of the Company’s Class A common stock. The FSI Preferred Stock may be converted into common stock of the Company at the option of the holder by using a conversion price which is the lower of (A) 80% of the average of the two (2) lowest closing bid prices for the twenty-day trading period prior to the conversion date, or (B) $0.004.

The Company’s issuances of shares of common stock upon any conversion of the FSI Series B Preferred Stock will be made without registration under the securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

During the year ended December 31, 2008, there were no conversions of FSI Series B Preferred Stock.  Subsequent to December 31, 2008, and through March 31, 2009, there were no conversions of FSI Series B Preferred Stock.

As of December 31, 2008, there were 125 shares of FSI Series B Preferred Stock outstanding.

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

THIS REPORT ON FORM 10-K CONTAINS, IN ADDITION TO HISTORICAL INFORMATION, FORWARD-LOOKING STATEMENTS THAT INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES.  ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS ANTICIPATED BY FONIX AND DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.  WHEN USED IN THIS ANNUAL REPORT, WORDS SUCH AS "BELIEVES," "EXPECTS," "INTENDS," "PLANS," "ANTICIPATES," "ESTIMATES," AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS, ALTHOUGH THERE MAY BE CERTAIN FORWARD-LOOKING STATEMENTS NOT ACCOMPANIED BY SUCH EXPRESSIONS.  ADDITIONALLY, STATEMENTS THAT RELATE TO THE FUTURE BUSINESS DEVELOPMENT, FINANCIAL PROJECTIONS, CAPITAL RAISING, CAPITAL REQUIRMENTS, GROWTH OF MARKETES OR CUSTOMER BASES, OR FUTURE BUSINESS COMBINATIONS MAY ALSO INCLUDE FORWARD-LOOKING STATEMENTS.FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES ARE DISCUSSED BELOW IN THE SECTION ENTITLED "INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS" AND UNDER THE HEADING "CERTAIN SIGNIFICANT RISK FACTORS," ABOVE.  FONIX CORPORATION SPECIFICALLY DISCLAIMS ANY OBLIGATION OR INTENTION TO UPDATE ANY FORWARD LOOKING STATEMENT.

The following Management’s discussion and Analysis of financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand Fonix Corporation, our operations and our present business environment.  MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes thereto contained in Item 8 of this report.  This overview summarizes MD&A, which includes the following sections:

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

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

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

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

We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements.  The discussion also provides information about the financial results of the various segments of our business to provide a better understanding of how those segments and their results affect the financial condition and results of operations of the Company as a whole.  This discussion should be read in conjunction with our financial statements as of December 31, 2008, and the year then ended and the notes accompanying those financial statements.

Overview

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

For the years ended December 31, 2008, 2007 and 2006, we generated revenues of $1,265,000, $1,838,000 and $1,329,000, respectively; with net loss of $6,169,000 in 2008, net income of $14,959,000 in 2007 and  net loss of $21,943,000 in 2006, and had negative cash flows from operating activities of $266,000, $2,312,000 and $4,048,000, respectively.  As of December 31, 2008,  we had an accumulated deficit of $286,367,000; negative working capital of $44,471,000; derivative liabilities of $34,582,000 related to the issuance of Series L Preferred Stock,  Series M Preferred Stock, Series N Preferred Stock, Series O Preferred Stock , Series P Preferred Stock and Series B Preferred Stock of our subsidiary; accrued liabilities of $6,510,000; accounts payable of $1,801,000; 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, 2009, primarily due to expenditure requirements associated with continued marketing and development of our speech-enabling technologies.

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

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

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Significant Accounting Policies

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

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

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

Goodwill – Goodwill represents the excess of the cost over the fair value of net assets of acquired businesses. Goodwill is not amortized, but is tested for impairment quarterly or when a triggering event occurs.  The testing for impairment requires the determination of the fair value of the asset or entity to which the goodwill relates (the reporting unit).  The fair value of a reporting  unit is determined based upon a weighting of the quoted market price of our common stock and present value techniques based upon estimated future cash flows of the reporting unit, considering future revenues, operating costs, the risk-adjusted discount rate and other factors.  Impairment is indicated if the fair value of the reporting unit is allocated to the assets and liabilities of that unit, with the excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities assigned to the fair value of goodwill.  The amount of impairment of goodwill is measured by the excess of the goodwill’s carrying value over its fair value.  At December 31, 2007, we tested the carrying value of goodwill and determined that it was fully impaired.

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

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

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

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

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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, 2008, consisted of the following:

Description	Criteria for Recognition	December 31, 2008
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.

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

Stock-Based Employee Compensation The Company has outstanding stock options to directors and employees, which are described more fully in Note 10.  The Company accounts for its stock options in accordance with Statements of Financial Standards 123R, Share-Based Payment (SFAS 123R). SFAS 123R requires the recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements and is measured based on the grant date fair value of the award. SFAS 123R also requires the stock option compensation expense to be recognized over the period during which an employee is required to provide service in exchange for the award (the vesting period).

The Company has not recognized any stock-based employee compensation expense for the years ended December 31, 2008, 2007, and 2006.

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

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

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

New Accounting Policies – In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement.” This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. We adopted SFAS No. 157 effective January 1, 2008 and the adoption did not have a significant effect on our consolidated results of operations, financial position or cash flows. In February 2008, the FASB issued FSP SFAS No. 157-2 which delays the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). We are currently evaluating the impact of the pending adoption in 2009 of SFAS No. 157 non-recurring fair value measures.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115,” effective on January 1, 2008, and permits companies to choose, at specified dates, to measure certain eligible financial instruments at fair value. The provisions of SFAS No. 159 apply only to entities that elect to use the fair value option and to all entities with available-for-sale and trading securities. At the effective date, companies may elect the fair value option for eligible items that exist at that date, and the effect of the first remeasurement to fair value must be reported as a cumulative-effect adjustment to the opening balance of retained earnings. The adoption of SFAS No. 159 has not had a material impact on the Company’s financial position or results of operations.

Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting and disclosure for uncertainty in tax positions. The Company has analyzed its filing positions in all jurisdictions where it is required to file income tax returns for the open tax years in such jurisdictions. The Company’s federal income tax returns for the years ended December 31, 2005 through 2007 remain subject to examination.  The Company currently believes that all significant filing positions are highly certain and that all of its significant income tax filing positions and deductions would be sustained upon audit. Therefore, the Company has no significant reserves for uncertain tax positions and no adjustments to such reserves were required upon adoption of FIN 48.  No interest or penalties have been levied against the Company and none are anticipated, therefore interest or penalty has been included in our provision for income taxes in the consolidated statements of operations.

Recent Accounting Pronouncements – In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133, which changes the disclosure requirements for derivative instruments and hedging activities. Enhanced disclosures are required to provide information about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement will require the additional disclosures described above.  The Company does not expect the adoption of SFAS 161 to have a material impact on its results of operations or financial condition.

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In April 2008, FASB issued FASB Staff Position SFAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP SFAS No. 142-3”). FSP SFAS No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognizable intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). The intent of FSP SFAS No. 142-3 is to improve the consistency between the useful life of a recognizable intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R), “Business Combinations” and other U.S. generally accepted accounting principles. FSP SFAS No. 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company does not anticipate that the adoption of FSP SFAS No. 142-3 will have an impact on its financial position or results of operations.

In November 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (FAS 160).  FAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity.  FASB 160 is effective for fiscal years beginning on or after December 15, 2008.  FASB 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests.  All other requirements of FAS 160 will be applied prospectively.  Early adoption is prohibited.  The Company does not anticipate that the adoption of FASB 160 will have an impact on its financial position or results of operations.

Results of Continued Operations

Fiscal Year 2008 Compared to 2007

During 2008, we recorded revenues of $1,265,000, a decrease of $573,000 from $1,838,000 in 2007.  The decrease was primarily due to decreased royalties of $506,000, decreased licensing revenue of $87,000, and decreased non-recurring engineering speech revenues of $20,000.

Cost of revenues was $54,000, a decrease of $87,000 from $141,000 in 2007.  The decrease is primarily due to the decreased costs of third-party royalty fees.

Selling, general and administrative expenses were $2,238,000 in 2008, a decrease of $241,000 from $2,479,000 in 2007.  The decrease is primarily due to decreased salary and wage expenses of $177,000, decreased other operating expense of $85,000, decreased occupancy related expenses of $41,000, decreased investor relations expenses of $38,000, decreased legal and accounting fees of $18,000, decreased taxes, licenses and permits of $13,000, decreased depreciation expenses of $9,000, partially offset by increased consulting expenses of $136,000, increased travel expenses of $2,000 and decreased promotions of $2,000.

We incurred research and product development expenses of $1,925,000 in 2008, an increase of $353,000 from $1,572,000 in 2007.  The increase was primarily due to an overall increase in salaries and wage-related expenses of $540,000, partially offset by decreased occupancy related expenses of $51,000, decreased consulting expenses of $51,000, decreased travel expenses of $37,000, decreased operating expenses of $31,000 and decreased depreciation expenses of $11,000.

Other income (expense) was a loss of $3,217,000 for 2008, an decrease of $23,161,000 from the gain of $19,944,000 for 2007.  The overall decrease was due to the gain on forgiveness of liabilities of $21,018,000 in 2007, primarily resulting from the bankruptcy of the discontinued subsidiaries of $20,819,000, and a loss on derivative liability of $512,000 in 2008, compared to the gain on derivative liability of $813,000 in 2007 and the increase in interest expense of $865,000.

Fiscal Year 2007 Compared to 2006

During 2007, we recorded revenues of $1,838,000, an increase of $509,000 from $1,329,000 in 2006.  The increase was primarily due to increased licensing revenue of $287,000, increased royalties of $324,000, partially offset by decreased non-recurring engineering speech revenues of $102,000.

Cost of revenues was $141,000, an increase of $123,000 from $18,000 in 2006.  The increase is primarily due to the increased costs of third party royalty fees.

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Selling, general and administrative expenses were $2,479,000 in 2007, a decrease of $2,877,000 from $5,356,000 in 2006.  The decrease is primarily due to the decreased bad debt expense of $1,214,000, decreased salary and wage expenses of $912,000, decreased other operating expense of $328,000, decreased legal and accounting fees of $213,000, decreased travel expenses of $206,000, decreased promotions of $27,000, decreased investor relations expenses of $23,000 and decreased depreciation expenses of $12,000 partially offset by increased occupancy related expenses of $43,000, increased taxes, licenses and permits of $10,000 and increased consulting expenses of $5,000.

We incurred research and product development expenses of $1,572,000 in 2007, a decrease of $571,000 from $2,143,000 in 2006.  The decrease was primarily due to an overall decrease in salaries and wage-related expenses of $489,000, decreased occupancy related expenses of $67,000, decreased travel expenses of $22,000, depreciation expenses of $15,000, partially offset by increased consulting expenses of $11,000 and increased other operating expenses of $11,000.

Other income (expense) was a gain of $19,944,000 for 2007, an increase of $24,452,000 from the expense of $4,508,000 for 2006.  The overall decrease was due to the gain on forgiveness of liabilities of $21,018,000, primarily resulting for the bankruptcy of the discontinued subsidiaries of $20,819,000, and a gain on derivative liability of $813,000 compared to the loss on derivative liability of $2,771,000, increased gain on forgiveness of liabilities of $199,000, partially offset by  an increase in interest expense of $150,000.

Selected Quarterly Operations Data

The following tables set forth selected unaudited statement of operations data for each of the quarters in the years ended December 31, 2008 and 2007.  This data has been derived from our unaudited financial statements that have been prepared on the same basis as the audited financial statements and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the information when read in connection with the financial statements and the related notes.  Our quarterly operating results have varied substantially in the past and may vary substantially in the future.  Conclusions about our future results for any period should not be drawn from the selected unaudited statement of operations data, either for any particular quarter or taken as a whole.

	For the Quarter Ended
	Mar 31, 2008			Jun 30, 2008			Sep 30, 2008			Dec 31, 2008
	(Unaudited)
Net sales	$	286,000		$	560,000		$	223,000		$	196,000
Gross profit		261,000			535,000			220,000			195,000
Net gain/loss from continuing operations		(1,046,000	)		(1,293,000	)		(1,701,000	)		(2,129,000	)
Preferred stock dividends		(578,000	)		(447,000	)		(466,000	)		(764,000	)
Net gain/loss attributable to common stockholders		(1,624,000	)		(1,740,000	)		(2,167,000	)		(2,893,000	)
Basic gain (loss) per common share	$	(1.68	)	$	(1.35	)	$	(0.85	)	$	(0.01	)
Diluted gain per common share		--			--			--			--

	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	$	(3.93	)	$	(3.81	)	$	(2.03	)	$	23.27
Diluted gain per common share		--			--			--		$	0.83

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Liquidity and Capital Resources

We must raise additional funds to be able to satisfy our cash requirements during the next 12 months.  It is anticipated that we will need to raise approximately $2 to $3 million over the next 12 months to meet obligations and continue our product development, corporate operations and marketing expenses.  Because we presently have only limited revenue from operations, we intend to continue to rely primarily on financing through the sale of our equity and debt securities to satisfy future capital requirements until such time as we are able to enter into additional third-party licensing, collaboration, or co-marketing arrangements such that we will be able to finance ongoing operations from license, royalty, and sales revenue.  We are working with game developers and other potential licensors of our speech product offerings to develop additional revenue streams for our speech technologies.  There can be no assurance that we will be able to enter into such agreements.  Furthermore, the issuance of equity or debt securities which are or may become convertible into equity securities of Fonix in connection with such financing could result in substantial additional dilution to the stockholders of Fonix.

Our cash resources are limited to collections from customers, proceeds from the issuance of preferred stock, and loan proceeds, and are only sufficient to cover current operating expenses and payments of current liabilities.  At December 31, 2008, we had negative working capital of $44,471,000; derivative liabilities of $34,582,000 related to the issuance of Series L Preferred Stock,  Series M Preferred Stock, Series N Preferred Stock,  Series O Preferred Stock, Series P Preferred Stock and Fonix Speech Series B Preferred Stock; accrued liabilities of $6,510,000; accounts payable of $1,801,000; and deferred revenues of $445,000.

We had $1,265,000 in revenue and net loss of $6,169,000 for the year ended December 31, 2008.  Net cash used in operating activities of $266,000 for the year ended December 31, 2008, resulted principally from the net loss incurred of $6,169,000,  partially offset by the non-cash accretion of the discount on notes payable of $2,124,000, increased other accrued liabilities of $1,663,000, issuance of shares for employee grants of $911,000, the loss on derivative liability of $512,000, increased accounts payable of $393,000, decreased prepaid expenses and other current assets of $194,000, decreased other assets of $96,000, and depreciation expense of $10,000.  Net cash used in investing activities was $20,000 for the year ended December 31, 2008.  Net cash provided by financing activities of $262,000 consisting primarily of the receipt of $730,000 in cash related to the sale of shares of Series O preferred stock and $72,000 in proceeds from related party notes, partially offset by payments on accrued settlement obligation of $540,000.

We had negative working capital of $44,471,000 at December 31, 2008, compared to negative working capital of $34,384,000 at December 31, 2007.  Current assets decreased by $85,000 to $2,000 from $87,000 from December 31, 2008, to December 31, 2007.  Current liabilities increased by $10,002,000 to $44,473,000 from $38,027,000 during the same period.  The change in working capital from December 31, 2007, to December 31, 2008, reflects, in part, the derivative related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Series N Preferred Stock,  Series O Preferred Stock , Series P Preferred Stock  and Fonix Speech Series B Preferred Stock; and increases in accrued liabilities and accounts payable, partially offset by decreases in accrued settlement obligation due to payments made during the year ended December 31, 2008.  Total assets were $40,000 at December 31, 2008, compared to $211,000 at December 31, 2007.

Notes Payable Related Parties

During 2002, two executive officers of the Company (the “Lenders”) sold shares of the Company’s Class A common stock owned by them and advanced the resulting proceeds amounting to $333,000 to the Company under the terms of a revolving line of credit and related promissory note.  The funds were advanced for use in Company operations.  The advances bear interest at 12 percent per annum, which interest is payable on a semi-annual basis.  The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, was originally due and payable on June 10, 2003.  The Company and the Lenders have agreed to postpone the maturity date on several occasions.  The note was due September 30, 2006.  All or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of the Company at any time.  The conversion price was the average closing bid price of the shares at the time of the advances.  To the extent the market price of the Company’s shares is below the conversion price at the time of conversion, the Lenders are entitled to receive additional shares equal to the gross dollar value received from the original sale of the shares.  A beneficial conversion option of $15,000 was recorded as interest expense in connection with this transaction.  The Lenders may also receive additional compensation as determined appropriate by the Board of Directors.

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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.  For the year ended December 31, 2007, the Company received additional advances of $102,000. For the year ended December 31, 2008, the Company received additional advances of $91,000 and made principal payments to the Lenders against the note of $19,000. The balance due at December 31, 2008, was $917,000.

The balance due of $917,000 is secured by the Company’s intellectual property rights and common stock of Fonix Speech.  For the year ended December 31, 2008, the Lenders converted $56,000 of the principal balance into 113,194 shares common stock, and also converted $111,000 of accrued interest into 146,426 shares of common stock for the benefit of one of the Lenders, Thomas A. Murdock, a former officer and director of the Company.

Notes Payable

In connection with the acquisition of the capital stock of LTEL Holdings in 2004, 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.

On September 8, 2006, the Company received a default notice (the “Default Notice”) from McCormack in respect of the Note  In the Default Notice, McCormack stated that it intended to exercise its rights, including any and all rights set forth in the Note, as amended.  McCormack has taken no action to collect amounts due under the Note.

During the fourth quarter of 2006, the Company entered into two promissory notes with McCormack Avenue, Ltd., 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.  These promissory notes were exchanged for shares of the Company’s Series P Preferred Stock.  See table below.

During the quarter ended March 31, 2007, the Company entered into five promissory notes with McCormack Avenue, Ltd. and Sovereign Partners LP., 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.  These promissory notes were exchanged for shares of the Company’s Series P Preferred Stock.  See table below.

On September 30, 2008, the Company entered into a Series P 9% Convertible Preferred Stock Exchange Agreement (the “Exchange Agreement”) with McCormack and Sovereign Partners, LP (“Sovereign”), whereby McCormack exchanged the Note, along with other promissory notes and the Series E debenture (discussed in Note 5), and Sovereign exchanged two promissory notes, for shares of the Company’s Series P 9% Convertible Preferred Stock (the Series P Preferred Stock”).  A table listing the obligations exchanged and the number of shares of Series P Preferred Stock issued is included below.

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Purchaser	Nature of Obligation Exchanged	Amount of Obligation Exchanged	Number of Series P Preferred Shares to be Issued
Sovereign Partners LP	Promissory Note, dated February 22, 2007, in the principal amount of $100,000, and interest of $16,278	$116,278	11.6278
Sovereign Partners LP	Promissory Note, dated March 13, 2007, in the principal amount of $100,000, and interest of $15,750	$115,750	11.575
McCormack Avenue, Ltd.	Promissory Note, dated January 11, 2007, in the principal amount of $50,000, and interest of $8,722	$58,722	5.8722
McCormack Avenue, Ltd.	Promissory Note, dated January 19, 2007, in the principal amount of $100,000, and interest of $17,222	$117,222	11.7222
McCormack Avenue, Ltd.	Promissory Note, dated January 26, 2007, in the principal amount of $100,000, and interest of $17,028	$117,028	11.7028
McCormack Avenue, Ltd.	Promissory Note, dated December 28, 2006, in the principal amount of $95,000, and 16,942	$111,942	11.1942
McCormack Avenue, Ltd.	Promissory Note, dated December 15, 2006, in the principal amount of $235,000, and interest of $42,701	$277,701	27.7701
McCormack Avenue, Ltd.	Note Payable, dated February, 2004, in the principal amount of $8,732,620, and interest of $1,311,105	$10,043,725	1,004.3725
McCormack Avenue, Ltd.	Series E Debenture, dated December 7, 2007, in the principal amount of $1,754,464, and interest of $291,763	$2,046,227	204.6227

Series D Debentures

On October 11, 2002, we issued $1,500,000 of Series D 12% Convertible Debentures (the "Debentures"), due April 9, 2003, and 194,444 shares of Class A common stock to Breckenridge Fund, LLC ("Breckenridge"), an unaffiliated third party, for $1,500,000 before offering costs of $118,000.  The outstanding principal amount of the Debentures was convertible at any time at the option of the holder into shares of our common stock at a conversion price equal to the average of the two lowest closing bid prices of our Class A common stock for the twenty trading days immediately preceding the conversion date, multiplied by 90%.

We determined that Breckenridge had received a beneficial conversion option on the date the Debentures were issued.  The net proceeds of $1,382,000, were allocated to the Debentures and to the Class A common stock based upon their relative fair values and resulted in allocating $524,000 to the Debentures, $571,000 to the related beneficial conversion option, $373,000 to the 194,444 shares of Class A common stock, less $86,000 of deferred loan costs.  The resulting $976,000 discount on the Debentures and the deferred loan costs were amortized over the term of the Debentures as interest expense.

The Debentures were originally due April 9, 2003.  However, Fonix and Breckenridge agreed in January 2003 to modify the terms of the Debentures requiring the following principal payments plus accrued interest: $400,000 in January 2003; $350,000 in February 2003; $250,000 in March 2003; $250,000 in April 2003; and $250,000 in May 2003.  Additionally, we agreed to release 237,584 of the Collateral Shares to Breckenridge as consideration (the "Released Shares") for revising the terms of the purchase agreement.  The additional shares were accounted for as an additional discount of $285,000.  The value of the shares was amortized over the modified term of the Debentures as interest expense.  We did not make the last three payments as scheduled.  Breckenridge asserted its rights under the Debenture agreement for penalties as we did not meet the prescribed payment schedule.  Breckenridge asserted a claim of $379,000 which we disputed.  Both parties subsequently agreed to satisfy the claim in full through the issuance of 1,550,000 shares of our Class A common stock with a value of $225,000.  We transferred the shares to Breckenridge on October 20, 2003, in full satisfaction of the claim and recorded the penalty as interest expense.

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In connection with the issuance of the Debentures, we entered into a registration rights agreement in which we agreed to register the resale of the shares underlying the Debentures, the Collateral Shares, and the Released Shares.  We filed a registration statement on Form S-2, which became effective February 14, 2003.  Additionally, we filed another registration statement on July 2, 2003, which was declared effective on July 7, 2003, which included shares issuable to Breckenridge in connection with the Debentures.  We were obligated to file such post-effective amendments as necessary to keep the registration statements effective as required by the registration rights agreement.

Through December 31, 2003, we had paid $650,000 of the outstanding principal, together with $54,000 in accrued interest.  Additionally, through December 31, 2003, the holder of the Debentures converted the remaining $850,000 principal amount and $41,000 in interest into 7,359,089 shares of Fonix Class A common stock.

As part of the Debenture agreement, we were required to pay Breckenridge a placement fee in the amount of $350,000 payable in stock at the conclusion of the Debenture.  We satisfied the obligation through the issuance of 2,000,000 shares of our Class A common stock valued at $358,000, or $0.179 per share and 377,717 shares of our Class A common stock valued at $59,000, or $0.157 per share.  We recorded the expense as interest expense.

In March 2004, we discovered that during 2003 an aggregate of 2,277,777 shares of Class A common stock (the "Unauthorized Shares") were improperly transferred to the Debenture holder as a result of (i) the unauthorized release from escrow of the Collateral Shares (net of the Released Shares), and (ii) the transfer to the Debenture holder of a duplicate certificate for 194,445 shares where the original certificate was not returned to the transfer agent for cancellation.  The Unauthorized Shares were, therefore, in excess of the shares the Debenture holder was entitled to receive.  No consideration was paid to or received by us for the Unauthorized Shares during 2003; therefore, we did not recognize the Unauthorized Shares as being validly issued during 2003.

Upon discovering in March 2004 that the Unauthorized Shares had been improperly transferred to the Debenture holder, we attempted to settle the matter with the Debenture holder but was unable to reach a settlement.  Accordingly, on May 3, 2004, we filed a lawsuit against the Debenture holder, alleging the improper transfer to and subsequent sale of the Unauthorized Shares by the Debenture holder.  The lawsuit was subsequently dismissed without prejudice and refiled on October 12, 2004.  The complaint sought (i) a declaratory judgment that we may set off the fair value of the Unauthorized Shares against the value we owed to the Debenture holder in connection with the Series I Preferred Stock transaction, (ii) judgment against the Debenture holder for the fair value of the Unauthorized Shares, and (iii) punitive damages from the Debenture holder for improper conversion of the Unauthorized Shares.

On September 27, 2005, we agreed with Breckenridge to settle and discontinue the three pending legal actions between us and 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 Company’s Series I 8% Convertible Preferred Stock (the “Series I Preferred”) by Breckenridge; and (iii) Breckenridge’s claims that the Company breached agreements in connection with the Series I Preferred, 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, we entered into a Mutual Release of Claims Agreement (the “Mutual Release”), pursuant to which we 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 us 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.  We agreed 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 we had previously paid into an escrow account in connection with the Breckenridge Lawsuits.

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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.

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 the full amount . No further obligations are required by the Company to Breckenridge.

Equity Lines of Credit

We have previously entered into several equity lines of credit with Queen, LLC (the “Equity Line Investor”).

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

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

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

For the year ended December 31, 2006, we received $3,378,000 in funds drawn under the Seventh Equity Line, less commissions and fees of $114,000.  We 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, we terminated the Seventh Equity Line, and we have withdrawn the third registration statement related to the Seventh Equity Line.  As such, as of the date of this report, we did not have an equity line of credit financing available to us.

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Stock Options and Warrants

During 2006, we granted options to purchase 12 shares of Class A common stock in addition to the option granted in connection with the option exchange program described above.  The options were granted at exercise price of $50.00.  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.

As of December 31, 2007, we had warrants to purchase a total of 3 shares of Class A common stock outstanding that expire through 2010.

For the year ended December 31, 2008, we granted no options to employees to purchase.  As of December 31, 2008, we had a total of 40 options to purchase Class A common stock outstanding.

Summary of Contractual Obligations

The following summary reflects payments due under long-term obligations as of December 31, 2008:

	Total		Less Than One		One to Three		Three to Five		More than Five
Notes payable	$	917,000	$	917,000	$	--	$	--		--
Operating lease obligations		299,000		71,000		150,000		78,000		--
Preferred stock dividends		8,900,000		1,780,000		3,560,000		3,560,000		**
Total contractual cash obligations	$	10,116,000	$	2,768,000	$	3,710,000	$	3,638,000

**  Preferred stock dividends do not have a definite life, therefore dividend payment requirements greater than five years cannot reasonably be estimated.

Other

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

Corporate Outlook

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

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

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

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As noted above, as of December 31, 2008, we had an accumulated deficit of $286,367,000, negative working capital of $44,471,000, derivative liabilities of $34,582,000 related to the issuance of Series L Preferred Stock, Series M Preferred Stock, Series N Preferred Stock, Series O Preferred Stock, , Series P Preferred Stock and Series B Preferred Stock of our subsidiary, accrued liabilities of $6,510,000, accounts payable of $1,801,000 deferred revenues of $445,000.  Sales of products and revenue from licenses based on our technologies have not been sufficient to finance ongoing operations.  These matters raise substantial doubt about our ability to continue as a going concern.  Our continued existence is dependent upon several factors, including our success in (1) increasing speech license, royalty and services revenues, (2) raising sufficient additional funding, and (3) minimizing operating costs.  Until sufficient revenues are generated from operating activities, we expected to continue to fund our operations through debt instruments.  We are currently pursuing additional sources of liquidity in the form of traditional commercial credit, asset based lending, or additional sales of our equity securities to finance our ongoing operations.  Additionally, we are pursuing other types of commercial and private financing, which could involve sales of our assets or sales of one or more operating divisions.  Our sales and financial condition have been adversely affected by our reduced credit availability and lack of access to alternate financing because of our significant ongoing losses and increasing liabilities and payables.  As we have noted in our previous annual reports and other public filings, if additional financing is not obtained in the near future, we will be required to more significantly curtail our operations or seek protection under bankruptcy laws.

Information Concerning Forward-Looking Statements

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

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

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

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

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

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

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

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

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

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

•               the extent to which we reduce outstanding debt.

ITEM 8.                 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements:

Report of Independent Registered Public Accounting Firm	F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 2008 and 2007	F-3
Consolidated Statements of Operations and Comprehensive Loss for the Years Ended
December 31, 2008, 2007 and 2006	F-4
Consolidated Statements of Stockholders’ Deficit for the Years Ended
December 31, 2006, 2007 and 2008	F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006	F-6
Notes to Consolidated Financial Statements	F-8

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

None.

ITEM 9A.              CONTROLS AND PROCEDURES

Management's Report on Internal Control Over Financial Reporting

        Our management, currently consisting of one individual, is responsible for establishing and maintaining effective internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or Rule 15d-(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, a company's principal executive officer and principal financial officer and effected by the company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that:

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  • pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

  • provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

  • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our Chief Executive Officer assessed the effectiveness of our internal control over financial reporting as of December 31, 2008. In making its assessment, he used the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on his assessment, management determined that, as of December 31, 2008, we maintained effective internal control over financial reporting based on those criteria.

Based on his assessment, our Chief Executive Officer determined that, as of December 31, 2008, our internal controls over financial reporting, based on those criteria, were not effective.  This was due to deficiencies that existed in the design or operation of our internal control over financial reporting, or the implementation and staffing of such controls and procedures, that adversely affected our internal controls and that may be considered to be material weaknesses.

The matters involving internal controls and procedures that the Company's management considered to be material weaknesses under COSO and SEC rules were:

(1)lack of segregation of duties, due to management being consolidated in one individual;

(2)lack of a functioning audit committee, resulting in ineffective oversight in the establishment and monitoring of required internal controls and procedures; and

(3)ineffective implementation of controls over period end financial disclosure and reporting processes, due in part to the consolidation of management in one individual.

The aforementioned material weaknesses were identified by the Company's Chief Executive Officer in connection with the preparation of our financial statements as of December 31, 2008.

The Company’s Chief Executive Officer believes that the material weaknesses set above did not have an effect on the Company's financial results. However, management believes that the lack of a functioning audit committee, resulting in ineffective oversight in the establishment and monitoring of required internal controls and procedures, can impact the Company's financial statements for the future years.

We are committed to improving our financial organization. As part of this commitment, and as resources permit, we intend to hire additional management personnel and to create positions to segregate duties consistent with control objectives and to increase our personnel resources and technical accounting expertise within the accounting function when funds are available to the Company, by: i) appointing one or more additional directors of our board of directors to an audit committee of the Company resulting in a fully functioning audit committee who will undertake the oversight in the establishment and monitoring of required internal controls and procedures; and ii) preparing and implementing sufficient written policies and checklists which will set forth procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements.

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Our Chief Executive Officer believes that the appointment of one or more additional directors to a fully functioning audit committee, will remedy the lack of a functioning audit committee. In addition, management believes that preparing and implementing sufficient written policies and checklists will remedy the following material weaknesses: (i) insufficient written policies and procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements; and (ii) ineffective controls over period end financial close and reporting processes. Further, management believes that the hiring of additional personnel, as well as additional executive officers, who have the technical expertise and knowledge will result proper segregation of duties and provide more checks and balances within the department. Additional personnel will also provide the cross training needed to support the Company if personnel turn over issues within the department occur. Our Chief Executive Officer believes that these steps, coupled with the appointment of additional directors, will greatly decrease any control and procedure weaknesses or deficiencies the Company may encounter in the future.

We will continue to monitor and evaluate the effectiveness of our internal controls and procedures and our internal controls over financial reporting on an ongoing basis and are committed to taking further action and implementing additional enhancements or improvements, as necessary and as funds allow.]

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

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

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

No Attestation Report.  This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the  Securities and Exchange Commission that permit the company to provide only management's report in this annual report.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

The following table sets forth certain information concerning the executive officers and directors of Fonix as of March 31, 2008:

Name	Age	Position
Roger D.  Dudley	57	Director, Chief Executive Officer & Chief Financial Officer

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

As noted elsewhere in this report, Thomas A. Murdock served as President, Chief Executive Officer, and Chairman of the Company during 2007 and through his resignation on March 5, 2008.

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As noted elsewhere in this Report, William A. Maasberg, Jr., served as a Director and Chief Operating Office of the Company during 2007 and through his resignation as a Director on March 5, 2008, and as Chief Operating Office on March 31, 2008.  Since the resignations of Mr. Murdock and Mr. Maasberg, Mr. Dudley has been the sole officer and director of the Company.

ROGER D.  DUDLEY is a co-founder of Fonix and has served as an executive officer and member of our board of directors since June 1994.  Mr. Dudley currently serves as the Company’s sole Director, chief executive officer and chief financial officer.  After several years at IBM in marketing and sales, he began his career in the investment banking industry.  He has extensive experience in corporate finance, equity and debt private placements and asset management.

Audit Committee Financial Expert

The Board of Directors has determined that we do not have an audit committee financial expert.  We have been seeking to add an individual with these qualifications to our Board of Directors but have been unable to find a suitable individual.  We continue to search for someone who meets the qualifications of an audit committee financial expert.

Compliance With Section 16(a) of the Exchange Act

Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who beneficially own more than 10% of a registered class of our equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission.  Officers, directors and greater than 10% shareholders are required by regulation of the Securities and Exchange Commission to furnish us with copies of all Section 16(a) forms which they file.  Based solely on its review of the copies of such forms furnished to us during the fiscal year ended December 31, 2008, we are aware of the following untimely filings:

Mr. Dudley filed a late Form 5.

Code of Ethics Disclosure

In March 2004, our Board of Directors adopted a Code of Ethics (the “Code”) that applies to it and our executive officers, including, among others, our chief executive officers and senior financial officers, as well as all of our employees at all levels, including our subsidiaries.  The Code is designed to deter wrongdoing and to matters of business ethics including, but not limited to:

• Business Ethics - The Code states that it is the policy of the Company that each employee should conduct his or her affairs with uncompromising honesty and integrity.

• Public Reports - The Code notes that Fonix is a public reporting company, and expresses the policy that any employee who has a responsibility for assisting in preparation of public reports or other public filings must assure that the information contained in the report or filing is complete, accurate, and true in every respect.

• Conflicts of Interest - The Code discusses possible situations of conflicts of interest, and requires that potential conflicts of interest be cleared through the Company's Audit Committee.

• The Code prohibits gifts, bribes, or kickbacks being given or received by Fonix employees.  Additionally, the Code prohibits: loans to officers or directors; improper use or theft of Company property; falsifying records; abuse of Company, customer, associate, or vendor information; gathering information regarding competitors of the Company; defamation or misstatements; and improper use of Company or third-party software.

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A copy of our Code of Ethics was an exhibit to the annual report filed for 2003.  Additionally, we undertake to provide to any person without charge, upon request, a copy of our Code of Ethics.  Such request may be made in writing to the Board of Directors at our address listed on the first page of this report.

ITEM 11.                      EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

The following is a discussion of the Company’s program for compensation of its named executive officers and directors.  During 2008, the compensation committee of the Board of Directors was responsible for determining the Company’s compensation program.  On March 5, 2008 Messrs. Murdock and Maasberg resigned as directors of the Company, and as such, Mr. Dudley, as the sole director during the period covered by this Report was responsible for the Company’s compensation program.

Compensation Program Objectives

The Company’s compensation program is designed to encompass several factors in determining the compensation of the Company’s named executive officers.  The following are the main objectives of the compensation program for the Company’s named executive officers:

-              Retain qualified officers.

- Provide overall corporate direction for the officers and also to provide direction that is specific to officer’s respective areas of authority.  The level of compensation amongst the officer group, in relation to one another, is also considered in order to maintain a high level of satisfaction within the leadership group. We consider the relationship that the officers maintain to be one of the most important elements of the leadership group.

-              Provide a performance incentive for the officers.

The Company’s compensation program is designed to reward the officers in the following areas:

-              achievement of specific goals;

-              professional education and development;

- creativity in the form of innovative ideas and analysis for new programs and projects;

-              new program implementation;

-              attainment of company goals, budgets, and objectives;

-              results oriented determination and organization;

-              positive and supportive direction for company personnel; and

-              community involvement.

As of the date of this Report, there were three principal elements of named executive officer compensation.  The Compensation Committee determines the portion of compensation allocated to each element for each individual named executive officer.  The discussions of compensation practices and policies are of historical practices and policies.  Our Compensation Committee is expected to continue these policies and practices, but will reevaluate the practices and policies as it considers advisable.

The elements of the compensation program include:

-           Base salary;

-           Stock options and stock awards;

-           Employee benefits in the form of:

-           health and dental insurance;

-           auto reimbursement

-           Other de minimis benefits.

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Base salary

Base salary is intended to provide competitive compensation for job performance and to attract and retain qualified named executive officers.  The base salary level is determined by considering several factors inherent in the market place such as: the size of the company; the prevailing salary levels for the particular office or position; prevailing salary levels in a given geographic locale; and the qualifications and experience of the named executive officer.

Stock options and stock awards

Stock ownership is provided to enable named executive officers and directors to participate in the success of the Company.  The direct or potential ownership of stock will also provide the incentive to expand the involvement of the named executive officer to include, and therefore be mindful of, the perspective of stockholders of the Company.

Employee benefits

Several of the employee benefits for the named executive officers are selected to provide security for the named executive officers.  Most notably, health insurance coverage is intended to provide a level of protection to that will enable the named executive officers to function without having the distraction of having to manage undue risk.  The health insurance also provides access to preventative medical care which will help the named executive officers function at a high energy level, to manage job related stress, and contribute to the overall well being of the named executive officers, all of which contribute to an enhanced job performance.

Other de minimis benefits

Other de minimis employee benefits such as cell phones and auto usage reimbursements are directly related to job functions but contain a personal use element which is considered to be a goodwill gesture that contributes to enhanced job performance.

As discussed above, the Compensation Committee determines the portion of compensation allocated to each element for each individual named executive officer.  As a general rule, base salary is competitively based while giving consideration to employee retention, qualifications, performance, and general market conditions.  Typically, stock options are based on the current market value of the option and how that will contribute to the overall compensation of the named executive officer.  Consideration is also given to the fact that the option has the potential for an appreciated future value.  As such this future value may in fact be the most significant factor of the option, but it is also more difficult to quantify as a benefit to the named executive officer.

Accordingly, in determining the compensation program for the Company, as well as setting the compensation for each named executive officer, the Compensation Committee of the Board of Directors attempts to attract the interest of the named executive officer within in the constraints of a compensation package that is fair and equitable to all parties involved.

EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

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 ($)
Roger D. Dudley   Executive vice President & Chief   Financial Officer (2)	2008	$ 309,400 (1)	--	--	$25,330	--	--	$ 5,742 (3)	$ 340,472

(1) Due to cash flow difficulties, Mr. Dudley was not paid his full contracted rate of $309,400 for 2008, but was paid $68,024.

(2) We have an executive employment agreement Mr.Dudley.  The expiration date is December 31, 2010.  The material terms of the executive employment agreement with Mr. Dudley are as follows: the annual base salary is $309,400 and may be adjusted upward in future years as deemed appropriate by the board of directors.

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

The executive employment agreement contains a non-disclosure, confidentiality, non-solicitation and non-competition clause.  Under the terms of the non-competition clause, Mr. Dudley has agreed that for a period of one year after termination of his employment

with us the executive will not engage in any capacity in a business which competes with or may compete with Fonix.

(3) These amounts relate to expenses paid by the Company for the use of automobiles for the named executive officer.

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GRANTS OF PLAN-BASED AWARDS

For Fiscal Year Ended December 31, 2008

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 (#)
Roger D. Dudley	N/A	--	--	--	--	--	--	--	--	--

For the year ended December 31, 2008, there were no grants of plan based awards.

OUTSTANDING EQUITY AWARDS AT FISCAL 2008 YEAR-END

	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 ($)
Roger D. Dudley	20	--	--	$200.00	2010	--	$19	--	--

This table lists the securities underlying unexercised options as of December 31, 2008, and related information.

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OPTION EXERCISES AND STOCK VESTED

For Fiscal Year Ended December 31, 2008

	Option Awards		Stock Awards
Name of Executive Officer	Number of Shares Acquired on Exercise (#)	Value Realized on Exercise ($)	Number of Shares Acquired on Vesting (#)	Value Realized on Vesting ($)
Roger D. Dudley	--	--	--	--

For the year ended December 31, 2008, there were no option exercises.

PENSION BENEFITS

For Fiscal Year Ended December 31, 2008

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

For the year ended December 31, 2008, there were no pension benefits paid.  We do not currently have a pension plan.

NONQUALIFIED DEFERRED COMPENSATION

For Fiscal Year Ended December 31, 2008

Name	Executive Contributions in Last FY ($)	Registrant Contributions in Last FY ($)	Aggregate Earnings in Last FY ($)	Aggregate Withdrawals/ Distributions ($)	Aggregate Balance at Last FYE ($)
Roger D. Dudley	--	--	--	--	--

For the year ended December 31, 2008, there was no non-qualified compensation.

DIRECTOR COMPENSATION

For Fiscal Year Ended December 31, 2008

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 ($)
Roger D. Dudley	--	--	--	--	--	--	--

For the year ended December 31, 2008, no compensation was paid to the directors for their service as directors.

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Board of Directors Meetings, Committees and Director Compensation

Our board of directors took action at 2 duly noticed meetings of the board during 2008.  Each director attended (in person or telephonically) all of the meetings of Fonix’s board of directors.  On March 5, 2008, Messrs. Murdock and Maasberg resigned as directors of the Company.  Because Mr. Dudley is the sole remaining director, as of the date of this Report the Company had no board committees.

Compensation of Directors

Prior to April 1996, our directors received no compensation for their service.  We historically have reimbursed our directors for actual expenses incurred in traveling to and participating in directors’ meetings, and we intend to continue that policy for the foreseeable future.  On March 30, 1996, our board of directors adopted, and our shareholders subsequently approved, our 1996 Directors’ Stock Option Plan (the “Directors’ Plan”).  Under the Directors’ Plan, members of the Board as constituted on the date of adoption received options to purchase 5,000 shares of our Class A common stock for each year (or any portion thereof consisting of at least six months) during which such persons had served on the board for each of fiscal years 1994 and 1995 and were granted 5,000 shares for each of fiscal years 1996 through 2002, which options vested after completion of at least six months’ service on the board during those fiscal years.  These options have terms of ten years.  No options were granted to our directors under the Directors’ Plan during 2008.  Similar grants have been made to our under our 1998 Stock Option Plan, as set forth elsewhere in this report.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth, as of March  16, 2009, the number of shares of Common Stock of Fonix beneficially owned by all persons known to be holders of more than five percent of our Common Stock and by the executive officers and directors of Fonix individually and as a group.    Unless indicated otherwise, the address of the stockholder is our principal executive offices, 387 South 520 West, Suite 110, Lindon, Utah 84042.

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	5,430,455(3)	48.79%
Thomas A.  Murdock (2) Former Chairman of the Board & Former Chief Executive Officer	1,328,049(4)	18.53%
Officer and Director as a Group (1 persons)	6,758,504	54.25%

(1)           Percentages rounded to nearest 1/100th of one percent.  Except as indicated in the footnotes below, each of the persons listed exercises sole voting and investment power over the shares of Common Stock listed for each such person in the table.

(2)           On March 5, 2008, Mr. Murdock resigned as the Company’s Chairman, President, and Chief Executive Officer.

(3)           Includes 8 shares of Common Stock deposited in a voting trust (the “Voting Trust”) as to which Mr. Dudley is the sole trustee and 5,292,926 shares of Common Stock issuable as of March 31, 2008, into the Voting Trust under a convertible promissory note (the “Convertible Note”) held by Mr. Murdock and Mr. Dudley.  Persons who have deposited their shares of Common Stock into the Voting Trust have dividend and liquidation rights (“Economic Rights”) in proportion to the number of shares of Common Stock they have deposited in the Voting Trust, but have no voting rights with respect to such shares.  All voting rights associated with the shares deposited into the Voting Trust are exercisable solely and exclusively by the Trustee of the Voting Trust.  The voting trust expires, unless extended according to its terms, upon the earlier to occur of (i)(a) the sale of all of the shares of common stock of the Company issued and issuable to the Shareholders upon conversion of the entire unpaid of the Note in accordance with the terms and conditions of the Note and the LOC Agreement; and (b) sale or distribution of the Shares Certificates to the Shareholders; or (ii)(a)the payment in full of the Note in accordance with the terms and conditions of the Note and the LOC Agreement; and (b) sale or distribution of the Shares Certificates to the Shareholders.  Although as the sole trustee of the Voting Trust Mr. Dudley exercises the voting rights of all of the shares deposited into the Voting Trust, and accordingly has listed all shares in the table above, he has no economic or pecuniary interest in any of the shares deposited into the Voting Trust except for 3,964,957 shares issuable as of March 16, 2009, under the Convertible Note as to which he will directly own Economic Rights when issued.  Also, (iv) includes 71 shares owned directly by Mr. Dudley, (v) options to purchase 20 shares of the Company’s Common Stock, and (vi) 4 shares held in the Voting Trust.

(4)           Includes (i) 1,328,049 common Stock issuable as of March 16, 2008, under the Convertible Note which will be deposited into the Voting Trust when issued,  (ii) 20 shares held in the Voting Trust.

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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	40	$800.00	3,887
Equity compensation plans not approved by shareholders	--	--	--
Total	40	$800.00	3,887

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

Loans from Senior Management to Company

During 2002, two of our executive officers (the “Lenders”) sold shares of our Class A common stock owned by them and advanced the resulting proceeds amounting to $333,000 to us under the terms of a revolving line of credit and related promissory note.  The funds were advanced for use in our operations.  The advances bear interest at 12 percent per annum, which interest is payable on a semi-annual basis.  The entire principal, along with unpaid accrued interest and any other unpaid charges or related fees, was originally due and payable on June 10, 2003.  Fonix and the Lenders have agreed to postpone the maturity date on several occasions.  The note was due September 30, 2006.  As of March 19, 2008, we had not made payment against the outstanding balance due on the note. All or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of Fonix at any time.  The conversion price was the average closing bid price of the shares at the time of the advances.  To the extent the market price of our shares is below the conversion price at the time of conversion, the Lenders are entitled to receive additional shares equal to the gross dollar value received from the original sale of the shares.  The Lenders may also receive additional compensation as determined appropriate by the Board of Directors.

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

During the fourth quarter of 2003, we made a principal payment of $26,000 against the outstanding balance of the promissory note.  During 2004, we entered into an agreement with the holders of the promissory note to increase the balance of the note payable by $300,000 in exchange for a release of the $1,443,000 of accrued liabilities related to prior indemnity agreements between us and the note holders.  We classified the release of $1,143,000 as a capital contribution in the Consolidated Financial Statements during the fourth quarter of 2004.  We made principal payments against the note of $253,000 during the year ended December 31, 2004.  During the year ended December 31, 2005, we received an additional advance of $50,000 under the note from the Lenders.  The balance due the Lenders at December 31, 2005 was $486,000.  For the year ended December 31, 2006 we 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.  For the year ended December 31, 2007, the Company received additional advances of $102,000. For the year ended December 31, 2008, the Company received additional advances of $72,000. The balance due at December 31, 2008, was $917,000.

47

The balance due of $940,000 is secured by the Company’s intellectual property rights and common stock of Fonix Speech.  For the year ended December 31, 2008, the Lenders converted $56,000 of the principal balance into 113,194 shares common stock, and also converted $111,000 of accrued interest into 96,425 shares of common stock for the benefit of one of the Lenders, Thomas A. Murdock, a former officer and director of the Company.

As of December 31, 2008, our director was not an “independent director” as he was employed by the Company as an executive officer, as discussed above.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

(1) AUDIT FEES

The aggregate fees billed for the fiscal years ended December 31, 2008 and 2007, for professional services rendered by Hansen Barnett & Maxwell P.C., for the audit of the registrant's annual financial statements and review of the financial statements included in the registrant's Form 10-Q or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for fiscal year 2007 and 2006 were $70,000 and $59,000, respectively.

(2) AUDIT-RELATED FEES

The aggregate fees billed for the fiscal year ended December 31, 2008 and 2007 for assurance and related services by Hansen Barnett & Maxwell P.C., that are reasonably related to the performance of the audit or review of the registrant's financial statements for fiscal year 2008 and 2007 were $0 and $0, respectively.

 (3) TAX FEES

The aggregate fees billed for each of the fiscal years ended December 31, 2008 and 2007, for professional services rendered by Hansen Barnett & Maxwell P.C. for tax compliance, tax advice, and tax planning, for those fiscal years were $1,000 and $1,000, respectively.  Services provided included preparation of federal and state income tax returns.

(4) ALL OTHER FEES

The aggregate fees billed in each of the fiscal years ended December 31, 2008 and 2007, for products and services provided by Hansen Barnett & Maxwell P.C. other than those services reported above, for those fiscal years were $0 and $10,000.  The other fees billed in 2007 related to Hansen Barnett & Maxwell’s participation in an audit of the Company’s 401K plan.  This participation was approved by the Board of Directors prior to commencement.  Hansen Barnett & Maxwell made no management decisions.

(5) AUDIT COMMITTEE POLICIES AND PROCEDURES

Not applicable.

(6) If greater than 50 percent, disclose the percentage of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees.

Not applicable.

48

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(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, 2008 and 2007

Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007 and 2006

Consolidated Statements of Stockholders’ Deficit for the Years Ended December 31, 2008, 2007 and 2006

Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006

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

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.

49

SIGNATURES

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

		Fonix Corporation
Date: April 15, 2009	By:	/s/  Roger D.  Dudley
		Roger D.  Dudley, President, Chief Executive Officer
		and Chief Financial Officer
		(Principal  Executive Officer, Principal Financial and Accounting Officer)

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

/s/  Roger D.  Dudley                                           

Roger D.  Dudley, Executive Vice President,

Chief Financial Officer, and Director

April 15, 2009

Date

50

FONIX CORPORATION AND SUBSIDIARIES

INDEX TO FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm	F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 2008 and 2007	F-3
Consolidated Statements of Operations and Comprehensive Loss for the Years Ended
December 31, 2008, 2007 and 2006	F-4
Consolidated Statements of Stockholders’ Deficit for the Years Ended
December 31, 2006, 2007 and 2008	F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006	F-6
Notes to Consolidated Financial Statements	F-8

F-1

HANSEN, BARNETT& MAXWELL, P.C.
A Professional Corporation	Registered with the Public Company
CERTIFIED PUBLIC ACCOUNTANTS	Accounting Oversight Board
5 Triad Center, Suite 750
Salt Lake City, UT 84180-1128
Phone: (801) 532-2200 Fax: (801) 532-7944
www.hbmcpas.com	A Member of the Forum of Firms

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and the Stockholders

Fonix Corporation

We have audited the accompanying consolidated balance sheets of Fonix Corporation and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations and comprehensive loss, stockholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, and audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fonix Corporation and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.  As discussed in Note 1 to the consolidated financial statements, the Company has incurred significant operating losses and negative cash flows from operating activities during each of the three years in the period ended December 31, 2008. As of December 31, 2008, the Company had an accumulated deficit of $286,367,000, and negative working capital of $44,471,000. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with respect to these matters are also described in Note 1. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

HANSEN, BARNETT & MAXWELL. P.C.

Salt Lake City, Utah

April 15, 2009

F-2

Fonix Corporation

CONSOLIDATED BALANCE SHEETS

	December 31,			December 31,
	2008			2007
ASSETS
Current assets
Cash and cash equivalents	$	2,000		$	26,000
Prepaid expenses and other current assets		-			61,000
Total current assets		2,000			87,000
Property and equipment, net of accumulated depreciation of $1,303,000 and $1,293,000, respectively		26,000			16,000
Deposits and other assets		12,000			108,000
Total assets	$	40,000		$	211,000
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Accrued liabilities	$	6,510,000		$	4,505,000
Accounts payable		1,801,000			1,532,000
Derivative liability		34,582,000			20,742,000
Accrued payroll and other compensation		211,000			211,000
Accrued settlement obligation		-			540,000
Deferred revenues		445,000			445,000
Notes payable - related parties		917,000			902,000
Series E debentures		-			1,754,000
Current portion of notes payable		-			3,833,000
Deposits and other		7,000			7,000
Total current liabilities		44,473,000			34,471,000
Long-term notes payable, net of current portion		-			3,556,000
Total liabilities		44,473,000			38,027,000
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; 1,498 shares and 1,535 shares outstanding , respectively		-			-
Common stock, $0.0001 par value; 20,000,000,000 shares authorized;
Class A voting, 3,447,501 shares and 857,423 shares outstanding, respectively		1,000			1,000
Class B non-voting, none outstanding		-			-
Additional paid-in capital		240,949,000			239,142,000
Outstanding warrants to purchase Class A common stock		474,000			474,000
Cumulative foreign currency translation adjustment		10,000			10,000
Accumulated deficit		(286,367,000	)		(277,943,000	)
Total stockholders' deficit		(44,433,000	)		(37,816,000	)
Total liabilities and stockholders' deficit	$	40,000		$	211,000

See accompanying notes to consolidated financial statements.

F-3

Fonix Corporation

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

	Years Ended December 31,
	2008			2007			2006
Revenues
Speech licenses, royalties and maintenance	$	1,265,000		$	1,838,000		$	1,329,000
Total Revenue		1,265,000			1,838,000			1,329,000
Cost of revenues
Speech licenses, royalties and maintenance		54,000			141,000			18,000
Total cost of revenues		54,000			141,000			18,000
Gross profit		1,211,000			1,697,000			1,311,000
Operating expenses:
Selling, general and administrative		2,238,000			2,479,000			5,356,000
Impairment of goodwill		-			2,631,000			-
Product development and research		1,925,000			1,572,000			2,143,000
Total operating expenses		4,163,000			6,682,000			7,499,000
Other income (expense):
Interest expense		(2,752,000	)		(1,887,000	)		(1,737,000	)
Gain (loss) on derivative liability		(512,000	)		813,000			(2,771,000	)
Gain on forgiveness of liabilities		47,000			21,018,000			-
Other income (expense), net		(3,217,000	)		19,944,000			(4,508,000	)
Income (loss) from continuing operations		(6,169,000	)		14,959,000			(10,696,000	)
Loss from discontinued operations		-			-			(11,247,000	)
Net income (loss)		(6,169,000	)		14,959,000			(21,943,000	)
Preferred stock dividends		(2,255,000	)		(1,702,000	)		(18,735,000	)
Income (loss) attributable to common stockholders	$	(8,424,000	)	$	13,257,000		$	(40,678,000	)
Basic income (loss) per common share from continuing operations	$	(3.02	)	$	30.94		$	(73.22	)
Basic and diluted income (loss) per common share from discontinued operations	$	-		$	-		$	(69.63	)
Diluted income per common share from continuing operations	$	-		$	0.66		$	-
Net income (loss)	$	(6,169,000	)	$	14,959,000		$	(21,943,000	)
Other comprehensive income - foreign currency translation		-			-			8,000
Comprehensive income (loss)	$	(6,169,000	)	$	14,959,000		$	(21,935,000	)

See accompanying notes to consolidated financial statements.

F-4

Fonix Corporation

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

YEARS ENDED DECEMBER 31, 2006, 2007 AND 2008

														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, 2005		170,026		$	5,859,000			78,586		$	1,000	$	228,943,000	$	474,000	$	18,000		$	(250,521,000	)	$	(15,226,000	)
Issuance of common stock under equity lines of credit		-			-			60,000			-		3,280,000		-		-			-			3,280,000
Shares issued for payment of dividends on Series H Preferred		-			-			568			-		65,000		-		-			-			65,000
Series J Preferred Stock beneficial conversion dividend		-			-			-			-		1,587,000		-		-			(1,587,000	)		-
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	)		3,006			-		266,000		-		-			-			-
Conversion of Series K Preferred into common stock		(1,093	)		(1,093,000	)		21,860			-		1,093,000		-		-			-			-
Conversion of Series L Preferred into common stock		(142	)		-			97,974			-		1,832,000		-		-			-			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			261,993		$	1,000	$	237,066,000	$	474,000	$	10,000		$	(291,200,000	)	$	(53,149,000	)
Shares issued in conection with investor relations		-			-			40,000			-		62,000		-		-			-			62,000
Conversion of Series L Preferred into common stock		(173	)		-			555,431			-		2,014,000		-		-			-			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			857,424		$	1,000	$	239,142,000	$	474,000	$	10,000		$	(277,943,000	)	$	(37,816,000	)
Shares issued to emploees		-			-			1,296,788			-		911,000		-		-			-			911,000
Shares issued in connection with payment on related-party note		-			-			259,620			-		167,000		-		-			-			167,000
Shares issued in conection with consulting services		-			-			145,225			-		133,000		-		-			-			133,000
Shares issued in conection with accrued legal expenses		-			-			124,941			-		125,000		-		-			-			125,000
Conversion of Series L Preferred into common stock		(37	)		-			705,696			-		400,000		-		-			-			400,000
Conversion of Series L Preferred dividends into common stock		-			-			140,617					71,000		-		-			-			71,000
Fractional shares canceled due to reverse stock split		-			-			(82,810	)						-		-			-			-
Dividend on Series L Preferred		-			-			-			-		-		-		-			(1,520,000	)		(1,520,000	)
Dividend on Series M Preferred		-			-			-			-		-		-		-			(137,000	)		(137,000	)
Dividend on Series N Preferred		-			-			-			-		-		-		-			(145,000	)		(145,000	)
Dividend on Series O Preferred		-			-			-			-		-		-		-			(40,000	)		(40,000	)
Dividend on Series P Preferred		-			-			-			-		-		-		-			(299,000	)		(299,000	)
Dividend on Series B Preferred		-			-			-			-		-		-		-			(114,000	)		(114,000	)
Net income for year ended December 31, 2008		-			-			-			-		-		-		-			(6,169,000	)		(6,169,000	)
BALANCE, DECEMBER 31, 2008		168,315		$	500,000			3,447,501		$	1,000	$	240,949,000	$	474,000	$	10,000		$	(286,367,000	)	$	(44,433,000	)

See accompanying notes to consolidated financial statements.

F-5

Fonix Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS

	2008			2007			2006
Cash flows from operating activities
Net income (loss)	$	(6,169,000	)	$	14,959,000		$	(21,943,000	)
Adjustments to reconcile net loss to net cash used in operating activities:
Discontinued operations		-			-			11,644,000
Gain (loss) on derivative liability		512,000			(813,000	)		2,772,000
Accretion of discount on notes payable		2,124,000			1,068,000			832,000
Issuance of shares for employee grants		911,000			-			-
Accretion of discount on legal settlement		-			-			117,000
Impairment of goodwill		-			2,631,000			-
Write down of intercompany receivable		-			-			1,214,000
Gain on forgiveness of liabilities		-			(21,018,000	)		-
Depreciation		10,000			32,000			58,000
Foreign exchange loss (gain)		-			-			(8,000	)
Changes in assets and liabilities
Funds held in escrow		-			-			-
Accounts receivable		-			-			1,000
Prepaid expenses and other current assets		194,000			5,000			135,000
Other assets		96,000			9,000			(93,000	)
Accounts payable		393,000			28,000			549,000
Accrued payroll and other compensation		-			(3,000	)		(9,000	)
Other accrued liabilities		1,663,000			805,000			689,000
Deferred revenues		-			(15,000	)		(6,000	)
Net cash used in operating activities		(266,000	)		(2,312,000	)		(4,048,000	)
Cash flows from investing activities
Purchase of property and equipment		(20,000	)		-			(12,000	)
Net cash used in investing activities		(20,000	)		-			(12,000	)
Cash flows from financing activities
Proceeds from issuance of Class A common stock, net		-			-			3,504,000
Proceeds from related party note payable		72,000			102,000			419,000
Proceeds from debentures		-			-			650,000
Proceeds from credit advance		-			-			75,000
Proceeds from Series B Preferred Stock		-			1,250,000			-
Proceeds from Series N Preferred Stock		-			1,350,000			-
Advance on Series N Preferred Stock		-			-			-
Proceeds from issuance of Series O Preferred Stock		730,000			-			-
Proceeds from issuance of Series B Preferred Stock		-			-			-
Proceeds from notes payable		-			450,000			330,000
Payments on accrued settlement obligation		(540,000	)		(819,000	)		(440,000	)
Payments on related party note payable		-			-			(105,000	)
Discontinued operations		-			-			(536,000	)
Net cash provided by financing activities		262,000			2,333,000			3,897,000
Net increase (decrease) in cash and cash equivalents		(24,000	)		21,000			(163,000	)
Cash and cash equivalents at beginning of period		26,000			5,000			168,000
Cash and cash equivalents at end of period	$	2,000		$	26,000		$	5,000

See accompanying notes to consolidated financial statements.

F-6

Fonix Corporation

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

	Years Ended December 31,
	2008		2007		2006
Supplemental Disclosure of Cash Flow Information
Cash paid during the year for interest	$	–	$	29,000	$	22,000
Cash paid during the year for income taxes		–		–		–

Supplemental Schedule of Non-cash Investing and Financing Activities

For the Year Ended December 31, 2008

Issued 705,696 shares of Class A common stock upon conversion of 37 shares of Series L Convertible Preferred Stock.

Issued  1,296,788 shares of Class A common stock for employee stock grants

Issued 124,941 shares of Class A common stock for unpaid legal fees.

Issued 145,225 shares of Class A common stock for consulting services.

Issued 140,671shares of Class A common stock upon conversion of $71,000 in accrued interest.

Issued 259,620 shares of Class A common stock upon conversion of $167,000 in notes payable – related parties.

Accrued $1,520,000 of dividends on Series L Preferred Stock.

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

Accrued $145,000 of dividends on Series N Preferred Stock.

Accrued $40,000 of dividends on Series O Preferred Stock.

Accrued $299,000 of dividends on Series P Preferred Stock.

Accrued $114,000 of dividends on Fonix Speech Series B Preferred Stock.

For the Year Ended December 31, 2007

Issued 555,431 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 3,006 shares of Class A common stock in conversion of 266 shares of Series J Convertible Preferred Stock.

Issued 21,860 shares of Class A common stock in conversion of 1,093 shares of Series K Convertible Preferred Stock.

Issued 568 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 97,974 shares of Class A common stock in conversion of 142 shares of Series L Preferred Stock.

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.

Reverse Stock Split- December 26, 2008 the Company effected a 1 for 5,000 reverse split of its common stock, which reduced its issued and outstanding shares from 17,651,553,852 to 3,447,501  The accompanying financial statements have been presented to retrospectively reflect this reverse stock split for all periods

Business Condition - For the years ended December 31, 2008, 2007 and 2006, we generated revenues of $1,265,000, $1,838,000 and $1,329,000, respectively; with net loss of $6,169,000 in 2008, net income of $14,959,000 in 2007 and  net loss of $21,943,000 in 2006, and had negative cash flows from operating activities of $266,000, $2,312,000 and $4,048,000, respectively.  As of December 31, 2008,  we had an accumulated deficit of $286,367,000, negative working capital of $44,471,000, derivative liabilities of $34,582,000 related to the issuance of Series L Preferred Stock,  Series M Preferred Stock, Series N Preferred Stock, Series O Preferred Stock, Series P Preferred Stock and Series B Preferred Stock of our subsidiary, accrued liabilities of $6,510,000, accounts payable of $1,801,000 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, 2009, primarily due to expenditure requirements associated with continued marketing and development of our speech-enabling technologies.

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.

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 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.

F-8

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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, 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.

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.

F-9

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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, 2008 and 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.

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.

Stock-Based Employee Compensation – The Company has outstanding stock options to directors and employees, which are described more fully in Note 10.  The Company accounts for its stock options in accordance with Statements of Financial Standards 123R, Share-Based Payment (SFAS 123R). SFAS 123R requires the recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements and is measured based on the grant date fair value of the award. SFAS 123R also requires the stock option compensation expense to be recognized over the period during which an employee is required to provide service in exchange for the award (the vesting period).

The Company has not recognized any stock-based employee compensation expense for the years ended December 31, 2008, 2007, and 2006.

F-10

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

Advertising Costs - Advertising costs are expensed when incurred.  Total advertising expense was $15,000, $13,000 and $40,000 for the years ended December 31, 2008, 2007 and 2006, 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, 2008, 2007 and 2006, there were outstanding common stock equivalents to purchase or receive 172,332,239, 19,642,337 and 1,129,549 and shares of common stock, respectively. At December 31, 2008, 166,710 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, 2008 and 2007 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.

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, 2008, 2007, and 2006:

	Years Ended December 31,
	2008				2007				2006
				Per				Per				Per
				Share				Share				Share
	Amount			Amount	Amount			Amount	Amount			Amount
Net income (loss) from continuing operations	$	(6,169,000	)		$	14,959,000			$	(10,696,000	)
Net loss from discontinued operations		-				-				(11,247,000	)		$ (73.22)
Net income (loss)	$	(6,169,000	)			14,959,000				(21,943,000	)
Preferred stock dividends		(2,255,000	)			(1,702,000	)			(18,735,000	)
Net income (loss) attributable to common stockholders	$	(8,424,000	)		$	13,257,000			$	(40,678,000	)
Basic weighted-average common shares outstanding		2,044,645		$ (4.12)		483,542		$ 27.42		153,615			$ (264.80)
Diluted weighted-average common shares outstanding		2,044,645		$ (4.12)		20,125,879		$0.66		153,615			$ (264.80)

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

Foreign Currency Translation - The functional currency of 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.

F-11

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

New Accounting Policies – In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement.” This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. We adopted SFAS No. 157 effective January 1, 2008 and the adoption did not have a significant effect on our consolidated results of operations, financial position or cash flows. In February 2008, the FASB issued FSP SFAS No. 157-2 which delays the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). We are currently evaluating the impact of the pending adoption in 2009 of SFAS No. 157 non-recurring fair value measures.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115,” effective on January 1, 2008, and permits companies to choose, at specified dates, to measure certain eligible financial instruments at fair value. The provisions of SFAS No. 159 apply only to entities that elect to use the fair value option and to all entities with available-for-sale and trading securities. At the effective date, companies may elect the fair value option for eligible items that exist at that date, and the effect of the first remeasurement to fair value must be reported as a cumulative-effect adjustment to the opening balance of retained earnings. The adoption of SFAS No. 159 has not had a material impact on the Company’s financial position or results of operations.

Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting and disclosure for uncertainty in tax positions. The Company has analyzed its filing positions in all jurisdictions where it is required to file income tax returns for the open tax years in such jurisdictions. The Company’s federal income tax returns for the years ended December 31, 2005 through 2007 remain subject to examination.  The Company currently believes that all significant filing positions are highly certain and that all of its significant income tax filing positions and deductions would be sustained upon audit. Therefore, the Company has no significant reserves for uncertain tax positions and no adjustments to such reserves were required upon adoption of FIN 48.  No interest or penalties have been levied against the Company and none are anticipated, therefore interest or penalty has been included in our provision for income taxes in the consolidated statements of operations.

Recent Accounting Pronouncements – In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133, which changes the disclosure requirements for derivative instruments and hedging activities. Enhanced disclosures are required to provide information about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement will require the additional disclosures described above.  The Company does not expect the adoption of SFAS 161 to have a material impact on its results of operations or financial condition.

In April 2008, FASB issued FASB Staff Position SFAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP SFAS No. 142-3”). FSP SFAS No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognizable intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). The intent of FSP SFAS No. 142-3 is to improve the consistency between the useful life of a recognizable intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R), “Business Combinations” and other U.S. generally accepted accounting principles. FSP SFAS No. 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The Company does not anticipate that the adoption of FSP SFAS No. 142-3 will have an impact on its financial position or results of operations.

F-12

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

In November 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (FAS 160).  FAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity.  FASB 160 is effective for fiscal years beginning on or after December 15, 2008.  FASB 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests.  All other requirements of FAS 160 will be applied prospectively.  Early adoption is prohibited.  The Company does not anticipate that the adoption of FASB 160 will have an impact on its financial position or results of operations.

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 $10,000, $32,000 and $58,000 for the years ended December 31, 2008, 2007, and 2006, respectively.  Property and equipment consisted of the following at December 31, 2008 and 2007:

	2008			2007
Computer equipment	$	990,000		$	980,000
Software		201,000			201,000
Furniture and fixtures		138,000			128,000
		1,329,000			1,309,000
Less accumulated depreciation and amortization		(1,303,000	)		(1,293,000	)
Net Property and Equipment	$	26,000		$	16,000

NOTE 3.  GOODWILL AND INTANGIBLE ASSETS

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 during 2007, which is reported in the accompanying 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 was 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.

F-13

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

On September 8, 2006, the Company received a default notice (the “Default Notice”) from McCormack in respect of the Note  In the Default Notice, McCormack stated that it intended to exercise its rights, including any and all rights set forth in the Note, as amended.  McCormack has taken no action to collect amounts due under the Note.

During the fourth quarter of 2006, the Company entered into two promissory notes with McCormack Avenue, Ltd., 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.  These promissory notes were exchanged for shares of the Company’s Series P Preferred Stock.  See table below.

During the quarter ended March 31, 2007, the Company entered into five promissory notes with McCormack Avenue, Ltd. and Sovereign Partners LP., 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.  These promissory notes were exchanged for shares of the Company’s Series P Preferred Stock.  See table below.

On September 30, 2008, the Company entered into a Series P 9% Convertible Preferred Stock Exchange Agreement (the “Exchange Agreement”) with McCormack and Sovereign Partners, LP (“Sovereign”), whereby McCormack exchanged the Note, along with other promissory notes and the Series E debenture (discussed in Note 6), and Sovereign exchanged two promissory notes, for shares of the Company’s Series P 9% Convertible Preferred Stock (the Series P Preferred Stock”).  The obligations exchanged and the number of shares of Series P Preferred Stock issued is as follows:

Purchaser	Nature of Obligation Exchanged	Amount of Obligation Exchanged	Number of Series P Preferred Shares Issued
Sovereign Partners LP	Promissory Note, dated February 22, 2007, in the principal amount of $100,000, and interest of $16,278	$116,278	11.6278
Sovereign Partners LP	Promissory Note, dated March 13, 2007, in the principal amount of $100,000, and interest of $15,750	$115,750	11.575
McCormack Avenue, Ltd.	Promissory Note, dated January 11, 2007, in the principal amount of $50,000, and interest of $8,722	$58,722	5.8722
McCormack Avenue, Ltd.	Promissory Note, dated January 19, 2007, in the principal amount of $100,000, and interest of $17,222	$117,222	11.7222
McCormack Avenue, Ltd.	Promissory Note, dated January 26, 2007, in the principal amount of $100,000, and interest of $17,028	$117,028	11.7028
McCormack Avenue, Ltd.	Promissory Note, dated December 28, 2006, in the principal amount of $95,000, and $16,942	$111,942	11.1942
McCormack Avenue, Ltd.	Promissory Note, dated December 15, 2006, in the principal amount of $235,000, and interest of $42,701	$277,701	27.7701
McCormack Avenue, Ltd.	Note Payable, dated February, 2004, in the principal amount of $8,732,620, and interest of $1,311,105	$10,043,725	1,004.3725
McCormack Avenue, Ltd.	Series E Debenture, dated December 7, 2007, in the principal amount of $1,754,464, and interest of $291,763	$2,046,227	204.6227

 

F-14

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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.  All or part of the outstanding balance and unpaid interest may be converted at the option of the Lenders into shares of Class A common stock of the Company at any time.  The conversion price was the average closing bid price of the shares at the time of the advances.  To the extent the market price of the Company’s shares is below the conversion price at the time of conversion, the Lenders are entitled to receive additional shares equal to the gross dollar value received from the original sale of the shares.  A beneficial conversion option of $15,000 was recorded as interest expense in connection with this transaction.  The Lenders may also receive additional compensation as determined appropriate by the Board of Directors.

During the year ended December 31, 2005, the Company received an additional advance of $50,000 against the promissory note.  The balance due at December 31, 2005 was $486,000.  During the year ended December 31, 2006, the Company received additional advances and other consideration from the Lenders in the aggregate amount of $419,000 and made principal payments to the Lenders against the note of $105,000.  For the year ended December 31, 2007, the Company received additional advances of $102,000. For the year ended December 31, 2008, the Company received additional advances of $91,000 and made principal payments to the Lenders against the note of $19,000. The balance due at December 31, 2008, was $917,000.

The balance due of $917,000 is secured by the Company’s intellectual property rights and common stock of Fonix Speech.  For the year ended December 31, 2008, the Lenders converted $56,000 of the principal balance into 113,194 shares common stock, and also converted $111,000 of accrued interest into 146,426 shares of common stock for the benefit of one of the Lenders, Thomas A. Murdock, a former officer and director of the Company.

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 “Debenture”) in the principal amount of $850,000.

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

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

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

F-15

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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

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

The McCormack Debenture was convertible into shares of the Company’s Class A common stock on the same terms as the Debenture.

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

This debenture was exchanged for shares of the Company’s Series P Preferred Stock.  See Note 4.

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, 2008, 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 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.

F-16

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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%).

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%).

F-17

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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.

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, 2008 and 2007 the fair value of the Series L Preferred Stock derivative liability was $15,838,000 and $16,148,000, respectively.

For the year ended December 31, 2006, the Company issued 97,974 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 555,431 shares of our Class A common stock in conversion of 173 shares of its Series L Preferred Stock. For the year ended December 31, 2008, the Company issued 705,696 shares of our Class A common stock in conversion of 37 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, 2008, 1,498 shares of Series L Preferred Stock remained outstanding.  Subsequent to December 31, 2008, the Company issued 1,294,393 shares of our Class A common stock in conversion of 4 shares of Series L Preferred Stock and accrued dividends.

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, 2008 and 2007, the fair value of the Series M Preferred Stock derivative liability was $1,542,000 and $1,577,000, respectively.

As of December 31, 2008, there were 150 shares of Series M Preferred Stock outstanding.

F-18

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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

Pursuant to the agreement, the Company agreed to issue up to 2,400 shares of its Series N 9% Convertible Preferred Stock (the “Series N Preferred Stock”) at a per share price of $1,000 to Trillium Partners, LP and other unnamed future investors, for gross proceeds of up to $2,400,000.  As of the date of this report, the Company had issued 1,755 shares of the Series N Preferred Stock, for cash proceeds of $1,755,000.

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, 2008 and 2007, the fair value of the Series N Preferred Stock derivative liability was $1,803,000 and $1,109,000, respectively.

As of December 31, 2008, there were 1,755 shares of Series N Preferred Stock outstanding.

Series O Convertible Preferred Stock – Between January 25, 2008, and December 31, 2008, the Company received advances from three entities in connection with the purchase agreements related to the Company’s Series O 9% Convertible Preferred Stock (“Series O Preferred Stock”). On May 20, 2008, the Company entered into Securities Purchase Agreements with Southridge Partners LP, Southshore Capital Fund LTD, Sovereign Partners LP (collectively, the “Series O Purchasers”) for the sale of an aggregate of 730 shares of Series O Preferred Stock for gross proceeds of $730,000.  The material terms of the purchase agreements had been agreed upon prior to receipt of the advances.  Therefore, the Series O Preferred Stock was accounted for as discussed below on the dates cash proceeds were received by the Company.  The Company also began accruing dividends upon receiving the advances.

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

F-19

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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

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

The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the redemption of $290,000 due to the value of the conversion feature of the Series O Preferred Stock. The liability was calculated using the Black-Scholes valuation model with the following assumptions: dividend yield of 0%, expected volatility of 128%, risk-free rate of 5.0% and expected life of 4 years. As the value of the derivative liability was greater than the face value of the Series O Preferred Stock, no value was prescribed to the Series O Preferred Stock. At December 31, 2008, the fair value of the Series O Preferred Stock derivative liability was $750,000.

As of December 31, 2008, there were 730 shares of Series O Preferred Stock outstanding.

Series P Convertible Preferred Stock – On September 30, 2008, Fonix Corporation (the “Company”) entered into a Series P 9% Convertible Preferred Stock Exchange Agreement (the “Exchange Agreement”) with Sovereign Partners, LP (“Sovereign”), and McCormack Avenue Ltd. (“McCormack”).  Pursuant to the Exchange Agreement, Sovereign and McCormack exchanged certain debt obligations, discussed more fully below, for shares of the Company’s Series P 9% Convertible Preferred Stock (the “Series P Preferred Stock”).

The Series P Preferred Stock entitles the holders to receive dividends in an amount equal to 9% of the then-outstanding balance of shares of Series P 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 P Preferred Stock may be converted into common stock of the Company at the option of the holder by using a conversion price which shall be 80% of the average of the two (2) lowest closing bid prices for the twenty-day trading period prior to the conversion date.

Redemption of the Series P Preferred Stock, whether at our option or that of the holder, requires us to pay, as a redemption price, the stated value of the outstanding shares of Series P 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 P were issued in exchange for certain outstanding debt obligations of the Company, we did not receive any proceeds in connection with the issuance of the Series P Preferred Stock to McCormack and Sovereign.

In connection with the issuance of the Series P Preferred Stock, on September 26, 2008, we filed with the State of Delaware a Certificate of Designation and Series P 9% Convertible Stock Terms (the “Series P Terms”), which become a part of our Certificate of Incorporation, as amended.

The Company followed the accounting treatment in SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” SFAS 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Company recognized a derivative liability upon the redemption of $290,000 due to the value of the conversion feature of the Series P 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 P Preferred Stock, no value was prescribed to the Series P Preferred Stock. At December 31, 2008, the fair value of the Series P Preferred Stock derivative liability was $13,365,000.

As of December 31, 2008, there were 1,305 shares of Series P Preferred Stock outstanding.

F-20

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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, 2008 and 2007, the fair value of the Series B Preferred Stock derivative liability was $1,285,000 and $1,314,000, respectively.

As of December 31, 2008, there were 125 shares of Series B Preferred Stock outstanding.

NOTE 8.  EQUITY LINES OF CREDIT

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

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

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

F-21

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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 60,000 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.

NOTE 9.  COMMON STOCK

Common Stock – As described elsewhere in this Annual Report, in December 2008 the Company implemented a 1 for 5000 share reverse stock split.  The share numbers in these notes have been adjusted to reflect the reverse stock split.  During 2008, the Company issued 2,672,887 shares of Class A common stock.  Of such shares, 1,296,788 shares were issued as employee stock grants, 259,620 shares were issued as payment on the related party note, 145,225 shares were issued for consulting services, 124,941 shares were issued as payment on legal expenses, 705,696 shares were issued in conversion of 37 shares of Series L Preferred Stock and 140,617 shares were issued as payment of accrued dividends of Series L Preferred Stock.

During 2007, the Company issued 595,431 shares of Class A common stock.  Of such shares, 555,431 shares were issued in conversion of 173 shares of Series L Preferred Stock and 40,000 shares were issued for consulting services.

During 2006, the Company issued 183,407 shares of Class A common stock.  Of such shares, 60,000 were issued in connection with draws on the Seventh Equity Line, 3,006 shares were issued in conversion of 266 shares of Series J Preferred Stock, 21,860 shares were issued in conversion of 1,093 shares of Series K Preferred Stock, 568 shares were issued in payment of dividends on Series H Preferred Stock and 97,974 shares were issued in conversion of 142 shares of Series L Preferred Stock.

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 50.  The Company subsequently determined that it had issued 51 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 50 to 110 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 110 to 4000.  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, 2008, there were 3,818 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 38.  As of December 31, 2008, there were 38 shares available for grant under this plan.

F-22

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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 27.  The plan provides that each director shall receive options to purchase 1 share 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, 2008, shares available for grant under this plan were 27.

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 5.  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, 2008, shares available for grant under this plan were 5.

During 2006, the Company granted options to purchase 12 shares of Class A common stock at exercise price $50.00.  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 2008 and2007, 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, 2008, 2007, and 2006, is presented below:

	2008					2007					2006
	Stock Options			Weighted Average Exercise Price		Stock Options			Weighted Average Exercise Price		Stock Options			Weighted Average Exercise Price
Outstanding at beginning of the year		75		$	500		182		$	650		266		$	660
Granted		-			-		-			-		12			50
Exercised		-			-		-			-		-			-
Forfeited		(35	)		750		(107	)		750		(96	)		650
Outstanding at end of the year		40			800		75			500		182			650
Exercisable at the end of the year		40		$	800		73		$	550		155		$	650

A summary of options outstanding and options exercisable under the Company’s various stock option plans at December 31, 2008, 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
$ 67 – 200	11	3.6 years	$    174	11	$    174
200 – 500	11	1.0 years	175	11	175
720 – 1,473	18	2.1 years	485	18	485

The weighted average fair value of options granted during the years ended December 31, 2006 were $50 per share.  The options outstanding at December 31, 2008 and December 31, 2007 had an aggregate intrinsic value of zero.

F-23

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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:

	2006
Risk-free interest rate	3.75%
Expected dividend yield	0.0%
Expected exercise lives	5 years
Expected volatility	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, 2008, 2007, and 2006, is presented below:

	2008				2007				2006
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price		Shares			Weighted Average Exercise Price
Outstanding at beginning of the year		3	$	200,000		3	$	200,000		196		$	550
Granted		—		—		—		—		—			—
Forfeited		—		—		—		—		(193	)		2,550
Outstanding at end of the year		3		200,000		3		200,000		3			200,000
Exercisable at end of the year		3		200,000		3		200,000		3			200,000

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 2008, 2007 and 2006, the Company incurred expenses of approximately $254,000, $207,000 and $368,000 respectively, to the law firm for services provided to the Company.

NOTE 12.  INCOME TAXES

At December 31, 2008 and 2007, net deferred income tax assets, before considering the valuation allowance, totaled $61,032,000 and $58,731,000, 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 and increase of $2,301,000 for 2008, a decrease of $5,582,000 for 2007 and an increase of $8,187,000 for 2006.

At December 31, 2008, the Company has unused federal net operating loss carryforwards available of approximately $150,494,000 and unused state net operating loss carryforwards of approximately $141,774,000 which may be applied against future taxable income, if any, and which expire in various years from 2011 through 2028.  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-24

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, 2008 and 2007 are as follows:

Deferred income tax assets:	2008			2007
Net operating loss carryforwards:
Federal	$	51,167,904		$	48,614,944
State		4,678,537			4,430,748
Research expenditures credits		2,537,005			2,487,000
Accrued liabilities		117,049			86,000
Deferred revenues		166,133			172,000
Amortization of intangible assets		2,365,295			2,437,000
Total deferred income tax assets		61,031,923			64,313,000
Valuation allowance		(61,031,923	)		(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,
	2008			2007			2006
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		(37.3	)		(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, 2008, 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.

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.

F-25

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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, 2008, were as follows:

Year ending December 31,
2009	$	71,000
2010		74,000
2011		76,000
	$	221,000

The Company incurred rental expense of $275,000, $382,000, $350,000 during 2008, 2007 and 2006, respectively, related to these leases.

Forgiveness of Trade Payables and Accrued Interest - The Company negotiated reductions in amounts due various trade vendors amounting to $0, $199,000 and $0 during 2008, 2007 and 2006, respectively.

NOTE 14.  LITIGATION

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.  On October 2, 2008, a judgment was entered against the Company in the amount of $28,050.

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.

F-26

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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, 2008, 2007 and 2006 were:

	2008				2007				2006
United States	$	635,000	50	%	$	913,000	50	%	$	546,000	41	%
Asia Pacific		508,000	40	%		830,000	45	%		591,000	44	%
Other		122,000	10	%		95,000	5	%		192,000	15	%
	$	1,265,000			$	1,838,000			$	1,329,000

For the year ended December 31, 2008 no one customer accounted for more than 10% of total revenue.  For the year ended December 31, 2007, four customers accounted for 20% of total revenues, 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.

NOTE 17.  SUBSEQUENT EVENTS

Subsequent to December 31, 2008, the Company has issued 1,078,393 shares of its Class A common stock in conversion of 4 shares of Series L Preferred Stock.

Subsequent to December 31, 2008, the Company has issued 216,000 shares of its Class A common stock in payment of accrued dividends on the Series L Preferred Stock.

Through December 31, 2008, the Company has issued 909,621shares of its Class A common stock in conversion of principle on the related party note.

Through December 31, 2008, the Company has issued 167,089 shares of its Class A common stock in conversion of interest on the related party note.

Exchange Agreement

In March 2009, the Company announced that it had closed a previously announced transaction whereby its subsidiary Fonix GS Acquisition Corporation, Inc. (“Fonix GS”) acquired 80% of the issued and outstanding shares of G-Soft Limited, a Hong Kong corporation (“G-Soft”), which is the ultimate parent of Shanghai Gaozhi Software Systems Limited ("GaozhiSoft"), a Chinese software developer and solutions provider in 2G (second-generation) and 3G (third-generation) mobile networks in China and throughout the Asian Pacific region.

In a Current Report filed with the SEC on August 12, 2008, the Company announced that it had formed Fonix GS for the purpose of acquiring the GaozhiSoft shares.

On June 27, 2008, the Company and Fonix GS entered into an exchange agreement (the “Exchange Agreement”), with Southridge LLC, a Connecticut limited liability company (“Southridge”), G-Soft and the shareholders of G-Soft (the “Sellers”).  G-Soft, through its wholly owned subsidiary, owns 100% of the outstanding equity of GaozhiSoft. Pursuant to the Exchange Agreement, Fonix GS agreed to purchase 80% of the issued and outstanding shares of G-Soft from the Sellers, and Southridge agreed to purchase the remaining 20% of the issued and outstanding G-Soft shares, thereby making Fonix GS and Southridge the ultimate shareholders of GaozhiSoft.

F-27

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

The Exchange Agreement was amended by that certain First Amendment to the Exchange Agreement, dated as of December 12, 2008 (the “First Amendment”), modifying the consideration for the purchase of the G-Soft shares and certain other closing conditions, as set forth therein.  Pursuant to the Exchange Agreement, as amended, in exchange for 20% of the outstanding shares of G-Soft, Southridge agreed to transfer shares of the Company’s Series L Convertible Preferred Stock (the “Series L Preferred Stock”) in the amounts set forth in the First Amendment.  In return for the purchase of 80% of the outstanding shares of G-Soft, the Company agreed to issue an aggregate of one hundred and twenty shares (120) of a new series of preferred stock (the “Series P Preferred Stock”) to the Sellers.  Additionally, subject to the terms of the First Amendment, the Sellers are entitled to annual earn-out payments equal to fifty percent (50%) of the prior year’s net income of GaozhiSoft, to be paid in the form of Series P Preferred Stock (the “Earn-Out Payments”).  The aggregate of the Earn-Out Payments is limited to three hundred and eighty (380) shares of Series P Preferred.  The First Amendment also amended and restated section 6.1 of the Exchange Agreement, relating to additional closing conditions, and section 8.2 of the original agreement relating to indemnification.

The Sellers and Fonix entered into an Escrow Agreement (the “Escrow Agreement”) with Adam L. Goldberg, whereby Mr. Goldberg agreed to act as escrow agent and hold the Series P Preferred Stock issued or issuable to the Sellers to purchase their interests in G-Soft.  The Escrow Agreement outlined Mr. Goldberg’s duties and obligations as Escrow Agent.

The First Amendment and the Escrow Agreement were described in more detail in, and attached as exhibits to, the Current Report on Form 8K, filed with the SEC on December 19, 2008.

Additionally, Fonix GS and the Sellers entered into a side letter agreement, dated February 18, 2009 (the “Side Letter”), attached hereto as an exhibit, modifying certain closing conditions of the Exchange Agreement, as amended by the First Amendment.  The Side Letter establishes certain conditions regarding: (1) management and directorships of GaozhiSoft; (2) filing of certain administrative government documents in China; and (3) operations of GaozhiSoft.

The final closing conditions have been met, and the share exchange transaction closed as of March 27, 2009.

The foregoing summaries of the terms and conditions of the Exchange Agreement, First Amendment, Escrow Agreement and Side Letter do not purport to be complete and are qualified in their entirety by reference to the full text of the Exchange Agreement, First Amendment, Escrow Agreement and Side Letter, which were filed as exhibits to Current Reports previously filed with the SEC.

Issuance of Series P 9% Convertible Preferred Stock in G-Soft Transaction

As disclosed in a Current Report filed with the Commission on March 27, 2009, Fonix Corporation (the “Company”) issued an aggregate of one hundred and twenty shares (120) of the Company’s Series P 9% Convertible Preferred Stock (the “Series P Preferred Stock”) to G-Soft Limited, a Hong Kong corporation (“G-Soft”), which is the ultimate parent of Shanghai Gaozhi Software Systems Limited ("GaozhiSoft"), and the shareholders of G-Soft (collectively, the “Sellers”).  The Shares of Series P Preferred Stock were issued pursuant to an exchange agreement (the “Exchange Agreement”), with Southridge LLC, a Connecticut limited liability company (“Southridge”), and the Sellers.  Additionally, subject to the terms of the amended agreement with the Sellers, the Sellers are entitled to annual earn-out payments equal to fifty percent (50%) of the prior year’s net income of GaozhiSoft, to be paid in the form of Series P Preferred Stock (the “Earn-Out Payments”).  The aggregate of the Earn-Out Payments is limited to three hundred and eighty (380) shares of Series P Preferred, which were issued into an escrow account.

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

F-28

Fonix Corporation and Subsidiaries

Notes to Consolidated Financial Statements

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

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

On September 26, 2008, the Company filed with the State of Delaware a Certificate of Designation and Series P 9% Convertible Stock Terms (the “Series P Terms”), which become a part of the Company’s Certificate of Incorporation, as amended.

Under the G-Soft Agreement and the Series P Terms, the holders of the Series P Preferred Stock may convert shares of Series P Preferred Stock into shares of the Company’s common stock.  The Company’s issuances of shares of common stock upon any conversion of the Series P Preferred Stock will be made without registration under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.  The Company’s sale and issuance of the Series P Preferred Stock to the Sellers was made without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

Issuance of Shares of Series P 9% Convertible Preferred Stock to Acquire Remaining 20% of G-Soft

In connection with the G-Soft transaction described above, on March 27, 2009, the Company entered into a Series P Convertible Preferred Stock Purchase Agreement (the “Preferred Stock Purchase Agreement”), with Southridge Partners LP (“Southridge”).  Pursuant to the Preferred Stock Purchase Agreement, the Company issued 189 shares of Series P Preferred Stock in exchange for the 20% of G-Soft shares which Southridge had purchased in the G-Soft Transaction described above.

The Series P Preferred Stock issued to Southridge has the same terms as described above.

Under the Preferred Stock Purchase Agreement and the Series P Terms, Southridge may convert shares of Series P Preferred Stock into shares of the Company’s common stock.  The Company’s issuances of shares of common stock upon any conversion of the Series P Preferred Stock will be made without registration under the Securities Act of 1933 (the “1933 Act”) in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.  The Company’s sale and issuance of the Series P Preferred Stock to Southridge was made without registration under the 1933 Act in reliance on Section 4(2) of the 1933 Act and the rules and regulations promulgated thereunder.

The foregoing summaries of the terms and conditions of the Exchange Agreement and the Preferred Stock Purchase Agreement do not purport to be complete and are qualified in their entirety by reference to the full text of the Exchange Agreement and the Preferred Stock Purchase Agreement, filed previously with the Commission.

F-29