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UNITED STATESSECURITIES 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, 2003

o

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(State or other jurisdiction ofincorporation or organization) |  | 87-0494518(I.R.S. EmployerIdentification No.) | 
| | --------------------------------------------------------------------- |  | --------------------------------------------- | 

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

(801) 365-2800(Registrants telephone number, including area
code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes o No

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act.)

x Yes o No

As of May 8, 2003 there were 19,932,163 shares of the registrants common stock outstanding.

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SONIC INNOVATIONS, INC.TABLE OF CONTENTS



|        |  |                       |  |                                                                                                   | Page
|------- |  | --------------------- |  | ------------------------------------------------------------------------------------------------- | ----
|        |  |                       |  |                                                                                                   |     
|PART I  |  | FINANCIAL INFORMATION | 
|        |  |                       |  |                                                                                                   |     
|        |  | ITEM 1.               |  | Unaudited Condensed Consolidated Financial Statements:                                            |     
|        |  |                       |  |                                                                                                   |     
|        |  |                       |  | Condensed Consolidated Balance Sheetsas of March 31, 2003 and December 31, 2002                   | 3   
|        |  |                       |  |                                                                                                   |     
|        |  |                       |  | Condensed Consolidated Statements of Operationsfor the Three Months Ended March 31, 2003 and 2002 | 4   
|        |  |                       |  |                                                                                                   |     
|        |  |                       |  | Condensed Consolidated Statements of Cash Flowsfor the Three Months Ended March 31, 2003 and 2002 | 5   
|        |  |                       |  |                                                                                                   |     
|        |  |                       |  | Notes to Condensed Consolidated Financial Statements                                              | 6   
|        |  |                       |  |                                                                                                   |     
|        |  | ITEM 2.               |  | Managements Discussion and Analysis of Financial Condition and Results of Operations             | 11  
|        |  |                       |  |                                                                                                   |     
|        |  | ITEM 3.               |  | Quantitative and Qualitative Disclosures about Market Risks                                       | 15  
|        |  |                       |  |                                                                                                   |     
|        |  | ITEM 4.               |  | Controls and Procedures                                                                           | 15  
|        |  |                       |  |                                                                                                   |     
|        |  |                       |  | Factors That May Affect Future Performance                                                        | 16  
|        |  |                       |  |                                                                                                   |     
|PART II |  | OTHER INFORMATION     | 
|        |  |                       |  |                                                                                                   |     
|        |  | ITEM 1.               |  | Legal Proceedings                                                                                 | 21  
|        |  |                       |  |                                                                                                   |     
|        |  | ITEM 4.               |  | Submission of Matters to a Vote of Security Holders                                               | 21  
|        |  |                       |  |                                                                                                   |     
|        |  | ITEM 6.               |  | Exhibits and Reports on Form 8-K                                                                  | 21  

|SIGNATURE      | 22
|-------------- | --
|               |   
|CERTIFICATIONS | 23





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PART I

FINANCIAL INFORMATION

ITEM 1.

UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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



|                                                      |  | March 31,2003 |         | December 31,2002 |  
|----------------------------------------------------- |  | ------------- | ------- | ---------------- | -
|                                                      |  |               |         |                  |  
|                                                      |  |               |         |                  |  
|ASSETS                                                |  |               |         |                  |  
|Current assets:                                       |  |               |         |                  |  
|Cash and cash equivalents                             |  | $             | 19,371  |                  | $
|Marketable securities                                 |  |               | 10,247  |                  |  
|Accounts receivable                                   |  |               | 9,076   |                  |  
|Inventories                                           |  |               | 6,814   |                  |  
|Prepaid expenses and other                            |  |               | 1,695   |                  |  
|                                                      |  |               |         |                  |  
|Total current assets                                  |  |               | 47,203  |                  |  
|Long-term marketable securities                       |  |               | 4,188   |                  |  
|Property and equipment                                |  |               | 5,740   |                  |  
|Goodwill and other indefinite-lived intangible assets |  |               | 14,097  |                  |  
|Definite-lived intangible assets                      |  |               | 1,548   |                  |  
|Other assets                                          |  |               | 2,206   |                  |  
|                                                      |  |               |         |                  |  
|Total assets                                          |  | $             | 74,982  |                  | $
|                                                      |  |               |         |                  |  
|                                                      |  |               |         |                  |  
|LIABILITIES AND SHAREHOLDERS EQUITY                  |  |               |         |                  |  
|Current liabilities:                                  |  |               |         |                  |  
|Accounts payable                                      |  | $             | 5,098   |                  | $
|Accrued payroll and related expenses                  |  |               | 2,257   |                  |  
|Reserve for warranty                                  |  |               | 3,598   |                  |  
|Other accrued liabilities                             |  |               | 4,397   |                  |  
|Capital lease obligation                              |  |               | 30      |                  |  
|                                                      |  |               |         |                  |  
|Total current liabilities                             |  |               | 15,380  |                  |  
|Shareholders equity:                                 |  |               |         |                  |  
|Common stock                                          |  |               | 21      |                  |  
|Additional paid-in capital                            |  |               | 113,461 |                  |  
|Deferred stock-based compensation                     |  |               | (113    | )                |  
|Accumulated deficit                                   |  |               | (52,430 | )                |  
|Accumulated other comprehensive income                |  |               | 2,066   |                  |  
|Treasury stock, at cost                               |  |               | (3,403  | )                |  
|                                                      |  |               |         |                  |  
|Total shareholders equity                            |  |               | 59,602  |                  |  
|                                                      |  |               |         |                  |  
|Total liabilities and shareholders equity            |  | $             | 74,982  |                  | $
|                                                      |  |               |         |                  |  

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 ended March 31, |       
|----------------------------------------------------------- |  | ---------------------------- | ------
|                                                            |  |                              |       
|                                                            |  | 2003                         |       
|                                                            |  |                              |       
|Net sales                                                   |  | $                            | 17,014
|Cost of sales                                               |  |                              | 7,795 
|                                                            |  |                              |       
|Gross profit                                                |  |                              | 9,219 
|Selling, general and administrative expense                 |  |                              | 7,968 
|Research and development expense                            |  |                              | 2,487 
|Stock-based compensation expense                            |  |                              | 43    
|                                                            |  |                              |       
|Operating loss                                              |  |                              | (1,279
|Other income, net                                           |  |                              | 557   
|                                                            |  |                              |       
|Loss before income taxes                                    |  |                              | (722  
|Provision for income taxes                                  |  |                              | 124   
|                                                            |  |                              |       
|Net loss                                                    |  | $                            | (846  
|                                                            |  |                              |       
|Basic and diluted loss per common share                     |  | $                            | (0.04 
|                                                            |  |                              |       
|Weighted average number of common shares outstanding        |  |                              | 19,824
|                                                            |  |                              |       
|Stock-based compensation expense allocable to each caption: |  |                              |       
|Cost of sales                                               |  | $                            | 2     
|Selling, general and administrative expense                 |  |                              | 35    
|Research and development expense                            |  |                              | 6     
|                                                            |  |                              |       
|Stock-based compensation expense                            |  | $                            | 43    
|                                                            |  |                              |       

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, |       
|----------------------------------------------------------------------------------------- |  | ---------------------------- | ------
|                                                                                          |  |                              |       
|                                                                                          |  | 2003                         |       
|                                                                                          |  |                              |       
|Cash flows from operating activities:                                                     |  |                              |       
|Net loss                                                                                  |  | $                            | (846  
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                              |       
|Depreciation and amortization                                                             |  |                              | 570   
|Stock-based compensation                                                                  |  |                              | 43    
|Foreign currency gain                                                                     |  |                              | (384  
|Changes in assets and liabilities, excluding the affect of acquisitions:                  |  |                              |       
|Accounts receivable                                                                       |  |                              | (168  
|Inventories                                                                               |  |                              | (69   
|Prepaid expenses and other                                                                |  |                              | (351  
|Other assets                                                                              |  |                              | 46    
|Accounts payable and accrued expenses                                                     |  |                              | 411   
|                                                                                          |  |                              |       
|Net cash provided by (used in) operating activities                                       |  |                              | (748  
|Cash flows from investing activities:                                                     |  |                              |       
|Acquisitions, net of cash acquired                                                        |  |                              | (388  
|Purchases of property and equipment                                                       |  |                              | (279  
|Investments and advances, net                                                             |  |                              | (380  
|Proceeds from marketable securities, net                                                  |  |                              | 7,436 
|                                                                                          |  |                              |       
|Net cash provided by (used in) investing activities                                       |  |                              | 6,389 
|Cash flows from financing activities:                                                     |  |                              |       
|Principal payments on long-term obligations                                               |  |                              | (72   
|Purchases of common stock for treasury                                                    |  |                              |      
|Proceeds from exercise of stock options                                                   |  |                              | 27    
|                                                                                          |  |                              |       
|Net cash used in financing activities                                                     |  |                              | (45   
|Effect of exchange rate changes on cash and cash equivalents                              |  |                              | 85    
|                                                                                          |  |                              |       
|Net increase (decrease) in cash and cash equivalents                                      |  |                              | 5,681 
|Cash and cash equivalents, beginning of the period                                        |  |                              | 13,690
|                                                                                          |  |                              |       
|Cash and cash equivalents, end of the period                                              |  | $                            | 19,371
|                                                                                          |  |                              |       
|Supplemental cash flow information:                                                       |  |                              |       
|Cash paid for interest                                                                    |  | $                            | 1     
|Cash paid for income taxes                                                                |  |                              | 10    

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 accounting principles generally accepted in the
United States of America 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, 2003 are not necessarily indicative of results that may be expected for the full year ending December 31, 2003. 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, 2002 as filed with the Securities and Exchange Commission.

The accompanying unaudited condensed
consolidated financial statements include the accounts of Sonic Innovations, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

2.

ACQUISITIONS

The Company acquired one hearing aid business in the first quarter of 2002, five hearing aid businesses in the second quarter of 2002 and one hearing aid business in the fourth quarter of 2002, all
outside the U.S. In addition to initial cash payments totaling $7,511 (net of cash acquired), if certain financial milestones are achieved by some of these businesses over a two-year period, the Company is committed to pay up to an additional
$1,876. The Company paid $350 (previously accrued) in the first quarter 2003 and accrued an additional $205 related to the milestones. Milestone payments are added to goodwill. Four of these businesses were existing distributors of the
Companys products. The acquisitions were accounted for as purchases in accordance with Statement of Financial Accounting Standards No. 141 Business Combinations. The purchase prices of these businesses have been allocated to the
net assets acquired based on managements determinations of relative fair market values of the respective net assets and independent valuations.

3.

MARKETABLE SECURITIES

Management
designates the appropriate classification of marketable securities at the time of purchase and re-evaluates such designation at each balance sheet date. As of March 31, 2003 and December 31, 2002, the Companys investment portfolio consisted of
money market funds and short and long-term corporate debt securities, which were classified as held-to-maturity and presented at amortized cost, which approximates market value.

4.

INVENTORIES

Inventories are stated at the lower of cost or market value using the first-in, first-out (FIFO) method and consisted of the following:



|                 |  | March 31,2003 |       | December 31,2002 |  
|---------------- |  | ------------- | ----- | ---------------- | -
|                 |  |               |       |                  |  
|Raw materials    |  | $             | 1,363 |                  | $
|Components       |  |               | 1,336 |                  |  
|Work in progress |  |               | 130   |                  |  
|Finished goods   |  |               | 3,985 |                  |  
|                 |  |               |       |                  |  
|Total            |  | $             | 6,814 |                  | $
|                 |  |               |       |                  |  

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5.

DEFINITE-LIVED INTANGIBLE ASSETS

Definite-lived intangible assets consisted of the following:



|                            |  | March 31,2003 |       | December 31,2002 |  
|--------------------------- |  | ------------- | ----- | ---------------- | -
|                            |  |               |       |                  |  
|Technology licenses         |  | $             | 1,425 |                  | $
|Other definite-lived assets |  |               | 610   |                  |  
|                            |  |               |       |                  |  
|                            |  |               | 2,035 |                  |  
|Accumulated amortization    |  |               | (487  | )                |  
|                            |  |               |       |                  |  
|Total                       |  | $             | 1,548 |                  | $
|                            |  |               |       |                  |  

Technology licenses relate to agreements with (i) a partnership of hearing aid companies to which the
Company paid $1,800 for a paid-up license to use the partnerships technology, and (ii) a private company to which the Company paid $75 for the use of certain materials used in hearing aids. The company has received cash dividends through March
31, 2003 of $450 from the partnership. Other definite-lived intangible assets acquired in the Companys acquisitions, including trade names and distribution agreements, were identified by independent valuations as having separate
values.

6.

OTHER
ASSETS

Other assets consisted of the following:



|                         |  | March 31,2003 |       | December 31,2002 |  
|------------------------ |  | ------------- | ----- | ---------------- | -
|                         |  |               |       |                  |  
|Investments and advances |  | $             | 1,996 |                  | $
|Other                    |  |               | 210   |                  |  
|                         |  |               |       |                  |  
|Total                    |  | $             | 2,206 |                  | $
|                         |  |               |       |                  |  

Investments and advances consisted of one investment and one advance to two separate business
partners and several advances to customers. The advances are secured by the assets of the business, life insurance policies and/or personal guarantees and bear interest at rates ranging from 5% to 8% with terms from one to five years. Investments
and advances are stated at cost, net of a valuation allowance of $110 at March 31, 2003 and December 31, 2002.

7.

INCOME TAXES

In the first quarter 2003, certain of the
Companys non-U.S. operations were profitable, resulting in a current provision for income taxes of $124. The Companys provision for income taxes is based on the annualized effective tax rate for each tax jurisdiction. If future changes
in market conditions cause actual results to be more or less favorable, adjustments to the effective income tax rate on a quarterly basis would be required. The Company has not provided for U.S. deferred income taxes or foreign withholding taxes on
the undistributed earnings of its non-U.S. subsidiaries since these earnings are intended to be reinvested indefinitely.

In the first quarter 2002, no income tax provision or
benefit was recorded because operating losses were incurred in most tax jurisdictions and income tax loss carryforwards offset tax provisions in other tax jurisdictions.

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8.

COMPREHENSIVE
LOSS

Comprehensive loss for the three months ended March 31, 2003 and 2002 consisted of the following:



|                      |  | 2003 |      | 2002 |  
|--------------------- |  | ---- | ---- | ---- | -
|                      |  |      |      |      |  
|Net loss              |  | $    | (846 | )    | $
|Foreign currency gain |  |      | 533  |      |  
|                      |  |      |      |      |  
|Comprehensive loss    |  | $    | (313 | )    | $
|                      |  |      |      |      |  

Foreign currency gains reflect changes in the exchange rates of foreign currencies relative to the
U.S. dollar on the translation of the Companys net investment in its foreign subsidiaries.

9.

STOCK-BASED COMPENSATION

The Company accounts for stock options
issued to employees, officers and directors under Accounting Principles Board (APB) Opinion No. 25 and those issued to consultants or nonemployees under Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation. Under APB No. 25, compensation cost is recognized if an options exercise price is below the fair market value of the Companys common stock at the grant date. Under SFAS No. 123,
compensation cost is recognized for the fair market value of each option as estimated on the date of grant using the Black-Scholes option-pricing model.

SFAS No. 148
Accounting for Stock-Based Compensation  Transition and Disclosure, amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair market value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require new prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company has elected to adopt the disclosure only provisions of SFAS No. 148.

If compensation
expense for all stock options had been determined in accordance with SFAS No. 123, the Companys net loss and basic and diluted net loss per share for would have been as follows:



|                                                                                 |  | Three months ended March 31, |       
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------
|                                                                                 |  |                              |       
|                                                                                 |  | 2003                         |       
|                                                                                 |  |                              |       
|Net loss:                                                                        |  |                              |       
|As reported                                                                      |  | $                            | (846  
|Add back stock-based employee compensation expense recorded                      |  |                              | 43    
|Deduct stock-based employee compensation expense in accordance with SFAS No. 123 |  |                              | (730  
|                                                                                 |  |                              |       
|Pro forma                                                                        |  | $                            | (1,533
|                                                                                 |  |                              |       
|Basic and diluted net loss per share:                                            |  |                              |       
|As reported                                                                      |  | $                            | (0.04 
|                                                                                 |  |                              |       
|Pro forma                                                                        |  | $                            | (0.08 
|                                                                                 |  |                              |       



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10.

LOSS PER
COMMON SHARE

Basic and diluted net loss per common share was computed by dividing net loss by the weighted average number of common shares outstanding. Common stock
equivalents, consisting of 4,724 stock options, were not considered since their effect would be anti-dilutive, thereby decreasing the loss per common share.

11.

SEGMENT INFORMATION

The table below
presents selected information for the Companys geographic segments. Rest-of-world (ROW) includes export sales from the U.S. to ROW countries.



|                                  |  | North America |        | Europe |   | ROW    |  | Total |       
|--------------------------------- |  | ------------- | ------ | ------ | - | ------ |  | ----- | ------
|                                  |  |               |        |        |   |        |  |       |       
|                                  |  |               |        |        |   |        |  |       |       
|Three months ended March 31, 2003 |  |               |        |        |   |        |  |       |       
|Net sales to external customers   |  | $             | 9,504  |        | $ | 4,298  |  | $     | 3,212 
|Operating profit (loss)           |  |               | (1,527 | )      |   | 63     |  |       | 185   
|Three months ended March 31, 2002 |  |               |        |        |   |        |  |       |       
|Net sales to external customers   |  | $             | 9,236  |        | $ | 2,946  |  | $     | 2,922 
|Operating profit (loss)           |  |               | (1,482 | )      |   | 329    |  |       | 345   
|March 31, 2003                    |  |               |        |        |   |        |  |       |       
|Identifiable segment assets       |  | $             | 51,055 |        | $ | 13,221 |  | $     | 10,706
|Long-lived assets                 |  |               | 9,170  |        |   | 6,851  |  |       | 7,570 
|December 31, 2002                 |  |               |        |        |   |        |  |       |       
|Identifiable segment assets       |  | $             | 50,305 |        | $ | 14,047 |  | $     | 10,394
|Long-lived assets                 |  |               | 8,776  |        |   | 6,764  |  |       | 7,143 

12.

WARRANTY

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. The warranty period is generally one to three years for hearing aid products and 30 to 120 days for component products. We analyze the amount of
historical warranty by product family and model when evaluating the adequacy of the reserve. Because of the length of the warranty period, adjustments to the originally recorded provisions may be necessary from time to time. The following table
reflects changes in the Companys reserve for warranty during the three months ended March 31, 2003.



|Reserve for warranty, December 31, 2002 |  | $ | 3,601 |  
|--------------------------------------- |  | - | ----- | -
|Provision for warranty                  |  |   | 717   |  
|Actual expenditures                     |  |   | (720  | )
|                                        |  |   |       |  
|Reserve for warranty, March 31, 2003    |  | $ | 3,598 |  
|                                        |  |   |       |  

13.

LEGAL PROCEEDINGS

The Company is a defendant in a lawsuit filed
in October 2000 claiming that the Company and certain of its officers and directors violated federal securities laws by providing materially false and misleading information or concealing information about the Companys relationship with
Starkey Laboratories, Inc. This lawsuit, which is pending in the US District Court for the District of Utah, purports to be brought as a class action on behalf of all purchasers of the Companys common stock from May 2, 2000 to October 24, 2000
and seeks damages in an unspecified amount. The complaint alleges that as a result of false statements or omissions, the Company was able to complete its IPO, artificially inflate its financial projections and results and have its stock trade at
inflated levels. The Company strongly denies these allegations and will defend itself vigorously; however, litigation is inherently uncertain and there can be no assurance that the Company will not be materially affected. Discovery has commenced,
but no class has been certified and no trial date has been scheduled.

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14.

RECENTLY
ENACTED ACCOUNTING STANDARDS

In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 146, Accounting for Costs Associated with Exit
or Disposal Activities, which requires a liability to be recorded for costs associated with an exit or disposal activity when that liability is incurred and can be measured at fair value. A liability is incurred when an event obligates the
entity to transfer or use assets (i.e., when an event leaves the company little or no discretion to avoid transferring or using the assets in the future). Under previous accounting rules, if a companys management approved an exit plan, the
company generally could record the costs of that plan as a liability on the approval date, even if the company did not incur the costs until a later date. Under SFAS No. 146, some of those costs might qualify for immediate recognition, while others
might be recorded during one or more future periods. The Company adopted SFAS No. 146 on January 1, 2003 with no impact on its results of operations and financial position.

In
November 2002, the FASB issued Financial Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others, (FIN 45), which expanded
previously issued accounting guidance and disclosure requirements for certain guarantees. FIN 45 requires recognition of an initial liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition
and measurement of the liability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The Company adopted FIN 45 on January 1, 2003 with no impact on its results of operations and financial
position.

In January 2003, the FASB issued Financial Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, (FIN
46), which addresses the consolidation by business enterprises of variable interest entities as defined therein and applies immediately to variable interests in variable interest entities created or obtained after January 31, 2003. The Company
adopted FIN 46 on January 31, 2003 with no impact on its results of operations and financial position.

15.

SUBSEQUENT EVENT

On May 9, 2003, the Company signed a definitive
purchase agreement to acquire Sanomed Handelsgesellschaft mbH, a privately held company headquartered in Hamburg, Germany. Sanomed markets various manufacturers hearing aids throughout Germany. The initial purchase price is approximately
$13,000, with the potential for contingent purchase price of approximately $4,600 provided certain financial milestones are achieved over the next three years. The Company expects to borrow the majority of the initial purchase price.

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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. These forward-looking statements include statements regarding the
following factors: market transition from analog to digital hearing aids, particularly lower priced digital aids; shift of sales mix toward lower-priced products and the resultant negative impact on gross margin; anticipation of gross profit
improvement due to increased unit sales; increased selling, general and administrative expense; quarterly variations in selling and marketing expenses; increased research and development expense; amortization of deferred stock-based compensation;
the use of cash to fund operations and acquisition; and sufficiency of cash to fund our operations. Our actual results could differ materially and adversely from those anticipated in such forward-looking statements. Factors that could contribute to
these differences include, but are not limited to, the risks discussed in the section titled, Factors That May Affect Future Performance elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year
ended December 31, 2002. Our critical accounting policies are described in our Annual Report on Form 10-K for the year ended December 31, 2002. All amounts are reflected in thousands, except per share data.

OVERVIEW

We design, develop, manufacture and market advanced digital hearing aids designed to provide the highest levels of satisfaction
for hearing impaired customers. Capitalizing on our advanced understanding of human hearing, we have developed patented digital signal processing (DSP) technologies and embedded them in the smallest single-chip DSP platform ever
installed in a hearing aid. In the U.S., Denmark, England, Austria, Switzerland, Canada and the Netherlands, we sell finished hearing aids principally to hearing care professionals. In other parts of the world, we sell finished hearing aids and
hearing aid kits principally to distributors, except in Australia, where hearing aids are also sold on a retail basis to the hearing impaired consumer. We occasionally sell hearing aid components to other hearing aid manufacturers.

In reporting our financial condition and results of operations, we report three geographic segments. We generally evaluate our operating results on a company-wide basis because all of our
products are sourced from the United States, and all research and development and considerable marketing and administrative support are provided globally from the United States.

RESULTS OF OPERATIONS

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



|                                            |  | March 31,2003 |    | March 31,2002 |   
|------------------------------------------- |  | ------------- | -- | ------------- | --
|                                            |  |               |    |               |   
|Net sales                                   |  | 100.0         | %  | 100.0         | % 
|Cost of sales                               |  | 45.8          |    | 49.3          |   
|                                            |  |               |    |               |   
|Gross profit                                |  | 54.2          |    | 50.7          |   
|Selling, general and administrative expense |  | 46.8          |    | 41.8          |   
|Research and development expense            |  | 14.6          |    | 13.5          |   
|Stock-based compensation expense            |  | 0.3           |    | 0.7           |   
|                                            |  |               |    |               |   
|Operating loss                              |  | (7.5          | )  | (5.3          | ) 
|Other income, net                           |  | 3.3           |    | 2.5           |   
|                                            |  |               |    |               |   
|Loss before income taxes                    |  | (4.2          | )  | (2.8          | ) 
|Provision for income taxes                  |  | (0.8          | )  |              |   
|                                            |  |               |    |               |   
|Net loss                                    |  | (5.0          | )% | (2.8          | )%
|                                            |  |               |    |               |   

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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 were $17,014 for the quarter ended March 31, 2003, a 13% increase from $15,104 recorded for the quarter ended March 31, 2002. The weakening U.S. dollar significantly benefited overall sales and accounted for approximately one-half of the
year-over-year sales increase.

By geography, North America hearing aid sales in the first quarter 2003 of $9,504 increased 3% from first quarter 2002 sales of $9,236. The North
America sales improvement was a result of revenues from our Canadian operations, which were acquired in the second quarter 2002. The U.S. hearing aid market contracted by 3% in units from first quarter 2002 to first quarter 2003, and our U.S. sales
decreased by more than 4%. While industry sales of digital-based hearing aids have been increasing, sales of analog-based hearing aids, particularly non-programmable models, have been decreasing at a faster rate. We believe that this transition from
lower priced analog aids to higher priced digital aids, along with the poor economic climate, have caused consumers to seek out lower priced digital aids. The consumer would like a digital aid at an analog price. Because we do not sell analog
products while our competitors do, we believe customers that are shifting from analog aids find it easier to migrate to our competitors low priced digital aids. However, we have been aggressively pursuing the low-priced digital market with our
Tribute product family in order to gain customers in this growing market segment. This will negatively impact gross margin, but should improve gross profit due to increased unit sales.

Sales in Europe of $4,298 in the first quarter 2003 were up 46% from first quarter 2002 sales of $2,946 as a result of incremental sales resulting from our acquisitions in the U.K., Austria, Switzerland and the Netherlands, as well as the
weakness in the U.S. dollar. Rest-of-world hearing aid sales of $3,212 were up 10% from first quarter 2002 sales of $2,922 as a result of our Australian operations success with the introduction of our lower-priced Quartet custom product line.
Outside of Australia, sales were down in Japan because our distributor was acquired by a competitor and were down in Brazil due to the sluggish Brazilian economy.

We generally
have a 60-day return policy for our hearing aid products and a no return policy for our component products. Sales returns were $3,616 and $3,895 for the quarters ended March 31, 2003 and 2002, respectively. Sales returns as a percentage of hearing
aid sales were 17.5% in the first quarter 2003, down from 20.6% in the first quarter 2002. The decrease in returns was mainly a result of (i) a shift in U.S. sales mix towards lower-priced products (lower-priced hearing aids are generally returned
at a lower rate) and (ii) a higher level of non-U.S. sales (a lower return rate exists outside the U.S.).

Cost of Sales.Cost of sales consists of
manufacturing costs, royalty expenses, quality assurance costs and costs associated with product returns, remakes and repairs. Cost of sales was $7,795 for the quarter ended March 31, 2003, an increase of $354 (5%) from cost of sales of $7,441 for
the quarter ended March 31, 2002. Gross margin was 54.2% in the first quarter 2003, up from 50.7% in the first quarter 2002 despite the significant reduction in higher-margin component sales. The improvement in gross margin principally resulted from
reductions in the cost of purchased components, better labor utilization, manufacturing structure changes, lower warranty costs per unit, favorable foreign currency, and less expensive outsourcing and contracting activities, as well as the
incremental gross margin improvement resulting from acquiring several former distributors. We anticipate some additional gross margin improvement as a result of these factors, although an anticipated sales mix shift toward lower-priced products will
put downward pressure on gross margin.

We provide for the cost of remaking and repairing products under warranty. Warranty periods range from one to three years for hearing aids
and 30 to 120 days for components. Warranty expenditures were $720 and $620 for the quarters ended March 31, 2003 and 2002, respectively. The increase in warranty expenditures was principally due to the increase in sales, partially offsetting this
increase was a reduction in repair cost per unit.

Selling, General and Administrative.Selling, general and administrative expense consists primarily
of wages and benefits for personnel, sales commissions, promotions and advertising, marketing support, conventions and administrative expenses. Selling, general and administrative expense was $7,968, or 46.8% of net sales, for the quarter ended
March 31, 2003, an increase of $1,655 (26%) from selling, general and administrative expense of $6,313, or 41.8% of net sales, for the quarter ended March 31, 2002. The increase in selling, general and administrative expense for the three months
ended March 31, 2003 was principally a result of our acquisitions, increased Australian selling costs, and expenses relating to the launch of the Companys Natura 3 product line, which was introduced in April 2003.

We expect selling, general and administrative expense to increase in dollars, although not necessarily as a percentage of sales. In addition, selling and marketing expenses may vary from quarter to
quarter as a result of our new product introductions, the timing of our advertising campaigns and convention costs.

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Research and Development.Research and development expense consists primarily of wages and benefits for personnel, consulting,
software, intellectual property, clinical study and engineering support costs. Research and development expense was $2,487, or 14.6% of net sales, for the quarter ended March 31, 2003, an increase of $435 (21%) from research and development expense
of $2,052, or 13.5% of net sales, for the quarter ended March 31, 2002. The increase in research and development expense for the three months ended March 31, 2003 was principally due to costs associated with design and development of certain aspects
of our next generation integrated circuitry by a third-party contractor. We expect research and development expense to increase in dollars, although not necessarily as a percentage of sales.

Stock-based Compensation.Deferred stock-based compensation represents the difference between the exercise price and the deemed fair value of our common stock on the grant date for stock
options granted in the one-year period preceding the initial filing of our Initial Public Offering and is being amortized over the vesting periods of the individual stock options, periodically adjusted for employee separations. For the quarters
ended March 31, 2003 and 2002, stock-based compensation expense was $43 and $106, respectively. As of March 31, 2003, deferred stock-based compensation of $113 is expected to be amortized as follows: April 1, to December 31, 2003 - $76; 2004 - $26;
and 2005 - $11.

Other Income. Other income in the first quarter 2003 was $557, an increase from other income of $389 in the first quarter 2002, as
reduced interest income resulting from a lower cash balance and reduced interest rates was more than offset by higher foreign currency exchange gains resulting from the impact of a weaker U.S. dollar on the intercompany balances between our US
parent company and our non-U.S. subsidiaries.

Income Taxes.For the three months ended March 31, 2003, certain of the Companys non-U.S.
operations were profitable, resulting in a current provision for income taxes of $124. The Company has not provided for US deferred income taxes or foreign withholding taxes on the undistributed earnings of its non-U.S. Subsidiaries since these
earnings are intended to be reinvested indefinitely.

Net Loss.Net loss for the three months ended March 31, 2003 was $846 ($0.04 per share) compared
to a net loss for the three months ended March 31, 2002 of $419 ($0.02 per share).

LIQUIDITY AND CAPITAL RESOURCES

Net cash used in operating activities of $748 for the three months ended March 31, 2003 resulted from a net loss of $846 and changes in assets and liabilities of $131, offset in part by non-cash items of
$229.

Net cash provided by investing activities of $6,389 for the three months ended March 31, 2003 resulted from net proceeds from the maturity of marketable securities of
$7,436, offset in part by cash paid for acquisitions of $388 (earnout consideration), purchases of property and equipment of $279 and net advances to certain customers of $380.

Net cash used in financing activities of $45 for the three months ended March 31, 2003 resulted from repayment of long-term obligations of $72, offset in part by proceeds from stock option exercises of $27.

On May 9, 2003, the Company signed a definitive purchase agreement to acquire Sanomed Handelsgesellschaft mbH, a privately held company headquartered in Hamburg, Germany. Sanomed markets various
manufacturers hearing aids throughout Germany. The initial purchase price is approximately $13,000, with the potential for contingent purchase price of approximately $4,600 provided certain financial milestones are achieved over the next three
years. The Company expects to borrow the majority of the initial purchase price.

As of March 31, 2003, we had $33,806 in cash, cash equivalents and marketable securities. We
anticipate using cash to fund operations and make acquisitions of complementary businesses and technologies. We do not expect net cash flows from operations to be significant in the near term; however, we do expect to have sufficient cash to fund
our operating requirements in the foreseeable future.

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RECENTLY ENACTED ACCOUNTING STANDARDS

In June 2002, the Financial Accounting
Standards Board (FASB) issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which requires a liability to be recorded for costs associated with an exit or disposal activity when that
liability is incurred and can be measured at fair value. A liability is incurred when an event obligates the entity to transfer or use assets (i.e., when an event leaves the company little or no discretion to avoid transferring or using the assets
in the future). Under previous accounting rules, if a companys management approved an exit plan, the company generally could record the costs of that plan as a liability on the approval date, even if the company did not incur the costs until a
later date. Under SFAS No. 146, some of those costs might qualify for immediate recognition, while others might be recorded during one or more future periods. The Company adopted SFAS No. 146 on January 1, 2003 with no impact on its results of
operations and financial position.

In November 2002, the FASB issued Financial Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for
Guarantees, including Indirect Guarantees of Indebtedness of Others, (FIN 45), which expanded previously issued accounting guidance and disclosure requirements for certain guarantees. FIN 45 requires recognition of an initial
liability for the fair value of an obligation assumed by issuing a guarantee. The provision for initial recognition and measurement of the liability will be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The
Company adopted FIN 45 on January 1, 2003 with no impact on its results of operations and financial position.

In December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based CompensationTransition and Disclosure, which amends SFAS No. 123 Accounting for Stock-Based Compensation, and gives companies electing to expense employee stock options three methods to do so.
In addition, the statement amends the disclosure requirements to require more prominent disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported results in both annual and interim
financial statements. The Company has elected to continue using the intrinsic value method of accounting for stock-based compensation. Therefore, SFAS No. 148 will not have any effect on the Companys results of operations and financial
position. See Note 9 for additional disclosures regarding stock-based compensation.

In January 2003, the FASB issued Financial Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51, (FIN 46), which addresses the consolidation by business enterprises of variable interest entities as defined therein and applies immediately to variable interests in
variable interest entities created or obtained after January 31, 2003. The Company adopted FIN 46 on January 31, 2003 with no impact on its results of operations and financial position.

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Interest Rate Risk.We generally invest our cash in money market
funds and corporate debt securities that are subject to minimal credit and market risk considering that they are 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. The interest rates on our customer advances and capital lease obligations approximate the market rates for comparable instruments and are fixed. We believe the market risks associated with these financial instruments are
minimal.

Foreign Currency Risk.We face foreign currency risks primarily as a result of the revenues we receive from sales made outside the U.S. and
from intercompany account balances between our U.S. parent and our international subsidiaries. In the first quarter 2003, approximately 44.2% of our net sales and 34.8% 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 Australian dollar, Euro, Canadian dollar,
British Pound Sterling and Danish Krone 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 or 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 to manage our foreign currency exposure. Average currency exchange rates to convert one U.S. dollar into each local currency for the quarters ended March 31, 2003 and 2002 were as follows:



|                       |  | 2003 |  | 2002 | 
|---------------------- |  | ---- |  | ---- | 
|                       |  |      |  |      | 
|Australian dollar      |  | 1.69 |  | 1.93 | 
|Euro                   |  | 0.93 |  | 1.14 | 
|Canadian dollar        |  | 1.51 |  | 1.59 | 
|British pound sterling |  | 0.62 |  | 0.70 | 
|Danish krone           |  | 6.93 |  | 8.48 | 

ITEM 4.

CONTROLS AND PROCEDURES

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (Exchange Act), within the 90 days prior to the
filing date of this report, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision of our Chief Executive Officer and Chief
Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the date we carried out the evaluation.

Disclosure controls and procedures are controls and other
procedures that are designed to ensure that information required to be disclosed in Company reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and
Exchange Commissions rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated
to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

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FACTORS THAT MAY AFFECT FUTURE PERFORMANCE

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

WE HAVE A HISTORY OF LOSSES AND NEGATIVE OPERATING CASH FLOWS

We incurred a net loss of $0.8 million in the quarter ended March 31, 2003, and have an accumulated deficit of $52.4 million at March 31, 2003. Cash and marketable securities declined from $35.6 million at December 31, 2002 to $33.8 million
at March 31, 2003. We may incur net losses and negative operating cash flows in the future. Whether or not we achieve and maintain profitability will depend in significant part on increasing our net sales, maintaining or improving our gross margin
and reducing, or limiting increases to, our operating expenses. Consequently, it is possible that we will not achieve or maintain profitability, or increase profitability on a quarterly or annual basis in the future.

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

We encounter aggressive competition from a number of competitors worldwide, six of which have far greater sales and more extensive financial and business resources than we have. Some of our competitors have invested in
or advanced money, offered forgivable loans and provided other monetary incentives to retail hearing aid operations. Although we have implemented similar programs on a limited basis, we may not choose to, or be able to, match these incentives, which
could put us at a competitive disadvantage. Most of our competitors have introduced less expensive digital hearing aids, which could have the effect of limiting our market penetration, and has caused us to introduce less expensive products, which
will likely depress the overall average selling price of our products.

In addition, competitors may purchase or establish their own network of owned or franchised retail hearing
aid operations, which could cause us to lose existing customers. If we fail to compete effectively, our net sales and operating results will suffer.

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

Our quarterly and annual operating results have fluctuated in the past and may fluctuate
significantly in the future. These fluctuations could cause our stock price to fluctuate significantly or decline. Factors that may cause fluctuations in our operating results include the following: demand for and market acceptance of our products;
cancellation of or a reduction in orders from larger customers; manufacturing problems; high levels of returns, remakes and repairs; changes in our product or customer mix; competitive pressures resulting in lower selling prices or significant
promotional costs; unanticipated delays or problems in the introduction of new products; inability to forecast revenue accurately; nonpayment of accounts and notes receivable; write-offs of intangible assets created as a result of acquisitions; and
the announcement or introduction of new products or services by our competitors.

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

WE HAVE MADE A NUMBER OF ACQUISITIONS AND ANTICIPATE MAKING ADDITIONAL ACQUISITIONS, WHICH COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS, DILUTE THE EQUITY OF OUR SHAREHOLDERS AND HARM OUR
OPERATING RESULTS

We may not be able to meet performance expectations for, or successfully integrate, businesses we have acquired or may acquire on a timely basis or at all.
To manage the expansion of our operations and future growth, we will be required to (i) improve financial and management information controls and reporting systems and procedures; (ii) hire, train and manage additional qualified personnel; (iii)
expand our direct and indirect sales channels; and (iv) transition acquired businesses to sell more of our branded products.

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As part of our business strategy, we expect that we will continue to make acquisitions that complement or expand our existing business. Our acquisition of
businesses and expansion of operations involve risks, including (i) the inability to successfully integrate acquired businesses or to realize anticipated synergies, economies of scale or other expected value; (ii) difficulties in managing and
coordinating operations at new sites; (iii) loss of key employees of acquired businesses; (iv) loss of key customers of acquired businesses, (v) diversion of managements attention from other business concerns; and (vi) risks of entering
markets in which we have no direct or limited prior experience.

Acquisitions of other businesses may result in the utilization of cash and marketable securities, dilutive
issuances of equity securities and the incurrence of debt. In addition, acquisitions may (i) result in the creation of certain definite-lived intangible assets that increase amortization expense, or (ii) result in the creation of goodwill and other
indefinite-lived intangible assets that subsequently may result in large write-offs should these assets become impaired.

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

We anticipate that our operating results in any given period will
continue to depend somewhat upon revenues from a small number of larger customers. Our customers are not generally contractually obligated to purchase any fixed quantities of products, and they may stop placing orders with us at any time. We may be
unable to retain our current customers, and may be unable to recruit replacement or additional customers. We are selling an increasing number of hearing aids to several audiology clinic consolidators that have a large number of owned or franchised
retail hearing aid clinics. We are subject to the risk of losing our larger customers, incurring significant reductions in sales to these customers or reducing future prices in order to maintain our business. In addition, we are subject to the risk
of being unable to collect accounts and notes receivable balances from these customers. We had one hearing aid customer who accounted for 5% of net sales in the first quarter 2003, 7% of net sales in 2002 and 10% of net sales in 2001. This customer
accounted for 5% of our gross accounts receivable balance at March 31, 2003.

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

We are currently a defendant in a lawsuit filed in October 2000 claiming that we and certain of our officers and
directors violated federal securities laws by providing materially false and misleading information, or concealing information, about our relationship with Starkey Laboratories, Inc. This lawsuit, which is pending in the U.S. District Court for the
District of Utah, is being brought as a class action on behalf of all purchasers of our common stock from May 2, 2000 to October 24, 2000 and seeks damages in an unspecified amount. We deny the allegations in this action and will defend ourselves
vigorously; however, litigation is inherently uncertain and there can be no assurance that we will not be materially affected. Discovery has commenced, but no class has been certified and no trial date has been scheduled.

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

Certain components used in our products are currently available only from a single or limited number of suppliers. For example, our
proprietary digital signal processing chips are manufactured by a single supplier. Our relationship with this supplier is critical to our business because only a small number of suppliers would be able or willing to produce our chips in the
relatively small quantities and with the exacting specifications we require. This supplier may not be willing or able to satisfy our future advanced technology requirements. Under our agreement with this supplier, we are required to make minimum
annual purchases, which may be higher than our requirements. The receivers and microphones used in all our products are available from only two suppliers. We also rely on contractors for certain hearing aid component assembly and advanced integrated
circuit design and development and are therefore subject to their performance, over which we have little control. We may be forced to cease producing our products if we experience significant shortages of critical components from these key suppliers
or lose the services of our contractors. Finding a substitute part, process, supplier or contractor may be expensive, time-consuming or impossible.

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

We generally offer a 60-day return policy
and a minimum of a one-year warranty on our hearing aids and a no return policy on our component sales. Sales returns were $3.6 million in the first quarter 2003, $16.3 million in 2002 and $15.7 million in 2001. Warranty costs for remakes and
repairs were $0.7 million in the first quarter 2003, $3.1 million in 2002 and $2.7 million in 2001. We may not be able to attain lower levels of returns, remakes and repairs and, in fact, these levels may increase, which could reduce our net sales
and operating results.

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IF WE FAIL TO DEVELOP NEW AND INNOVATIVE PRODUCTS, OUR COMPETITIVE POSITION WILL SUFFER, AND IF OUR NEW PRODUCTS DO NOT GAIN MARKET SHARE AS RAPIDLY AS
WE ANTICIPATE, OUR OPERATING RESULTS WILL SUFFER

In order to be successful, we must develop new products and be a leader in the commercialization of new technology
innovations in the hearing aid market. Technological innovation is expensive and unpredictable and may require hiring (i) expert personnel who are difficult to find and attract, or (ii) external vendors to perform complex tasks. Without the timely
introduction of new products, our existing products are likely to become technologically obsolete over time, which would harm our business. We may not have the technical capabilities necessary to develop further technologically innovative products.
In addition, any enhancements to, or new generations of, our products, even if successfully developed, may not generate revenue in excess of the costs of development. Our products may be rendered obsolete by changing consumer preferences or the
introduction of products embodying new technologies or features by us or our competitors. If our products do not gain market share as rapidly as we anticipate, our net sales and operating results will suffer.

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

To be successful, we must manufacture our products in commercial quantities in compliance with regulatory requirements at
acceptable costs. We may not be able to expand our manufacturing capabilities at acceptable costs or enter into agreements with third parties with respect to these activities. We would incur significant expenses if we expanded our facilities and
hired additional personnel.

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

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

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

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

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

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

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

We anticipate that international sales will continue to account for a material portion of our net sales. Our reliance on international operations exposes us to related risks and uncertainties which,
if realized, could cause our international sales and operating results to decrease. For example, in order to market our products in the European Union (EU), we are required to have the EUs CE

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Mark certification. Any failure to maintain our CE Mark certification would significantly reduce our net sales and operating results. In addition, we face
foreign currency risks primarily as a result of the revenues we derive from sales made outside the U.S. and from the intercompany account balances between our U.S. parent company and our non-U.S. subsidiary companies. Fluctuations in the exchange
rates between the U.S. dollar and other currencies could affect the sales price of our products in international markets where the prices of our products are denominated in U.S. dollars or lead to currency exchange losses where the prices of our
products are denominated in local currencies.

WE MAY NOT BE ABLE TO MAINTAIN OR EXPAND OUR BUSINESS IF WE ARE UNABLE TO HIRE AND RETAIN SUFFICIENT TECHNICAL AND SALES
PERSONNEL

Competition for qualified personnel in technology industries can be intense. If we are unable to hire and retain sufficient technical and sales personnel our
business and operating results may suffer.

IF OUR STOCK PRICE DOES NOT INCREASE, WE MAY HAVE DIFFICULTY RETAINING KEY EMPLOYEES

Stock options are an important component of the compensation of our key personnel. If our stock price does not increase in the future, we may face difficulty retaining key employees and may need to exchange existing
options for new options or issue new options to motivate and retain our key employees, which would be dilutive to the equity of our shareholders.

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

Although we have not experienced any significant product liability issues to
date, we may be held liable if any product we develop causes injury or is found otherwise unsuitable. If we are sued for an injury caused by our products, the resulting liability could result in significant expense beyond our products liability
insurance limits, which would harm our operating results.

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

Our products are considered to be medical devices and are, accordingly, subject to regulation in the U.S. by the Food and Drug Administration (FDA). We
must comply with facility registration and product listing requirements of the FDA and adhere to its Quality System Regulations. Noncompliance with applicable FDA requirements can result in fines, injunctions, civil penalties, recall or seizure of
products, total or partial suspension of production or criminal prosecution.

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

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

THERE MAY BE SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK BY VENTURE CAPITAL SHAREHOLDERS OR OUR DIRECTORS AND OFFICERS, AND THESE SALES COULD CAUSE OUR STOCK PRICE TO FALL

Sales of substantial amounts of our common stock in the public market, or the perception that such sales will occur, could adversely affect the market price of our common stock. Approximately
5.5 million of our outstanding shares of common stock continue to be held by venture capital firms that have not yet distributed their shares to their limited partners. In addition, some of our officers have adopted trading plans under SEC Rule
10b5-1 in order to dispose of a portion of their shares in an orderly manner. Other officers or directors may adopt such a trading plan in the future.

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

Our officers, directors and their affiliated entities
together control over 19% of our outstanding common stock. As a result, these shareholders, if they acted together, would be able to exert a significant degree of influence over matters requiring shareholder approval, including the election of
directors and approval of significant corporate transactions. In addition, this concentration of ownership may delay or prevent a change in control, which could cause our stock price to decline.

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

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

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##### Table of Contents

PART II - OTHER INFORMATION

ITEM
1.

LEGAL PROCEEDINGS

The Company is a defendant in a lawsuit filed in October 2000 claiming that the Company and certain of its officers and directors
violated federal securities laws by providing materially false and misleading information, or concealing information, about the Companys relationship with Starkey Laboratories, Inc. This lawsuit, which is pending in the U.S. District Court for
the District of Utah, is being brought as a class action on behalf on all purchasers of the Companys common stock from May 2, 2000 to October 24, 2000 and seeks damages in an unspecified amount. The Company strongly denies the allegations in
this action and will defend itself vigorously; however, litigation is inherently uncertain and there can be no assurance that the Company will not be materially and adversely affected. Discovery has commenced, but no class has been certified and no
trial has been scheduled.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Companys annual meeting of shareholders was held on May 1, 2003. Directors elected at the
meeting were:



|Director           |  | For        |  | Withheld | 
|------------------ |  | ---------- |  | -------- | 
|                   |  |            |  |          | 
|Andrew G. Raguskus |  | 16,884,313 |  | 79,215   | 
|Lawrence C. Ward   |  | 16,851,235 |  | 112,293  | 

Other directors whose terms of office continued after the meeting were as follows: Lewis S.
Edelheit, Anthony B. Evnin, Kevin J. Ryan and Samuel L. Westover. Allan M. Wolfe did not stand for re-election.

One other item of business concerned the ratification of the
appointment of KPMG LLP as the Companys independent auditors, which was approved as follows:



|                                                                    |  | For        |  | Against |  | Abstain | 
|------------------------------------------------------------------- |  | ---------- |  | ------- |  | ------- | 
|                                                                    |  |            |  |         |  |         | 
|Ratification of the appointment of KPMG LLP as independent auditors |  | 16,939,204 |  | 23,024  |  | 1,300   | 

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

(a)

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



|Exhibit # |  | Description                                                                                    
|--------- |  | -----------------------------------------------------------------------------------------------
|          |  |                                                                                                
|99.1      |  | Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
|          |  |                                                                                                
|99.2      |  | Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002.

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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 14, 2003



| |  |  |  | /s/ STEPHENL.WILSON                                               
| |  |  |  | ------------------------------------------------------------------
| |  |  |  |                                                                   
| |  |  |  | Stephen L. WilsonSenior Vice President and Chief Financial Officer

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CERTIFICATION PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934AS ADOPTED PURSUANT TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Andrew G. Raguskus, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sonic Innovations,
Inc.

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge,
the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this quarterly report;

4. The registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants
board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect
the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal controls; and

6. The registrants other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

May 14,
2003



| |  |  |  | /s/ ANDREWG.RAGUSKUS                                   
| |  |  |  | -------------------------------------------------------
| |  |  |  |                                                        
| |  |  |  | Andrew G. RaguskusPresident and Chief
Executive Officer

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CERTIFICATION PURSUANT TO RULE 13A-14 OF THE SECURITIES EXCHANGE ACT OF 1934AS ADOPTED PURSUANT
TOSECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Stephen L. Wilson, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sonic Innovations, Inc.

2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly
report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrants other
certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and procedures as of
a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrants other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrants internal controls; and

6. The registrants other certifying officer and I have indicated in this quarterly report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material
weaknesses.

May 14, 2003



| |  |  |  | /s/ STEPHENL.WILSON                           
| |  |  |  | ----------------------------------------------
| |  |  |  |                                               
| |  |  |  | Stephen L. WilsonSenior Vice President and
CFO

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