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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549
                            ------------------------
                                    FORM 10-K

                        FOR ANNUAL AND TRANSITION REPORTS
                     PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934

                 For the Fiscal Year Ended December 31, 1998, 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 number: 0-20046

                               RESOUND CORPORATION
             (Exact name of Registrant as specified in its charter)

                   California                                77-0019588
(State or other jurisdiction of incorporation or          (I.R.S. Employer
                  organization)                          Identification No.)

        220 Saginaw Drive, Seaport Centre, Redwood City, California 94063
             (Address of principal executive offices and zip code)

       Registrant's telephone number, including area code: (650) 780-7800
                       ----------------------------------

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

           Securities registered pursuant to Section 12(g) of the Act:
                     Common Stock, $0.01 par value per share
                         Preferred Share Purchase Rights

                       ----------------------------------

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

Indicate by check mark 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. [X]

The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $53,116,000 as of February 26, 1999, based upon the
closing sale price on the Nasdaq National Market reported for such date. Shares
of common stock held by each officer and director and by each person who owns 5%
or more of the outstanding common stock have been excluded in that such persons
may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.

There were 20,846,169 shares of the Registrant's common stock issued and
outstanding as of February 26, 1999.

                       DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the definitive proxy
statement for the Annual Meeting of Shareholders to be held on May 28, 1999.

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                             INTRODUCTORY STATEMENT

         Words such as "anticipates," "estimates," "expects," "believes" and the
like in this Annual Report on Form 10-K and in the Annual Report to Shareholders
identify forward-looking statements. These statements are subject to certain
risks and uncertainties that could cause the actual results to differ materially
from those projected. These risks and uncertainties are discussed below under
the captions "Business" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Factors That May Affect Future Operating
Results," and in the Company's reports filed with the Securities and Exchange
Commission. Copies of these reports are available from the Company upon request.
The Company assumes no obligation to update any forward-looking statements
contained herein.

Encore, ReSound and ReSource are registered trademarks of, and Advanced Program
Selection, APS, Avance, Cochlea Dynamics, Digital Cochlea Dynamics, P3, Premium,
ReSound Digital, Tradition and True Feedback Cancellation are trademarks of,
ReSound Corporation. CommPort is a registered trademark of Motorola, Inc.
("Motorola").

                                     PART I

ITEM 1.       BUSINESS

OVERVIEW

         Founded in 1984, ReSound Corporation (together with its wholly-owned
subsidiaries, "ReSound" or the "Company") is a corporation organized under the
laws of the State of California. The Company is a hearing health care and human
communications company that designs, develops, manufactures and sells
technologically advanced hearing and communications devices. The Company's
products utilize proprietary sound processing technology originally developed by
AT&T Bell Laboratories and subsequently enhanced and refined by ReSound.
ReSound's Multiband Full Dynamic Range Compression ("MFDRC") sound processing
technology enables the Company's hearing devices to be individually programmed
to adjust the amplification of sound continuously in response to the acoustic
environment and a customer's residual range of hearing. The Company offers its
MFDRC sound processing technology in In-the-Ear ("ITE"), Behind-the-Ear ("BTE"),
In-the-Canal ("ITC"), and Completely-in-the-Canal ("CIC") versions of its
hearing healthcare products.

         ReSound's MFDRC sound processing technology is also found in the
Company's newly introduced CommPort communications device, an integrated
microphone and speaker system developed jointly with Motorola to provide
firefighters, police officers and other public safety personnel with a
hands-free, comfortable and high performance personal interface with
communications equipment.

         Since inception, the Company has sold approximately 1.2 million hearing
devices worldwide. ReSound currently distributes its hearing healthcare products
through more than 10,000 audiologists and hearing device retail locations in
over 35 countries. The Company also sells its hearing healthcare products to
retail chains and hearing device dispensers through wholly-owned subsidiaries in
Germany, the Netherlands, the United Kingdom, Ireland, France, Austria, Sweden,
Switzerland and Australia and has non-exclusive distribution agreements with
retail chains and single stores in Canada, Italy, Austria, Spain, Belgium, and
Denmark. The Company also operates a joint venture, ReSound Asia Ltd., which
operates a retail store in Hong Kong. The Company has exclusive distribution
agreements for Japan with Hoya Medical Corporation and for South Korea with
Kwang

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Woo International, Inc. The Company manufactures the CommPort device for
marketing and sale by Motorola.

         In January 1998, ReSound Autac GmbH, a newly formed subsidiary of the
Company located in Zurich, Switzerland, acquired all of the assets and
liabilities of a former Swiss distributor for $401,000. In April 1998, ReSound -
Viennatone Ltd. (a U.K. company) acquired all of the assets and liabilities of
Apex Acoustics, Ltd. from the Ultratone Group, the largest hearing device retail
chain in the United Kingdom for $750,000. In September 1998, Viennatone AG
acquired the minority interest it did not already own in Viennatone BVG, its
subsidiary retail operation, and in November 1998, sold 100% of the shares of
Viennatone BVG to the Amplifon Group, a European hearing instruments retail
distribution company, headquartered in Italy. See also "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Acquisitions and
Strategic Alliances".

PRODUCTS

         Core Sound Processing Technology

         The Company's core sound processing technology is a proprietary sound
processing technology originally developed by AT&T Bell Laboratories and
subsequently enhanced and refined by ReSound. The Company's MFDRC sound
processing technology allows the Company's hearing devices to be individually
programmed to adjust the amplification of sound continuously in response to the
acoustic environment and the wearer's residual range of hearing. MFDRC sound
processing technology operates across the full dynamic range of speech,
separating incoming sounds into multiple frequency bands (two bands in the case
of the Company's analog products, and up to fourteen bands in the Company's
newly introduced ReSound Digital 5000 Series of products) and amplifying low and
high intensity sounds differently within each band. Low intensity, high
frequency consonant sounds that are critical to speech intelligibility can be
amplified more than sounds that are already loud, such as background noise.
Consequently, since most sounds are amplified to an appropriate loudness and
over-amplification is avoided, speech intelligibility and listening comfort may
be greatly improved for many persons with hearing impairment.

         In 1996, ReSound introduced its "Cochlea Dynamics" sound processing
technology, an enhanced version of its patented MFDRC technology. While offering
equivalent or improved performance compared to the Company's earlier sound
processing technology, Cochlea Dynamics allowed for an integrated circuit that
is 40% smaller and consumes about 30% less power. Given these size and power
advantages, the Company's Cochlea Dynamics sound processing technology was
featured in the Company's first CIC device. Hearing devices incorporating this
advanced sound processing technology can be digitally programmed to fit a wide
range of hearing losses and configurations. Using automatic multiband full
dynamic range compression circuitry, the devices specifically address a common
psychoacoustic problem called "loudness recruitment" associated with
sensorineural hearing loss. Incoming sound is separated into low and high
frequency bands for independent processing, and maximum gain is applied to the
softest speech components while progressively lower gain is provided for higher
intensity sounds. Very weak high frequency sounds like consonants are therefore
amplified much more than intense speech sounds such as vowels. This leads to
better speech understanding for the hearing-impaired user of the Company's
hearing devices, since the signals are now audible, yet not uncomfortably loud.

         The Company's latest MFDRC sound processing technology can be found in
its recently launched ReSound Digital 5000 Series of products. These products
use a powerful and flexible, software-based, digital signal processing platform
that supports powerful algorithms, including Digital Cochlea Dynamics sound
processing, Dual Microphone Technology, Adaptive True Feedback 


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4

Cancellation and Multiband Noise Reduction. The Company believes that the
Digital Cochlea Dynamics sound processing software found in its new line of
digital products closely mimics the function of the human ear by dividing the
hearing spectrum into fourteen independent frequency bands and applying
multiband compression in each band. This makes for a very flexible system that
allows for compensation of a wide variety of hearing loss configurations.

         The Company also markets and sells other products incorporating its own
sound processing technology. After the acquisition of the hearing healthcare
business activity of Minnesota Mining and Manufacturing Company in 1996, the
Company renamed the business Sonar Hearing Health Corporation ("SHH") and began
to market and sell the "Sonar" brand of products. SHH offers a full line of
programmable and non-programmable hearing instruments in both BTE and custom
models. SHH's non-programmable product line incorporates nonproprietary,
nonlinear sound processing into ITC and ITE custom hearing devices. SHH's
programmable product lines incorporate sound processing technology on
proprietary integrated circuits to separate incoming sounds into two frequency
bands and provide independent processing in the two bands. Thus, low intensity,
high frequency sounds can be processed differently than high level, low
frequency sound such as background noise.

         In December 1994, the Company acquired Viennatone AG, a hearing
instrument manufacturer headquartered in Vienna, Austria. The Viennatone product
line consists of programmable and non-programmable products that span all
segments of the market, from BTE products to high power instruments with a large
number of options. While Viennatone's earlier product offerings incorporated
non-proprietary, linear sound processing technology, its newer product offerings
incorporate patented, non-linear sound processing technology designed to improve
performance in situations involving background noise and to avoid the need for
manual volume control. In 1995, Viennatone patented its adaptive zoom
technology. The concept uses two miniature microphones connected to a signal
processing circuit to selectively enhance sounds coming from the front
(typically desirable speech) over ambient sound (typically undesirable noise).
The zoom technology is designed to improve signal to noise ratio and help
hearing impaired users understand speech in difficult listening environments.
The experience derived from this development effort benefited the Company in the
development of its new ReSound Digital 5000 Series of products.

         New Products Introduced in 1998

         Hearing Healthcare

         ReSound introduced three new product platforms in 1998. In October
1998, the Company launched the ReSound Digital 5000 family of products,
including three non-custom, BTE models, the BT5, BZ5 and BP5, and two custom ITE
models, the ED5 and EZ5. These devices are built on a software-based, digital
signal processing platform offering unique advantages to a dispenser and the end
user. The flexible architecture supports powerful algorithms including Digital
Cochlea Dynamics sound processing, Dual Microphone Technology, Adaptive True
Feedback Cancellation and Multiband Noise Reduction. The Company believes that
Digital Cochlea Dynamics sound processing technology most closely mimics the
function of the human ear by dividing the hearing spectrum into fourteen
independent frequency bands and applying multiband compression in each of the
bands. The multiple bands make the system very flexible and allow for
compensation of a wide variety of hearing loss configurations. The Dual
Microphone Technology improves signal-to-noise ratio and helps the user focus on
specific sounds in the presence of certain noisy backgrounds. Speech clarity is
optimized through the use of digitally matched microphones and programmable
directional patterns to meet individual listening requirements. Adaptive True
Feedback Cancellation eliminates feedback, 


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the annoying whistle heard from hearing devices which do not fit snugly or when
an object is placed close to an operating unit. Unlike other methods currently
in use, the ReSound Digital 5000 device eliminates feedback without affecting
the gain or frequency response of the system. Multiband Noise Reduction
processing enhances speech clarity and the overall quality of sounds in quiet
and in noise. In addition, the BTE models feature a proprietary gold-plating
process which eliminates interference from digital cellular telephones.

         A completely new software fitting and programming system, ReSource II,
was launched with the ReSound Digital 5000 Series of products. The ReSource II
fitting software comes in two configurations, a software module for use with the
NOAH industry standard platform, and a stand-alone version that can run on any
PC platform. ReSource II offers three sophistication levels for fitting and
fine-tuning. It also supports new fitting algorithms, digital loudness growth
measurements and a convenient interface with SoundPro, a software program that
allows hearing professionals to simulate a variety of sound environments and
speech passages for use during fitting.

         In the fourth quarter of 1998, the Company launched the Avance hearing
enhancer into selected test markets in the United States and the United Kingdom.
The Avance hearing enhancer is targeted at the large, underserved, mild to
moderate hearing-impaired segment of the market that would rather tolerate
hearing impairment than go through the time and expense of being fitted with a
traditional hearing device. Its unique form factor makes it lightweight,
comfortable, easy to use and nearly invisible when worn. The product is designed
to be easy to fit and is very competitively priced when compared to traditional
hearing devices. In January 1999, hearing professionals in four additional
cities in the U.S. were trained to dispense the Avance hearing enhancer. In the
first half of 1999, other international markets including Germany, the
Netherlands, Italy, Hong Kong, Singapore and Australia will begin test marketing
the product.

         Communications

         The Company's joint development efforts with Motorola resulted in the
joint announcement of the introduction of the CommPort device in September 1998.
The CommPort is an integrated microphone and speaker system, designed to enhance
communications by providing firefighters, police officers and other public
safety personnel with a hands-free, comfortable and high performance personal
interface with two-way radios and other communications equipment. The Company
manufactures the CommPort device on an OEM basis for marketing and sale by
Motorola. The Company expects that its joint development effort with Motorola
will result in further technological developments that can be incorporated into
other products for marketing and sale into other segments of the communications
market and the hearing healthcare market.

         Current ReSound Brand Products

         In addition to the top-of-the-line ReSound Digital 5000 family of
products, the Company's product lines include the Premium Series line of
products, the midrange Encore Series line and the Tradition Series line. Each of
these lines of products incorporates the Company's proprietary MFDRC sound
processing technology.

         The Premium Series line of products are multichannel, multiprogram
devices. They can support two or three listening programs with an optional
ultrasonic remote control and feature optional telecoil and direct audio input
capability. The Encore Series products come with a single listening program.
Both the Premium and Encore products are digitally programmable using the
ReSound fitting systems which comprise the P3 proprietary portable prescriptive
programmer and the 


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ReSource fitting module for the industry standard platform, NOAH. In late 1995,
the Company introduced a new line of products called the Tradition Series. The
Tradition Series hearing instruments contain the proven Cochlea Dynamics sound
processing, and can be digitally programmed either in the factory or at the
point-of-sale using the Company's proprietary ReSource fitting software. The
Tradition Series products feature seven programs derived from a patient's
audiometric data using a proprietary clustering technique applied to a database
of successful ReSound fittings. The Tradition Series products are available in
BTE and ITE configurations.

         Within each product line, there are different configurations. The
behind-the-ear or BTE version is a non-custom product worn over and behind the
ear. The device contains a microphone, sound processing electronics, a receiver
or speaker and an appropriate battery in a plastic case and a sound output tube
which attaches to a custom earmold. U.S. retail prices for the Company's
digitally programmable BTE devices typically range from $1,100 to $2,250 for a
single device. The BTE version is still very popular in Europe. The in-the-ear
or ITE version comprises a custom shell that matches the ear impression. The
shell contains a microphone, sound processing electronics and a receiver. The
shell fills the concha area of the patient's ear. U.S. retail prices for the
Company's ITE products typically range from $1,200 to $2,300 for a monaural
(single ear) fitting. The in-the-canal or ITC version is similar to the ITE, but
smaller; it fits in the ear canal. The completely-in-the-canal or CIC version is
the smallest custom configuration. This model fits completely in the ear canal
and is the most cosmetically appealing custom version. U.S. retail prices for
the Company's ITC and CIC products typically range from $1,800 to $2,800 per
unit. ITE, ITC and CIC configurations constitute the custom category, and these
products are very popular in the United States and in some parts of Asia and
Europe.

         During 1997, several products were added to the Company's product
lines. The Premium Series BTE model, the BT4, was introduced in April 1997. This
device incorporates Cochlea Dynamics sound processing technology in a
custom-designed case available in a variety of colors. The innovative case
design allows dispensers to easily change the configuration of the device from
an adult to a pediatric version and from one case color to another. Telecoil and
direct audio input are standard features. The BT4 offers an integrated solution
for the pediatric population with moderate to severe hearing losses.

         In the third quarter of 1997, the ITC model, the IE4, was launched. The
IE4 is the smallest Encore Series product from ReSound. It is fully programmable
and has a single listening program.

         During the fourth quarter of 1997, ReSound introduced the CC4, a CIC,
Premium Series product. By reducing the size of one of the critical component
chips, the overall hybrid size was reduced by 50%. Therefore, the CC4 offers
advanced technology in a small and attractive package. The device, when worn,
sits completely in the patient's ear canal and is cosmetically very appealing.
The CC4 also has a smooth frequency response due to improved receiver
construction. The CC4 combines the benefits of deep microphone placement in the
ear canal and the smaller residual volume between the instrument and the eardrum
with improvements in circuit design to offer improved sound quality and 30% less
current drain than the standard hybrid. In certain key markets, the CC4 is built
using a new shell material for improved strength and durability.

         Fitting Systems

         The ReSource II fitting system now supports all programmable ReSound
brand products. Dispensers can use this software at the point-of-sale. The
ReSource II software is the successor to the 

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ReSource software introduced in 1996 as a fitting module for the industry
standard software platform, NOAH. The new fitting software can be used with NOAH
or in a stand-alone version on any PC platform. The programming interface is the
industry standard HI-PRO. The Company's proprietary portable prescriptive
programmer, P3, is being discontinued but can still be used by dispensers to
program and fit the Company's digitally programmable products. However, the P3
cannot be used with the new ReSound Digital 5000 Series of products. As of March
1, 1999, there were approximately 12,970 NOAH users worldwide. For dispensers
who do not wish to program the devices at the point-of-sale, the Company offers
factory-programmed versions of Tradition Series products. Advanced Program
Selection technology (APS), featured in the Tradition products, does not require
special fitting tools at the point-of-sale, so it is easy to fit and fine tune
the devices. APS devices are well suited for certain markets including Eastern
Europe and parts of Asia.

         Tactical Brand Products

         During 1997, SHH introduced mini-canal configurations in all of its
major lines. In October 1997, the SHH sales force and marketing functions were
integrated into ReSound's existing U.S. organization. No new Sonar brand
products were introduced in 1998 as the Company transitions Sonar brand
customers to ReSound products.

         Viennatone designs, manufactures and distributes linear and
nonproprietary compression circuit-based hearing devices for moderate and
moderate to severe hearing losses. During 1997, two new BTE products, the 130K
and 130DUO, were added to the successful 130 series. In October 1997, the
Contact Star, a high power bone conduction hearing device configured as an
eyeglass aid, and the Silent Star, a Tinnitus product, were announced at the
German Congress. The Contact Star replaced two existing products. The Silent
Star is designed as a therapeutic noise generator for Tinnitus therapy. The
Model 180, the first member of the 4Power family of Viennatone products was
introduced in 1998. The Model 180 is a high power, linear device with analog
feedback cancellation. Other models in the 4Power family are under development.

MANUFACTURING

         The Company manufactures its hearing devices according to
specifications received from hearing healthcare professionals. In the case of an
ITE, ITC or CIC device, after receiving an impression of the patient's ear canal
and the programming requirements of the device, the Company manufactures the
custom earmold shell and assembles the electronic circuitry of the device. In
the case of a BTE device, the Company assembles the electronic circuitry into a
case the Company produces or purchases.

         ReSound's manufacturing operations consist of coordination of
integrated circuit production, assembly and testing of electronic subsystems,
fabrication of custom earmolds, integration of the electronic sub systems into
the device shell, and final testing of the complete system. Electronic assembly
operations include the attachment of three integrated circuits onto a printed
circuit board along with other components by an outside vendor. A microphone and
speaker are wired and attached to this circuit board which is then attached to a
faceplate and tested. The faceplates are stored in inventory until, in the case
of an ITE, ITC or CIC, an impression of the patient's ear canal and audiological
information are received from a hearing device dispenser. The Company then
produces the custom ITE, ITC or CIC shell and assembles the product. In the case
of a BTE device, the Company either purchases a standard case from a supplier,
or makes use of an internally designed and manufactured case, and assembles the
electronic circuitry into the case. The Company subcontracts manufacture of its
proprietary P3 system and remote control used with its hearing 


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devices. The Company's primary manufacturing facilities are in Redwood City,
California; Eagan, Minnesota; Cork, Ireland; Munster, Germany; Grafenschachen,
Austria; Vienna, Austria; and Oxford, United Kingdom. In addition, small custom
hearing device laboratories are located within the Company's subsidiaries in
France, Australia, Sweden and Switzerland.

         The Company subcontracts for the manufacture of the P3 system from a
single supplier. The P3 system is purchased under a supply contract, while
other components are purchased pursuant to purchase orders on an as-needed
basis. With the acquisition of Sonar Design & Hortechnik GmbH in January 1994
(renamed ReSound Deutschland in 1996), the Company established an ITE
manufacturing capability in Germany. See also "Sales and Marketing".

         The Company also subcontracts the manufacture of the CommPort device
and the Avance hearing enhancer. Each device is purchased pursuant to an
agreement with a turnkey manufacturer of the product.

         Viennatone manufactures its hearing devices in Vienna and
Grafenschachen, Austria. SHH manufactures its custom hearing devices in Eagan,
Minnesota. Viennatone and SHH manufacture the custom hearing instruments in
accordance with specifications received from the respective hearing care
professional. In the case of an ITE device, after receiving an impression of the
patient's ear canal and the programming requirements of the device, the custom
earmold shell is manufactured and the electronic circuitry of the device is
assembled. In the case of a BTE device, a standard case is manufactured and the
electronic circuitry is assembled into the device. Viennatone and SHH
manufacturing operations consist of coordination of integrated circuit
production, assembly and testing of electronic subsystems, fabrication of custom
earmolds, integration of the electronic components into the device shell and
final testing of the complete system.

         In the United States, the Company is subject to inspection on a routine
basis by the United States Food and Drug Administration ("FDA") and the states
of California and Minnesota to ensure compliance with the FDA's Quality System
Regulations ("QSR") and comparable state regulations that impose certain
procedural and documentation requirements upon the Company with respect to
manufacturing and quality assurance activities. Manufacturing sites outside of
the United States supplying the U.S. market are also subject to compliance with
the FDA's QSR regulations and inspections. Viennatone's, ReSound Deutschland's
and ReSound Redwood City, U.S.'s ISO 9001 and Cork, Ireland's ISO 9002
certifications will require periodic audits by a registrar to maintain the
certifications. See also "Government Regulation".

PRODUCT RETURNS, REPAIRS AND REMAKES

         The Company believes that the hearing device industry in the United
States is characterized by a relatively high rate of product returns
(approximately 16 to 32 percent) and that these returns are due to a number of
factors. Many states have laws that require hearing device dispensers to allow
purchasers a minimum period of time for return of their hearing devices,
typically 30 days. In addition, the relatively poor performance of many existing
hearing devices may cause patients to return them. Further, patients may not be
able to judge the performance of a new hearing device at the dispenser's office.
Finally, the Company believes that many dispensers encourage potential
purchasers to try a variety of hearing devices on a trial basis, in part because
of the industry's liberal return policy.

         ReSound allows its hearing devices sold in the U.S. and Canada to be
returned without charge for a period of 90 days after delivery to the dispenser.
In Europe and Asia, the Company sells 


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primarily to chains of hearing device dispensers, and all returns from the end
user are the responsibility of these chains. In addition, in the U.S. and
Canada, ReSound currently offers warranties of one to two years to the end user
on the electronic components of its hearing devices and a 12-month warranty
against defects in the manufacture of the custom shell. The Company offers a
12-month warranty to the dispenser on the P3 system and other programming
systems in the U.S. Internationally, the Company offers a 12-month warranty to
the distributor on the components of its hearing devices.

         The Company believes that its product returns are primarily the result
of the advanced sound processing of its products, which provides greater
amplification than other products and therefore requires a more precise fit of
the hearing device in order to reduce feedback. Other factors include the
relatively high price of the Company's products and the challenge of
appropriately training some of its dispensers, particularly in the area of
device programming. In addition, many repairs have been required on the
Company's ITE and ITC hearing devices due to blockage of the speaker by
accumulated ear wax. The natural production of ear wax in the ear canal can clog
hearing devices periodically. The Company has also experienced a high rate of
repair and remake requests related to imperfect fitting of the ITE and ITC
shell. The Company is attempting to reduce these occurrences by continuing to
improve its manufacturing processes, its fitting procedures and its fitting
systems software, by teaching hearing care professionals more effective
techniques for screening patients, and by offering a standard trial unit that
hearing care professionals may utilize to demonstrate the ReSound technology to
the patient.

         See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for a discussion of the impact of warranty claims on the
Company's business.

SALES AND MARKETING

         In the United States and Canada, hearing devices typically have been
sold by hearing device dispensers and audiologists. There are approximately
6,000 dispensers of hearing devices and approximately 6,000 dispensing
audiologists in the United States. ReSound's products are positioned primarily
as premium-priced, premium-performance devices. Because the Company's
programmable product lines are more technically advanced than many competitors'
conventional hearing products, the Company has targeted audiologists and
qualified hearing device specialists to distribute its products. The Company's
sales staff, consisting of fourteen people, seven of whom are audiologists,
supports over 5,500 audiologists and hearing device retail locations in the
United States. In addition, retail chains and buying groups are becoming an
increasingly important factor in the distribution of hearing devices in the
United States for the industry, including ReSound. The Company believes that it
is well positioned to meet these changes in the United States distribution
structure.

         As part of its sales and marketing efforts, ReSound seeks to
differentiate itself to the hearing healthcare professional by offering a
comprehensive training program to its network of dispensers. The Company's
training program is designed to educate the hearing device dispenser about
ReSound's products and to train the hearing device dispenser in the proper
fitting of patients. In addition, the Company's sales and marketing force
provides ongoing support and service to audiologists and hearing device
dispensers.

         ReSound employs several distribution channels to market and sell its
products internationally. The Company is a party to an exclusive distribution
agreement covering the Japanese market that expires in December 2002 with Hoya
Medical Corporation, a large Japanese company with retail outlets and
substantial experience in the contact and intraocular lens markets. During 1992,
the 


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Company expanded distribution of its products into Germany, Belgium and Spain by
entering into non-exclusive distributor arrangements with leading retailers of
hearing devices in those countries. During 1993, an exclusive distributor
arrangement with France's leading hearing device retail chain was converted into
a non-exclusive distributor arrangement. In 1992, ReSound established a
subsidiary, ReSound GmbH Hortechnologie ("ReSound GmbH"), for marketing and
distribution of its current and future products, primarily in Germany, Austria
and Switzerland. ReSound GmbH has captured a significant share of Germany's BTE
hearing device market. On January 1, 1994, ReSound completed the acquisition of
all of the outstanding ownership interest in Sonar Design & Hortechnik GmbH
located in Munster, Germany. This entity was renamed ReSound Deutschland in
1996. Coupling ReSound Deutschland's significant ITE market share and expertise
in ITE design and manufacturing with ReSound's BTE devices has given ReSound a
complete line of high technology hearing devices in Germany. Through this
subsidiary, ReSound sells, services and manufactures custom hearing devices for
the German market.

         In 1993, ReSound established a Dutch subsidiary, ReSound B.V., for
distribution of the Company's products in the Netherlands. In 1994, ReSound
established ReSound Asia Limited ("RSND Limited"), a British Virgin Islands
company which is a joint venture with a large Hong Kong group with diversified
business interests. Headquartered in Hong Kong, RSND Limited sells ReSound
products in Hong Kong through a Hong Kong based subsidiary. Viennatone sells to
distributors in numerous countries, to a major retail chain of stores in Europe
and to subsidiaries in the United Kingdom, France and Germany. In 1995, ReSound
established subsidiaries in Australia and Sweden. Sales of the Company's
products to Taiwan, Singapore and the People's Republic of China are currently
made through the Australian subsidiary. The Company also has branch operations
in Canada and New Zealand, and has converted its branch operation in Switzerland
into a subsidiary, ReSound Autac GmbH, in connection with its January 1998
acquisition of its Swiss distributor. International sales accounted for 51% of
the Company's total sales in 1998. See Note 11 of "Notes to Consolidated
Financial Statements".

         The Company manufactures the new CommPort device on an OEM basis for
marketing and sale by Motorola.

THIRD-PARTY REIMBURSEMENT

         In the United States, third-party reimbursement generally is not
available for the purchase of hearing devices. As a result, the price of a
hearing device may be a key factor in the patient's decision to purchase such a
device. Third-party reimbursement is generally provided in most European
countries and tends to be covered by either government or private funded health
insurance schemes. The levels of reimbursement vary from country to country and
have been reduced significantly in most European markets in recent years.
Typically in Germany today, patients will be reimbursed up to $500 for any one
hearing device which is around 40% lower than reimbursement levels of two years
ago. The reduction in reimbursement levels has had a negative effect on the
Company's revenues in those countries affected.

         See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors That May Affect Future Operating Results" for a
discussion of the risks and uncertainties with respect to future changes in
government reimbursement levels.


                                       10
<PAGE>   11


GOVERNMENT REGULATION

         The development, production and marketing of the Company's current
hearing healthcare products and products planned for future introduction are
subject to regulation by numerous governmental authorities in the United States,
including the FDA, the California Department of Health Services and the State of
Minnesota, and in other countries. In the United States, all medical device
products are subject to rigorous FDA review. Hearing aids are classified by the
FDA as Class I medical devices with a restricted status.

         The United States Federal Food, Drug, and Cosmetic Act (the "FDC Act")
and other federal statutes and regulations govern or influence the design,
testing, manufacture, labeling, sale, storage, record keeping, approval,
advertising and promotion of such products. Noncompliance with applicable
requirements can result in fines, recall or seizure of products, total or
partial suspension of production, refusal of the government to approve product
license applications or withdrawal of approvals, injunctions, civil fines and
criminal prosecution.

         Historically, in order to obtain FDA permission to market a new medical
device, the Company had to submit proof of substantial equivalence in a 510(k)
pre-market notification submission or proof of safety and efficacy in a
Pre-Market Approval Application ("PMAA"). In many cases, such proof entailed
extensive clinical tests. The testing, preparation of necessary applications and
processing of those applications by the FDA were typically expensive,
time-consuming and of uncertain outcome. In November 1997, President Clinton
signed into law the "Food and Drug Administration Modernization Act of 1997," a
three-year effort which amends provisions of the FDC Act relating to every
product under the FDA's authority. As a result, as of February 19, 1998, all
air-conduction hearing aids became exempt from this substantial equivalence
process.

         Clinical testing of devices under development requires compliance with
federal and state regulations involving Investigational Device Exemptions
("IDE"). These regulations govern many important aspects of the clinical
investigation of medical products, including obtaining informed consent from
clinical subjects, securing the approval of an Institutional Review Board for
the intended clinical protocol and maintaining required documentation relating
to the conduct of the investigational study. The FDA, at its discretion, may
also require additional post-marketing surveillance to monitor the performance
of products in the market. Marketing permission may be withdrawn if compliance
with regulatory requirements is not maintained or if significant problems occur
following initial marketing.

         The Company also must register annually as a medical device
manufacturer with the FDA and be licensed by the Food and Drug Branch of the
California Department of Health Services and the State of Minnesota. The Company
is subject to inspection on a routine basis by both the FDA and the States of
California and Minnesota for compliance with the FDA's new Quality System
Regulation ("QSR"), effective July 1997, and medical device reporting ("MDR")
regulations and equivalent state regulations. These regulations impose certain
procedural and documentation requirements on the Company with respect to design,
manufacturing, labeling, advertising, safety and quality assurance activities.

         The FDA actively enforces regulations prohibiting marketing of products
for non-indicated uses as well as products that violate design, safety and
performance claims and the other requirements mentioned above.

         The new QSR and more stringent European ISO regulations increase the
Company's cost of 


                                       11
<PAGE>   12


regulatory compliance. The Company also is subject to numerous federal, state
and local laws relating to such matters as safe working conditions,
manufacturing practices, environmental protection, fire hazard control and
disposal of hazardous or potentially hazardous substances.

         Sales of medical device products outside the United States are subject
to international regulatory requirements that vary widely from country to
country. The time required to obtain approvals required by other countries may
be significantly longer or shorter than that required for typical FDA approval.
International distribution, importation and manufacturing licensing may differ
substantially from even the new harmonized FDA regulations. Some countries have
historically required extensive product performance data, clinical evaluations
and physical device samples above and beyond the baseline FDA submission
requirements. Other countries, such as Japan, have standards similar to those of
the FDA. This disparity in the regulation of medical devices may result in more
rapid product approvals and sales in certain countries than in other countries.
In 1995, the European Union adopted the Medical Device Directive mandating the
CE Mark for all medical devices to be sold within the Union. The Company has
obtained the required certifications of quality and regulatory systems and is
now applying the CE Marking on its products within Europe. Viennatone, ReSound
Deutschland and the Redwood City, California facility have obtained and are
maintaining the ISO 9001 and EN 46001 quality system certifications. ReSound
Ireland has achieved and is maintaining ISO 9002 certification. Individual
country requirements regarding third party reimbursements, advertising,
professional training, language of labeling materials and other areas continue
to apply and may make certain markets more difficult to penetrate. Compliance
with proposed revisions to the European Medical Device Directive for
electromagnetic compatibility, device hazard and risk assessments and digital
cellular telephone interference immunity may result in significant regulatory
compliance costs for the Company in the future and may have a material adverse
effect upon the Company's business, financial condition and results of
operations.

         Certain of the Company's products also may be subject to U.S. Federal
Communications Commission ("FCC") regulation, which establishes radio frequency
emission standards for certain electronic equipment. Products that fail to
comply with these regulations may not be sold in the United States until
appropriate modifications are made. Various countries in which the Company
markets its products, or in which the Company may do so in the future, also have
regulatory agencies or standards authorities that perform functions comparable
to the FCC, and the Company will need to comply with these requirements to the
extent that it markets covered products in such countries.

         See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors That May Affect Future Operating Results" for a
discussion of the risks and uncertainties with respect to government regulation.

RESEARCH AND DEVELOPMENT

         ReSound's research and development staff consisted of 74 people at
December 31, 1998. Its responsibilities include integrated circuit development,
software development, mechanical and electroacoustic engineering, clinical
research, FDA-related regulatory affairs, long-term product development, and
development and maintenance of ReSound's intellectual property. The Company also
retains consultants with special expertise to augment internal product
development.

         ReSound's research and development is primarily focused on the
development of a new generation of hearing health care products based on digital
signal processing technology (DSP), on the development of the fitting systems
required for this new generation of devices, on the 



                                       12
<PAGE>   13


development of new products to address the needs of different segments of the
hearing health care market, on proprietary technology for hearing health care
and human communications products in conjunction with its alliance with
Motorola, and on the enhancement of its current hearing device products.

         Some acoustic and magnetic clinical investigations are conducted at the
California Ear Institute at Stanford in Palo Alto, California which has an
affiliation with the faculty at the Stanford University School of Medicine. Dr.
Rodney Perkins, Chairman of the Company's Board of Directors, is the President
of the California Ear Institute at Stanford and a professor at the Stanford
University School of Medicine.

        With the acquisition of SHH, the Company obtained a large portfolio of
patents and intellectual property for programmable and digital devices. SHH also
provides ReSound with technology related to manufacturing engineering of custom
shells and analog signal processing. The programmable and DSP patents obtained
from the SHH acquisition were made available to the industry through a
partnership ("HIMPP") formed in 1996, comprised of eight hearing device
manufacturers, including ReSound, at December 31, 1998.

        The Company incurred research and development expenses of $16.4 million,
$16.9 million and $14.9 million in the years ended December 31, 1998, 1997, and
1996, respectively.

        See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors That May Affect Future Operating Results" for a
discussion of the risks and uncertainties involved in new product development.

COMPETITION

         The hearing device industry is fiercely competitive. Many of the
Company's competitors, including Siemens, Starkey, Oticon, Phonak, Philips,
Widex, Beltone and GN Danavox A/S, may have substantially greater financial,
manufacturing, marketing or technical resources than those of the Company. In
addition, the Company is aware that several of its competitors have programs for
the development of technologically advanced hearing devices. A number of
companies including Siemens, Oticon, Widex, Philips and Danavox have advanced
technology DSP hearing devices. Some of these competitors who launched high-end
digital products earlier than the Company, have also introduced fully digital,
midrange products in the last year. The Company has now launched its ReSound
Digital 5000 line of completely digital processing, high end products. These
software-based products have significantly more processing power than other
digital devices on the market. This allows for extensive customization to
address individual patient needs and also permits advancements derived from
future research to be implemented more rapidly for use by hearing professionals
and their patients. There can, however, be no assurance that the Company's
competitors will not develop products that may be lower priced or more effective
than the Company's products in overcoming the communication challenges imposed
by hearing loss, or that the Company's technologies and products may not be
rendered obsolete or noncompetitive by such developments. Principal competitive
factors in the market for the Company's hearing healthcare products include
price, product quality, reliability, technical support and service, marketing
and distribution channels.

         The first communications product jointly developed by ReSound and
Motorola, the CommPort, was announced in September 1998. In this arena, Phonak
Communications, a subsidiary of Phonak A/G, already has one-way wireless
products for use with hearing devices and for non-hearing impaired applications.
Other competitors in the Company's core market may also be


                                       13
<PAGE>   14



developing products based on wireless technologies for the hearing healthcare
market.

         See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors That May Affect Future Operating Results" for a
discussion of the risks and uncertainties with respect to competition.

PATENTS, TRADE SECRETS AND LICENSES

         The Company's policy is to protect its proprietary position by, among
other methods, filing United States and international patent applications to
protect technology, inventions and improvements that are important to the
development of its business and, in this regard, the Company owns and has filed
applications for a number of patents and patent applications in the United
States and elsewhere in the world. While the Company believes that its patents
and applications have value, it also believes that its competitive position
depends on its ability to develop new technology and to establish successful
relationships with strategic partners and outside suppliers.

         The Company typically requires its employees, consultants and advisors
to execute a confidentiality agreement upon the commencement of an employment,
consulting or advisory relationship with the Company.

         Certain patents used, or of potential use, by the Company in its
business are licensed from third parties. Most of these licenses are fully paid.
In addition, the Company has entered into agreements to license certain of its
own patents to third parties under various compensation arrangements.

         See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Factors that May Affect Future Operating Results" for a
discussion of the protection afforded by the Company's patents and other
intellectual property, patent infringement litigation, and other risks and
uncertainties in connection with the Company's intellectual property.

PRODUCT LIABILITY AND INSURANCE

         Medical device companies are subject to an inherent risk of product
liability and other liability claims in the event that the use of their products
or a medical procedure associated with prescribing and fitting their products
results in personal injury claims. Any such claims could have an adverse effect
on the Company. The Company currently maintains liability insurance with
coverage of $20 million per occurrence and an annual aggregate maximum of $21
million. There can be no assurance that product liability or other claims will
not exceed such insurance coverage limits or that such insurance will continue
to be available on commercially acceptable terms, or at all.

EMPLOYEES

         As of December 31, 1998, the Company had 1,041 employees, including 74
in research and development, 676 in manufacturing, 181 in sales and marketing,
and 110 in administration. The Company believes it maintains competitive
compensation, benefits, equity participation and work environment policies to
assist in attracting and retaining qualified personnel. Viennatone's employees
are compulsorily covered by a collective bargaining agreement with respect to
the electronics industry and are compulsorily members of the Austrian Chamber of
Workers. The Company believes that the success of its business will depend, in
part, on its ability to attract and retain qualified personnel. The Company
believes its relationship with its employees is good.



                                       14
<PAGE>   15




ADVISORY BOARDS

         The Company has a Scientific Advisory Board and a Medical Advisory
Board comprised of leading scientists and physicians in the acoustic, auditory
and electrical engineering fields. Both Boards meet and consult with the
Company's management and technical staff on an as-needed basis. Some members of
the Boards may also receive compensation for consulting or clinical work
performed for the Company under consulting contracts. The aggregate compensation
paid by the Company under these consulting arrangements was approximately
$30,000 during 1998, excluding amounts paid to Dr. Richard Goode and Dr. Rodney
Perkins who are also members of the Company's Board of Directors. See
"Compensation of Directors" in the Company's Proxy Statement for the 1999 Annual
Meeting of Shareholders for information on amounts paid to Dr. Goode and Dr.
Perkins for consulting services and services as members of the Company's Board
of Directors.

        The current members of the Scientific Advisory Board are:

        Jont Allen, Ph.D., a member of the technical staff of AT&T Bell
Laboratories in the acoustics research department. Dr. Allen was involved in the
development of AT&T's internal hearing device venture, with particular emphasis
on the fitting system, and has experience in acoustics, cochlear modeling and
related electrical engineering fields. Dr. Allen holds a Ph.D. from the
University of Pennsylvania.

        Harry Levitt, Ph.D., Distinguished Professor at City University of New
York for the Center of Research in Speech and Hearing Science. Dr. Levitt is one
of the world's leading scientists in the hearing aid field. He regularly
presents, often as an invited speaker, at the most important hearing aid
conferences. Dr. Levitt has over 200 publications in major audiology journals
and textbooks.

        Brian Moore, Ph.D., Professor of Auditory Perception at Cambridge
University in England. Dr. Moore has performed extensive basic and applied
research in the fields of hearing, hearing impairment, hearing device design,
and signal processing, with long-term Program Grant support from the Medical
Research Council (U.K.). He has authored or edited more than eight books and has
published over 250 book chapters and research articles. Dr. Moore holds a Ph.D.
from Cambridge University.

        Vincent Pluvinage, Ph.D., Chief Executive Officer of Preview Software.
Dr. Pluvinage was formerly employed by ReSound for 10 years in various
functions: Vice President for Research and Development, Vice President and later
President for International Operations, and Executive Vice President. Before
joining ReSound, from June 1985 to March 1987, Dr. Pluvinage worked at AT&T Bell
Laboratories, where he was in charge of digital processing hardware and clinical
research in connection with sound processing. He was a member of the internal
venture at AT&T Bell Laboratories that originally developed the technology that
is employed in ReSound's current products. Dr. Pluvinage holds a Ph.D. in
bioengineering from the University of Michigan and an engineering degree (summa
cum laude) in applied physics engineering from Universite Catholique de Louvain
in Belgium.

        Edgar Villchur, President and Director of Research of the Foundation for
Hearing Aid Research. Mr. Villchur was the founder of Acoustics Research, a
manufacturer of stereophonic equipment, and has been a visiting scientist at the
Massachusetts Institute of Technology and the Albert Einstein School of
Medicine. Mr. Villchur has authored many books and papers on the reproduction of
sound and signal processing for the hearing impaired. Mr. Villchur holds an
M.S.Ed. from the City College of New York.

                                       15
<PAGE>   16



        The current members of the Medical Advisory Board are:

        Derald E. Brackmann, M.D., senior otologic surgeon at the House Ear
Institute in Los Angeles. Dr. Brackmann is past President of the Academy of
Otolaryngology-Head and Neck Surgery and past President of the American
Neurotologic Society. He has published extensively on clinical topics in
otologic surgery (ear surgery). Dr. Brackmann is Clinical Professor of
Otolaryngology at the University of Southern California School of Medicine. Dr.
Brackmann holds an M.D. from the University of Illinois School of Medicine.

        Professor Doctor Ugo Fisch, Professor and Chairman of the Department of
Otolaryngology at the University Hospital in Zurich. Dr. Fisch is a leading
surgeon in the fields of otologic surgery and neurotologic surgery (surgery of
the neural components of the ear and related structures) and has over 30 years
of research and teaching experience. Dr. Fisch is an Honorary Fellow of the
Royal College of Surgeons of England. Dr. Fisch holds an M.D. from the
University of Zurich.

        Bruce J. Gantz, M.D., Professor of Otolaryngology-Head and Neck Surgery
at the University of Iowa College of Medicine. Dr. Gantz has received extensive
funding from the National Institutes of Health for research on advanced hearing
devices and cochlear implants. Dr. Gantz holds an M.D. from the University of
Iowa.

        William House, M.D., widely recognized as the founder of the field of
neurotologic surgery. Dr. House did his pioneering work in cochlear implants and
the development of advanced neurotologic surgical procedures at the House Ear
Institute in Los Angeles. He has over 35 years experience in research and
development of implantable hearing devices. Dr. House holds a D.D.S. from the
University of California at Berkeley and an M.D. from the University of Southern
California School of Medicine.

        Richard L. Goode, M.D. and Rodney Perkins, M.D., members of the Board of
Directors, also serve on the Medical Advisory Board.

ITEM 2.  PROPERTIES

         The Company leases 47,553 square feet of office, research and
development and manufacturing space in Redwood City, California under a
non-cancelable operating lease and sublease through June 2000. Additionally, the
Company leases 6,575 square feet in Redwood City under a lease which expires in
December 2000. Sonar Hearing Health Corporation, in Eagan, Minnesota, leases
36,341 square feet under a noncancelable operating lease which expires in June
2001. ReSound GmbH Hortechnologie, leases approximately 3,000 square feet of
space in Munich, Germany under a lease that expires in March 1999, and the
Company's Dutch subsidiary, ReSound B.V., leases approximately 2,750 square feet
of space in Oosterhout. ReSound Deutschland leases approximately 11,500 square
feet in Munster, Germany. ReSound Ireland Limited leases a total of
approximately 16,800 square feet in Cork, Ireland. Viennatone's leased
headquarters building, located in Vienna, Austria, consists of approximately
37,700 square feet. Viennatone also has a leased manufacturing facility in
Grafenschachen, Austria, which consists of approximately 8,200 square feet.
Subsidiaries of the Company operating in France, the United Kingdom, Sweden,
Switzerland and Australia, in total lease approximately 27,400 square feet of
building space. The Company expects that it may require additional space in the
future and that such space will be available on acceptable terms if required.



                                       16
<PAGE>   17




ITEM 3.    LEGAL PROCEEDINGS

           Not Applicable.

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

           Not Applicable.

                                       17
<PAGE>   18



                                     PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS

         The Company's common stock is traded on the Nasdaq National Market
under the symbol RSND. The prices per share reflected in the table below
represent the range of low and high closing sale prices for the Company's common
stock as reported in the Nasdaq National Market for the quarters indicated.
<TABLE>
<CAPTION>

             FISCAL 1997                                            HIGH                     LOW
             -----------                                            ----                     ---
<S>                                                                <C>                        <C>
             First Quarter ended March 31, 1997                      8 3/8                   5 7/8
             Second Quarter ended June 30, 1997                      7 3/4                   3 3/4
             Third Quarter ended September 30, 1997                  6                       4 3/8
             Fourth Quarter ended December 31, 1997                  6 15/16                 5 1/8

             FISCAL 1998                                            HIGH                      LOW
             -----------                                            ----                      ---

             First Quarter ended March 28, 1998                      6 5/8                   4 3/4
             Second Quarter ended June 27, 1998                      7                       5
             Third Quarter ended September 26, 1998                  6 9/16                  4
             Fourth Quarter ended December 31, 1998                  6                       3 1/2
</TABLE>

             There were 462 shareholders of record as of February 26, 1999.

         The Company has never paid cash dividends on its capital stock. The
Company currently anticipates that it will retain all available funds for use in
the operation and expansion of its business, and does not anticipate paying any
cash dividends in the foreseeable future. Under the terms of the Company's line
of credit, obtained from a U.S. bank in February 1999, the Company's ability to
pay cash dividends is restricted.

                                       18
<PAGE>   19



ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
                                                                                     YEARS ENDED DECEMBER 31,
                                                                                     ------------------------
                                                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                                                 1998        1997            1996(3)          1995        1994(4)
                                                             ---------     ---------      ---------         ---------   ---------
<S>                                                          <C>           <C>            <C>            <C>            <C>      
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
 Net sales                                                   $ 123,442     $ 130,463      $ 125,646      $ 107,330      $  62,253
 Cost of sales                                                  60,370(1)     62,592(2)      57,241         53,626         26,461
                                                             ---------     ---------      ---------      ---------      ---------
       Gross profit                                             63,072        67,871         68,405         53,704         35,792
 Operating expenses:
     Research and development                                   16,360(1)     16,883(2)      14,898         11,181          8,862
     Selling, general and administrative                        58,388(1)     54,189(2)      50,899         45,606         21,403
     Restructuring and other charges                            12,138(1)     12,561(2)          --             --             --
                                                             ---------     ---------      ---------      ---------      ---------
       Total operating expenses                                 86,886        83,633         65,797         56,787         30,265
                                                             ---------     ---------      ---------      ---------      ---------
  Income (loss) from operations                                (23,814)      (15,762)         2,608         (3,083)         5,527
  Interest income (expense), net                                  (958)       (1,222)        (1,819)        (1,860)           553
  Other income (expense), net                                    3,407          (578)          (359)          (368)           496
  Provision for litigation and related costs                        --            --             --             --        (19,230)
                                                             ---------     ---------      ---------      ---------      ---------
  Income (loss) before income taxes                            (21,365)      (17,562)           430         (5,311)       (12,654)
  Provision for income taxes                                       560           876          1,397            591          1,635
                                                             ---------     ---------      ---------      ---------      ---------

 Net loss                                                    $ (21,925)(1) $ (18,438)(2)  $    (967)     $  (5,902)     $ (14,289)
                                                             =========     =========      =========      =========      =========

 Net loss applicable to common shareholders                  $ (21,925)    $ (18,676)     $  (1,192)     $  (5,902)     $ (14,289)
                                                             =========     =========      =========      =========      =========

 Basic and diluted net loss per common share (5)             $   (1.07)    $   (0.96)     $   (0.07)     $   (0.38)     $   (0.95)
                                                             =========     =========      =========      =========      =========
 Shares used in basic and diluted net loss per common
   share calculation (5)                                        20,460        19,518         17,591         15,439         15,089
                                                             =========    =========      =========      =========      =========
</TABLE>


<TABLE>
<CAPTION>

                                                                                    DECEMBER 31,
                                                                                    ------------
                                                                                  (IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA
                                                         1998            1997           1996            1995            1994
                                                      ---------       ---------      ----------       ----------      ----------
<S>                                                   <C>             <C>             <C>             <C>             <C>      
Working capital                                       $  10,334       $  19,883       $  25,957       $   9,324       $   5,995
   Total assets                                          69,762          89,775         114,752          83,370          95,116
   Long-term liabilities, net of current portion         15,831          18,512          26,565          30,729          23,146
   Accumulated deficit                                  (79,803)        (57,878)        (39,202)        (38,010)        (32,108)
   Shareholders' equity                                  20,694          37,019          57,596          18,221          21,169
</TABLE>

(1)     Includes special charges of $17.6 million as follows: cost of sales -
        $1.8 million; research and development - $0.5 million; selling, general
        and administrative - $3.2 million; restructuring and other charges -
        $12.1 million (of which $8.1 million is the result of a write-down of
        goodwill).

(2)     Includes special charges of $18 million as follows: cost of sales - $3.1
        million; research and development - $0.1 million; selling, general and
        administrative - $2.2 million; restructuring and other charges - $12.6
        million (of which $10.3 million is the result of a write-down of
        goodwill).

(3)     Includes the operating results of Sonar Hearing Health Corporation,
        subsequent to the purchase of certain assets of the hearing health
        business activity of 3M in June 1996. See Note 2 of Notes to
        Consolidated Financial Statements.

(4)     Includes the operating results of Sonar Design & Hortechnik AG and
        Viennatone AG from their purchase dates of January and December 1994,
        respectively. See Note 2 of Notes to Consolidated Financial Statements.

(5)     Amounts for all periods have been restated to reflect the requirements
        of SFAS No. 128. See Note 1 of Notes to Consolidated Financial
        Statements.

                                       19
<PAGE>   20




UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL DATA 
(in thousands, except per share data)

<TABLE>
<CAPTION>

                                                                      THREE MONTH PERIOD ENDED
1998                                                 MARCH 28,    JUNE 27,      SEPTEMBER 26,      DECEMBER 31,
----                                                 ---------    --------      -------------      ------------
<S>                                                 <C>           <C>           <C>               <C>     
Consolidated Statements of Operations Data:
Net sales                                            $ 31,143       $ 33,884       $ 30,255           $ 28,160
Gross profit                                           16,686         18,897         13,750             13,739
Net income (loss)                                         974            683        (17,192)(1)         (6,390)(2)

Basic and diluted net income (loss) per common
   share                                             $    .05       $    .03       $   (.84)          $   (.31)


                                                                        THREE MONTH PERIOD ENDED
1997                                                MARCH 31,         JUNE 30,       SEPTEMBER 30,      DECEMBER 31,
----                                                ---------         --------       -------------      ------------

Consolidated Statements of Operations Data:
Net sales                                           $ 32,211          $ 32,230         $ 31,934          $ 34,088
Gross profit                                          17,100            17,499           15,710            17,562
Net loss                                                (894)           (1,499)         (13,295)(3)        (2,750)(4)

Basic and diluted net loss per common share         $   (.05)         $   (.08)        $   (.69)         $   (.14)

</TABLE>

(1)  Includes special charges of $16.6 million as follows: cost of sales - $1.8
     million; selling, general and administrative - $3.0 million; restructuring
     and other charges - $11.8 million (of which $8.1 million is the result of a
     write-down of goodwill).

(2)  Includes special charges of $1.0 million as follows: research and
     development - $0.5 million; selling, general and administrative - $0.2
     million; restructuring and other charges - $0.3 million.

(3)  Includes special charges of $13.6 million as follows: cost of sales - $1.8
     million; selling, general and administrative - $0.6 million; restructuring
     and other charges - $11.2 million (of which $10.3 million is the result of
     a write-down of goodwill).

(4)  Includes special charges of $4.4 million as follows: cost of sales - $1.3
     million; research and development - $0.1 million; selling, general and
     administrative - $1.6 million; restructuring and other charges - $1.4
     million.

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

OVERVIEW

         The Company was primarily engaged in research and development from its
inception in February 1984 through December 1989, when it commenced shipments of
its first In-the-Ear ("ITE") hearing devices and its Digital Hearing System
("DHS"), a hearing testing and programming system. Through December 31, 1998,
the Company has sold approximately 1.2 million hearing devices worldwide,
including over 294,000 in 1998, to more than 13,600 audiologists and hearing
device retail locations. In general, the Company's net sales have increased
primarily from higher volumes of product shipments and a broader product line
(due to both internal growth and acquisitions) rather than from increases in
product prices. Increases in the number of audiologists and hearing device
dispensers selling the Company's hearing instruments have contributed to the
higher volume of shipments.

         In the last several years, the Company has established significant
operations outside the United States. In 1994, the Company expanded its business
by acquiring two existing hearing health care companies in Europe, establishing
a manufacturing facility in Ireland and entering into an Asian distribution
joint venture. In 1995, the Company formed wholly owned subsidiaries in 



                                       20
<PAGE>   21


Australia and Sweden. In 1998, the Company formed a wholly owned subsidiary in
Switzerland, acquired an existing hearing healthcare company in the United
Kingdom, and sold the Viennatone retail business in Austria. The Company
currently derives 51% of its revenues from outside the United States.

ACQUISITIONS AND STRATEGIC ALLIANCES

         In 1994, the Company completed two acquisitions. On January 1, 1994,
the Company acquired all the outstanding ownership interests in Sonar Design &
Hortechnik GmbH for approximately $3.5 million in cash and 100,000 shares of
ReSound Common Stock. In 1996, this company was renamed ReSound Deutschland.
ReSound Deutschland, located in Munster, Germany, is a manufacturer and
distributor of both Sonar branded and ReSound branded hearing devices.

         On August 9, 1994, the Company entered into a joint venture agreement
establishing ReSound Asia Limited ("RSND Limited") with a large Hong Kong group
with diversified business interests. RSND Limited sells ReSound products in Hong
Kong through a Hong Kong based subsidiary. ReSound holds a 50% equity position
in the joint venture and provides technical and clinical expertise to the joint
venture.

         In December 1994, a newly formed Austrian subsidiary of the Company
acquired 100% of the shares of Viennatone AG, an Austrian company, for
approximately $27.7 million, and the Company's German subsidiary acquired the
net assets of a related business for approximately $0.6 million, or a total of
approximately $28.3 million (Viennatone AG owned an 80% interest in its Austrian
distribution company, Viennatone BVG). Viennatone, based in Vienna, Austria,
designs, manufactures and distributes BTE, ITE and other hearing devices and
components worldwide. The acquisition of Viennatone provided the Company with
Viennatone's electroacoustic and electromechanical technologies; expanded
distribution of ReSound products through Viennatone's established subsidiaries
in the United Kingdom, France, and Germany, as well as a retail chain in Austria
consisting of 19 stores; and provided access to high quality hearing device
cases and components. In 1996, the Company purchased the remaining minority
interest in Viennatone Hannover for $1.9 million in cash. In 1997, the Company
sold Viennatone's mechanical switch business for $1.5 million at the closing and
potential future royalty income of up to a further $1.5 million. In September
1998, Viennatone AG purchased the remaining minority interest in Viennatone BVG
for $82,000 and 40,000 shares of the Company's common stock (which will be
issued in 1999). In November 1998, the Company sold Viennatone BVG to the
Amplifon Group, a European hearing instruments retail distribution company,
headquartered in Italy, for $3.3 million. As part of the transaction, Viennatone
AG and Amplifon have entered into a strategic partnership under which Amplifon
has agreed to market and sell ReSound and Viennatone hearing healthcare products
throughout its retail outlets in Europe.

         In June 1996, the Company completed the purchase of certain assets of
the hearing health business activity of Minnesota Mining and Manufacturing
Company ("3M") for $25.4 million and established a subsidiary in the United
States, Sonar Hearing Health Corporation ("SHH"), to manage this activity on an
ongoing basis. International distribution of former 3M products is undertaken
through the Company's international subsidiaries. To finance this purchase and
provide working capital, the Company raised approximately $32.9 million (net
proceeds) through the private sale of 3,212,176 shares of common stock. Hearing
health constituted a small business activity in 3M's worldwide operations which
was neither a division nor subject to the maintenance of discrete accounting
records such that financial statements could be or are determinable. However,
the Company believes that this business activity generated revenues for 3M of
approximately $9.3 



                                       21
<PAGE>   22

million and $16.6 million for the six months ended June 30, 1996 and for the
year ended December 31, 1995, respectively. The total purchase price of $25.4
million included a cash payment of $24.9 million and $500,000 for related
acquisition expenses. Together with patents acquired from 3M valued at $7.5
million, patents valued at $2.5 million were separately acquired in July 1996 in
connection with the above acquisition. These patents were contributed to a
partnership comprised of eight hearing device manufacturers, including ReSound,
at December 31, 1998. In consideration, ReSound received cash payments from the
partnership members of $10.9 million (net) through December 31, 1998. Any future
amounts paid to the partnership will be divided equally among the partners. Cash
receipts from the sale of partnership interests has lowered the net purchase
price of the hearing health business activity of 3M to $14.5 million at December
31, 1998. In October 1998, the SHH sales force and marketing functions were
integrated into ReSound's existing U.S. organization. The newly integrated sales
force has actively encouraged the SHH customer base to convert to dispensing
ReSound devices. The SHH manufacturing facility will serve as a regional
manufacturing site supplying both the Sonar and ReSound devices. In Europe, SHH
has been integrated into ReSound's existing distribution structure.

         In January 1998, ReSound Autac GmbH, a newly formed subsidiary of the
Company located in Zurich, Switzerland, acquired all of the assets and
liabilities of a former Swiss distributor for $401,000. The agreement contains a
clause which obligates the seller for a period of five years not to compete in
the area of manufacture or distribution of hearing devices. Additionally, an
employment agreement was negotiated with the seller through December 31, 2002.

         In April 1998, ReSound-Viennatone Ltd. (a U.K. company) acquired all of
the assets and liabilities of Apex Acoustics, Ltd. from the Ultratone
Group, the largest hearing device retail chain in the United Kingdom, for
$750,000. Concurrent with the acquisition, the Company entered into a multi-year
supply agreement with Ultratone for customer hearing devices.

SALES

         The Company recognizes revenue upon shipment of products. Net sales
consist of gross sales less discounts and allowances for estimated returns. In
general, the Company has a 90-day return policy for sales in the United States.
The Company believes that the hearing device industry in the U.S. is
characterized by a relatively high rate of returns due to a number of factors,
including liberal consumer trial periods required by law in many states.
However, the Company's return rates in the U.S. are within the range it believes
are experienced by other programmable hearing device manufacturers. In 1998,
1997 and 1996, the provision for estimated sales returns in the U.S., expressed
as a percentage of domestic sales, has been 27%, 26% and 27%, respectively. Due
to the need to provide a return policy competitive with industry practice in the
U.S. and because of the importance of the initial fitting process, the Company
expects sales returns will continue at a relatively high rate. In Europe and
Asia, returns are not material due in part to the much higher proportion of
standard BTE sales versus custom product sales than in the U.S. as well as 
regional retail chain and dispenser practices.

COSTS AND EXPENSES

         Cost of sales consists of manufacturing costs, royalty expenses,
quality assurance costs and accruals associated with warranty repairs and
product remakes. In 1998, cost of sales as a percentage of net sales increased
to 49% from 48% in 1997 primarily due to pricing pressures on the Company's
analog product lines.


                                       22
<PAGE>   23



         The Company provides for estimated warranty costs at the time of sale
and adjusts these estimates based on subsequent experience. The period over
which warranty claims may be made in the U.S. is one to two years for electronic
components and 12 months for the custom shell used for ITE, ITC and CIC devices.
In 1998, 1997 and 1996, the approximate provisions for estimated warranty cost
(and as a percentage of net sales domestically) were $4.7 million (7.5%), $5.1
million (7.7%), and $4.4 million (7.6%), respectively. The period over which
warranty claims may be made in Europe and Asia is 12 months, and the amount of
these claims has not been material. The Company experiences a high rate of
warranty claims related to damage and blockage of the speaker caused by moisture
and accumulated ear wax. The Company expects such claims to continue to be
significant and expects warranty costs for the current hearing device product
line to continue to represent a significant component of cost of sales.

         In the second half of 1997, the Company recorded special charges of
$18.0 million associated with the Company's strategic restructuring program.
This program was designed to streamline operations and control costs through
management restructuring, operations consolidations, and increased focus on core
activities and product lines.

         The special charges provided for costs associated with employee
termination benefits for approximately 100 employees from all functional areas
in various subsidiary locations; lease termination costs; the write-down of
goodwill associated with the acquired hearing health business activity of 3M
(which was renamed Sonar Hearing Health, "SHH"); the incremental impairments in
the carrying value of certain product inventories; and losses on supplier
commitments arising directly from the decision to exit product lines.

         As of December 31, 1998 and 1997, $0.8 million and $6.2 million,
respectively, remained of the 1997 restructuring accrual. The Company made cash
payments of approximately $2.2 million and $819,000 relating to the special
charges in 1998 and 1997, respectively. The remaining 1997 restructuring accrual
of $0.8 million will be substantially utilized by December 31, 1999.

         In the second half of 1998, the Company recorded special charges of
$17.6 million associated with the Company's new strategic restructuring program.
This program is designed to realign the Company's organizational structure,
streamline internal processes, and consolidate facilities worldwide in order to
achieve sustainable profitability.

         The special charges provided for costs associated with write-down of
inventories to net realizable value and losses on supplier commitments,
write-down of capital assets to fair value, write-down of goodwill, employee
termination benefits and lease termination costs, and other exit costs, as
follows (in thousands):
<TABLE>
<CAPTION>

<S>                                                                                                   <C>   
Employee termination benefits and lease termination costs                                             $4,038
Write-down of goodwill in ReSound Autac and Viennatone                                                 8,082
Write-down of inventories to net realizable value and losses 
   on supplier commitments commitments                                                                 1,832
Write-down of capital assets to fair value                                                             1,344
Other exit costs                                                                                       2,328
                                                                                                     -------
                                                                                                     $17,624
                                                                                                     =======

</TABLE>



                                       23
<PAGE>   24

RESULTS OF OPERATIONS

         The following table sets forth, for the periods indicated, certain
statements of operations data as a percentage of net sales:

<TABLE>
<CAPTION>
                                            YEARS ENDED DECEMBER 31,
                                          1998        1997      1996
                                          ----        ----      ----

<S>                                  <C>               <C>      <C> 
Net sales                                  100%       100%       100%
Cost of sales                               49         48         46
                                          ----       ----       ----
Gross profit                                51         52         54
Operating expenses:
  Research and development                  13         13         12
  Selling, general and administrative       47         41         41
  Restructuring and other charges           10         10         --
                                          ----       ----       ----
         Total operating expenses           70         64         53
                                          ----       ----       ----
Income (loss) from operations              (19)       (12)         1
Interest expense, net                       (1)        (1)        (1)
Other income (expense), net                  3         --         --
                                          ----       ----       ----
Income (loss) before income taxes          (17)       (13)        --
Provision for income taxes                   1          1          1
                                          ----       ----       ----
Net loss                                   (18)%      (14)%       (1)%
                                          ====       ====       ====
</TABLE>


Years Ended December 31, 1998 and 1997

         Net sales decreased by 5.4% to $123.4 million in 1998 compared to
$130.5 million in 1997. International sales accounted for 51% of the Company's
net sales in 1998 compared to 49% in 1997. International sales in 1998 were $62
million, down from $64 million in 1997. The shortfall in international revenue
resulted primarily from a delay in the shipment of a significant tender order at
the end of 1998, increased pricing pressures on analog devices, poor hearing
device market conditions in Germany and Austria together with management and
employee turnover at Viennatone, the Company's Austrian subsidiary, and weaker
European currencies compared to the U.S. dollar. Additionally, economic
uncertainty in Japan coupled with lower shipments to the Company's Japanese
distributor contributed to sales reductions in the Asia-Pacific region in 1998
when compared to 1997. The decrease in these regions sales was partly offset by
strong sales in Northern Europe, particularly Scandinavia. The shortfall in
revenue in North America in 1998 compared to 1997 was primarily attributable to
a more rapid than expected decrease in Sonar Hearing Health orders as the
Company completes conversion of Sonar customers to the ReSound product line, a
slower than expected ramp up in manufacturing for the new Digital 5000 products,
and continued pricing pressures on analog products. The Company believes the
issues contributing to the sales shortfall, particularly in the fourth quarter
of 1998, compared to the same period in 1997, are temporary and will be resolved
in 1999. Ramp up of production of the Digital 5000 is on track and the Company
expects to be able to meet customer demand for the products in the first quarter
of 1999. The total number of audiologists and hearing device retail locations
selling the Company's products increased in the U.S. from over 4,700 at the end
of 1997 to over 5,500 at the end of 1998. The number of acousticians and hearing
device dispensers selling the Company's products internationally was 4,464 at
the end of 1998, compared to 3,715 at the end of 1997.

         Cost of sales decreased to $60.4 million in 1998 from $62.6 million in
1997. Gross profit decreased to $63.1 million in 1998 from $67.9 million in
1997, and as a percentage of net sales 

                                       24
<PAGE>   25


decreased to 51% in 1998 from 52% in 1997. Excluding the impact of special
charges, gross profit in 1998 was 53% of net sales, compared to 54% of net sales
in 1997. Special charges to cost of sales of $1.8 million in 1998 compared with
$3.1 million in 1997 relate primarily to the write-off of inventory for
discontinued product lines. Gross profit was adversely affected by continued
pricing pressures on analog products and a slower than expected ramp up of
production for the Digital 5000.

         Research and development ("R&D") expenses decreased by 3% to $16.4
million (13% of net sales) in 1998 from $16.9 million (13% of net sales) in
1997. Excluding the impact of special charges, R&D spending in 1998 was $15.9
million compared to $16.8 million in 1997. Spending was primarily attributable
to development of new products including new digital signal processing
platforms, the Avance - the Company's hearing enhancer product, and
communication products developed through the joint alliance with Motorola.
During 1997, the Company entered into a joint development agreement with
Motorola whereby Motorola has committed to provide joint development funds,
technology and other resources for this project through January 2000. During
1998 and 1997, Motorola paid $2.9 million and $2.0 million, respectively, to
ReSound as part of this alliance. The funds received by the Company have been
recorded as a reduction of the Company's R&D expenses. Total costs incurred by
the Company related to this agreement were $3.8 million and $1.3 million in 1998
and 1997, respectively. In September 1998, the Company and Motorola announced
the introduction of the CommPort system, an integrated microphone and receiver
two-way radio system for the public safety market.

         Selling, general and administrative ("SG&A") expenses increased by 8%
to $58.4 million (47% of net sales) in 1998 from $54.2 million (41% of net
sales) in 1997. Excluding the impact of special charges, SG&A spending in 1998
was $55.2 million compared to $52.0 million in 1997. The increase in SG&A
expenses in 1998 was primarily attributable to the additional expenses resulting
from the acquisitions of Apex Acoustics in the United Kingdom and Autac in
Switzerland, and higher sales and marketing expenses related to introductions of
the new Digital 5000 and Avance product lines.

         Restructuring charges of $12.1 million and $12.6 million were recorded
in 1998 and 1997, respectively. The restructuring charges resulted primarily
from the write-down of goodwill relating to the acquisitions of ReSound Autac
and Viennatone AG ($8.1 million), and the acquired hearing health business
activity of 3M ($10.3 million) in 1998 and 1997, respectively. The remaining
charges in both 1998 and 1997 resulted from lease termination costs and employee
termination benefits relative to work force reductions.

         The Company expects expenses generally to continue at comparable
levels, excluding the special charges, but to fluctuate as a percentage of
sales. As discussed above, the Company is undertaking programs to increase
operational efficiency and effectiveness in order to reduce expenses, but no
assurance can be given that reductions will be obtained, especially when
measured on a percentage of sales basis which may vary substantially
quarter-to-quarter.

         Net interest expense was $958,000 in 1998, compared to $1.2 million in
1997. This year-to-year decrease is primarily due to the Company's continued
repayment of debt in 1998, partially offset by lower interest income earned on
its average cash balances.

         Net other income (expense) was $3.4 million (income) in 1998 compared
to $578,000 (expense) in 1997. The year-to-year change was primarily
attributable to receipts of $3.0 million under a patent license agreement in
1998, and favorable foreign currency exchange rates.

                                       25

<PAGE>   26

         Income tax provisions were $560,000 in 1998 and $876,000 in 1997.
Income taxes primarily represent taxes on profits earned at the Company's
European subsidiaries in Ireland, Germany and the Netherlands. At December 31,
1998, the Company had U.S. federal and California net operating loss
carryforwards of approximately $37.3 million and $8.5 million, respectively. The
federal net operating loss carryforwards will expire at various dates beginning
in 2002 through 2018, if not utilized. The California net operating loss
carryforwards will expire at various dates beginning in 1999 through 2003, if
not utilized. Each international subsidiary is subject to income taxes in the
countries in which it operates. The income of these subsidiaries is not included
in the Company's U.S. federal and state income tax returns. The Company had
foreign net operating loss carryforwards of approximately $36.5 million at
December 31, 1998, which will expire at various dates beginning in 1999 through
2004, if not utilized.

         The Company had a net loss of $21.9 million in 1998 compared to a net
loss of $18.7 million in 1997. Excluding the impact of special charges, the
Company had a net loss of $4.3 million in 1998 compared to a net loss of $0.7
million in 1997.

Years Ended December 31, 1997 and 1996

         Net sales increased by 3.8% to $130.5 million in 1997 compared to
$125.6 million in 1996 due to new product introductions, continued strong sales
of the Encore product line, the inclusion of sales relating to products acquired
from 3M Hearing Health for a full year, and the increased sales of the Company's
ITE and ITC hearing devices. These increases were partially offset by
intensified competition in the programmable segment of the hearing device market
from digital signal processing product offerings, pricing pressures from
competitors' analog products, a product mix shift to more moderately priced
models, and decreased international sales. Further, the Viennatone subsidiary
experienced increased competition and pricing pressures which resulted in an
increase in price and unit volume erosion during 1997. The total number of
audiologists and hearing device retail locations selling the Company's products
increased in the U.S. from over 3,600 at the end of 1996 to over 4,700 at the
end of 1997. The number of acousticians and hearing device dispensers selling
the Company's products internationally was 3,715 at the end of 1997.
International sales for the twelve months ended December 31, 1997 were 10% lower
in comparison with 1996 due primarily to the adverse impact of foreign currency
exchange fluctuations. At constant foreign exchange rates, international sales
increased approximately 2%. International sales as a percentage of net sales in
1997 and 1996 were 49% and 56%, respectively. International sales were
unfavorably impacted by increased competition, slowing market conditions in key
European countries due in part to sluggish economies, and negative changes in
governmental reimbursement programs. Additionally, during the fourth quarter of
1997, the German hearing device market was negatively impacted by adverse
publicity surrounding hearing device dispensers and ear, nose and throat doctors
regarding the distribution of hearing devices. Sales of the Company's products
in the German market were correspondingly negatively impacted.

         Cost of sales increased to $62.6 million in 1997 from $57.2 million in
1996. Gross profit decreased to $67.9 million in 1997 from $68.4 million in
1996, and as a percentage of net sales decreased to 52% in 1997 from 54% in
1996. The year-to-year decrease in gross profit was largely attributable to the
$3.1 million special charge for discontinued product lines, as part of a
comprehensive program to streamline operations. Additionally, average unit sales
prices declined due to increasing competition and product mix sales shifts,
particularly in the U.S., from the higher priced Premium Series product line to
the more moderately priced Encore Series product line. This impact was largely
offset by reductions in the cost of goods sold.


                                       26

<PAGE>   27

         R&D expenses increased by 13% to $16.9 million (13% of net sales) for
1997 from $14.9 million (12% of net sales) for 1996. The Company increased
spending during the twelve months ended December 31, 1997 relative to the prior
year for the continued development of new products being introduced throughout
1997 and for products planned for future years. In April 1997, the Company
introduced its Advanced ReSound Processing chip incorporating ReSound's Cochlea
Dynamics technology into a BTE and a CIC hearing device. In addition, expenses
were incurred for the development of a standard hardware platform for Digital
Signal Processing technology as part of an alliance with AudioLogic, Inc., and
GN Danavox A/S which was announced in April 1996 and finalized on September 30,
1996. Expenses were also incurred for the development of proprietary technology
relating to potential communications products and hearing devices in conjunction
with the alliance with Motorola. Such expenses were partially offset by $2.0
million of payments received from Motorola.

         Restructuring charges of $12.6 million in 1997 resulted from the
write-down of goodwill associated with the acquired hearing health business
activity of 3M ($10.3 million), lease termination costs and employee termination
benefits relative to work force reductions.

         SG&A expenses increased by 6% to $54.2 million (41% of net sales) in
1997 from $50.9 million (41% of net sales) in 1996. This year-to-year increase
in expenditures resulted mainly from the inclusion of a full year of SHH
expenses, and special charges of $2.2 million relating to a strategic program to
streamline operations and control costs.

         Interest income was $269,000 in 1997, compared to $184,000 in 1996.
This year-to-year increase was primarily due to an increase in the average cash
and short-term investment balances resulting from the increase in cash
collections of accounts receivable and the reduction of inventory kept on hand.

         Interest expense was $1.5 million in 1997, compared to $2.0 million in
1996. This decrease was primarily due to the Company paying down debt in 1997.

         Other expense was $578,000 in 1997 compared to $359,000 in 1996. The
year-to-year increase was primarily attributable to realized losses on foreign
currency transactions of $984,000 which were partially offset by a $300,000 gain
on sale of Viennatone's switch business and a $431,000 reduction in the
liability for a minority shareholder's interest in a subsidiary of Viennatone.
The 1996 amount consisted primarily of realized losses on foreign currency
transactions.

         Income tax provisions were $876,000 in 1997 and $1.4 million in 1996.
Income taxes primarily represent taxes on profits earned at the Company's
European subsidiaries in Ireland, Germany and the Netherlands. Each
international subsidiary is subject to income taxes in the countries in which it
operates. The income of these subsidiaries is not included in the Company's U.S.
federal and state income tax returns.

LIQUIDITY AND CAPITAL RESOURCES

         Operating Activities

         Net cash used in operations in 1998 was $10.4 million compared to $13.1
million in cash generated from operations in 1997. The additional $23.5 million
used in 1998 compared to 1997 related primarily from the following: (1) a $21.9
million net loss in 1998, compared to an $18.4 


                                       27
<PAGE>   28

million net loss in 1997; (2) an increase in inventory of $2.6 million primarily
due to a delay in the shipment of a significant tender order at the end of 1998
compared to a decrease in inventory of $6.6 million in 1997; (3) an increase in
other assets of $4.3 million due primarily to a strengthening of certain
European currencies against the U.S. dollar, $1.7 million in other receivables,
representing the final installment of the sales price for the Viennatone retail
business and $1.0 million of restricted cash on deposit with the Company's
primary bank (see "Financing Activities" below) and (4) decreases in accrued
liabilities and accounts payable of $6.2 million caused primarily by the timing
of expenditures in connection with the Company's 1997 strategic restructuring
program. The above uses of cash in operations were partially offset by non-cash
charges of $15.0 million associated with restructuring charges in the second
half of 1998, non-cash charges of $8.1 million relating to depreciation and
amortization, and a decrease in accounts receivable compared with December 31,
1997 of $1.3 million.

         Investing Activities

         Net cash used in investing activities in 1998 was $3.3 million compared
to $150,000 in cash provided by investing activities in 1997. The use of cash in
1998 resulted from additions of property and equipment of $8.0 million and cash
used in the acquisitions of ReSound Autac, Apex Acoustics and the remaining
minority interest in Viennatone BVG of $1.2 million. These amounts were
partially offset by positive changes in accumulated comprehensive income
(cumulative translation adjustment), by proceeds from the sale of Viennatone BVG
of $3.3 million and by $900,000 in patent fees received for licensing certain
technology acquired by the Company in 1996 and 1997. Net cash generated by
investing activities in 1997 resulted primarily from proceeds from the patent
club contributions and the sale of the Viennatone switch activity offset by
additions to property and equipment.

         Financing Activities

         Net cash provided by financing activities in 1998 was $0.5 million due
primarily to proceeds from issuance of common stock of $2.0 million and $0.5
million in new bank loans partially offset by payments on long-term debt of $2.0
million. Net cash used in financing activities in 1997 was $1.4 million due
primarily to payments on long-term debt of $2.0 million partially offset by
proceeds from issuance of common stock of $642,000.

         At December 31, 1998, the Company had available cash and cash
equivalents of $6.7 million. In addition, included in other current assets at
December 31, 1998 is $500,000 of cash which was deposited with the Company's
primary bank as security for a letter of credit in connection with the purchase
of technology. The letter of credit and the cash hold on collateral were
released in March 1999. Further, other assets at December 31, 1998 included
restricted cash of $525,000 which was deposited with the Company's primary bank.
These deposits related to the Company's Purchase Card program, which is secured
by an ongoing deposit of $125,000 and an additional $400,000 secures debt,
through February 2002, of an executive officer of the Company, related to the
purchase of a private residence in connection with the executive officer's
relocation. While the Company believes that available cash will be sufficient to
meet the Company's short-term operating and capital requirements through
December 31, 1999, the Company may be required to raise additional capital for
its currently envisaged long-term needs and in connection with any future
strategic activities. In February 1999, the Company obtained a line of credit of
up to $3 million, secured by its U.S. assets, from a U.S. bank.

                                       28
<PAGE>   29

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

         Competition and pricing pressures, especially from mid-priced new
digital products, are expected to increase. The Company's ability to grow and
achieve profitability will depend upon its ability to continue to develop or
otherwise acquire and effectively market competitive hearing health care
products based on digital signal processing technology (DSP). There can be no
assurance that the Company can develop and introduce these products in a timely
manner, or that these products will be able to compete effectively against
current or new competing products. The development or acquisition of new
products is always subject to technological risks and uncertainties which could
cause termination of the development of the product or termination of or delay
in the introduction of the product, or which could significantly decrease the
originally anticipated level of customer acceptance of the product. Also, there
can be no assurance that a new product can be manufactured on a cost-effective
basis, that regulatory approvals, where necessary, can be obtained, or that the
expected level of customer acceptance will be met. In addition, announcements of
new products may cause hearing health care professionals or hearing impaired
persons to defer purchases of existing products or return previously purchased
products. The Company's failure to introduce competitive products in a timely
manner would have a material, adverse impact on the Company's business,
financial condition and results of operations. See "Business - Competition" for
a discussion of the competitive environment.

         During 1997 and 1998, the Company initiated strategic restructuring
programs. There can be no assurance that the Company will be able to implement
these programs in a timely manner, consolidate targeted operations successfully,
or otherwise achieve the cost reductions and other restructuring benefits
anticipated.

         Due to weak economic conditions in certain countries in Europe (in
particular, Germany, Austria and France) and elsewhere, some governments have
reduced and/or are under increasing pressure to reduce government reimbursement
levels available to consumers on the purchases of hearing devices. Recent
reductions in reimbursement levels have had a negative impact on the Company's
revenues in the affected markets. Any future reimbursement reductions can also
be anticipated to have a negative impact on the Company's revenues. The Company
cannot predict whether or the extent to which further reimbursement reductions
will be implemented.

         Similarly, it can be expected that the Company's sales results in
Europe would be adversely impacted if there were a future recurrence of the
appreciation of the U.S. dollar versus European currencies that was experienced
in 1997.

         A much publicized dispute in Germany between ear, nose and throat
professionals who prescribe hearing devices and acousticians who dispense them,
negatively impacted the overall hearing health care market. Consumer demand for
hearing devices in the fourth quarter of 1997 in the German market was down
substantially from the fourth quarter of 1996, and sales of the Company's
products were correspondingly unfavorably impacted. This effect has continued in
1998. The Company cannot predict how long and the extent to which its sales in
Germany will continue to be negatively impacted by this dispute.

         The Company is subject to regulation by the FDA and numerous other
federal, state, local and international laws and regulations involving, among
other matters, the development, production and marketing of its products, safe
working conditions, manufacturing practices, and environmental protection.
Failure to comply with applicable regulatory statutes and regulations can result
in fines, suspensions, delays in marketing or loss of permission to market
products, seizures or recalls of 



                                       29
<PAGE>   30



products, operating restrictions, injunctions, civil fines and criminal
prosecution. Also, new regulatory requirements may significantly increase the
costs of compliance with these laws and regulations. See "Business - Government
Regulation" for a description of these laws and regulations.

         The Company has been issued or has applied for a substantial number of
patents. No assurance can be given that pending patent applications will be
approved, that current or future patents will provide or continue to provide
competitive advantages for the Company's products, will not be challenged or
circumvented, or will afford the same degree of protection for future products
as they do for current products. Also, the Company may be contacted by parties
claiming that the Company's products infringe such parties' patent or other
proprietary rights. The Company may also find it necessary to institute
litigation to enforce patents issued to it, to protect trade secrets or know-how
owned by it or to determine the scope and validity of the patents or other
proprietary rights of others. Resolution of these claims generally involves
complex legal and factual questions and is highly uncertain. The cost of
prosecuting or defending these suits is high, and adverse determinations could
subject the Company to significant liabilities to third parties and require the
Company to seek licenses from other parties, prevent the Company from
manufacturing and selling its products, and/or require the Company to redesign
its products, all of which could have a materially adverse effect on the
Company's financial condition. Also, there can be no assurance that
confidentiality agreements between the Company and its employees or consultants
will not be breached, or that the Company will have adequate remedies for any
breach, or that it will otherwise be able to protect its trade secrets.
Furthermore, no assurance can be given that competitors will not independently
develop substantially equivalent proprietary technology or disclose such
technology, or that the Company can meaningfully protect its rights in such
unpatented proprietary technology. See "Business-Patents, Trade Secrets and
Licenses" for a discussion of the Company's patents and other intellectual
property.

         During the last year, the Company experienced various changes in its
management and technical staff. Competition for employees with technical,
management and other skills is intense. The Company's failure to retain the
services of key personnel or to attract additional qualified employees could
materially and adversely affect the Company's business.

         Certain key components used in the Company's products are currently
available only from single or limited sources. The Company's inability to obtain
sufficient sole source or limited source components or subassemblies as
required, or to develop alternative sources if and as required, would have a
material adverse effect on the Company's financial condition.

         Other factors which could impact the Company's revenues and results of
operations include a significant reduction in product sales to certain
customers, economic downturns in certain markets, and the costs incurred to
expand distribution in Europe and Asia. In connection with the Company's
international sales, a number of risks are inherent in international
transactions. Fluctuations in the exchange rates between the U.S. dollar and
other currencies could increase the sales price of the Company's products in
international markets where the prices of the Company's products are denominated
in U.S. dollars or lead to currency exchange losses where the prices of the
Company's products are denominated in local currencies. International sales and
operations may also be limited or disrupted by the imposition of governmental
controls, regulation of medical devices, export license requirements, political
instability, trade restrictions, changes in tariffs, and difficulties in
staffing and managing international operations.



                                       30
<PAGE>   31

         On January 1, 1999, eleven of the fifteen member countries of the
European Union established fixed conversion rates between their existing
sovereign currencies and the Euro, and adopted the Euro as their new common
legal currency. As of that date, the Euro is traded on currency exchanges and
the sovereign currencies remain legal tender in the participating countries for
a transition period between January 1, 1999 and January 1, 2002. During the
transition period, non-cash transactions can be made in Euros, and parties can
elect to pay for goods and services and transact business using either the Euro
or sovereign currency. Between January 1, 2002 and July 1, 2002, the
participating countries will introduce Euro notes and coins and withdraw all
legacy currencies so that they will no longer be available. The Euro conversion
may affect cross-border competition by creating cross-border price transparency.
The Company has assessed its pricing/marketing strategy in order to insure that
it remains competitive in a broader European market. The Company has also
assessed its information technology systems to allow transactions to take place
in both the legacy currencies and the Euro, and to allow for the eventual
elimination of the legacy currencies. Additionally, the Company is reviewing
whether certain existing contracts will need to be modified. The Company's
currency risk and risk management for operations in participating countries may
be reduced as the legacy currencies are converted to the Euro. The Company will
continue to evaluate issues involving the introduction of the Euro. Based on the
Company's assessment of current information, it is not expected that the Euro
conversion will have a material adverse effect on its business, financial
condition, or results of operations.

           The market price of the Company's common stock may be subject to
significant fluctuations. These fluctuations may be due to factors specific to
the Company, such as quarterly fluctuations in the Company's financial results,
changes in analysts' estimates of future results, litigation and regulatory
developments, changes in investors' perceptions of the Company or the
announcement of new or enhanced products by the Company or its competitors. In
addition, such fluctuations may be due to or exacerbated by general conditions
in the medical device industry or conditions in the financial markets generally.

         The Company has for the most part assessed the impact that the arrival
of the year 2000 may have on its business and operations. This issue arises
because many of the computer systems and software products currently in use are
coded to accept only two-digit entries in the date code field. When the year
2000 arrives, these date code fields will have to accept four-digit entries to
distinguish between dates in the twentieth century from those in the
twenty-first. There is widespread concern that, given the extent to which
computers, software and integrated circuits have come to permeate every facet of
today's society, including the world of commerce, the failure to distinguish
between dates beginning with "19" and those beginning with "20" may cause
widespread disruption to the conduct of business in the United States and
throughout the world.

         In response to these concerns, the Company launched a program to assess
the impact of the year 2000 on its products, operations and business and on the
products, operations and businesses of those third-party vendors and suppliers
with which the Company has material relationships.

         In assessing the impact on operations, the Company has completed an
inventory of the various hardware platforms and software products used
throughout the Company. These include centralized software applications used by
the Company to manage its core operations, such as supply chain management,
engineering, customer service and accounting, desktop applications used by
Company employees, and infrastructure hardware such as mid-range platforms,
desktop PCs, and plant floor equipment.


                                       31
<PAGE>   32


         The next step in the assessment process was to determine whether or not
the infrastructure hardware and various software applications used by the
Company are year 2000 compliant; that is, whether the arrival of the year 2000
will cause the subject hardware or software to malfunction or cause a disruption
to the Company's operations.

         The Company has determined that year 2000 issues exist with certain of
the desktop software applications in use throughout the Company. The Company
intends to implement solutions to these issues as they become available from the
vendors of these applications. To the extent that solutions are not made
available by the vendors of such products, the Company will replace such
products with equivalent year 2000 compliant desktop applications. The Company
has commenced implementation and expects that by the end of the third quarter of
1999, it will have fully implemented vendor-provided solutions to these issues
or have completed its program to implement replacement applications.

         The Company has determined that its supply chain management, customer
service, and accounting software applications may have year 2000 issues.
However, the Company had previously intended to and is in the process of
upgrading such software applications, which upgrades are designed to resolve any
year 2000 issues. The Company expects all U.S. locations, and its manufacturing
locations outside the U.S., to be upgraded by the end of the second quarter of
1999, and all other locations to be upgraded by the end of the third quarter of
1999. The timing of and expense associated with such upgrades have not been
affected by the need to address year 2000 concerns.

         The Company has implemented, where necessary, year 2000 compliant
solutions for its infrastructure hardware and engineering software.

         In addition to assessing the impact of the year 2000 on its internal
operations, the Company has also assessed the impact of the year 2000 on its
products. The Company has assessed the impact of the year 2000 on its hearing
devices and fitting systems software products and has communicated with vendors
of critical components to assess the year 2000 compliance of such components and
such vendors' state of readiness for the year 2000. The Company has determined
that its hearing devices are year 2000 compliant. The Company's fitting systems
software products have also been determined to be year 2000 compliant.
Additionally, by the end of April 1999, the Company will have completed an
assessment of the impact of the year 2000 on the vendors of critical components
and their products.

         To date, the Company has incurred approximately $200,000 in addressing
the impact of the year 2000. Such amounts have been expensed as incurred. The
Company estimates that total costs of addressing the year 2000 problem will not
exceed $400,000.

         The Company believes that a significant risk it faces from the year
2000 is risk that is outside of its control. Notwithstanding written assurances
from the Company's vendors regarding year 2000 compliance, there is no guarantee
that the year 2000 will not cause a disruption in supply of critical components.
To address this issue, the Company is considering a contingency plan of
establishing a reasonable safety stock of critical, sole-sourced components in
amounts that will permit the Company to weather an interruption of supply. Given
the Company's reliance on suppliers of critical, sole-sourced components for its
devices, the Company is relying on these suppliers to address the year 2000
issues in their own products and operations, and the failure of such suppliers
to adequately address these issues could have a material adverse effect on the
Company's business, financial condition and results of operations.

                                       32
<PAGE>   33

         The discussion of the Company's efforts and expectations relating to
year 2000 compliance are forward-looking statements. The Company's ability to
achieve year 2000 compliance both with respect to its internal operations and
its products, and the level of incremental costs associated therewith, could be
adversely impacted by, among other things, failure to identify all susceptible
systems or products, the availability and costs of upgrades to hardware
platforms and software products necessary to achieve year 2000 compliance, the
availability and costs of alternative hardware platforms and software products
that may be necessary to replace non year-2000 compliant products, the actions
of vendors with respect to components critical to the Company's products,
particularly sole-sourced components, and unanticipated problems identified in
the Company's ongoing assessment. Any of such factors could have a material
adverse effect on the Company's business, financial condition, and results of
operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The information required by this Item is included under the section 
entitled "Management's Discussion and Analysis of Financial Condition and 
Results of Operations -- Factors That May Affect Future Operating Results" on 
pages 29 and 30.


                                       33
<PAGE>   34




ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>

                                                                   PAGE
                                                                   ----

<S>                                                                <C>
   Report of Ernst & Young LLP, Independent Auditors                35

   Consolidated Financial Statements:

       Consolidated Balance Sheets                                  36

       Consolidated Statements of Operations                        37

       Consolidated Statement of Shareholders' Equity               38

       Consolidated Statements of Cash Flows                        39

       Notes to Consolidated Financial Statements                   40

</TABLE>



                                       34
<PAGE>   35





                REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS


To the Board of Directors and Shareholders
ReSound Corporation

         We have audited the accompanying consolidated balance sheets of ReSound
Corporation as of December 31, 1998 and 1997, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. Our audits also included the
financial statement schedule listed in the Index at item 14(a)(2). These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our 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 consolidated financial position of
ReSound Corporation at December 31, 1998 and 1997, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.



Ernst & Young LLP


Palo Alto, California
January 22, 1999


                                       35



                                       
<PAGE>   36

                               RESOUND CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                        (IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>

                                     ASSETS
                                                                                              DECEMBER 31,
                                                                                     --------------------------
                                                                                       1998              1997
                                                                                       ----              ----
<S>                                                                                  <C>               <C>
Current assets:
  Cash and cash equivalents                                                          $  6,715          $ 19,853
  Accounts receivable, net of allowances for estimated
    returns and doubtful accounts of $6,214 and $7,064
    at December 31, 1998 and 1997, respectively                                        16,892            17,966
  Inventories                                                                          16,199            14,183
  Other receivables                                                                     2,313               432
  Other current assets                                                                  1,452             1,693
                                                                                     --------          --------
         Total current assets                                                          43,571            54,127

Property and equipment, net                                                            10,734            10,838
Goodwill, net of accumulated amortization
   of $5,433 and $4,547 at December 31, 1998 and 1997,
   respectively                                                                        12,263            20,217
Other assets                                                                            3,194             4,593
                                                                                     --------          --------
                                                                                     $ 69,762          $ 89,775
                                                                                     ========          ========
                                     LIABILITIES AND SHAREHOLDERS' EQUITY
                                       
Current liabilities:
  Bank loans                                                                         $  4,646          $  1,663
  Accounts payable                                                                      8,253             8,735
  Accrued liabilities                                                                  18,548            19,484
  Long-term debt, current portion                                                       1,790             4,362
                                                                                     --------          --------
         Total current liabilities                                                     33,237            34,244

Long-term liabilities:
  Long-term debt, non-current portion                                                  12,815            14,274
  Employee benefits                                                                     2,891             3,738
  Other accrued liabilities                                                               125               500
                                                                                     --------          --------
         Total long-term liabilities                                                   15,831            18,512

Commitments and contingencies (Note 7)

Shareholders' equity:
  Common stock, par value $0.01:
     Authorized: 50,000,000 shares;
     Issued and outstanding: 20,737,396 and 20,147,720
     shares at December 31, 1998 and 1997, respectively                                99,363            96,785
   Deferred compensation                                                                 (360)              ---
   Accumulated comprehensive income (loss)                                              1,494            (1,888)
   Accumulated deficit                                                                (79,803)          (57,878)
                                                                                     --------          --------
         Total shareholders' equity                                                    20,694            37,019
                                                                                     --------          --------
                                                                                     $ 69,762          $ 89,775
                                                                                     ========          ========
</TABLE>

              The accompanying notes are an integral part of these
                       consolidated financial statements.

                                       36
<PAGE>   37




                               RESOUND CORPORATION
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>


                                                                      YEAR ENDED DECEMBER 31,
                                                           -------------------------------------------
                                                             1998             1997             1996
                                                           ---------        ---------        ---------

<S>                                                        <C>              <C>              <C>      
Net sales                                                  $ 123,442        $ 130,463        $ 125,646
Cost of sales                                                 60,370           62,592           57,241
                                                           ---------        ---------        ---------
         Gross profit                                         63,072           67,871           68,405

Operating expenses:
  Research and development                                    16,360           16,883           14,898
  Selling, general and administrative                         58,388           54,189           50,899
  Restructuring and other charges                             12,138           12,561               --
                                                           ---------        ---------        ---------
         Total operating expenses                             86,886           83,633           65,797
                                                           ---------        ---------        ---------

Income (loss) from operations                                (23,814)         (15,762)           2,608

Interest expense, net                                           (958)          (1,222)          (1,819)
Other income (expense), net                                    3,407             (578)            (359)
                                                           ---------        ---------        ---------

Income (loss) before income taxes                            (21,365)         (17,562)             430
Provision for income taxes                                       560              876            1,397
                                                           ---------        ---------        ---------

Net loss                                                   $ (21,925)       $ (18,438)       $    (967)
Preferred dividends                                               --             (238)            (225)
                                                           ---------        ---------        ---------
Net loss applicable to common shareholders                 $ (21,925)       $ (18,676)       $  (1,192)
                                                           =========        =========        =========

Basic and diluted net loss per common share                $   (1.07)       $   (0.96)       $   (0.07)
                                                           =========        =========        =========

Shares used in basic and diluted net loss per common
  share calculation                                           20,460           19,518           17,591
                                                           =========        =========        =========
</TABLE>




              The accompanying notes are an integral part of these
                       consolidated financial statements.

                                       37

<PAGE>   38
                               RESOUND CORPORATION
                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                    Accumulated                   Total
                                           Preferred       Common      Deferred    Comprehensive  Accumulated  Shareholders'
                                             Stock         Stock     Compensation  Income (Loss)   Deficit        Equity
                                           ---------      --------   ------------  -------------  -----------  ------------
<S>                                        <C>            <C>        <C>           <C>            <C>          <C>     
Balances at December 31, 1995               $     --      $ 54,292     $     --      $  1,939      $(38,010)     $ 18,221
                                                                                                                 --------
  Net loss                                        --            --           --            --          (967)         (967)
  Change in cumulative translation
    adjustment                                    --            --           --        (1,046)           --        (1,046)
                                                                                                                 --------
  Comprehensive loss                              --            --           --            --            --        (2,013)
                                                                                                                 --------
  Issuance of 54 shares of 6%
     convertible redeemable
     preferred stock                           5,000            --           --            --            --         5,000
  Exercise of stock options for 225
     shares of common stock                       --         1,055           --            --            --         1,055
  Issuance of 71 shares of common
     stock for employee stock
     purchase plan                                --           385           --            --            --           385
  Issuance of 3,212 shares of
     common stock under private
     placement (net proceeds)                     --        32,900           --            --            --        32,900
  Issuance of 266 shares of common
     stock upon conversion of
     Company's promissory note and
     related interest                             --         2,048           --            --            --         2,048
  Accrued dividends on preferred stock           225            --           --            --          (225)           --
                                            --------      --------     --------      --------      --------      --------
Balances at December 31, 1996                  5,225        90,680           --           893       (39,202)       57,596
                                                                                                                 --------
 Net loss                                         --            --           --            --       (18,438)      (18,438)
 Change in cumulative translation
    adjustment                                    --            --           --        (2,781)           --        (2,781)
                                                                                                                 --------
 Comprehensive loss                               --            --           --            --            --       (21,219)
                                                                                                                 --------
 Conversion of preferred stock and
    accrued dividends of $463 into 600
    shares of common stock                    (5,463)        5,463           --            --            --            --
 Exercise of stock options for 44
    shares of common stock                        --           149           --            --            --           149
 Issuance of 88 shares of common stock
    for employee stock purchase plan              --           493           --            --            --           493
 Accrued dividends on preferred stock            238            --           --            --          (238)           --
                                            --------      --------     --------      --------      --------      --------
Balances at December 31, 1997                     --        96,785           --        (1,888)      (57,878)       37,019
                                                                                                                 --------
 Net loss                                         --            --           --            --       (21,925)      (21,925)
 Change in cumulative translation
    adjustment                                    --            --           --         3,382            --         3,382
                                                                                                                 --------
 Comprehensive loss                               --            --           --            --            --       (18,543)
                                                                                                                 --------
 Issuance of 100 shares of common stock
    under restricted stock purchase
    agreement                                     --             1           --            --            --             1
 Deferred compensation related
    to restricted stock purchase agreement        --           543         (543)           --            --            --
 Amortization of deferred compensation            --            --          183            --            --           183
 Exercise of stock options for 390
    shares of common stock                        --         1,533           --            --            --         1,533
 Issuance of 100 shares of common
 stock for employee stock  purchase
 plan                                             --           501           --            --            --           501
                                            --------      --------     --------      --------      --------      --------
Balances at December 31, 1998               $     --      $ 99,363     $   (360)     $  1,494      $(79,803)     $ 20,694
                                            ========      ========     ========      ========      ========      ========
</TABLE>


                 The accompanying notes are an integral part of
                    these consolidated financial statements.


                                       38


<PAGE>   39
                               RESOUND CORPORATION
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                                YEAR ENDED DECEMBER 31,
                                                                                           ------------------------------------
                                                                                            1998           1997          1996
                                                                                           --------      --------      --------
<S>                                                                                        <C>           <C>           <C>      
Cash flows from operating activities:
   Net loss                                                                                $(21,925)     $(18,438)     $   (967)
   Adjustments to reconcile net loss to net cash provided by (used in) operating
     activities:
     Depreciation and amortization                                                            8,051         7,915         6,066
     Loss on disposal of property and equipment                                                  61            82            --
     Noncash portion of special charges                                                      14,971        17,157            --
     Amortization of deferred compensation                                                      183            --            --
     Gain on sale of Viennatone switch activity                                                  --          (300)           --
  Changes in assets and liabilities:
     Accounts receivable                                                                      1,343         2,238          (982)
     Inventories                                                                             (2,555)        6,631        (1,732)
     Other assets                                                                            (4,255)       (1,202)       (3,435)
     Accounts payable                                                                          (846)          257        (1,711)
     Accrued liabilities                                                                     (5,388)       (1,254)        1,663
     Provision for litigation and related costs                                                  --            --          (492)
                                                                                           --------      --------      --------
           Net cash provided by (used in) operating activities                              (10,360)       13,086        (1,590)
                                                                                           --------      --------      --------
Cash flows from investing activities:
   Acquisition of Sonar Hearing Health                                                           --            --       (25,443)
   Acquisition of Autac GmbH                                                                   (401)           --            --
   Acquisition of Apex Acoustics, Ltd.                                                         (750)           --            --
   Purchase of minority shareholder's interest in Viennatone BVG                                (82)           --            --
   Purchase of minority shareholder's interest in a subsidiary of Viennatone                     --            --        (1,857)
   Proceeds from sale of Viennatone switch activity                                              --         1,500            --
   Proceeds from sale of Viennatone BVG                                                       3,304            --            --
   Proceeds from patent contributions to partnership (net)                                       --         3,600         7,300
   Proceeds from patent license agreements                                                      900            --            --
   Change in cumulative translation adjustment                                                1,731          (465)          538
   Additions of property and equipment                                                       (7,974)       (4,485)       (7,547)
                                                                                           --------      --------      --------
           Net cash provided by (used in) investing activities                               (3,272)          150       (27,009)
                                                                                           --------      --------      --------

Cash flows from financing activities:
    Loans payable                                                                               505            --        (3,630)
    Payments on long-term debt                                                               (2,046)       (2,005)       (4,222)
    Proceeds from issuance of preferred stock                                                    --            --         5,000
    Proceeds from issuance of common stock                                                    2,035           642        34,340
                                                                                           --------      --------      --------
           Net cash provided by (used in) financing activities                                  494        (1,363)       31,488
                                                                                           --------      --------      --------

Net increase (decrease) in cash and cash equivalents                                        (13,138)       11,873         2,889
Cash and cash equivalents at the beginning of the year                                       19,853         7,980         5,091
                                                                                           --------      --------      --------
Cash and cash equivalents at the end of the year                                           $  6,715      $ 19,853      $  7,980
                                                                                           ========      ========      ========

Supplemental disclosure of cash flow information:
   Cash paid during the year for:
      Interest                                                                             $  1,341      $  1,815      $  2,104
                                                                                           ========      ========      ========
      Income taxes                                                                         $    823      $  1,436      $  1,102
                                                                                           ========      ========      ========
Supplemental schedule of non-cash investing and financing activities:
      Issuance of common stock on conversion of promissory notes                           $     --      $     --      $  2,048
      Accrual of preferred stock dividend                                                  $     --      $    238      $    225
      Conversion of preferred stock to common stock                                        $     --      $  5,463      $     --
</TABLE>

                 The accompanying notes are an integral part of
                    these consolidated financial statements.


                                       39


<PAGE>   40
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


NOTE 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         Basis of Presentation

         In 1998, the Company adopted the policy of closing its fiscal quarters
on the last Saturday falling within the calendar quarter, except that the fiscal
year ends at the calendar year end.

         Principles of Consolidation

         The consolidated financial statements include the accounts of the
Company's wholly owned subsidiaries. All significant intercompany accounts have
been eliminated.

         Except for the Company's European manufacturing subsidiary located in
Ireland, for which the U.S. dollar is the functional currency, the functional
currency for each international subsidiary generally is its respective local
currency. Accordingly, all assets and liabilities related to these subsidiaries
are translated at the current exchange rates at the end of each period. The
resulting translation adjustments are recorded directly to the cumulative
translation adjustment account included in shareholders' equity. Sales and
expenses are translated at average exchange rates in effect during the period.
Foreign currency transaction gains and losses are included in other income
(expense), net. The Company recorded a gain of $302,000, and losses of $984,000
and $175,000 in 1998, 1997 and 1996, respectively.

         Use of Estimates

         The preparation of financial statements in conformity with generally
accepted accounting principles 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 revenues and expenses during the
reporting period. Actual results inevitably will differ from those estimates,
and such differences may be material to the financial statements.

         Sales and Credit Risk

         The Company sells its products to audiologists, acousticians, hearing
device chains and hearing device dispensers primarily in North America, Europe,
and the Asia-Pacific region. The Company performs ongoing credit evaluations of
its customers and generally does not require collateral. The Company maintains
reserves for potential credit losses, and such losses have been within
management's expectations.

         Sales are recognized when products are shipped. Net sales consist of
product sales less discounts and estimated returns. Estimated U.S. returns are
provided for at time of shipment. Company policy allows for a 90-day return
period on U.S. sales. The provisions for expected returns, expressed as a
percentage of gross U.S. sales, were as follows: 27% (1998); 26% (1997) and 27%
(1996). Most returns are resolved or settled within several months of the
initial sale. In Europe and Asia, returns are not material.


                                       40


<PAGE>   41
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         The Company's sales to customers outside of the United States accounted
for approximately 51%, 49%, and 56% of net sales for the years ended December
31, 1998, 1997, and 1996, respectively. A number of risks are inherent in
international transactions. Fluctuations in the exchange rates between the U.S.
dollar and other currencies could increase the sales price of the Company's
products in international markets where the prices of the Company's products are
denominated in U.S. dollars or lead to currency exchange losses where the prices
of the Company's products are denominated in local currencies. International
sales and operations may also be limited or disrupted by the imposition of
governmental controls, regulation of medical devices, export license
requirements, political instability, trade restrictions, changes in tariffs and
difficulties in staffing and managing international operations.

         Warranty Costs

         The Company provides at the time of sale for the estimated cost of
remaking and repairing products under warranty. Such costs are included in Cost
of sales. In the U.S., the warranty period is one year for the custom hearing
device shell and one to two years for electronic components. Because of the
length of the warranty period, adjustments to the originally recorded
provisions, both increases and decreases, may be necessary from time to time. In
1998, 1997, and 1996, the approximate U.S. provisions for estimated warranty
costs (and as a percentage of U.S. net sales) were $4.7 million (7.5%), $5.1
million (7.7%), and $4.4 million (7.6%), respectively. The period over which
warranty claims may be made in Europe and Asia is one year. The amount of these
claims has not been material.

         Research and Development Expenses

         All research and development costs are expensed as incurred and consist
mainly of personnel costs, outside services, materials, supplies, and general
and administrative expenses.

         The Company is engaged in research and development efforts to design
and develop technologies that are anticipated to result in human communications
and hearing health care products. During 1997, the Company entered into a joint
development agreement with Motorola whereby Motorola has committed to provide
joint development funds, technology and other resources for this project through
January 2000. During 1998 and 1997, Motorola paid $2.9 million and $2.0 million,
respectively to ReSound as part of this commitment. Such funds received by the
Company have been recorded as a reduction of the Company's research and
development expenses. Total costs incurred by the Company related to this
agreement were $3.8 million and $1.3 million in 1998 and 1997, respectively. The
Company is currently in discussions with Motorola concerning levels of payments
through the remaining period of the joint development agreement. In September
1998, the Company and Motorola announced the introduction of the CommPort
system, an integrated microphone and receiver two-way radio system for the
public safety market. The Company is not required to make any royalty payments
under the terms of this agreement. However, to the extent that the technology
being developed is using certain technology under a current sublicense
agreement, the Company is required to make royalty payments on sales of
developed products sold worldwide that may incorporate this technology.


                                       41


<PAGE>   42
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         Advertising Expenses

         The Company accounts for advertising costs as expense in the period in
which the costs are incurred. Advertising expense for 1998, 1997, and 1996 was
approximately $6.6 million, $4.3 million, and $2.8 million, respectively.

         Other Income (Expense), Net

         In 1998, other income resulted primarily from receipts of $3.0 million
under a patent license agreement. This agreement requires no additional payments
to be made to the Company.

         Income Taxes

         The Company accounts for income taxes under the liability method. The
Company's net operating loss carryforwards have not been given benefit in the
financial statements.

         Computation of Basic and Diluted Net Loss per Common Share

         In 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings per Share ("SFAS No. 128"). SFAS No. 128 replaced the calculation
of primary and fully diluted earnings per common share with basic and diluted
earnings per common share. Unlike primary earnings per common share, basic
earnings per common share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per common share is very similar to the
previously reported fully diluted earnings per common share. Net loss per common
share amounts for all periods have been restated to conform to the SFAS No. 128
requirement. Common equivalent shares from stock options, warrants and preferred
stock are excluded from the computation of diluted net loss per common share for
all periods presented as their effect is antidilutive.

         Had the Company been in a net income position, diluted earnings per
common share would have included 633,000, 434,000, and 255,000 shares related to
outstanding stock options, warrants and preferred stock not included above for
the years ended December 31, 1998, 1997 and 1996, respectively.

         Cash and Cash Equivalents

         The Company considers all highly liquid investments purchased with
original maturities of ninety days or less from the date of purchase to be cash
equivalents. Cash and cash equivalents include money market funds and various
deposit accounts.

         Restricted Cash

         Included in other current assets at December 31, 1998, is $500,000 of
cash which was deposited with the Company's primary bank as security for a
letter of credit in connection with the purchase of technology. The letter of
credit and the cash hold on collateral were released in March 1999.


                                       42


<PAGE>   43
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         Other assets at December 31, 1998 included restricted cash of $525,000
which was deposited with the Company's primary bank. These deposits related to
the Company's Purchase Card program, which is secured by an ongoing deposit of
$125,000 and an additional $400,000 secures debt, through February 2002, of an
executive officer of the Company, related to the purchase of a private residence
in connection with the executive officer's relocation.

         Inventories

         Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market value. Inventories at December 31, 1998 and 1997
consist of the following (in thousands):


<TABLE>
<CAPTION>
                     1998        1997
                    -------     -------
<S>                 <C>         <C>    
Raw materials       $10,260     $ 9,191
Work in process       2,576       2,869
Finished goods        3,363       2,123
                    -------     -------
     Total          $16,199     $14,183
                    =======     =======
</TABLE>


         Other Receivables

         At December 31, 1998, the Company was owed $1,692,000 from Amplifon
International NV, representing the final installment of the sales price of the
Viennatone retail business in Austria. The final installment was received by the
Company in March 1999.

         Property and Equipment

         Property and equipment are recorded at cost and are depreciated on a
straight-line basis over their estimated useful lives of two to ten years.
Leasehold improvements are amortized over the shorter of their estimated useful
lives or the lease term. Maintenance and repairs are charged to operations as
incurred. Property and equipment at December 31, 1998 and 1997 consist of the
following (in thousands):


<TABLE>
<CAPTION>
                                                     1998         1997
                                                   --------     --------
<S>                                                <C>          <C>     
Land and building                                  $  3,576     $  3,011
Machinery and equipment                              31,245       25,637
Furniture, fixtures and improvements                  8,246       10,271
                                                   --------     --------
                                                     43,067       38,919
Less accumulated depreciation and amortization      (32,333)     (28,081)
                                                   --------     --------
     Total property and equipment, net             $ 10,734     $ 10,838
                                                   ========     ========
</TABLE>


         Other Assets

         Other long-term assets consist primarily of patents which are being
amortized over useful lives ranging from five to ten years.


                                       43


<PAGE>   44
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         Goodwill

         Goodwill resulted from the unallocated excess purchase cost of
acquisitions recorded using the purchase method of accounting and is being
amortized over 20 years. Goodwill is reviewed for impairment whenever events or
circumstances indicate an impairment might exist, or at least annually. Goodwill
amortization, excluding write-offs related to the 1998 and 1997 strategic
restructuring programs, was approximately $1.2 million, $1.6 million and $1.8
million in 1998, 1997 and 1996, respectively.

         Accrued Liabilities

         Accrued liabilities at December 31, 1998 and 1997 consist of the
following (in thousands):


<TABLE>
<CAPTION>
                                             1998        1997
                                           -------     -------
<S>                                        <C>         <C>    
Accrued compensation and payroll taxes     $ 3,197     $ 4,077
Accrued warranty                             4,639       5,869
Income taxes payable                           708         484
Restructuring accrual                        2,455       2,387
Other                                        7,549       6,667
                                           -------     -------
    Total                                  $18,548     $19,484
                                           =======     =======
</TABLE>


         Fair Value of Financial Instruments

         The Company has evaluated the estimated fair value of financial
instruments. The amounts reported for cash and cash equivalents, accounts
receivable, accounts payable and accrued liabilities approximate fair value due
to their short maturities. It was not practicable to estimate the fair value of
the Company's bank loans, short-term debt and long-term debt because of the lack
of a quoted market price and the inability to estimate fair value without
incurring excessive costs. The amounts recorded at December 31, 1998 represent
future minimum payments on debt obligations.

         Reclassifications

         Certain amounts in the consolidated financial statements have been
reclassified to conform with the current year presentation. These
classifications and restatements did not impact previously reported total
assets, liabilities, shareholders' equity or net loss.

         Recent Accounting Pronouncements

         In June 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income, which establishes standards for reporting and display of
income and its components (revenue, expenses, gains, and losses) in a full set
of general-purpose financial statements. The Company adopted SFAS No. 130 as of
January 1, 1998 and has presented comprehensive loss for all periods presented
in the Statement of Shareholders' Equity.


                                       44


<PAGE>   45
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


         In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information. SFAS No. 131 supersedes FASB SFAS No.
14, Financial Reporting for Segments of a Business Enterprise. SFAS No. 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports. SFAS No. 131 also establishes standards for related
disclosures about products and services, geographic areas and major customers.
The adoption of SFAS No. 131, as of January 1, 1998, did not affect results of
operations or financial position, but did affect the disclosure of segment
information (see Note 11).

         In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. SFAS No. 133 requires
that all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether a
derivative is designed as part of a hedge transaction and, if it is, the type of
hedge transaction. The Company does not expect that the adoption of SFAS No. 133
will have a material impact on its consolidated financial statements because the
Company does not currently hold any derivative instruments.

NOTE 2.  ACQUISITIONS AND DISPOSITIONS

         The Company acquired all the outstanding stock of two European-based
companies in 1994 and certain assets of Minnesota Mining and Manufacturing
Company's ("3M") hearing health business activity in 1996. In each instance, the
acquisitions were accounted for as purchase transactions. The acquired assets
and liabilities were recorded at their estimated fair values at the date of
acquisition, and the unallocated excess purchase price amounts (goodwill), after
impairment losses recorded in 1998 and 1997, are being amortized on a straight
line basis over 20 years. The operating results of each subsidiary have been
included in the consolidated statements of operations from the respective
acquisition dates.

         ReSound Deutschland

         On January 1, 1994, the Company's existing German subsidiary acquired
all the shares of Sonar Design & Hortechnik GmbH, a German company, for
approximately $3.5 million in cash and 100,000 shares of the Company's common
stock. In 1996, this company was renamed ReSound Deutschland. ReSound
Deutschland is a manufacturer and distributor of both Sonar branded and ReSound
branded hearing devices.

         Viennatone

         On December 9, 1994, a newly-formed Austrian subsidiary of the Company
acquired 100% of the shares of Viennatone AG ("Viennatone"), an Austrian
company, for approximately $27.7 million, and the Company's German subsidiary
acquired the net assets of a related business for approximately $0.6 million, or
a total of approximately $28.3 million (Viennatone AG owned an 80% interest in
its


                                       45


<PAGE>   46
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

Austrian distribution company, Viennatone BVG). To finance the acquisition, the
Austrian subsidiary borrowed approximately $17.3 million from an Austrian bank.
The balance of the purchase price was provided by available cash funds of the
Company and $6.85 million in loans against the Company's short-term investment
securities. Viennatone manufactures and markets hearing devices through various
subsidiaries of the Company. It uses both independent distributors and in
Austria, until its divestiture in November 1998, its own retail chain. In 1996,
the Company purchased the remaining minority interest in Viennatone Hannover for
$1.9 million in cash. In September 1998, Viennatone purchased the remaining
minority interest in Viennatone BVG for $82,000 and 40,000 shares of the
Company's common stock, which will be issued in 1999.

         On November 28, 1998, the Company sold Viennatone BVG to Amplifon
International NV ("Amplifon"), a European hearing instruments retail
distribution company, headquartered in Italy. In the third quarter of 1998, the
Viennatone BVG net assets and associated goodwill were written down to their
expected realizable value as part of the Company's strategic restructuring
program. There was no net gain or loss on the sale. As part of this sale
transaction, Viennatone and Amplifon have entered into a strategic arrangement
under which Amplifon has agreed to market and sell ReSound and Viennatone
hearing healthcare products throughout its retail outlets in Europe. Amplifon
has committed to purchase a minimum unit volume at agreed prices beginning on
January 1, 1999 for a period of three years in markets outside of Austria and
for a period of five years in Austria. The agreement contains certain penalty
charges for units not purchased in the three year period in markets outside of
Austria.

         Sonar Hearing Health Corporation

         In June 1996, the Company completed the acquisition of certain assets
of the hearing health business activity of 3M and established a subsidiary,
Sonar Hearing Health Corporation ("SHH"), to manage this activity on an ongoing
basis. The acquisition was accounted for as a purchase and the operating results
of SHH have been included in the consolidated statements of operations since the
acquisition date. The total purchase price of approximately $25.4 million
consisted of a cash payment of $24.9 million and $500,000 for related
acquisition expenses. The allocation of the purchase price was as follows (in
thousands):


<TABLE>
<S>                                                       <C>    
Net tangible assets acquired, principally receivables
   and inventories                                        $ 4,132
Patents                                                     7,500
Goodwill                                                   13,811
                                                          -------
Total purchase price                                      $25,443
                                                          =======
</TABLE>


         Hearing health constituted a small business activity in 3M's worldwide
operations which was neither a division nor subject to the maintenance of
discrete accounting records such that financial statements could be or are
determinable. However, the Company believes that this business activity
generated revenues for 3M of approximately $9.3 million (unaudited) and $16.6
million (unaudited) for the six months ended June 30, 1996, and for the year
ended December 31, 1995, respectively. The Company believes that profits, if
any, generated from the hearing health activity of 3M for the above-mentioned
periods were minimal, and it may not have been profitable as a historical
activity.


                                       46


<PAGE>   47
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         In addition to the patents acquired from 3M valued at $7.5 million,
patents valued at $2.5 million were separately acquired by the Company in July
1996 in connection with the above acquisition. These patents were contributed to
a partnership formed in 1996 comprised of eight hearing device manufacturers
including ReSound. In consideration, ReSound received cash payments from the
partnership members of $10.9 million (net) through December 31, 1998 and has
rights to additional receipts as future licenses are sold. Any such future
amounts paid to the partnership will be divided equally among the partners and
recognized as license income.

         As further discussed in Note 6, Special Charges, the goodwill remaining
from this acquisition was written off during 1997.

         Viennatone - Switch Production

         On December 23, 1997, the Company sold the net assets of its switch
production activity which was performed at the ReSound Viennatone Hortechnologie
AG subsidiary. The net gain on disposal of the discontinued activity was
recorded in other income (expense), net, and consists of the following (in
thousands):


<TABLE>
<CAPTION>
<S>                                                           <C>   
Proceeds from sale                                            $1,500
Costs:
     Net book value of assets sold                               200
     Write-off of goodwill allocated to switch production      1,000
                                                              ------
Net gain                                                      $  300
                                                              ======
</TABLE>


         In connection with this transaction, the Company is also entitled to
receive a royalty on the sale of switches made by the acquirer to third parties
for a period of three years from the sale. The royalty will only be earned once
a minimum sales level has been achieved and such royalty will not exceed $1.5
million. This revenue will be recorded as received. No royalty revenue was
received in 1998. Additionally, the Company has committed to purchase a minimum
number of switches from the acquirer for the next three years. The minimum
purchase commitment is not in excess of the Company's projected needs for these
items.

         Resound Autac

         In January 1998, ReSound Autac GmbH, a newly formed subsidiary of the
Company located in Zurich, Switzerland, acquired all of the assets and
liabilities of a former Swiss distributor for $401,000. At the time of the
transaction, that distributor owed the Company $979,000 for previous financial
assistance. The agreement contains a clause which obligates the seller for a
period of five years not to compete in the area of manufacture or distribution
of hearing devices. Additionally, an employment agreement was negotiated with
the seller through December 31, 2002.


                                       47


<PAGE>   48
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         The allocation of the purchase price was as follows (in thousands):


<TABLE>
<S>                             <C>    
Working capital acquired        $   507
Property and equipment, net         163
Goodwill                          1,342
Bank loans                         (632)
Loan from ReSound                  (979)
                                -------
Total purchase price            $   401
                                =======
</TABLE>


         As part of the Company's strategic restructuring program announced in
the third quarter of 1998, the goodwill associated with the purchase of ReSound
Autac GmbH was written off during the third quarter of 1998.

         Apex Acoustics, Ltd.

         In April 1998, Resound-Viennatone Ltd. (a U.K. company) acquired all of
the assets and liabilities of Apex Acoustics, Ltd. from the Ultratone Group, the
largest hearing device retail chain in the United Kingdom, for $750,000.
Concurrent with the acquisition, the Company entered into a multi-year supply
agreement with Ultratone for customer hearing devices.

         The allocation of the purchase price was as follows (in thousands):


<TABLE>
<S>                             <C>  
Working capital acquired        $ 419
Property and equipment, net       135
Goodwill                          321
Other liabilities                (125)
                                -----
Total purchase price            $ 750
                                =====
</TABLE>


NOTE 3.  BANK LOANS

         Bank loans consisted of the following at December 31, 1998 and 1997 (in
thousands):

<TABLE>
<CAPTION>
                                      1998       1997 
                                     ------     ------
<S>                                  <C>        <C>   
Bank loan to ReSound-Viennatone
  Hortechnologie GmbH                $3,754     $1,663
Bank loan to ReSound Deutschland
  GmbH                                  184         --
Bank loan to ReSound Autac GmbH         708         --
                                     ------     ------
    Total                            $4,646     $1,663
                                     ======     ======
</TABLE>


         These loans bear interest at rates varying from 4.75% to 9.5%. The
ReSound-Viennatone bank loan from an Austrian bank is denominated in Austrian
Schillings and secured by eligible receivables.


                                       48


<PAGE>   49
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

The ReSound Deutschland bank loan from a German bank is denominated in German
Marks and secured by a Letter of Comfort from its German parent company. The
ReSound Autac bank loan from a Swiss bank is denominated in Swiss Francs and
secured by eligible receivables, assignment of intercompany loans and by a
Letter of Comfort from ReSound Corporation.

NOTE 4.  LONG-TERM DEBT

         Long-term debt consists of the following at December 31, 1998 and 1997
(in thousands):


<TABLE>
<CAPTION>
                                                         1998          1997
                                                       --------      --------

<S>                                                    <C>           <C>     
8% convertible promissory note to shareholder
   due in February 2000                                $ 10,000      $ 10,000
Bank Austria loan to ReSound Horgerate GmbH:
   8.15% term loan, due in quarterly installments
   over seven years beginning June 30, 1995               4,256         8,234
Bank loan to ReSound Deutschland GmbH:
   6.5% term loan, due in semi-annual installments
   over eight years beginning September 1995                336           383
Bank term loan to ReSound Pty. Ltd.                          13            19
                                                       --------      --------
                                                         14,605        18,636
Less current portion                                     (1,790)       (4,362)
                                                       --------      --------
Non-current portion                                    $ 12,815      $ 14,274
                                                       ========      ========
</TABLE>


         The 8% note is convertible into 1,000,000 shares of the Company's
common stock at $10.00 per share. The Bank Austria loan is denominated in
Austrian Schillings and secured by the capital stock of Viennatone.

         The maturities of long-term debt are as follows (in thousands): 1999,
$1,790; 2000, $12,629; 2001, $75; 2002, $75 and 2003, $36.

NOTE 5.  VIENNATONE ACCRUED EMPLOYEE BENEFITS

         Viennatone's accrued employee benefits by category at December 31, 1998
and 1997 are as follows (in thousands):


<TABLE>
<CAPTION>
                                     1998       1997 
                                    ------     ------
<S>                                 <C>        <C>   
Pensions                            $  149     $  443
Termination indemnities              2,102      2,321
Employees' long service premium        373        507
                                    ------     ------
    Total                           $2,624     $3,271
                                    ======     ======
</TABLE>


                                       49


<PAGE>   50
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         Pensions

         Viennatone has an unfunded defined benefit pension plan under which a
number of senior management employees in Austria have pension entitlements.
Viennatone's liability under this pension plan is funded partially by
contributions to an insurance company and partially by fixed interest, long-term
marketable securities held by Viennatone in accordance with Austrian tax
requirements.

         The status of the defined benefit plan at December 31, 1998 and 1997 is
as follows (in thousands):


<TABLE>
<CAPTION>
                                         1998     1997
                                         ----     ----
<S>                                      <C>      <C> 
Accumulated benefit obligation (ABO)     $149     $443
Projected benefit obligation (PBO)        149      443
Service cost                               --       --
Net periodic pension cost                  --       --
Interest                                   14       29
</TABLE>


         The interest rate used was 7%.

         The expected projected benefit obligation ("PBO") for 1999 has been
estimated as $149,000. Differences between expected and projected benefit
obligations are not material. The pension accrual recorded represents the
projected benefit obligation at December 31, 1998 and 1997. The weighted average
discount rate used to evaluate the increase in rate of compensation was 4.25%.

         Termination Indemnities

         Viennatone provides for termination benefits as earned in accordance
with Austrian law. Indemnities range from two to twelve months' salary based on
length of service. Employees are entitled to indemnities after three years of
employment or according to contract. Payments are made upon normal retirement or
other cause of termination, except voluntary departures or terminations for
cause. The amount accrued at year end represents the projected benefit
obligation. This calculation has been made under the assumption that the
majority of expected payments will be upon normal retirement. The liability is
also partially funded by fixed interest, long-term marketable securities held by
Viennatone in accordance with Austrian tax requirements.

         The status of the accrual for termination indemnities at December 31,
1998 and 1997 is as follows (in thousands):


<TABLE>
<CAPTION>
                                          1998       1997
                                         ------     ------
<S>                                      <C>        <C>   
Accumulated benefit obligation (ABO)     $1,484     $1,640
Projected benefit obligation (PBO)        2,102      2,321
Service cost                                164        182
Net periodic pension cost                    --         --
Interest                                    143        156
</TABLE>


                                       50


<PAGE>   51
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         The interest rate used was 7%.

         The expected projected benefit obligation for 1999 has been estimated
as $2.1 million. Differences between expected and projected benefit obligations
are not material. The termination indemnities accrual has been recorded at the
amount of the PBO at December 31, 1998 and 1997.

         Employees' Long Service Premium

         According to the Viennatone work agreement, employees are entitled to a
premium after ten years of service. Such a premium is also paid out after 15,
25, 35 and 45 years of service. A calculation of the total liability as of the
balance sheet date is made on a discounted cash-flow basis, using an interest
rate of 7%. The liability was calculated at $373,000 and $507,000 at December
31, 1998 and 1997, respectively.

NOTE 6.  SPECIAL CHARGES

         1997 Strategic Restructuring Program

         In the second half of 1997, the Company recorded special charges of
$18.0 million associated with the Company's strategic restructuring program.
This program is designed to streamline operations and control costs through
management restructuring, operations consolidations, and increased focus on core
activities and product lines.

         The special charges provided for costs associated with employee
termination benefits for approximately 100 employees from all functional areas
in various subsidiary locations; lease termination costs; the write-down of
goodwill associated with the acquired hearing health business activity of 3M
(which was renamed Sonar Hearing Health, "SHH"); the incremental impairments in
the carrying value of certain product inventories; and losses on supplier
commitments arising directly from the decision to exit product lines.

         The $18.0 million in special charges was recorded as follows:

         Employee termination benefits and lease termination costs (recorded as
Restructuring and other charges) -- $2.3 million; write-down of SHH goodwill
(recorded as Restructuring and other charges) -- $10.3 million; write-down of
inventories to net realizable value and losses on supplier commitments (recorded
as Cost of sales) -- $3.1 million; write-down of capital assets to fair value
(recorded as Selling, general and administrative -- $633,000 and Research and
development -- $123,000) and other exit costs (recorded as Selling, general and
administrative) -- $1.6 million.

         As of December 31, 1998 and 1997, $0.8 million and $6.2 million,
respectively remained of the 1997 restructuring accrual. The Company made
approximately $2.2 million and $819,000 of cash payments relating to the special
charges in 1998 and 1997, respectively. The remaining 1997 restructuring accrual
of $0.8 million will be substantially utilized by December 31, 1999.


                                       51


<PAGE>   52
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         1998 Strategic Restructuring Program

         In the second half of 1998, the Company recorded special charges of
$17.6 million associated with the Company's new strategic restructuring program.
This program is designed to realign the Company's organizational structure,
streamline internal processes, and consolidate facilities worldwide in order to
achieve sustained profitability. The program will result in a work force
reduction of up to 100 people worldwide in all functional areas. Of the $17.6
million in special charges, approximately $10.1 million reflects non-cash items
for the write-down of goodwill and discontinued product lines. The remaining
charges of approximately $7.5 million reflect cash and non-cash items pertaining
primarily to employee severance and consolidation activities.

         The $17.6 million in special charges has been recorded as follows: Cost
of sales -- $1.8 million (for the write-down of inventories to net realizable
value and losses on supplier commitments); Research and development -- $0.5
million; Selling, general and administrative -- $3.2 million (for the write-down
of capital assets to fair value and other exit costs); Restructuring and other
charges -- $12.1 million (for the write-down of goodwill -- $8.1 million, and
employee termination benefits and lease termination costs -- $4.0 million).

         In the second half of 1998, the Company utilized $12.8 million of the
1998 restructuring accrual. Of this $12.8 million, $8.1 million was utilized for
the write-down of goodwill in ReSound Autac GmbH and Viennatone; $2.7 million
for employee termination benefits and lease termination costs; $0.6 million for
the write-down of capital assets to fair value and $1.5 million for the
write-down of inventories to net realizable value.

         The Company made approximately $2.7 million of cash payments relating
to the special charges in the second half of 1998. The remaining 1998
restructuring accrual of approximately $4.8 million at December 31, 1998 will be
substantially utilized by December 31, 1999.

NOTE 7.  COMMITMENTS AND CONTINGENCIES

         Operating Leases

         The Company leases its present facilities and certain equipment under
noncancelable operating lease agreements for periods of up to 20 years. Some of
the leases have renewal options ranging from two to three years and contain
provisions for maintenance, taxes or insurance. Rent expense was $2.9 million,
$2.3 million, and $1.7 million in 1998, 1997 and 1996, respectively.

         At December 31, 1998, total future minimum lease payments are as
follows (in thousands):


<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S>                        <C>   
   1999                       $1,954
   2000                        1,228
   2001                          425
   2002                          209
   2003                          206
Thereafter                       715
                              ------
Total minimum 
 payments required            $4,737
                              ======
</TABLE>


                                       52


<PAGE>   53
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         401(k) Plan

         Under the Company's retirement savings plan (the "401(k) Plan"), a U.S.
employee may defer and invest up to 19% of his or her annual compensation,
subject to an annual dollar limitation. The Company has elected to make matching
contributions in the amount of 25% of the employee's contributions, up to a
potential maximum of $2,250 per employee. All U.S. full-time employees who have
three months of service are eligible to participate in the 401(k) Plan. The
Company contributed $248,000, $222,700, and $138,000 to the 401(k) Plan in 1998,
1997 and 1996, respectively.

         Litigation

         From time to time, the Company has been contacted by various other
parties who have alleged that certain of the Company's products infringe or may
infringe patents that such parties claim to hold. Management believes the
Company has not infringed any such patents and does not believe such claims, if
pursued, will result in a material adverse effect on the financial position or
results of operations of the Company.

         The Company is also subject to other legal proceedings and claims that
arise in the ordinary course of its business. While management currently
believes the amount of ultimate liability, if any, with respect to these actions
will not materially affect the financial position, results of operations, or
liquidity of the Company, the ultimate outcome of any litigation is uncertain.
Were an unfavorable outcome to occur, the impact could be material to the
Company.

NOTE 8.  SHAREHOLDERS' EQUITY

         Preferred Stock

         Under the Company's Articles of Incorporation, the Company is
authorized to issue preferred stock. At December 31, 1998, 2,000,000 shares of
preferred stock were authorized.

         In March 1996, the Company issued 54,055 shares of Series B Preferred
Stock for an aggregate purchase price of $5.0 million in a private placement to
an existing shareholder. The Series B Preferred Stock had a cumulative dividend
rate of six percent, payable in shares of the Company's common stock on the date
of any conversion. In October 1997, all of the outstanding preferred stock and
accumulated dividends of $463,000 were converted into 600,600 shares of common
stock of the Company.

         At December 31, 1998 and 1997, no preferred stock was issued and
outstanding.

         Common Stock

         In June 1996, the Company raised approximately $32.9 million (net
proceeds) through the private sale of 3,212,176 shares of common stock. The
proceeds from this sale were used in connection with the purchase of certain
assets of the hearing health business activity of 3M and to provide working
capital. These proceeds reflect most of the proceeds shown as issuance of common
stock on the Company's consolidated statements of cash flows for the year ended
December 31, 1996.


                                       53


<PAGE>   54
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         Warrants

         In conjunction with a convertible promissory note issued in November
1995 (subsequently repaid in June 1996), the Company issued two warrants, each
to purchase 38,897 shares of common stock at an exercise price of $7.7125 per
share. These warrants may be exercised at any time and expire on October 30,
2000. As of December 31, 1998, these warrants have not been exercised. The
values ascribed to these warrants are not material.

         In conjunction with a guaranteed bank loan funded in October 1995 and
subsequently repaid in July 1996, the Company issued a warrant to purchase
49,230 shares of common stock to the bank at an exercise price of $8.13 per
share. This warrant may be exercised at any time and expires on October 29,
2000. In addition, the Company issued warrants to purchase an aggregate of
105,492 shares of common stock to the six directors who guaranteed the debt at
an exercise price of $8.13 per share. These warrants may be exercised at any
time and expire on December 1, 2000. As of December 31, 1998, these warrants
have not been exercised. The values ascribed to these warrants are not material.

         1992 Employee Stock Purchase Plan

         Under the 1992 Employee Stock Purchase Plan, substantially all
employees may purchase common stock through payroll deductions at a price equal
to 85% of its fair market value as of certain specified dates. Stock purchases
under this plan are limited to 10% of an employee's compensation, and in no
event may exceed $8,500 per year. As of December 31, 1997, a total of 400,000
shares of common stock were reserved for issuance to employees. At the Annual
Meeting of Shareholders of the Company on May 21, 1998, the shareholders voted
to authorize the amendment of the 1992 Employee Stock Purchase Plan to increase
the number of shares of common stock reserved for issuance thereunder by 200,000
shares to an aggregate of 600,000 shares. As of December 31, 1998, 347,390
shares had been issued under this plan, including 99,587 shares issued in 1998.

Fixed Stock Option Plans

         1992 Directors' Stock Option Plan

         Under the 1992 Directors' Stock Option Plan, the Company has reserved
300,000 shares of common stock for issuance to non-employee directors. Such
options may only be non-qualified stock options issued at not less than fair
market value, and all options granted must be exercised within five years from
the date of grant. Each eligible director is to be granted annually on December
31 an option to purchase 5,000 shares, exercisable after four years. Each new
director is to receive an initial option grant to purchase 20,000 shares, which
becomes exercisable in 25 percent increments annually beginning after one year.

         1988 Stock Option Plan

         Under the 1988 Stock Option Plan, the Company has reserved 4,000,000
shares of common stock for issuance. Options for shares of common stock were
granted to employees and consultants. Options were exercisable at such times and
under such conditions as determined by the Board of Directors. Options granted
generally vested at the rate of 1/48th of the number of shares subject to such
option at the end of each month for a period of 48 months from date of grant.
However, certain options granted to replenish existing options did not


                                       54


<PAGE>   55
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

begin vesting for up to 36 months from the date of grant (when vesting
commenced, it was generally prorated on a monthly basis over periods up to 48
months). The Plan expired in April 1998, and of the remaining 831,998 shares
available for grant, 650,000 shares were transferred to the 1997 Stock Plan and
181,998 shares were cancelled.

         1997 Stock Plan

         Under the 1997 Stock Plan, which expires in 2007, a total of 650,000
shares have been reserved for issuance. Options for shares of common stock and
stock purchase rights may be granted to employees and consultants. Options are
exercisable at such times and under such conditions as determined by the Board
of Directors. Options granted generally vest at the rate of 1/48th of the number
of shares subject to such option at the end of each month for a period of 48
months from date of grant.

         Other Option Grants

         During 1998, the Company issued options to purchase an aggregate of
812,663 shares of its common stock to newly hired executive officers and options
to purchase 6,250 shares of its common stock to a consultant outside of any
shareholder approved equity incentive plan. These options did not constitute
Incentive Stock Options under Section 422 of the Internal Revenue Code of 1986,
as amended. Options are exercisable at such times and under such conditions as
determined by the Board of Directors. Options granted generally vest at the rate
of 1/48th of the number of shares subject to such option at the end of each
month for a period of 48 months from date of grant. The values ascribed to the
options granted to a consultant are not material.

         Additional information relative to the Company's fixed stock option
plans is as follows:


<TABLE>
<CAPTION>
                                             1998                             1997                           1996
                                  ----------------------------    -----------------------------    ----------------------------
                                              Weighted-Average                 Weighted-Average                Weighted-Average
                                   Options     Exercise Price      Options       Exercise Price     Options      Exercise Price
                                  ---------   ----------------    ---------    ----------------    ---------   ----------------
<S>                               <C>         <C>                 <C>          <C>                 <C>         <C>
Outstanding - beginning of                     
  year                            3,406,399        $4.71          3,600,867          $8.85         3,379,533         $8.50
     Granted                      1,394,323        $5.38            350,200          $4.54           931,650         $9.23
     Exercised                     (390,089)       $3.67            (44,553)         $3.61          (225,358)        $4.68
     Canceled                      (476,867)       $6.56           (500,115)         $9.14          (484,958)        $9.07
                                  ---------                       ---------                        ---------
Outstanding - end of year         3,933,766        $4.83          3,406,399          $4.71         3,600,867         $8.85
                                  ---------                       ---------                        ---------
Exercisable at end of year        1,815,462                       1,546,296                        1,534,494
Weighted-average fair value                    
  of options granted during
  the year                                         $2.25                             $4.54                           $4.13
</TABLE>


                                       55


<PAGE>   56
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         Outstanding and Exercisable By Price Range as of December 31, 1998:


<TABLE>
<CAPTION>
                                                Options Outstanding                           Options Exercisable
                           ------------------------------------------------------------------------------------------------
                                Number           Weighted-Average                            Number         
    Range of                 Outstanding at          Remaining      Weighted-Average     Exercisable at    Weighted-Average 
Exercise Prices            December 31, 1998     Contractual Life    Exercise Price    December 31, 1998    Exercise Price
----------------           -----------------     ----------------   ----------------   -----------------   ----------------
<S>                        <C>                   <C>                <C>                <C>                 <C>
$ 0.30 -  $ 0.40                   6,696                1.5             $  0.39                 6,696          $  0.39
$ 0.50 -  $ 0.50                  71,447                2.6             $  0.50                71,447          $  0.50
$ 4.19 -  $ 6.25               3,503,873                3.1             $  4.71             1,654,529          $  4.56
$ 6.50 -  $ 8.88                 321,750                4.0             $  6.69                52,790          $  6.85
$ 9.88 -  $11.00                  30,000                0.9             $ 10.06                30,000          $ 10.06
----------------             -----------               ----              -------          -----------          -------
$ 0.30 -  $11.00               3,933,766                3.1             $  4.83             1,815,462          $  4.54
</TABLE>


         At December 31, 1998, options to purchase 1,815,462 shares of common
stock were exercisable at an average exercise price of $4.54 per share and
3,933,766 shares of common stock were reserved in the event options are
exercised.

         In April 1997, the Board of Directors authorized the repricing of
options granted to employees and directors to purchase 2,626,877 shares of
common stock effective as of the close of business on April 25, 1997, to the
then fair market value of $4.4375 per share. Under the terms of the repricing,
the repriced options that were not vested at April 25, 1997 were subject to a
one-year extension of their vesting terms, and any repriced options that were
vested at April 25, 1997 were not exercisable during the one-year period
commencing April 25, 1997. The term of the repriced options was extended by one
year.

         In April 1998, pursuant to a restricted stock purchase agreement,
100,000 shares of common stock were purchased by an executive officer of the
Company at $0.01 per share. Deferred compensation expense of $543,000,
representing the excess of the quoted market price of the Company's common stock
at grant date over the grant price was recorded related to this agreement. The
restricted stock purchase agreement contains provisions for the repurchase of
common stock by the Company in the event of termination of employment during the
three years following the date of the agreement. One hundred percent of the
shares will be released from the repurchase option on the third anniversary of
the vesting commencement date provided that the executive officer's employment
with the Company has not been terminated prior to such date.

         Deferred compensation resulting from the issuance of common stock under
the restricted stock purchase agreement as of December 31, 1998 and 1997 is
$360,000 and $0, respectively. Deferred compensation is amortized over the
vesting period of three years, which resulted in compensation expense of
$183,000, $0 and $0 being recognized in the years ended December 31, 1998, 1997
and 1996, respectively.

         Stock -Based Compensation

         The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation
("SFAS 123"). Accordingly, no


                                       56


<PAGE>   57
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

compensation cost has been recognized for the plans (including the Employee
Stock Purchase Plan). Had compensation cost for the plans been determined based
on the fair value at the grant date for awards in 1998, 1997 and 1996 consistent
with the provisions of SFAS 123, the Company's net loss and basic and diluted
net loss per common share for the years ended December 31, 1998, 1997 and 1996
would have been increased to the pro forma amounts indicated below (in
thousands, except per share data):


<TABLE>
<CAPTION>
                                                    1998            1997            1996
                                                 ----------      ----------      ----------
<S>                                              <C>             <C>             <C>        
Net loss applicable to common
shareholders:
     As reported                                 $  (21,925)     $  (18,676)     $   (1,192)
     Pro forma                                   $  (22,246)     $  (21,963)     $   (2,990)
Basic and diluted net loss per common share:
     As reported                                 $    (1.07)     $    (0.96)     $    (0.07)
     Pro forma                                   $    (1.09)     $    (1.13)     $    (0.17)
</TABLE>


The fair value of each option grant is estimated on the date of grant using the
Black-Scholes multiple option-pricing model. The following weighted average
assumptions were used for grants in 1998, 1997 and 1996: risk-free interest
rates of 5.0 percent, 6.0 percent and 6.3 percent, respectively, expected
volatility of 0.61, 0.61 and 0.57, respectively, an expected option life of 0.8
years beyond each respective vesting period and dividend yield of zero. The
Black-Scholes model used by the Company to calculate option values for purposes
of this note, as well as other currently accepted option valuation models (as
called for in accordance with SFAS 123), were developed to estimate the fair
value of stock options that are freely tradable and fully transferable and that
have no vesting restrictions. These models also require highly subjective
assumptions, including future stock price volatility and expected time until
exercise, which greatly affect the calculated values. Accordingly, management
believes that this model does not necessarily provide a reliable measure of the
fair value of the Company's option awards.

NOTE 9.  INCOME TAXES

         The provision for income taxes for 1998, 1997 and 1996 consists of the
following (in thousands):


<TABLE>
<CAPTION>
                       1998        1997        1996
                     -------     -------     -------
<S>                  <C>         <C>         <C>    
Current:
    State            $     8     $    16     $    --
    Foreign              552         860       1,769
                     -------     -------     -------
    Subtotal             560         876       1,769
Deferred:
    Foreign               --          --        (372)
                     -------     -------     -------
Total provision:     $   560     $   876     $ 1,397
                     =======     =======     =======
</TABLE>

         Foreign pre-tax income (loss) was $(15.7) million, $(7.0) million and
$5.0 million in 1998, 1997 and 1996, respectively.


                                       57


<PAGE>   58
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

         The difference between the provision for taxes on income and the amount
computed by applying the federal statutory income tax rate to income before
provision for income taxes is presented below (in thousands):


<TABLE>
<CAPTION>
                                          1998         1997         1996
                                         -------      -------      -------
<S>                                      <C>          <C>          <C>     
Tax at federal statutory rate            $(7,477)     $(6,110)     $  (151)
Unbenefited losses                         8,852        7,971        3,307
Income taxed at higher/(lower) rates        (815)        (994)      (1,840)
Other                                         --            9           81
                                         -------      -------      -------
Provision for income taxes               $   560      $   876      $ 1,397
                                         =======      =======      =======
</TABLE>


         At December 31, 1998, the Company had U.S. federal and California net
operating loss carryforwards of approximately $37.3 million and $8.5 million,
respectively. The federal net operating loss carryforwards will expire at
various dates beginning in 2002 through 2018, if not utilized. The California
net operating loss carryforwards will expire at various dates beginning in 1999
through 2003, if not utilized. The Company has foreign net operating loss
carryforwards of approximately $36.5 million at December 31, 1998, which will
expire at various dates beginning in 1999 through 2004, if not utilized.

         Utilization of net operating losses may be subject to an annual
limitation due to ownership change limitations provided in the Internal Revenue
Code of 1986 and similar state provisions.

         Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amount used for income tax purposes. Based upon the
Company's earnings history, a valuation allowance for deferred tax assets of
$34.9 million and $26.7 million at December 31, 1998 and 1997, respectively, is
required to reduce the Company's net deferred tax assets to the amount
realizable at present. Significant components of the Company's deferred tax
assets for federal and California income taxes as of December 31, 1998 and 1997
are as follows (in thousands):


<TABLE>
<CAPTION>
                                                     1998          1997
                                                   --------      --------
<S>                                                <C>           <C>     
Deferred tax assets:
   U.S. net operating loss carryforwards           $ 13,500      $ 13,500
   Foreign net operating loss carryforwards           8,809         3,300
   Tax credits (expiring 2000 - 2018)                 3,600         2,300
   Allowance for returns and doubtful accounts        2,200         2,100
   Depreciation and amortization                      2,500         2,600
   Warranty accruals                                  1,900         1,800
   Other                                              2,400         1,100
Less: valuation allowance                           (34,909)      (26,700)
                                                   --------      --------
   Net deferred tax assets                         $     --      $     --
                                                   ========      ========
</TABLE>


         The valuation allowance increased by $7.1 million in 1997.


                                       58


<PAGE>   59
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

NOTE 10.  RELATED PARTY TRANSACTIONS

         Hoya Corporation

         Hoya Corporation ("Hoya"), a shareholder of the Company, purchases from
the Company certain inventory for resale in Japan under an exclusive
distribution agreement entered into in June 1990. Sales to Hoya in 1998, 1997
and 1996 totaled $2.1 million, $3.4 million and $3.4 million, respectively.
Accounts receivable from Hoya at December 31, 1998 and 1997 were $122,000 and
$653,000, respectively.

         California Ear Institute at Stanford

         Dr. Rodney Perkins, the Chairman of the Company's Board of Directors
and a shareholder of the Company, is also the President of the California Ear
Institute ("CEI") at Stanford. Sales of the Company's products to CEI in 1998,
1997, and 1996 totaled $149,000, $119,000 and $192,000, respectively. Accounts
receivable from CEI were $30,200 and $30,000 at December 31, 1998 and 1997,
respectively.

NOTE 11.  SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION

         The Company adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, as of January 1, 1998. The prior year
segment information has been restated to present the Company's reportable
segments: North America, Europe, and Asia Pacific/Latin America. The North
America and Europe segments design, develop, manufacture, and market hearing
devices through audiologists, acousticians and other qualified hearing device
dispensers and distributors. The Asia Pacific/Latin America segment primarily
markets hearing devices through audiologists, acousticians and other qualified
hearing device dispensers and distributors.

         The accounting policies the segments are the same as those described
in Note 1, "Summary of Significant Accounting Policies". The Company evaluates
the performance of its sales and marketing segments (North America, Europe and
Asia Pacific/Latin America) and allocates resources to them based on earnings
from operations, which does not include nonrecurring gains and losses and
foreign exchange gains and losses. Additionally, the Company separately records
and analyzes R&D and Corporate operating expenses.

         The Company attributes the operating results of intersegment sales and
transfers based upon the region in which the sale to a third party customer
occurs.

         The Company's reportable segments are geographic locations. The
reportable segments are each managed separately because they have different
economic characteristics.


                                       59


<PAGE>   60
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998

        The table below presents information about reported segments for the
years ended December 31, 1998, 1997, and 1996 (in thousands):


<TABLE>
<CAPTION>
                                          North                     Asia Pacific/      R&D/
1998                                     America         Europe     Latin America    Corporate        Totals
                                        ---------      ---------    -------------    ---------      ---------
<S>                                     <C>            <C>          <C>              <C>            <C>      
Net sales to external customers         $  63,471      $  54,449      $   5,522      $      --      $ 123,442
Operating income (loss) - excluding
   restructure and other special
   charges                                 17,398          1,860          1,087        (26,535)        (6,190)
Restructure and other special
   charges                                 (3,062)       (14,496)           (66)            --        (17,624)
Operating income (loss) - including
   restructure and other special
   charges                                 14,336        (12,636)         1,021        (26,535)       (23,814)
Segment assets                             20,716         47,286          1,760             --         69,762
Expenditures for segment assets             4,459          3,349            166             --          7,974
Long-lived assets                           7,487         18,524            180             --         26,191
</TABLE>


<TABLE>
<CAPTION>
                                          North                      Asia Pacific/     R&D/
1997                                     America         Europe     Latin America    Corporate        Totals
                                        ---------      ---------    -------------    ---------      ---------
<S>                                     <C>            <C>          <C>              <C>            <C>      
Net sales to external customers         $  68,981      $  55,920      $   5,562      $      --      $ 130,463
Operating income (loss) - excluding
   restructure and other special
   charges                                 17,187          4,279          1,174        (20,426)         2,214
Restructure and other special
   charges                                (12,720)        (2,747)          (406)        (2,103)       (17,976)
Operating income (loss) - including
   restructure and other special
   charges                                  4,467          1,532            768        (22,529)       (15,762)
Segment assets                             33,448         56,197            130             --         89,775
Expenditures for segment assets             2,419          1,994             72             --          4,485
Long-lived assets                           8,533         26,931            184             --         35,648
</TABLE>


                                       60


<PAGE>   61
                               RESOUND CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998


<TABLE>
<CAPTION>
                                          North                     Asia Pacific/       R&D/
1996                                     America        Europe      Latin America     Corporate       Totals
                                        --------       --------     -------------     --------       --------
<S>                                     <C>            <C>            <C>             <C>            <C>     
Net sales to external customers         $ 57,136       $ 64,166       $  4,378        $    (34)      $125,646
Operating income (loss) - excluding
   restructure and other special
   charges                                14,283          6,533          1,127         (19,335)         2,608
Restructure and other special
   charges                                    --             --             --              --             --
Operating income (loss) - including
   restructure and other special
   charges                                14,283          6,533          1,127         (19,335)         2,608
Segment assets                            41,518         72,423            811              --        114,752
Expenditures for segment assets            3,526          3,986             35              --          7,547
Long-lived assets                         22,181         35,805            218              --         58,204
</TABLE>


        No one customer accounted for 10% or more of net sales in 1998, 1997 or
1996.

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

Not applicable.


                                       61


<PAGE>   62
                                    PART III

        Certain information required by Part III is omitted from this report
because the Registrant will file a definitive proxy statement within 120 days
after the end of its fiscal year pursuant to Regulation 14A (the "Proxy
Statement") for its annual meeting of shareholders to be held May 28, 1999 and
the information included therein is incorporated herein by reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

        Information with respect to directors of the Company and the Chairman of
the Company's Board of Directors is incorporated by reference from the
information under the caption "Election of Directors - Nominees" in the
Registrant's Proxy Statement.

        The names of the Company's executive officers and certain information
about them as of March 26, 1999, are set forth below:


<TABLE>
<CAPTION>
              Name                      Age                      Position
              ----                      ---                      --------
<S>                                     <C>    <C>
Russell D. Hays.....................    54     President, Chief Executive Officer and Director
Laureen De Buono....................    41     Executive Vice President, Chief Operating Officer
John H. Giroux......................    54     Senior Vice President and President, ReSound North America
Peter Nolan.........................    44     Senior Vice President, Worldwide Operations
David S. Thrower....................    34     Senior Vice President, Global Marketing
Robert D. Luttrell..................    39     Vice President, Chief Financial Officer
Edward Lopez........................    39     Vice President, Business Development, General Counsel and
                                               Secretary
Chaslav V. Pavlovic.................    50     Vice President, Research and Development
</TABLE>


        Russell D. Hays joined ReSound as President and Chief Executive Officer,
and was elected to its Board of Directors, in February 1998. From 1995 to 1998,
Mr. Hays served as Executive Vice President and President of the Hospital
Business of Nellcor Puritan Bennett, a medical device company that develops and
markets products that diagnose, monitor and treat respiratory disorders. From
1992 to 1995, Mr. Hays served as President and Chief Executive Officer of
Enzytech, Inc., a company that develops and markets drug delivery technologies.
From 1985 to 1992, Mr. Hays held senior management positions with Baxter
Healthcare Corporation, most recently as Vice President and General Manager of
the Immunotherapy Division of Baxter Biotech, and before that in the areas of
strategic planning and business development, marketing and business development,
and technology assessment and development. Prior to this, he held various
positions with Stryker Corporation, Baxter Travenol Labs, Inc., Amerace
Corporation, Reynolds Products, Inc., and Schaub Engineering Company. Mr. Hays
holds an M.B.A. from the J.L. Kellogg Graduate School at Northwestern
University and a B.S. in Physics from Elmhurst College.


                                       62


<PAGE>   63
        Laureen DeBuono joined the Company in October 1998 as Executive Vice
President, Chief Operating Officer and Chief Financial Officer. With the
addition of Robert D. Luttrell as Vice President, Chief Financial Officer in
February 1999, Ms. DeBuono no longer serves as Chief Financial Officer. Before
joining the Company, Ms. DeBuono was Executive Vice President, Human Resources,
General Counsel and Secretary at Nellcor Puritan Bennett from 1994 to 1998 and
served as General Counsel and Secretary at Nellcor Puritan Bennett from April
1992 to June 1994. Prior to joining Nellcor Puritan Bennett, Ms. DeBuono was
Division and Corporate Counsel with the Clorox Company, a diversified consumer
products company, from 1987 to 1992 and Corporate Counsel with Varian
Associates, Inc., an electronics device company, from 1984 to 1987. Ms. DeBuono
holds a B.A from Duke University, a M.A. from Stanford University and a J.D.
from New York University.

        John H. Giroux joined the Company in January 1991 as Vice President,
Marketing. He was elected Vice President, Sales and Marketing in December 1991
and in June 1993 was promoted to Senior Vice President, Sales and Marketing. In
January 1996, he was elected Senior Vice President of the Company and President
of ReSound U.S.A. Mr. Giroux has 27 years of experience in the marketing of
consumer health care products. Before joining the Company, Mr. Giroux was Vice
President of Marketing for Allergan Optical at Allergan, Inc., from February
1988 to June 1990. Prior to joining Allergan, Inc., Mr. Giroux was Vice
President at Ogilvy & Mather Worldwide, an advertising firm, from July 1984 to
February 1988. Prior to July 1984, Mr. Giroux was Vice President, Sales and
Marketing of the Consumer Products Division of G.D. Searle and Company, a
pharmaceutical company. Mr Giroux holds a B.A. in economics from Providence
College.

        Peter Nolan joined the Company in June 1994 as General Manager of
ReSound Ireland Ltd. He was named Vice President of Manufacturing in December
1995 and was promoted to Senior Vice President of Worldwide Operations in
October 1998. Before joining the Company, Mr. Nolan was General Manager of Wang
Laboratories Ireland B.V., the European manufacturing and distribution
headquarters for Wang, from 1992 until June 1994 and held other senior
management positions with that company, which he joined in 1984. Mr. Nolan has
also held various manufacturing and engineering positions with Digital Equipment
International B.V., Atari Ltd., Varian Instruments Ltd., and Westinghouse
Electronics Ltd.. Mr. Nolan holds a Bachelor of Technology - Production
Engineering from the University of Limerick, Ireland.

        David S. Thrower joined ReSound in July 1998 as Senior Vice President of
Global Marketing. In December 1998, Mr. Thrower's role was expanded to include
responsibility for ReSound Communications. Before joining ReSound, Mr. Thrower
served as Vice President of Quattro Consulting, Inc., a management consulting
firm exclusively focused on the medical device and technology industries, from
1993 to 1998. Prior to Quattro Consulting, Inc., Mr. Thrower was a consultant at
Bain & Company, from 1986 to 1990 and again from 1992 to 1993. Mr. Thrower holds
an MBA from Harvard Graduate School of Business Administration and a BS in
Mathematical and Computational Sciences from Stanford University.

        Robert D. Luttrell joined ReSound in February 1999 as Vice President,
Chief Financial Officer. Before joining the Company, Mr. Luttrell served as
Corporate Controller for Nellcor Puritan Bennett from 1995 until January 1999,
and held other financial management positions since joining that company in
1990. From 1987 to 1990, Mr. Luttrell held various financial management
positions with Applied Biosystems, a supplier of life sciences analytical
instrumentation and consumables. Mr. Luttrell also held financial management
positions with Fairchild Semiconductor from 1985 to 1987 and worked on the audit
staff of Arthur Young and Company from 1983 through 1985. Mr. Luttrell holds a
B.S. degree in business from San Francisco State University and is a Certified
Public Accountant in California.


                                       63


<PAGE>   64
        Edward Lopez joined ReSound in June 1998 as Vice President, Business
Development and General Counsel. In December 1998, Mr. Lopez was elected to the
office of Secretary of the Company. Prior to joining ReSound, Mr. Lopez was
Corporate Counsel and Senior Corporate Counsel with Nellcor Puritan Bennett from
October 1993 to February 1998. From 1987 until joining Nellcor Puritan Bennett
in 1993, Mr. Lopez worked with Morrison & Foerster, an international law firm
headquartered in San Francisco, California, where he focused his practice on
general corporate, mergers and acquisition, securities and finance matters. Mr.
Lopez received a J.D. from the Harvard Law School in 1985 and an A.B. in
economics and political science from Columbia University in 1982. Mr. Lopez is a
member of the Corporate Law Departments Committee of the Business Law Section of
the State Bar of California.

        Chaslav V. Pavlovic joined the Company in February 1994 as Vice
President of Research. In December 1996, he was promoted to Vice President for
Research and Development. Before joining the Company, Dr. Pavlovic was Associate
Professor of Audiology at the University of Iowa from December 1985 through
February 1993; Professor of Audiology at the University of Provence, France,
from March 1993 to June 1998; and a Coordinator of the European project EURAUD
(European Audiological Tests and Station); Chair, American National Standards
Institute S3-79 Writing Group (Calculation of the Articulation Index); USA
representative to the International Standards Organization ISO/TC 43/SC1;
Coordinator of the Overall Quality Assessment Subgroup, European Consortium for
Speech Assessment Methods (SAM, Project Esprit); Coordinator of participating
French laboratories on projects TIDE and OSCAR (pattern extraction hearing
aids); Member, American National Standards institute S12-8 Writing Group (rating
noise with respect to speech interference); Member of the Editorial Board,
Acoustics; Staff Editor, Journal D'Acoustique; Board of Directors, Journal
D'Acoustique; and Member, Technical Committee on Speech Communication,
Acoustical Society of America. Dr. Pavlovic has produced more than 50
publications and over 60 major international presentations. Dr. Pavlovic has a
Ph.D. in Audiology from Wichita State University, and an M.S. and B.S. in
Electrical Engineering from Salford University, England and the University of
Belgrade, Yugoslavia, respectively.

        Information with respect to compliance with Section 16(a) of the
Securities Exchange Act of 1934 is incorporated by reference from the
information under the caption, "Section 16(a) Beneficial Ownership Reporting
Compliance," in the Registrant's Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

        Incorporated by reference from the information under the captions
"Compensation of Executive Officers" and "Transactions with Management and
Others" in the Registrant's Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        Incorporated by reference from the information under the caption "Common
Stock Ownership of Certain Beneficial Owners and Management" in the Registrant's
Proxy Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        Incorporated by reference from the information under the captions
"Compensation of Executive Officers" and "Transactions with Management and
Others" in the Registrant's Proxy Statement.


                                       64


<PAGE>   65
                                     PART IV

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


(a)      The following documents are filed as part of this Report:


<TABLE>
<CAPTION>
                                                                                                               PAGE
                                                                                                               ----
<S>                                                                                                            <C>
         (1)      Consolidated Financial Statements and Report of Ernst &
                  Young LLP, Independent Auditors

                  Report of Ernst & Young LLP, Independent
                  Auditors.                                                                                     35

                  Consolidated Balance Sheets at December 31,
                  1998 and 1997.                                                                                36

                  Consolidated Statements of Operations -
                  Years ended December 31, 1998, 1997 and 1996.                                                 37

                  Consolidated Statement of Shareholders' Equity -
                  Three Years ended December 31, 1998.                                                          38

                  Consolidated Statements of Cash Flows -
                  Years ended December 31, 1998, 1997 and 1996.                                                 39

                  Notes to Consolidated Financial Statements.                                                   40

         (2)      Financial Statement Schedules
                  The following financial statement schedule is included herein:

                  Schedule II - Valuation and Qualifying Accounts                                               70

                  All other schedules are omitted because they are not required
                  or the required information is included in the consolidated
                  financial statements or notes thereto.

         (3)      Exhibits (numbered in accordance with Item 601 of Regulation S-K)
</TABLE>


                                       65


<PAGE>   66

<TABLE>
<CAPTION>
Exhibit
Number                                 Description
-------                                -----------
<S>            <C>
3.1            Amended and Restated Articles of Incorporation of Registrant. (3)

3.2            Bylaws of Registrant, as amended. (14)

4.1            Certificate of Determination of Rights, Preferences and
               Privileges of Series B Preferred Stock of ReSound Corporation.
               (6)

10.1           1988 Stock Option Plan, as amended. (5.1)

10.2           1992 Directors' Stock Option Plan, as amended. (5)

10.3           Form of Directors' and Officers' Indemnification Agreement. (1)

10.4           Amendment Number Eight to and Restatement of Registration Rights
               Agreement of ReSound Corporation dated as of August 21, 1992, as
               amended October 19, 1992. (1)

10.5           Contract Consulting Agreement dated July 25, 1996 with Dr. Rodney
               Perkins. (9)

10.6           Contract Consulting Agreement dated July 25, 1996 with Dr.
               Richard L. Goode. (9)

10.7           Lease Agreement between the Registrant and Seaport Centre Phase
               II dated June 15, 1988, as amended on August 31, 1988, March 21,
               1991, November 27, 1991 and December 28, 1992. (1)

10.8           Fifth Amendment dated December 5, 1995 to Lease Agreement with
               Seaport Centre Phase II (Exhibit 10.7). (6)

10.9           Sublease between the Registrant and Devices for Vascular
               Intervention, Inc. dated as of December 29, 1995. (6)

10.10          Technical Information and Patent License Agreement with American
               Telephone and Telegraph Company dated as of February 27, 1987, as
               amended effective January 1, 1988. (1)

10.11          Custom IC Agreement with American Telephone and Telegraph Company
               dated 1987, as supplemented on April 6, 1990, April 24, 1990,
               July 15, 1992 and December 11, 1992, for the manufacture of
               custom integrated circuits. (1)(2)

10.16          Loan Agreement between the Registrant, ReSound GmbH and Bank
               Austria Aktiengesellschaft dated December 7, 1994. (4)

10.17          Note Purchase Agreement between the Registrant and Cagen Holdings
               Limited dated as of February 21, 1995 and related Convertible
               Promissory Note. (5)

10.18          Note Purchase Agreement between the Registrant and The Mingly
               Corporation Limited dated as of February 21, 1995 and related
               Convertible Promissory Note. (5)

10.19          Note Purchase Agreement between the Registrant and Charter
               Ventures II, L.P. dated as of February 21, 1995 and related
               Convertible Promissory Note. (5)
</TABLE>


                                       66


<PAGE>   67
<TABLE>
<CAPTION>
Exhibit
Number                                 Description
-------                                -----------
<S>            <C>
10.20          Loan and Security Agreement with Silicon Valley Bank dated
               October 27, 1995, and related Registration Rights Agreement,
               Patent Mortgage and Collateral Assignment Agreement and Warrant.
               (6)

10.21          Note and Warrant Purchase Agreement between the Registrant and
               Cagen Holdings Limited dated as of November 21, 1995 and related
               Convertible Promissory Note and Warrant. (6)

10.22          Note and Warrant Purchase Agreement between the Registrant and
               Charter Ventures II, L.P. dated as of November 21, 1995 and
               related Convertible Promissory Note and Warrant. (6)

10.23          Form of Common Stock warrant dated December 1, 1995 issued to
               certain directors of the Registrant. (6)

10.24          Purchase Agreement by and between the Registrant and Minnesota
               Mining and Manufacturing Company dated June 28, 1996. (8)

10.25          Letter agreement with respect to Purchase of Series B Preferred
               Stock dated March 8, 1996 between the Company and S-E-Banken
               Lakemedelsfond. (7)

10.26          AudioLogic Hearing Systems, L.P. Amended and Restated Agreement
               of Limited Partnership dated as of September 30, 1996. (7) (10)

10.27          Series C Convertible Preferred Stock and Common Stock Purchase
               Agreement dated September 30, 1996. (7)

10.28          Development, Licensing and Distribution Agreement by and among
               AudioLogic, Inc., GN Danavox A/S, ReSound Corporation and
               AudioLogic Hearing Systems, L.P. dated September 30, 1996. (7)
               (10)

10.29          Assignment Agreement between ReSound Corporation and K/S
               HIMPP.25. (7)

10.30          Lease Agreement dated September 24, 1996 between the Registrant
               and Don and Carole Tanklage dba Tanklage Properties. (9)

10.31          ReSound Corporation 1997 Stock Plan. (11)

10.32          Separation Agreement. (12)

10.33          Change of Control Agreement. (13)

10.34          Agreement in Contemplation of Separation. (15)

10.35          Amended and Restated Change of Control Agreement. (16)

10.36          1997 Stock Plan. (17)

10.37          1992 Employee Stock Purchase Plan. (18)

10.38          Loan and Security Agreement with Silicon Valley Bank dated
               February 12, 1999. (14)

10.39          Consulting Agreement dated January 1, 1999 with Dr. Rodney
               Perkins. (14)
</TABLE>


                                       67


<PAGE>   68
<TABLE>
<CAPTION>
Exhibit
Number                                 Description
-------                                -----------
<S>            <C>
10.40          Settlement Agreement and Release dated December 21, 1998 between
               Registrant and Andreas Joder. (14)

10.41          Settlement Agreement and Release dated December 22, 1998 between
               Registrant and Stephan Becker-Vogt. (14)

10.42          Consulting Agreement dated October 31, 1998 between Registrant
               and Andreas B. Joder. (14)

10.43          Consultancy Agreement dated January 1, 1999 between Registrant
               and Stephan Becker-Vogt. (14)

10.44          Notarial Deed dated November 28, 1998 between ReSound-Viennatone
               Hortechnologie GmbH and Amplifon International N.V. (14)

10.45          Cooperation and Sales Agreement dated November 28, 1998 between
               ReSound-Viennatone Hortechnologie GmbH and Amplifon International
               N.V. (14)

21.1           Subsidiaries of Registrant. (14)

23.1           Consent of Ernst & Young LLP, Independent Auditors (see page 65).
               (14)

24.1           Power of Attorney (see page 66). (14)
</TABLE>


(b)            Reports on Form 8-K: 
               None

--------------------
(1)            Incorporated by reference to exhibits filed in response to Item
               16(a), "Exhibits," of the Registrant's Registration Statement on
               Form S-1 and Amendment No. 1, Amendment No. 2 and Amendment No. 3
               thereto (File No. 33-46527), which became effective on March 4,
               1993.

(2)            Confidential treatment granted by order effective February 24,
               1993.

(3)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K," of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1993.

(4)            Incorporated by reference to exhibits filed in response to Item
               7, "Financial Statements, Pro Forma Financial Information and
               Exhibits," of the Registrant's Report on Form 8-K dated December
               9, 1994.

(5)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K," of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1994.

(5.1)          Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits," of the Registrant's Statement on Form S-8 (File
               No. 333-09303), which became effective July 31, 1996.

(6)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K," of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1995.


                                       68


<PAGE>   69
(7)            Incorporated by reference to exhibits filed in response to Item
               6, "Exhibits, and Reports on Form 8-K," of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended
               September 30, 1996.

(8)            Incorporated by reference to exhibits filed in response to Item
               7, "Financial Statements and Exhibits" of Registrant's Report on
               Form 8-K filed with the Securities and Exchange Commission on
               July 15, 1996 (as amended and filed September 12, 1996).

(9)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K" of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1997.

(10)           Confidential treatment granted by order effective March 1997.

(11)           Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits," of the Registrant's Registration Statement on Form
               S-8 (File No. 333-46585), which became effective February 4,
               1998.

(12)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K" of the Registrant's Quarterly Report on Form 10-Q for the
               fiscal quarter ended June 30, 1997.

(13)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits and Reports on Form 8-K" of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended
               September 30, 1997.

(14)           Filed herewith

(15)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits and Reports on Form 8-K" of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended March
               28, 1998.

(16)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits and Reports on Form 8-K" of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended
               September 26, 1998.

(17)           Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits" of the Registrant's Statement on Form S-8 (File No.
               333-46585), which became effective February 19, 1998.

(18)           Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits of the Registrant's Statement on Form S-8 (File No.
               333-57709), which became effective June 25, 1998.


                                       69


<PAGE>   70
                                   SCHEDULE II

                               RESOUND CORPORATION

                        VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                         BALANCE AT     CHARGED AGAINST                     BALANCE AT
                                         BEGINNING OF    SALES OR TO        RETURNS/          END OF
           DESCRIPTION                    THE YEAR         EXPENSE         WRITE-OFFS        THE YEAR
                                         ------------   ---------------    ----------       ----------
<S>                                      <C>            <C>                <C>              <C>       
Year ended December 31, 1996:
Allowances for estimated
  returns and doubtful accounts          $    4,123       $   17,786       $   15,390       $    6,519
Reserves for warranty expenses                4,585            5,981            5,466            5,100
                                         ----------       ----------       ----------       ----------
                                         $    8,708       $   23,767       $   20,856       $   11,619
                                         ==========       ==========       ==========       ==========

Year ended December 31, 1997:
Allowances for estimated
  returns and doubtful accounts          $    6,519       $   20,730       $   20,185       $    7,064
Reserves for warranty expenses                5,100            6,625            5,856            5,869
                                         ----------       ----------       ----------       ----------
                                         $   11,619       $   27,355       $   26,041       $   12,933
                                         ==========       ==========       ==========       ==========

Year ended December 31, 1998:
Allowances for estimated
  returns and doubtful accounts          $    7,064       $   21,903       $   22,753       $    6,214
Reserves for warranty expenses                5,869            3,692            4,922            4,639
                                         ----------       ----------       ----------       ----------
                                         $   12,933       $   25,595       $   27,675       $   10,853
                                         ==========       ==========       ==========       ==========
</TABLE>


                                       70


<PAGE>   71
               CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

         We consent to incorporation by reference in the Registration Statements
(Form S-8 Nos. 333-09303, 33-61302, 333-46585, 333-48695, 333-57709 and
333-61297) pertaining to the 1988 Stock Option Plan, the 1992 Employee Stock
Purchase Plan, the 1992 Directors' Stock Option Plan, the 1997 Stock Plan and
the 1998 New Executive Stock Option Plan of ReSound Corporation of our report
dated January 22, 1999, with respect to the consolidated financial statements
and schedule of ReSound Corporation, included in this Annual Report (Form 10-K),
for the year ended December 31, 1998.



                                                           /s/ Ernst & Young LLP
Palo Alto, California
March 26, 1999


                                       71


<PAGE>   72
                                   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. RESOUND CORPORATION

     Date: March 26, 1999          By:  /s/ Russell D. Hays
                                        ----------------------------------
                                        Russell D. Hays
                                        President and Chief Executive Officer

                                POWER OF ATTORNEY

         KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Rodney Perkins, Russell D. Hays and
Robert D. Luttrell, jointly and severally, his attorneys-in-fact, each with the
power of substitution, for him in any and all capacities, to sign any amendments
to this Report on Form 10-K, and to file the same, with exhibits thereto and
other documents in connection therewith with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


<TABLE>
<CAPTION>
           Signature                                              Title                              Date    
           ---------                                              -----                              ----    
<S>                                           <C>                                                 <C> 
/s/ Rodney Perkins, M.D.                      Chairman of the Board of Directors                  March 26, 1999
----------------------------------------
(Rodney Perkins, M.D.)

/s/ Russell D. Hays                           President, Chief Executive Officer                  March 26, 1999
----------------------------------------      and Director (principal executive officer)
(Russell D. Hays)                             

/s/ Robert D. Luttrell                        Vice President, Chief Financial Officer             March 26, 1999
----------------------------------------      (principal financial and accounting officer)
(Robert D. Luttrell)                          

/s/ Richard L. Goode, M.D.                    Director                                            March 26, 1999
----------------------------------------
(Richard L. Goode, M.D.)

/s/ Michael P. Downey                         Director                                            March 26, 1999
----------------------------------------
(Michael P. Downey)

/s/ Eugene Kleiner                            Director                                            March 26, 1999
----------------------------------------
(Eugene Kleiner)

/s/ Philip S. Schlein                         Director                                            March 26, 1999
----------------------------------------
(Philip S. Schlein)

/s/ Robert C. Wilson                          Director                                            March 26, 1999
----------------------------------------
(Robert C. Wilson)
</TABLE>


                                       72


<PAGE>   73
                                 Exhibit Index

<TABLE>
<CAPTION>
Exhibit
Number                                 Description
-------                                -----------
<S>            <C>
3.1            Amended and Restated Articles of Incorporation of Registrant. (3)

3.2            Bylaws of Registrant, as amended. (14)

4.1            Certificate of Determination of Rights, Preferences and
               Privileges of Series B Preferred Stock of ReSound Corporation.
               (6)

10.1           1988 Stock Option Plan, as amended. (5.1)

10.2           1992 Directors' Stock Option Plan, as amended. (5)

10.3           Form of Directors' and Officers' Indemnification Agreement. (1)

10.4           Amendment Number Eight to and Restatement of Registration Rights
               Agreement of ReSound Corporation dated as of August 21, 1992, as
               amended October 19, 1992. (1)

10.5           Contract Consulting Agreement dated July 25, 1996 with Dr. Rodney
               Perkins. (9)

10.6           Contract Consulting Agreement dated July 25, 1996 with Dr.
               Richard L. Goode. (9)

10.7           Lease Agreement between the Registrant and Seaport Centre Phase
               II dated June 15, 1988, as amended on August 31, 1988, March 21,
               1991, November 27, 1991 and December 28, 1992. (1)

10.8           Fifth Amendment dated December 5, 1995 to Lease Agreement with
               Seaport Centre Phase II (Exhibit 10.7). (6)

10.9           Sublease between the Registrant and Devices for Vascular
               Intervention, Inc. dated as of December 29, 1995. (6)

10.10          Technical Information and Patent License Agreement with American
               Telephone and Telegraph Company dated as of February 27, 1987, as
               amended effective January 1, 1988. (1)

10.11          Custom IC Agreement with American Telephone and Telegraph Company
               dated 1987, as supplemented on April 6, 1990, April 24, 1990,
               July 15, 1992 and December 11, 1992, for the manufacture of
               custom integrated circuits. (1)(2)

10.16          Loan Agreement between the Registrant, ReSound GmbH and Bank
               Austria Aktiengesellschaft dated December 7, 1994. (4)

10.17          Note Purchase Agreement between the Registrant and Cagen Holdings
               Limited dated as of February 21, 1995 and related Convertible
               Promissory Note. (5)

10.18          Note Purchase Agreement between the Registrant and The Mingly
               Corporation Limited dated as of February 21, 1995 and related
               Convertible Promissory Note. (5)

10.19          Note Purchase Agreement between the Registrant and Charter
               Ventures II, L.P. dated as of February 21, 1995 and related
               Convertible Promissory Note. (5)
</TABLE>


<PAGE>   74
<TABLE>
<CAPTION>
Exhibit
Number                                 Description
-------                                -----------
<S>            <C>
10.20          Loan and Security Agreement with Silicon Valley Bank dated
               October 27, 1995, and related Registration Rights Agreement,
               Patent Mortgage and Collateral Assignment Agreement and Warrant.
               (6)

10.21          Note and Warrant Purchase Agreement between the Registrant and
               Cagen Holdings Limited dated as of November 21, 1995 and related
               Convertible Promissory Note and Warrant. (6)

10.22          Note and Warrant Purchase Agreement between the Registrant and
               Charter Ventures II, L.P. dated as of November 21, 1995 and
               related Convertible Promissory Note and Warrant. (6)

10.23          Form of Common Stock warrant dated December 1, 1995 issued to
               certain directors of the Registrant. (6)

10.24          Purchase Agreement by and between the Registrant and Minnesota
               Mining and Manufacturing Company dated June 28, 1996. (8)

10.25          Letter agreement with respect to Purchase of Series B Preferred
               Stock dated March 8, 1996 between the Company and S-E-Banken
               Lakemedelsfond. (7)

10.26          AudioLogic Hearing Systems, L.P. Amended and Restated Agreement
               of Limited Partnership dated as of September 30, 1996. (7) (10)

10.27          Series C Convertible Preferred Stock and Common Stock Purchase
               Agreement dated September 30, 1996. (7)

10.28          Development, Licensing and Distribution Agreement by and among
               AudioLogic, Inc., GN Danavox A/S, ReSound Corporation and
               AudioLogic Hearing Systems, L.P. dated September 30, 1996. (7)
               (10)

10.29          Assignment Agreement between ReSound Corporation and K/S
               HIMPP.25. (7)

10.30          Lease Agreement dated September 24, 1996 between the Registrant
               and Don and Carole Tanklage dba Tanklage Properties. (9)

10.31          ReSound Corporation 1997 Stock Plan. (11)

10.32          Separation Agreement. (12)

10.33          Change of Control Agreement. (13)

10.34          Agreement in Contemplation of Separation. (15)

10.35          Amended and Restated Change of Control Agreement. (16)

10.36          1997 Stock Plan. (17)

10.37          1992 Employee Stock Purchase Plan. (18)

10.38          Loan and Security Agreement with Silicon Valley Bank dated
               February 12, 1999. (14)

10.39          Consulting Agreement dated January 1, 1999 with Dr. Rodney
               Perkins. (14)
</TABLE>


<PAGE>   75
<TABLE>
<CAPTION>
Exhibit
Number                                 Description
-------                                -----------
<S>            <C>
10.40          Settlement Agreement and Release dated December 21, 1998 between
               Registrant and Andreas Joder. (14)

10.41          Settlement Agreement and Release dated December 22, 1998 between
               Registrant and Stephan Becker-Vogt. (14)

10.42          Consulting Agreement dated October 31, 1998 between Registrant
               and Andreas B. Joder. (14)

10.43          Consultancy Agreement dated January 1, 1999 between Registrant
               and Stephan Becker-Vogt. (14)

10.44          Notarial Deed dated November 28, 1998 between ReSound-Viennatone
               Hortechnologie GmbH and Amplifon International N.V. (14)

10.45          Cooperation and Sales Agreement dated November 28, 1998 between
               ReSound-Viennatone Hortechnologie GmbH and Amplifon International
               N.V. (14)

21.1           Subsidiaries of Registrant. (14)

23.1           Consent of Ernst & Young LLP, Independent Auditors (see page 65).
               (14)

24.1           Power of Attorney (see page 66). (14)
</TABLE>


(b)            Reports on Form 8-K: 
               None

--------------------
(1)            Incorporated by reference to exhibits filed in response to Item
               16(a), "Exhibits," of the Registrant's Registration Statement on
               Form S-1 and Amendment No. 1, Amendment No. 2 and Amendment No. 3
               thereto (File No. 33-46527), which became effective on March 4,
               1993.

(2)            Confidential treatment granted by order effective February 24,
               1993.

(3)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K," of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1993.

(4)            Incorporated by reference to exhibits filed in response to Item
               7, "Financial Statements, Pro Forma Financial Information and
               Exhibits," of the Registrant's Report on Form 8-K dated December
               9, 1994.

(5)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K," of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1994.

(5.1)          Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits," of the Registrant's Statement on Form S-8 (File
               No. 333-09303), which became effective July 31, 1996.

(6)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K," of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1995.


<PAGE>   76
(7)            Incorporated by reference to exhibits filed in response to Item
               6, "Exhibits, and Reports on Form 8-K," of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended
               September 30, 1996.

(8)            Incorporated by reference to exhibits filed in response to Item
               7, "Financial Statements and Exhibits" of Registrant's Report on
               Form 8-K filed with the Securities and Exchange Commission on
               July 15, 1996 (as amended and filed September 12, 1996).

(9)            Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K" of the Registrant's Annual Report on Form 10-K for the
               fiscal year ended December 31, 1997.

(10)           Confidential treatment granted by order effective March 1997.

(11)           Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits," of the Registrant's Registration Statement on Form
               S-8 (File No. 333-46585), which became effective February 4,
               1998.

(12)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits, Financial Statement Schedules and Reports on Form
               8-K" of the Registrant's Quarterly Report on Form 10-Q for the
               fiscal quarter ended June 30, 1997.

(13)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits and Reports on Form 8-K" of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended
               September 30, 1997.

(14)           Filed herewith

(15)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits and Reports on Form 8-K" of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended March
               28, 1998.

(16)           Incorporated by reference to exhibits filed in response to Item
               14, "Exhibits and Reports on Form 8-K" of the Registrant's
               Quarterly Report on Form 10-Q for the fiscal quarter ended
               September 26, 1998.

(17)           Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits" of the Registrant's Statement on Form S-8 (File No.
               333-46585), which became effective February 19, 1998.

(18)           Incorporated by reference to exhibits filed in response to Item
               8, "Exhibits of the Registrant's Statement on Form S-8 (File No.
               333-57709), which became effective June 25, 1998.