<PAGE>

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                   FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
    ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001

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

                        Commission File No.  000-30335

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

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

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

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

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

                               [X]  Yes  [_]  No

As of August 3, 2001 there were 20,014,984 shares of the registrant's common
stock outstanding.
<PAGE>

                            SONIC INNOVATIONS, INC.
                               TABLE OF CONTENTS

                                   FORM 10-Q

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

ITEM 1. Condensed Consolidated Financial Statements (unaudited):

           Condensed Consolidated Balance Sheets as of June 30, 2001
           and December 31, 2000                                             1

           Condensed Consolidated Statements of Operations for the
           Three and Six Months Ended June 30, 2001 and 2000                 2

           Condensed Consolidated Statements of Cash Flows for the
           Six Months Ended June 30, 2001 and 2000                           3

           Notes to Condensed Consolidated Financial Statements              4

ITEM 2. Management's Discussion and Analysis of Financial Condition
         and Results of Operations                                           7

ITEM 3. Quantitative and Qualitative Disclosures about Market Risks         10

        Factors That May Affect Future Performance                          10

PART II OTHER INFORMATION

ITEM 1. Legal Proceedings                                                   15

ITEM 2. Changes in Securities and Use of Proceeds                           15

ITEM 4. Submission of Matters to a Vote of Security Holders                 16

ITEM 6. Exhibits and Reports on Form 8-K                                    16

        Signature                                                           16
</TABLE>
<PAGE>

PART I  FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

<TABLE>
<CAPTION>
                                                               June 30, 2001     December 31, 2000
                                                               -------------     -----------------
<S>                                                            <C>               <C>
                                    ASSETS
Current assets:
Cash and cash equivalents.................................       $  8,878            $  7,312
Marketable securities.....................................         29,145              44,898
Accounts receivable, net..................................          6,249               9,881
Inventories...............................................          6,969               7,418
Prepaid expenses and other................................            768                 667
                                                                 --------            --------

     Total current assets.................................         52,009              70,176

Long-term marketable securities...........................         14,945                   -
Property and equipment, net...............................          4,057               4,202
Other assets..............................................          2,123               1,870
                                                                 --------            --------

     Total assets.........................................       $ 73,134            $ 76,248
                                                                 ========            ========

                    LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable and accrued expenses.....................       $ 10,745            $ 10,899
Current portion of long-term obligations..................            476                 627
                                                                 --------            --------

     Total current liabilities............................         11,221              11,526

Long-term obligations, net of current portion.............            282                 451

Shareholders' equity:
Common stock..............................................             20                  20
Additional paid-in capital................................        112,030             111,633
Deferred stock-based compensation.........................           (855)             (1,346)
Accumulated deficit and comprehensive loss................        (49,546)            (46,036)
Treasury stock, at cost...................................            (18)                  -
                                                                 --------            --------

     Total shareholders' equity...........................         61,631              64,271
                                                                 --------            --------

     Total liabilities and shareholders' equity...........       $ 73,134            $ 76,248
                                                                 ========            ========
</TABLE>

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

                                       1
<PAGE>

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

<TABLE>
<CAPTION>
                                                                               Three months ended             Six months ended
                                                                                    June 30,                       June 30,
                                                                          --------------------------    --------------------------
<S>                                                                       <C>             <C>           <C>             <C>
                                                                             2001            2000          2001            2000
                                                                          ----------      ----------    ----------      ----------
Net sales............................................................        $11,552         $13,121       $26,585         $25,517
Cost of sales........................................................          6,862           6,544        14,662          12,657
                                                                          ----------      ----------    ----------      ----------


     Gross profit....................................................          4,690           6,577        11,923          12,860

Selling, general and administrative expense..........................          5,583           4,753        11,180           9,037
Research and development expense.....................................          2,310           2,026         4,599           3,882
Stock-based compensation expense.....................................            214             604           440           1,311
                                                                          ----------      ----------    ----------      ----------


Operating loss.......................................................         (3,417)           (806)       (4,296)         (1,370)

Other income (expense), net..........................................            502            (452)        1,131          (1,189)
                                                                          ----------      ----------    ----------      ----------


Net loss.............................................................         (2,915)         (1,258)       (3,165)         (2,559)

Accretion on mandatorily redeemable convertible preferred stock......              -            (261)            -            (959)
                                                                          ----------      ----------    ----------      ----------


Net loss applicable to common stockholders...........................        $(2,915)        $(1,519)      $(3,165)        $(3,518)
                                                                          ==========      ==========    ==========      ==========


Basic and diluted net loss per common share..........................        $  (.15)        $  (.12)      $  (.16)        $  (.49)
                                                                          ==========      ==========    ==========      ==========


Weighted average number of common shares outstanding.................         19,932          12,864        19,890           7,191
                                                                          ==========      ==========    ==========      ==========

Pro forma information (see note 9):

Net loss applicable to common shareholders...........................                        $  (582)                      $(1,519)
                                                                                          ==========                    ==========


Basic and diluted net loss per common share..........................                        $  (.03)                      $  (.09)
                                                                                          ==========                    ==========


Weighted average number of common shares outstanding.................                         17,944                        16,413
                                                                                          ==========                    ==========

Stock-based compensation allocable to each caption:

Cost of sales........................................................        $    11         $    28       $    20         $    61
Selling, general and administrative expense..........................            175             495           360           1,074
Research and development expense.....................................             28              81            60             176
                                                                          ----------      ----------    ----------      ----------

                                                                             $   214         $   604       $   440         $ 1,311
                                                                          ==========      ==========    ==========      ==========
</TABLE>

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

                                       2
<PAGE>

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

<TABLE>
<CAPTION>
                                                                                                  Six months ended
                                                                                                      June 30,
                                                                                           -----------------------------
                                                                                                2001             2000
                                                                                           --------------    -----------
<S>                                                                                        <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................................................      $ (3,165)       $ (2,559)
Adjustments to reconcile net loss to net cash provided by (used in)
 operating activities:
  Depreciation and amortization.........................................................           778             772
  Imputed interest......................................................................            --           1,244
  Stock-based compensation..............................................................           440           1,311
Changes in assets and liabilities:
   Accounts receivable..................................................................         3,388          (5,800)
   Inventories..........................................................................           328          (1,798)
   Prepaid expenses and other...........................................................          (114)             65
   Other assets.........................................................................           255             536
   Long-term obligations................................................................          (100)             --
   Accounts payable and accrued expenses................................................           (60)            307
                                                                                              --------        --------

     Net cash provided by (used in) operating activities................................         1,750          (5,922)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment......................................................          (652)         (1,043)
Increase in other assets................................................................          (500)             --
Purchase of marketable securities.......................................................       (30,258)         (5,764)
Proceeds from marketable securities.....................................................        31,066              --
                                                                                              --------        --------

     Net cash used in investing activities..............................................          (344)         (6,807)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from initial public offering, net of costs.....................................            --          52,228
Proceeds from convertible promissory notes..............................................            --           6,000
Line of credit repayment................................................................            --          (1,966)
Principal payments on long-term obligations.............................................          (220)         (1,650)
Purchase of treasury stock..............................................................           (18)             --
Proceeds from exercise of stock options and employee stock purchases....................           449             634
                                                                                              --------        --------

     Net cash provided by financing activities..........................................           211          55,246

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS............................           (51)            169
                                                                                              --------        --------

NET INCREASE IN CASH AND CASH EQUIVALENTS...............................................         1,566          42,686
CASH AND CASH EQUIVALENTS, beginning of the period......................................         7,312           5,939
                                                                                              --------        --------

CASH AND CASH EQUIVALENTS, end of the period............................................      $  8,878        $ 48,625
                                                                                              ========        ========
SUPPLEMENTAL CASH FLOW INFORMATION:
  Cash paid for interest................................................................      $     58        $    153

SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING AND INVESTING
 ACTIVITIES:
  Mandatorily redeemable convertible preferred stock accretion..........................      $     --        $    959
  Conversion of convertible promissory notes and related accrued
    interest to equity..................................................................      $     --        $ 15,104
  Conversion of preferred stock.........................................................      $     --        $ 37,430
</TABLE>

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

                                       3
<PAGE>

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

1. BASIS OF PRESENTATION

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

   The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with U.S. generally accepted accounting principles
for interim financial information, and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the
information and footnotes required by U.S. generally accepted accounting
principles for complete financial statements.  In the opinion of management, all
adjustments (consisting only of normal recurring adjustments) considered
necessary for a fair presentation have been included. The results of operations
for the three and six month periods ended June 30, 2001 are not necessarily
indicative of results that may be expected for the full year ending December 31,
2001.  For further information, refer to the consolidated financial statements
and footnotes thereto included in the Company's Annual Report on Form 10-K for
the year ended December 31, 2000 as filed with the Securities and Exchange
Commission.

2. MARKETABLE SECURITIES

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

3. CONCENTRATIONS OF CREDIT RISK

   The Company had one customer that comprised 0% and 31% of net sales for the
three months ended June 30, 2001 and 2000, respectively, and 7% and 32% of net
sales for the six months ended June 30, 2001 and 2000, respectively.  See
"Factors that may affect future performance - The loss of any large customer or
a reduction in orders from any large customer could significantly reduce our net
sales and harm our operating results" elsewhere in this Report on Form 10-Q.

4. INVENTORIES

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

                                                  June 30,      December 31,
                                                    2001            2000
                                                ------------   --------------


Raw materials................................      $  928          $3,093
Components...................................       3,404           2,207
Work in progress.............................         488             536
Finished goods...............................       2,149           1,582
                                                ------------   --------------

Total........................................      $6,969          $7,418
                                                ============   ==============

5. COMPREHENSIVE LOSS

   Comprehensive loss consisted of the following:

                                 Three months ended         Six months ended
                                      June 30,                   June 30,
                                --------------------      --------------------
                                  2001        2000          2001        2000
                                --------    --------      --------    --------

Net loss......................  $(2,915)    $(1,258)      $(3,165)    $(2,559)
Foreign currency gain (loss)..      (90)         13          (345)         55
                                --------    --------      --------    --------

Comprehensive loss............  $(3,005)    $(1,245)      $(3,510)    $(2,504)
                                ========    ========      ========    ========

                                       4
<PAGE>

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

6. NET LOSS PER COMMON SHARE

   Basic and diluted net loss per common share were computed by dividing net
loss applicable to common shareholders by the weighted average number of common
shares outstanding. Common stock equivalents were not considered since their
effect would be antidilutive, thereby decreasing the net loss per common share.
As of June 30, 2001, common stock equivalents consisted of options for 3,013,513
shares and a warrant for 20,706 shares.

7. SEGMENT INFORMATION

   The table below presents selected information for the Company's geographic
operating segments for the three and six months ended June 30, 2001 and 2000.
U.S. net sales include export sales.

Three months ended June 30, 2001           United States   Europe     Total
--------------------------------           -------------   ------     -----

Net sales to external customers...........       $ 9,501   $2,051   $11,552
Operating loss............................        (3,310)    (107)   (3,417)

Three months ended June 30, 2000
--------------------------------

Net sales to external customers...........        11,379    1,742    13,121
Operating loss............................          (428)    (378)     (806)

Six months ended June 30, 2001
------------------------------

Net sales to external customers...........        21,810    4,775    26,585
Operating loss............................        (4,099)    (197)   (4,296)

Six months ended June 30, 2000
------------------------------

Net sales to external customers...........        21,933    3,584    25,517
Operating loss............................          (978)    (392)   (1,370)

8. INITIAL PUBLIC OFFERING (IPO)

   The Company filed a registration statement with the Securities and Exchange
Commission that became effective on May 1, 2000 and sold 4,140 shares of common
stock at $14.00 per share. The Company received net proceeds of $52,228. In
connection with the IPO the following items were converted into common stock:
   . All outstanding convertible preferred stock into 12,533 shares of common
     stock;
   . $4,500 of convertible promissory notes (plus accrued interest) into 336
     shares of common stock at a conversion price equal to 100% of the IPO
     price;
   . $7,000 of convertible promissory notes (plus accrued interest) into 545
     shares of common stock at a conversion price equal to 93% of the IPO price;
   . $3,000 of convertible promissory notes issued on the closing of the IPO
     into 214 shares of common stock at a conversion price equal to 100% of the
     IPO price; and
   . Outstanding warrants to purchase 203 shares of common stock (net of 33
     shares surrendered in lieu of cash payment of the exercise price for
     certain warrants) at an exercise price of $3.80 per share.

                                       5
<PAGE>

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

9.  PRO FORMA INFORMATION

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

<TABLE>
<CAPTION>
                                                                                           Three months ended    Six months ended
                                                                                              June 30, 2000        June 30, 2000
                                                                                           ------------------    ----------------
  <S>                                                                                      <C>                   <C>
  Numerator:
  Net loss applicable to common shareholders...........................................               $(1,519)            $(3,518)
  Reversal of interest expense on convertible promissory notes.........................                   141                 505
  Reversal of accretion on convertible preferred stock.................................                   261                 959
  Reversal of beneficial conversion feature on certain convertible promissory notes....                   535                 535
                                                                                           ------------------    ----------------
  Pro forma net loss...................................................................               $  (582)            $(1,519)
                                                                                           ==================    ================

  Denominator:
  Weighted average common shares outstanding...........................................                12,864               7,191
  Conversion of convertible preferred stock............................................                 4,683               8,607
  Conversion of convertible promissory notes...........................................                   321                 475
  Exercise of warrants.................................................................                    76                 140
                                                                                           ------------------    ----------------
  Pro forma weighted average common shares outstanding.................................                17,944              16,413
                                                                                           ==================    ================
</TABLE>

10. SHARE REPURCHASE PROGRAM

    On May 9, 2001, the Board of Directors authorized the repurchase of up to
1,000 shares of the Company's common stock as market conditions warrant.
Through June 30, 2001, the Company has repurchased 3.7 shares of common stock
under this program.

11. LEGAL PROCEEDINGS

    The Company is currently a defendant in a lawsuit filed in October 2000
claiming that the Company and certain of its officers violated federal
securities laws by providing materially false and misleading information or
concealing information about the Company's relationship with Starkey
Laboratories, Inc. This lawsuit, which is pending in the U.S. District Court for
the District of Utah, purports to be brought as a class action on behalf of all
purchasers of the Company's common stock from May 2, 2000 to October 24, 2000
and seeks damages in an unspecified amount. The complaint alleges that as a
result of false statements or omissions, the Company was able to complete its
IPO, artificially inflate its 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.

    The Company had been accused of infringing two patents owned by SyberSay
Communications Corporation ("SyberSay," formerly Audio Technology Partners LLC).
The Company believed that it did not infringe these patents, and to that end,
commenced an action on August 4, 2000 in Federal District Court in Utah by which
it sought a declaratory judgment that the patents were invalid and not infringed
by the Company.  In July 2001, the companies reached an out-of-court settlement
in which both parties agreed to discontinue their claims against one another.
In doing so, the Company paid $225 to SyberSay for a small equity interest in
SyberSay, and also received a warrant to purchase additional shares and a paid-
up license to elements of their technology.

12. SUBSEQUENT EVENT

    Effective July 1, 2001, the Company purchased M-E Hearing Systems Pty, Ltd.
("M-E Hearing") for $5,000.  M-E Hearing, the Company's former Australian
distributor, operates 28 retail locations in Australia, as well as a wholesale
business supplying other companies' retail locations.  The acquisition will be
accounted for in accordance with Statement of Financial Accounting Standards No.
("FAS") 141 "Business Combinations" and FAS 142 "Goodwill and Other Intangible
Assets," both of which were issued in June 2001.  FAS 141 requires that all
acquisitions after June 30, 2001 be accounted for as purchases and FAS 142
requires that goodwill, estimated to be approximately $2,500, not be amortized,
but be subject to a periodic test of impairment.

                                       6
<PAGE>

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

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

OVERVIEW

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

RESULTS OF OPERATIONS

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

                                           Three months ended  Six months ended
                                                 June 30,           June 30,
                                           ------------------  ----------------
                                             2001       2000     2001     2000
                                             ----       ----     ----     ----

Net sales................................   100.0%     100.0%   100.0%   100.0%

Cost of sales............................    59.4       49.9     55.2     49.6
                                           ------     ------   ------   ------

Gross profit.............................    40.6       50.1     44.8     50.4

Selling, general and administrative......    48.3       36.2     42.0     35.4
Research and development.................    20.0       15.4     17.3     15.2
Stock-based compensation.................     1.9        4.6      1.7      5.2
                                           ------     ------   ------   ------

Operating loss...........................   (29.6)      (6.1)   (16.2)    (5.4)

Other income (expense)...................     4.4       (3.5)     4.3     (4.6)
                                           ------     ------   ------   ------

Net loss.................................   (25.2)%     (9.6)%  (11.9)%  (10.0)%
                                           ======     ======   ======   ======

    Net Sales.  Net sales consist of product sales less a provision for sales
returns which is made at the time of sales. We divide our sales into two
categories: branded product sales, which includes NATURA, ALTAIR and CONFORMA
hearing aids; and hearing aid component sales, which includes sales of our DSP
chip to several other hearing aid manufacturers.  Branded product sales were
$11,433 for the quarter ended June 30, 2001, a 45% increase from branded product
sales of $7,889 recorded for the quarter ended June 30, 2000.  By geography,
U.S. branded sales in the second quarter of $8,989 were up 62% from second
quarter 2000 sales of $5,542.  Sales of our ALTAIR line, which was introduced
last November, have continually increased since introduction and comprised 29%
of U.S. branded sales in Q2.  Outside the U.S., or OUS, branded sales in the
second quarter of $2,444 were up 4% from second quarter 2000 sales of $2,347.
Of our OUS sales, Europe sales of $2,051 were up 18% from second quarter sales
of $1,742; and to the rest of world, or ROW, sales of $393 were down 35% from
second quarter 2000 sales of $605.  The ROW shortfall principally related to

                                       7
<PAGE>

reduced orders from our Japanese distributor, Hoya Healthcare, which Hoya has
indicated is a reflection of the slow Japanese economy. Hearing aid component
sales in the second quarter were $119, down from second quarter 2000 component
sales of $5,232. The majority of the shortfall resulted from a reduction in
sales to Starkey Laboratories which were zero for the quarter ended June 30,
2001 compared to $4,061 for the quarter ended June 30, 2000. Revenue recognition
on a second quarter shipment to Starkey of $1,950 has been deferred pending
payment, which we expect to receive in the third quarter. As of August 14, 2001,
we have collected $1,300 of the $1,950 balance. In addition, there were no
component sales to our Japanese OEM customer, Rion, in the second quarter 2001
compared with sales to Rion of $1,171 in the second quarter 2000, reflecting the
slow Japanese economy.

   Branded product sales were $23,735 for the six months ended June 30, 2001, a
57% increase from branded product sales of $15,134 for the six months ended June
30, 2000.  U.S. branded sales in the first six months of 2001 were $17,658, up
66% from first half 2000 sales of $10,624.  U.S. branded sales growth was
favorably affected by the introduction of products containing our second
generation integrated circuitry, offset somewhat by a reduction in CONFORMA
sales.  OUS branded sales in the six months ended June 30, 2001 of $6,077 were
up 35% from first half 2000 sales of $4,510.  Of our OUS sales, Europe sales of
$4,775 were up 33% from first half 2000 sales of $3,584; and ROW sales of $1,302
were up 40% from first half 2000 sales of $926.  For the six months ended June
30, 2001, hearing aid component sales were $2,850, down from first half 2000
sales of $10,383.  The majority of the shortfall resulted from a reduction in
sales to Starkey Laboratories, which were $1,950 in first half 2001 compared to
$8,144 in first half 2000.  In addition, component sales to Rion were $733 in
the first half 2001 compared to sales of $2,239 in the first half 2000.

   We generally have a 60-day return policy for our branded products and a no
return policy for our component products. Sales returns were $3,985 and $2,966
for the quarters ended June 30, 2001 and 2000, respectively, and $7,747 and
$5,664 for the six months ended June 30, 2001 and 2000, respectively. Growth in
returns principally related to the increase in branded product sales from 2000
to 2001. We believe that the hearing aid industry, particularly in the United
States, experiences a high level of product returns due to factors such as
statutorily required liberal return policies and product performance
inconsistent with consumers' expectations. We believe our return levels are
within the range experienced by other hearing aid manufacturers with premium-
performance, premium-priced products.

   Cost of Sales. Cost of sales consists of manufacturing costs, royalty
expenses, quality assurance costs and costs associated with product returns,
remakes and repairs. Cost of sales was $6,862 for the quarter ended June 30,
2001, an increase of $318 (5%) from cost of sales of $6,544 for the quarter
ended June 30, 2000.  For the six months ended June 30, 2001, cost of sales was
$14,662, an increase of $2,005 (16%) from cost of sales of $12,657 for the six
months ended June 30, 2000.  As a percentage of net sales, gross margin was
40.6% for the quarter ended June 30, 2001 compared to 50.1% for the quarter
ended June 30, 2000 and 44.8% for the six months ended June 30, 2001 compared to
50.4% for the six months ended June 30, 2000.  This is a result of a decrease in
higher margin hearing aid component sales, price erosion on all products and an
increase in sales of our lower margin ALTAIR line, offset somewhat by the fixed
costs of our manufacturing operations being spread over a greater sales level
and operating efficiencies derived from producing at higher quantities.

   We provide for the cost of remaking and repairing products under warranty,
including hearing aid components. The warranty period ranges from one to three
years for branded products and 30 to 120 days for hearing aid components.
Warranty costs were $519 and $365 for the quarters ended June 30, 2001 and 2000,
respectively, and $1,085 and $783 for the six months ended June 30, 2001 and
2000, respectively.  The increase is due to the growth of sales.

   Selling, General and Administrative. Selling, general and administrative
expense consists primarily of wages and benefits for sales and marketing
personnel, sales commissions, promotions and advertising, marketing support and
administrative expenses. Selling, general and administrative expense was $5,583
for the quarter ended June 30, 2001, an increase of $830 (17%) from selling,
general and administrative expense of $4,753 for the quarter ended June 30,
2000. For the first six months of 2001, selling, general and administrative
expense was $11,180, an increase of $2,143 (24%) from selling, general and
administrative expense of $9,037 for the six months ended June 30, 2001.  The
increase in selling, general and administrative expense for the three and six
months ended June 30, 2001 was primarily a result of increased sales headcount,
marketing programs and literature, convention expenditures and legal expenses.

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

   Research and Development. Research and development expense consists primarily
of wages and benefits for personnel, consulting, software, intellectual
property, clinical study and engineering support costs. Research and development
expense was $2,310 for the quarter ended June 30, 2001, an increase of $284
(14%) from the $2,026 recorded for the quarter ended June 30, 2000.  For the
first six months of 2001, research and development expense was $4,599, an
increase of $717 (18%) from the $3,882 recorded for the six months ended June
30, 2001.  The increase was principally the result of additional headcount,
establishing a business

                                       8
<PAGE>

development function and increased expenses in the areas of new product
introduction and sustaining engineering. We are making continual efforts to
improve our existing products as well as to develop new products because we
believe that new and better products are critical to our long-term success. As a
result, we expect research and development expense to continue to increase in
absolute dollars, although not necessarily as a percentage of sales.

   Stock-based Compensation. Deferred stock-based compensation represents the
difference between the exercise price and the deemed fair value of our common
stock on the grant date for stock options granted in the one-year period
preceding the initial filing of our IPO and is being amortized over the vesting
periods of the individual stock options, periodically adjusted for employee
separations.  For the quarters ended June 30, 2001 and 2000, stock-based
compensation expense was $214 and $604, respectively.  For the six months ended
June 30, 2001 and 2000, stock-based compensation expense was $440 and $1,311,
respectively.   As of June 30, 2001, deferred stock-based compensation of $855
is expected to be amortized as follows:

     July 1, 2001 to December 31, 2001...................   $337
     2002................................................    358
     2003................................................    123
     2004................................................     26
     2005................................................     11
                                                            ----

                                                            $855
                                                            ====

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

<TABLE>
<CAPTION>
                                              Three months ended   Six months ended
                                                    June 30,           June 30,
                                              ------------------   ----------------
                                                2001      2000       2001      2000
                                                ----      ----       ----      ----
     <S>                                      <C>        <C>       <C>      <C>
     Interest income........................   $ 663     $ 489     $1,395   $   496
     Interest expense.......................     (58)      (57)       (82)     (159)
     Foreign currency exchange loss.........     (51)     (106)      (111)     (283)
     Non-cash imputed interest expense......       -      (778)         -    (1,243)
     Loss on disposal of assets and other...     (52)        -        (71)        -
                                               -----     -----     ------   -------
                                               $ 502     $(452)    $1,131   $(1,189)
                                               =====     =====     ======   =======
</TABLE>

   Interest income increased significantly due to investing the IPO proceeds
which were received in May 2000.  Interest expense decreased because certain
debt was repaid with proceeds from the IPO.

   Non-cash imputed interest expense of $778 and $1,243 for the three and six
months ended June 30, 2000, respectively related to the following:

   .  Imputed interest charges on bank financing issued with warrants as a
      result of allocating the financing's proceeds between the debt and
      warrants of $102 and $204, respectively;
   .  Beneficial conversion feature offered on certain convertible debt of $535
      for the three and six months ended June 30, 2000;
   .  Imputed interest charges on convertible debt financing issued with
      warrants as a result of allocating the financing's proceeds between the
      debt and warrants of $79 and $316, respectively; and
   .  Interest accrued on converted debt of $62 and $188, respectively.

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

   Net Loss.  Net loss for the three and six months ended June 30, 2001 was
$2,915 ($.15 per share) and $3,165 ($.16 per share), respectively based on
shares outstanding of 19,932 and 19,890, respectively.  Pro forma net loss for
the three and six months ended June 30, 2000 was $582 ($.03 per share) and
$1,519 ($.09 per share), based on shares outstanding of 17,944 and 16,413,
respectively (see note 9 to the condensed consolidated financial statements).

                                       9
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

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

  Net cash provided by operating activities of $1,750 for the six months ended
June 30, 2001 resulted principally from a decrease in accounts receivable of
$3,388.  This decrease more than offset the net loss of $3,165, which included
$1,218 of non-cash expenses pertaining to depreciation, amortization and stock-
based compensation.

  Net cash used in investing activities of $344 for the six months ended June
30, 2001 consisted mainly of a $500 note to a business partner, offset by net
proceeds from the maturity of marketable securities of $808 and purchases of
property and equipment of $652.  We purchased M-E Hearing for $5,000 in July
2001.

  Net cash provided by financing activities of $211 for the six months ended
June 30, 2001 consisted of repayment of long-term obligations, offset by
proceeds from stock option exercises and shares sold under the Company's
employee stock purchase plan.  At June 30, 2001, we had $52,968 in cash, cash
equivalents and marketable securities.

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

NEW ACCOUNTING STANDARDS

  In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. ("FAS") 141, "Business Combinations"  and FAS
142, "Goodwill and Other Intangible Assets".  FAS 141 addresses the initial
recognition and measurement of goodwill and other intangible assets acquired in
a business combination. FAS 142 addresses the initial recognition and
measurement of intangible assets acquired outside of a business combination,
whether acquired individually or with a group of other assets, and the
accounting and reporting for goodwill and other intangibles subsequent to their
acquisition. These standards require all future business combinations to be
accounted for using the purchase method of accounting.  Goodwill will no longer
be amortized, but instead will be subject to an impairment test each reporting
period. We are required to adopt FAS 141 and FAS 142 on a prospective
basis as of January 1, 2002; however, certain provisions of these new standards
will apply to our acquisition of M-E Hearing in July 2001.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

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

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

FACTORS THAT MAY AFFECT FUTURE PERFORMANCE

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

                                       10
<PAGE>

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

  We have an accumulated deficit of $49.5 million at June 30, 2001. We incurred
a net loss of $3.2 million and negative cash flow of $7.1 million from operating
activities for the year ended December 31, 2000, and a net loss of $3.2 million
for the six month period ended June 30, 2001.  We have not achieved
profitability on an annual basis. We may incur net losses and negative cash
flows in the future. We expect to increase our operating expenses and therefore,
must generate additional revenue to achieve profitability. The size of our
losses and whether or not we achieve profitability will depend in significant
part on the rate of growth of our net sales. Consequently, it is possible that
we will not achieve profitability, and even if we do achieve profitability, we
may not sustain or increase profitability on a quarterly or annual basis in the
future.

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

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

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

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

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

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

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

  We also sell hearing aid components to a limited number of hearing aid
manufacturers.  These arrangements have accounted for a significant portion of
our net sales to date.  The loss of any of these large customers, or a
significant reduction in sales to these customers, would significantly reduce
our net sales and have a negative effect on our operating results.  Sales of
components to Starkey Laboratories, Inc. accounted for $12.3 million, or 24%, of
net sales for the year ended December 31, 2000 and $2.0 million, or 7%, of net
sales for the six months ended June 30, 2001.  We shipped an additional $2.0
million of components to Starkey in April 2001 and will recognize revenue when
the payment is received, which we expect in the third quarter.  We are subject
to the risk of collecting this account, which has a remaining balance of $.6
million at August 14, 2001.  We do not anticipate any further orders from
Starkey.  Accordingly, our net sales and operating results may decline and our
gross margin will be negatively affected.

                                       11
<PAGE>

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

  We are currently a defendant in a lawsuit filed in October 2000 claiming that
we and certain of our officers violated federal securities laws by providing
materially false and misleading information, or concealing information, about
our relationship with Starkey Laboratories, Inc.  This lawsuit, which is pending
in the U.S. District Court for the District of Utah, is being brought as a class
action on behalf of all purchasers of our common stock from May 2, 2000 to
October 24, 2000 and seeks damages in an unspecified amount. The complaint
alleges that as a result of false statements or omissions, we were able to
complete our IPO, artificially inflate our projections and results and have our
stock trade at inflated levels. We strongly deny these allegations and will
defend ourselves vigorously; however, litigation is inherently uncertain and
there can be no assurance that we will not be materially affected. We anticipate
that we will incur associated litigation expense in connection with this action.

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

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

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

  We launched NATURA, our first hearing aid line, in the fourth quarter 1998. We
introduced our CONFORMA product in the first quarter 2000; our second generation
NATURA line, NATURA 2SE, and our second-generation CONFORMA product, CONFORMA
2SE, in the second quarter 2000; and our ALTAIR line in the fourth quarter 2000.
Accordingly, we have a limited selling history on which investors can base an
evaluation of our products, business and prospects.  Our revenue and income
potential are unproven, and our business model will continue to evolve.  For
example, our "SE" products, which contain a noise reduction feature that we
introduced in the second quarter 2000, and our ALTAIR line, which we introduced
in the fourth quarter 2000, now comprise the majority of our branded product
sales.  If our current and new products do not gain market share as rapidly as
we anticipate, our net sales and operating results will suffer.

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

  We generally offer a 60-day return policy and a minimum of a one-year warranty
on our branded products. Our components warranty is generally 30 to 120 days. To
date, we have experienced high levels of returns, remakes and repairs. Sales
returns were $12.9 million for the year ended December 31, 2000 and $7.7 million
for the six months ended June 30, 2001. Warranty costs for remakes and repairs
were $1.6 million for the year ended December 31, 2000 and $1.1 million for the
six months ended June 30, 2001. We may not be able to attain lower levels of
returns, remakes and repairs and, in fact, these levels may increase, which
could reduce our net sales and operating results.

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

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

                                       12
<PAGE>

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

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

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

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

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

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

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

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

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

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

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

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

                                       13
<PAGE>

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

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

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

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

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

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

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

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

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

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

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

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

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

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

                                       14
<PAGE>

in order to dispose of a portion of their shares in an orderly manner. Other
officers or directors may adopt such a trading plan in the future.

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

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

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

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

PART II  OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

  We are currently a defendant in a lawsuit filed in October 2000 claiming that
we and certain of our officers violated federal securities laws by providing
materially false and misleading information or concealing information about 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 our 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, we were able to
complete our IPO, artificially inflate our projections and results and have our
stock trade at inflated levels. We strongly deny these allegations and will
defend ourselves vigorously; however, litigation is inherently uncertain and
there can be no assurance that we will not be materially affected.   We
anticipate that we will incur associated legal expenses as a result of this
legal proceeding.

    The Company had been accused of infringing two patents owned by SyberSay
Communications Corporation ("SyberSay," formerly Audio Technology Partners
LLC). The Company believed that it did not infringe these patents, and to that
end, commenced an action on August 4, 2000 in Federal District Court in Utah by
which it sought a declaratory judgment that the patents were invalid and not
infringed by the Company. In July 2001, the companies reached an out-of-court
settlement in which both parties agreed to discontinue their claims against one
another. In doing so, the Company paid $.2 million to SyberSay for a small
equity interest in SyberSay, and also received a warrant to purchase additional
shares and a paid-up license to elements of their technology.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

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

    Of the $58.0 million in aggregate proceeds we raised in the IPO, (i) $4.1
million was paid to underwriters in connection with the underwriting commission,
and (ii) approximately $1.7 million was paid in connection with offering
expenses, printing fees, filing fees, and legal and accounting fees. There were
no other direct or indirect payments to directors or officers of Sonic
Innovations or any other person or entity. Through June 30, 2001, $2.2 million
of the IPO proceeds were used to purchase property and equipment and $8.4
million was used to fund working capital increases. The balance has been
invested in investment-grade debt securities and money market instruments. These
funds may be used for general corporate purposes, including funding our
operations; expanding our capacity and business; further development and
commercialization of our products; research and development; repayment of
remaining capital lease obligations; working capital; and possible acquisitions
or investments. The amounts and timing of our actual expenditures for each of
these purposes may vary significantly depending upon numerous factors, including
customer order levels, the status of our product development efforts,
competition, marketing and sales activities and market acceptance of our
products. Pending use for these or other purposes, we intend to continue to
invest the balance of the IPO proceeds in short-term, investment-grade
securities. Effective upon the closing of the IPO, all previously outstanding
preferred stock and convertible promissory notes converted into common stock.

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<PAGE>

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

    Our annual meeting of shareholders was held on May 9, 2001 in Salt Lake
City, Utah. An election of Class I directors was held and the following
individuals were elected at the meeting as Class I directors:

                                                  For       Against   Withheld
                                               ----------   -------   --------
    Luke B. Evnin                              16,105,525         -    116,385
    Kevin J. Ryan                              16,105,525         -    116,385

    Other directors whose terms of office continued after the meeting were as
follows:

    Class II directors: Anthony B. Evnin, G. Gary Shaffer, Sigrid Van Bladel.
Ms. Van Bladel subsequently resigned from the Board of Directors, and Walter G.
Loewenbaum II was appointed to the Board in Ms. Van Bladel's place.

    Class III directors: Allan M. Wolfe, Andrew G. Raguskus.

    The only other item of business concerned the ratification of the auditors
which was approved as follows:

                                                  For       Against   Withheld
                                               ----------   -------   --------
    Re-appointment of the independent
    public accountants (Arthur Andersen LLP)   16,194,440    26,380      1,090


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

    None.

(b) Reports on Form 8-K.

    None.


                                   SIGNATURE

   Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


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


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