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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006

or



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

Commission File No. 000-30335



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SONIC INNOVATIONS, INC.

(Exact name
of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 87-0494518                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer 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)



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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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer
and large accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (Check One):

Large accelerated
filer ̈Accelerated filer  x                Non-accelerated filer ̈

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 May 2, 2006, there were 22,186,453 shares of the registrants $0.001 par value
common stock outstanding.



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##### Table of Contents

SONIC INNOVATIONS, INC.

TABLE OF CONTENTS



|                              |  |                                                                                                    |  |     
|----------------------------- |  | -------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                    |  | Page
|                              | 
|PART I. FINANCIAL INFORMATION |  |                                                                                                   
|                              |  |                                                                                                   
|ITEM 1.                       |  | Condensed Consolidated Financial Statements (Unaudited):                                           |  |     
|                              |  |                                                                                                   
|                              |  | Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005                   |  | 3   
|                              |  |                                                                                                   
|                              |  | Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005 |  | 4   
|                              |  |                                                                                                   
|                              |  | Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005 |  | 5   
|                              |  |                                                                                                   
|                              |  | Notes to Condensed Consolidated Financial Statements                                               |  | 6   
|                              |  |                                                                                                   
|ITEM 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations              |  | 12  
|                              |  |                                                                                                   
|ITEM 3.                       |  | Quantitative and Qualitative Disclosures about Market Risks                                        |  | 18  
|                              |  |                                                                                                   
|ITEM 4.                       |  | Controls and Procedures                                                                            |  | 18  
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                   
|                              |  |                                                                                                   
|ITEM 1.                       |  | Legal Proceedings                                                                                  |  | 19  
|                              |  |                                                                                                   
|ITEM 1A.                      |  | Risk Factors                                                                                       |  | 19  
|                              |  |                                                                                                   
|ITEM 6.                       |  | Exhibits                                                                                           |  | 20  
|                              | 
|SIGNATURE                     |  | 21                                                                                                
|                              | 
|CERTIFICATIONS                |  |                                                                                                   



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|ITEM 1. | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
|------- | -------------------------------------------------------

SONIC INNOVATIONS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)



|                                                                                                |  |                |         |   |                   |   |         |  
|----------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                |  | March 31, 2006 |         |   | December 31, 2005 |  
|ASSETS                                                                                          |  |                |         |   |                   |   |         |  
|Current assets:                                                                                 |  |                |         |   |                   |   |         |  
|Cash and cash equivalents                                                                       |  | $              | 8,770   |   |                   | $ | 7,865   |  
|Restricted cash, cash equivalents and marketable securities                                     |  |                | 7,461   |   |                   |   | 8,384   |  
|Accounts receivable, net of allowance for doubtful accounts of $1,112 and $1,605                |  |                | 16,297  |   |                   |   | 14,870  |  
|Inventories                                                                                     |  |                | 10,024  |   |                   |   | 10,234  |  
|Prepaid expenses and other                                                                      |  |                | 2,114   |   |                   |   | 2,168   |  
|                                                                                                |  |                |         |   |                   |   |         |  
|Total current assets                                                                            |  |                | 44,666  |   |                   |   | 43,521  |  
|Property and equipment, net of accumulated depreciation and amortization of $16,872 and $15,962 |  |                | 8,248   |   |                   |   | 8,772   |  
|Goodwill and indefinite-lived intangible assets                                                 |  |                | 29,712  |   |                   |   | 29,514  |  
|Definite-lived intangible assets, net                                                           |  |                | 4,114   |   |                   |   | 4,311   |  
|Other assets                                                                                    |  |                | 1,126   |   |                   |   | 646     |  
|                                                                                                |  |                |         |   |                   |   |         |  
|Total assets                                                                                    |  | $              | 87,866  |   |                   | $ | 86,764  |  
|                                                                                                |  |                |         |   |                   |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                            |  |                |         |   |                   |   |         |  
|Current liabilities:                                                                            |  |                |         |   |                   |   |         |  
|Current portion of long-term loan                                                               |  | $              | 1,207   |   |                   | $ | 1,184   |  
|Payable to former owners of acquired business                                                   |  |                | 2,224   |   |                   |   | 1,843   |  
|Accounts payable                                                                                |  |                | 7,309   |   |                   |   | 7,346   |  
|Accrued payroll and related expenses                                                            |  |                | 3,972   |   |                   |   | 3,221   |  
|Accrued restructuring                                                                           |  |                | 1,763   |   |                   |   | 2,557   |  
|Accrued warranty                                                                                |  |                | 5,264   |   |                   |   | 4,922   |  
|Deferred revenue                                                                                |  |                | 3,273   |   |                   |   | 3,288   |  
|Other accrued liabilities                                                                       |  |                | 4,363   |   |                   |   | 3,283   |  
|                                                                                                |  |                |         |   |                   |   |         |  
|Total current liabilities                                                                       |  |                | 29,375  |   |                   |   | 27,644  |  
|Long-term loan, net of current portion                                                          |  |                | 4,830   |   |                   |   | 5,033   |  
|Deferred revenue, net of current portion                                                        |  |                | 3,963   |   |                   |   | 3,969   |  
|Other liabilities                                                                               |  |                | 520     |   |                   |   | 347     |  
|                                                                                                |  |                |         |   |                   |   |         |  
|Total liabilities                                                                               |  |                | 38,688  |   |                   |   | 36,993  |  
|Shareholders equity:                                                                           |  |                |         |   |                   |   |         |  
|Common stock                                                                                    |  |                | 23      |   |                   |   | 22      |  
|Additional paid-in capital                                                                      |  |                | 120,125 |   |                   |   | 120,578 |  
|Deferred stock-based compensation                                                               |  |                |        |   |                   |   | (1,270  | )
|Accumulated deficit                                                                             |  |                | (71,984 | ) |                   |   | (70,405 | )
|Accumulated other comprehensive income                                                          |  |                | 4,787   |   |                   |   | 4,619   |  
|Treasury stock, at cost                                                                         |  |                | (3,773  | ) |                   |   | (3,773  | )
|                                                                                                |  |                |         |   |                   |   |         |  
|Total shareholders equity                                                                      |  |                | 49,178  |   |                   |   | 49,771  |  
|                                                                                                |  |                |         |   |                   |   |         |  
|Total liabilities and shareholders equity                                                      |  | $              | 87,866  |   |                   | $ | 86,764  |  
|                                                                                                |  |                |         |   |                   |   |         |  

See accompanying notes to condensed consolidated financial statements.



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SONIC INNOVATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                       |  |                             |        |   |      |   |        |  
|---------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                       |  | Three months endedMarch 31, |       
|                                                                       |  | 2006                        |        |   | 2005 |  
|Net sales                                                              |  | $                           | 25,882 |   |      | $ | 25,891 |  
|Cost of sales                                                          |  |                             | 11,599 |   |      |   | 12,034 |  
|                                                                       |  |                             |        |   |      |   |        |  
|Gross profit                                                           |  |                             | 14,283 |   |      |   | 13,857 |  
|Selling, general and administrative expense                            |  |                             | 13,319 |   |      |   | 14,854 |  
|Research and development expense                                       |  |                             | 2,059  |   |      |   | 2,352  |  
|Asset impairment charge                                                |  |                             | 381    |   |      |   |       |  
|                                                                       |  |                             |        |   |      |   |        |  
|Operating loss                                                         |  |                             | (1,476 | ) |      |   | (3,349 | )
|Other income (expense), net                                            |  |                             | 69     |   |      |   | (40    | )
|                                                                       |  |                             |        |   |      |   |        |  
|Loss before income taxes                                               |  |                             | (1,407 | ) |      |   | (3,389 | )
|Provision for income taxes                                             |  |                             | 172    |   |      |   | 88     |  
|                                                                       |  |                             |        |   |      |   |        |  
|Net loss                                                               |  | $                           | (1,579 | ) |      | $ | (3,477 | )
|                                                                       |  |                             |        |   |      |   |        |  
|Basic and diluted loss per common share                                |  | $                           | (0.07  | ) |      | $ | (0.16  | )
|                                                                       |  |                             |        |   |      |   |        |  
|Basic and diluted weighted average number of common shares outstanding |  |                             | 21,850 |   |      |   | 21,215 |  
|                                                                       |  |                             |        |   |      |   |        |  

See accompanying notes to condensed consolidated financial statements.



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SONIC INNOVATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                                                   |  |                              |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------ |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                                                   |  | Three months ended March 31, |       
|                                                                                                                   |  | 2006                         |        |   | 2005 |  
|Cash flows from operating activities:                                                                              |  |                              |        |   |      |   |        |  
|Net loss                                                                                                           |  | $                            | (1,579 | ) |      | $ | (3,477 | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities:                          |  |                              |        |   |      |   |        |  
|Depreciation and amortization                                                                                      |  |                              | 1,213  |   |      |   | 1,328  |  
|Stock-based compensation expense                                                                                   |  |                              | 245    |   |      |   | 64     |  
|Foreign currency losses                                                                                            |  |                              | 23     |   |      |   | 151    |  
|Asset impairment charge                                                                                            |  |                              | 381    |   |      |   |       |  
|Changes in assets and liabilities:                                                                                 |  |                              |        |   |      |   |        |  
|Accounts receivable                                                                                                |  |                              | (1,293 | ) |      |   | (66    | )
|Inventories                                                                                                        |  |                              | 234    |   |      |   | (1,670 | )
|Prepaid expenses and other                                                                                         |  |                              | 269    |   |      |   | (728   | )
|Other assets                                                                                                       |  |                              | (76    | ) |      |   | (222   | )
|Accounts payable, accrued liabilities and deferred revenue                                                         |  |                              | 1,431  |   |      |   | 1,045  |  
|                                                                                                                   |  |                              |        |   |      |   |        |  
|Net cash provided by (used in) operating activities                                                                |  |                              | 848    |   |      |   | (3,575 | )
|Cash flows from investing activities:                                                                              |  |                              |        |   |      |   |        |  
|Payments related to acquisitions                                                                                   |  |                              |       |   |      |   | (677   | )
|Purchases of property and equipment                                                                                |  |                              | (520   | ) |      |   | (807   | )
|Investments and advances, net                                                                                      |  |                              | (619   | ) |      |   | 148    |  
|Proceeds from maturities of marketable securities                                                                  |  |                              |       |   |      |   | 717    |  
|                                                                                                                   |  |                              |        |   |      |   |        |  
|Net cash used in investing activities                                                                              |  |                              | (1,139 | ) |      |   | (619   | )
|Cash flows from financing activities:                                                                              |  |                              |        |   |      |   |        |  
|Principal payments on long-term loan                                                                               |  |                              | (300   | ) |      |   | (329   | )
|Decrease in restricted cash, cash equivalents and marketable securities, net                                       |  |                              | 923    |   |      |   | 946    |  
|Proceeds from pre-acquisition receivables payable to former owners of acquired business, net of payments and taxes |  |                              |       |   |      |   | 3,027  |  
|Proceeds from exercise of stock options and employee stock purchases                                               |  |                              | 573    |   |      |   | 20     |  
|                                                                                                                   |  |                              |        |   |      |   |        |  
|Net cash provided by financing activities                                                                          |  |                              | 1,196  |   |      |   | 3,664  |  
|Effect of exchange rate changes on cash and cash equivalents                                                       |  |                              |       |   |      |   | (186   | )
|                                                                                                                   |  |                              |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                                               |  |                              | 905    |   |      |   | (716   | )
|Cash and cash equivalents, beginning of the period                                                                 |  |                              | 7,865  |   |      |   | 8,221  |  
|                                                                                                                   |  |                              |        |   |      |   |        |  
|Cash and cash equivalents, end of the period                                                                       |  | $                            | 8,770  |   |      | $ | 7,505  |  
|                                                                                                                   |  |                              |        |   |      |   |        |  
|Supplemental cash flow information:                                                                                |  |                              |        |   |      |   |        |  
|Cash paid for interest                                                                                             |  | $                            | 66     |   |      | $ | 62     |  
|Cash paid (refunded) for income taxes                                                                              |  |                              | (12    | ) |      |   | 427    |  

See accompanying notes to condensed consolidated financial statements.



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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 months ended March 31, 2006 are not necessarily indicative of results that may be expected for the
full year ending December 31, 2006. 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, 2005 as filed with
the Securities and Exchange Commission.

Principles of Consolidation.The consolidated financial statements include the accounts of Sonic
Innovations, Inc. and its wholly owned subsidiaries. All 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, long-lived asset impairment, warranty accruals, legal contingency accruals, stock-based compensation and deferred income tax asset valuation allowances. Actual results could
differ from those estimates.

Revenue Recognition and Concentrations of Credit Risk.Sales of hearing aids are recognized when (i) products are
shipped, except for hearing aid retail 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 and
determinable, (v) contractual obligations have been satisfied, and (vi) collectibility is reasonably assured. The Company applies the provisions of Statement of Position (SOP) 97-02, Software Revenue Recognition, as
amended by SOP 98-09 to its auditory testing equipment operating segment. SOP 97-02, as amended, generally requires revenue earned on software arrangements involving multiple elements to be split between the elements such as software products and
technical support. The fair value of an element must be based on vendor-specific objective evidence, which the Company establishes based on the price charged when the same element is sold separately. Revenues related to sales of separately priced
extended service contracts are deferred and recognized on a straight-line basis over the contractual periods. Net sales consist of product sales less provisions for sales returns, which are made at the time of sale. The Company generally has a
60-day return policy for 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 March 31, |       
|                             |  | 2006                         |        |   | 2005 |  
|Balance, beginning of period |  | $                            | 3,468  |   |      | $ | 2,815  |  
|Provisions                   |  |                              | 3,737  |   |      |   | 2,775  |  
|Returns processed            |  |                              | (2,333 | ) |      |   | (2,732 | )
|                             |  |                              |        |   |      |   |        |  
|Balance, end of period       |  | $                            | 4,872  |   |      | $ | 2,858  |  
|                             |  |                              |        |   |      |   |        |  

Warranty Costs.The Company provides for the cost of remaking and repairing products under warranty at the
time of sale. These costs are included in cost of sales. When evaluating the adequacy of the warranty accrual, 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.



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Accrued warranty costs were as follows:



|                             |  |                              |        |   |      |   |        |  
|---------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                             |  | Three months ended March 31, |       
|                             |  | 2006                         |        |   | 2005 |  
|Balance, beginning of period |  | $                            | 4,922  |   |      | $ | 4,526  |  
|Provisions                   |  |                              | 1,412  |   |      |   | 994    |  
|Costs incurred               |  |                              | (1,070 | ) |      |   | (1,220 | )
|                             |  |                              |        |   |      |   |        |  
|Balance, end of period       |  | $                            | 5,264  |   |      | $ | 4,300  |  
|                             |  |                              |        |   |      |   |        |  

Marketable Securities.The Company designates the classification of its marketable securities at the time
of purchase and re-evaluates this designation as of each balance sheet date. As of March 31, 2006 and December 31, 2005, marketable securities consisted of U.S. government obligations classified as held-to-maturity and were presented at
amortized cost, which approximated market value. The amortized cost of U.S. government obligations is adjusted for amortization of premiums and accretion of discounts to maturity. A decline in the market value below cost that is deemed other than
temporary is charged to operations resulting in the establishment of a new cost basis. For the three months ended March 31, 2006 and 2005, the Company did not experience any declines in market value which were deemed other than temporary.

Inventories.Inventories are stated at the lower of cost or market using the first-in, first-out method. Material, labor and manufacturing overhead
is included 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 operations that sell on a retail
basis and recognize a sale only upon acceptance by the consumer. Inventories consisted of the following:



|                             |  |                |        |                   |   |       
|---------------------------- |  | -------------- | ------ | ----------------- | - | ------
|                             |  | March 31, 2006 |        | December 31, 2005
|Raw materials and components |  | $              | 5,735  |                   | $ | 6,029 
|Work in progress             |  |                | 178    |                   |   | 101   
|Finished goods               |  |                | 4,111  |                   |   | 4,104 
|                             |  |                |        |                   |   |       
|Total                        |  | $              | 10,024 |                   | $ | 10,234
|                             |  |                |        |                   |   |       

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.



|                                         |  |                              |        |   |      |   |        |  
|---------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                         |  | Three months ended March 31, |       
|                                         |  | 2006                         |        |   | 2005 |  
|Net loss                                 |  | $                            | (1,579 | ) |      | $ | (3,477 | )
|Foreign currency translation adjustments |  |                              | 168    |   |      |   | (1,118 | )
|                                         |  |                              |        |   |      |   |        |  
|Comprehensive loss                       |  | $                            | (1,411 | ) |      | $ | (4,595 | )
|                                         |  |                              |        |   |      |   |        |  

Stock-Based Compensation.Effective January 1, 2006, the Company adopted the provisions of Financial
Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. SFAS No. 123R sets accounting requirements for share-based compensation to
employees and requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation. The effect of the adoption of SFAS No. 123R was to increase the loss before income taxes and
net loss by $86 and had no impact on basic and diluted loss per common share for the three months ended March 31, 2006.

The Companys 2000 Stock Plan
provides for the issuance of a maximum of 9,786,670 shares of common stock and contains an evergreen provision that allows the Board of Directors to annually increase the number of shares available by the lesser of (i) 5% of the total
outstanding shares, (ii) 789,474 shares, or (iii) a lesser amount as determined by the Board. As of March 31, 2006, there were 2,554,044 shares available for grant under the plan. The plan allows for the grant of incentive or
unqualified stock options, stock purchase rights and restricted stock and is administered by the Board who determines the type, quantity, terms and conditions of any award, including any vesting conditions. Restricted stock and stock options
generally vest ratably over a four year service period, and stock options expire ten years from the date of grant. The exercise price of stock options granted is equivalent to the fair market value of the stock at the date of grant. The Company also
has an Employee Stock Purchase Plan under which shares of common stock may be purchased by eligible employees. Shares purchased under the Employee Stock Purchase Plan were temporarily suspended by the Board in December 2005.



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Under SFAS No. 123R, the fair value of each stock option grant is estimated on the grant date using the
Black-Scholes option-pricing model. Expected option lives and volatilities used in fair valuation calculations are based on historical data of the Company and the related expense is recognized on a straight-line basis over the vesting period. The
Company did not issue any stock options in the three months ended March 31, 2006. The fair value of options issued in 2005 were estimated on the date of grant based on a risk free rate of return of 3.8%, an expected dividend yield of 0.0%,
volatility of 74% and an expected life of 5 years. A summary of stock option activity for the three months ended March 31, 2006 is as follows:



|                                            |  |                 |   |  |                              |      |                                                 |      |                                  |   |      
|------------------------------------------- |  | --------------- | - |  | ---------------------------- | ---- | ----------------------------------------------- | ---- | -------------------------------- | - | -----
|                                            |  | Number ofshares |   |  | Weightedaverageexerciseprice |      | Weightedaverageremainingcontractualterm (years) |      | Aggregateintrinsicvalue ($000s)
|Options outstanding as of December 31, 2005 |  | 4,638,783       |   |  | $                            | 4.64 |                                                 |      |                                  |   |      
|Plus: Options granted                       |  |                |   |  |                              |     |                                                 |      |                                  |   |      
|Less:                                       |  |                 |   |  |                              |      |                                                 |      |                                  |   |      
|Options exercised                           |  | (211,067        | ) |  |                              | 3.22 |                                                 |      |                                  |   |      
|Options canceled or expired                 |  | (501,372        | ) |  |                              | 5.90 |                                                 |      |                                  |   |      
|                                            |  |                 |   |  |                              |      |                                                 |      |                                  |   |      
|Options outstanding as of March 31, 2006    |  | 3,926,344       |   |  |                              | 4.56 |                                                 | 6.18 |                                  | $ | 4,124
|                                            |  |                 |   |  |                              |      |                                                 |      |                                  |   |      
|Options exercisable as of March 31, 2006    |  | 3,482,455       |   |  |                              | 4.70 |                                                 | 5.84 |                                  |   | 3,452
|                                            |  |                 |   |  |                              |      |                                                 |      |                                  |   |      

Share-based compensation expense pertaining to stock options of $94 for the three months ended March 31, 2006
was recorded in cost of sales and operating expenses. As of March 31, 2006, there was $768 of unrecognized share-based compensation expense related to options that will be recognized over a weighted-average period of 1.7 years. An annual
forfeiture rate of 4.9%, as determined using historical data, was utilized in calculating stock option expense.

Restricted stock is issued on the date of
grant and entitles the holders to dividends and the right to vote their shares. A summary of restricted stock activity for the three months ended March 31, 2006 was as follows:



|                                     |  |                 |   |  |                                      |     
|------------------------------------ |  | --------------- | - |  | ------------------------------------ | ----
|                                     |  | Number ofshares |   |  | Weightedaverage grantdate fair value
|Unvested as of December 31, 2005     |  | 357,700         |   |  | $                                    | 4.54
|Plus: Awards granted                 |  | 160,000         |   |  |                                      | 4.30
|Less:                                |  |                 |   |  |                                      |     
|Awards vested                        |  | (59,500         | ) |  |                                      | 4.74
|Awards canceled or expired           |  | (33,000         | ) |  |                                      | 4.64
|                                     |  |                 |   |  |                                      |     
|Awards unvested as of March 31, 2006 |  | 425,200         |   |  |                                      | 4.41
|                                     |  |                 |   |  |                                      |     

Share-based compensation expense pertaining to restricted stock of $151 for the three months ended March 31,
2006 was recorded in cost of sales and operating expenses. The fair market value of restricted stock on the date of grant is amortized to expense evenly over the restriction period. An annual forfeiture rate of 4.9%, as determined using historical
data, was utilized in calculating restricted stock expense. As of March 31, 2006, there was $1,602 of unrecognized stock-based compensation expense related to unvested restricted stock that will be recognized over a weighted average period of
2.0 years. The fair value of shares vested in the three months ended March 31, 2006 was $1,469.

Share-based awards granted prior to the
Companys adoption of SFAS No. 123R were accounted for under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations.
Accordingly, no stock-based compensation expense was reflected in the statement of operations for the three months ended March 31, 2005, as all options granted under the Companys stock plans had exercise prices equal to the market value
of the underlying common stock on the date of grant. In anticipation of adopting SFAS No. 123R, the Company accelerated the vesting of certain unvested stock options in December 2004. The remaining unvested options as of December 2004 and
options granted in 2005 were valued using the valuation principles of SFAS No. 123 Accounting For Stock-Based Compensation.



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The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123R to stock-based compensation for periods presented prior to the Companys adoption of SFAS No. 123R:



|                                                                                |  |                                  |        |  
|------------------------------------------------------------------------------- |  | -------------------------------- | ------ | -
|                                                                                |  | Three months endedMarch 31, 2005 |       
|Net loss as reported                                                            |  | $                                | (3,477 | )
|Add: Stock-based compensation included in reported net loss                     |  |                                  | 64     |  
|Deduct: Stock-based compensation expense determined under the fair value method |  |                                  | (370   | )
|                                                                                |  |                                  |        |  
|Pro forma net loss                                                              |  | $                                | (3,783 | )
|                                                                                |  |                                  |        |  
|Basic and diluted loss per common share as reported                             |  | $                                | (0.16  | )
|                                                                                |  |                                  |        |  
|Pro forma basic and diluted loss per common share                               |  | $                                | (0.18  | )
|                                                                                |  |                                  |        |  

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 earnings 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 equivalents of 4,823,975 and 4,871,392 for the three months ended March 31, 2006 and 2005, respectively were
excluded from the diluted loss per share calculations.

New Accounting Pronouncements.In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections, which replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and requires that a
voluntary change in accounting principle be applied retrospectively to all prior period financial statements presented, unless it is impracticable to do so. SFAS No. 154 also provides that a change in method of depreciating or amortizing a
long-lived non-financial asset be accounted for as a change in estimate affected by a change in accounting principle, and that a correction of an error in previously issued financial statements be termed a restatement. SFAS No. 154
is effective for fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material effect on the Companys results of operations and financial position.

In November 2005, the FASB issued FASB Staff Position No. FAS 115-1 The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments
(FAS 151-1), which provides accounting guidance for determining and measuring other-than-temporary impairments of debt and equity securities, and confirms the disclosure requirements for investments in unrealized loss positions as
outlined in Emerging Issues Task Force Issue No. 03-01, The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments. The adoption of FAS 115-1 did not have a material effect on the Companys
results of operations and financial position.

In the first quarter 2006, there were no accounting standards issued that would have a material effect on
the Companys results of operations and financial position.

2. ACQUISITIONS

In connection with the Companys December 2004 acquisition of its auditory testing equipment business (Tympany), additional contingent consideration in the form of an earn-out will be paid based on the following
schedule: 2006  35% of net 2006 Tympany revenue, plus 10% of net 2006 hearing aid sales less 105% of a base amount; and 2007  20% of the lesser of 2007 or 2006 net Tympany revenue, plus 35% of any excess of 2007 net Tympany revenue over
2006 net Tympany revenue, plus 10% of net 2007 hearing aid sales less 110% of a base amount. Payment will be made in a combination of cash (60%) and Company common stock (40%). As of March 31, 2006, $2,224 pertaining to payments due
the former shareholders of Tympany was accrued. The amount payable is currently in dispute with the former owners of Tympany and is expected to be resolved in 2006. As a result of an asset impairment charge taken on this business in the third
quarter 2005, the Company will be expensing these earn-out amounts until such time as the expected cash flows from the business will support additional valuation. If that were to occur, the Company would capitalize these earn-out amounts as
additional purchase price.

In connection with the Companys May 2003 acquisition of its Germany-based business (Sanomed), additional
contingent consideration may be payable based on achievement of targeted net sales for the one year period ending May 31, 2006. The Company is required to remit to the former owners of Sanomed any money collected on certain accounts receivable
that were deemed uncollectible prior to the acquisition, and this amount is currently in dispute (see Note 5).



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3. INTANGIBLE ASSETS

Changes in goodwill and indefinite-lived intangible assets for the three months ended March 31, 2006 were as follows:



|                                                 |  |   |       
|------------------------------------------------ |  | - | ------
|Balance, beginning of period                     |  | $ | 29,514
|Effect of foreign currency exchange rate changes |  |   | 198   
|                                                 |  |   |       
|Balance, end of period                           |  | $ | 29,712
|                                                 |  |   |       

Definite-lived intangible assets were as follows:



|                                  |  |                       |  |                          |       |                       |   |                          |  |   |       |  |   |      
|--------------------------------- |  | --------------------- |  | ------------------------ | ----- | --------------------- | - | ------------------------ |  | - | ----- |  | - | -----
|                                  |  | Useful Lives          |  | March 31, 2006           |       | December 31, 2005    
|                                  |  | Gross Carrying Amount |  | Accumulated Amortization |       | Gross Carrying Amount |   | Accumulated Amortization
|Purchased technology and licenses |  | 3-13 years            |  | $                        | 3,066 |                       | $ | 1,174                    |  | $ | 3,066 |  | $ | 1,068
|Brand names                       |  | 3-15 years            |  |                          | 2,828 |                       |   | 968                      |  |   | 2,787 |  |   | 887  
|Non-compete agreements            |  | 5 years               |  |                          | 411   |                       |   | 244                      |  |   | 403   |  |   | 210  
|Customer databases                |  | 2-5 years             |  |                          | 330   |                       |   | 212                      |  |   | 326   |  |   | 196  
|Distribution agreements           |  | 2-5 years             |  |                          | 317   |                       |   | 292                      |  |   | 310   |  |   | 284  
|Software and other intangibles    |  | 1-5 years             |  |                          | 222   |                       |   | 170                      |  |   | 222   |  |   | 158  
|                                  |  |                       |  |                          |       |                       |   |                          |  |   |       |  |   |      
|Total                             |  |                       |  | $                        | 7,174 |                       | $ | 3,060                    |  | $ | 7,114 |  | $ | 2,803
|                                  |  |                       |  |                          |       |                       |   |                          |  |   |       |  |   |      

4. LONG-TERM LOAN

The Company obtained a loan from a German bank in 2003 to fund the acquisition of Sanomed. As of March 31, 2006, the balance of the loan was 5,000 Euro ($6,037). The interest rate applicable to the loan is 1.0% above the EURIBOR rate
(3.42% as of March 31, 2006). The loan is collateralized by a letter of credit from a U.S. bank, and the Company pledged certain amounts of its cash, cash equivalents and marketable securities as security to obtain a reduced interest rate of
0.6% on this letter of credit. The loan payments are 250 Euro ($302 as of March 31, 2006) per quarter. The effective interest rates on this loan for the three months ended March 31, 2006 and 2005 were 4.16% and 3.91%, respectively.

5. LEGAL PROCEEDINGS

In June 2005, Energy
Transportation Group, Inc. (ETG) filed a patent infringement lawsuit in the United States District Court for the District of Delaware against fourteen defendants, including the Company. ETG claims the defendants have infringed upon U.S.
Patent No. 4,731,850 entitled Programmable Digital Hearing Aid System and U.S. Patent No. 4,879,749 entitled Host Controller for Programmable Digital Hearing Aid System. ETG is seeking damages resulting from
defendants unauthorized manufacture, use, sale, offer to sell and/or importation into the U.S. products, methods, processes, services and/or systems that infringe the above-named patents. The Company has filed its answer denying all
allegations. Discovery has not begun and no trial date has been set.

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 that were deemed uncollectible prior to the acquisition, but which have been collected and are due the former
owners, were improper. The former owners seek damages in the amount of approximately $1,600. The Company filed its statement of defense in April 2006 and oral arguments are expected to occur by June 2006. In addition, as part of the Sanomed purchase
contract, the former owners were entitled to earn-out payments based on the achievement of certain revenue milestones. In certain circumstances, the former owners are entitled to these earn-outs irrespective of the achievement of the revenue
milestones. One former owner has filed suit against the Company claiming that he was wrongfully terminated and is therefore entitled to his full remaining earn-out of approximately $560.

The Company strongly denies the allegations contained in the ETG and the Sanomed lawsuits 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 liabilities when a particular contingency is probable and estimable. For contingencies noted above, the Company has accrued amounts considered probable and estimable.

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 itself. 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



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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.

6. SEGMENT INFORMATION

The Company is a hearing healthcare company that designs, develops, manufactures and markets advanced digital hearing aids and proprietary auditory testing equipment. The
Company has four operating segments for which separate information is available and evaluated regularly by management in deciding how to allocate resources and assess performance. The Company evaluates performance based on net sales and
operating profit, among other things.

The Companys four operating segments include hearing aid operations in North America, Europe and Rest-of World
and an auditory testing equipment operation. Inter-segment sales are eliminated in consolidation. 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 hearing aid research and development expenses to its hearing aid business segments. In 2005, the Company determined that the auditory testing equipment operation constituted a separate segment under SFAS
No. 131, Disclosures about Segments of an Enterprise and Related Information, and has revised the segment information for prior periods to conform to the current period presentation.



|                                                |  |                        |        |   |                            |   |               |             |   |        |       |  |   |        |   |  |   |        |   |  |   |        |  
|----------------------------------------------- |  | ---------------------- | ------ | - | -------------------------- | - | ------------- | ----------- | - | ------ | ----- |  | - | ------ | - |  | - | ------ | - |  | - | ------ | -
|                                                |  | Hearing Aid operations |        |   | Auditory Testing Equipment |   |               | Unallocated |   |        | Total | 
|                                                |  | North America          |        |   | Europe                     |   | Rest-of-world |             |   |        |      
|Three months ended March 31, 2006               |  |                        |        |   |                            |   |               |             |   |        |       |  |   |        |   |  |   |        |   |  |   |        |  
|Net sales to external customers                 |  | $                      | 10,275 |   |                            | $ | 9,855         |             | $ | 4,662  |       |  | $ | 1,090  |   |  | $ |       |   |  | $ | 25,882 |  
|Operating profit (loss)                         |  |                        | (1,019 | ) |                            |   | 1,520         |             |   | 541    |       |  |   | (753   | ) |  |   | (1,765 | ) |  |   | (1,476 | )
|Three months ended March 31, 2005               |  |                        |        |   |                            |   |               |             |   |        |       |  |   |        |   |  |   |        |   |  |   |        |  
|Net sales to external customers                 |  |                        | 7,737  |   |                            |   | 12,278        |             |   | 4,019  |       |  |   | 1,857  |   |  |   |       |   |  |   | 25,891 |  
|Operating profit (loss)                         |  |                        | (1,855 | ) |                            |   | 2,109         |             |   | (50    | )     |  |   | (1,400 | ) |  |   | (2,153 | ) |  |   | (3,349 | )
|As of March 31, 2006                            |  |                        |        |   |                            |   |               |             |   |        |       |  |   |        |   |  |   |        |   |  |   |        |  
|Identifiable segment assets                     |  |                        | 33,058 |   |                            |   | 37,459        |             |   | 14,121 |       |  |   | 3,228  |   |  |   |       |   |  |   | 87,866 |  
|Goodwill and indefinite-lived intangible assets |  |                        | 2,235  |   |                            |   | 20,420        |             |   | 7,057  |       |  |   |       |   |  |   |       |   |  |   | 29,712 |  
|Long-lived assets                               |  |                        | 6,901  |   |                            |   | 23,335        |             |   | 9,867  |       |  |   | 1,971  |   |  |   |       |   |  |   | 42,074 |  
|As of December 31, 2005                         |  |                        |        |   |                            |   |               |             |   |        |       |  |   |        |   |  |   |        |   |  |   |        |  
|Identifiable segment assets                     |  |                        | 31,771 |   |                            |   | 37,694        |             |   | 13,312 |       |  |   | 3,987  |   |  |   |       |   |  |   | 86,764 |  
|Goodwill and indefinite-lived intangible assets |  |                        | 2,238  |   |                            |   | 20,031        |             |   | 7,245  |       |  |   |       |   |  |   |       |   |  |   | 29,514 |  
|Long-lived assets                               |  |                        | 7,294  |   |                            |   | 23,000        |             |   | 10,078 |       |  |   | 2,225  |   |  |   |       |   |  |   | 42,597 |  

Long-lived assets consist of property and equipment, definite-lived and indefinite-lived intangible assets, and
goodwill. In addition to the U.S., the Company operates in two countries, Germany and Australia, in which assets and net sales were in excess of 10% of consolidated amounts.

7. ACCRUED RESTRUCTURING

In 2005, the Company took actions to improve its profitability, including reducing the size
of the management team, restructuring certain operations and eliminating excess facilities, which resulted in the termination of 37 employees. In the third quarter 2005, the Company recorded a restructuring charge of $1,186 mainly related to
termination of the management of Tympany and elimination of excess facilities. In the fourth quarter 2005, the Company recorded a restructuring charge of $2,805 mainly related to executive severance packages and employee terminations. Accrued
restructuring activity for the three months ended March 31, 2006 consisted of the following:



|                           |  |                  |       |   |                   |   |      |       |  |   |       |  
|-------------------------- |  | ---------------- | ----- | - | ----------------- | - | ---- | ----- |  | - | ----- | -
|                           |  | Employee Related |       |   | Excess Facilities |   |      | Total | 
|Balance, December 31, 2005 |  | $                | 2,263 |   |                   | $ | 294  |       |  | $ | 2,557 |  
|Payments                   |  |                  | (682  | ) |                   |   | (112 | )     |  |   | (794  | )
|                           |  |                  |       |   |                   |   |      |       |  |   |       |  
|Balance, March 31, 2006    |  | $                | 1,581 |   |                   | $ | 182  |       |  | $ | 1,763 |  
|                           |  |                  |       |   |                   |   |      |       |  |   |       |  



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

The following discussion contains forward-looking statements that involve risks and uncertainties. These statements refer to our future results, plans,
objectives, expectations and intentions including statements regarding: our mission to improve the quality of life of the hearing impaired; negative factors impacting hearing aid market growth rates today to decrease in importance in the future;
hearing aid prices decreasing in the future; hearing aids becoming smaller, less conspicuous and more comfortable through improvements in technology; more people who could benefit from hearing aids actually buying hearing aids in the future;
significant growth of the hearing impaired population, particularly as the developed worlds population ages; the market for hearing aids increasing significantly; developing the Innova platform technology into a broad product line of
full-featured hearing aids; Ion providing a significant opportunity to increase net sales; Tympanys unit sales and financial performance improving; improved profitability in each country in which we have a direct operation; sales of Ion being
largely incremental; Ion being particularly helpful for first time hearing aid wearers; Ion being smaller, lighter and more powerful than competing open-ear products; becoming more customer-centric; to be the hearing healthcare provider of choice;
European sales improving beginning in the second quarter 2006 due to the introduction of Ion; changes in management and sales structure in several European countries resulting in improved performance through 2006; the introduction of Natura Pro late
in the second quarter 2006; improving our overall average selling price and positively affecting our gross margin by introducing new products on a periodic basis; unit volume increasing and resulting in better overhead absorption because little
incremental overhead will be required to support increased volume; gross margin improvement throughout 2006 depending on overhead absorption, purchased component and assembly costs, sales return rates and degree of off-shore outsourcing; increased
net sales and decreased selling, general and administrative expense resulting in selling, general and administrative expense decreasing as a percentage of net sales beginning in the second quarter 2006; research and development expense increasing in
2006 in support of new product introductions; introduction of new products this year; expensing of Tympany earn-out payments until expected cash flows support additional valuation, at which time earn-out payments would be capitalized; other
income/expense being relatively minimal per quarter in 2006; financial instrument and customer credit risks; settlement payments; and sufficiency of cash to fund our operations in 2006. 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 following
risks: we have a history of losses and negative cash flow; we face aggressive competition in our business, mainly from six substantially larger competitors; our financial results and stock price have fluctuated in the past and may fluctuate in the
future; acquisitions could be difficult to integrate, disrupt our business, result in litigation, dilute the equity of our shareholders and subject us to amortization expense and/or write-down of intangible assets; our internal control over
financial reporting may not be considered effective; we may lose a large customer or suffer a reduction in orders from a large customer and may be unable to collect significant receivable balances; we rely on several suppliers and contractors who
may be unwilling or unable to meet our product, service or contracting requirements; we have high rates of returns, remakes and repairs; we must have innovative, technologically superior products to compete effectively and gain market share; our
products, due to their complexity, may contain errors or defects that are discovered by our customers, thus harming our reputation and business; we may have issues with infringing on others intellectual property; we may have issues protecting
our proprietary technology; we are dependent on international operations, particularly in Germany and Australia, which exposes us to a variety of risks that could result in lower international sales; new accounting rules relating to stock-based
compensation will negatively affect our results beginning in 2006; we could be sued for product liability; we could suffer penalties, injunctions or fines if we fail to comply with U.S. Food and Drug Administration regulations or various sales
related laws; our stock price could suffer due to sales of stock by our directors and officers; and provisions in our charter documents, shareholder rights plan and Delaware law could deter any takeover of the Company. These factors are discussed in
detail in the section titled, Factors That May Affect Future Performance included in Item 1-A of our Annual Report on Form 10-K for the year ended December 31, 2005. Investors should understand that it is not possible to
predict or identify all such factors that could cause actual results to differ from expectations, and we are under no obligation to update these factors.

OVERVIEW

Sonic Innovations Inc. is a hearing healthcare company. We design, develop, manufacture and market advanced digital hearing aids
intended to provide the highest levels of satisfaction for hearing impaired consumers and proprietary auditory testing equipment that automates the four most commonly performed hearing tests. We have developed patented DSP technologies based on what
we believe is an advanced understanding of human hearing. In those 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 principally to distributors. From our inception, we have focused on the therapeutic side of hearing care by developing high-performance digital hearing aids. In December 2004,



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we acquired Tympany, Inc. (Tympany), which enabled us to offer hearing diagnostic equipment to further help hearing impaired individuals. Our
mission is to improve the quality of life of the hearing impaired.

Market

The hearing aid market is large at both the wholesale (manufacturing) level (over $2.0 billion) and the retail level (over $5.0 billion). It is estimated less than 24% of those who could benefit from a hearing aid
actually own one. There are many factors that cause this low market penetration rate, such as the high cost of hearing aids, the stigma associated with wearing hearing aids, and the discomfort of wearing hearing aids. We believe that these negative
factors will decrease in importance in the future because we expect prices to decline and the stigma aspect to decrease as improvements in technology make the devices smaller, less conspicuous and more comfortable and as hearing loss becomes more
prevalent in society. Therefore, in the future, we expect that more people who could benefit from hearing aids will buy them, and we believe that the growth rate of the hearing impaired population will be significant, particularly as the developed
worlds population ages. As a result, we believe the market for hearing aids will increase significantly in the future. The following conditions in our market are affecting us in a negative way currently:



| |  |  | 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, which attracts more customers to these lower-priced products resulting in a lower overall average
selling price.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The rate of transition from analog to digital hearing aids has slowed considerably because digital devices now represent a very significant percentage in most developed markets. For
example, in the United States digital hearing aids now represent 89% of the market.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Economic conditions worldwide for the elderly cause them to defer the purchase of a new hearing aid.
| | - |  | ----------------------------------------------------------------------------------------------------



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



| |  |  | The available market continues to shrink as our competitors implement vertical integration strategies and buying groups limit the number of manufacturers with whom they do business.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Product Developments

In
2005, we introduced our Innova product family of hearing aids based on a new technology platform that improved upon our two strongest existing features  noise reduction and directionality. Noise reduction allows the hearing aid to reduce
background noise so that speech sounds are clearer. We have the only omni-directional hearing aid that has been clinically proven to improve speech intelligibility with background noise present. Directionality allows the hearing aid wearer to better
understand speech sounds through the use of directional microphones in the device. We launched Innova in the second quarter 2005 in English speaking countries and by the end of 2005 in non-English speaking countries. The Innova technology platform
provides us the opportunity to develop a broad product line of full-featured hearing aids that can allow us to compete effectively at more price points of the hearing aid market. In November 2005, we launched our Applause product line on a worldwide
basis. Applause is a mid-range product brand on the Innova technology platform. In March 2006, we introduced our first open-ear product, Ion, which is based on the Innova technology platform. Open-ear products generally eliminate the
effect of occlusion because there is no ear-mold involved, rather these products have an ear-bud that allows air into the ear. The market for open-ear products, which have been in the market more than a year, is growing very rapidly. We believe that
Ion will provide us a significant opportunity to increase our net sales.

Distribution Developments

We are competing in an industry that includes six much larger competitors who have significantly more resources and have established relationships and
reputations. Their product offerings are broad and their infrastructure and marketing and distribution capabilities are well established, and they continue to vertically integrate. This makes it difficult for us to compete in the traditional
distribution fashion. For this reason, we are interested in non-traditional distribution methods. We believe we are making progress with this strategy in several countries. In Germany, we sell direct to the consumer and use the ear-nose-throat
(ENT) doctor to perform the hearing aid fitting. In Australia and Switzerland, we sell direct to the consumer through retail stores. In Austria, our largest customer is a chain of electronics stores that also sells hearing aids. In the
Netherlands, our largest customer is a chain of optical stores that also sells hearing aids. As a result of our purchase of Tympany in December 2004, we sell an auditory testing device, the Otogram, to primary care physicians, ENT doctors,
audiologists and hearing instrument specialists.



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Financial Results

Our financial results in the first quarter 2006 improved from the first quarter 2005 and the fourth quarter 2005 as a result of the following:



| |  |  | We introduced our open-ear product, Ion, in March 2006. This is a new product category for us, so we believe that sales of this product will be largely incremental. In addition, the
open-ear segment of the market appears to be the only growing segment of the hearing aid market. Some customers estimate that open-ear products now comprise some 20% plus of their total sales. This product is particularly helpful for first time
hearing aid wearers who experience a high-frequency hearing loss, and Ion is targeted to aging baby-boomers. We believe Ion is smaller, lighter and yet more powerful than competing open-ear products.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We restructured our Tympany operation in late 2005. While we continue to incur operating losses, we expect unit sales to improve as a result of changing our strategy from placing
Otograms with the primary care physician and charging a per procedure fee to selling Otograms to the primary care physician, the ENT doctor, the audiologist and the hearing instrument specialist. It is difficult to sell the Otogram to the primary
care physician who has limited experience dealing with hearing loss. The ENT doctor, audiologist and hearing instrument specialist are the experts in hearing, and we believe they will see the value of the Otogram. We are hopeful that this change in
strategy will result in a further improvement in the financial performance of our Tympany operation.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We reorganized our executive management team and reduced executive overhead and replaced general or sales management in each of our three major geographies  the U.S., Germany
and Australia - in late 2005.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have a business plan focused on enhancing our profitability and have adjusted our business operation by country such that we are planning to improve our profitability in each
country in which we have a direct operation.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We introduced our high-end Innova product late in 2005 in Europe, which meant Innova was available on a worldwide basis.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | We introduced our new mid-range product, Applause, on a worldwide basis late in 2005.
| | - |  | -------------------------------------------------------------------------------------



| |  |  | We have increased our management and operational focus on our product distribution channels. In addition, we are increasing our efforts to become more customer-centric. Our goal is
to be the hearing healthcare provider of choice to customers who value unparalleled levels of service and quality, great products and competitive pricing.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

RESULTS OF OPERATIONS

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



|                                            |  |                                  |    |  |       |   
|------------------------------------------- |  | -------------------------------- | -- |  | ----- | --
|                                            |  | For three months ended March 31, |   
|                                            |  | 2006                             |    |  | 2005  |   
|Net sales                                   |  | 100.0                            | %  |  | 100.0 | % 
|Cost of sales                               |  | 44.8                             |    |  | 46.5  |   
|                                            |  |                                  |    |  |       |   
|Gross profit                                |  | 55.2                             |    |  | 53.5  |   
|Selling, general and administrative expense |  | 51.5                             |    |  | 57.3  |   
|Research and development expense            |  | 8.0                              |    |  | 9.1   |   
|Asset impairment charge                     |  | 1.5                              |    |  | 0.0   |   
|                                            |  |                                  |    |  |       |   
|Operating loss                              |  | (5.8                             | )  |  | (12.9 | ) 
|Other income (expense), net                 |  | 0.3                              |    |  | (0.2  | ) 
|                                            |  |                                  |    |  |       |   
|Loss before income taxes                    |  | (5.5                             | )  |  | (13.1 | ) 
|Provision for income taxes                  |  | 0.7                              |    |  | 0.3   |   
|                                            |  |                                  |    |  |       |   
|Net loss                                    |  | (6.2                             | )% |  | (13.4 | )%
|                                            |  |                                  |    |  |       |   



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##### Table of Contents

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 March 31, |       
|                           |  | 2006                         |        | 2005 |   | Change | 
|Hearing aids:              |  |                              |        |      |   |        |  |     |  
|North America              |  | $                            | 10,275 |      | $ | 7,737  |  | 33  | %
|Europe                     |  |                              | 9,855  |      |   | 12,278 |  | (19 | )
|Rest-of-world              |  |                              | 4,662  |      |   | 4,019  |  | 16  |  
|Auditory testing equipment |  |                              | 1,090  |      |   | 1,857  |  | (41 | )
|                           |  |                              |        |      |   |        |  |     |  
|Total                      |  | $                            | 25,882 |      | $ | 25,891 |  | 0   | %
|                           |  |                              |        |      |   |        |  |     |  

Net sales in the first quarter 2006 were $25,882, which was about equal to first quarter 2005 net sales of
$25,891. Hearing aid sales were up $758, or 3%, and auditory testing equipment sales were down $767, or 41%.

North American hearing aid sales in the first
quarter 2006 of $10,275 were up $2,538, or 33%, from last years first quarter sales level of $7,737. First quarter 2006 U.S. sales increased by 33% and Canadian sales increased by 34% over last years first quarter levels. These
significant improvements were the result of new sales leadership, sales process improvements and the introduction of our new open-ear product, Ion, which was introduced in March 2006. Open-ear is a whole new product category, or market segment, for
us, which should result in incremental sales.

European hearing aid sales of $9,855 in the first quarter 2006 were down $2,423, or 19%, from record first
quarter 2005 sales of $12,278 mainly as a result of the unfavorable effect of foreign currency translation due to the stronger U.S. dollar and decreased sales in Germany, which had enjoyed a high level of sales in the first quarter 2005. Sales in
the balance of Europe were also down from the first quarter 2005 to the first quarter 2006, but we expect that Ion, which was introduced in all of Europe in April 2006, will result in higher sales levels beginning in the second quarter 2006. In
addition, changes in the management and sales structure and the addition of sales people in several countries, most particularly Germany, should result in improved performance through the balance of 2006.

Rest-of-world hearing aid sales of $4,662 in the first quarter 2006 were up $643, or 16%, from first quarter 2005 sales of $4,019 as Australian sales benefited from new
leadership and new sales and marketing programs.

As of April 2006, we have launched our Ion product worldwide, and we expect to launch our new Natura
line, Natura Pro, late in the second quarter 2006.

Auditory testing equipment (Tympany) sales of $1,090 in the first quarter 2006 were down $767, or 41%,
from first quarter 2005 sales of $1,857. The first quarter 2005 figure included the recognition of $1,309 of revenue pertaining to upgraded Otograms that had been deferred at the time of our acquisition of Tympany in December 2004. Excluding this,
auditory testing equipment sales would have increased by $542 million, or 99%.

We generally have a 60-day return policy for our hearing aids. Provisions
for sales returns were $3,737 and $2,775 in the first quarter 2006 and 2005, respectively. Actual sales returns were $2,333 and $2,732 in the first quarter 2006 and 2005, respectively. The increase in the provision was principally the result of
increased sales in the U.S., particularly sales of Ion, which was introduced in March 2006. 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. In Germany, Australia, Switzerland and a portion of the Netherlands, sales are at the retail level and are recognized upon
customer acceptance, and therefore, sales returns in these countries are considerably lower than in the balance of our business.



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##### Table of Contents

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 March 31, |       
|                           |  | 2006                         |        |  | 2005 |  
|Hearing aids:              |  |                              |        |  |      |   |  |   |        |  |      |  
|North America              |  | $                            | 5,168  |  | 50.3 | % |  | $ | 4,476  |  | 57.8 | %
|Europe                     |  |                              | 5,219  |  | 52.9 |   |  |   | 6,216  |  | 50.6 |  
|Rest-of-world              |  |                              | 3,238  |  | 69.5 |   |  |   | 2,674  |  | 66.5 |  
|Auditory testing equipment |  |                              | 658    |  | 60.4 |   |  |   | 491    |  | 26.4 |  
|                           |  |                              |        |  |      |   |  |   |        |  |      |  
|Total                      |  | $                            | 14,283 |  | 55.2 | % |  | $ | 13,857 |  | 53.5 | %
|                           |  |                              |        |  |      |   |  |   |        |  |      |  

Gross profit in the first quarter 2006 of $14,283 was up 3% from last years first quarter level of $13,857
and first quarter gross margin of 55.2% increased from gross margin of 53.5% in last years first quarter, primarily due to the elimination of $1,309 of low margin Tympany upgrade revenue, which had been deferred at the time of the acquisition
in December 2004 and was recognized in the first quarter 2005. The decrease in the U.S. gross margin resulted mainly from the sales mix of products sold and an increase in warranty expense.

Provision for warranty cost increased from $994 in the first quarter 2005 to $1,412 in the first quarter 2006. Actual warranty expenditures were $1,070 and $1,220 in the
first quarter 2006 and 2005, respectively. The increase in the provision from first quarter 2005 to first quarter 2006 was mainly due to increased sales in the U.S. and, specifically, increased sales of newer products, which generally have longer
warranty periods.

We expect that competitive pricing will continue to put pressure on our selling prices and gross margin. If we are able to continue to
introduce new products on a periodic basis, we are hopeful that we can maintain or improve our overall average selling price and positively affect our gross margin. We expect to increase our unit volume in 2006, and we believe that little additional
overhead will be required by manufacturing operations to support increasing volume. This, in combination with expected reduced purchased component and assembly costs, lower sales return rates and more off-shore outsourcing, should result in our
gross margin improving during 2006.

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 expenses.

Selling, general and administrative expense in dollars and as a percent of sales by reportable operating segment was as follows:



|                           |  |                              |        |  |      |   |  |   |        |  |      |  
|-------------------------- |  | ---------------------------- | ------ |  | ---- | - |  | - | ------ |  | ---- | -
|                           |  | Three months ended March 31, |       
|                           |  | 2006                         |        |  | 2005 |  
|Hearing aids:              |  |                              |        |  |      |   |  |   |        |  |      |  
|North America              |  | $                            | 6,187  |  | 60.2 | % |  | $ | 6,331  |  | 81.8 | %
|Europe                     |  |                              | 3,699  |  | 37.5 |   |  |   | 4,107  |  | 33.5 |  
|Rest-of-world              |  |                              | 2,697  |  | 57.8 |   |  |   | 2,724  |  | 67.8 |  
|Auditory testing equipment |  |                              | 736    |  | 67.6 |   |  |   | 1,692  |  | 91.1 |  
|                           |  |                              |        |  |      |   |  |   |        |  |      |  
|Total                      |  | $                            | 13,319 |  | 51.5 | % |  | $ | 14,854 |  | 57.3 | %
|                           |  |                              |        |  |      |   |  |   |        |  |      |  

Selling, general and administrative expense in the first quarter 2006 of $13,319 was down $1,535, or 10%, from
last years first quarter level of $14,854 and selling, general and administrative expense as percentage of sales decreased from 57.3% in the first quarter 2005 to 51.5% in the first quarter 2006 principally as a result of current period
benefits from the restructuring activities that were undertaken in the second half of 2005 and lower spending to introduce Ion in the first quarter 2006 compared to introducing Innova in the first quarter 2005. We expect a combination of increased
net sales and decreased selling, general and administrative expense beginning in the second quarter 2006 to result in selling, general and administrative expense as a percentage of net sales decreasing.

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 in the first quarter 2006 of $2,059 decreased by $293, or 12%, from last years first
quarter level of $2,352 mainly as a result of the cost of developing Innova, which was introduced last year in the first quarter, versus the cost of developing Ion, which was introduced in this years first quarter.



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##### Table of Contents

As a percentage of sales, research and development expenses went from 9.1% in the first quarter 2005 to 8.0% in the first quarter 2006. We expect research
and development expense to increase in dollars as we are working to speed development of several new products to be introduced later this year.

Asset
Impairment.As a result of an asset impairment charge taken on the auditory testing equipment operating segment (Tympany) in the third quarter 2005, we have expensed the first quarter 2006 Tympany earn-out of $381. We will continue to expense
these earn-out payments until such time as the expected cash flows from the business can support additional valuation. If that were to occur, we would capitalize these earn-out amounts as additional purchase price.

Other Income/Expense. Other income/expense primarily consisted of foreign currency gains and losses and interest income and interest expense. Other income was $69
in the first quarter 2006 compared to other expense of $40 in the first quarter 2005. The first quarter 2005 included foreign currency translation losses pertaining to intercompany balances of $192.

Provision for Income Taxes. Provision is made for taxes on pre-tax income. In some jurisdictions net operating loss carryforwards reduce or offset tax provisions.
We had an income tax provision in the first quarter 2006 of $172, which resulted from pre-tax profits in Germany, compared to an income tax provision of $88 in the first quarter 2005. Income taxes on profits in the U.S. and a number of our foreign
subsidiaries are currently negated by our net operating loss carryforwards, which total approximately $44,500. Our effective tax rate going forward will depend mainly on our profitability in Germany, where we do not have a net operating loss
carryforward.

LIQUIDITY AND CAPITAL RESOURCES

Net
cash provided by operating activities was $848 for the three months ended March 31, 2006. Negative cash flow resulted from the net loss of $1,579, as positively affected by certain non-cash expenses including depreciation and amortization of
$1,213, stock-based compensation of $245, an asset impairment charge of $381and foreign currency losses of $23. Negative cash flow also resulted from an increase in accounts receivable of $1,293 and an increase in other assets of $76. These negative
cash flow items were offset by cash provided by increases in accounts payable, accrued expenses and deferred revenue of $1,431, a decrease in inventories of $234 and a decrease in prepaid expenses and other of $269. The increase in accounts payable,
accrued expenses and deferred revenue includes the net accrued earn-out to the former owners of Tympany.

Net cash used in investing activities of $1,139
for the three months ended March 31, 2006 resulted from an increase in customer advances of $619 and purchases of property and equipment of $520.

Net
cash provided by financing activities of $1,196 for the three months ended March 31, 2006 resulted from stock option exercises of $573 and net proceeds from restricted cash, cash equivalents and marketable securities of $923. These positive
cash flow items were partially offset by loan principal payments of $300.

Our cash and marketable securities, including restricted amounts, totaled
$16,231 as of March 31, 2006. We have a number of items that will negatively affect our cash balance in 2006. The more significant items follow:



| |  |  | We will make cash payments for restructuring charges accrued in 2005.
| | - |  | ---------------------------------------------------------------------



| |  |  | We will make payments on our long-term loan.
| | - |  | --------------------------------------------



| |  |  | We will make earn-out payments in connection with previous acquisitions.
| | - |  | ------------------------------------------------------------------------

In addition, we may make (i) settlement payments regarding our disputes with ETG and the former owners of Sanomed; (ii) acquisitions of complementary businesses and (iii) customer loans. We believe that our cash and
marketable securities balance will be adequate to meet our operating, working capital and investment requirements for 2006.

RECENT ACCOUNTING
PRONOUNCEMENTS

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which replaced APB Opinion
No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, and requires that a voluntary change in accounting principle be applied retrospectively to all prior period
financial statements presented, unless it is impracticable to do so. SFAS No. 154 also provides that a change in method of depreciating or amortizing a long-lived non-financial asset be accounted for as a change in estimate affected by a change
in accounting principle, and that a correction of an error in previously issued financial statements be termed a restatement. SFAS No. 154 is effective for fiscal years beginning after December 15, 2005. The adoption of SFAS
No. 154 did not have a material effect on our results of operations and financial position.



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##### Table of Contents

In November 2005, the FASB issued FASB Staff Position No. FAS 115-1 The Meaning of Other-Than-Temporary Impairment
and its Application to Certain Investments (FAS 115-1), which provides accounting guidance for determining and measuring other-than-temporary impairments of debt and equity securities, and confirms the disclosure requirements for investments
in unrealized loss positions as outlined in Emerging Issues Task Force Issue No. 03-01, The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments. The adoption of FAS 115-1did not have a material
effect on our results of operations and financial position.

In the first quarter 2006, there were no accounting standards issued that would have a
material effect on our results of operations and financial position.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS (Amounts in thousands)
|------- | ----------------------------------------------------------------------------------

Interest Rate Risk. We generally invest our cash in money market funds, U.S. government obligations and investment grade corporate debt securities, which we believe are subject to minimal credit and market risk
considering that they are relatively short-term (expected maturities of 18 months or less from date of purchase) and provided that we hold them to maturity, which is our intention.

Derivative Instruments. We may enter into readily marketable forward contracts with financial institutions to minimize the short-term impact of foreign currency fluctuations on certain intercompany balances. 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. Our foreign exchange forward contracts generally mature three months from the contract date.

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. In the first quarter
2006, approximately 61% of our net sales and 46% of our operating expenses were denominated in currencies other than the U.S. dollar. Inventory purchases were transacted primarily 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 Euro and Australian dollar 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. 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.

For the three months ended March 31, 2006 and 2005, average currency exchange rates to convert one U.S. dollar into each local currency for which we had sales
greater than 10% of consolidated net sales were as follows:



|                  |  |      |  |     
|----------------- |  | ---- |  | ----
|                  |  | 2006 |  | 2005
|Euro              |  | 0.83 |  | 0.76
|Australian dollar |  | 1.35 |  | 1.29



|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 to provide reasonable assurance that information required to be included in
our Exchange Act reports is properly recorded, processed, summarized and reported within the time periods specified.

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.



18



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##### Table of Contents

PART II - OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

In February 2006, the former owners of Sanomed,
which we acquired in May 2003, filed a lawsuit in German civil court claiming that certain deductions made by us against accounts receivable amounts that were deemed uncollectible prior to the acquisition but which have been collected and are due
the former owners were improper. The former owners seek damages in the amount of approximately $1,600. We filed our statement of defense in April 2006 and oral arguments are expected to occur by June 2006. In addition, as part of the Sanomed
purchase contract, the former owners were entitled to an earn-out payment based on the achievement of certain revenue milestones. In certain circumstances, the former owners are entitled to these earn-outs irrespective of the achievement of the
revenue milestones. One former owner has filed suit against us claiming that he was wrongfully terminated and is therefore entitled to his full earn-out amounting to approximately $560.

See Note 5 to the consolidated financial statements for additional discussion of legal proceedings.



|ITEM 1-A. | RISK FACTORS
|--------- | ------------

In addition to the other information 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, 2005, 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.



19



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##### Table of Contents

|ITEM 6. | EXHIBITS
|------- | --------

(a) Exhibits required to be filed by
Item 601 of Regulation S-K:



|          |  |                                                                                  
|--------- |  | ---------------------------------------------------------------------------------
|Exhibit # |  | Description                                                                      
|          | 
|31.1      |  | Rule 13a-14(a) / 15-d-14(a) Certification of Chief Executive Officer             
|          | 
|31.2      |  | Rule 13a-14(a) / 15-d-14(a) Certification of Chief Financial Officer             
|          | 
|32        |  | Section 1350 Certification of Chief Executive Officer and Chief Financial Officer



20



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##### Table of Contents

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: May 10, 2006



/s/ STEPHEN L. WILSONStephen L. WilsonSenior Vice President and Chief Financial Officer and Secretary




21