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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934



FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002



Commission File No. 000-30335



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SONIC INNOVATIONS, INC.

(Exact name of
registrant as specified in its charter)

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

2795 East Cottonwood Parkway, Suite 660

Salt Lake City, UT 84121-7036

(Address of principal executive offices)



(801) 365-2800

(Registrants telephone number, including area code)



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Securities registered pursuant to section 12(b) of the Act:



None



Securities registered pursuant to section 12(g) of the Act:



Common Stock ($.001 Par Value)



Preferred Stock Purchase Rights

(Title of class)



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



Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.  x



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended).  x



The aggregate market value of the voting stock
held by non-affiliates of the registrant was approximately $78.2 million as of June 28, 2002, when the closing sale price of the stock, as reported on the Nasdaq National Market was $7.07 per share. Shares of the registrants common stock
held by executive officers, directors and holders of five percent or more of the registrants common stock as of June 28, 2002 have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination.



As of
March 19, 2003, there were 19,826,155 shares of the registrants common stock outstanding.





DOCUMENTS INCORPORATED BY REFERENCE



Portions of the registrants Annual Report to Shareholders for the year ended December 31, 2002 are
incorporated by reference in Part II of this Form 10-K. Portions of the registrants Proxy Statement for the 2003 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.





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PART I



This Form 10-K contains forward-looking
statements that involve risks and uncertainties. These statements refer to our future results, plans, objectives, expectations and intentions, include details regarding the following; strengthened international sales capability; demographic trends
accelerating the growth of the hearing impaired population; increasing hearing aid sales over time; growth in the digital segment of the hearing aid market and our benefiting from that growth; hearing aid performance; direct-to-consumer advertising
and promotion campaigns; new distribution opportunities; continuance of product improvement and new product development; increasing price pressure and intense marketing campaigns; ability to compete effectively; exemption of future products and
enhancements from the FDAs 501(k) process; reductions in returns, rework and repairs; and significance of large customers. Our actual results could differ materially and adversely from those anticipated in such forward-looking statements.
Investors are cautioned not to place undue reliance on such statements, which speak only as of the date made. Factors that could contribute to these differences are discussed in detail in the section titled Factors That May Affect Future
Performance included in Item 1 of this Form 10-K for the year ended December 31, 2002. Investors should understand that it is not possible to predict or identify all such factors that could cause actual results to differ from expectations, and
we are under no obligation to update these factors.



ITEM
1. BUSINESS



Our Company



Sonic Innovations, Inc. designs, develops, manufactures and
markets advanced digital hearing aids designed to provide the highest levels of satisfaction for hearing impaired consumers. 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., Canada, Denmark, the U.K., Switzerland, Austria 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 we sell hearing aids on a retail basis to hearing impaired consumers. We occasionally
sell hearing aid components to other hearing aid manufacturers. We first began shipping product in the fourth quarter of 1998.



Our NaturaTM, AltairTM, TributeTMand QuartetTMproduct
lines, which incorporate our DSP platform, are among the smallest products available today and can be purchased in the five common models for hearing aids: behind-the-ear (BTE); in-the-ear (ITE); in-the-canal
(ITC); mini-canal (MC); and completely-in-the-canal (CIC). Our AdessoTMproduct,
which also incorporates our DSP platform, is a programmable, instant-fit, CIC model that is the smallest digital-based hearing aid available today.



We acquired seven hearing aid businesses outside the U.S. in 2002, five of which were existing distributors of our products. We believe
this has significantly strengthened our international sales capability. Our 2002 hearing aid sales increased 28% from 2001 levels in a market that we believe was down 1%. In explaining the decline in hearing aid sales from 2001 to 2002, we believe
economic conditions have caused some people to defer the purchase of a new hearing aid or to repair or recondition an existing hearing aid rather than purchase a new hearing aid.



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Industry Background



The Market



The market for hearing aids is very large and has substantial
unmet needs. Industry researchers estimate that approximately 10% of the population of the industrialized world suffers from hearing loss, but only about 2% actually use hearing aids. Said differently, the total population that could benefit from a
hearing aid, only about 21% of those people own a hearing aid. This is depicted in the chart below.



Hearing Aid Market by Segment Industrialized World



|Type of hearing impairment |  | Hearing impaired percentage by type |   |  | Percentage of hearing aid owners within each type |   |  | Percentage of total hearing impaired who are hearing aid owners |  
|-------------------------- |  | ----------------------------------- | - |  | ------------------------------------------------- | - |  | --------------------------------------------------------------- | -
|Mild/moderate              |  | 75                                  | % |  | 10                                                | % |  | 7.5                                                             | %
|Severe                     |  | 20                                  |   |  | 50                                                |   |  | 10.0                                                            |  
|Profound                   |  | 5                                   |   |  | 70                                                |   |  | 3.5                                                             |  
|                           |  |                                     |   |  |                                                   |   |  |                                                                 |  
|Total                      |  | 100                                 | % |  |                                                   |   |  | 21.0                                                            | %
|                           |  |                                     |   |  |                                                   |   |  |                                                                 |  



As seen
in the above chart, the use of hearing aids is particularly low in the mild/moderate segment of the hearing impaired population. Hearing impaired people in this segment, which comprises a very large percentage of the hearing impaired population,
often do not purchase hearing aids for a variety of reasons, including their belief that their hearing loss is not significant enough to warrant a hearing aid, their concern regarding the stigma associated with wearing a hearing aid and their
perception that existing hearing aids are inadequate, uncomfortable, unreliable, expensive and unattractive.



Despite this low level of market penetration and high degree of dissatisfaction, worldwide retail sales of hearing aids are estimated to
be approximately $5 billion and wholesale sales are estimated to be approximately $2 billion. We anticipate that demographic trends, such as the aging of baby boomers, will accelerate the growth in the size of the hearing impaired
population, which should result in increasing hearing aid sales over time.



The hearing aid market can be categorized into two segmentsanalog and digital. Digital hearing aids were first introduced in 1996 and currently represent an estimated 46% of U.S. hearing aid
sales and 33% of global hearing aid sales. Digital-based hearing aids continue to gain market share at the expense of older technology, analog-based hearing aids. This is particularly true as digital hearing aids become more affordable and closer in
price to analog hearing aids. The U.S. digital market grew significantly in 2002 despite a 1% reduction in the overall U.S. hearing aid market. We believe that as companies like ours continue to take advantage of the full potential of the digital
platform over the next several years, the percentage of sales from digital hearing aids will continue to increase significantly. As a digital-based hearing aid company, we expect to benefit from this movement.



Hearing Aids



Early generation hearing aids simply amplified previously
inaudible sounds to an audible level, which caused sounds that were comfortable or fairly loud to become uncomfortably loud. Hence, the wearer was often forced to adjust the hearing aid volume control in order to avoid distortion and attempt to find
an acceptable balance between sounds of differing intensities. This problem severely limited improvements in speech intelligibility, so hearing was, in reality, only partially improved.



In the 1980s, hearing aids emerged that amplified sounds at different frequencies by predetermined
amounts. These hearing aids were also able to limit sound amplification beyond a specified level to avoid discomfort



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associated with
overamplification. Although hearing aids employing this technology helped somewhat and are still sold today, these hearing aids generally did not improve speech recognition to a level that satisfied users.



In the early 1990s, multiband compression was introduced
into hearing aids. This technology enabled differential amplification, which varies according to input intensity level, of two or more separate bands of the frequency spectrum. Many hearing aid companies have now developed multiband
compression circuits that improve speech intelligibility from previous levels.



By 1996, technological advances based on digital signal processing led to the first digital hearing aids. Digital technology allows for more bands to further segregate the frequency range and for more
effective sound processing algorithms to be built into smaller integrated circuits that consume less power. Analog technology can provide similar sound processing benefits, but not in the small-size, low-power integrated circuits required for small
hearing aids.



An estimated 72% of hearing aids
sold in the U.S. are classified as premium hearing aids. Premium hearing aids are often called programmables because a prescriptive correction adapted to an individuals particular hearing loss is programmed into each
hearing aid. Sophisticated multiband compression circuits enable these hearing aids to deliver differential amplification in the frequency bands where it is most needed. Some of these hearing aids have analog signal processing and digital
programming, while some have digital signal processing and digital programming. The U.S. hearing aid market, segmented by digital, programmable analog and non-programmable analog is depicted in the chart below:



LOGO



Hearing Impairment



The major causes of hearing loss are
aging, noise exposure, disease and injury. Hearing loss is usually gradual and painless, in many cases developing so slowly that it can be unnoticeable to the hearing impaired person, even though family, business associates and friends may be quite
aware of it. The effects of any hearing loss can be severe, often dramatically changing the affected persons lifestyle. In adults, hearing loss creates coping mechanisms, which may include isolation from family and friends and a reluctance to
participate in public events. In children, hearing loss may negatively affect the ability to learn, the development of communication skills and the ability to interact with others.





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Approximately
90% of all permanent hearing impairments are characterized as sensorineural losses, and the remaining 10% are characterized as conductive losses. Conductive losses, which are caused by structural imperfections in the ear, can generally be corrected
by surgery. Sensorineural losses, which stem from deterioration of or damage to the cochlea, typically cannot be corrected by medical or surgical means. Hearing aids offer the most effective means of overcoming sensorineural losses.



In the case of sensorineural hearing loss, all sounds are not
affected equally. Typically, higher frequencies are more difficult to perceive than lower frequencies. Accordingly, the first sounds to disappear are those that have the highest pitches, such as the voices of women and children.
Furthermore, speech becomes much more difficult to comprehend since it is the softer, higher-pitched consonants that provide essential information to facilitate discrimination among words. Consider the following word list: cat, hat, fat, sat.
Without the ability to clearly hear the first letter of each of these words, a person is rendered helpless to comprehend what is being said. As a result, people with hearing losses often complain that they can hear others talking but do not
understand what is being said.



An example of the
impact of high-frequency hearing loss is illustrated by this chart, which shows that the high-frequency sounds of consonants fall outside the hearing threshold of the hearing impaired person.



LOGO



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Obtaining a Hearing Aid



An individual who seeks help for a
sensorineural hearing loss is often referred by a primary care physician or an ear-nose-throat physician to a hearing care professionalan audiologist or a hearing aid dispenser. Most hearing aids in the U.S. are custom-made to each
individuals ear canal, particularly for users in the mild to moderate loss category. The hearing care professional first performs an audiologic examination before taking an impression of the persons ear canals with a liquid silicone
material that hardens to the approximate shape of the canal. This impression is sent to the manufacturer who then builds an aid with a custom shell that matches the impression. This process usually requires about one week. There is considerable art
and craftsmanship associated with creating custom hearing aids that fit comfortably. A great deal of judgment is involved in shaping the final shell. If the aid does not fit the patient properly, the hearing care professional may make small
modifications to the shell or send the hearing aid back to the manufacturer for a remake. It is not uncommon for a new hearing aid to require remaking, which often requires an additional week.



Our Technology



Our technology strategy is to combine a number of distinct
technologies, supported by 42 patents and patent applications in process to date, to produce premium digital hearing aids. We seek to protect our intellectual property through patents, licenses, trade secrets and non-disclosure agreements. We hold
29 U.S. patents, and we are the exclusive licensee for hearing aid and hearing protection applications under two patents held by Brigham Young University. We have 13 patent applications pending. The core of our technology is our proprietary DSP
platform, which is based on a significant advancement in the understanding of human hearing. Using state-of-the-art chip design capabilities, we have embedded our proprietary algorithms into the smallest, single-chip DSP platform available in a
hearing aid today. As a result, our products are among the smallest hearing aids available today.



Digital Signal Processing Platform



Our proprietary DSP platform contains a patented set of algorithms that are based on our advanced understanding of human hearing. These
algorithms pre-process the incoming sound and present it to the impaired cochlea in a way that helps restore natural loudness perception and preserves the cues necessary for speech understanding. In addition, our DSP platform processes sound at a
rate we believe to be faster than other digital hearing aids. Traditionally, these hearing aids have not processed sounds quickly enough to allow a wearer to localize sounds, or ascertain which direction a sound is coming from. We
believe that our products are the first to solve this problem, thus providing a much more natural hearing experience and restoring lost localization and directionality of sound.



Single Chip Solution



Using state-of-the-art chip design capabilities, we have embedded our proprietary DSP platform into a single chip that is the smallest,
most sophisticated DSP chip available in a hearing aid today. We are not aware of any other hearing aid company that has introduced a single-chip DSP solution. This proprietary DSP chip is an advanced, energy-efficient integrated circuit that powers
frequency-specific, level-dependent, multi-channel features. The result of this convergence of advanced hearing science and leading edge digital technology is several families of hearing aids that we believe deliver a more natural, lifelike
listening and communication experience to the hearing impaired.



Our Products



We have
packaged our proprietary technologies into a broad line of digital hearing aids that offer what we believe is superior sound quality, smaller size, enhanced personalization and increased reliability at competitive prices. All of our products
incorporate our proprietary DSP platform and are programmable to address the hearing loss of the individual user. We currently sell our hearing aid products both as completed hearing aids and as hearing aid kits, or faceplates, to others who then
market finished hearing aids generally under our brand names. In addition, we occasionally sell hearing aid components incorporating our DSP platform to other hearing aid manufacturers who then market their private label products containing our DSP
platform, but we do not expect any significant component sales in the future.





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Our Natura 2
SE, Altair, Tribute and Quartet product lines incorporate our DSP platform, are among the smallest custom products available today and can be purchased in the five common models for hearing aids: behind-the-ear; in-the-ear; in-the-canal; mini-canal;
and completely-in-the-canal.



Our Adesso product
is an innovative hearing aid configuration that also contains our DSP platform and delivers a fast, comfortable fit in the smallest digital-based hearing aid available. Adesso builds upon the experience we gained with our Conforma product. Adesso
physically consists of two parts: a tiny core about the size of a pencil eraser that contains the products electronics, and a soft disposable tip that conforms to the shape of the wearers ear canal. This compressible foam tip eliminates
the need to custom mold a hard plastic shell to fit the wearers ear canal, both increasing comfort for the wearer and enabling a custom fit in a single visit. This product fits in the ear canal of the wearer, making it nearly invisible and
significantly reducing the stigma of wearing a hearing aid. As a standardized product, Adesso eliminates the need for costly remakes. The disposable nature of the tip helps eliminate a major cause of manufacturer repairs by allowing the wearer to
simply replace the tip at regular intervals to avoid the build-up of earwax in the device.



Our DSP platform provides advanced, customized sound processing through nine independent channels; employs fast-acting, narrow-band compression to allow response to speech cues and other sounds in real
time; utilizes proprietary expansion technology to reduce the annoyance of some low-intensity sounds; incorporates alerting programming tones; and includes personalized noise reduction technology. These features are described in more detail below.



Independent Channels



Our products deliver a more natural, life-like sound quality
because they incorporate unique design features based on the characteristics of the cochlea. Like the cochlea, our DSP platform processes frequencies within narrow bands. Specifically, our DSP chip contains nine independent compression channels
programmable with one decibel (dB) accuracy. This allows our products to be personalized for each hearing loss with unprecedented accuracy.



Fast-Acting Narrow-Band Compression



Our products contain the only DSP platform sophisticated enough to employ both fast-acting and narrow-band compression, which produces
virtually instantaneous volume adjustments to sounds in various frequencies. Consequently, our products are designed to respond to speech cues and other sounds in real timewithout a delay. Many of todays digital hearing aids use
wide-band compression technology. With wide-band compression technology, sounds that are distinct to a person with normal hearing will not necessarily be processed distinctly by the hearing aid. Our multi-channel, narrow-band compression can process
these sounds separately and distinctly.



Expansion



To address a common complaint with
traditional wide dynamic range compression (WDRC) hearing aidsthe fact that they are noisy in relatively quiet environmentswe have adapted a technology called expansion from the professional audio field.
Traditional WDRC hearing aids apply the highest level of gain (volume) to the softest sounds, including non-speech sounds. As a result, individuals often complain that non-speech soft sounds, such as fan noise, get too loud and become annoying. The
expansion technology in our products, however, actually reduces the volume for low-intensity sounds and can be set to meet each individuals needs. As a result, our products are quiet, without compromising volume for normal-intensity sounds.



Program Tones



We have also incorporated alerting tones to tell users when
they have changed from one program (memory) setting to another. In addition, a set of distinct tones alerts users when the battery is low. The volume of these tones is adjustable, so they can be set to the appropriate level for each patient.



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Noise Reduction



Perhaps the number one complaint among
hearing impaired persons is that they find it difficult to understand speech in the presence of background noise. Most traditional hearing aids not only fail to reduce background noisesthey actually amplify them. Our Natura 3, Natura 2 SE and
Adesso hearing aids offer our Personalized Noise ReductionTMtechnology. This patent-pending technology detects and
reduces many background noises to provide the hearing impaired consumer with a more comfortable listening and communication experience, and because it is based on each hearing impaired consumers particular hearing needs, our Natura 3, Natura 2
SE and Adesso hearing aids provide truly personalized noise reduction technology. Noise reduction reduces unwanted background noises and applies gain (volume) only to speech-like inputs in each of the nine independent channels. This results
in an improved signal-to-noise ratio because the amplitude (loudness) of the noise is reduced without altering the amplitude of speech.



Studies conducted at two Midwestern U.S. medical centers, as well as our own internal research laboratory, provided the independent
corroboration necessary for us to make claims in our marketing campaigns that our Natura 2 SE products improve speech intelligibility in noise, in full compliance with federal regulations governing such claims. We believe we are the only hearing aid
manufacturer that has been able to clinically demonstrate this benefit of understanding speech in noise with omni-directional hearing aids. Our DSP platform is the key to implementing our patented algorithms, which pre-process the incoming sound,
making it more understandable for a hearing impaired listener. Our proprietary DSP integrated circuit processes sound faster than those in other hearing aids, which results in more timely audio cues that are necessary for a more natural hearing
experience. This advance in hearing aid technology represents another step in our ability to improve communication for the hearing impaired.



ExpressfitTMSoftware



In
order to ensure that our new model of human hearing and state-of-the-art technologies are properly programmed to the individual needs of the hearing aid wearer, we have developed a proprietary programming system, Expressfit, which enables our
hearing aids to be easily configured by the hearing care professional to the unique needs of each wearer. The advanced technology of our sophisticated DSP chip is programmed by our software to ensure that sounds within each half octave frequency
range are amplified appropriately in the right contrast to sounds in every other channel. Expressfit, which runs on standard PC programs, is an integral part of ensuring that our technologically advanced hearing aids meet the needs of each
individual hearing aid wearer.



Manufacturing



Our principal manufacturing facility is in
Eagan, Minnesota (near Minneapolis) and we also have manufacturing facilities in Herlev, Denmark (near Copenhagen); Copthorne, U.K. (near London) and Parkside, South Australia, (near Adelaide). Our principal manufacturing facility was established in
Eagan because the presence of many major medical device companies, including hearing aid manufacturers, has created a skilled labor pool that we have been able to access. Our manufacturing operations consist of the following activities:



| |  |  | overseeing the production of the DSP platform used in our products;
| | - |  | -------------------------------------------------------------------



| |  |  | assembling and testing the electronic subsystems and non-custom hearing aid products;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | Fabricating custom hearing aid shells;
| | - |  | --------------------------------------



| |  |  | integrating the electronic components into the hearing aid shell; and
| | - |  | ---------------------------------------------------------------------



| |  |  | testing and calibrating the finished hearing aid.
| | - |  | -------------------------------------------------



We assemble our custom CIC, MC, ITC and ITE products according to specifications received from hearing care professionals. We receive an
impression of the wearers ear canal and programming requirements of the hearing aid from the hearing care professional, and from that we produce a custom shell and place the electronic subsystems within the shell.



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Our BTE
products are assembled using a standard plastic housing and are not custom-molded for a wearers ear. Similarly, Adesso is assembled using standardized components, consisting of an electronic subsystem, a plastic housing, or core, and
disposable foam tips, which eliminates custom-molding steps associated with traditionally configured hearing aids.



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 our proprietary DSP chip is integral to our products and 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. 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 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.



Product Returns,
Repairs and Remakes



The hearing aid
industry experiences high levels of product returns due to factors such as statutorily required liberal return policies and product performance inconsistent with consumers expectations. This has been particularly true for companies like ours
that sell premium-performance, premium-priced devices. Sales returns were $16.3 million in 2002, $15.7 million in 2001 and $12.9 million in 2000. Our warranty (remake and repair) costs were $3.1 million in 2002, $2.7 million in 2001 and $1.9 million
in 2000. Although we have taken measures to reduce the levels of returns, remakes and repairs on our products, we may not be able to attain lower levels and these levels may increase, which could reduce our net sales and operating results.



Sales and Marketing



Hearing aids have traditionally been dispensed (sold to the
consumer) by hearing care professionals. Due to the hearing care professionals influence over a consumers choice of a hearing aid brand, we believe that developing and maintaining strong relationships with hearing care professionals is
the most critical aspect of our sales and marketing strategy. As a result, we aim to deliver a high level of customer service and support to hearing care professionals.



In the U.S., there are more than 13,000 hearing care professionals who sell hearing aids. We position our
products as premium-priced, premium-performance hearing aids and therefore, our direct sales force targets select hearing care professionals who are capable of and interested in dispensing premium digital hearing aids. We have sold our products to
over 3,300 hearing care professional accounts in the U.S.



In addition to our direct sales force, we have an inside sales force and in-house trainers. We also make extensive use of contract trainers, who both influence and train hearing care professionals in order to differentiate our
products and to ensure proficiency with hearing aid programming and fitting. We also advertise our products to hearing care professionals through promotional materials, trade publications and conventions. Our sales force is responsible for
implementing loyalty programs and cooperative advertising programs with specific customers to generate demand for our products.



Outside the U.S., we sell our products directly to hearing aid retailers in Canada, the U.K., Denmark, Switzerland, Austria and the
Netherlands. Elsewhere in the world, we sell through a network of established distributors, who in turn sell to hearing care professionals. Distribution agreements generally cover multi-year periods and are terminable for non-performance. Our
Australian subsidiary, Sonic Innovations Pty Ltd., sells direct to the hearing impaired consumer through more than 30 retail clinics and also sells on a wholesale basis to other hearing aid retailers.



To further our marketing efforts, we sometimes use
advertising, public relations and market research agencies. These organizations work in tandem with our internal marketing team to communicate our brands advantages to customers. We may, in the future, implement direct-to-consumer advertising
and promotion campaigns that reflect our belief that both consumers and hearing care professionals are important to the success of our products.



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We believe
that the evolution of the current distribution channel, combined with the characteristics of our hearing aids, particularly the ease of fitting and opportunity for reduced hearing aid returns, remakes and repairs, will create new distribution
opportunities. We are exploring alternative and emerging distribution channels, and we are currently selling to large hearing-care chains and other chain-based retailers.



Customers



Our net sales in 2002 of $68.0 million were comprised of hearing aid sales of $67.1 million and component sales of $0.9 million. Hearing
aid sales by geography were as follows: North America$39.7 million; Europe$14.2 million; and rest-of-world  $13.2 million. 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. If any of our larger customers were to stop or delay purchases, our net sales and operating results would be adversely affected, particularly on a quarterly basis. We may be unable to retain our
current customers, and we may be unable to recruit replacement or additional customers. We are selling an increasing number of hearing aids to several audiology clinic consolidators who have a large number of owned or franchised hearing aid clinics.
As sales to larger customers increase, we are subject to the risk of losing these customers, incurring significant reductions in sales to these customers or granting price concessions to these customers. In addition, we may become subject to the
risk of collecting accounts and notes receivable balances from these customers. We had one hearing aid customer who accounted for 7% and 10% of net sales in 2002 and 2001, respectively. This customer accounted for 7% of our gross accounts receivable
balance at December 31, 2002.



Research and Development



We continue to work on both product
improvements and new product development, and we expect to continue both activities in the future. We intend to use product improvements and new product development to enhance our competitive position in the market. As of December 31, 2002, there
were over 40 employees actively involved in research, development, clinical and regulatory activities. Their skills include audiology research, clinical testing, project management, integrated circuit design and engineering, software engineering,
mechanical engineering and materials science. Research and development expense was $8.3 million in 2002, $9.1 million in 2001 and $7.9 million in 2000.



Competition



We encounter aggressive competition from a number of hearing aid competitors worldwide. We compete principally with larger
companiesSiemens GmbH, Starkey Laboratories, Inc., Widex A/S, William Demant Holding A/S (through its Oticon division), Phonak S.A. and Great Nordic A/S (through its GN ReSound division)all of which have greater financial, sales and
marketing, manufacturing and development resources than we currently possess. Our competitors may develop products that are more effective in treating hearing loss than our own products, thus rendering our technologies and products obsolete or
uncompetitive. We may not be able to compete effectively with these competitors. The number of companies who have a manufacturing and marketing presence in the hearing aid industry is approximately one-half of what it was in 1990. Consolidation in
the hearing aid industry has occurred in the last several years, as evidenced by the acquisitions of Beltone, Dahlberg/Miracle Ear, ReSound, Philips, Unitron and Sonus, and further consolidation could produce stronger competitors. If we fail to
compete effectively, our net sales and operating results will suffer. For instance, we may have to reduce the prices of our products or offer additional customer incentives to stay competitive.



The digital segment of the hearing aid industry is
characterized by increasing competition and rapid new product introductions. Our lower priced Quartet and Tribute product families, both of which were introduced in 2002, are becoming increasingly important to our sales effort as relatively weak
economies are causing consumers to seek out lower priced hearing aids. The proliferation of digital hearing aids is likely to lead to increasing price pressure and intense marketing campaigns as each company tries to differentiate its product from
the others. We compete primarily on the basis of sound quality; technology; size, particularly in completely-in-the-canal models; quality; comfort; reliability; price; ease of fitting the hearing aid; marketing, sales and distribution capabilities;
and customer service, support and training. We believe we can compete effectively on each of these factors.



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Patents, Licenses and Trade
Secrets



We currently hold 29 U.S. patents
and are the exclusive licensee for hearing aid and hearing protection applications under two patents held by Brigham Young University (BYU). We also have 13 patent applications pending.



Under our 1995 license agreement with BYU, as amended in 1996
and 2000, we have an exclusive worldwide license to utilize patents and patents pending involving hearing aid signal processing, audio signal processing and hearing compression, including the fundamental sound processing algorithm incorporated into
our DSP platform. Under this agreement, which expires in 2013 on the expiration of the last claim of the patents, we are responsible for the payment of all fees and costs associated with filing and maintaining patent rights. As consideration for the
license, we issued 105,567 shares of our common stock and paid $580,000 to BYU.



In 1997, we entered into another license agreement with BYU giving us the perpetual right to use specified noise suppression technologies owned by BYU. We have exclusive worldwide rights to
use these technologies in hearing aid and hearing protection applications and a non-exclusive right to use them for other applications. We are required to make royalty payments to BYU equal to 0.5% of sales derived from products containing the
licensed technologies.



In 2000, we paid $1.8
million to K/S HIMPP, a Danish partnership that owns approximately 200 patents considered essential for the sale of programmable hearing aids, for a fully paid-up technology license. No further royalties are owed to K/S HIMPP for the use of the
licensed patents.



In 1999, in order to resolve a
claim of patent infringement made by one of our competitors, we entered into a license agreement under which we agreed to pay a royalty of 1.5% on all net sales of hearing aids and components from October 1998 through September 2001.



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. We also rely on trade secret information, technical know-how and innovation to expand our proprietary position. We require certain of our employees and consultants to execute non-disclosure and
assignment of inventions agreements upon commencement of their employment or engagement.



We may be required to spend significant resources to monitor and police our intellectual property rights. We may not be able to detect infringement and may lose our competitive position in the market
before we do so. In addition, competitors may design around our proprietary technology or develop competing technologies. Intellectual property rights may also be unavailable or limited in some foreign countries. Our pending patent and trademark
registration applications may not be allowed or competitors may challenge the validity or scope of these registrations. In addition, our patents may not provide us with a significant competitive advantage.



Government Regulation



Our products are considered to be medical devices and are
subject to regulation in the U.S. 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. Generally, medical devices must
either receive premarket clearance from the FDA through the 510(k) process or be an exempt product. We believe our products are exempt from the 510(k) process. We must comply with facility registration and product listing requirements of the FDA and
adhere to its Quality System Regulations (QSR). The FDA enforces the QSR through periodic inspections, which we have yet to undergo. If we or any third-party manufacturers of our products do not conform to the QSR, we will be required to
find alternative manufacturers that do conform, which could be a long and costly process. 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.



11



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Sales of our
products outside the U.S. are subject to foreign regulatory requirements that vary widely from country to country. The time required to obtain approvals required by other countries may negatively affect our ability to sell products in those
countries. In order to market our products in the member countries of the European Union (EU), we are required to obtain the EUs CE mark certification, which we have accomplished by meeting the requirements of ISO 9001. Any failure to maintain
our ISO 9001 certification or CE Mark could significantly reduce our net sales and operating results.



Employees



As of December 31, 2002, we had 288 employees in the U.S., including 27 in administration, 72 in sales and marketing, 46 in research, development, clinical and regulatory and 143 in operations. Outside the U.S., we had 243
employees, including 121 in Australia, 88 in Europe and 34 in Canada. The majority of employees outside the U.S. are in operations and sales and marketing. None of our employees are represented by a labor union. We have not experienced any work
stoppages, and we consider relations with our employees to be good.



Executive Officers of the Registrant



The following table sets forth our officers and their ages as of December 31, 2002:



|Name                 |  | Age |  | Position                                         
|-------------------- |  | --- |  | -------------------------------------------------
|Kevin J. Ryan        |  | 62  |  | Chairman of the Board                            
|Andrew G. Raguskus   |  | 57  |  | President and Chief Executive Officer            
|Stephen L. Wilson    |  | 49  |  | Senior Vice President and Chief Financial Officer
|Michael A. James     |  | 54  |  | Senior Vice President Commercial Operations      
|Jorgen Heide         |  | 64  |  | Senior Vice President Business Development       
|Gregory N. Koskowich |  | 42  |  | Vice President Research and Development          
|Victor H. Bray, Jr.  |  | 48  |  | Vice President Auditory Research                 
|Jerry L. DaBell      |  | 56  |  | Vice President Product Development               
|Weston O. Ison       |  | 62  |  | Vice President Operations and Quality            
|Michael D. Monahan   |  | 56  |  | Vice President U.S. Sales                        
|Michael M. Halloran  |  | 42  |  | Vice President and Corporate Controller          



Kevin J. Ryan became our
Chairman, an officer position, effective January 1, 2002. Mr. Ryan was Chairman, President and Chief Executive Officer of Wesley Jessen Vision Care, Inc., a manufacturer of contact lenses, from 1995 until its acquisition by Novartis in 2001. Prior
to that, Mr. Ryan was President of Biosource Technologies Inc., a bio-pharmaceutical company, from 1991 to 1995. He serves on the board of Large Scale Biology Corporation, a bio-technology company. Mr. Ryan earned a bachelors degree in
business and marketing from Notre Dame University.



Andrew G.
Raguskus joined Sonic Innovations in September 1996 as President, Chief Executive Officer and director. Mr. Raguskus was Chief Operating Officer of Sonic Solutions, Inc., a maker of digital audio workstations, during 1996. He was Senior Vice
President Operations of ReSound Corporation, a hearing aid company, from 1991 to 1995. Prior to joining ReSound, Mr. Raguskus held positions with various technology companies, including Sun Microsystems, Inc. and General Electrics Medical
Systems Division. He serves on the board of the Hearing Industries Association. Mr. Raguskus earned a bachelors degree in electrical engineering from Rensselaer Polytechnic Institute.



Stephen L. Wilson joined Sonic Innovations in October 1999 as Vice President
and Chief Financial Officer and became Senior Vice President and Chief Financial Officer in February 2003. From 1997 to 1999, Mr. Wilson was Executive Vice President and Chief Financial Officer of Computer Motion, Inc., a medical robotics company.
From 1990 to 1997, he was Vice President Finance and Chief Financial Officer of St. Jude Medical, Inc., a cardiovascular medical device company. He earned a bachelors degree in accounting from University of Connecticut and is a Certified
Public Accountant.



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Michael A. James joined Sonic
Innovations in October 2002 as Vice President Worldwide Field Operations and became Senior Vice President Commercial Operations in February 2003. From September 2000 through September 2002, Mr. James was Vice President Commercial Operations of the
Life Sciences division of Motorola, Inc. From 1996 to 2000, he was employed by Medtronic, Inc., most recently as Vice President Marketing of the Perfusion Systems business. Mr. James previous experience included positions at Abbott
Laboratories, Inc., Dart & Kraft, Inc. and Baxter Healthcare Corporation. He earned a bachelors degree in english from Wichita State University and an M.B.A. from University of Chicago.



Jorgen Heide joined Sonic Innovations in March 1997 as Vice President
Operations, became Vice President International in February 1998 and Senior Vice President Business Development in February 2003. From 1992 to 1997, Mr. Heide held three separate Vice President positions at ReSound Corporation, a hearing aid
company. He earned a masters degree in electronic engineering from Frederiksberg Tekniske Skole in Copenhagen, Denmark.



Gregory N. Koskowich, Ph.D., joined Sonic Innovations in June 1997 as Vice President Research and Development. From 1995 to 1997, he was Vice President
Product Development at IMP, Inc., a semi-conductor manufacturer. From 1992 to 1995, he was Manager of Microelectronics Engineering at ReSound Corporation, a hearing aid company. He earned a bachelors degree and a masters degree in
electrical engineering from University of Calgary and a Ph.D. in electrical engineering from University of Washington.



Victor H. Bray, Jr., Ph.D., joined Sonic Innovations in August 1997 as Vice President Auditory Research. From 1993 to 1997, he was Director of Clinical
Research, Clinical Research Manager and Senior Clinical Research Audiologist at ReSound Corporation, a hearing aid company. From 1986 to 1993, Dr. Bray was Director of Audiology and Clinical Audiologist at the Austin Ear Clinic. He earned a
bachelors degree in biochemistry from the University of Georgia, a masters degree in audiology from Auburn University and a Ph.D. in speech and hearing science from University of Texas at Austin.



Jerry L. DaBell joined Sonic Innovations in July 2000 as Vice President
Business Development and became Vice President Product Development in January 2002. He was Senior Vice President Business Development of IMP, Inc., a semi-conductor manufacturer, where he was employed from 1988 to 2000. He earned a bachelors
degree and a masters degree in electrical engineering from Brigham Young University.



Weston O. Ison joined Sonic Innovations in October 1999 as Vice President Quality and Regulatory and became Vice President Operations and Quality in June 2001. From 1992 to 1999, he served as Vice
President of Quality, Customer Service and Operations Planning at American National Can, a packaging company. Mr. Isons previous experience included positions at Case Corporation, Picker Medical and General Electric. He earned a
bachelors degree in electrical engineering from University of Utah.



Michael D. Monahan joined Sonic Innovations in March 1998 as Vice President U.S. Sales. From 1997 to 1998, he was Director of Sales of Enact, Inc., a tele-health information company. Prior to that, he was National Sales Manager of
HDC Corporation, a medical company, from 1996 to 1997; and Sales Manager of Menlo Care, Inc., a medical device company, from 1992 to 1996. He earned a bachelors degree in business administration from California State College.



Michael M. Halloran joined Sonic Innovations in April 1999 as Corporate
Controller and became Vice President and Corporate Controller in January 2003. From 1994 to 1999, Mr. Halloran was employed by C.R. Bard, Inc., a medical products company, in various financial capacities. He earned a bachelors degree in
accounting from State University of New York at Oswego and is a Certified Public Accountant.



Officers are elected by the board of directors and serve until their successors have been duly elected and qualified. There are no family relationships among any of our directors or officers.



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Availability of SEC Reports



We maintain an internet website at
www.sonici.com. We make available, free of charge through out website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a)
or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonability practicable after such reports are electronically filed with, or furnished to, the SEC. These reports may be accessed through our websites investor relations
page. The information contained on our website is not incorporated by reference in this annual report on Form 10-K and should not be considered a part of this report.



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 have an accumulated deficit of $51.6 million at December 31, 2002. Although we reported a small net income for the first time in 2002, cash and marketable securities declined from $45.8 million at December 31, 2001 to $35.6
million at December 31, 2002. We may incur net losses and negative operating cash flows in the future. We expect to increase our operating expenses and therefore, whether or not we maintain profitability will depend in significant part on the rate
of growth of our net sales and maintaining our gross margin. Consequently, it is possible that we will not 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 large 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.



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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.



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 7% of net sales in 2002 and 10% of net sales in 2001. This customer accounted for 7% of our gross accounts receivable balance at December 31, 2002.



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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. Our motion to dismiss plaintiffs Second Amended Complaint was denied. There has been no discovery to date, 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 PRODUCTION 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 $16.3 million in 2002 and $15.7 million in 2001. Warranty costs for remakes and repairs
were $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.



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.



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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.



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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 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



We may be held liable if any product we develop 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
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.



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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.



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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ITEM 2. PROPERTIES



We lease manufacturing and office space in
support of our business. Total leased space as of December 31, 2002 was 149,920 square feet as follows:



|Location                   |  | Square Footage |  | Lease Expiration
|-------------------------- |  | -------------- |  | ----------------
|Salt Lake City, Utah       |  | 55,000         |  | August 2004     
|Eagan, Minnesota           |  | 24,000         |  | December 2006   
|Copenhagen, Denmark        |  | 18,363         |  | August 2005     
|London, U.K.               |  | 4,030          |  | April 2009      
|Adelaide, Australia        |  | 5,667          |  | December 2004   
|Australia retail locations |  | 26,935         |  | Various         
|Birr-Lupfig, Switzerland   |  | 2,583          |  | September 2007  
|Leibnitz, Austria          |  | 1,442          |  | Month-to-month  
|Montreal, Canada           |  | 7,900          |  | May 2005        
|Ontario, Canada            |  | 4,000          |  | April 2003      
|                           |  |                |  |                 
|Total                      |  | 149,920        |  |                 
|                           |  |                |  |                 



We have
sufficient manufacturing capacity to satisfy current and forecasted demand for 2003. A significant increase in demand would likely require us to increase manufacturing capacity.



ITEM 3. LEGAL PROCEEDINGS



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. The complaint alleges that as a result of false statements or omissions, we were able
to complete our IPO, artificially inflate our financial projections and results and have our stock trade at inflated levels. We strongly 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. Our motion to dismiss plaintiffs Second Amended Complaint was denied. There has been no discovery to date, no class has been certified and no trial date has been
scheduled.



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



No matters were submitted to a vote of our
shareholders during the quarter ended December 31, 2002.



PART II



ITEM 5. MARKET FOR
REGISTRANTS COMMON EQUITY AND RELATED SHAREHOLDER MATTERS



The information set forth under the captions Stock Exchange Listing, Price Range of Sonic Innovations, Inc. Common Stock, and Dividends on the inside back cover of our 2002 Annual Report
to Shareholders is incorporated herein by reference.



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ITEM 6. SELECTED FINANCIAL
DATA (in thousands, except per share and other data)



|                                           |  | 2002 |        |   | 2001 |   |        | 2000 |  |   | 1999   |   |  | 1998 |        
|------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | -------
|Statements of Operations:                  |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        
|Net sales                                  |  | $    | 68,018 |   |      | $ | 57,267 |      |  | $ | 51,660 |   |  | $    | 28,694 
|Gross profit                               |  | $    | 35,421 |   |      | $ | 26,018 |      |  | $ | 25,473 |   |  | $    | 11,632 
|Percent of sales                           |  |      | 52.1   | % |      |   | 45.4   | %    |  |   | 49.3   | % |  |      | 40.5   
|Operating expenses                         |  | $    | 36,799 |   |      | $ | 33,746 |      |  | $ | 29,224 |   |  | $    | 25,383 
|Percent of sales                           |  |      | 54.1   | % |      |   | 58.9   | %    |  |   | 56.6   | % |  |      | 88.5   
|Operating loss                             |  | $    | (1,378 | ) |      | $ | (7,728 | )    |  | $ | (3,751 | ) |  | $    | (13,751
|Net income (loss)                          |  | $    | 32     |   |      | $ | (5,635 | )    |  | $ | (4,204 | ) |  | $    | (17,337
|Earnings (loss) per share                  |  | $    | 0.00   |   |      | $ | (0.28  | )    |  | $ | (0.31  | ) |  | $    | (12.72 
|Weighted average common shares outstanding |  |      | 19,595 |   |      |   | 19,822 |      |  |   | 13,479 |   |  |      | 1,363  
|Balance Sheets:                            |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        
|Cash and marketable securities             |  | $    | 35,561 |   |      | $ | 45,806 |      |  | $ | 52,210 |   |  | $    | 5,939  
|Total assets                               |  | $    | 74,746 |   |      | $ | 70,856 |      |  | $ | 76,248 |   |  | $    | 18,462 
|Total liabilities                          |  | $    | 14,901 |   |      | $ | 13,692 |      |  | $ | 11,977 |   |  | $    | 21,134 
|Shareholders equity (deficit)             |  | $    | 59,845 |   |      | $ | 57,164 |      |  | $ | 64,271 |   |  | $    | (38,801
|Other:                                     |  |      |        |   |      |   |        |      |  |   |        |   |  |      |        
|Countries with operations                  |  |      | 8      |   |      |   | 3      |      |  |   | 2      |   |  |      | 1      
|Number of employees                        |  |      | 531    |   |      |   | 430    |      |  |   | 342    |   |  |      | 211    



ITEM 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



The information set forth under the caption Managements Discussion and Analysis of Financial Condition and Results of Operations on pages 13 through 19 of our 2002 Annual Report to
Shareholders is incorporated herein by reference.



ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



The information set forth under the caption Quantitative and Qualitative Disclosures About Market Risk on pages 18 and 19 of our 2002 Annual Report to Shareholders is incorporated herein by reference.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



The following consolidated financial statements of Sonic
Innovations, Inc. and independent auditors reports set forth on pages 20 through 34 of our 2002 Annual Report to Shareholders are incorporated herein by reference:



|                                                                                                                                    
|------------------------------------------------------------------------------------------------------------------------------------
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                        
|                                                                                                                                    
|Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and
2000                                          
|                                                                                                                                    
|Consolidated Statements of Shareholders Equity and Comprehensive Income (Loss)
for the years ended December 31, 2002, 2001 and 2000
|                                                                                                                                    
|Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and
2000                                          
|                                                                                                                                    
|Notes to Consolidated Financial Statements                                                                                          
|                                                                                                                                    
|Independent Auditors Reports                                                                                                       



21



---



ITEM 9. CHANGES IN AND
DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE



On July 1, 2002, our Board of Directors, upon recommendation of the Audit Committee, unanimously approved the dismissal of Arthur Andersen LLP as our independent auditing firm and appointed KPMG LLP to
serve as our new independent auditing firm for the year ending December 31, 2002.



Arthur Andersens reports on our consolidated financial statements for each of the years ended December 31, 2001 and 2000 did not contain an adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles.



During the years ended December 31, 2001 and 2000 and the period from January 1, 2002 through July 1, 2002, there was no disagreement between us and Arthur Andersen on any matter of accounting
principles or practices, financial statements disclosure or auditing scope or procedure, which disagreement, if not resolved to Arthur Andersens satisfaction, would have caused Arthur Andersen to make reference to the subject matter of such
disagreement in its reports on our consolidated financial statements for such years; and there occurred no reportable event as defined in Item 304(a)(1)(v) of Regulation S-K.



During the years ended December 31, 2001 and 2000 and through July 1, 2002, we did not consult with KPMG
regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.



In accordance with Item 304 of Regulation S-K, we submitted this disclosure to Arthur Andersen and KPMG and presented this with the
opportunity to include a statement in this Form 10-K if they believe the above statements are incorrect or incomplete.



PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



The information concerning our directors as set forth under the captions Election of Directors on page 3 and Directors on pages 3 and 4 of our definitive Proxy Statement for the
May 1, 2003 Annual Meeting of Shareholders is incorporated herein by reference. Information concerning our executive officers is set forth in Part I, Item 1 hereto. The information set forth under the caption Section 16(a) Beneficial Ownership
Reporting Compliance in our definitive Proxy Statement for the May 1, 2003 Annual Meeting of Shareholders is incorporated herein by reference.



ITEM 11. EXECUTIVE COMPENSATION



The information set forth under the captions Executive Compensation and Other Information on pages 12 and 13 and
Director Compensation on page 5 of our definitive Proxy Statement for the May 1, 2003 Annual Meeting of Shareholders is incorporated herein by reference.



22



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ITEM 12. SECURITY OWNERSHIP
OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT



The information set forth under the caption Share Ownership by Certain Beneficial Owners and Named Executive Officers on pages 6 and 7 of our definitive Proxy Statement for the May 1, 2003 Annual Meeting of Shareholders
is incorporated herein by reference.



Securities Authorized
for Issuance under Equity Compensation Plans



The following table provides certain information concerning our equity compensation plans as of December 31, 2002:



|Equity Compensation Plan Information                      
|----------------------------------------------------------
|Plan category                                             
|                                                          
|Equity compensation plans approved by security holders    
|Equity compensation plans not approved by security holders
|                                                          
|Total                                                     
|                                                          



ITEM 13. CERTAIN
RELATIONSHIPS AND RELATED PARTY TRANSACTIONS



The information set forth under the caption Directors and Nominees on page 3 of our definitive Proxy Statement for the May 1, 2003 Annual Meeting of Shareholders is incorporated herein by reference.



ITEM 14. CONTROLS AND PROCEDURES



We maintain a system of disclosure controls and procedures
that is designed to ensure that information required to be disclosed by us in this Form 10-K and in other reports required to be filed under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported within the time periods
specified in the rules and forms for such filings. Our management, under the direction of Chief Executive Officer and Chief Financial Officer, has reviewed and evaluated the effectiveness of these disclosure controls and procedures within 90 days
prior to the date of this report. Based on that review and evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures are effective in providing them with material information
relating to the Company as required to be disclosed in our periodic filings under the Securities Exchange Act of 1934.



There were no significant changes in our internal controls, or in other factors that could significantly affect these controls subsequent
to the date of their evaluation.



23



---



PART IV



ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K



(a) LIST OF DOCUMENTS
FILED AS PART OF THIS REPORT



(1)
FINANCIAL STATEMENTS



The
following consolidated financial statements and independent auditors reports as set forth on pages 20 through 34 of our 2002 Annual Report to Shareholders are incorporated herein by reference:



| |  |  |  |  |  |  |  | Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                        
| |  |  |  |  |  |  |  | ------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  |  |  |  |  |  | Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and
2000                                          
|
| |  |  |  |  |  |  |  | Consolidated Statements of Shareholders Equity and Comprehensive Income (Loss)
for the years ended December 31, 2002, 2001 and 2000
|
| |  |  |  |  |  |  |  | Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and
2000                                          
|
| |  |  |  |  |  |  |  | Notes to Consolidated Financial Statements                                                                                          
|
| |  |  |  |  |  |  |  | Independent Auditors Reports                                                                                                       



(2) FINANCIAL STATEMENT SCHEDULE



The following financial statement schedule is filed as part of this Form 10-K:



|SCHEDULE NUMBER |  | DESCRIPTION                       |  | PAGE NUMBER
|--------------- |  | --------------------------------- |  | -----------
|II              |  | Valuation and Qualifying Accounts |  | 26         



The independent auditors reports with respect to the Companys financial statement schedule are on page 27. All other financial statements and schedules not listed have been omitted because the required information is
included in the consolidated financial statements or notes thereto, or is not applicable.



24



---



(3) EXHIBITS





|Exhibit Number |  | Exhibit Description                                                                                                            
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------
|3.1(1)         |  | Amended and Restated Certificate of Incorporation of the registrant.                                                           
|3.2(1)         |  | Amended and Restated Bylaws of the registrant.                                                                                 
|10.1(1)        |  | Form of indemnification agreement entered into by the registrant with each of its directors and executive
officers.            
|10.2(1)#       |  | 1993 Stock Plan and form of agreements thereunder.                                                                             
|10.3(5)#       |  | 2000 Stock Plan and form of agreements thereunder.                                                                             
|10.4(4)#       |  | 2000 Employee Stock Purchase Plan.                                                                                             
|10.5(1)        |  | Registration Rights Agreement dated October 23, 1998 between the registrant and certain shareholders, as
amended.              
|10.6(3)        |  | Preferred Stock Rights Agreement dated as of March 27, 2001 between the registrant and American Stock Transfer &
Trust Company.
|10.7(1)        |  | License and Manufacturing Agreement dated February 20, 1997 between the registrant and Atmel
Corporation.                      
|10.8(6)*       |  | Amendment dated January 7, 2002 to License and Manufacturing Agreement between the registrant and Atmel
Corporation.           
|10.9(6)#       |  | Employment Agreement dated January 1, 2002 between the registrant and Kevin J. Ryan.                                           
|10.10(1)       |  | Amended and Restated License Agreement dated March 21, 2000 between the registrant and Brigham Young
University.               
|10.11(1)       |  | Amended and Restated Exclusive License Agreement dated March 21, 2000 between the registrant and Brigham Young
University.     
|10.13(1)       |  | Lease Agreement dated April 28, 1999 between the registrant and 2795 E. Cottonwood Parkway, L.C.                               
|10.14(1)#      |  | Letter Agreement dated February 8, 1998 between the registrant and Michael D. Monahan.                                         
|10.15(1)#      |  | Letter Agreement dated May 4, 1997 between the registrant and Gregory N. Koskowich.                                            
|10.16(1)#      |  | Letter Agreement dated September 24, 1999 between the registrant and Stephen L. Wilson.                                        
|10.18(2)       |  | Subscription Agreement between K/S HIMPP and the registrant dated September 13, 2000.                                          
|10.19(2)       |  | Patent License Agreement between K/S HIMPP and the registrant dated September 13, 2000.                                        
|13.1           |  | Portions of the Annual Report to Shareholders for the year ended December 31, 2002.                                            
|21.1           |  | Subsidiaries of the registrant.                                                                                                
|23.1           |  | Consent of Independent Auditors.                                                                                               
|23.2           |  | Information regarding consent of Arthur Andersen LLP.                                                                          
|99.1           |  | Certifications of Chief Executive Officer and Chief Financial Officer.                                                         

---

|(1) |  | Incorporated by reference from the registrants Registration Statement on Form S-1 (file no. 333-30566), as amended.
|--- |  | --------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference from the registrants Annual Report on Form 10-K for the year ended December 31, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------

|(3) |  | Incorporated by reference from the registrants Registration Statement on Form 8-A filed on April 16, 2001.
|--- |  | -----------------------------------------------------------------------------------------------------------

|(4) |  | Incorporated by reference from the registrants Registration Statement on From S-8 filed
on August 16, 2002.
|--- |  | ------------------------------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference from the registrants Registration Statement on From S-8 filed
on August 30, 2002.
|--- |  | ------------------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference from the registrants Annual Report on Form 10-K for the year
ended December 31, 2002
|--- |  | ---------------------------------------------------------------------------------------------------------------

|# |  | Designates a management contract or compensatory plan or arrangement required to be filed as
an exhibit.
|- |  | --------------------------------------------------------------------------------------------------------

|* |  | Confidential treatment has been requested for portions of this exhibit.
|- |  | -----------------------------------------------------------------------



25



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(b) REPORTS
ON FORM 8-K



There were no
reports on Form 8-K filed during the quarter ended December 31, 2002.



(c) EXHIBITS



See Item 15(a)(1).



(d)
FINANCIAL STATEMENT SCHEDULE



See Item 15(a)(2).



Sonic Innovations, Inc.

Schedule II  Valuation and Qualifying Accounts

(in thousands)



|                                |  |      |  | Beginning balance |       | Additions |   | Deductions |  | Ending balance
|------------------------------- |  | ---- |  | ----------------- | ----- | --------- | - | ---------- |  | --------------
|Allowance for sales returns     |  | 2002 |  | $                 | 2,925 |           | $ | 16,004     |  | $             
|                                |  | 2001 |  |                   | 2,767 |           |   | 15,884     |  |               
|                                |  | 2000 |  |                   | 1,974 |           |   | 13,721     |  |               
|Allowance for doubtful accounts |  | 2002 |  |                   | 1,196 |           |   | 311        |  |               
|                                |  | 2001 |  |                   | 676   |           |   | 676        |  |               
|                                |  | 2000 |  |                   | 461   |           |   | 344        |  |               
|Warranty reserves               |  | 2002 |  |                   | 2,347 |           |   | 4,381      |  |               
|                                |  | 2001 |  |                   | 1,229 |           |   | 3,836      |  |               
|                                |  | 2000 |  |                   | 364   |           |   | 2,795      |  |               
|Inventory reserves              |  | 2002 |  |                   | 774   |           |   | 908        |  |               
|                                |  | 2001 |  |                   | 1,107 |           |   | 2,080      |  |               
|                                |  | 2000 |  |                   | 329   |           |   | 1,526      |  |               



26



---



Independent Auditors
Reports on Consolidated Financial Statement Schedule



The Board of Directors and Shareholders

Sonic Innovations,
Inc.:



Under date of January 27, 2003, we reported on the
consolidated balance sheet of Sonic Innovations, Inc. and subsidiaries as of December 31, 2002, and the related consolidated statements of operations, shareholders equity and comprehensive income (loss), and cash flows for the year then ended
included in Sonic Innovations, Inc.s Annual Report to Shareholders incorporated by reference in this Form 10-K. In connection with our audit of the aforementioned consolidated financial statements, we also audited the related consolidated
financial statement schedule as it relates to the year ended December 31, 2002 included in this Form 10-K. This consolidated financial statement schedule is the responsibility of the Companys management. Our responsibility is to express an
opinion on this consolidated financial statement schedule based on our audit.



In our opinion, the 2002 information included in the consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects,
the information set forth therein.



/s/    KPMG LLP



Salt Lake City, Utah

January 27, 2003



This is a copy of the audit report previously issued by Arthur Andersen LLP
in connection with the Companys financial statement schedule for 2001 and 2000 referred to in Item 14(a)(2) of our annual report on Form 10-K for the year ended December 31, 2001. This audit report has not been reissued by Arthur Andersen LLP
in connection with this schedule because Arthur Andersen LLP has ceased operations.



To Sonic Innovations, Inc.:



We have audited in accordance with auditing standards generally accepted in the United States, the consolidated financial statements included in Sonic
Innovations, Inc.s Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 24, 2001. Our audit was made for the purpose of forming an opinion on the basic financial statements
taken as a whole. The schedule referred to in Item 14(a)(2) is the responsibility of the Companys management and is presented for purposes of complying with the Securities and Exchange Commissions rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein
in relation to the basic financial statements taken as a whole.



/s/    ARTHUR ANDERSEN LLP



Salt Lake City, Utah

January 24, 2001



27



---



Signatures



Pursuant to the requirements of Section 13 or 15(d) 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.



|                        |  |  |  | SONIC INNOVATIONS, INC.
|----------------------- |  |  |  | -----------------------
|                       
|Date:    March 26, 2003 |  |  |  |                        
|                        |  |  |  |                        
|                        |  |  |  |                        
|                        |  |  |  |                        
|                       
|                        |  |  |  |                        
|                        |  |  |  |                        
|                        |  |  |  |                        



Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed below by the following directors on behalf of the registrant on March 26, 2003.



|   
|---
|By:
|   



|   
|---
|By:
|   



|   
|---
|By:
|   



|   
|---
|By:
|   



|   
|---
|By:
|   



|   
|---
|By:
|   



|   
|---
|By:
|   



28



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Certifications of Chief
Executive Officer and Chief Financial Officer



I, Andrew G.
Raguskus, President and Chief Executive Officer of Sonic Innovations, Inc., certify that:



| | 1. |  | I have reviewed this Annual Report on Form 10-K of Sonic Innovations, Inc. (the Registrant);
| | -- |  | ----------------------------------------------------------------------------------------------



| | 2. |  | Based on my knowledge, this Annual 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 Annual Report;
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. |  | Based on my knowledge, the financial statements, and other financial information included in this Annual 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 Annual 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 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 Annual 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 Annual Report
(the Evaluation Date); and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this Annual 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:
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (d) |  | 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
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (e) |  | 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 Annual Report whether 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.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Dated:    March 26, 2003



|/S/    ANDREW G.
RAGUSKUS                                          
|-------------------------------------------------------------------
|President and Chief Executive Officer (Principal Executive Officer)





29



---



I, Stephen L. Wilson, Senior
Vice President and Chief Financial Officer and Secretary of Sonic Innovations, Inc., certify that:



| | 2. |  | I have reviewed this Annual Report on Form 10-K of Sonic Innovations, Inc. (the Registrant);
| | -- |  | ----------------------------------------------------------------------------------------------



| | 3. |  | Based on my knowledge, this Annual 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 Annual Report;
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4. |  | Based on my knowledge, the financial statements, and other financial information included in this Annual 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 Annual Report;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 5. |  | 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 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 Annual 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 Annual Report
(the Evaluation Date); and
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (c) |  | presented in this Annual Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 6. |  | 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:
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (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
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| | 7. |  | The Registrants other certifying officer and I have indicated in this Annual Report whether 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.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Dated:    March 26, 2003



|                                                                                             
|---------------------------------------------------------------------------------------------
|/s/    STEPHEN L.
WILSON                                                                     
|Senior Vice President and Chief Financial Officer and Secretary (Principal Financial Officer)





30