UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549







FORM
10-Q







x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




FOR
THE QUARTERLY PERIOD ENDED JUNE 30, 2010




or




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




Commission
File No. 000-30335







OTIX GLOBAL,
INC.


(Exact
name of registrant as specified in its charter)





DELAWARE
            
            87-0494518(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer
              Identification
      No.)





4246
South Riverboat Road, Suite 300


Salt
Lake City, UT 84123


(Address
of principal executive offices)




(801)
312-1700


(Registrant’s
telephone number, including area code)









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




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).    
x  Yes    
 ̈
  No




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




Large accelerated filer
             ̈
            Accelerated
      filer
             ̈Non-accelerated
      filer
            x
            Smaller reporting company
             ̈




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act):


 ̈
  Yes     x
  No




As of
August 9, 2010, there were 5,584,747 shares of the registrant’s $0.005 par value
common stock outstanding.










OTIX GLOBAL, INC.


TABLE
OF CONTENTS




PagePART
      I. FINANCIAL INFORMATIONITEM 1.
            Condensed
      Consolidated Financial Statements (Unaudited):Condensed
      Consolidated Balance Sheets as of June 30, 2010 and December 31,
      2009
            
            
            3Condensed
      Consolidated Statements of Operations for the Three and Six Months Ended
      June 30, 2010 and 2009
            
            
            4Condensed
      Consolidated Statements of Cash Flows for the Six Months Ended June 30,
      2010 and 2009
            
            
            5Notes
      to Condensed Consolidated Financial Statements
            
            
            6ITEM 2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            
            15ITEM 3.
            Quantitative
      and Qualitative Disclosures about Market Risks
            
            
            25ITEM 4.
            Controls
      and Procedures
            
            
            26PART
      II. OTHER INFORMATIONITEM 1.
            Legal
      Proceedings
            
            
            26ITEM 1A.
            Risk
      Factors
            
            
            26ITEM
      4.
            Reserved
            
            
            27ITEM 6.
            Exhibits
            
            
            27SIGNATURE
            
            
            28CERTIFICATIONS




2




PART I. FINANCIAL INFORMATION




ITEM 1.
            CONDENSED
      CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)




OTIX
GLOBAL, INC.




CONDENSED
CONSOLIDATED BALANCE SHEETS


(in
thousands, except per share data)


(unaudited)





June
      30,
              2010
            
            
            December
      31,
              2009ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            9,741
            
            
            $
            12,154Restricted
      cash
            
            
            106
            
            
            
            71Accounts
      receivable, net of allowance for doubtful accounts of $867 and
      $851
            
            
            8,725
            
            
            
            10,625Inventories
            
            
            8,939
            
            
            
            8,754Prepaid
      expenses and other
            
            
            3,565
            
            
            
            4,315Total
      current assets
            
            
            31,076
            
            
            
            35,919Property
      and equipment, net of accumulated depreciation and amortization of $20,598
      and $19,941
            
            
            8,929
            
            
            
            8,755Definite-lived
      intangible assets, net
            
            
            2,827
            
            
            
            3,016Indefinite-lived
      intangible assets
            
            
            9,001
            
            
            
            9,368Goodwill
            
            
            6,824
            
            
            
            7,772Other
      assets
            
            
            1,807
            
            
            
            2,295Total
      assets
            
            $
            60,464
            
            
            $
            67,125LIABILITIES
      AND SHAREHOLDERS’ EQUITYCurrent
      liabilities:Current
      portion of long-term debt
            
            $
            6,104
            
            
            $
            4,923Accounts
      payable
            
            
            5,980
            
            
            
            6,426Accrued
      payroll and related expenses
            
            
            3,897
            
            
            
            4,515Accrued
      restructuring
            
            
            77
            
            
            
            356Accrued
      warranty
            
            
            3,713
            
            
            
            3,901Deferred
      revenue
            
            
            4,373
            
            
            
            4,602Other
      accrued liabilities
            
            
            3,494
            
            
            
            3,602Total
      current liabilities
            
            
            27,638
            
            
            
            28,325Long-term
      debt, net of current portion
            
            
            788
            
            
            
            452Deferred
      revenue, net of current portion
            
            
            3,835
            
            
            
            5,264Other
      liabilities
            
            
            213
            
            
            
            282Total
      liabilities
            
            
            32,474
            
            
            
            34,323Commitments
      and contingencies (Note 4) Shareholders’ equity:Preferred
      stock, $0.001 par value; 5,000 shares authorized; zero issued and
      outstanding
            
            
            -
            
            
            
            -Common
      stock; $0.005 par value; 14,000 shares authorized; 5,780 and 5,762 shares
      issued and outstanding, respectively
            
            
            29
            
            
            
            29Additional
      paid-in-capital
            
            
            145,927
            
            
            
            145,359Accumulated
      deficit
            
            
            (122,715
            )
            
            
            (118,244
            )Accumulated
      other comprehensive income
            
            
            8,522
            
            
            
            9,431Treasury
      stock; 195 shares at cost
            
            
            (3,773
            )
            
            
            (3,773
            )Total
      shareholders’ equity
            
            
            27,990
            
            
            
            32,802Total
      liabilities and shareholders’ equity
            
            $
            60,464
            
            
            $
            67,125




See
accompanying notes to condensed consolidated financial
statements.


3


OTIX GLOBAL, INC.




CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(in
thousands, except per share data)


(unaudited)







Three
      months ended
              June
      30,
            
            
            Six
      months ended
              June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Net
      sales
            
            $
            21,626
            
            
            $
            25,420
            
            
            $
            42,403
            
            
            $
            49,852Cost
      of sales
            
            
            8,233
            
            
            
            9,956
            
            
            
            15,694
            
            
            
            20,225Gross
      profit
            
            
            13,393
            
            
            
            15,464
            
            
            
            26,709
            
            
            
            29,627Selling,
      general and administrative expense
            
            
            14,686
            
            
            
            15,298
            
            
            
            29,429
            
            
            
            29,619Research
      and development expense
            
            
            894
            
            
            
            1,929
            
            
            
            1,959
            
            
            
            3,908Goodwill
      and definite-lived intangibles impairment charges
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            14,658Restructuring
      charge (credit)
            
            
            -
            
            
            
            525
            
            
            
            (20
            )
            
            
            525Operating
      loss
            
            
            (2,187
            )
            
            
            (2,288
            )
            
            
            (4,659
            )
            
            
            (19,083
            )Interest
      expense
            
            
            (77
            )
            
            
            (137
            )
            
            
            (129
            )
            
            
            (277
            )Other
      income (expense), net
            
            
            170
            
            
            
            (22
            )
            
            
            196
            
            
            
            86Loss
      before income taxes
            
            
            (2,094
            )
            
            
            (2,447
            )
            
            
            (4,592
            )
            
            
            (19,274
            )Provision
      (benefit) for income taxes
            
            
            44
            
            
            
            180
            
            
            
            (128
            )
            
            
            276Loss
      from continuing operations
            
            
            (2,138
            )
            
            
            (2,627
            )
            
            
            (4,464
            )
            
            
            (19,550
            )Income
      (loss) from discontinued operations, net of income taxes
            
            
            -
            
            
            
            35
            
            
            
            (7
            )
            
            
            (10
            )Net
      loss
            
            $
            (2,138
            )
            
            $
            (2,592
            )
            
            $
            (4,471
            )
            
            $
            (19,560
            )Basic
      and diluted loss per common share:Continuing
      operations
            
            $
            (0.38
            )
            
            $
            (0.47
            )
            
            $
            (0.80
            )
            
            $
            (3.54
            )Discontinued
      operations
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
      loss
            
            $
            (0.38
            )
            
            $
            (0.47
            )
            
            $
            (0.80
            )
            
            $
            (3.54
            )Weighted
      average number of common shares outstanding:Basic
      and diluted
            
            
            5,580
            
            
            
            5,533
            
            
            
            5,575
            
            
            
            5,525




See
accompanying notes to condensed consolidated financial
statements.


4




OTIX
GLOBAL, INC.




CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(in
thousands)


(unaudited)







For
      the six months ended
              June
      30,2010
            
            
            2009Cash
      flows from operating activities:Net
      loss
            
            $
            (4,471
            )
            
            $
            (19,560
            )Loss
      from discontinued operations, net of income taxes
            
            
            7
            
            
            
            10Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
            
            
            1,675
            
            
            
            2,046Stock-based
      compensation
            
            
            580
            
            
            
            808Foreign
      currency loss, net
            
            
            647
            
            
            
            160Deferred
      income taxes
            
            
            (107
            )
            
            
            (10
            )Amortization
      of interest on long-term debt
            
            
            2
            
            
            
            76Goodwill
      and definite-lived intangible impairment charges
            
            
            -
            
            
            
            14,658Loss
      on disposal of long-lived assets
            
            
            20
            
            
            
            -Changes
      in assets and liabilities:Accounts
      receivable
            
            
            1,272
            
            
            
            410Inventories
            
            
            (730
            )
            
            
            (2,145
            )Other
      assets
            
            
            89
            
            
            
            380Withholding
      taxes remitted on share-based awards
            
            
            (19
            )
            
            
            (37
            )Accrued
      restructuring
            
            
            (279
            )
            
            
            208Accounts
      payable, accrued expenses and deferred revenue
            
            
            (1,485
            )
            
            
            (57
            )Net
      cash used in operating activities from continuing
    operations
            
            
            (2,799
            )
            
            
            (3,053
            )Net
      cash provided by (used in) discontinued operations
            
            
            (40
            )
            
            
            22Net
      cash used in operating activities
            
            
            (2,839
            )
            
            
            (3,031
            )Cash
      flows from investing activities:Purchase
      of property and equipment
            
            
            (1,655
            )
            
            
            (1,706
            )Payment
      for technology license
            
            
            (204
            )
            
            
            -Customer
      loan repayments (advances), net
            
            
            1,089
            
            
            
            (358
            )Net
      cash used in investing activities
            
            
            (770
            )
            
            
            (2,064
            )Cash
      flows from financing activities:Proceeds
      from exercise of stock options and tax collected on vesting of restricted
      stock awards
            
            
            7
            
            
            
            20Reduction
      (increase) in restricted cash and cash equivalents
            
            
            (39
            )
            
            
            261Borrowings
      on line of credit
            
            
            3,000
            
            
            
            2,750Repayments
      on line of credit
            
            
            (2,140
            )
            
            
            -Borrowings
      on long-term debt
            
            
            1,765
            
            
            
            -Repayments
      on long-term debt
            
            
            (930
            )
            
            
            (2,492
            )Net
      cash provided by financing activities
            
            
            1,663
            
            
            
            539Effect
      of exchange rate changes on cash and cash equivalents from continuing
      operations
            
            
            (466
            )
            
            
            70Effect
      of exchange rate changes on cash and cash equivalents from discontinued
      operations
            
            
            (1
            )
            
            
            (10
            )Effect
      of exchange rate changes on cash and cash equivalents
            
            
            (467
            )
            
            
            60Net
      decrease in cash and cash equivalents
            
            
            (2,413
            )
            
            
            (4,496
            )Cash
      and cash equivalents, beginning of the period
            
            
            12,154
            
            
            
            13,129Cash
      and cash equivalents, end of the period
            
            $
            9,741
            
            
            $
            8,633Supplemental
      cash flow information:Cash
      paid for interest expense, net of amount capitalized
            
            $
            173
            
            
            $
            206Cash
      paid for income taxes
            
            
            880
            
            
            
            889




See
accompanying notes to condensed consolidated financial
statements.


5




OTIX
GLOBAL, INC.




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(in
thousands, except per share data)


(unaudited)




1.
BASIS OF PRESENTATION




The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by U.S. generally accepted accounting principles for
complete financial statements. In the opinion of management, all adjustments
(consisting only of normal recurring adjustments) considered necessary for a
fair presentation have been included. The results of operations for the six
months ended June 30, 2010 are not necessarily indicative of results that may be
expected for the full year ending December 31, 2010. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Otix Global, Inc. Annual Report on Form 10-K for the
year ended December 31, 2009 as filed with the U.S. Securities and Exchange
Commission (“SEC”).




On
September 1, 2008, the Company sold one European operation and closed a
second European operation. As of June 30, 2010 and December 31, 2009, there were
no material balances related to these operations remaining in the Condensed
Consolidated Balance Sheets. These operations have been classified as
discontinued operations in the Condensed Consolidated Statements of Operations
and the Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 2010 and 2009.




On March
12, 2010, Company management implemented the Board of Directors’ approval of a
reverse stock split at a 1-for-5 ratio, which became effective March 29, 2010.
The shareholders had approved the reverse stock split on May 7,
2009.  As a result of the reverse stock split, every 5 shares of the
Company’s common stock that were issued as of March 29, 2010 were combined into
one issued and outstanding share, with a change in the par value of such shares
from $0.001 to $0.005 per share, subject to the elimination of fractional
shares. The reverse stock split has been retroactively applied to all periods
presented.




As
further discussed in Note 2, in November 2008, the German government passed a
law that became effective April 1, 2009. The key implication to the
Company’s business model was that the new law will impose additional costs on
the doctors and insurance companies that conduct business with the Company’s
German subsidiary. The Company is currently renegotiating contracts in light of
the new legislative requirements and is working to contract with other insurance
companies as well. The lack of signed contracts, the imposition of new and
costly requirements on the ENT doctors and insurance companies, as well as the
uncertainty of regulatory requirements, make the long term prospects for the
Company's German subsidiary uncertain. Final regulatory requirements are
expected to be completed before the end of 2010, the impact of which is unknown
at this time.




The
Company’s ability to make payments on and to refinance its indebtedness, and to
fund planned capital expenditures and ongoing operations, will depend on its
ability to generate cash in the future. This depends, to a degree, on general
economic, financial, competitive, legislative, regulatory and other factors that
are beyond the Company’s control. The Company plans to continue to decrease
its receivables and inventory, pursue additional debt financing,
and together with available cash balances; it expects to be able to
fund future debt service payments, ongoing operations, and capital
expenditures through at least December 31, 2010.  The key to this plan will
be its German and U.S. retail operating performance. The Company has recently
amended the agreement on its line of credit and obtained additional financing to
help fund operational requirements (See Note 3 for further
details).




There can
be no assurance, however, that the Company’s business will generate sufficient
cash flow from operations, that currently anticipated cost savings and operating
improvements will be realized on schedule, or that future borrowings will be
available in an amount sufficient to enable it to pay its indebtedness or to
fund other liquidity needs. Furthermore, the Company cannot provide any
assurances that ongoing uncertainty in global capital markets and general
economic conditions will not have a material adverse impact on its future
operations and cash flows. The Company may need to refinance all or a
portion of its indebtedness on or before maturity and it cannot provide
assurances that it will be able to refinance any of its indebtedness on
commercially reasonable terms, or at all. Should the Company be unable to
renegotiate its debt service payments, it may need to sell assets of the
company, which will also be subject to market conditions existing at that time.
The Company’s bank debt includes a customary material adverse change clause that
allows the banks to call the loans, if invoked. None of the banks have invoked
this clause. The Company notified Silicon Valley Bank ("SVB") in May 2010
that compliance with its debt covenants, as structured, would be difficult.
Subsequently, in June 2010, the Company signed a letter of
understanding with SVB in which SVB agreed to suspend covenant testing as
of May 31, 2010 and June 30, 2010, respectively, and amend the financial
covenants, pending completion of a formal loan agreement by early August
2010.  Accordingly, on August 9, 2010, the Company and SVB signed an
agreement which suspended the debt covenants at May 31, 2010 and June 30, 2010,
respectively, and provided new covenants for the remaining term of the
agreement. The Company is in compliance with its amended debt covenants as
of June 30, 2010. As of June 30, 2010, the Company’s outstanding borrowings of
$3,976 on the line of credit represented the maximum allowable borrowing under
the terms of the agreement. In July 2010, the Company paid $2,339 on its
revolving credit facility with SVB due to reduced borrowing capacity under the
amended agreement.




6




The
Company monitors its capital structure on an ongoing basis and from time to time
considers financing and refinancing options to improve its capital structure and
to enhance its financial flexibility. The ability to enter into new financing
arrangements is subject to restrictions in the Company’s outstanding debt
instruments. At any given time the Company may pursue a variety of financing
opportunities, and its decision to proceed with any financing will depend, among
other things, on prevailing market conditions, near term maturities and
available terms.




Principles of Consolidation.
The condensed consolidated financial statements include the accounts of Otix and
its wholly owned subsidiaries. Intercompany balances and transactions are
eliminated in consolidation.




Use of Estimates. The
preparation of financial statements in conformity with U.S. 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 as of the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
most significant estimates affecting the financial statements are those related
to allowance for doubtful accounts, sales returns, inventory obsolescence,
goodwill, long-lived asset impairment, warranty accruals, legal contingency
accruals and deferred income tax asset valuation allowances. Actual results
could differ from those estimates.




Revenue Recognition. Sales of
hearing aids are recognized when: (i) products are shipped, except for
retail hearing aid sales, which are recognized upon acceptance by the consumer,
(ii) persuasive evidence of an arrangement exists, (iii) title and
risk of loss has transferred, (iv) the price is fixed or determinable,
(v) contractual obligations have been satisfied, and
(vi) collectability is reasonably assured. Revenues related to sales of
separately priced extended service contracts are deferred and recognized on a
straight-line basis over the contractual periods. Deferred revenue also includes
cash received prior to revenue recognition criteria being met (for example,
customer acceptance). Net sales consist of product sales, less provisions for
sales returns and rebates, which are made at the time of sale. The Company
generally has a 60 day return policy for wholesale and 30 days for retail
hearing aid sales, and allowances for sales returns are reflected as a reduction
of sales and accounts receivable. If actual sales returns differ from the
Company’s estimates, revisions to the allowance for sales returns will be
required. Allowances for sales returns were as follows:







Three
      months ended June 30,
            
            
            Six
      months ended June 30,2010
            
            
            2009
            
            
            2010
            
            
            2009Balance,
      beginning of period
            
            $
            1,170
            
            
            $
            2,070
            
            
            $
            1,196
            
            
            $
            1,994Provisions
            
            
            1,141
            
            
            
            2,028
            
            
            
            2,416
            
            
            
            4,335Returns
      processed
            
            
            (1,297
            )
            
            
            (2,032
            )
            
            
            (2,598
            )
            
            
            (4,263
            )Balance,
      end of period
            
            $
            1,014
            
            
            $
            2,066
            
            
            $
            1,014
            
            
            $
            2,066





For the
three months ended June 30, 2010 and 2009, the Australian Government’s Office of
Hearing Services, a division of the Department of Health and Aging, accounted
for approximately 23% and 13% of the Company’s total net sales, respectively.
For the six months ended June 30, 2010 and 2009, such sales accounted for
approximately 22% and 13% of the Company’s total net sales, respectively. No
other customer accounted for 10% or more of consolidated sales. No single
customer comprised more than 10% of accounts receivable as of June 30, 2010
and 2009.




Taxes Collected from Customers and
Remitted to Governmental Authorities. The Company recognizes taxes
assessed by a governmental authority that are directly imposed on a
revenue-producing transaction between a seller and a customer on a net basis
(excluded from net sales).




Warranty Costs. The Company
provides for the cost of remaking and repairing products under warranty at the
time of sale, typically for periods of six months to three years depending upon
customer, product and geography. These costs are included in cost of sales. When
evaluating the adequacy of the warranty reserve, the Company analyzes the amount
of historical and expected warranty costs by geography, by product family, by
model and by warranty period as appropriate. If actual product failure rates or
repair and remake costs differ from the Company’s estimates, revisions to the
warranty accrual will be required.




Accrued
warranty costs were as follows:







Three
      months ended June 30,
            
            
            Six
      months ended June 30,2010
            
            
            2009
            
            
            2010
            
            
            2009Balance,
      beginning of period
            
            $
            3,956
            
            
            $
            3,572
            
            
            $
            3,901
            
            
            $
            3,727Provisions
            
            
            651
            
            
            
            1,457
            
            
            
            1,564
            
            
            
            2,192Costs
      incurred
            
            
            (894
            )
            
            
            (1,016
            )
            
            
            (1,752
            )
            
            
            (1,906
            )Balance,
      end of period
            
            $
            3,713
            
            
            $
            4,013
            
            
            $
            3,713
            
            
            $
            4,013




Cash Equivalents. The Company
considers all short-term investments purchased with an original maturity of
three months or less to be cash equivalents. As of June 30, 2010 and
December 31, 2009, cash equivalents consisted of money market funds
totaling $1,462 and $4,860, respectively. As of June 30, 2010 and
December 31, 2009, the Company had pledged $106 and $71 of cash and cash
equivalents, respectively, as a security deposit for banking


arrangements.




7





Fair Value
Measurements. We account for financial assets and liabilities, and
applicable non-financial assets and non-financial liabilities according to ASC
820, “Fair Value Measurements
and Disclosures.” ASC 820 defines fair value, establishes a framework for
measuring fair value under generally accepted accounting principles and enhances
disclosures about fair value measurements. Fair value is defined as the exchange
price that would be received for an asset or paid to transfer a liability (an
exit price) in the principal or most advantageous market for the asset or
liability in an orderly transaction between market participants on the
measurement date. Valuation techniques used to measure fair value must maximize
the use of observable inputs and minimize the use of unobservable inputs. The
standard describes a fair value hierarchy based on three levels of inputs, of
which the first two are considered observable and the last unobservable, that
may be used to measure fair value which are the following:




·
            Level
      1 - Quoted prices in active markets for identical assets or
      liabilities.




·
            Level
      2 - Inputs other than Level 1 that are observable, either directly or
      indirectly, such as quoted prices for similar assets or liabilities;
      quoted prices in markets that are not active; or other inputs that are
      observable or can be corroborated by observable market data for
      substantially the full term of the assets or
  liabilities.




·
            Level
      3 - Unobservable inputs that are supported by little or no market activity
      and that are significant to the fair value of the assets or
      liabilities.




The
Company’s money market funds totaling $1,462 as of June 30, 2010 are
recorded at fair value using Level 1 observable inputs.




Derivative Instruments and Hedging
Activities. The Company follows ASC 815, “Derivatives and Hedging,” for
its derivative and hedging activities and related disclosures.




The
Company may enter into readily marketable forward contracts with financial
institutions to minimize the short-term impact of foreign currency fluctuations
on certain intercompany balances. The Company has not designated its contracts
as hedging instruments, nor does the Company enter into contracts for trading or
speculation purposes. Gains and losses on the contracts are included in the
results of operations and offset foreign exchange gains or losses recognized on
the revaluation of certain intercompany balances. The Company’s foreign exchange
forward contracts generally mature in three months or less from the contract
date. The Company entered into two foreign currency forward contracts during the
three months ended June 30, 2010 and the Company recorded a $410 gain in Other
income (expense), net in the Condensed Consolidated Statements of Operations for
the quarter ending June 30, 2010.  The contracts expired on June 29,
2010. The Company held forward contract hedges on €3,600 ($4,394) and Australian
$1,700 ($1,456) at June 30, 2010. As of June 30, 2010, the Company recognized an
unrealized loss of $38 in connection with its foreign currency forward
contracts. The unrealized loss is recorded in Other income (expense), net in the
Condensed Consolidated Statements of Operations, and in Other accrued
liabilities in the Condensed Consolidated Balance Sheets. The contracts will
expire in the third quarter of 2010. Effective in the second quarter 2008, the
Company entered into an interest rate swap agreement which effectively fixed the
interest rate of the long term debt associated with the German acquisition at
9.59% (see Note 3 for further details).




Inventories. Inventories are
stated at the lower of cost or market using the first-in, first-out method. The
Company includes material, labor and manufacturing overhead in the cost of
inventories. Provision is made (i) to reduce excess and obsolete
inventories to their estimated net realizable values and (ii) for estimated
product (inventory) returns in those countries that sell on a retail basis and
recognize a sale only upon acceptance by the consumer. Once the value is
adjusted, the original cost, less the inventory write-down represents the new
cost basis. Amounts are written off and the associated reserve is reversed when
the related inventory has been scrapped or sold. Inventories, net of reserves
consisted of the following:


June
      30,2010
            
            
            December
      31,
              2009Raw
      materials and components
            
            $
            4,454
            
            
            $
            3,410Work
      in progress
            
            
            73
            
            
            
            55Finished
      goods
            
            
            4,412
            
            
            
            5,289Total
            
            $
            8,939
            
            
            $
            8,754




Comprehensive Loss.
Comprehensive loss includes net loss plus the results of certain changes in
shareholders’ equity that are not reflected in the results of operations.
Comprehensive loss consisted solely of changes in foreign currency translation
adjustments, which were not adjusted for income taxes as they related to
specific indefinite investments in foreign subsidiaries and net
loss.







Three
      months ended June 30,
            
            
            Six
      months ended June 30,2010
            
            
            2009
            
            
            2010
            
            
            2009Net
      loss
            
            $
            (2,138
            )
            
            $
            (2,592
            )
            
            $
            (4,471
            )
            
            $
            (19,560
            )Foreign
      currency translation gain (loss)
            
            
            (1,352
            )
            
            
            2,430
            
            
            
            (909
            )
            
            
            1,011Comprehensive
      loss
            
            $
            (3,490
            )
            
            $
            (162
            )
            
            $
            (5,380
            )
            
            $
            (18,549
            )





8




Stock-Based Compensation.
Stock-based compensation cost is measured at the grant date, based on the fair
value of the award and is recognized over the employee requisite service period.
For further information, refer to the footnotes included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2009 as filed with the
SEC. Stock-based compensation consisted of the following:




Three
      months ended June 30,
            
            
            Six
      months ended June 30,2010
            
            
            2009
            
            
            2010
            
            
            2009Cost
      of sales
            
            $
            52
            
            
            $
            48
            
            
            $
            107
            
            
            $
            101Selling,
      general and administrative
            
            
            187
            
            
            
            246
            
            
            
            381
            
            
            
            588Research
      and development
            
            
            36
            
            
            
            46
            
            
            
            92
            
            
            
            119Total
            
            $
            275
            
            
            $
            340
            
            
            $
            580
            
            
            $
            808




Stock
option and restricted stock award grants were as follows:


Three
      months ended June 30,
            
            
            
            Six
      months ended June 30,2010
            
            
            
            2009
            
            
            
            2010
            
            
            
            2009Awards
      Issued
            
            
            
            Fair
      Value
            
            
            
            Awards
      Issued
            
            
            
            Fair
      Value
            
            
            
            Awards
      Issued
            
            
            
            Fair
      Value
            
            
            
            Awards
      Issued
            
            
            
            Fair
      ValueStock
      options
            
            
            15
            
            
            $
            38
            
            
            
            -
            
            
            
            -
            
            
            
            27
            
            
            $
            68
            
            
            
            -
            
            
            
            -Restricted
      stock
            
            
            -
            
            
            
            -
            
            
            
            54
            
            
            $
            33
            
            
            
            -
            
            
            
            -
            
            
            
            54
            
            
            $
            33




The fair
value of the options issued to members of the board of directors during the
three months ended June 30, 2010 was estimated on the date of grant based on a
risk free rate of return of 2.1%, an expected dividend yield of 0.0%, volatility
of 62.6%, and an expected life of 5 years. The fair value of the options issued
to employees during the three months ended March 31, 2010 was estimated on
the date of grant based on a risk free rate of return of 2.6%, an expected
dividend yield of 0.0%, volatility of 62.5%, and an expected life of 5
years.





During
the three months ended June 30, 2009, the Company granted 54 restricted stock
awards to members of the board of directors with an aggregate fair value of $33
and did not grant any stock option awards. The Company did not grant any
restricted stock awards or stock option awards during the three months ended
March 31, 2009.





As of
June 30, 2010, there was $745 and $915 of unrecognized stock-based compensation
expense relating to options and restricted stock awards, respectively, that will
be recognized over a weighted-average period of 2.5 and 3.0 years,
respectively.




Loss Per Common Share. Basic
loss per common share is calculated based upon the weighted average shares of
common stock outstanding during the period. Diluted loss per share is calculated
based upon the weighted average number of shares of common stock outstanding,
plus the dilutive effect of common stock equivalents calculated using the
treasury stock method. Antidilutive common stock share equivalents of 697 and
699 for the three and six months ended June 30, 2010, respectively were excluded
from the diluted loss per share calculation. Antidilutive common stock share
equivalents of 644 and 654 for the three and six months ended June 30, 2009,
respectively were excluded from the diluted loss per share
calculation.




Income Taxes. In some
jurisdictions net operating loss carry-forwards reduce or offset tax provisions.
The Company’s income tax provision (benefit) for the three months ended June 30,
2010 and 2009 was $44 and $180, respectively and for the six months ended June
30, 2010 and 2009 was ($128) and $276, respectively. The current year income tax
benefit was principally the result of pre-tax losses in certain foreign
jurisdictions, partially offset by alternative minimum tax in the U.S., and
state taxes. Income taxes on profits in the U.S. and a number of the Company’s
foreign subsidiaries are currently negated by its net operating loss
carry-forwards.




Recent Accounting
Pronouncements. In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair
Value Measurements.”  ASU 2010-06 both expands and clarifies
the disclosure requirements related to fair value measurements. Entities are
required to disclose separately the amounts of significant transfers in and out
of Level 1 and Level 2 of the fair value valuation hierarchy and describe the
reasons for the transfers. Additionally, entities are required to disclose
information about purchases, sales, issuances, and settlements on a gross basis
in the reconciliation of Level 3 fair-value measurements. The new guidance also
clarifies existing fair-value measurement disclosure guidance about the level of
disaggregation, inputs, and valuation techniques.  The Company adopted
the new disclosures effective January 1, 2010, except for the Level 3
roll-forward disclosures. The Level 3 roll-forward disclosures will be effective
for the Company January 1, 2011.  The adoption of the ASU did not
have a material impact on the Company’s disclosures as it did not have
significant transfers in and out of Level 1 and Level 2 of the fair value
valuation hierarchy in the first half of 2010.





In
October 2009, the FASB issued ASU 2009-13, “Revenue Recognition (ASU Topic
605) – Multiple Deliverable Revenue Arrangements,” a consensus of the
FASB Emerging Issues Task Force which is effective for the Company in the first
quarter of fiscal year 2011, with early adoption permitted, modifies the fair
value requirements of ASC subtopic 605-25, “Revenue Recognition-Multiple
Element Arrangements,” by allowing the use of the “best estimate of
selling price” in addition to vendor-specific objective evidence (“VSOE”) and
verifiable objective evidence (“VOE”) (now referred to as “TPE” standing for
third-party evidence) for determining the selling price of a deliverable. A
vendor is now required to use its best estimate of the selling price when VSOE
or TPE of the selling price cannot be determined. In addition, the residual
method of allocating arrangement consideration is no longer permitted. In
October 2009, the FASB also issued ASU 2009-14,“Software (ASC Topic 985) – Certain
Revenue Arrangements That Include Software Elements,” a consensus of the
FASB Emerging Issues Task Force. This guidance modifies the scope of ASC
subtopic 965-605, “Software-Revenue
Recognition,” to exclude from its requirements (a) non-software
components of tangible products and (b) software components of tangible
products that are sold, licensed, or leased with tangible products when the
software components and non-software components of the tangible product function
together to deliver the tangible product’s essential functionality. ASU 2009-13
is required to be applied prospectively to new or materially modified revenue
arrangements in fiscal years beginning on or after June 15, 2010. This update
requires expanded qualitative and quantitative disclosures once adopted. The
Company is currently evaluating the impact of adopting this pronouncement and
does not expect the standard to have a material impact on its condensed
consolidated financial statements.




9




2. INTANGIBLE ASSETS




In
accordance with the ASC 360-10, “ Property, Plant and
Equipment,” long-lived assets such as property, plant, and equipment, and
purchased intangible assets subject to amortization, are amortized over their
respective estimated useful lives and are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
or asset group may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of an asset or asset
group to estimated undiscounted future cash flows expected to be generated by
the asset or asset group. If the carrying amount of an asset or asset group
exceeds its estimated future cash flows, an impairment charge is recognized in
the amount by which the carrying amount of the asset exceeds the fair value of
the asset or asset group. The Company performs its annual impairment test in
December or when a triggering event has occurred.  There were no
triggering events during the first six months of 2010.




Goodwill
represents the excess of the cost of businesses acquired over the fair value of
the assets acquired and liabilities assumed. In accordance with the provisions
of ASC 350, “Intangibles-
Goodwill and Other,” the Company does not amortize goodwill, but tests it
for impairment annually using a fair value approach at the “reporting unit”
level. In accordance with ASC 350, a reporting unit is the operating segment, or
a business one level below an operating segment (the “component” level) if
discrete financial information is prepared and regularly reviewed by senior
management. However, components are aggregated as a single reporting unit if
they have similar economic characteristics.




Goodwill
and intangible assets that have indefinite useful lives are tested annually for
impairment at year end, or more frequently if impairment indicators are present.
Such indicators of impairment include, but are not limited to, changes in
business climate, and operating or cash flow losses related to such assets. To
measure the amount of an impairment loss, the standard prescribes a two-step
method. The first step requires the Company to determine the fair value of the
reporting unit and compare that fair value to the net book value of the
reporting unit. The fair value of the reporting unit is determined using the
income approach (discounted cash flow analysis). Under the income approach, the
fair value of the asset is based on the value of the estimated cash flows that
the asset can be expected to generate in the future. These estimated cash flows
were discounted at a rate of 16.0% to arrive at the fair values in the Company’s
2009 calculations. The Company also considers market information (market
approach) when such information is available to validate the more detailed
discounted cash flow calculations. Market information typically includes the
Company’s general knowledge of sale transaction multiples and/or previous
discussions the Company has had with third parties regarding the value of a
similar reporting unit or the Company’s specific reporting unit. The Company
relies principally on the income approach because it reflects the reporting
unit’s expected cash flows and incorporates management’s detailed knowledge of
products, pricing, competitive environment, global economic conditions, industry
conditions, interest rates, and management actions, whereas market information
may not be available, or may be less precise due to a lack of comparability to
the Company’s particular reporting unit. The second step requires the Company to
determine the implied fair value of goodwill and measure the impairment loss as
the difference between the book value of the goodwill and the implied fair value
of the goodwill. The implied fair value of goodwill must be determined in the
same manner as if the Company had acquired those reporting units.




Legislation
passed by the Federal Council of Germany in November 2008 and which became
effective on April 1, 2009, resulted in sweeping changes to the way doctors
and healthcare providers interact and are reimbursed from insurance companies.
These changes require the Company’s German subsidiary to renegotiate contracts
with insurance companies and ENT doctors on a new basis. In the first three
months of 2009, the Company believed its German subsidiary was making progress
in negotiating new contracts. However, on April 1, 2009, the Company was
notified by one large insurance company representing approximately 25% of its
German revenue that they would not enter into a contract; therefore, the
Company’s German subsidiary filed a lawsuit in the Social Court in Hamburg,
Germany against this insurance company, requesting that the court compel the
insurance company to enter into a contract with it. On April 28, 2009, the
Court rejected these claims. The Company’s German subsidiary subsequently filed
an appeal of this decision, which was rejected without review. Without
renegotiated insurance contracts and the ability to pay customary fitting fees
to the ENT doctors, the Company expected revenue to decline substantially and
cash flow of the operation would not be sufficient to support its intangibles
balances.




The
Company determined that an interim impairment test was necessary at the end of
the first quarter of 2009, in this reporting unit. In the step one calculation,
the Company assumed a full year revenue of approximately 45% of 2008 levels
(which resulted from a full first quarter 2009 and approximately 27% of revenue
thereafter) and operating expenses of approximately 90% of 2008 levels as the
Company continued to attempt to renegotiate additional contracts and service
existing contracts. However, renegotiation was expected to be difficult given
the political pressures posed by local acousticians, the Company’s largest
competitors, and the adverse result in the social court case. Accordingly, the
Company could not reasonably expect revenue in excess of those contracts which
had already been renegotiated for one year terms. In addition, there continued
to be high risk that some or all of the insurance companies who had renegotiated
their contracts would not renew their contracts with the Company upon expiration
in April 2010, given the political climate and the social court decision.
Accordingly, the Company estimated that it would maintain 27% of revenue for one
year and would be unable to successfully renegotiate with additional insurers.
The Company used a discount rate of 14.5%. A sensitivity analysis was not
performed given the significant disparity between the estimated fair value and
carrying value. Reasonable changes to the assumptions used, based on
then-existing facts and circumstances, would not have changed the outcome. After
completing step one of the prescribed test, the Company determined that the
estimated fair value of the reporting unit was less than its book value on
March 31, 2009. The Company performed the step two test and concluded that
the reporting unit’s goodwill and trade name were impaired. As a result, an
impairment loss of $14,205 for goodwill and $453 for definite lived intangibles
was recorded in the first quarter of 2009 in the Company’s Europe
segment.





10




Goodwill
and indefinite-lived intangible assets (arrangement with the Australian
government to supply hearing aids) in 2010 and 2009 were as
follows:




North
            
            
            
            
            
            Rest-of-Balance
      as of December 31, 2009
            
            America
            
            
            Europe
            
            
            World
            
            
            TotalGoodwill
      and indefinite-lived intangible assets
            
            $
            16,033
            
            
            $
            22,385
            
            
            $
            9,368
            
            
            $
            47,786Accumulated
      impairment charges
            
            
            (14,632
            )
            
            
            (16,014
            )
            
            
            -
            
            
            
            (30,646
            )1,401
            
            
            
            6,371
            
            
            
            9,368
            
            
            
            17,140Indefinite-lived
      intangible assets acquired during the year
            
            
            -
            
            
            
            -
            
            
            
            18
            
            
            
            18Effect
      of exchange rate changes
            
            
            -
            
            
            
            (948
            )
            
            
            (385
            )
            
            
            (1,333
            )Balance
      as of June 30, 2010Goodwill
      and indefinite-lived intangible assets
            
            
            16,033
            
            
            
            21,437
            
            
            
            9,001
            
            
            
            46,471Accumulated
      impairment charges
            
            
            (14,632
            )
            
            
            (16,014
            )
            
            
            -
            
            
            
            (30,646
            )$
            1,401
            
            
            $
            5,423
            
            
            $
            9,001
            
            
            $
            15,825




Definite-lived intangible
assets consisted of the following:


June
      30, 2010
            
            
            December
      31, 2009Useful
            
            Gross
      Carrying
            
            
            Accumulated
            
            
            Gross
      Carrying
            
            
            AccumulatedLives
            
            Value
            
            
            Amortization
            
            
            Value
            
            
            AmortizationPurchased
      technology and licenses
            3-13
      years
            
            $
            2,181
            
            
            $
            1,434
            
            
            $
            1,976
            
            
            $
            1,357Brand
      and trade names
            1-3
      years
            
            
            129
            
            
            
            129
            
            
            
            129
            
            
            
            129Customer
      databases
            2-10
      years
            
            
            7,406
            
            
            
            6,059
            
            
            
            7,433
            
            
            
            5,940Non-compete
      agreements
            1-5
      years
            
            
            2,109
            
            
            
            1,376
            
            
            
            2,189
            
            
            
            1,285Total
            
            
            $
            11,825
            
            
            $
            8,998
            
            
            $
            11,727
            
            
            $
            8,711




3. LONG-TERM DEBT




As of
June 30, 2010, the current portion of long-term debt was $6,104 and the
long-term portion was $788. Future principal payments on long-term debt
consisted of the following as of June 30, 2010:




Effective
            
            
            
            
            
            
            Future
      PaymentsInterest
            
            
            
            
            
            
            Rest
      ofRate
            
            
            Total
            
            
            
            2010
            
            
            
            2011
            
            
            
            2012
            
            
            
            2013
            
            
            
            ThereafterGerman
      loan
            
            
            9.59%
            
            $
            915
            
            
            $
            610
            
            
            $
            305
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Australian
      loans
            
            
            6.50-
      8.97%
            
            
            1,696
            
            
            
            90
            
            
            
            1,051
            
            
            
            214
            
            
            
            235
            
            
            
            106Line
      of credit
            
            
            5.11%
            
            
            3,976
            
            
            
            3,976
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Leases
      and acquisition loans
            
            
            0.00-12.25%
            
            
            305
            
            
            
            117
            
            
            
            108
            
            
            
            80
            
            
            
            -
            
            
            
            -Total
      carrying amount
            
            
            
            
            $
            6,892
            
            
            $
            4,793
            
            
            $
            1,464
            
            
            $
            294
            
            
            $
            235
            
            
            $
            106




The
German bank loan bears interest at the EURIBOR rate plus 4.00%. As of June 30,
2010, the balance of the loan was €750 ($915). The loan payments are €250 ($305
as of June 30, 2010) per quarter. In September 2008, the Company entered
into an interest rate swap agreement with an initial notional amount of €2,500
to be reduced €250 per quarter through January 2011. Under this agreement
the Company receives a floating rate based on the EURIBOR interest rate, and
pays a fixed rate of 9.59% on the notional amount effectively fixing the
interest rate on the Company’s German loan. Therefore, the effective interest
rate on this loan was 9.59% for the six months ended June 30, 2010 and
2009.




11





Acquisition
loans relate to the purchase of retail audiology practices acquired under the
Company’s retail distribution initiative. Generally, these notes are secured by
the acquired assets, subordinated to the revolving credit facility, and are due
in annual installments from the acquisition date.




On
March 10, 2010, the Company finalized the Second Amendment to the Amended
and Restated Loan and Security Agreement with SVB, to renew and extend the
revolving credit facility to April 11, 2011. The credit facility is secured
by substantially all tangible U.S. assets. There is an annual fee of 0.38% on
the average unused portion of the credit facility. The amendment modified the
previous agreement to provide additional borrowing capacity of unrestricted cash
held at SVB up to $2,000, no longer reduced borrowing capacity related to
foreign currency hedging instruments, and modified the EBITDA
requirement.





On August
9, 2010, the Company finalized the Second Amended and Restated Loan and Security
Agreement with SVB, under which borrowings of up to $4,000 are available.
Borrowings under the credit facility are subject to interest at the domestic
prime rate. If the adjusted quick ratio is greater than or equal to 1.00, then
the interest rate is the prime rate plus 1.00 percentage points; if the adjusted
quick ratio is less than 1.00, the interest rate is the prime rate plus 1.50
percentage points.  SVB suspended financial covenant testing as of May
31, 2010 and June 30, 2010 and further amended the financial covenants to remove
the EBITDA requirement, include a minimum liquidity ratio of 1.50 to 1.00 and
include a minimum tangible net worth requirement of $5,500.





The
Company entered into two additional loans in Australia during the second quarter
of 2010. The Company entered into a Bill Facility with National Australia Bank
Health (“NAB”), providing for a non-amortizing and non-revolving credit
facility, under which the Company borrowed Australian $1,000 ($883). There is a
bi-annual fee of 0.50% on the borrowed portion of the credit facility.
Borrowings under the credit facility are subject to interest at a floating rate
of approximately 5.82%, at June 30, 2010, plus an activation fee of 2.00%. The
floating rate is calculated based on the Australian Bank Bill Swap Rate plus
0.70%. The credit facility is secured by substantially all tangible Australia
assets. Covenants under this agreement require the Company to maintain a minimum
capital adequacy of 35% as measured on a daily basis and reported in relation to
the six month period starting on June 30, 2010. Additionally, the Company is
required to maintain a minimum interest cover ratio of 2.00% measured every
three month period starting on June 30, 2010. The Company is in compliance with
the aforementioned covenants as of June 30, 2010. The effective interest rate on
this loan for the second quarter of 2010 was 6.50%. The credit facility is due
on April 30, 2011 and the full amount outstanding as of June 30, 2010 is
recorded as a current liability on the Company’s Consolidated Balance Sheet.
Additionally, during the second quarter 2010, the Company entered into a four
year equipment loan with Medfin Australia Pty Ltd (“Medfin”) in which the
Company borrowed Australian $1,000 ($882) by collateralizing the loan with
specific Australia tangible assets. The Company remits monthly payments to
Medfin and the effective interest rate for the second quarter of 2010 was
8.97%.





At June
30, 2010, the Company’s net borrowings on the SVB line of credit were $3,976 and
net borrowings on this line of credit at December 31, 2009 were $3,116. As of June 30, 2010, the
interest rate on the Company’s line of credit was 5.11% and the Company’s
outstanding borrowings represented the maximum allowable borrowing under the
terms of the agreement. The fair value of the Company’s debt obligations
approximates the carrying value as of June 30, 2010. The Company notified SVB in
May 2010 that compliance with its debt covenants, as structured, would be
difficult.  Subsequently, in June 2010, the Company signed a letter of
understanding with SVB in which SVB agreed to suspend covenant testing as
of May 31, 2010 and June 30, 2010, respectively, and amend the financial
covenants, pending completion of a formal loan agreement by early August
2010.  Accordingly, on August 9, 2010, the Company and SVB signed an
agreement which suspended the debt covenants at May 31, 2010 and June 30, 2010,
respectively, and provided new covenants for the remaining term of the
agreement. The Company is in compliance with its amended debt covenants as
of June 30, 2010.The
Company’s bank debt includes a customary material adverse change clause that
allows the banks to call the loans, if invoked. The banks have not invoked this
clause. In accordance with ASC 470-10, “Debt,” the Company has
classified the outstanding balance on the revolving credit facility as a short
term liability as of June 30, 2010 and December 31, 2009, respectively, due to
the inability of the Company to determine the likelihood that any future events
or circumstances affecting the Company may reduce the borrowing base
availability or constitute a material adverse event under the terms of the
revolving credit facility agreement causing SVB to exercise its right to
accelerate payment of amounts due under the revolving credit facility
agreement.  In July 2010, the Company paid $2,339 on its revolving
credit facility with SVB due to reduced borrowing capacity under the amended
agreement.





4.
LEGAL PROCEEDINGS




In
February 2006, the former owners of Sanomed, which the Company acquired in 2003,
filed a lawsuit in German civil court claiming that certain deductions made by
the Company against certain accounts receivable amounts and other payments
remitted to the former owners were improper. The former owners sought damages in
the amount of approximately €2,600 ($3,800). The Company filed its statement of
defense and presented its position during oral arguments. The court asked the
parties to attempt to settle the matter and on July 20, 2009, the Company
and the former owners agreed to settle the claim. Under the terms of the
settlement, the Company agreed to pay the former owners of Sanomed an aggregate
sum of €1,050 ($1,471), approximately the amount reserved in the Company’s
balance sheet at December 31, 2008 for this matter. The Company remitted
the settlement payment in August 2009.




As part
of the Sanomed purchase agreement, the former owners were entitled to contingent
consideration based on the achievement of certain revenue milestones. In certain
circumstances, the former owners were entitled to contingent consideration
irrespective of the achievement of the revenue milestones. In addition to the
above noted lawsuit, two of the former owners filed suits against the Company,
one of which was settled in 2007, and the other former owner’s contingent
consideration claim against the Company for approximately €1,100 ($1,343) plus
interest, was dismissed in July 2008, with the German court rendering its
decision in favor of the Company. The former owner has appealed. The Company
continues to strongly deny the allegations contained in the former owner’s
appeal and intends to defend itself vigorously; however, litigation is
inherently uncertain and an unfavorable result could have a material adverse
effect on the Company. The Company establishes reserves when a particular
contingency is probable and estimable.




12


From time
to time the Company is subject to legal proceedings, claims and litigation
arising in the ordinary course of its business. Most of these legal actions are
brought against the Company by others and, when the Company feels it is
necessary, it may bring legal actions against others. Actions can stem from
disputes regarding the ownership of intellectual property, customer claims
regarding the function or performance of the Company’s products, government
regulation or employment issues, among other sources. Litigation is inherently
uncertain, and therefore the Company cannot predict the eventual outcome of any
such lawsuits. However, the Company does not expect that the ultimate resolution
of any known legal action, other than as identified above, will have a material
adverse effect on its results of operations and financial position.





5. RESTRUCTURING





During
2009, the Company took actions to improve profitability by: 1) reducing the
total number of employees in North America; 2) closing three U.S. retail
locations resulting in a restructuring charge of $98 and goodwill and
definite-lived intangible write-off of $135; and 3) reducing headcount and
selling two retail shops in Europe. The total restructuring charge from these
actions was $769, which included $158 in sale proceeds from the two European
shops. During the six months ended June 30, 2010, the Company reversed accruals
of $20 primarily relating to favorable lease settlements and made payments as
listed in the following table in relation to its 2008 and 2009 restructuring
charges:




Employee
            
            
            Excess
            
            
            ImpairmentRelated
            
            
            Facilities
            
            
            and
      Other
            
            
            TotalBalance,
      December 31, 2009
            
            $
            289
            
            
            $
            22
            
            
            $
            45
            
            
            $
            356Restructuring
      Charge
            
            
            -
            
            
            
            (20
            )
            
            
            -
            
            
            
            (20
            )Payments
      and foreign exchange
            
            
            (193
            )
            
            
            (2
            )
            
            
            (6
            )
            
            
            (201
            )Balance,
      March 31, 2010
            
            
            96
            
            
            
            -
            
            
            
            39
            
            
            
            135Payments
      and foreign exchange
            
            
            (55
            )
            
            
            -
            
            
            
            (3
            )
            
            
            (58
            )Balance,
      June 30, 2010
            
            $
            41
            
            
            $
            -
            
            
            $
            36
            
            
            $
            77











6.
DISCONTINUED OPERATIONS




In 2008,
a decision was made to divest certain European operations. The Company sold one
European operating unit and closed a second operation. These operations have
been classified as discontinued operations in the Condensed Consolidated
Statements of Operations for the six months ended June 30, 2010 and
2009.




The
following amounts relate to discontinued operations and have been segregated
from continuing operations:





For
      the three months ended
            
            
            For
      the six months endedJune
      30,
            
            
            June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Net
      sales
            
            $
            -
            
            
            $
            17
            
            
            $
            -
            
            
            $
            (57
            )Income
      (loss) from discontinued operations, net of zero taxes
            
            $
            -
            
            
            $
            35
            
            
            $
            (7
            )
            
            $
            (10
            )




13





7.
SEGMENT INFORMATION




As of
June 30, 2010, the Company has three operating segments for which separate
financial information is available and evaluated regularly by management in
deciding how to allocate resources and assess performance. The Company evaluates
performance principally based on net sales and operating profit.




The
Company’s three operating segments include North America, Europe and
Rest-of-World. Inter-segment sales are eliminated in consolidation.
Manufacturing profit and distributors’ sales are recorded in the geographic
location where the sale occurred. This information is used by the chief
operating decision maker to assess the segments’ performance and in allocating
the Company’s resources. The Company does not allocate corporate or research and
development expenses to its operating segments.







North
      America
              
              
              Europe
              
              
              Rest-of-World
              
              
              Unallocated
              
              
              TotalThree
      months ended June 30, 2010Net
      sales to external customers
              
              $
              6,784
              
              
              $
              6,256
              
              
              $
              8,586
              
              
              $
              -
              
              
              $
              21,626Operating
      profit (loss)
              
              
              (2,152
              )
              
              
              1,153
              
              
              
              1,155
              
              
              
              (2,343
              )
              
              
              (2,187
              )Income
      (loss) from continuing operations
              
              
              (2,008
              )
              
              
              1,086
              
              
              
              1,127
              
              
              
              (2,343
              )
              
              
              (2,138
              )Three
      months ended June 30, 2009Net
      sales to external customers
              
              
              9,696
              
              
              
              9,193
              
              
              
              6,531
              
              
              
              -
              
              
              
              25,420Operating
      profit (loss)
              
              
              (868
              )
              
              
              1,792
              
              
              
              808
              
              
              
              (4,020
              )
              
              
              (2,288
              )Income
      (loss) from continuing operations
              
              
              (995
              )
              
              
              1,697
              
              
              
              691
              
              
              
              (4,020
              )
              
              
              (2,627
              )Six
      months ended June 30, 2010Net
      sales to external customers
              
              
              13,735
              
              
              
              12,372
              
              
              
              16,296
              
              
              
              -
              
              
              
              42,403Operating
      profit (loss)
              
              
              (4,084
              )
              
              
              2,332
              
              
              
              1,946
              
              
              
              (4,853
              )
              
              
              (4,659
              )Income
      (loss) from continuing operations
              
              
              (3,923
              )
              
              
              2,272
              
              
              
              2,040
              
              
              
              (4,853
              )
              
              
              (4,464
              )Six
      months ended June 30, 2009Net
      sales to external customers
              
              
              17,912
              
              
              
              20,270
              
              
              
              11,670
              
              
              
              -
              
              
              
              49,852Operating
      profit (loss)
              
              
              (2,181
              )
              
              
              (10,028
              )
              
              
              1,046
              
              
              
              (7,920
              )
              
              
              (19,083
              )Income
      (loss) from continuing operations
              
              
              (2,360
              )
              
              
              (10,201
              )
              
              
              931
              
              
              
              (7,920
              )
              
              
              (19,550
              )As
      of June 30, 2010Identifiable
      segment assets
              
              
              28,320
              
              
              
              11,778
              
              
              
              20,366
              
              
              
              -
              
              
              
              60,464Goodwill
      and indefinite-lived intangible assets
              
              
              1,401
              
              
              
              5,423
              
              
              
              9,001
              
              
              
              -
              
              
              
              15,825Long-lived
      assets
              
              
              5,794
              
              
              
              313
              
              
              
              2,822
              
              
              
              -
              
              
              
              8,929As
      of December 31, 2009Identifiable
      segment assets
              
              
              30,237
              
              
              
              16,431
              
              
              
              20,457
              
              
              
              -
              
              
              
              67,125Goodwill
      and indefinite-lived intangible assets
              
              
              1,401
              
              
              
              6,371
              
              
              
              9,368
              
              
              
              -
              
              
              
              17,140Long-lived
      assets
              
              
              5,477
              
              
              
              430
              
              
              
              2,848
              
              
              
              -
              
              
              
              8,755




The
following table represents revenues and long-lived assets that are considered
material reporting units within the Company’s segments:




Revenues
            
            
            Long-lived
      assetsFor
      the three months ended June 30,
            
            
            For
      the six months ended June 30,North
      America
            
            2010
            
            
            2009
            
            
            2010
            
            
            2009
            
            
            June
      30,2010
            
            
            December
      31,2009U.S.
      wholesale
            
            
            50
            %
            
            
            60
            %
            
            
            51
            %
            
            
            58
            %
            
            
            94
            %
            
            
            92
            %U.S.
      retail
            
            
            40
            %
            
            
            29
            %
            
            
            39
            %
            
            
            32
            %
            
            
            5
            %
            
            
            7
            %EuropeGermany
            
            
            67
            %
            
            
            72
            %
            
            
            67
            %
            
            
            75
            %
            
            
            92
            %
            
            
            93
            %Rest-of-WorldAustralia
            
            
            100
            %
            
            
            100
            %
            
            
            100
            %
            
            
            100
            %
            
            
            100
            %
            
            
            100
            %




Long-lived
assets consist of property and equipment. The majority of the Company’s assets
as of June 30, 2010 and December 31, 2009 were attributable to its U.S.
operations.


14




ITEM 2.            
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (Amounts in thousands, except per share data)




This
report contains “forward-looking statements” within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Rule 175
promulgated thereunder, and Section 21E of the Securities Exchange Act of
1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent
risks and uncertainties. Any statements about our plans, objectives,
expectations, strategies, beliefs, or future performance or events constitute
forward-looking statements. Such statements are identified as those that include
words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,”
“objective,” “continue” or similar expressions or future or conditional verbs
such as “will,” “would,” “should,” “could,” “might,” “may” or similar
expressions. Forward-looking statements involve known and unknown risks,
uncertainties, assumptions, estimates and other important factors that could
cause actual results to differ materially from any results, performance or
events expressed or implied by such forward-looking statements. All
forward-looking statements are qualified in their entirety by reference to the
factors discussed more fully in Item 1A of our Form 10-K for the year ended
December 31, 2009: (i) deterioration of economic conditions; (ii) our
continued losses; (iii) aggressive competitive factors;
(iv) fluctuations in our financial results; (v) our common stock could
be subject to delisting; (vi) negative impact of our recent acquisition
activities; (vii) ineffective internal financial control systems;
(viii) dependence on significant customers; (ix) dependence on
critical suppliers and contractors; (x) high levels of product returns and
repairs; (xi) inability to introduce new and innovative products;
(xii) undiscovered product errors or defects; (xiii) potential
infringement on the intellectual property rights of others;
(xiv) uncertainty of intellectual property protection; (xv) dependence
on international operations; (xvi) potential product liability;
(xvii) failure to comply with FDA regulations; (xviii) our stock price
could suffer due to sales of stock by our directors and officers; (xix) our
charter documents and shareholder agreements may prevent certain acquisitions;
and (xx) debt covenant default.




Because
the foregoing factors could cause actual results or outcomes to differ
materially from those expressed or implied in any forward-looking statements,
undue reliance should not be placed on any forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which it is made,
and we undertake no obligation to update any forward-looking statement to
reflect events or circumstances after the date on which the statement is made or
to reflect the occurrence of future events or developments.




OVERVIEW




Otix is a
premier provider of technologically advanced hearing care solutions focused on
the therapeutic aspects of hearing care. We design, develop, manufacture, market
and distribute high-performance digital hearing aids intended to provide the
highest levels of satisfaction for hearing impaired consumers. We have developed
patented digital-signal-processing (“DSP”) technologies based on what we believe
is an advanced understanding of human hearing. In countries where we have direct
(owned) operations, we sell our products to hearing care professionals or
directly to hearing impaired consumers. In other parts of the world, where we do
not have direct operations, we sell primarily to distributors.




We were
acquisitive after raising capital in an initial public offering in 2000 and a
Private Investment in a Public Equity (“PIPE”) offering in 2006. Product
evolution continues, but the differentiation between product offerings by
hearing aid companies and new generations has narrowed, and thus distribution
and access to distribution continues to grow in importance. Accordingly, we
acquired a number of our then distributors between the years 2000 to 2003.
Thereafter, we acquired an operation in Germany with a unique distribution model
using the Ear-nose-throat (“ENT”) physician. Then, from 2006 to 2008, we
acquired a number of retail practices. This was all to strengthen our
distribution network.




Germany Legislation. Recent
legislation requires that the fitting fee payments to the doctors come from the
insurance companies rather than us.  The direct payment to doctors for
fitting services under our business model was one of the keys to success for our
sales model in Germany.  The law changed the market by giving more power to
the insurers by allowing discretion as to which business models they contract
with to supply hearing aids and related services.  Insurers are the sole
gatekeepers for access to the reimbursement schemes for the end consumer. 
These changes required our German subsidiary to: a) assist the insurance
companies in addressing the new requirements for invoicing, receiving and
paying doctor’s honorarium; b) renegotiate contracts with insurance
companies; and c) negotiate contracts between and with the insurance company and
the ENT doctors.  In early 2009, we were working with insurance companies
to incorporate the legislative changes in existing contracts. One insurance
company representing approximately 25% of our 2008 German revenue refused to
enter into a contract; therefore, we filed a lawsuit in the Social Court in
Hamburg, Germany. On April 28, 2009, the Court rejected our claim to force the
company to sign a contract with us.  We subsequently filed an appeal of
this decision, which was rejected without review.  In addition, a number of
other insurance companies were unsure if they should sign a contract because
there were rumors that the newly enacted law could potentially change again,
requiring the need to renegotiate within a short period of time.  Without
renegotiated insurance contracts and the ability to pay customary fitting fees
to the ENT doctors, we experienced a substantial decline in our Germany
revenues, and cash flows from operations. As such, our revenues and cash flows
were not sufficient to support our intangibles balances. As a result, we
recognized a $14,658 non-cash write-off of our goodwill and trade name
associated with our German operation in the first quarter of 2009.




15





In June
2009, the German government passed additional amendments to the law that became
effective July 23, 2009. The key implication of these amendments to our
business model was that the new law will impose additional costs on the doctors
and insurance companies that conduct business with our German operation and
disrupt the normal flow of fitting hearing aids on the first visit to the
doctor’s office.




We are
currently renegotiating contracts in light of the new legislative requirements
and are working to contract with other insurance companies as well. The
lack of signed insurance contracts and the imposition of new and costly
requirements on the ENT doctors and the insurance companies as well as the
uncertainty of regulatory requirements will continue to impact our
German business. Final regulatory requirements are expected to be completed
before the end of 2010.  Currently, continued negotiations are
delaying a quick resolution. Until the legislation is finalized, we cannot
completely determine any necessary changes to our operations, if any. Therefore,
the profitability of our German operation is uncertain for the near
future.




Germany
represented 67% and 72% of Europe segment revenues and 71% and 75% (excluding
first quarter 2009 impairment charges) of Europe segment operating profit for
the three months ended June 30, 2010 and 2009, respectively, and 67% and 75% of
Europe segment revenues and 72% and 84% of Europe segment operating profit for
the six months ended June 30, 2010 and 2009, respectively.




Market




The
market for hearing aids is very large and has substantial unmet needs. Industry
researchers estimate that approximately 10% of the population suffers from
hearing loss. There is no single, audited source of sales data for the worldwide
hearing aid market, but U.S. data is maintained by the Hearing Industry
Association and is generally adopted and used by the industry as a proxy for
worldwide data. As depicted in the following table, less than 25% of the U.S.
total population in 2008 that could benefit from a hearing aid actually owned a
hearing aid:




2004
            
            
            2008
            
            
            ChangeHearing
      Loss PopulationU.S.
      households (millions)
            
            
            111.1
            
            
            
            116.1
            
            
            
            4.5%Hearing
      difficulty per 1,000 households
            
            
            283
            
            
            
            295
            
            
            
            4.2%Number
      of hearing impaired (millions)
            
            
            31.5
            
            
            
            34.3
            
            
            
            8.9%2004
            
            
            2008
            
            
            ChangeHearing
      Aid PopulationHearing
      aid adoption rate
            
            
            23.5%
            
            
            
            24.6%
            
            
            
            4.7%Hearing
      aid owners (millions)
            
            
            7.4
            
            
            
            8.4
            
            
            
            13.5%Hearing
      impaired, non-owners (millions)
            
            
            24.1
            
            
            
            25.8
            
            
            
            7.1%




The
hearing loss population in the United States has grown to approximately 34
million. Over the last generation, the hearing loss population grew at the rate
of 1.6 times the U.S. population growth, primarily due to the aging of America.
Hearing aid adoption continues to increase slowly (now 1 in 4 people with
hearing loss) as do binaural fittings (8 out of 10). While 4 in 10 people with
moderate-to-severe hearing loss use amplification for their hearing loss, fewer
than 1 in 10 people with mild hearing loss use amplification. Hearing impaired
people in this segment, which comprise the majority of the hearing impaired
population, often do not purchase hearing aids for a variety of reasons,
including their belief that their hearing loss is not significant enough to
warrant hearing aids, their concern regarding the stigma associated with wearing
hearing aids and their perception that existing hearing aids are uncomfortable,
do not perform well, cannot solve specific hearing problems and are too
expensive.




Despite
this low level of market penetration, annual worldwide retail sales of hearing
aids are estimated to be over $6 billion and wholesale sales are estimated to be
over $2 billion. We anticipate that demographic trends, such as the aging of the
developed world’s population and increased purchasing power in developing
nations, will accelerate the growth of the hearing impaired population, which
should result in increasing hearing aid sales over time.




Offsetting
this trend are the following market conditions affecting us in a negative
way:




·
            Competition
      is intense and new product offerings by our competitors are coming to
      market more quickly than in the
past.




·
            The
      performance, features and quality of lower-priced products continue to
      improve.





·
            Many
      consumers feel that hearing aids are simply too expensive and they cannot
      justify the purchase on a cost-benefit
basis.




·
            Governments
      who reimburse for hearing aids are reducing the amount per device or are
      increasing the technology requirements for the same level of
      reimbursement.




·
            Our
      operations and performance depend on general economic conditions. The
      global economy is experiencing uncertainty which is causing slower
      economic activity. Such fluctuations in the global economy could cause,
      among other results, deterioration and continued decline in consumer
      spending and increases in the cost of labor and
  materials.




16




·
            The
      available wholesale market continues to shrink as our competitors
      implement forward integration strategies and buying groups limit the
      number of manufacturers with whom they do business. Therefore, we plan to
      continue to develop additional distribution
  capacities.




Product
Developments




We have
packaged our proprietary technologies into a broad line of digital hearing aids
that we believe offer superior sound quality, smaller size, enhanced
personalization and increased reliability at competitive prices. All of our
products incorporate our proprietary sound processing and are programmable to
address the hearing loss of the individual user. We currently sell our hearing
aid products both as completed hearing aids and as hearing aid kits, or
faceplates, to others who then market finished hearing aids generally under our
brand names.




In May
2010, we launched Endura, a super-power behind-the-ear (“BTE”). This is our
first power product to meet this market segment which is estimated to be about
5% of the total hearing aid market. Endura is designed specifically to have a
broad range and can fit mild-to-profound hearing losses. Endura features our
patented sound processing, clinically proven noise reduction, and advanced
directional strategies. With its emphasis on low- and mid-frequency
amplification, Endura provides more output across these frequencies than any
other power or super-power BTE. Endura also incorporates great ease-of-use
features, such as large user controls, connectivity to external Bluetooth
devices, and integrated direct audio input.





We
launched Touch, our first receiver-in-canal (“RIC”) product family, in March
2009. RIC has become a very popular product type, representing approximately 35%
of hearing aids sold in the United States. In addition to its sophisticated
design, very small size and ease of use features, we believe Touch is the
smallest and has the best moisture resistance of any RIC product on the market.
Our Touch products incorporate many of the sound processing technologies present
in our Velocity series of hearing solutions. Touch provides natural sound
quality, superior noise-reduction, and excellent directionality, driven by our
unique DIRECTIONALfocus®
technology. Touch is offered at three price points and available in a choice of
five base colors and 15 accent color clips. The three Touch products are
readily identified by the number of processing channels. Touch 6 has six
channels and two programs, Touch 12 has 12 channels and three programs, and
Touch 24 has 24 channels, four programs and voice alerts.




In 2008,
we launched four new products specifically designed to provide competitive
features and additional price options for our customers. Velocity 24, our
premium product, combines a superior set of algorithms to provide the consumer
with hands-free operation in a variety of listening environments. Our
advanced-level product, Velocity 12, offers many sophisticated features, such as
automatic and adaptive directionality, data logging, and auto telephone. With
Velocity 6, we have a highly competitive mid-level product line. Velocity 4, our
entry-level offering, makes our patented and proven noise-reduction available at
a price-point that is particularly attractive to cost-sensitive consumers. All
Velocity products are available in a full line of custom models and feature a
robust standard BTE that can accommodate a severe hearing loss. Velocity 24,
Velocity 12, and Velocity 6 also offer a miniBTE model that provides both
open-fit and standard fittings, a powerful fitting range and extendable
functionality such as Bluetooth and direct audio import support.




Also in
2008, we added a microBTE, ion 400. This style of BTE is very small (about 20 mm
long, 7 mm wide and 9 mm high) and is nearly invisible behind the ear. Our
Velocity and ion products are among the smallest custom and behind-the-ear
products available today. Because our microBTEs are designed to be used with
either a thin tube and open dome or a more conventional tubing and earmold
configuration, they offer increased fitting flexibility. When paired with the
thin tube and open dome, these products practically eliminate the dissatisfying
affect of occlusion.




The
market is using RIC and open-fit products to target the first-time hearing aid
wearer. The market for RIC and open-fit products has grown rapidly, as
illustrated by the Hearing Industries Association data. The BTE category, into
which open-fit and RIC products fall, continues to grow as a percentage of the
hearing aid market, representing in excess of 55% of the units sold in the
United States in 2008, up from 51% in 2007 and 44% in 2006.




We now
have nine active product families – Endura, Touch, Velocity, ion, Balance,
Applause, Natura Pro, Natura 2SE and Quartet.




17




Distribution
Developments
  Hearing
aids are generally sold through the following distribution
channels:
  ·
                Independent
      retailers,
  ·
                Purchasing
      groups,
  ·
                Retail
      chains,
  ·
                Governments,
  ·
                Internet,
      and
  ·
                Manufacturer-owned
      retail.
  The
growth today is in retail chains, governments, internet (small but growing) and
manufacturer-owned retail. Independent retailers are shrinking for a number of
reasons, but foremost due to consolidation through acquisition by large
retailers and manufacturers. We are competing in an industry that includes six
much larger competitors who have significantly more resources and have
established relationships and reputations. Our competitors continue to forward
integrate by buying independent retailers and offering financial arrangements
through loans and other lock-up agreements. Therefore, the market available for
us in the wholesale business is shrinking, making it difficult for us to compete
in the traditional distribution fashion. For this reason, we are interested in
both new and existing distribution methods. In certain cases, we sell direct to
the consumer utilizing the ENT doctor to perform the hearing aid fitting, while
in other cases, we sell directly to the consumer through various retail stores.
We believe a combination of wholesale and direct-to-consumer distribution will
continue to be critical for us in certain geographies.
  In parts
of the world where we do not have direct operations, we sell principally to
distributors with payment terms ranging from cash-in-advance to 120 days.
Certain distributors are offered volume discounts that are earned upon meeting
unit volume targets. Distributor agreements do not grant price protection or
price concession rights.
  Financial
Results
  Our loss
from continuing operations of $4,464 for the six months ended June 30, 2010,
compared with a loss from continuing operations of $19,550 for the six months
ended June 30, 2009, was primarily impacted by the following items:
  ·
                Non-cash
      goodwill and definite-lived intangibles impairment charge in the first
      quarter of 2009 of $14,658 as a result of an adverse legal decision and
      regulatory changes in Germany. Excluding this charge, the year-to-date
      2010 loss from continuing operations is comparable to the same period for
      2009.
  ·
                The
      legislative changes in Germany reduced our German sales and profitability.
      Sales in our European business for the six months ended June 30, 2010 were
      $12,372 compared with $20,270 in the same period in 2009, a reduction of
      39%. The loss of sales in Germany was partially offset by an increase in
      sales to other European countries. Excluding the 2009 impairment charge of
      $14,658, operating profit in our Europe segment was reduced by $2,298 from
      $4,630 for the six months ended June 30, 2009 to $2,332 for the six months
      ended June 30, 2010.  We have been unable to reduce our
      operating expenses in Germany to the same percentage as the sales decline
      because the business requires a base level of infrastructure to sustain
      ongoing operations.
  ·
                A
      decline in year-to-date North America sales of 31% and 7% in wholesale and
      retail, respectively. Operating expenses decreased 32% for wholesale and
      increased 5% for retail.
  ·
                A
      reduction in corporate and research and development expenses of $3,067 or
      39% for the six months ended June 30, 2010 compared to the same period in
      2009.
  ·
                  Rest-of-World
      sales, excluding foreign currency, increased 12% while operating expenses
      increased a similar amount.  We continue to invest in the
      Rest-of-World by hiring more audiologists and establishing a franchise
      business.
   18
  Our
future sales and financial results for the next 12 months are expected to be
driven by the following items:
  ·
                Continued
      penetration of the Touch product family, especially in Germany where we
      launched the product early in the fourth quarter
  2009.
  ·
                Launched
      Endura, our super-power BTE product, in May 2010 for those individuals
      with profound hearing loss.  This product covers about 5% of the
      overall hearing aid market in which we previously did not
      compete.
  ·
                Focusing
      on improving the results of retail audiology practices we acquired between
      2006 and 2008.
  ·
                Continued
      focus on cost savings. We significantly reduced costs in our wholesale
      business, corporate, and research and development. However, we increased
      costs in our retail operations as well as a direct-to-consumer marketing
      initiative that began in the third quarter of 2009.  We have
      spent $523 over the past two quarters on this initiative.  In
      the third quarter of 2010, we will spend significantly less on this
      initiative.
  ·
                Sales
      growth with the U.S. Veteran’s Administration (“the VA”). The contract
      began in November of 2009. According to data from the Hearing Industry
      Association, the VA represents approximately 18% of the market for hearing
      aids and experienced unit growth of more than 20% annually this past year.
      We were successful in receiving an award in each of the categories in
      which we bid, allowing us to sell our custom, behind-the-ear and
      receiver-in-canal products through the VA. The contract award from the VA
      is a one-year contract with four, one-year extensions, at the VA’s option.
      According to contract documents, the VA anticipates purchasing a total of
      approximately 430,000 hearing aids across the nine contract awardees in
      the first year, with steady growth in volume over the following four
      years. We spent $355 in the second quarter of 2010 to train VA
      providers.
 
 Offsetting
these developments will be the possible continued decline of sales to insurance
companies in our German operation as a result of future potential regulatory
changes, and the possible continued decline in our U.S. wholesale and retail
volumes.
 
 The
following table sets forth selected statement of operations information for the
periods indicated, expressed as a percentage of net sales.
  Three
      months ended
                  June
      30,
                
                
                Six
      months ended
                  June
      30,2010
                
                
                2009
                
                
                2010
                
                
                2009Net
      sales
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %
                
                
                100.0
                %Cost
      of sales
                
                
                38.1
                %
                
                
                39.2
                %
                
                
                37.0
                %
                
                
                40.6
                %Gross
      profit
                
                
                61.9
                %
                
                
                60.8
                %
                
                
                63.0
                %
                
                
                59.4
                %Selling,
      general and administrative expense
                
                
                67.9
                %
                
                
                60.2
                %
                
                
                69.4
                %
                
                
                59.4
                %Research
      and development expense
                
                
                4.1
                %
                
                
                7.6
                %
                
                
                4.6
                %
                
                
                7.8
                %Goodwill
      and definite-lived intangibles impairment charges
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                29.4
                %Restructuring
      charge
                
                
                -
                
                
                
                2.1
                %
                
                
                -
                
                
                
                1.1
                %Operating
      loss
                
                
                (10.1
                %)
                
                
                (9.0
                %)
                
                
                (11.0
                %)
                
                
                (38.3
                %)Interest
      expense
                
                
                (0.4
                %)
                
                
                (0.5
                %)
                
                
                (0.3
                %)
                
                
                (0.6
                %)Other
      income (expense), net
                
                
                0.8
                %
                
                
                (0.1
                %)
                
                
                0.5
                %
                
                
                0.2
                %Loss
      before income taxes
                
                
                (9.7
                %)
                
                
                (9.6
                %)
                
                
                (10.8
                %)
                
                
                (38.7
                %)Provision
      (benefit) for income taxes
                
                
                0.2
                %
                
                
                0.7
                %
                
                
                (0.3
                %)
                
                
                0.6
                %Loss
      from continuing operations
                
                
                (9.9
                %)
                
                
                (10.3
                %)
                
                
                (10.5
                %)
                
                
                (39.2
                %)Income
      from discontinued operations, net of income taxes
                
                
                -
                
                
                
                0.1
                %
                
                
                -
                
                
                
                -Net
      loss
                
                
                (9.9
                %)
                
                
                (10.2
                %)
                
                
                (10.5
                %)
                
                
                (39.2
                %)
  Net Sales. Net sales consist
of product sales less a provision for sales returns, which is made at the time
of the related sale. Net sales by reportable operating segment were as
follows:
  Three
      months ended June 30,
                
                
                Six
      months ended June 30,2010
                
                
                2009
                
                
                Change
                
                
                2010
                
                
                2009
                
                
                ChangeNorth
      America
                
                $
                6,784
                
                
                $
                9,696
                
                
                
                (30.0
                %)
                
                $
                13,735
                
                
                $
                17,912
                
                
                
                (23.3
                %)Europe
                
                
                6,256
                
                
                
                9,193
                
                
                
                (31.9
                %)
                
                
                12,372
                
                
                
                20,270
                
                
                
                (39.0
                %)Rest-of-World
                
                
                8,586
                
                
                
                6,531
                
                
                
                31.5
                %
                
                
                16,296
                
                
                
                11,670
                
                
                
                39.6
                %Total
      net sales
                
                $
                21,626
                
                
                $
                25,420
                
                
                
                (14.9
                %)
                
                $
                42,403
                
                
                $
                49,852
                
                
                
                (14.9
                %)
  19
  The
following table reflects the significant components of sales activity for the
three months ended June 30, 2009 to the three months ended June 30,
2010.
  North
      America
                
                
                Europe
                
                
                Rest-of-World
                
                
                Total$
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %Sales
      for the three months ended June 30, 2009
                
                $
                9,696
                
                
                
                
                
                
                $
                9,193
                
                
                
                
                
                
                $
                6,531
                
                
                
                
                
                
                $
                25,420Organic
      growth (reduction)
                
                
                (2,998
                )
                
                
                (30.9
                %)
                
                
                (2,641
                )
                
                
                (28.7
                %)
                
                
                899
                
                
                
                13.8
                %
                
                
                (4,740
                )
                
                
                (18.6
                %)Foreign
      currency
                
                
                86
                
                
                
                0.9
                %
                
                
                (296
                )
                
                
                (3.2
                %)
                
                
                1,156
                
                
                
                17.7
                %
                
                
                946
                
                
                
                3.7
                %Sales
      for the three months ended June 30, 2010
                
                $
                6,784
                
                
                
                (30.0
                %)
                
                $
                6,256
                
                
                
                (31.9
                %)
                
                $
                8,586
                
                
                
                31.5
                %
                
                $
                21,626
                
                
                
                (14.9
                %)
  The
following table reflects the significant components of sales activity for the
six months ended June 30, 2009 to the six months ended June 30,
2010.
  North
      America
                
                
                Europe
                
                
                Rest-of-World
                
                
                Total$
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %Sales
      for the six months ended June 30, 2009
                
                $
                17,912
                
                
                
                
                
                
                $
                20,270
                
                
                
                
                
                
                $
                11,670
                
                
                
                
                
                
                $
                49,852Organic
      growth (reduction)
                
                
                (4,363
                )
                
                
                (24.4
                %)
                
                
                (7,904
                )
                
                
                (39.0
                %)
                
                
                1,410
                
                
                
                12.1
                %
                
                
                (10,857
                )
                
                
                (21.8
                %)Foreign
      currency
                
                
                186
                
                
                
                1.1
                %
                
                
                6
                
                
                
                -
                
                
                
                3,216
                
                
                
                27.5
                %
                
                
                3,408
                
                
                
                6.9
                %Sales
      for the six months ended June 30, 2010
                
                $
                13,735
                
                
                
                (23.3
                %)
                
                $
                12,372
                
                
                
                (39.0
                %)
                
                $
                16,296
                
                
                
                39.6
                %
                
                $
                42,403
                
                
                
                (14.9
                %)
 
 Net sales
from continuing operations for the three months ended June 30, 2010 of $21,626
decreased 14.9% from net sales from continuing operations of $25,420 for the
three months ended June 30, 2009. Net sales from continuing operations for the
six months ended June 30, 2010 of $42,403 decreased 14.9% from net sales from
continuing operations of $49,852 for the six months ended June 30,
2009.  The decrease in the second quarter and for the year-to-date is
due to the legislative changes in Germany and their impact on our ability to
conduct business, and declines in North America unit sales and lower
wholesale average selling prices. The impact on our German business related to
legislative changes started in the second quarter of 2009, and had a more
dramatic impact each successive quarter thereafter. Sequential sales for the
first two quarters of 2010 have improved modestly in our German operation.
Partially offsetting these reductions is a 31.5% and 39.6% increase in
Rest-of-World sales in the second quarter and year-to-date 2010,
respectively.
 
 North
America hearing aid sales of $6,784 for the three months ended June 30,
2010 were down 30.0% from the prior year three months ended June 30, 2009 sales
level of $9,696. North America hearing aid sales of $13,735 for the six months
ended June 30, 2010 were down 23.3% from the prior year six months ended June
30, 2009 sales level of $17,912. The decrease in sales in the second quarter and
year-to-date is due primarily to declining average selling price in our
wholesale business as a result of two factors: VA sales which have a lower
selling price and lower wholesale prices due to competitive pressures we are
seeing in the marketplace.  We also saw reductions in year-over-year
unit volume of 42.8% and 30.9%, for the three and six months ended June 30,
2010. We are finding increased price competition in the wholesale market as more
manufactures compete over less business in the North American independent
audiologist market due to manufacturers’ retail acquisitions.
  Europe
sales of $6,256 for the three months ended June 30, 2010 decreased 31.9% from
net sales of $9,193 for the three months ended June 30, 2009.  Europe
sales of $12,372 for the six months ended June 30, 2010 decreased 39.0% from net
sales of $20,270 for the six months ended June 30, 2009. Europe sales were
primarily impacted by the legislative changes in Germany which were effective
April 1, 2009 and impacted sales in two ways.  First, the impact of
not having contracts with the insurers resulted in net units sold in our German
operation declining 58.6% in the first half of 2010 compared to the same period
in 2009.  Second, we previously billed the insurance company the full
price of a hearing aid, which included the doctor’s fee as part of the
reimbursement. The full reimbursement was recorded as revenue and the payment to
the ENT doctors as a cost of sale. We are now only billing for the hearing aid,
with the doctors billing separately for their fitting services and no longer
recording the doctor’s fees as revenue and cost of sales.
  Rest-of-World
sales of $8,586 for the three months ended June 30, 2010 increased 31.5% from
the three months ended June 30, 2009 sales of $6,531. Year-to-date sales were
$16,296 for the six months ended June 30, 2010 increased 39.6% from the six
months ended June 30, 2009 sales of $11,670. Second quarter and year-to-date
organic growth of 13.8% and 12.1%, respectively, was due to having more fitters
employed and additional marketing expenditures, which translated into more
sales. The Australian dollar strengthened against the U.S. dollar for both the
second quarter and year-to-date which improved sales by 17.7% and 27.5%,
respectively.
  We
generally have a 60 day return policy for wholesale hearing aid sales and 30
days for retail sales. Provisions for sales returns for continuing operations
were $1,141, or 5.0% and $2,028, or 7.4% of gross hearing aid sales from
continuing operations, for the three months ended June 30, 2010 and 2009,
respectively. The year-to-date provision for sales returns for continuing
operations is $2,416, or 5.4% of gross hearing aid sales, and $4,335, or 8.0% of
gross hearing aid sales from continuing operations, for the six months ended
June 30, 2010 and 2009, respectively. The percentage decrease for both the
second quarter and year-to-date ended June 30, 2010 was driven by lower sales in
wholesale, where return rates tend to be higher than in our retail operations,
and lower return rates in our wholesale operation. Retail sales are recognized
after fitting and “acceptance,” which results in lower return rates, whereas in
wholesale, revenue is recognized on shipment and a reserve is established for
expected returns. We believe that the hearing aid industry, particularly in the
U.S., experiences a high level of product returns due to factors such as
statutorily required liberal return policies and product performance that is
inconsistent with hearing impaired consumers’ expectations.
  20
  Gross Profit. Cost of sales
primarily consists of manufacturing costs, royalty expenses, quality costs and
costs associated with product remakes and repairs (warranty). Gross profit and
gross margin by reportable operating segment were as follows:
 
 Three
      months ended June 30,
                
                
                Six
      months ended June 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Continuing
      operationsNorth
      America
                
                $
                3,227
                
                
                
                47.6
                %
                
                $
                5,540
                
                
                
                57.1
                %
                
                $
                6,574
                
                
                
                47.9
                %
                
                $
                9,839
                
                
                
                54.9
                %Europe
                
                
                3,976
                
                
                
                63.6
                %
                
                
                5,140
                
                
                
                55.9
                %
                
                
                8,091
                
                
                
                65.4
                %
                
                
                11,667
                
                
                
                57.6
                %Rest-of-World
                
                
                6,190
                
                
                
                72.1
                %
                
                
                4,784
                
                
                
                73.3
                %
                
                
                12,044
                
                
                
                73.9
                %
                
                
                8,121
                
                
                
                69.6
                %Total
      gross profit
                
                $
                13,393
                
                
                
                61.9
                %
                
                $
                15,464
                
                
                
                60.8
                %
                
                $
                26,709
                
                
                
                63.0
                %
                
                $
                29,627
                
                
                
                59.4
                %
  Gross
profit from continuing operations of $13,393 for the three months ended June 30,
2010 decreased 13.4% from the quarter ended June 30, 2009 gross profit of
$15,464, but gross margin increased to 61.9% from 60.8% in the same period of
2009. Gross profit from continuing operations of $26,709 for the six months
ended June 30, 2010 decreased 9.8% from the quarter ended June 30, 2009 gross
profit of $29,627, but gross margin increased to 63.0% from 59.4% in the same
period of 2009. The decrease in gross profit for the first and second quarters
is due to lower sales partially offset by a higher gross margin. The gross
margin increased due to a higher mix of retail sales, a weaker U.S. dollar and a
change in reimbursement in our German business.  Partially offsetting
this are higher warranty and material costs related to our receiver-in-canal
product family lower average selling prices in North America, and sales to the
VA which carry a lower gross margin when compared to the balance of our
business.
  North
America gross margin decreased to 47.6% and 47.9% for the three and six months
ended June 30, 2010, respectively, from 57.1% and 54.9% for the three and six
months ended June 30, 2009, respectively. The decrease in gross margin is
primarily a result of lower average selling prices, partially offset by an
increase in the percentage of retail sales which carry a higher gross
margin.
  Europe
gross margin increased to 63.6% and 65.4% for the three and six months ended
June 30, 2010, respectively, from 55.9 % and 57.6% for the three and six months
ended June 30, 2009, respectively. The higher gross margin is due to higher
average selling prices and a change in reimbursement for Germany. Previously we
recorded equal and offsetting reimbursement for doctor fees as net sales and
cost of sales.  As a result of the recent German legislation, the
doctors must bill and collect for their services.  Thus, the fees are
no longer recorded as a sale and cost of sale.
 
 Rest-of-World
gross margin decreased to 72.1% for the three months ended June 30, 2010 from
73.3% for the three months ended June 30, 2009 and increased to 73.9% for the
six months ended June 30, 2010 from 69.6% for the six months ended June 30,
2009. The gross margin impact for the quarter and year-to-date were primarily
due to the exchange rate between the U.S. and Australian dollar with the second
quarter 2009 margin strength driven by the launch of Touch.
  Provisions
for warranty for continuing operations decreased to $651 and $1,564 for the
three and six months ended June 30, 2010 from $1,457 and $2,192 for the three
and six months ended June 30, 2009, respectively, primarily due to lower sales
volumes and favorable repair rates, partially offset by sales of RIC products.
The receiver assembly associated with the RIC products may need to be replaced
frequently and thus the warranty per unit is higher than other products we sell.
We adjust the warranty estimates as we obtain more experience with this product
line.
  Selling, General and
Administrative. Selling, general and administrative expense primarily
consists of wages and benefits for sales and marketing personnel, sales
commissions, promotions and advertising, marketing support, distribution and
administrative, stock-based compensation, and depreciation and amortization
expenses.
  Selling,
general and administrative expense in dollars and as a percent of sales by
reportable operating segment was as follows:
  Three
      months ended June 30,
                
                
                Six
      months ended June 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Continuing
      operationsNorth
      America
                
                $
                5,379
                
                
                
                79.3
                %
                
                $
                6,407
                
                
                
                66.1
                %
                
                $
                10,699
                
                
                
                77.9
                %
                
                $
                12,020
                
                
                
                67.1
                %Europe
                
                
                2,823
                
                
                
                45.1
                %
                
                
                3,349
                
                
                
                36.4
                %
                
                
                5,738
                
                
                
                46.4
                %
                
                
                7,037
                
                
                
                34.7
                %Rest-of-World
                
                
                5,035
                
                
                
                58.6
                %
                
                
                3,976
                
                
                
                60.9
                %
                
                
                10,098
                
                
                
                62.0
                %
                
                
                7,075
                
                
                
                60.6
                %Corporate
                
                
                1,449
                
                
                
                -
                
                
                
                1,566
                
                
                
                -
                
                
                
                2,894
                
                
                
                -
                
                
                
                3,487
                
                
                
                -Total
      selling, general and administrative
                
                $
                14,686
                
                
                
                67.9
                %
                
                $
                15,298
                
                
                
                60.2
                %
                
                $
                29,429
                
                
                
                69.4
                %
                
                $
                29,619
                
                
                
                59.4
                %
  21
 
 The
following table reflects the components of selling, general and administrative
expense for the three months ended June 30, 2009 to the three months ended June
30, 2010.
  North
      America
                
                
                Europe
                
                
                Rest-of-World
                
                
                Corporate
                
                
                Total$
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %Selling,
      general and administrative expense for the three months ended June 30,
      2009
                
                $
                6,407
                
                
                
                
                
                
                $
                3,349
                
                
                
                
                
                
                $
                3,976
                
                
                
                
                
                
                $
                1,566
                
                
                
                
                
                
                $
                15,298Organic
      growth (reduction)
                
                
                (1,061
                )
                
                
                (16.6
                %)
                
                
                (347
                )
                
                
                (10.4
                %)
                
                
                373
                
                
                
                9.4
                %
                
                
                (117
                )
                
                
                (7.5
                %)
                
                
                (1,152
                )
                
                
                (7.5
                %)Foreign
      currency
                
                
                33
                
                
                
                0.6
                %
                
                
                (179
                )
                
                
                (5.3
                %)
                
                
                686
                
                
                
                17.2
                %
                
                
                -
                
                
                
                -
                
                
                
                540
                
                
                
                3.5
                %Selling,
      general and administrative expense for the three months ended June 30,
      2010
                
                $
                5,379
                
                
                
                (16.0
                %)
                
                $
                2,823
                
                
                
                (15.7
                %)
                
                $
                5,035
                
                
                
                26.6
                %
                
                $
                1,449
                
                
                
                (7.5
                %)
                
                $
                14,686
                
                
                
                (4.0
                %)
  The
following table reflects the components of selling, general and administrative
expense for the six months ended June 30, 2009 to the six months ended June 30,
2010.
   North
      America
                
                
                Europe
                
                
                Rest-of-World
                
                
                Corporate
                
                
                Total$
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %
                
                
                $
                
                
                
                %Selling,
      general and administrative expense for the six months ended June 30,
      2009
                
                $
                12,020
                
                
                
                
                
                
                $
                7,037
                
                
                
                
                
                
                $
                7,075
                
                
                
                
                
                
                $
                3,487
                
                
                
                
                
                
                $
                29,619Organic
      growth (reduction)
                
                
                (1,391
                )
                
                
                (11.6
                %)
                
                
                (1,250
                )
                
                
                (17.8
                %)
                
                
                1,020
                
                
                
                14.4
                %
                
                
                (593
                )
                
                
                (17.0
                %)
                
                
                (2,214
                )
                
                
                (7.5
                %)Foreign
      currency
                
                
                70
                
                
                
                0.6
                %
                
                
                (49
                )
                
                
                (0.7
                %)
                
                
                2,003
                
                
                
                28.3
                %
                
                
                -
                
                
                
                -
                
                
                
                2,024
                
                
                
                6.9
                %Selling,
      general and administrative expense for the six months ended June 30,
      2010
                
                $
                10,699
                
                
                
                (11.0
                %)
                
                $
                5,738
                
                
                
                (18.5
                %)
                
                $
                10,098
                
                
                
                42.7
                %
                
                $
                2,894
                
                
                
                (17.0
                %)
                
                $
                29,429
                
                
                
                (0.6
                %)
  Selling,
general and administrative expense for the three months ended June 30, 2010 of
$14,686 decreased by $612 or 4.0%, from the three months ended June 30, 2009
level of $15,298. Selling, general and administrative expense for the six months
ended June 30, 2010 of $29,429 decreased $190 or 0.6% from $29,619 for the six
months ended June 30, 2009. We substantially reduced costs in certain
geographies and increased spending in others. In percentage terms, we reduced
wholesale division expenses in excess of the sales decline. Additionally, we
reduced expenses in our Europe operation and increased spending in Rest-of-World
and the U.S. retail division of North America.  Our focus was to
invest in those markets where shareholder value would be enhanced.  We
increased marketing spending in the U.S. for a direct-to-consumer initiative in
an effort to increase the number of appointments in our retail locations.
Rest-of-World selling, general and administrative expenses increased as we
invested in additional audiologists.
  North
America selling, general and administrative expense for the three and six months
ended June 30, 2010 was lower than the corresponding periods for the previous
year by $1,028 or 16.0% and $1,321 or 11.0%, respectively.  This was a
result of reducing headcount and discretionary spending in our wholesale
operation, including the costs of our annual audiology
convention.  However, this was partially offset by expenses for the
new Veteran Administration business of $355 and $480 for the three and six
months ended June 30, 2010, respectively, spending for a direct to consumer
initiative of $66 and $523 for the three and six months ended June 30, 2010,
respectively, and an increase in marketing in our U.S. retail in order to
increase appointments.
  Europe
selling, general and administrative expenses decreased $526, or 15.7% and
$1,299, or 18.5%, for the three and six months ended June 30, 2010,
respectively. We decreased expenses primarily by reducing headcount in Europe as
a result of the reduction in Germany net sales.
  Rest-of-World
selling, general and administrative expense for the three and six months ended
June 30, 2010 increased by $1,059 and $3,023 or 26.6% and 42.7%, respectively.
The weakening of the U.S. dollar against the Australian dollar was the primary
factor relating to our growth in expenses, and we added audiologists and
marketing costs to increase sales and profitability.
 
 Corporate.Corporate expense
primarily consists of wages and benefits for corporate employees, select
officers, worldwide marketing efforts, and general administrative expenses not
directly related to sales.  Corporate expense of $1,449 and $2,894,
for the three and six months ended June 30, 2010 decreased $117 or 7.5% and $593
or 17.0% over the same periods in the prior year.  We decreased
expenses by reducing stock-based compensation, marketing spend, and facility
rent.
 
 Research and Development.
Research and development expense primarily consists of wages and benefits for
research and development, engineering, regulatory and clinical personnel and
also includes consulting, intellectual property, clinical studies and
engineering support costs. Research and development expense of $894, or 4.1% of
net sales, for the three months ended June 30, 2010 decreased $1,035, or 53.7%,
over the research and development expense of $1,929, or 7.6% of net sales, for
the six months ended June 30, 2009. For the six months ended June 30, 2010,
research and development costs decreased $1,949 or 49.9%.  The
decrease for the three and six months ended June 30, 2010 is a result of
eliminating approximately 20 positions in the second quarter of 2009. We are
outsourcing more of our research and development activities and therefore, we
expect that our royalty costs, classified in cost of sales, will increase in the
future to offset the reduced research and development expenditures.
 
 Restructuring and Impairment
Charges. In the first quarter of 2010, we reversed $20 of previously
recorded restructuring charges as a result of adjustments to previous accrual
estimates related to lease settlements. In the first quarter of 2009, as a
result of the German court decision previously described, we recognized a
goodwill impairment charge of $14,205 and a trade name impairment charge of
$453, resulting in total impairment charges of $14,658 related to our German
operation. In the second quarter of 2009, we took actions to improve the
profitability of our operation by reducing the total number of employees in
North America and Research and Development. Accordingly we have recorded
restructuring charges of $525.
  22
 
 Interest Expense and Other Income
(Expense), Net. Other income (expense), net, primarily consists of
foreign currency gains and losses, interest income and other non-operating gains
and losses. Interest income was lower due to lower customer loan balances and
interest expense was lower due to lower rates on outstanding debt and a lower
average balance for the periods. The significant change is due to a recognized
gain in foreign currency translation of our intercompany balances for the three
months ended June 30, 2010, whereas we recognized a loss for the three months
ended June 30, 2009.
  Provision (Benefit) for Income
Taxes. In some jurisdictions net operating loss carry-forwards reduce or
offset tax provisions. We had an income tax benefit from continuing operations
for the six months ended June 30, 2010 of $128 compared to an income tax
provision from continuing operations of $276 for the six months ended June 30,
2009.  The income tax benefit was the result of losses in foreign
locations where we pay taxes, partially offset by alternative minimum tax in the
U.S., and state taxes. The prior year income tax provision was principally the
result of pre-tax profits in foreign jurisdictions, alternative minimum tax in
the U.S., amortization of goodwill, and state taxes.
  LIQUIDITY AND CAPITAL RESOURCES
  Our cash
flows from operating, investing and financing activities, as reflected in the
Condensed Consolidated Statement of Cash Flows for the six months ended June 30,
2010 and 2009 are summarized as follows:
  For
      the six months endedJune
      30,2010
                
                
                2009Net
      cash used in operating activities from continuing
    operations
                
                $
                (2,799
                )
                
                $
                (3,053
                )Net
      cash provided by (used in) discontinued operations
                
                
                (40
                )
                
                
                22Net
      cash used in operating activities
                
                
                (2,839
                )
                
                
                (3,031
                )Net
      cash used in investing activities
                
                
                (770
                )
                
                
                (2,064
                )Net
      cash provided by financing activities
                
                
                1,663
                
                
                
                539Effect
      of exchange rate changes on cash and cash equivalents from continuing
      operations
                
                
                (466
                )
                
                
                70Effect
      of exchange rate changes on cash and cash equivalents from discontinued
      operations
                
                
                (1
                )
                
                
                (10
                )Net
      decrease in cash and cash equivalents
                
                
                (2,413
                )
                
                
                (4,496
                )Cash
      and cash equivalents, beginning of the period
                
                
                12,154
                
                
                
                13,129Cash
      and cash equivalents, end of the period
                
                $
                9,741
                
                
                $
                8,633
  Net cash
used in operating activities from continuing operations was $2,799 for the six
months ended June 30, 2010. Negative cash flow resulted from a net loss from
continuing operations of $4,464 which was positively affected by certain
non-cash expenses including depreciation and amortization of $1,675, stock-based
compensation of $580, foreign currency loss of $647, and loss on disposal of
long-lived assets of $20. Positive operating cash flow also resulted from a
decrease in accounts receivable of $1,272, primarily due to improved collection
efforts and lower sales during the first two quarters of 2010, and a decrease in
other assets of $89. These positive cash flow items were offset by a non-cash
decrease in deferred income taxes of $107, an increase in inventory of $730, and
a decrease in accounts payable of $1,485 and accrued restructuring of $279 and
withholding taxes remitted on stock-based awards of $19.
  Net cash
used in operating activities of discontinued operations was $40 for the six
months ended June 30, 2010.
  Net cash
used in operating activities from continuing operations was $3,053 for the six
months ended June 30, 2009. Negative cash flow resulted from a net loss of
$19,560 which was positively affected by certain non-cash expenses including
goodwill and definite-lived intangible impairment charges of $14,658 relating to
our German operation, depreciation and amortization of $2,046, stock-based
compensation of $808, foreign currency loss of $160, and the amortization of
discounts on long-term debt of $76. Positive operating cash flow also resulted
from a decrease in accounts receivables of $410, primarily due to collection
efforts during 2009, a decrease in other assets of $380, and a net increase of
accrued restructuring liabilities of $208. These positive cash flow items were
offset by an increase in inventory of $2,145 for new product launches; an
increase in accounts payable, accrued expenses and deferred revenue of $57,
withholding taxes remitted on stock-based awards of $37, and deferred income
taxes of $10.
  Net cash
provided by operating activities of discontinued operations was $22 for the six
months ended June 30, 2009.
  Net cash
used in investing activities of $770 for the six months ended June 30, 2010
resulted from the purchase of property and equipment of $1,655, and purchase of
a technology license of $204 partially offset by net customer loan repayments of
$1,089.
 
 Net cash
used in investing activities from continuing operations of $2,064 for the six
months ended June 30, 2009 resulted from the purchase of property and
equipment of $1,706 and net customer advances of $358.
  23
  Net cash
provided by financing activities of $1,663 for the six months ended June 30,
2010 resulted from borrowings on the line of credit of $3,000 less repayments of
$2,140. Positive cash flows resulted from proceeds from taxes collected on the
vesting of restricted shares of $7, and borrowings on long-term debt of $1,765
less repayments of $930 partially offset by a transfer of $39 to restricted
cash.
  Net cash
provided by financing activities from continuing operations of $539 for the six
months ended June 30, 2009 resulted from borrowings on the line of credit
of $2,750, decreases in restricted cash and cash equivalents of $261 and
proceeds from tax payments received on vested restricted stock of $20, partially
offset by principal loan payments of $2,492.
  In the
first two quarters of 2010, we borrowed $3,000 on our revolving credit facility
and repaid $2,140, for a net increase of $860. In the second quarter of 2010 we
borrowed $1,765 on two notes in Australia. Our bank debt agreements include a
customary material adverse change clause that allows the banks to call the
loans, if invoked. The banks have not invoked such clauses.
  Our
ability to make payments on and to refinance our indebtedness, and to fund
planned capital expenditures and ongoing operations, will depend on our ability
to generate cash in the future. This depends, to a degree, on general economic,
financial, competitive, legislative, regulatory and other factors that are
beyond our control. We plan to continue to decrease our receivables and
inventory, pursue additional debt financing, and together with available
cash balances; we expect to be able to fund future debt service payments,
ongoing operations, and capital expenditures through at least December 31, 2010.
The key to this plan will be our German and U.S. retail operating performance.
We have recently amended the agreement on our line of credit and obtained
additional financing to help fund operational requirements. As of June 30, 2010,
our outstanding borrowings on our line of credit of $3,976 represented the
maximum allowable borrowing under the terms of the agreement.
  There can
be no assurance, however, that our business will generate sufficient cash flow
from operations, that currently anticipated cost savings and operating
improvements will be realized on schedule or that future borrowings will be
available to us in an amount sufficient to enable us to pay our indebtedness or
to fund our other liquidity needs. Furthermore, we cannot provide any assurances
that ongoing uncertainty in global capital markets and general economic
conditions will not have a material adverse impact on our future operations and
cash flows. We may need to refinance all or a portion of our indebtedness
on or before maturity and we cannot provide assurances that we will be able to
refinance any of our indebtedness on commercially reasonable terms, or at all.
Should we be unable to renegotiate our debt service payments, we may need to
sell assets of the company, which will also be subject to market conditions
existing at that time. We notified SVB in May 2010 that compliance with our debt
covenants, as structured, would be difficult. Subsequently, in June 2010, we
signed a letter of understanding with SVB in which SVB agreed to suspend
covenant testing as of May 31, 2010 and June 30, 2010, respectively, and amend
the financial covenants, pending completion of a formal loan agreement by early
August 2010.  Accordingly, on August 9, 2010, we signed an agreement
which suspended the debt covenants at May 31, 2010 and June 30, 2010,
respectively, and provided new covenants for the remaining term of the
agreement. We are in compliance with our amended debt covenants as of June
30, 2010. As of June 30, 2010, our outstanding borrowings of $3,976 on the line
of credit represented the maximum allowable borrowing under the terms of the
agreement. In July 2010, we paid $2,339 on our revolving credit facility with
SVB due to reduced borrowing capacity under the amended agreement.
  We
monitor our capital structure on an ongoing basis and from time to time we
consider financing and refinancing options to improve our capital structure and
to enhance our financial flexibility. Our ability to enter into new financing
arrangements is subject to restrictions in our outstanding debt instruments. At
any given time we may pursue a variety of financing opportunities, and our
decision to proceed with any financing will depend, among other things, on
prevailing market conditions, near term maturities and available
terms.
  Contractual Obligations
  As of
June 30, 2010, we had uncertain tax positions of $288, of which $255 is recorded
as a liability and which could result in cash outlays in the event of
unfavorable taxing authority rulings.
  There
have been no material changes to our contractual obligations outside the
ordinary course of business since December 31, 2009.
 
 RECENT ACCOUNTING PRONOUNCEMENTS
  In
January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair
Value Measurements.” ASU 2010-06 both expands and clarifies the
disclosure requirements related to fair value measurements. Entities are
required to disclose separately the amounts of significant transfers in and out
of Level 1 and Level 2 of the fair value valuation hierarchy and describe the
reasons for the transfers. Additionally, entities are required to disclose
information about purchases, sales, issuances, and settlements on a gross basis
in the reconciliation of Level 3 fair-value measurements. The new guidance also
clarifies existing fair-value measurement disclosure guidance about the level of
disaggregation, inputs, and valuation techniques.  We adopted the new
disclosures effective January 1, 2010, except for the Level 3 roll-forward
disclosures. The Level 3 roll-forward disclosures will be effective for us
January 1, 2011.  The adoption of the ASU did not have a material
impact on our disclosures as it did not have any significant transfers in and
out of Level 1 and Level 2 of the fair value valuation hierarchy in the first
half of 2010.
  24
 
 In
October 2009, the FASB issued ASU 2009-13,“Revenue Recognition (ASU Topic
605) – Multiple Deliverable Revenue Arrangements,” a consensus of the
FASB Emerging Issues Task Force which is effective for us in the first quarter
of fiscal year 2011, with early adoption permitted, modifies the fair value
requirements of ASC subtopic 605-25,“Revenue Recognition-Multiple
Element Arrangements,” by allowing the use of the “best estimate of
selling price” in addition to vendor-specific objective evidence (“VSOE”) and
verifiable objective evidence (“VOE”) (now referred to as “TPE” standing for
third-party evidence) for determining the selling price of a deliverable. A
vendor is now required to use its best estimate of the selling price when VSOE
or TPE of the selling price cannot be determined. In addition, the residual
method of allocating arrangement consideration is no longer permitted. In
October 2009, the FASB also issued ASU 2009-14,“Software (ASC Topic 985) – Certain
Revenue Arrangements That Include Software Elements,” a consensus of the
FASB Emerging Issues Task Force. This guidance modifies the scope of ASC
subtopic 965-605, “Software-Revenue
Recognition,” to exclude from its requirements (a) non-software
components of tangible products and (b) software components of tangible
products that are sold, licensed, or leased with tangible products when the
software components and non-software components of the tangible product function
together to deliver the tangible product’s essential functionality. ASU 2009-13
is required to be applied prospectively to new or materially modified revenue
arrangements in fiscal years beginning on or after June 15, 2010. This update
requires expanded qualitative and quantitative disclosures once adopted. We are
currently evaluating the impact of adopting this pronouncement and do not expect
the standard to have a material impact on the condensed consolidated financial
statements.
  ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISKS
  Interest Rate Risk. We
generally invest our cash in money market funds and corporate debt securities.
These are subject to minimal credit and market risk. As of June 30, 2010, we had
$1,462 held in commercial money market instruments that carry an effective
interest rate of 0.15%. The interest rates on our customer advances approximate
the market rates for comparable instruments and are fixed.
  As of
June 30, 2010 we had $915, in short-term bank debt that bears interest at the
EURIBOR rate plus 4.00%. In addition, we had $856, in short-term bank debt that
bears interest at the Australian Bank Bill Swap Rate plus 0.70%, as well as
$840, in short-term and long-term bank debt on our equipment loan in Australia
that bears interest at 8.97%.
 
 A
hypothetical one percentage point change in interest rates would not have had a
material effect on our results of operations and financial position. Given
current interest rates, we believe the market risks associated with these
financial instruments are minimal.
  Derivative Instruments and Hedging
Activities. We may employ derivative financial instruments to manage
risks, including the short term impact of foreign currency fluctuations on
certain intercompany balances, or variable interest rate exposures. We do not
enter into these contracts for trading or speculation purposes. Gains and losses
on the contracts are included in the results of operations and offset foreign
exchange gains or losses recognized on the revaluation of certain intercompany
balances, or interest expense due to movement in variable interest rates, as
applicable.
  Our
foreign exchange forward contracts generally mature in three months or less from
the contract date. We held forward contract hedges on €3,600 ($4,394) and
Australian $1,700 ($1,456) at June 30, 2010. As of June 30, 2010, we recognized
an unrealized loss of $38 in connection with our foreign currency forward
contracts. The unrealized loss is recorded in Other income (expense), net in the
Condensed Consolidated Statements of Operations, and in Other accrued
liabilities in the Condensed Consolidated Balance Sheets. The contracts will
expire in the third quarter of 2010.
  Effective
in the second quarter 2008, we entered into an interest rate swap agreement. The
contract effectively fixes the interest rate of our long term debt associated
with the German acquisition at 9.59%.
  Foreign Currency Risk. We face
foreign currency risks primarily as a result of the revenues we derive from
sales made outside the U.S., expenses incurred outside the U.S., and from
intercompany account balances between our U.S. parent and our non-U.S.
subsidiaries. For the three months ended June 30, 2010, approximately 68.6%
of our net sales and 53.5% of our operating expenses were denominated in
currencies other than the U.S. dollar. For the six months ended June 30,
2010, approximately 67.6% of our net sales and 53.8% of our operating expenses
were denominated in currencies other than the U.S. dollar. For the three months
ended June 30, 2009, approximately 58.5% of our net sales and 41.4% of our
operating expenses were denominated in currencies other than the U.S.
dollar.  For the six months ended June 30, 2009, approximately 60.5%
of our net sales and 40.8% of our operating expenses were denominated in
currencies other than the U.S. dollar.
  Inventory
purchases were transacted in U.S. dollars. The local currency of each foreign
subsidiary is considered the functional currency, and revenue and expenses are
translated at average exchange rates for the reported periods. Therefore, our
foreign sales and expenses will be higher in a period in which there is a
weakening of the U.S. dollar and will be lower in a period in which there is a
strengthening of the U.S. dollar. The Australian dollar and Euro are our most
significant foreign currencies. Given the uncertainty of exchange rate
fluctuations and the varying performance of our foreign subsidiaries, we cannot
estimate the affect of these fluctuations on our future business, results of
operations and financial condition. Fluctuations in the exchange rates between
the U.S. dollar and other currencies could effectively increase or decrease the
selling prices of our products in international markets where the prices of our
products are denominated in U.S. dollars. For example, subsequent to June 30,
2010, the Euro significantly strengthened against the U.S. dollar, which if
continued, will have a positive impact on our Europe segment operating results.
We regularly monitor our foreign currency risks and may take measures to reduce
the impact of foreign exchange fluctuations on our operating results. To date,
we have not used derivative financial instruments for hedging, trading or
speculating on foreign currency exchange, except to hedge intercompany
balances.
  25
  For the
six months ended June 30, 2010 and 2009, average currency exchange rates to
convert one U.S. dollar into each local currency for which we had sales of over
$5,000 by quarter were as follows:
  2010
                
                
                2009Euro
                
                
                0.75
                
                
                
                0.75Australian
      dollar
                
                
                1.12
                
                
                
                
                1.41
  ITEM 4.
                CONTROLS
      AND PROCEDURES
  Evaluation of Disclosure Controls
and Procedures. Under the supervision and with the participation of our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of the design and
operation of our disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange
Act”), as of the end of the period covered by this report. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures were effective.
  Changes in Internal Controls Over
Financial Reporting. During the period covered by this report, there were
no changes in our internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, such internal controls
over financial reporting.
  PART
II - OTHER INFORMATION
  ITEM 1.
                LEGAL
      PROCEEDINGS
  In
February 2006, the former owners of Sanomed, which we acquired in 2003, filed a
lawsuit in German civil court claiming that certain deductions made by us
against certain accounts receivable amounts and other payments remitted to the
former owners were improper. The former owners sought damages in the amount of
approximately €2,600 ($3,800). We filed our statement of defense and presented
our position during oral arguments. The court asked the parties to attempt to
settle the matter and, on July 20, 2009, we agreed to settle the claim with
the former owners. Under the terms of the settlement, we agreed to pay the
former owners of Sanomed an aggregate sum of €1,050 ($1,471), approximately the
amount reserved in our balance sheet at December 31, 2008 for this matter.
We remitted the settlement payment in August 2009.
  As part
of the Sanomed purchase agreement, the former owners were entitled to contingent
consideration based on the achievement of certain revenue milestones. In certain
circumstances, the former owners were entitled to contingent consideration
irrespective of the achievement of the revenue milestones. In addition to the
above noted lawsuit, two of the former owners filed suit against us, one of
which was settled in 2007, and the other former owner’s contingent consideration
claim against us for approximately €1,100 ($1,343) plus interest was dismissed
on July 2008, with the German court rendering its decision in our favor. The
former owner has appealed. We continue to strongly deny the allegations
contained in the former owner’s appeal and intend to vigorously defend
ourselves; however, litigation is inherently uncertain and an unfavorable result
could have a material adverse effect. We establish liabilities when a particular
contingency is probable and estimable.
  Also see
Item 1-A, below, regarding our recent litigation against a German insurance
company.
  From time
to time, we are subject to legal proceedings, claims and litigation arising in
the ordinary course of its business. Most of these legal actions are brought
against us by others and, when we feel it is necessary, we may bring legal
actions. Actions can stem from disputes regarding the ownership of intellectual
property, customer claims regarding the function or performance of our products,
government regulation or employment issues, among other sources. Litigation is
inherently uncertain, and therefore, we cannot predict the eventual outcome of
any such lawsuits. However, we do not expect that the ultimate resolution of any
known legal action, other than as identified above, will have a material adverse
effect on our results of operations and financial position.
  ITEM 1-A.
                RISK
      FACTORS
  In
addition to the risk factors set forth in this report, you should carefully
consider the factors discussed in Part I, Item 1-A, “Factors That May
Affect Future Performance” in our Annual Report on Form 10-K for the year ended
December 31, 2009 which could materially affect our business, results of
operations and financial position. The risks described in our Annual Report on
Form 10-K are not the only risks facing our Company. Additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial also may materially adversely affect our business, results of
operations and financial position.
  26
 
 Germany
Legislation
  Recent
legislation requires that the fitting fee payments to the doctors come from the
insurance companies rather than us.  The direct payment to doctors for
fitting services under our business model was one of the keys to success for our
sales model in Germany.  The law changed the market by giving more power to
the insurers by allowing discretion as to which business models they contract
with to supply hearing aids and related services.  Insurers are the sole
gatekeepers for access to the reimbursement schemes for the end consumer. 
These changes required our German subsidiary to: a) assist the insurance
companies in addressing the new requirements for invoicing, receiving and
paying doctor’s honorarium; b) renegotiate contracts with insurance
companies; and c) negotiate contracts between and with the insurance company and
the ENT doctors.  In early 2009, we were working with insurance companies
to incorporate the legislative changes in existing contracts. One insurance
company representing approximately 25% of our 2008 German revenue refused to
enter into a contract; therefore, we filed a lawsuit in the Social Court in
Hamburg, Germany. On April 28, 2009, the Court rejected our claim to force the
company to sign a contract with us.  We subsequently filed an appeal of
this decision, which was rejected without review.  In addition, a number of
other insurance companies were unsure if they should sign a contract because
there were rumors that the newly enacted law could potentially change again,
thus requiring the need to renegotiate within a short period of time. 
Without renegotiated insurance contracts, and the ability to pay customary
fitting fees to the ENT doctors, we experienced a substantial decline in our
Germany revenues, and determined that cash flows of the operation would not be
sufficient to support our intangibles balances. As a result, we recognized a
$14,658 non-cash write-off of our goodwill and trade name associated with our
German operation in the first quarter of 2009.
 
 In June
2009, the German government passed additional amendments to the law that became
effective July 23, 2009. The key implication of these amendments to our
business model was that the new law will impose additional costs on the doctors
and insurance companies that conduct business with our German operation and
disrupt the normal flow of fitting hearing aids on the first visit to the
doctor’s office.
  We are
currently renegotiating contracts in light of the new legislative requirements
and are working to contract with other insurance companies as well. The
lack of signed insurance contracts and the imposition of new and costly
requirements on the ENT doctors and the insurance companies as well as the
uncertainty of regulatory requirements will continue to impact our
German business. Final regulatory requirements are expected to be completed
before the end of 2010.  Currently, continued negotiations are
delaying a quick resolution. Until the legislation is finalized, we cannot
completely determine any necessary changes to our operations, if any. Therefore,
the profitability of our German operation is uncertain for the near
future.
 
 Germany
represented 67% and 72% of Europe segment revenues and 71% and 75% (excluding
first quarter 2009 impairment charges) of Europe segment operating profit for
the three months ended June 30, 2010 and 2009, respectively and 67% and 75% of
Europe segment revenues and 72% and 84% of Europe segment operating profit for
the six months ended June 30, 2010 and 2009, respectively.
  ITEM 4.
                RESERVED
  ITEM 6.
                EXHIBITS
  (a)
Exhibits required to be filed by Item 601 of Regulation S-K:
  Exhibit #
                
                Description10.1
                
                Second
      Amended and Restated Loan and Security Agreement with Silicon Valley Bank
      (filed on our Form 8-K on August 13, 2010 and incorporated by
      reference herein).31.1
                
                Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
                
                Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32
                
                Certification
      of Chief Executive Officer and Chief Financial Officer Pursuant to 18
      U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
      of 2002.
  27
 
 SIGNATURE
  Pursuant
to the requirements 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.
  Date:
August 13, 2010
  /s/
      MICHAELM.HALLORANMichael
      M. HalloranVice President and Chief Financial Officer
  28