<PAGE>

                                  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 SEPTEMBER 30, 2001

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

                          Commission File No. 000-30335

                             SONIC INNOVATIONS, INC.
                             -----------------------
             (Exact name of registrant as specified in its charter)

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

                     2795 East Cottonwood Parkway, Suite 660
                          Salt Lake City, UT 84121-7036
                          -----------------------------
                    (Address of principal executive offices)

                                 (801) 365-2800
                                  -------------
              (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

As of November 5, 2001 there were 19,724,791 shares of the registrant's common
stock outstanding.

                                       1

<PAGE>

                             SONIC INNOVATIONS, INC.
                                TABLE OF CONTENTS

                                    FORM 10-Q

<TABLE>
<CAPTION>
                                                                                        Page
<S>                                                                                     <C>
PART I       FINANCIAL INFORMATION

ITEM 1.      Condensed Consolidated Financial Statements (unaudited):

                Condensed Consolidated Balance Sheets as of September 30, 2001
                and December 31, 2000                                                     3

                Condensed Consolidated Statements of Operations for the
                Three and Nine Months Ended September 30, 2001 and 2000                   4

                Condensed Consolidated Statements of Cash Flows for the
                Nine Months Ended September 30, 2001 and 2000                             5

                Notes to Condensed Consolidated Financial Statements                      6

ITEM 2.      Management's Discussion and Analysis of Financial Condition
             and Results of Operations                                                    8

ITEM 3.      Quantitative and Qualitative Disclosures about Market Risks                 12

             Factors That May Affect Future Performance                                  12

PART II      OTHER INFORMATION

ITEM 1.      Legal Proceedings                                                           16

ITEM 2.      Changes in Securities and Use of Proceeds                                   16

ITEM 6.      Exhibits and Reports on Form 8-K                                            17

Signature                                                                                17
</TABLE>

                                        2

<PAGE>

PART I  FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                             SONIC INNOVATIONS, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                  September 30, 2001      December 31, 2000
                                                  ------------------      -----------------
<S>                                               <C>                     <C>
ASSETS
Current assets:
Cash and cash equivalents.........................          $ 11,695               $  7,312
Marketable securities.............................            24,965                 44,898
Accounts receivable, net..........................             6,983                  9,881
Inventories.......................................             6,376                  7,418
Prepaid expenses and other........................               827                    667
                                                            --------               --------

     Total current assets.........................            50,846                 70,176

Long-term marketable securities...................            10,617                      -
Property and equipment, net.......................             5,097                  4,202
Intangible assets.................................             3,456                      -
Other assets......................................             2,353                  1,870
                                                            --------               --------

     Total assets.................................          $ 72,369               $ 76,248
                                                            ========               ========


LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable and accrued expenses.............          $ 12,067               $ 10,899
Current portion of long-term obligations..........               487                    627
                                                            --------               --------

     Total current liabilities....................            12,554                 11,526

Long-term obligations, net of current portion.....               194                    451

Shareholders' equity:
Common stock......................................                20                     20
Additional paid-in capital........................           112,003                111,633
Deferred stock-based compensation.................              (645)                (1,346)
Accumulated deficit and comprehensive loss........           (50,866)               (46,036)
Treasury stock, at cost...........................              (891)                     -
                                                            --------               --------

     Total shareholders' equity...................            59,621                 64,271
                                                            --------               --------

     Total liabilities and shareholders' equity...          $ 72,369               $ 76,248
                                                            ========               ========
</TABLE>


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

                                        3

<PAGE>

                             SONIC INNOVATIONS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                                      Three months ended      Nine months ended
                                                                                         September 30,           September 30,
                                                                                         -------------           -------------
                                                                                      2001          2000       2001        2000
                                                                                      ----          ----       ----        ----
<S>                                                                                 <C>           <C>        <C>         <C>
Net sales ........................................................................  $15,521       $14,003    $42,106     $39,520
Cost of sales ....................................................................    8,603         6,778     23,265      19,435
                                                                                    -------       -------    -------     -------

      Gross profit ...............................................................    6,918         7,225     18,841      20,085

Selling, general and administrative expense ......................................    6,442         4,765     17,622      13,802
Research and development expense. ................................................    2,303         2,028      6,902       5,910
Stock-based compensation expense. ................................................      173           394        613       1,705
                                                                                    -------       -------    -------     -------

Operating profit (loss). .........................................................   (2,000)           38     (6,296)     (1,332)

Other income (expense), net ......................................................      527           627      1,658        (562)
                                                                                    -------       -------    -------     -------

Net income (loss). ...............................................................   (1,473)          665     (4,638)     (1,894)

Accretion on mandatorily redeemable convertible preferred stock ..................        -             -          -        (959)
                                                                                    -------       -------
Net income (loss) applicable to common stockholders. .............................  $(1,473)      $   665    $(4,638)    $(2,853)
                                                                                    =======       =======    =======     =======

Basic and diluted net income (loss) per common share .............................  $  (.07)      $   .03    $  (.23)    $  (.25)
                                                                                    =======       =======    =======     =======

Weighted average number of common shares outstanding
         Basic ...................................................................   19,903        19,633     19,894      11,369
                                                                                    =======       =======    =======     =======
         Diluted .................................................................   19,903        21,574     19,894      11,369
                                                                                    =======       =======    =======     =======


Pro forma information (see note 10):

     Net loss. ...................................................................                                       $  (854)
                                                                                                                         =======

     Basic and diluted net loss per common share .................................                                       $  (.05)
                                                                                                                         =======

     Weighted average number of common shares outstanding. .......................                                        17,495
                                                                                                                         =======

Stock-based compensation allocable to each caption:

     Cost of sales ...............................................................  $     8       $    18    $    28     $    79
     Selling, general and administrative expense .................................      142           323        502       1,396
     Research and development expense. ...........................................       23            53         83         230
                                                                                    -------       -------    -------     -------

                                                                                    $   173       $   394    $   613     $ 1,705
                                                                                    =======       =======    =======     =======
</TABLE>


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

                                        4

<PAGE>
                             SONIC INNOVATIONS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
                                   (unaudited)

<TABLE>
<CAPTION>
                                                                                         Nine months ended
                                                                                           September 30,
                                                                                           -------------
                                                                                         2001         2000
                                                                                         ----         ----
<S>                                                                                  <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .......................................................................     $ (4,638)     $ (1,894)
Adjustments to reconcile net loss to net cash provided by (used in)
  operating activities:
     Depreciation and amortization .............................................        1,181         1,163
     Imputed interest ..........................................................            -         1,243
     Stock-based compensation ..................................................          613         1,705
     Loss on disposal of assets ................................................            -            17
Changes in assets and liabilities net of effects of acquisition:
     Accounts receivable .......................................................        3,421        (9,974)
     Inventories ...............................................................        1,868        (2,486)
     Prepaid expenses and other.................................................         (144)           20
     Other assets. .............................................................         (437)          578
     Long-term obligations .....................................................         (100)            -
     Accounts payable and accrued expenses .....................................          255           915
                                                                                     --------      --------
       Net cash provided by (used in) operating activities .....................        2,019        (8,713)

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition, net of cash acquired ..............................................       (5,206)            -
Purchase of property and equipment .............................................       (1,063)       (1,448)
Proceeds from (purchases of) marketable securities..............................        9,316       (29,433)
                                                                                     --------      --------
       Net cash provided by (used in) investing activities .....................        3,047       (30,881)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net of costs.............................            -        52,228
Proceeds from convertible promissory notes .....................................            -         6,000
Line of credit repayment .......................................................            -        (1,966)
Principal payments on long-term obligations.....................................         (297)       (1,814)
Purchase of treasury stock .....................................................         (891)            -
Proceeds from exercise of stock options and employee stock purchases ...........          458           720
                                                                                     --------      --------
       Net cash provided by (used in) financing activities .....................         (730)       55,168

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS ...................           47           169
                                                                                     --------      --------

NET INCREASE IN CASH AND CASH EQUIVALENTS.......................................        4,383        15,743
CASH AND CASH EQUIVALENTS, beginning of the period .............................        7,312         5,939
                                                                                     --------      --------
CASH AND CASH EQUIVALENTS, end of the period ...................................     $ 11,695      $ 21,682
                                                                                     ========      ========

SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest .........................................................     $     94      $    194

SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING
  ACTIVITIES:
  Mandatorily redeemable convertible preferred stock accretion .................     $      -      $    959
  Conversion of convertible promissory notes and related accrued interest ......            -        15,103
  Conversion of preferred stock.................................................            -        37,418
</TABLE>

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

                                       5

<PAGE>

                             SONIC INNOVATIONS, 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 three
and nine month periods ended September 30, 2001 are not necessarily indicative
of results that may be expected for the full year ending December 31, 2001. For
further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 2000 as filed with the Securities and Exchange
Commission.

The accompanying condensed consolidated financial statements include the
accounts of Sonic Innovations, Inc. and its wholly owned subsidiaries, Sonic
Innovations A/S and Sonic Innovations Pty Ltd (see note 2). All intercompany
balances and transactions have been eliminated in consolidation.


2. ACQUISITION

Effective July 1, 2001, the Company purchased M-E Hearing Systems Pty Ltd.,
renamed Sonic Innovations Pty Ltd., for $5,000. M-E Hearing, the Company's
former Australian distributor, operates 28 retail locations in Australia, as
well as a wholesale business supplying other companies' retail locations. The
acquisition was accounted for in accordance with Statement of Financial
Accounting Standards No. ("FAS") 141 "Business Combinations" and FAS 142
"Goodwill and Other Intangible Assets," both of which were issued in June 2001.
FAS 141 requires that all acquisitions after June 30, 2001 be accounted for as
purchases and FAS 142 requires that goodwill not be amortized, but be subject to
a periodic test of impairment.

The following table sets forth the preliminary allocation of the purchase
consideration consisting of $5,000 in cash and $215 in direct expenses.

                Current assets             $1,628
                Property and equipment      1,056
                Other assets                   37
                Goodwill                    3,456
                Current liabilities          (962)
                                           ------
                Purchase consideration     $5,215
                                           ======

The excess purchase price has been preliminary allocated to goodwill and the
Company is undertaking a valuation to determine the existence of any acquired
intangible assets.

3. MARKETABLE SECURITIES

Management designates the appropriate classification of marketable securities at
the time of purchase and re-evaluates such designation as of each balance sheet
date. As of September 30, 2001, the Company's investment portfolio consisted of
short and long-term corporate debt securities, which were classified as
held-to-maturity and presented at their amortized cost.

4. CONCENTRATIONS OF CREDIT RISK

The Company had one customer that comprised 13% and 26% of net sales for the
three months ended September 30, 2001 and 2000, respectively, and 9% and 30% of
net sales for the nine months ended September 30, 2001 and 2000, respectively.
See "Factors that may affect future performance - The loss of any large customer
or a reduction in orders from any large customer could significantly reduce our
net sales and harm our operating results" elsewhere in this Report on Form 10-Q.

5. INVENTORIES

Inventories are stated at the lower of cost or market value using the first- in,
first-out ("FIFO") method. Inventories at September 30, 2001 and December 31,
2000 consisted of the following:

                                                    September 30,   December 31,
                                                         2001           2000
                                                        ------         ------
Raw materials..................................         $  778         $3,093
Components.....................................          2,342          2,207
Work in progress...............................            143            536
Finished goods.................................          3,113          1,582
                                                        ------         ------

Total..........................................         $6,376         $7,418
                                                        ======         ======

                                        6

<PAGE>

                             SONIC INNOVATIONS, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                      (in thousands, except per share data)
                                   (unaudited)

6. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) consisted of the following:

<TABLE>
<CAPTION>
                                                             Three months ended        Nine months ended
                                                                September 30,            September 30,
                                                                -------------            -------------
                                                              2001          2000       2001         2000
                                                              ----          ----       ----         ----
<S>                                                         <C>           <C>        <C>         <C>
Net income (loss)                                           $(1,473)       $ 665     $(4,638)     $(1,894)
Foreign currency gain (loss)                                    153         (168)        192         (113)
                                                            -------        -----     -------      -------

Comprehensive income (loss)                                 $(1,320)       $ 497     $(4,830)     $(2,007)
                                                            =======        =====     =======      =======
</TABLE>

7. NET INCOME (LOSS) PER COMMON SHARE

Basic and diluted net income (loss) per common share were computed by dividing
net income (loss) applicable to common shareholders by the weighted average
number of common shares outstanding. Common stock equivalents were not
considered in periods of net loss since their effect would be antidilutive,
thereby decreasing the net loss per common share. The difference between basic
and diluted common shares outstanding for the quarter ended September 30, 2000
was the assumed exercise of 2,517,000 common stock options which resulted in a
diluted effect of 1,941,000 shares after applying the treasury stock method. As
of September 30, 2001, common stock equivalents consisted of options to purchase
3,117,038 shares and a warrant for 20,706 common shares.

8. SEGMENT INFORMATION

The table below presents selected information for the Company's geographic
operating segments for the three and nine months ended September 30, 2001 and
2000. Rest of world (ROW) sales include Sonic Innovations Pty Ltd. and export
sales. Previously export sales were included in U.S. sales.

<TABLE>
<CAPTION>
   Three months ended September 30, 2001                           United States            Europe              ROW          Total
   -------------------------------------                           -------------            ------              ---          -----
   <S>                                                             <C>                     <C>               <C>         <C>
   Net sales to external customers............................           $11,493            $1,934           $2,094       $ 15,521
   Operating profit (loss)....................................            (1,765)             (272)              37         (2,000)

   Three months ended September 30, 2000
   -------------------------------------

   Net sales to external customers............................            10,868             1,665            1,470         14,003
   Operating profit (loss)....................................              (800)             (230)           1,068             38

   Nine months ended September 30, 2001
   ------------------------------------

   Net sales to external customers............................            31,269             6,709            4,128         42,106
   Operating profit (loss)....................................            (7,033)             (468)           1,205         (6,296)

   Nine months ended September 30, 2000
   ------------------------------------

   Net sales to external customers............................            29,635             5,249            4,636         39,520
   Operating profit (loss)....................................            (3,924)             (622)           3,214         (1,332)
</TABLE>


9. INITIAL PUBLIC OFFERING (IPO)

    The Company filed a registration statement with the Securities and Exchange
    Commission that became effective on May 1, 2000 and sold 4,140 shares of
    common stock at $14.00 per share. The Company received net proceeds of
    $52,228. In connection with the IPO, the following items were converted into
    common stock:

      .  All outstanding convertible preferred stock into 12,533 shares of
         common stock;
      .  $4,500 of convertible promissory notes (plus accrued interest) into 336
         shares of common stock at a conversion price equal to 100% of the IPO
         price;
      .  $7,000 of convertible promissory notes (plus accrued interest) into 545
         shares of common stock at a conversion price equal to 93% of the IPO
         price;


                                        7

<PAGE>

                             SONIC INNOVATIONS, INC.
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
                      (in thousands, except per share data)
                                   (unaudited)

      .  $3,000 of convertible promissory notes issued on the closing of the IPO
         into 214 shares of common stock at a conversion price equal to 100% of
         the IPO price; and
      .  Outstanding warrants to purchase 203 shares of common stock (net of 33
         shares surrendered in lieu of cash payment of the exercise price for
         certain warrants) at an exercise price of $3.80 per share.

10. PRO FORMA INFORMATION

The pro forma information assumes that the conversions of convertible preferred
stock and convertible promissory notes and the exercise of warrants occurred as
of January 1, 2000, or the date of issuance, if later. The numerator and the
denominator used for purposes of computing the pro forma net loss per common
share for the nine months ended September 30, 2000 were derived as follows:

<TABLE>
<CAPTION>
                                                                                         Nine months ended
                                                                                        September 30, 2000
                                                                                        ------------------
<S>                                                                                     <C>
 Numerator:
 Net loss applicable to common shareholders..........................................              $(2,853)
 Reversal of interest expense on convertible promissory notes........................                  505
 Reversal of accretion on convertible preferred stock................................                  959
 Reversal of beneficial conversion feature on certain convertible promissory notes...                  535
                                                                                                   -------

 Proforma net loss...................................................................              $  (854)
                                                                                                   =======

 Denominator:
 Weighted average common shares outstanding..........................................               11,369
 Conversion of convertible preferred stock...........................................                5,718
 Conversion of convertible promissory notes..........................................                  315
 Exercise of warrants................................................................                   93
                                                                                                   -------

 Pro forma weighted average common shares outstanding................................               17,495
                                                                                                   =======
</TABLE>

11. SHARE REPURCHASE PROGRAM

On May 9, 2001, the Board of Directors authorized the repurchase of up to 1,000
shares of the Company's common stock as market conditions warrant. Through
September 30, 2001, the Company has repurchased 232 shares of common stock at a
cost of $891 under this program.

12. LEGAL PROCEEDINGS

The Company is currently a defendant in a lawsuit filed in October 2000 claiming
that the Company and certain of its officers violated federal securities laws by
providing materially false and misleading information or concealing information
about the Company's relationship with Starkey Laboratories, Inc. This lawsuit,
which is pending in the U.S. District Court for the District of Utah, purports
to be brought as a class action on behalf of all purchasers of the Company's
common stock from May 2, 2000 to October 24, 2000 and seeks damages in an
unspecified amount. On October 24, 2001, the court held a hearing on the
Company's motion to dismiss the entire complaint. The court granted the
Company's motions with leave to amend. Pursuant to the court's order, the
amended complaint is to be filed on December 14, 2001. The Company denies the
allegations in this action and will defend itself vigorously, however,
litigation is inherently uncertain and there can be no assurance that the
Company will not be materially affected.

13. RECENTLY ENACTED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires
companies to use the purchase method of accounting for all business combinations
initiated after June 30, 2001 and eliminates the use of the pooling-of-interests
method of accounting for business combinations. SFAS No. 141 also establishes
criteria that must be used to determine whether acquired intangible assets
should be recognized separately from goodwill in the Company's financial
statements. Management does not expect the adoption of SFAS No. 141 to have a
material effect on the Company's financial position or results of operations.

SFAS No. 142 changes the accounting for goodwill and intangible assets with
indefinite lives from an amortization method to an impairment-only approach.
Upon adoption the Company will cease to amortize goodwill. Other intangible
assets will continue to be amortized over their useful lives. SFAS No. 142 also
requires an annual impairment test. During 2002, the Company will perform the
first of the required impairment tests of goodwill. Based upon the management's
preliminary analysis, it does not appear that there will be any impairment in
the value of the Company's goodwill.

In August 2001, the Financial Accounting Standard Board issued SFAS No. 144,
"Accounting for Impairment of Long-Lived Assets". The new standard supercedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Although retaining many of the fundamental
recognition and measurement provisions of SFAS 121, the new rules significantly
change the criteria that would have to be met to classify an asset as
held-for-sale. The new standard also supercedes the provisions of Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions", and will require expected
future operating losses from discontinued operations to be displayed in
discontinued operations in the period(s) in which the losses are incurred
rather than as of the measurement date as presently required. The provisions of
SFAS No. 144 are effective for financial statements beginning after December 15,
2001, but allow for early application. The adoption of this statement is not
expected to have a material effect on the Company's financial position and
results of operations.


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion contains forward-looking statements that involve risks
and uncertainties. These statements refer to our future results, plans,
objectives, expectations and intentions. These forward-looking statements
include statements regarding the following: increased selling, general and
administrative expense, additional customers, expansions in staff, expanded
product offerings, anticipated growth of our business, component sales, future
branding and advertising campaigns, conventions, increased research and
development expense, amortization of stock-based compensation, increased capital
expenditures, growth in operating expenses, future acquisitions, repurchase of
our stock, future cash requirements and uses. Our actual results could differ
materially and adversely from those anticipated in such forward-looking
statements. Factors that could contribute to these differences include, but are
not limited to, the risks discussed in the section titled "Factors That May
Affect Future Performance." All amounts are reflected in thousands, except per
share data.

                                        8

<PAGE>

OVERVIEW

We design, manufacture and market advanced digital hearing aids and hearing aid
components designed to provide the highest levels of satisfaction for hearing
impaired customers. Capitalizing on a new understanding of human hearing, we
have developed patented digital signal processing ("DSP") technologies and
embedded them in the smallest single-chip DSP platform ever installed in a
hearing aid. We sell finished hearing aids, hearing aid kits and hearing aid
components to hearing care professionals, distributors and other hearing aid
manufacturers in the United States, and much of Europe, Japan and Canada and
operate 28 retail locations in Australia as a result of our acquisition of Sonic
Innovations Pty Ltd. We launched our first hearing aid product line, NATURA, in
the fourth quarter 1998, our CONFORMA product in the first quarter 2000 and our
ALTAIR product line in the fourth quarter 2000. In reporting our financial
condition and results of operations, we report three geographic operating
segments. We generally evaluate our operating results on a company-wide basis
because all of our products are sourced from the United States, and all research
and development and considerable marketing and administrative support are
provided globally from the United States.

RESULTS OF OPERATIONS

The following table sets forth selected statement of operations information for
the periods indicated expressed as a percentage of our net sales.

<TABLE>
<CAPTION>
                                                                                      Three months ended    Nine months ended
                                                                                         September 30,        September 30,
                                                                                         -------------        -------------
                                                                                         2001     2000        2001     2000
                                                                                         ----     ----        ----     ----

<S>                                                                                     <C>       <C>         <C>      <C>
Net sales ........................................................................      100.0%    100.0%      100.0%   100.0%

Cost of sales ....................................................................       55.4      48.4        55.3     49.2
                                                                                         ----      ----        ----     ----

Gross profit .....................................................................       44.6      51.6        44.7     50.8

Selling, general and administrative ..............................................       41.5      34.0        41.8     34.9
Research and development .........................................................       14.9      14.5        16.4     15.0
Stock-based compensation .........................................................        1.1       2.8         1.5      4.3
                                                                                         ----      ----        ----     ----

Operating profit (loss) ..........................................................      (12.9)       .3       (15.0)    (3.4)

Other income (expense) ...........................................................        3.4       4.4         4.0     (1.4)
                                                                                         ----      ----        ----     ----

Net income (loss) ................................................................       (9.5)%     4.7%      (11.0)%   (4.8)%
                                                                                         =====     ====        ====     ====
</TABLE>


Net Sales. Net sales consist of product sales less a provision for sales returns
which is made at the time of sales. We divide our sales into two categories:
hearing aid product sales, which includes NATURA, ALTAIR and CONFORMA hearing
aids; and hearing aid component sales, which includes sales of our DSP chip to
several other hearing aid manufacturers. Hearing aid product sales were $13,480
for the quarter ended September 30, 2001, a 46% increase from $9,241 recorded
for the quarter ended September 30, 2000. By geography, U.S. hearing aid product
sales in the third quarter of $9,463 were up 31% from third quarter 2000 sales
of $7,237. Sales of our ALTAIR line, which was introduced last November,
comprised 14% of U.S. hearing aid product sales in the third quarter 2001.
Outside the U.S., ("OUS") hearing aid product sales in the third quarter
included sales of $1,963 from the company's Australian subsidiary which was
acquired in July 2001. Of our OUS sales, Europe sales of $1,934 were up 16% from
third quarter 2000 sales of $1,665; and rest of world ("ROW") sales of $111,
excluding Australia, were down 64% from third quarter 2000 sales of $339. The
ROW shortfall principally related to reduced orders from our Japanese
distributor, Hoya Healthcare, which Hoya has indicated is a reflection of the
slow Japanese economy. Hearing aid component sales in the third quarter were
$2,041 included $1,950 of sales to Starkey Laboratories, Inc., down from third
quarter 2000 component sales of $4,762 which included sales to Starkey
Laboratories of $3,630. The company has stated previously that component sales
would represent a decreasing portion of its business, mainly due to the winding
down of sales to Starkey Laboratories. Additionally, the company's Japanese OEM
partner, Rion, did not order in the third quarter, citing a slowing of consumer
spending in Japan.

Hearing aid product sales were $37,215 for the nine months ended September 30,
2001, a 53% increase from hearing aid product sales of $24,376 for the nine
months ended September 30, 2000. U.S. hearing aid product sales for the first
nine months of 2001 were $27,121, up 52% from first nine months 2000 sales of
$17,861. U.S. hearing aid product sales growth was favorably affected by the
introduction of products containing our second generation integrated circuitry,
offset somewhat by a reduction in CONFORMA sales. OUS hearing aid product sales
for the nine months ended September 30, 2001 of $10,093 were up 55% from first
nine months 2000 sales of $6,515. OUS hearing aid product sales included sales
of $1,963 from our Australian subsidiary, which was acquired in July 2001. Of
our OUS sales, Europe sales of $6,709 were up 28% from first nine months 2000
sales of $5,249 and ROW sales, excluding Australia, of $2,165

                                       9

<PAGE>

were up 71% from first nine months 2000 sales of $1,266. For the nine months
ended September 30, 2001, hearing aid component sales were $4,892, down 68% from
first nine months 2000 sales of $15,145. The majority of the shortfall resulted
from a reduction in sales to Starkey Laboratories, which were $3,900 for first
nine months of 2001 compared to $11,774 for first nine months 2000. In addition,
component sales to Rion were $3,370 in the first nine months 2000 compared to
sales of $744 for the first nine months 2001.

We generally have a 60-day return policy for our hearing aid products and a no
return policy for our component products. Sales returns were $3,621 and $2,646
for the quarters ended September 30, 2001 and 2000, respectively, and $11,368
and $8,310 for the nine months ended September 30, 2001 and 2000, respectively.
Growth in returns principally related to the increase in hearing aid product
sales from 2000 to 2001. We believe that the hearing aid industry, particularly
in the United States, experiences a high level of product returns due to factors
such as statutorily required liberal return policies and product performance
inconsistent with consumers' expectations. We believe our return levels are
within the range experienced by other hearing aid manufacturers with premium-
performance, premium-priced products.

Cost of Sales. Cost of sales consists of manufacturing costs, royalty expenses,
quality assurance costs and costs associated with product returns, remakes and
repairs. Cost of sales was $8,603 for the quarter ended September 30, 2001, an
increase of $1,825 (27%) from cost of sales of $6,778 for the quarter ended
September 30, 2000. For the nine months ended September 30, 2001, cost of sales
was $23,265, an increase of $3,830 (20%) from cost of sales of $19,435 for the
nine months ended September 30, 2000. As a percentage of net sales, gross margin
was 44.6% for the quarter ended September 30, 2001 compared to 51.6% for the
quarter ended September 30, 2000, and 44.7% for the nine months ended September
30, 2001 compared to 50.8% for the nine months ended September 30, 2000. Lower
gross margins are a result of a decrease in higher margin hearing aid component
sales, price erosion on all products and an increase in sales of our lower
margin ALTAIR line, offset somewhat by the fixed costs of our manufacturing
operations being spread over a greater sales level and operating efficiencies
derived from producing at higher quantities.

We provide for the cost of remaking and repairing products under warranty,
including hearing aid components. The warranty period ranges from one to three
years for hearing aid products and 30 to 120 days for hearing aid components.
Warranty costs were $537 and $570 for the quarters ended September 30, 2001 and
2000, respectively, and $1,622 and $1,502 for the nine months ended September
30, 2001 and 2000, respectively. The increases in warranty costs were due to the
growth of sales.

Selling, General and Administrative. Selling, general and administrative expense
consists primarily of wages and benefits for personnel, sales commissions,
promotions and advertising, marketing support, conventions and administrative
expenses. Selling, general and administrative expense was $6,442 for the quarter
ended September 30, 2001, an increase of $1,677 (35%) from selling, general and
administrative expense of $4,765 for the quarter ended September 30, 2000. For
the first nine months of 2001, selling, general and administrative expense was
$17,622, an increase of $3,820 (28%) from selling, general and administrative
expense of $13,802 for the nine months ended September 30, 2000. The increase in
selling, general and administrative expense for the three and nine months ended
September 30, 2001 was primarily a result of increased sales headcount,
marketing programs and literature.

We expect selling and marketing expense to increase as we add new customers,
expand our staff, expand our product offerings, incur additional costs related
to the anticipated growth of our business, and pursue branding and advertising
campaigns. Selling and marketing expenses may also vary considerably from
quarter to quarter as a result of the timing of our advertising campaigns and
convention costs. As a result, we expect selling, general and administrative
expense to continue to increase in dollars, although not necessarily as a
percentage of sales.

Research and Development. Research and development expense consists primarily of
wages and benefits for personnel, consulting, software, intellectual property,
clinical study and engineering support costs. Research and development expense
was $2,303 for the quarter ended September 30, 2001, an increase of $275 (14%)
from the $2,028 for the quarter ended September 30, 2000. For the first nine
months of 2001, research and development expense was $6,902, an increase of $992
(17%) from the $5,910 for the nine months ended June 30, 2001. The increases
were principally the result of additional headcount, establishing a business
development function and increased expenses in the areas of new product
introduction and sustaining engineering. We are making continual efforts to
improve our existing products as well as to develop new products because we
believe that new and better products are critical to our long-term success. As a
result, we expect research and development expense to continue to increase in
absolute dollars, although not necessarily as a percentage of sales.

Stock-based Compensation. Deferred stock-based compensation represents the
difference between the exercise price and the deemed fair value of our common
stock on the grant date for stock options granted in the one-year period
preceding the initial filing of our IPO and is being amortized over the vesting
periods of the individual stock options, periodically adjusted for employee
separations. For the quarters ended September 30, 2001 and 2000, stock-based
compensation expense was $173 and $394, respectively. For the nine months ended
September 30, 2001 and 2000, stock-based compensation expense was $613 and
$1,705, respectively.

                                       10

<PAGE>

As of September 30, 2001, deferred stock-based compensation of $645 is expected
to be amortized as follows:

        October 1, 2001 to December 31, 2001. ...........................   $134
        2002 ............................................................    354
        2003 ............................................................    121
        2004 ............................................................     26
        2005 ............................................................     10
                                                                            ----
                                                                            $645
                                                                            ====

    Other Income (Expense). Other income (expense) consisted of the following:

<TABLE>
<CAPTION>
                                                                 Three months ended    Nine months ended
                                                                    September 30,         September 30,
                                                                    -------------         -------------
                                                                    2001     2000         2001     2000
                                                                    ----     ----         ----     ----
               <S>                                               <C>        <C>         <C>      <C>
               Interest income                                     $   541  $   841     $ 1,937  $ 1,337
               Interest expense                                        (12)     (41)        (94)    (200)
               Foreign currency exchange gain (loss)                    72     (158)        (39)    (434)
               Non-cash imputed interest expense                         -        -           -   (1,243)
               Loss on disposal of assets and other                    (74)     (15)       (146)     (22)
                                                                   -------  -------     -------  -------

                                                                   $   527  $   627     $ 1,658  $  (562)
</TABLE>

Interest income resulted principally from investing the IPO proceeds which were
received in May 2000. Interest expense decreased because certain debt was repaid
with proceeds from the IPO. Non-cash imputed interest expense in 2000 related to
the following: imputed interest charges on bank financing issued with warrants
as a result of allocating the financing's proceeds between the debt and warrants
of $204; beneficial conversion feature offered on certain convertible debt of
$535; imputed interest charges on convertible debt financing issued with
warrants as a result of allocating the financing's proceeds between the debt and
warrants of $316 and interest accrued on converted debt of $188.

Income Taxes. We have generated operating losses since inception and no
provision or benefit for income taxes has been recorded to date.

Net Loss. Net loss for the three and nine months ended September 30, 2001 was
$1,473 ($.07 per share) and $4,638 ($.23 per share), respectively based on
shares outstanding of 19,903 and 19,894, respectively. Net income for the three
months ended September 30, 2000 was $665 ($.03 per share). Pro forma net loss
for the nine months ended September 30, 2000 was $854 ($.05 per share) (see note
10 to the condensed consolidated financial statements).

LIQUIDITY AND CAPITAL RESOURCES

Prior to our IPO, our principal sources of funds were the sale of common and
preferred stock, the sale of subordinated convertible debt, capital lease
financing arrangements and bank borrowings, totaling approximately $46,400 since
our inception. In May 2000, we completed an IPO in which we sold 4,140 shares of
common stock at $14.00 per share. Net proceeds from the IPO, after deducting the
underwriting commission and offering expenses, were $52,228.

Net cash provided by operating activities of $2,019 for the nine months ended
September 30, 2001 resulted principally from decreases in accounts receivable of
$3,421 and inventory of $1,868. This decrease more than offset the net loss of
$4,638, which included $1,794 of non-cash expenses pertaining to depreciation,
amortization and stock- based compensation.

Net cash provided by investing activities of $3,047 for the nine months ended
September 30, 2001 consisted of net proceeds from the maturity of marketable
securities of $9,315 offset somewhat by the purchase of M-E Hearing of $5,206
and purchases of property, and equipment of $1,062.

Net cash used in financing activities of $730 for the nine months ended
September 30, 2001 consisted of repayment of long-term obligations of $297 and
the purchase of treasury stock of $891, offset somewhat by proceeds from stock
option exercises and shares sold under our employee stock purchase plan of $458.
At September 30, 2001, we had $47,277 in cash, cash equivalents and marketable
securities.

We expect to experience growth in our operating expenses in order to execute our
business plan, particularly in the areas of research and development and selling
and marketing. As a result, we expect that these operating expenses, as well as
capital expenditures to improve our manufacturing capability will constitute a
significant use of our cash resources for at least the next twelve months. In
addition, we may use cash resources to fund acquisitions of complimentary
businesses and technologies and repurchase our stock from time to time.

                                       11

<PAGE>

RECENTLY ENACTED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires
companies to use the purchase method of accounting for all business combinations
initiated after June 30, 2001 and eliminates the use of the pooling-of-interests
method of accounting for business combinations. SFAS No. 141 also establishes
criteria that must be used to determine whether acquired intangible assets
should be recognized separately from goodwill in the Company's financial
statements. Management does not expect the adoption of SFAS No. 141 to have a
material effect on the Company's financial position or results of operations.

SFAS No. 142 changes the accounting for goodwill and intangible assets with
indefinite lives from an amortization method to an impairment-only approach.
Upon adoption the Company will cease to amortize goodwill. Other intangible
assets will continue to be amortized over their useful lives. SFAS No. 142 also
requires an annual impairment test. During 2002, the Company will perform the
first of the required impairment tests of goodwill. Based upon the management's
preliminary analysis, it does not appear that there will be any impairment in
the value of the Company's goodwill.

In August 2001, the Financial Accounting Standard Board issued SFAS No. 144,
"Accounting for Impairment of Long-Lived Assets". The new standard supercedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Although retaining many of the fundamental
recognition and measurement provisions of SFAS 121, the new rules significantly
change the criteria that would have to be met to classify an asset as
held-for-sale. The new standard also supercedes the provisions of Accounting
Principles Board Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions", and will require expected
future operating losses from discontinued operations to be displayed in
discontinued operations in the period(s) in which the losses are incurred
rather than as of the measurement date as presently required. The provisions of
SFAS No. 144 are effective for financial statements beginning after December 15,
2001, but allow for early application. The adoption of this statement is not
expected to have a material effect on the Company's financial position and
results of operations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Interest Rate Risk. To date, we have not utilized derivative financial
instruments or derivative commodity instruments. We invest our cash primarily in
money market funds and short-term investment grade debt securities which we
believe are subject to minimal credit and market risk. The interest rate on our
capital lease obligations approximates market and is fixed.

Foreign Currency Risk. We face foreign currency risks primarily as a result of
revenues we receive from sales made outside the United States and from the
intercompany account balance between our U.S., Danish and Australian companies.
Fluctuations in the exchange rates between the U.S. dollar and other currencies
could affect the sales price of our products in international markets where the
prices of our products are denominated in U.S. dollars or lead to currency
exchange losses where the prices of our products are denominated in local
currencies.

FACTORS THAT MAY AFFECT FUTURE PERFORMANCE

Our future results, plans, objectives, expectations and intentions could be
affected by any of the following "risk factors." Investors should understand
that it is not possible to predict or identify all such factors, and we are
under no obligation to update these factors. Investors should not consider all
factors listed as a complete statement of all potential risks and uncertainties.

WE HAVE A HISTORY OF OPERATING LOSSES AND NEGATIVE CASH FLOWS FROM OPERATING
ACTIVITIES, AND WE EXPECT OUR OPERATING EXPENSES TO CONTINUE TO INCREASE

We have an accumulated deficit which includes other comprehensive income of
$50.9 million at September 30, 2001. We incurred a net loss of $3.2 million and
negative cash flow of $7.1 million from operating activities for the year ended
December 31, 2000, and a net loss of $4.6 million for the nine month period
ended September 30, 2001. We have not achieved profitability on an annual basis.
We may incur net losses and negative cash flows in the future. We expect to
increase our operating expenses and therefore, must generate additional revenue
to achieve profitability. The size of our losses and whether or not we achieve
profitability will depend in significant part on the rate of growth of our net
sales. Consequently, it is possible that we will not achieve profitability, and
even if we do achieve profitability, we may not sustain or increase
profitability on a quarterly or annual basis in the future.

OUR FINANCIAL RESULTS MAY FLUCTUATE SIGNIFICANTLY, WHICH MAY CAUSE OUR STOCK
PRICE TO DECLINE

Our quarterly and annual operating results have fluctuated in the past and may
fluctuate significantly in the future. These fluctuations could cause our stock
price to fluctuate significantly or decline. Factors that may cause fluctuations
in our operating results include the following: cancellation or changes in the
timing of product orders, particularly significant orders from other hearing aid
manufacturers for our hearing aid components or from audiology clinic
consolidators for our hearing aid products; demand for and market acceptance of
our products; manufacturing problems; high levels of returns, remakes and
repairs; litigation expenses; changes in our product or customer mix;
competitive pressures resulting in lower selling prices or significant
promotional costs; unanticipated delays or problems in the introduction of new
products; inaccurate forecasting of revenues; and the announcement or
introduction of new products or services by our competitors.

If net sales for a particular period were below our expectations, it is unlikely
that we would proportionately reduce our operating expenses for that period.
Therefore, any revenue shortfall would have a disproportionately negative effect
on our operating results for the period. You should not rely on our results for
any one quarter as an indication of our future performance. In future quarters,
our operating results may be below the expectations of public market analysts or
investors. If this occurs, our stock price would very likely decrease.

ANY ACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR
BUSINESS, DILUTE OUR STOCKHOLDERS AND HARM OUR OPERATING RESULTS

                                       12

<PAGE>

We may acquire complimentary businesses, products and technologies. Any
anticipated benefits of an acquisition may not be realized. We have in the past
and will continue to evaluate acquisition prospects that would complement our
existing product offerings, augment our market coverage or distribution
channels, enhance our technological capabilities, or that may otherwise offer
growth opportunities. Acquisitions of other companies may result in dilutive
issuances of equity securities, the incurrence of debt and the amortization of
intangible assets or the write-down of goodwill. In addition, acquisitions
involve numerous risks, including difficulties in the assimilation of
operations, technologies, products and personnel of the acquired company,
diversion of management's attention from other business concerns, risks of
entering markets in which we have no direct or limited prior experience, and the
potential loss of key employees of ours and the acquired company. For example,
we acquired M-E Hearing Systems Pty Ltd. in July 2001. We may encounter
difficulties in integrating M-E Hearing's operations with our own on an
economically advantageous basis. In addition, other manufacturers that sold
hearing aids through M-E Hearing may cancel their agreements, which would result
in lost revenue. Failure to successfully integrate acquisitions we make could
harm our business and operating results.

THE LOSS OF ANY LARGE CUSTOMER OR A REDUCTION IN ORDERS FROM ANY LARGE CUSTOMER
COULD SIGNIFICANTLY REDUCE OUR NET SALES AND HARM OUR OPERATING RESULTS

We anticipate that our operating results in any given period will continue to
depend upon revenues from a small number of large customers. Our customers are
not generally contractually obligated to purchase any fixed quantities of
products, and they may stop placing orders with us at any time regardless of any
forecast they may have previously provided. We may be unable to retain our
current customers, and may be unable to recruit replacement or additional
customers. We sell hearing aid products to several audiology clinic
consolidators who have a large number of owned or franchised hearing aid
clinics. If sales to these consolidators increase, we will become subject to the
risk of losing these customers or incurring significant reductions in sales to
these customers. In addition, we may become subject to the risk of collecting
accounts receivable balances from these customers.

We also sell hearing aid components to a limited number of hearing aid
manufacturers. These arrangements have accounted for a significant portion of
our net sales to date. The loss of any of these large customers, or a
significant reduction in sales to these customers, would significantly reduce
our net sales and have a negative effect on our operating results. Sales of
components to Starkey Laboratories, Inc. accounted for $12.3 million, or 24%, of
net sales for the year ended December 31, 2000 and $3.9 million, or 9%, of net
sales for the nine months ended September 30, 2001. We do not anticipate any
further orders from Starkey. Accordingly, our net sales and operating results
may decline and our gross margin will be negatively affected.

WE ARE A DEFENDANT IN A CLASS ACTION LAWSUIT IN WHICH THE PLAINTIFF IS CLAIMING
THAT WE AND CERTAIN OF OUR OFFICERS VIOLATED FEDERAL SECURITIES LAWS.

We are currently a defendant in a lawsuit filed in October 2000 claiming that we
and certain of our officers violated federal securities laws by providing
materially false and misleading information, or concealing information, about
our relationship with Starkey Laboratories, Inc. This lawsuit, which is pending
in the U.S. District Court for the District of Utah, is being brought as a class
action on behalf of all purchasers of our common stock from May 2, 2000 to
October 24, 2000 and seeks damages in an unspecified amount. On October 24,
2001, the court held a hearing on our motions to dismiss the entire complaint.
The court granted our motions with leave to amend. Pursuant to the courts order,
the amended complaint is to be filed on December 14, 2001. We deny these
allegations in this action and will defend ourselves vigorously; however,
litigation is inherently uncertain and there can be no assurance that we will
not be materially affected. We anticipate that we will incur associated
litigation expense in connection with this action.

WE RELY ON SEVERAL SOLE SOURCE OR LIMITED SOURCE SUPPLIERS AND MANUFACTURERS,
AND OUR PRODUCTION WILL BE SERIOUSLY HARMED IF THESE SUPPLIERS AND MANUFACTURERS
ARE NOT ABLE TO MEET OUR DEMAND AND ALTERNATIVE SOURCES ARE NOT AVAILABLE

A number of key components used in our products are currently available only
from a single or limited number of suppliers. For example, our proprietary
digital signal processing chips are manufactured by a single supplier. Our
relationship with this supplier is critical to our business because only a small
number of suppliers would be able or willing to produce our chip in the
relatively small quantities and with the exacting specifications we require. In
addition, the disposable tips used in some of our hearing aids are produced by a
single supplier and the receivers and microphones used on all our products are
available from only two suppliers. We also rely on contract manufacturers and
are therefore subject to their performance, over which we have little control.
We may be forced to cease producing our products if we experience significant
shortages of critical components from these key suppliers or lose the services
of our contract manufacturers. Finding a substitute part, process, supplier or
manufacturer may be expensive, time-consuming or impossible.

WE HAVE NEW PRODUCTS AND A LIMITED SELLING HISTORY, WHICH MAKES IT DIFFICULT TO
EVALUATE OUR BUSINESS, AND OUR OPERATING RESULTS WILL SUFFER IF OUR PRODUCTS DO
NOT GAIN MARKET SHARE AS RAPIDLY AS WE ANTICIPATE

We launched NATURA, our first hearing aid line, in the fourth quarter 1998. We
introduced our CONFORMA product in the first quarter 2000; our second generation
NATURA line, NATURA 2SE, and our second-generation CONFORMA product, CONFORMA

                                       13

<PAGE>

2SE, in the second quarter 2000; and our ALTAIR line in the fourth quarter 2000.
Accordingly, we have a limited selling history on which investors can base an
evaluation of our products, business and prospects. Our revenue and income
potential are unproven, and our business model will continue to evolve. For
example, our "SE" products, which contain a noise reduction feature that we
introduced in the second quarter 2000, and our ALTAIR line, which we introduced
in the fourth quarter 2000, now comprise the majority of our sales. If our
current and new products do not gain market share as rapidly as we anticipate,
our net sales and operating results will suffer.

WE HAVE HIGH LEVELS OF PRODUCT RETURNS, REMAKES AND REPAIRS, AND OUR NET SALES
AND OPERATING RESULTS WILL BE LOWER IF THESE LEVELS REMAIN HIGH OR INCREASE

We generally offer a 60-day return policy and a minimum of a one-year warranty
on our hearing aid products. Our components warranty is generally 30 to 120
days. To date, we have experienced high levels of returns, remakes and repairs.
Sales returns were $12.9 million for the year ended December 31, 2000 and $11.4
million for the nine months ended September 30, 2001. Warranty costs for remakes
and repairs were $1.6 million for the year ended December 31, 2000 and $1.6
million for the nine months ended September 30, 2001. We may not be able to
attain lower levels of returns, remakes and repairs and, in fact, these levels
may increase, which could reduce our net sales and operating results.

WE FACE AGGRESSIVE COMPETITION IN OUR BUSINESS, AND IF WE DO NOT COMPETE
EFFECTIVELY OUR NET SALES AND OPERATING RESULTS WILL SUFFER

We encounter aggressive competition from a number of competitors worldwide, many
of which have far greater sales and more extensive financial and business
resources than we have. Some of our competitors offer forgivable loans and other
incentives to their hearing aid dispenser customers. We may not choose to, or be
able to, match these incentives, which could put us at a competitive
disadvantage. We may not be able to compete effectively with these competitors.
Consolidation within the industry has accelerated in the last several years, and
further consolidation could produce stronger competitors. If we fail to compete
effectively, our net sales and operating results will suffer.

IF WE FAIL TO DEVELOP NEW AND INNOVATIVE PRODUCTS, OUR COMPETITIVE POSITION WILL
SUFFER

In order to be successful, we must develop new products and be a leader in the
commercialization of new technology innovations in the hearing aid market.
Technological innovation is expensive and unpredictable and may require hiring
expert personnel who are difficult to find and attract. Without the timely
introduction of new products, our existing products are likely to become
technologically obsolete over time, which would harm our business. We may not
have the technical capabilities necessary to develop further technologically
innovative products. In addition, any enhancements to or new generations of our
products, even if successfully developed, may not generate revenue in excess of
the costs of development. Our products may be rendered obsolete by changing
consumer preferences or the introduction of products embodying new technologies
or features by us or our competitors.

SELLING HEARING AID COMPONENTS TO OUR COMPETITORS MAY INCREASE THEIR COMPETITIVE
POSITION RELATIVE TO OURS IF THEY DESIGN AND MANUFACTURE MORE COMPETITIVE
HEARING AIDS OR MARKET THEIR PRODUCTS MORE EFFECTIVELY THAN WE MARKET OURS

Selling hearing aid components to our competitors may place us in a vulnerable
position. We may find that these competitors are able to capture a larger
portion of the hearing aid market, limiting our ability to expand our share of
the hearing aid market. This could harm our net sales growth and operating
results.

WE HAVE LIMITED MANUFACTURING EXPERIENCE AND MAY BE UNABLE TO EXPAND OUR
MANUFACTURING CAPABILITIES SUFFICIENTLY OR TO FIND THIRD PARTIES TO MANUFACTURE
OUR PRODUCTS, WHICH WOULD LIMIT OUR ABILITY TO DEVELOP AND DELIVER SUFFICIENT
QUANTITIES OF PRODUCTS IN A TIMELY MANNER

To be successful, we must manufacture our products in commercial quantities in
compliance with regulatory requirements at acceptable costs. We may not be able
to expand our manufacturing capabilities at acceptable costs or enter into
agreements with third parties with respect to these activities. We could incur
significant expenses, particularly as we expand our facilities and hire
additional personnel. We may seek collaborative arrangements with other
companies to manufacture current products or new products.

THIRD PARTIES HAVE CLAIMED AND MAY CLAIM IN THE FUTURE THAT WE ARE INFRINGING
THEIR INTELLECTUAL PROPERTY, AND WE COULD SUFFER SIGNIFICANT EXPENSE OR BE
PREVENTED FROM SELLING PRODUCTS IF THESE CLAIMS ARE SUCCESSFUL

Third parties have claimed and may claim in the future that we are infringing
their intellectual property rights. While we do not believe that any of our
products infringe the proprietary rights of third parties, we may be unaware of
intellectual property rights of others that may cover some of our technology.
Whether or not we actually infringe a third party's rights, any litigation
regarding patents or other intellectual property could be costly and
time-consuming and divert our management and key personnel from our business
operations. Claims of intellectual property infringement might also require us
to enter into costly royalty or license

                                       14

<PAGE>

agreements.

BECAUSE OUR SUCCESS DEPENDS ON OUR PROPRIETARY TECHNOLOGY, IF THIRD PARTIES
INFRINGE OUR INTELLECTUAL PROPERTY, WE MAY BE FORCED TO EXPEND SIGNIFICANT
RESOURCES ENFORCING OUR RIGHTS OR SUFFER COMPETITIVE INJURY

Our success depends in large part on our proprietary technology. We rely on a
combination of patents, copyrights, trademarks, trade secrets, confidentiality
procedures and licensing arrangements to establish and protect our proprietary
technology. If we fail to successfully enforce our intellectual property rights,
our competitive position will suffer.

OUR ENTRY INTO ADDITIONAL DISTRIBUTION CHANNELS COULD HARM OUR RELATIONSHIPS
WITH EXISTING CUSTOMERS AND CAUSE THEM TO PURCHASE FEWER OF OUR PRODUCTS, WHICH
WOULD REDUCE OUR NET SALES AND OPERATING RESULTS

We are currently exploring or testing additional distribution channels, such as
selling our hearing aids through alternative or emerging retail channels. Our
current initiatives or any future expansion of these initiatives could alienate
our traditional hearing care professional customers. It is possible that our
hearing care professional channel will react by reducing or discontinuing their
purchases from us. In such a scenario, the resulting loss of revenue may not be
offset by our revenue from new distribution channels, and we may choose not to
continue using any of these new channels. Should hearing care professionals
react unfavorably to such a strategy, they would likely purchase fewer of our
products, which would reduce our net sales and operating results.

WE ARE DEPENDENT ON INTERNATIONAL SALES AND OPERATIONS, WHICH EXPOSES US TO A
VARIETY OF RISKS THAT COULD RESULT IN LOWER INTERNATIONAL SALES

We anticipate that international sales will continue to account for a material
portion of our sales. Our reliance on international sales and operations exposes
us to related risks and uncertainties which, if realized, could cause our
international sales and operating results to decrease. For example, in order to
market our products in the European Union, we are required to have the EU's CE
mark certification. Any failure to maintain our ISO 9001 certification or CE
mark would significantly reduce our net sales and operating results. In
addition, we face foreign currency risks primarily as a result of the revenues
we receive from sales made outside the United States and from the intercompany
account balance between our U.S., Danish and Australian companies. Fluctuations
in the exchange rates between the U.S. dollar and other currencies could affect
the sales price of our products in international markets where the prices of our
products are denominated in U.S. dollars or lead to currency exchange losses
where the prices of our products are denominated in local currencies.

COMPETITION FOR QUALIFIED PERSONNEL IS INTENSE IN TECHNOLOGY INDUSTRIES SUCH AS
OURS, AND WE MAY NOT BE ABLE TO MAINTAIN OR EXPAND OUR BUSINESS IF WE ARE UNABLE
TO HIRE AND RETAIN SUFFICIENT TECHNICAL, SALES, MARKETING AND MANUFACTURING
PERSONNEL

If we are unable to hire and retain sufficient technical, sales, marketing and
manufacturing personnel our business will suffer. We also must attract qualified
research scientists and engineers in order to continue to develop innovative
products. If we fail to retain and hire a sufficient number and type of
personnel, we will not be able to maintain and expand our business.

WE MAY ENCOUNTER DIFFICULTIES IN MANAGING OUR GROWTH, WHICH COULD ADVERSELY
AFFECT OUR OPERATING RESULTS

We have experienced a period of rapid growth that has placed and may continue to
place a strain on our human and capital resources. If we are unable to manage
this growth effectively, our operating results could suffer.

COMPLICATIONS MAY RESULT FROM HEARING AID USE, AND WE MAY INCUR SIGNIFICANT
EXPENSE IF WE ARE SUED FOR PRODUCT LIABILITY

We may be held liable if any product we develop, or any product that uses or
incorporates any of our technologies, causes injury or is found otherwise
unsuitable. Although we have not experienced any significant product liability
issues to date, product liability is an inherent risk in the production and sale
of hearing aid products. If we are sued for an injury caused by our products,
the resulting liability could result in significant expense, which would harm
our operating results.

IF WE FAIL TO COMPLY WITH FOOD AND DRUG ADMINISTRATION REGULATIONS, WE MAY
SUFFER FINES, INJUNCTIONS OR OTHER PENALTIES

Our products are considered to be medical devices and are, accordingly, subject
to regulation in the United States by the Food and Drug Administration ("FDA"),
which may hamper the timing of our product introductions or subject us to costly
penalties in the event we fail to comply. We must comply with facility
registration and product listing requirements of the FDA and adhere to its
Quality System regulations. Noncompliance with applicable FDA requirements can
result in fines, injunctions, civil penalties, recall or seizure

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of products, total or partial suspension of production or criminal prosecution.

TECHNOLOGY STOCKS HAVE EXPERIENCED EXTREME VOLATILITY, AND OUR STOCK PRICE COULD
BE EXTREMELY VOLATILE. CONSEQUENTLY, YOU MAY NOT BE ABLE TO RESELL YOUR SHARES
AT OR ABOVE THE PRICE YOU PAID FOR THEM

The stock market in general, and technology stocks in particular, have
experienced extreme volatility that has often been unrelated to the operating
performance of particular companies. These broad market fluctuations may
adversely affect the market price of our common stock. Since our initial public
offering, the market price of our common stock has been volatile.

THERE MAY BE SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK BY PRE-INITIAL
PUBLIC OFFERING SHAREHOLDERS, AND THESE SALES COULD CAUSE OUR STOCK PRICE TO
FALL

Sales of substantial amounts of our common stock in the public market, or the
perception that such sales will occur, could adversely affect the market price
of our common stock. Approximately 15.5 million of the approximately 20.0
million shares of our common stock outstanding became available for resale in
the public market upon the expiration of the 180-day IPO lock-up period in
October 2000. Approximately 7.2 million of our outstanding shares continue to be
held by venture capital firms that have not yet distributed their shares to
their limited partners. In addition, some of our officers have adopted trading
plans under SEC Rule 10b5-1 in order to dispose of a portion of their shares in
an orderly manner. Other officers or directors may adopt such a trading plan in
the future.

INSIDERS HAVE SUBSTANTIAL CONTROL OVER US, WHICH COULD DELAY OR PREVENT A CHANGE
IN CONTROL AND MAY NEGATIVELY AFFECT YOUR INVESTMENT

Our officers, directors and their affiliated entities together control a
significant portion of our outstanding common stock. As a result, these
shareholders, if they acted together, would be able to exert a significant
degree of influence over our management and affairs and over matters requiring
shareholder approval, including the election of directors and approval of
significant corporate transactions. In addition, this concentration of ownership
may delay or prevent a change in control, which could cause our stock price to
decline.

PROVISIONS IN OUR CHARTER DOCUMENTS, OUR SHAREHOLDERS RIGHTS PLAN AND DELAWARE
LAW MAY DETER TAKEOVER EFFORTS THAT YOU FEEL WOULD BE BENEFICIAL TO SHAREHOLDER
VALUE

Our certificate of incorporation and bylaws, shareholder rights plan and
Delaware law contain provisions which could make it harder for a third party to
acquire us without the consent of our board of directors. While we believe these
provisions provide for an opportunity to receive a higher bid by requiring
potential acquirers to negotiate with our board of directors, these provisions
apply even if the offer may be considered beneficial by some shareholders and a
takeover bid otherwise favored by a majority of our shareholders might be
rejected by our board of directors.

PART II  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are currently a defendant in a lawsuit filed in October 2000 claiming that we
and certain of our officers violated federal securities laws by providing
materially false and misleading information or concealing information about our
relationship with Starkey Laboratories, Inc. This lawsuit, which is pending in
the U.S. District Court for the District of Utah, is being brought as a class
action on behalf on all purchasers of our common stock from May 2, 2000 to
October 24, 2000 and seeks damages in an unspecified amount. On October 24,
2001, the court held a hearing on our motions to dismiss the entire complaint.
The court granted our motions with leave to amend. Pursuant to the courts order,
the amended complaint is to be filed on December 14, 2001. We deny the
allegations in this action and will defend ourselves vigorously; however,
litigation is inherently uncertain and there can be no assurance that we will
not be materially affected. We anticipate that we will incur associated legal
expenses as a result of this legal proceeding.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On May 5, 2000, we completed the sale of an aggregate of 4,140,000 shares of our
common stock, par value $0.001 per share, at a price of $14.00 per share in a
firm commitment underwritten initial public offering ("IPO"). The IPO was
effected pursuant to a Registration Statement on Form S-1 (Registration No.
333-30566), which the United States Securities and Exchange Commission declared
effective on May 1, 2000. Goldman, Sachs & Co., Deutsche Bank Securities, Inc.
and U.S. Bancorp Piper Jaffray Inc. were the lead underwriters for the offering.

Of the $58.0 million in aggregate proceeds we raised in the IPO, (i) $4.1
million was paid to underwriters in connection with the underwriting commission,
and (ii) approximately $1.7 million was paid in connection with offering
expenses, printing fees, filing fees, and legal and accounting fees. There were
no other direct or indirect payments to directors or officers of Sonic
Innovations or any other person or entity. Through September 30, 2001, $2.7
million of the IPO proceeds were used to purchase property and equipment and
$8.1 million was used to fund working capital increases. The balance has been
invested in investment-grade debt securities and money market instruments. These
funds may be used for general corporate purposes, including funding our
operations; expanding our capacity and business; further development and
commercialization of our products; research and development; repayment of

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remaining capital lease obligations; working capital; and possible acquisitions
or investments. The amounts and timing of our actual expenditures for each of
these purposes may vary significantly depending upon numerous factors, including
customer order levels, the status of our product development efforts,
competition, marketing and sales activities and market acceptance of our
products. Pending use for these or other purposes, we intend to continue to
invest the balance of the IPO proceeds in short-term, investment-grade
securities. Effective upon the closing of the IPO, all previously outstanding
preferred stock and convertible promissory notes converted into common stock.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

None.

(b) Reports on Form 8-K.

None.

                                    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: November 14, 2001              /s/ Stephen L. Wilson
                                     ---------------------
                                     Stephen L. Wilson
                                     Vice President and Chief Financial Officer

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