**SECURITIES AND EXCHANGE**
 **COMMISSION**
 
 **Washington, D.C. 20549**
 
 **FORM 10-K/A**
 **(Amendment No. 2)**
 
 **For Annual and Transition Reports**
 **Pursuant to Sections 13 or 15 (d) of the**
 **Securities Exchange Act of 1934**
 
 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 For the fiscal year ended June 30, 2004
 
 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 For the transition period from _____________ to _____________
 
 Commission File Number: **0-14961**
 
 **PRIMESOURCE HEALTHCARE, INC.**
 (Exact name of registrant as specified in its charter)
 
 **Massachusetts**    **04-2741310**
 (State or other jurisdiction of    (I.R.S. Employer
 incorporation or organization)     Identification No.)
 
 **3708 East Columbia Street - Tucson, Arizona - 85714**
 (Address of principal executive offices) (Zip code)
 
 Registrant's telephone number, including area code:
 **(520) 512-1100**
 
 Securities registered pursuant to Section 12(b) of the Act:
 **None**
 
 Securities registered pursuant to Section 12(g) of the Act:
 **Common Stock, $.01 par value per share**
 (Title of class)
 
 Indicate by checkmark 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 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. Yes X 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 the 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 Act). Yes __ No _X
 
 The estimated aggregate market value of the voting common stock held by non-affiliates of the registrant was $61,841 as of December 31, 2003. Because PrimeSources common stock is not listed or quoted on an exchange, this computation is based on an estimated market value of $.01 per share of common stock as of September 1, 2004.
  As of September 1, 2004, 22,375,144 shares of common stock, $.01 par value, were issued and outstanding.
  **DOCUMENTS INCORPORATED BY REFERENCE**
  List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated:
  
 2
 
 
 **TABLE OF CONTENTS**
 
 Explanatory Note
4Part IItem 1.   Business ..........................................................................................................................................................................
5Part IIItem 5.   Market for Registrants Common Equity and Related Stockholder Matters ...........................................................................
18Item 6.   Selected Financial Data ....................................................................................................................................................
20Item 7.   Managements Discussion and Analysis of Financial Condition and
Results of Operations .......................................................................................................................................................
24Item 8.    Financial Statements and Supplementary Data (As restated, see Note 15) ...........................................................................
36Item 9A.Controls and Procedures ..................................................................................................................................................
64Signatures
..............................................................................................................................................................
65
 
 
  3   **EXPLANATORY NOTE**
 
 This Form 10-K/A (Amendment No. 2) is being filed to amend the PrimeSource Healthcare, Inc. (the Company) June 30, 2004 Annual Report for the fiscal year ended June 30, 2004 in order to reflect the restatement of the Companys Consolidated Financial Statements and amendments to related disclosures as of June 30, 2004 and June 30, 2003 and for each of the three years in the period ended June 30, 2004. The restatement arose from managements determination that the Companys Series G Convertible Redeemable Preferred Stock (Series G Stock) should have been included in mezzanine equity in the Companys balance sheet, and not as a liability as previously recorded under Financial Accounting Standards Board Statement No. 150,*Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.*Additionally, the Company also corrected certain errors in its accounting for the Series G Stock from August 6, 2002, the date of original issuance, as it related to the accounting for the conversion and redemption features of the Series G Stock, and to the fair values assigned to the Companys Series G Stock and common stock upon issuance. The Company also separately presented product sales and commissions revenues in the amendment in response to comments from the Securities and Exchange Commission. See Note 15 to the Notes to the Consolidated Financial Statements for detail on the restatement and its effects.
 
 Generally, no attempt has been made in this Form 10-K/A (Amendment No. 2) to modify or update other disclosures presented in the original report on form 10-K/A (Amendment No. 1) except as required to reflect the effect of the restatement. This Form 10-K/A (Amendment No. 2) does not reflect events occurring after the filing of the original Form 10-K/A (Amendment No. 1) or modify or update those disclosures. Information not affected by the restatement is unchanged and is therefore not included in this filing, but is included in the original filing of the Form 10-K/A (Amendment No. 1) with the Securities and Exchange Commission on September 28, 2004. Accordingly, this Form 10-K/A (Amendment No. 2) should be read in conjunction with the Companys filings made with the Securities and Exchange Commission subsequent to the filing of the original Form 10-K/A (Amendment No. 1). The following items have been amended as a result of the restatement:
 
 Part I - Item 1 - Business
 Part II - Item 5 - Market for Registrants Common Equity and Related Stockholder Matters
 Part II - Item 6 - Selected Financial Data
 Part II - Item 7 - Managements Discussion and Analysis of Financial Condition and Results of Operations
 Part II - Item 8 - Financial Statements and Supplementary Data
 Part II - Item 9A - Controls and Procedures
 
 
 
 The Annual Report on Form 10-K was previously amended to provide information responsive to Items 10-14 of Part III of Form 10K/A (Amendment No. 1) that the Registrant originally intended to incorporate by reference from its definitive proxy statement.
  ****4  **PART I**
  When we refer to we, us, our, or PrimeSource, we mean PrimeSource Healthcare, Inc., a Massachusetts corporation, formerly known as Luxtec Corporation, and its consolidated subsidiaries. This document includes various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs concerning future events. Statements containing expressions such as "believes," anticipates" or "expects" which might be used in our press releases and periodic reports on Forms 10-K and 10-Q filed with the Securities and Exchange Commission are intended to identify forward-looking statements. All forward-looking statements involve risks and uncertainties. Although we believe our expectations are based upon reasonable assumptions within the bounds of our knowledge and operations, there can be no assurances that actual results will not materially differ from expected results. We caution that these and similar statements included in this report and in previously filed periodic reports, including reports filed on Forms 10-K and 10-Q are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. Such factors include, without limitation, those listed under Item 7.  Managements Discussion and Analysis of Financial Condition and Results of Operations , under the subheading Risk Factors.
  We caution readers not to place undue reliance on forward-looking statements, which speak only as of the date thereof. We undertake no obligation to publicly release any revisions to such forward-looking statements to reflect events or circumstances after the date hereof.
 
 As discussed in Note 15 to the consolidated financial statements, the Companys June 30, 2004 financial statements have been restated. The accompanying managements discussion and analysis gives effect to that restatement.
  
  **ITEM 1.     BUSINESS**
 **General**
 
 We are a specialty medical products sales, marketing, manufacturing and service company. We sell a broad portfolio of high quality, differentiated specialty medical products, some of which we manufacture, to hospitals and surgery centers nationwide through a dedicated organization of sales and marketing professionals. We believe that we are continuing to build a valuable niche franchise in the estimated $5 billion specialty medical marketplace, selling technologically innovative products that command premium pricing.
  Today, we have three primary businesses: Specialty Medical Distribution- Surgical, Specialty Medical Distribution- Critical Care and Manufactured Products Division or Manufactured Products. Information on our business segments can be found in Note 13 to the accompanying consolidated financial statements. The Company was incorporated on November 11, 1981. As of June 30, 2004, we had 132 **** employees and generated total revenue of $48.8 million for the fiscal year ending June 30, 2004.
  ****5
 On March 2, 2001, we completed a merger with PrimeSource Surgical, Inc., or PrimeSource Surgical, resulting in PrimeSource Surgical becoming our wholly owned subsidiary. Subsequent to the merger with PrimeSource Surgical, we changed our name from Luxtec Corporation, to PrimeSource Healthcare, Inc. (PrimeSource or the Company).
  During the year ended June 30, 2002, we commenced a restructuring plan which involved narrowing the focus of our operations, consolidation of certain under-performing sales regions, reduction of corporate overhead through workforce reductions and facility consolidation, restructuring of our balance sheet through the recapitalization of equity and refinancing of our senior bank debt and reduction of debt levels through cost reductions and improved efficiency of operations.
  On September 20, 2002, Ruby Merger Sub, Inc., the Companys indirect wholly owned subsidiary (Ruby), sold all of the assets of the former Professional Equipment Co., Inc. (PEC) line of business in exchange for the cancellation of previously issued stock to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business.
 
 On June 30, 2003, PrimeSource Surgical sold all of the issued and outstanding capital stock of Ruby for cash proceeds of $1,000,000 to New England Medical Specialties, Inc., a newly formed entity (NMSI). Peter Miller, a stockholder of NMSI, was the Regional Manager of Ruby prior to the disposition of the capital stock of Ruby. In connection with the sale of the capital stock of Ruby, Mr. Miller concluded his employment relationship with PrimeSource. Cash proceeds from the Ruby sale were partly used to pay off the PrimeSource Surgical Amended and Restated Term Note (the PrimeSource Surgical Term Loan) and to reduce the revolving line of credit with Citizens Bank of Massachusetts (Citizens). The loss on the disposal of the operation of $73,830, net of income tax, was included as discontinued operations in the fourth quarter of 2003, and the related results of operations for the operation were re-classified as discontinued operations.
 
 In December 2003, we consolidated our senior debt facilities. Our senior debt financing is now provided under a revolving $7,500,000 demand note from Wells Fargo Business Credit, Inc. (Wells Fargo). As of June 30, 2004, the Company had $5,204,139 of outstanding borrowings under the PrimeSource Healthcare Credit and Security Agreement, dated as of December 10, 2003, by and among the Company, PrimeSource Surgical, Bimeco, Inc. (Bimeco) and Wells Fargo (the Credit and Security Agreement) as further discussed in Note 7 to the accompanying consolidated financial statements.
  **Business Strategy**
  Our goal is to be one of the nations leading suppliers of specialty medical products to hospitals and surgery centers. We intend to continue to grow by:
  ·
hiring experienced territory sales representatives;  ·
securing additional specialty product lines to increase our product offerings; and  ·
selectively acquiring specialty medical products manufacturers. We expect to benefit from the acquisition of select specialty medical products manufacturers by increasing sales of acquired product lines through use of our direct specialty medical products sales force.  ****6
 Our Manufactured Products business continues to lead the surgical headlamp business and focuses its research and development efforts on new and innovative products which can be sold through our distribution segment.
  We believe we are well positioned to continue our growth within the specialty medical products industry. We expect to experience sales growth in the specialty medical products industry as a result of:
 
 ·
favorable industry demographics;  ·
sustaining or increasing our market share;  ·
the acquisition of other specialty medical products manufacturers;  ·
expanding margin opportunities in our manufactured products business;  ·
further penetration of existing customer accounts due to our introduction of new products and services; and  ·
entrance into new specialty domestic markets and expansion into international markets.  **Industry**
  The medical products industry has grown in recent years due to the aging of the population and the development of new medical products and technologies that create new product opportunities for manufacturers and suppliers. Healthcare industry analysts estimate that the overall market for medical products and supplies in the United States is in excess of $45 billion. An estimated $15 billion is distributed by the larger medical and surgical, or med-surg, distributors, such as Owens & Minor, Inc., Cardinal Health, Inc. and McKesson Corporation. These distributors primarily market commodity products and supplies to group purchasing organizations (GPOs) and integrated delivery networks (IDNs). It is estimated that an additional $25 billion in medical product sales is sold directly by medical device manufacturers to end customers. Local and regional distributors account for an estimated $5 billion of specialty medical products sold to hospitals, clinics and physicians. PrimeSource competes within this segment of the medical products and supplies market.
  Historically, the specialty medical products industry has been highly fragmented. During the past decade, healthcare providers have consolidated into larger IDNs in an effort to reduce costs. In addition, in order to gain purchasing power, buyers of medical products and supplies have consolidated their purchases through large, national GPOs. In addition to our traditional customer base, composed primarily of hospitals and surgery centers, we also market (on a limited basis) to IDNs and GPOs. IDNs and GPOs purchase a significant percentage of medical products and supplies for hospitals. GPO contractors typically require purchasing volume of at least $10 million when structuring purchasing contracts with distributors. By aggregating specialty products, we have created an opportunity for GPOs to reduce their overall purchasing costs. We do this by eliminating multiple specialty products vendor relationships in favor of one - PrimeSource. Our ability to access IDNs and GPOs has created an advantage for smaller product manufacturers (who cannot easily access the IDN and GPO customer base) with whom we do business over their competitors who might be unable to satisfy IDN and GPO minimum volume purchasing requirements.
 
 7
 We believe that we are well positioned within our industry because we:
 
 ·
provide a consultative, specialty-focused sales approach through a network of highly trained sales professionals; 
 ·
operate in a complementary niche outside the volume-driven model of large, national med-surg distributors; 
 ·
offer a broader range of products, services, and solutions exceeding those of any single specialty medical product manufacturers direct sales force; and 
 ·
reach a national customer base of GPOs and IDNs that is beyond the scope of local and regional specialty medical products distributors. 
 We believe that customers seek to consolidate their purchases of products and services in the highly fragmented specialty medical products and services market in order to reduce their procurement costs. We help customers reduce the number of vendors that they work with, thereby reducing the overall costs of products and services.
 
 **Products and Services**
 
 *Specialty Medical Distribution*
 
 Within the Specialty Medical Distribution business, we have the PrimeSource Surgical business, or Surgical, and PrimeSource Critical Care business, or Critical Care. The Surgical business is a regional sales and marketing organization that markets and sells a large number of surgical products primarily to hospitals and surgery centers in the midwestern, mid-atlantic and southeastern United States. The Critical Care business is a regional sales and marketing organization that sells a large number of products primarily to hospitals and surgery centers in the southeastern and northeastern United States.
 
 Within the Surgical business, the primary specialties are:
 
 ·
Cardio Vascular; 
 ·
Endoscopy; 
 ·
General Surgery; and 
 ·
Gynecology. 
 Within the Critical Care business, the primary specialties are:
 
 ·
Neonatal Intensive Care; and 
 ·
Maternal and Child Care. 
 8
 Our products services are primarily used in hospital operating rooms and intensive care units, outpatient surgery centers and, to a lesser degree, doctors' offices. Most of our products are technologically innovative medical products, or specialty products, that require hands-on training of clinicians and medical personnel. We continue to expand our product base to include additional instruments and equipment, thereby allowing customers to use us as a source for a greater percentage of their specialty products needs.
 
 The sale of specialty disposable products and capital equipment accounts for the majority of our revenues. Our capital equipment products are typically complex and require significant consultative selling to medical staff personnel which is provided as part of our marketing and customer service efforts. Our specialty disposable products are often sold to support the capital equipment products and offer a recurring and stable source of revenue.
 
 *Manufactured Products Division*
 
 We operate the Manufactured Products business through our Luxtec division, which designs, manufactures and markets fiber optic headlight and video camera systems, light sources, cables, retractors and surgical and other custom-made equipment for the medical and dental industries. Luxtec has developed a proprietary, fiber optic drawing system designed to manufacture optical glass to a specified diameter. The fibers are utilized in fiber optic cables, which are incorporated with Luxtec's surgical headlight systems and video camera systems, as well as into an array of fiber optic transilluminators utilized with Luxtecs surgical instruments. Luxtec also markets replacement fiber optic cables, bulbs, and light sources for use with other manufacturers' products, including various endoscopic systems used in minimally invasive surgical procedures.
 
 Fiber optics allow for the transmission of a light or image from one place to another through a flexible conduit of optical glass rods and tubes. The flexible conduit provides for an improved ability to bend and transmit light and images to and from places with limited or difficult access.
 
 The technology used by Luxtec to provide illumination directly to the surgical site is facilitated by fiber optic cables transmitting light to an adjustable headlight composed of a series of lenses and mirrors mounted on a headband. These lenses then focus the light directly on the surgical site when worn by the surgeon. This provides a lightweight, low temperature illumination source to enhance visualization for microsurgical and deep cavity illumination. A summary of the Luxtec divisions specific product offerings is as follows:
 
 ***Headlight Systems:*** Luxtec designs and manufactures a proprietary line of fiber optic headlight systems that assist surgeons by brightly illuminating the surgical site. Designed to provide maximum performance and comfort, Luxtec's patented headlight systems are lightweight and provide the surgeon with a virtually unobstructed view of the surgical area.
 
 ***Light Sources:*** Luxtec manufactures a product line of high quality, solid state xenon and halogen fiber optic light sources. Luxtec's light sources offer a wide range of light intensities in order to serve the varying requirements in illuminating surgical and diagnostic procedures. The lamps illuminate the end surface of the fiber optic cable through which the light is transmitted, without transmitting heat. Luxtec's light sources are designed and manufactured to comply with
 
 9
 Underwriters Laboratories 544 medical safety standards and are listed domestically with ETL Laboratories. Internationally, Luxtec strives to achieve compliance with all applicable international standards to compete effectively on a worldwide basis (including the CE mark, which has been attained on the present product line).
 
 ***Fiber Optic Cables:*** Luxtec designs and manufactures a complete range of fiber optic cables and holds patents on certain fiber optic cable assemblies. See "Patents and Trademarks." Luxtec offers surgeons a range of fiber bundle diameters in order to optimize the use of surgical instruments. Luxtec employs a proprietary technology that enables the fiber optic interface to withstand significantly higher temperatures and permits the use of higher output light sources. In addition, all of Luxtec's fiber optic cables are adaptable to light sources made by other manufacturers.
 
 ***Fiber Optic Headlight and Video Camera Systems:*** Luxtec manufactures and markets a series of video products that are currently being used in the United States and in over 25 countries around the world. Luxtec's Microlux headlight camera systems are designed to televise surgical procedures. The system is a very small, lightweight, solid state television camera mounted at the front of a headband, manufactured by Luxtec, and integrated with fiber optic illumination.
 
 **Sales and Marketing**
 
 We sell our products and services to hospitals, IDNs, surgery centers and physician offices. In fiscal year ended June 30, 2004, within the Specialty Medical Distribution business, we sold specialty medical products to over 3,000 customers, primarily in the United States. We are not dependent on any single customer or geographic group of customers. Our largest customer accounted for 2.3% of our gross profit during our fiscal year ended June 30, 2004.
 
 We maintain an extensive sales organization that is highly experienced and skilled in representing clinical products and services. Our sales representatives serve as a service and educational resource to the marketplace. They assist clinicians in selecting and purchasing products, help customers better manage inventories of specialty medical products and direct the appropriate utilization of our clinically focused products. Each sales representative works within an assigned sales territory under the supervision of a dedicated regional sales manager. Our sales representatives are primarily compensated on a commission basis.
 
 Within the surgical illumination industry, Luxtec is the domestic market leader in surgical headlight systems with over 50,000 surgeons using their products on a worldwide basis. Within the United States, the Luxtec fiber optic and illumination products are primarily distributed through our Surgical segments sales force, supported by Luxtec field specialists and a customer support team now located at our Birmingham, Alabama facility. Luxtec also distributes domestically through a number of other regional specialty medical distributors. Internationally, Luxtec distributes through a network of local distributors.
 
 Our net revenues, based upon the customers country of origin by geographic area for the year ended June 30, 2004, 2003 and 2002, totaled $46,065,000, $44,015,000 and $51,688,000, respectively, for sales in the United States and $2,698,000, $2,345,000 and $2,008,000, respectively, for sales to foreign customers.
  10   **Distribution**
  We believe that responsive delivery of quality specialty medical products and supplies is a key element to providing complete customer satisfaction. Our customers place orders for medical products and supplies by telephone, facsimile or via EDI. All orders are routed through our centralized computer ordering, shipping and inventory management system, which is linked to our distribution centers. Rapid and accurate order fulfillment is a principal component of our value-added approach.
  In order to assure the availability of our broad product lines for prompt delivery to customers, we must maintain sufficient inventories at our distribution centers. Our inventory levels are centralized with and managed by a purchasing department using an integrated inventory control system. Our inventory consists primarily of medical products and supplies.
 
 **Manufacturing and Suppliers**
  Manufacturer relationships are an integral part of our businesses. Our Specialty Medical Distribution business represents more than 125 manufacturers with over 90% of our sales concentrated among products purchased from approximately 30 of these manufacturers. A majority of the business is comprised of stocking relationships whereby we stock the vendors products and provide substantially all fulfillment services (i.e., customer service, shipping, returns, etc.). The remainder of the revenue is received on an "agency" basis whereby we do not stock the vendor's products and do not provide fulfillment services. In the case of an agency sale, the manufacturer provides substantially all fulfillment services for customers and we provide sales and marketing support to facilitate the sale of the vendors product. For providing the sales and marketing support, we are paid a sales commission on each sale of the vendor's products.
  Within the Manufactured Products business, Luxtec purchases components and materials from more than 200 vendors and believes it can purchase substantially all of its product requirements from other competing vendors under similar terms. Luxtec has no long-term contract with any supplier but does maintain long-standing relationships with certain vendors.
  Our Specialty Medical Distribution business aggressively pursues the opportunity to market and sell medical equipment and supplies on an exclusive basis. Manufacturers of specialty medical products and supplies typically offer distribution rights only to a select group of distributors and are increasingly seeking to reduce the number of distributors selling their products to end users in an effort to reduce the overall costs associated with selling and marketing their products. We have been successful in assisting manufacturers in their development and marketing plans and in obtaining the exclusive rights to sell certain products. We believe that our ability to capture and retain such distribution rights represents a barrier to the entry of competitors.
  Within the Specialty Medical Distribution business, our network of manufacturers is continually seeking representation or market introduction for their products, resulting in a growth pipeline of attractive, innovative products accretive to our portfolio of distributed products. Moreover, we have been able to enter into contractual relationships with certain manufacturers that are typically exclusive in nature, extend for several years in duration, and include a right of first refusal on new product introductions.
  ****11
 **Information Systems**
  Our Specialty Medical Distribution business employs a single, centralized, enterprise management information system utilized across all business units via a wide-area data network. This approach yields significant benefits including:
 
 ·
increased inventory utilization; 
 ·
greater visibility as to sales performance; and 
 ·
the coordination necessary to address the needs and requirements of an increasing number of IDNs and GPOs whose members are geographically dispersed. 
 We continue to offer our web-based Surg-E-Track (TM) system to our direct sales force as well as select manufacturer partners. Surg-E-Track provides sales personnel and manufacturer partners with comprehensive customer purchasing data in a variety of formats. We are able to enhance sales representative productivity, customer service levels and assist our manufacturer partners to more effectively manage their businesses through the Surg-E Track system.
 
 **Competition**
 
 We compete with a variety of companies including manufacturers that utilize direct sales forces, national specialty distributors and a number of significantly smaller local and regional specialty distributors. We compete to a lesser degree with national med-surg distribution companies such as Cardinal Health, Inc., McKesson Corporation and Owens & Minor, Inc. A brief overview of the Companys competition follows:
 
 ·
***Product Manufacturers Direct Sales Forces****.*Product**manufacturers direct, internal sales forces offer manufacturers direct access to healthcare providers. Manufacturers, however, periodically outsource the sales and marketing of some of their products to specialty sales and marketing organizations such as PrimeSource. 
 ·
***National Specialty Distributors****.*Several companies serve the national specialty medical products market. These national specialty distributors tend to focus and specialize within a particular segment of the specialty medical products market. 
 ·
***Regional Specialty Distributors****.*Regional specialty distributors represent our primary competition in the specialty medical products market. 
 ·
***National Med-Surg Distributors****.*In most respects, we complement, rather than compete, with national med-surg distributors. These larger supply companies, such as McKesson Corporation, Owens & Minor, Inc., and Cardinal Health, Inc., have historically focused on distributing a broad array of lower-margin, later-stage products, aiming to give healthcare providers aggressive pricing and the convenience of one-stop shopping. As a result, their core expertise does not reside in creating a market for complex specialty products, which often require important services such as on-site training and product support. In addition, these suppliers are generally not viewed by their customers as experts within specific specialty areas. As a result, specialty product manufacturers tend to outsource sales and marketing services to specialists rather than national med/surg distributors. 
 12
 Within the Manufactured Products business, Luxtec competes with a number of manufacturers of proprietary light source systems. Competitors within the United States include the Cogent division of Welch Allyn and Sunoptic Technologies (formerly Cuda FiberOptics) and Illumination Industrial Isolux, SA. Some of Luxtecs competitors have historically relied on metal halide technology rather than the state-of-the-art xenon technology offered by Luxtec. The xenon technology is more widely accepted and provides a broader color spectrum than metal halide technology. Foreign competitors include Richard Wolf GMBH, Scholly GMBH and those companies previously mentioned above.
 
 **Patents and Trademarks**
 
 We maintain a policy of seeking patent and trademark protection in connection with certain elements of our technology and brand names. We own the following U.S. Patents and Trademarks:
 
 Patents
 ·
Patent No. 4616257 for Headlight Camera System issued October 7, 1986. ·
Patent No. 5295052 for a light source assembly issued March 15 1994. ·
Patent No. D345368 for surgical telescopes issued March 22, 1994. ·
Patent No. D349123 for spectacles having integral illumination issued July 26, 1994. ·
Patent No. D350760 for an eyeglass frame temple issued September 20, 1994. ·
Patent No. D415285 for Pinhole Headlamp Video Camera for Medical and Surgical Applications issued October 12, 1999. ·
Patent No. D398403 for Headband for Surgeons with Removable Headboard Hanger issued September 15, 1998. ·
Patent No. 6258037 for blood pressure monitoring in noisy environments issued July 10, 2001. ·
Patent No. 4998713 for needle connector issued March 12, 1991. ·
Patent No. 5893635 for headlamp with enhanced light gathering condenser issued April 13, 1999. 
 Trademarks
 ·
LUXTEC, U.S. federal trademark registration number 1,453,098, registered August 18, 1987. ·
LUXTEC (and design), U.S. federal trademark registration number 1,476,726, registered February 16, 1988. ·
LUXTEC (stylized), U.S. federal trademark registration number 1,758,176, registered March 16, 1993. ·
LUXTEC, U.S. federal trademark registration number 1,956,027, registered February 13, 1996. ·
Luxtec is also the owner of the following foreign trademark registrations for its LUXTEC trademark: (i) Chile, registration number 452.314, registered October 31, 1995; and (ii) Peru, registration number 016214, registered June 14, 1995.  13   ·
BIMECO, U.S. federal trademark registration number 1,190,584, registered February, 23 1981 ·
MegaTech Medical, U.S. federal trademark registration number 1,930,021, registered October 24, 1995 ·
TMC ·
Clearfield ·
ValueFlex 
 Luxtec relies on its development and manufacturing efforts, rather than patent protection, to establish and maintain its industry position. In general, we treat our design, technical, customer, vendor and other Company data as confidential and rely on nondisclosure agreements, trade secrets laws and non-competition agreements to protect our proprietary position; however, we cannot assure that these measures will adequately protect our proprietary technologies.
 ****
 **Government Regulation**
 
 The manufacturing, marketing, distribution and sale of specialty medical products sold by us are subject to government regulation in the United States and other countries. Among the federal laws which impact us are the Federal Food, Drug and Cosmetic Act, which regulates the advertising, record keeping, labeling, handling, storage and distribution of drugs and medical devices, and which requires us to be registered with the United States Food and Drug Administration (FDA), and the Safe Medical Devices Act of 1990, which imposes certain reporting requirements on distributors in the event of an incident involving serious illness, injury or death caused by a medical device. In addition, in order to clinically test, produce and market products for human diagnostic or therapeutic use, we must comply with mandatory procedures and safety standards established by the FDA and comparable state and foreign regulatory agencies. Typically, products must meet regulatory standards as safe and effective for their intended use prior to being marketed for human applications. The clearance process is expensive and time consuming, and no assurance can be given that any agency will grant clearance for the sale of our products or that the length of time the process will require will not be extensive. We believe that we are in substantial compliance with all of the foregoing laws and that we possess all licenses required in the conduct of our business.
 
 **Employees**
 
 As of September 1, 2004, we had 136 employees, of which 41 are engaged in the Surgical segment, 19 in the Critical Care segment, 56 in the Manufactured Products business and 20 in corporate and shared services. We believe that our continued success depends on our ability to attract and retain highly qualified personnel. None of our employees are covered by a collective bargaining agreement.
  14   **Executive Officers and Key Management Personnel**
 
 Following are the names and ages, as of September 1, 2004, of our executive officers and key management personnel, their positions and summaries of their backgrounds and business experience.
 
 Name
Age
PositionJoseph H. Potenza
57
President and Chief Executive OfficerShaun D. McMeans
42
Chief Operating Officer and Chief Financial OfficerSamuel M. Stein
64
Vice President & General Manager, Manufacturing DivisionMark A. Jungers
52
Regional Vice President, Distribution DivisionBruce R. Hoadley
45
Regional Vice President, Distribution DivisionScott F. Billman
48
Regional Vice President, Distribution Division 
 ***Joseph H. Potenza, President & Chief Executive Officer:*** Prior to joining PrimeSource in February 2001, Mr. Potenza held senior management positions with McKesson Corporation as Vice President of the Corporate Program and with the former Medibuy where he was responsible for the National Accounts and Corporate Program. From 1977 to 1997, Mr. Potenza developed his career with American Hospital Supply Corporation/Baxter Healthcare Corporation, culminating as Eastern Region President, where he was responsible for a $750 million distribution business with 650 employees and seven distribution facilities. He received a Bachelor of Arts degree in English from Norwich University and a Master of Arts degree in Management from Central Michigan University.
 
 ***Shaun D. McMeans, Chief Operating Officer & Chief Financial Officer:*** Mr. McMeans has over 20 years of experience in manufacturing and distribution businesses, specializing in operations, accounting and financial management. Prior to becoming the Companys Chief Financial Officer, he served as Vice President of Operations and Corporate Controller. Prior to joining the Company in April 2000, Mr. McMeans held operational and financial management positions with Burnham Corporation, a leading domestic manufacturer and distributor of residential and commercial boilers. Mr. McMeans earned a Bachelor of Science degree in Accounting from Pennsylvania State University and is a certified public accountant. He began his career in public accounting with the former Peat, Marwick, Mitchell and Company.
 
 ***Samuel M. Stein, Vice President & General Manager, Manufacturing Division*** **:** Mr. Steins career has focused on high growth technology companies. Prior to becoming General Manager of the Companys Luxtec Division, Mr. Stein served as Luxtec's Chief Financial Officer. Prior to joining Luxtec in 1993, Mr. Stein served as Chief Operating and Chief Financial Officer of Mitrol, Inc. of which he was also co-founder. He has served as Chief Financial Officer with companies ranging from start-ups to subsidiaries of Fortune 500 corporations. Mr. Stein earned a Bachelor of Science degree in Business Administration from the University of Toledo and a Master of Science degree from Rensselaer Polytechnic Institute.
 
 ***Mark A. Jungers, Regional Vice President, Distribution Division:*** Mr. Jungers has an extensive background in med-surg and critical care product sales and management. Mr. Jungers joined PrimeSource through its 1999 acquisition of Bimeco, a leading distributor of specialty medical products to the critical care market in the southeastern United States, where he served as a Sales Manager. Prior to joining Bimeco in 1979, he held sales and marketing positions with the Extracorporeal Medical Division of Johnson & Johnson. Mr. Jungers earned a Bachelor of Science degree in Business Administration from Marquette University.
 
 15
 ***Bruce R. Hoadley, Regional Vice President, Distribution Division:***  Mr. Hoadley has worked for over 20 years in the sales and management of specialty surgical products. He was the Sales Manager for Futuretech, a leading distributor of specialty medical products to the surgical market in the southeastern United States, from 1991 until its acquisition by PrimeSource in 1999. Prior to joining Futuretech, Mr. Hoadley held sales management positions with Kendall Healthcare and Devon. He earned a Bachelor of Arts degree in Marketing from the University of Alabama.
 
 ***Scott F. Billman, Regional Vice President, Distribution Division:***  Mr. Billman has spent his entire career in sales, marketing, and operations management. He has worked for over 20 years in the healthcare industry, holding several management positions primarily focused on the sales and marketing of surgical products. He most recently served as Senior Vice President of Product Marketing for the former Medibuy. Mr. Billman earned a Bachelor of Science degree in Business Administration and an MBA from Bowling Green State University.
 
 **Risk Factors**
 
 *Our Business Will Suffer if We Fail to Attract and Retain Experienced Sales Representatives.* The success and growth of our business depends on our ability to attract and retain qualified and experienced sales representatives. There is significant competition for experienced specialty medical products sales representatives. It is uncertain whether we can continue to attract and retain qualified personnel. If we cannot attract, retain and motivate qualified sales personnel, we will not be able to expand our business and our ability to perform under our existing contracts will be impaired, which would negatively affect our results of operations.
 
 *Our Business Would Suffer if We Lost Key Suppliers.* Our success is partly dependent on our ability to successfully predict and adjust production capacity to meet demand, which is partly dependent upon the ability of external suppliers to deliver components at reasonable prices and in a timely manner. Capacity or supply constraints, as well as purchase commitments, could adversely affect our future operating results. We cannot assure that we will be able to maintain our existing supplier relationships or secure additional suppliers as needed.
 
 *If Suppliers Terminate Their Agreements with Us, Our Product Offerings May Suffer.* Following an initial one-year term, many of our standard supplier agreements may be terminated by either party on 90 days' notice or upon a change in control of PrimeSource. After expiration of the initial term, such suppliers may terminate or seek to renegotiate their agreements. If a significant number of suppliers terminate their agreements with us, the range of products we will be able to offer would be adversely affected. The ability of suppliers to terminate their agreements may result in new agreement terms that are less favorable to us, which could have a material adverse effect on our earnings.
 
 *PrimeSource Surgical Has a Limited Operating History, Which Makes it Difficult to Predict its Future Performance* . PrimeSource Surgical, which is our material subsidiary, commenced operations in 1996, and grew rapidly through the acquisition of a number of specialty medical products sales and marketing organizations. Accordingly, PrimeSource Surgical has only a limited operating history from which to evaluate and forecast its business. As a result of PrimeSource Surgical's limited operating history, we may be unable to accurately forecast financial results going forward. Moreover, failure to meet our revenue targets and financial projections may have an immediate and negative impact on our total results of operations.
 
 16
 *If We are Unable to Achieve Our Business Objectives and Comply with the Covenants in Our Credit Facilities We May Have to Suspend or Cease Operations.* We had net income of $2,177,213 for our fiscal year ended June 30, 2004. If we are unable to generate sufficient positive cash flow and/or raise additional equity or debt capital, we may have insufficient funds to continue our operations. In addition, if we are unable to comply with the covenants of our credit facilities, our creditors may accelerate repayment of the borrowings under our credit facility.
 
 *The Industry In Which We Participate is Increasingly Competitive Which Could Make it More Difficult for Us to Improve Our Financial Performance* . The changing health-care environment in recent years has led to increasingly intense competition among health-care suppliers. Competition is focused on price, service and product performance. Pressure in these areas is expected to continue. Increased competition may lead to price and other forms of competition that could have a material adverse effect on our market share, business and results of operations. Also, we may face increased competition for acquisition opportunities, which may inhibit our ability to consummate suitable acquisitions on favorable terms. Many of our competitors are, or are affiliated with, major companies. These competitors have substantially greater financial and marketing resources and greater name recognition and more established relationships with a large base of current and potential customers than we do. Accordingly, it may be more difficult to compete against these large competitors.
  *Sales to Larger Customers May Increase the Length of Our Sales Cycle and Decrease Our Profit Margins* . Increasing sales to larger buyers may be an important element of a future business strategy. As we sell to larger organizations, it is expected that the time from initial contact to final approval will increase. During this sales cycle, we may expend substantial funds and management resources without any corresponding revenue. If approval of contracts is delayed or does not occur, our financial condition and operating results for a particular period may be adversely affected. Approval of contracts may be subject to delays for reasons over which we will have little or no control, including:
    potential customers' internal approval processes;
   customers' concerns about implementing a new method of doing business; and
   seasonal and other timing effects.
  Increased sales to larger accounts may result in lower profit margins as larger customers typically have greater leverage in negotiating the price and other terms of business relationships. If we do not generate sufficient transaction volume to offset any lower margins, our operating results may be materially and adversely affected.
  *Governmental or Private Initiatives To Reduce Healthcare Costs Could Have a Material Adverse Effect on the Specialty Medical Products Industry.* The primary trend in the United States healthcare industry is toward cost containment. Comprehensive government healthcare reforms intended to reduce healthcare costs, the growth of total healthcare expenditures and expanded healthcare coverage for the uninsured have been proposed in the past and may be considered again in the near future. Implementation of government healthcare reforms may adversely affect specialty medical products companies, which could
 
 17
 decrease the business opportunities available to us. In addition, the increasing use of managed care, centralized purchasing decisions and consolidations among, and integration of, healthcare providers are continuing to affect purchasing and usage patterns in the healthcare system. Decisions regarding the use of specialty medical products are increasingly being consolidated into group purchasing organizations, regional integrated delivery systems and similar organizations and are becoming more economically focused, with decision makers taking into account the cost of the product and whether a product reduces the cost of treatment. Significant cost containment initiatives adopted by government or private entities could have a material adverse effect on our business.
  *Our Major Stockholder Has Substantial Control of Us and Could Delay or Prevent a Change In Control that Stockholders May Believe Would Improve Management and/or Our Business* . As a result of its ownership of Series G Preferred Stock and common stock , GE Capital Equity Investments, Inc., is able to exercise substantial control over the election of our directors and many corporate actions requiring the approval of such stockholders.
 
 *Our Common Stock is Not Listed on an Exchange Which Makes it Difficult for Our Stockholders to Sell Their Stock**.*Although we are a public reporting company and incur the costs and regulatory burden associated with our reporting obligations, our shares of capital stock are not listed on any stock exchange or quoted on any quotation system. We cannot assure that holders of our capital stock will be able to dispose of their shares. Our ability to use our stock as consideration in potential acquisition will be hindered by the limited trading market for our stock.
 
 
 
 
 
 **PART II**
 
 **ITEM 5.     MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**
 
 Our common stock was listed on the American Stock Exchange (the "AMEX") under the AMEX symbol "LXU.EC") from April 20, 1994 through November 17, 2000, at which time it was delisted by the AMEX because it no longer continued to satisfy the AMEXs listing requirements. On November 16, 2000, the trading day immediately before our common stock was delisted by the AMEX, the closing price was $1.00.
 
 Our common stock is not currently listed on any public exchange or market. There is no established public trading market for our common stock and no assurance can be given that an established trading market for our common stock will develop in the future.
 
 As of September 1, 2004, there were approximately 534 registered holders of record of our common stock. We estimate that there are approximately 800 beneficial holders of our common stock.
 
 18
 We have not paid any cash dividends on our common stock since our inception and the Board of Directors does not contemplate doing so in the foreseeable future. The Board of Directors currently intends to retain any future earnings for use in expanding our business. We may not declare or pay any dividend without the consent of lenders and our preferred stockholders.
 
 On August 6, 2002, the Company created a new series of preferred stock, Series G Convertible Redeemable Preferred Stock, no par value (the Series G Stock). The Series G Stock has 230,000 authorized shares and at June 30, 2004 222,501 shares are issued and outstanding. In connection with the issuance of the Series G Stock, the Company issued warrants to purchase an aggregate of 3,300,000 shares of common stock at $.01 per share. These warrants became exercisable on December 31, 2002 and expire on August 6, 2012. Each share of Series G Stock is convertible into 100 shares of common stock, subject to adjustment, at the option of the holder. Each share of Series G Stock has one vote for each share of common into which it would be convertible. In addition, Series G Stock ranks senior to all other outstanding stock of the Company. Series G Stock accrues dividends at the rate of 8% per year of the original issuance price of $32.00 per share, compounded annually, and has a liquidation preference equal to $64.00 per share plus an amount equal to all accrued but unpaid dividends. The Series G Stock is redeemable at the election of not less than 60% of the Series G Stockholders any time after June 30, 2005, and is redeemable at $64.00 per share plus accrued but unpaid dividends. The Series G Stock also has special consent rights to certain of the Companys activities, including, but not limited to, amendment of the Companys articles or bylaws and merger or consolidation of the Company.
  **Equity Compensation Plan Information****June 30, 2004****Number of securities****Number of securities**



**remaining available for****to be issued**

**Weighted-average**

**future issuance under****upon exercise of**

**exercise price of**

**equity compensation plans****outstanding options,**

**outstanding options,**

**(excluding securities****warrants and rights**

**warrants and rights**

**reflected in column (a))****Plan category**
**(a)**

**(b)**

**(c)**Equity compensationplans approved by
26,562,698

$ 0.1930

2,912,070security holdersEquity compensationplans not approvedby security holders (1)
7,499

16.00

0Total
26,570,197

$ 0.1975

2,912,070  (1)  On August 6, 2002, we granted Bradford C. Walker an option to purchase 7,500 shares of our Series G Convertible Redeemable Preferred Stock at an exercise price of $16 per share. This option became fully vested and exercisable on the first anniversary of the grant date and expires upon the tenth (10 th ) anniversary of the grant date. Mr. Walker subsequently left the Company and the options are exercisable at any time prior to the earlier of (i) the date that is one (1) year following the registration of the applicable options underlying shares under the Securities Act of 1933 on an effective registration statement on Form S-8, as amended or (ii) March 1, 2009, 5 years after Mr. Walkers severance date. On October 15, 2003, an option for the purchase of one share of Series G Stock was exercised for $16.
  19
 **ITEM 6.     SELECTED CONSOLIDATED FINANCIAL DATA**
  The selected consolidated financial data presented below has been derived from our historical audited consolidated financial statements of PrimeSource for each of the five years in the period ended June 30, 2004. The following data should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the notes thereto. Data is in thousands except per share data.
   **Operating Data:**
**Fiscal Year****Ended June 30****2004(1)(9)**
**2003(2)(3)(9)**
**2002(4)(5)(9)**
**2001(6)**
**2000(7)(8)****(In thousands, except per share data)****Net revenues**
$   48,763
$  46,360
$   53,696
$    48,402
$    54,411**Income (loss) from continuing****operations**
$     2,177
$       778
$   (6,292)
$   (4,832)
$   (1,384)**Per share income (loss) from****continuing operations**
$    (0.05)
$   (0.10)
$     (1.13)
$     (1.37)
$     (0.69)**Net income (loss)**
$    2,177
$ (3,629)
$   (6,191)
$   (4,382)
$   (1,384)**Per share income (loss)****- Basic & Diluted**
$   (0.05)
$   (0.31)
$     (1.11)
$     (1.37)
$     (0.69)**Total assets**
$  29,899
$  31,665
$   37,587
$    45,450
$    31,297**Long-term obligations and redeemable****preferred stock**
$  12,535
$    9,166
$   23,285
$    20,335
$    15,968**Stockholders' equity****(Capital deficiency)**
$    6,038
$    7,219
$   (5,349)
$      (562)
$      (567)
 
  (1) In December 2003, the Company refinanced its senior debt facilities. The Company paid off its Luxtec revolving note in the amount of $1,271,585. Simultaneously, the Company paid off its PrimeSource Surgical revolving line of credit in the amount of $4,793,944.
 
 (2) In accordance with the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 142, the Company completed the transitional test for impairment in March 2003 and concluded that consolidated goodwill was impaired in the amount of $4,454,656. The Company recorded a non-cash charge of $4,454,656 to reduce the carrying value of its goodwill. This charge is non-operational in nature and is reflected as a cumulative effect of a change in accounting principle, effective July 1, 2002, in the accompanying Consolidated Statements of Operations.
 
 (3) In the fiscal year ended June 30, 2003, the Company restructured its outstanding preferred and common stock. The recapitalization, as discussed in Note 15 to the accompanying consolidated financial statements, resulted in preferred stockholders exchanging preferred stock with a redemption value of approximately $21,993,000 for preferred stock with a redemption value of $6,500,000, common stock and common stock warrants. As a result of the recapitalization, loss attributable to common stockholders was decreased by $270,130.
 
 20
 (4) In the fiscal year ended June 30, 2002, PrimeSource approved plans for restructuring of operations involving narrowing the focus of its operations, consolidation of certain under performing sales regions, reduction of corporate overhead through workforce reductions, restructuring of its balance sheet through the refinancing of PrimeSource Healthcares and PrimeSource Surgical s senior bank debt and the reduction of debt levels through cost reductions and improved efficiency of operations . The related restructuring expenses, excluding the $1,038,823 discussed in footnote (5) below, included charges of $ 2,915,675.
 
 (5) On September 20, 2002, in connection with the restructuring, Ruby sold all of the assets of its former PEC line of business in exchange for the cancellation of stock previously issued to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business. The Company recognized a loss on the transaction totaling $1,038,823 and is included as restructuring expense in the fiscal year ending June 30, 2002, as the assets were held for sale and deemed impaired at that date.
 
 (6) Effective March 2, 2001, PrimeSource Surgical completed a merger with Luxtec Corporation with aggregate consideration exchanged of approximately $4,791,000, where PrimeSource Surgical assumed liabilities, net of assets acquired and costs of approximately $3,931,000. The acquisition was accounted for using the purchase method of accounting and the results of operations of Luxtec have been included in the financial statements of PrimeSource Surgical as of the date of acquisition. In December 2000, the Company acquired two entities, PEC and NEM, for aggregate consideration of $1,310,000. The acquisition was accounted for using the purchase method of accounting and the results of operations of the acquired entities have been included in the consolidated financial statements from the date of acquisition through date of sale, as discussed above.
 
 (7) In June 2000, PrimeSource Surgical sold an entity for approximately $398,000, which resulted in a recorded loss of approximately $732,000. In addition, in April 2000, PrimeSource Surgical acquired an entity for $405,000. The acquisition was accounted for using the purchase method of accounting and the results of operations are included in the consolidated financial statements from the date of acquisition.
 
 (8 ) In the fiscal year  ended June 30, 2000, PrimeSource Surgical approved plans for a major restructuring of its operations with the goal of centralizing distribution facilities, eliminating unprofitable divisions and reducing costs . The aggregate cost s of the restructu ring included total charges of $ 1,031,000.
 
 (9) As restated, see Note 15 in the Notes to Consolidated Financial Statements.
 
 21  **Operating Data:**
  The following table sets forth unaudited quarterly consolidated operating results for each of our last eight quarters. We have prepared this information on a basis consistent with our audited consolidated financial statements and included all adjustments, consisting only of normal recurring adjustments that we consider necessary for a fair presentation of the data. These quarterly results are not necessarily indicative of future results of operations. This information should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and the notes thereto. Data is in thousands, except per share data.
  **Sep-30,**

**Dec-31,**

**Mar-31,**

**Jun-30,**

**Sep-30,**

**Dec-31,**

**Mar-31,**

**Jun-30,****2002**(1)(2)

**2002**(2)

**2003**(2)

**2003**(2)

**2003**(2)

**2003**(2)

**2004**(2)

**2004**(2)Net revenues

$
11,790

$
11,588

$
11,127

$
11,856

$
12,162

$
12,541

$
12,253

$
11,807Cost of products sold

$
7,499

$
7,307

$
6,885

$
7,606

$
7,666

$
7,853

$
7,956

$
7,556Gross profit

$
4,291

$
4,281

$
4,242

$
4,250

$
4,496

$
4,688

$
4,297

$
4,251Income (loss) from continuingoperations

$
444

$
384

$
(42
)
$
(8
)
$
345

$
430

$
401

$
1,001Income (loss) from continuing operationsavailable (attributable) to common stockholders

$
(214
)
$
(305
)
$
(772
)
$
(751
)
$
(500
)
$
(416
)
$
(437
)
$
162Income (loss) Per share - basic anddiluted

$
(0.01
)
$
(0.01
)
$
(0.03
)
$
(0.03
)
$
(0.02
)
$
(0.02
)
$
(0.02
)
$
0.01Net income (loss)

$
(3,971
)
$
416

$
(3
)
$
(71
)
$
345

$
430

$
401

$
1,001Income available (loss attributable) tocommon stockholders

$
(4,629
)
$
(273
)
$
(733
)
$
(814
)
$
(500
)
$
(416
)
$
(437
)
$
162Income (loss) Per share - basic anddiluted

$
(0.27
)
$
(0.01
)
$
(0.03
)
$
(0.04
)
$
(0.02
)
$
(0.02
)
$
(0.02
)
$
0.01
 
  Our results of operations historically have fluctuated on a quarterly basis and can be expected to continue to be subject to quarterly fluctuations.
 
 22
 The 2003 and 2004 quarterly results for basic and diluted income (loss) per share, when totaled, may not equal the basic and diluted income (loss) per share for the years ended June 30, 2003 and 2004. These variances are due to rounding, certain options and warrants being antidilutive for certain quarters and the issuance of a large number of common shares in the first quarter of fiscal year 2003.
 
 (1)
In accordance with SFAS No. 142, the Company recorded a non-cash charge of $4,454,656 to reduce the carrying value of its goodwill. This is a non-cash charge and is reflected as a cumulative effect of a change in accounting principle, effective July 1, 2002. 
 (2) These figures give effect to the restatement described in Note 15 of the Notes to the Consolidated Financial Statements.
   The following changes were made to the previously reported quarterly information in connection with the restatement
 
 **September 30, 2002**
**September 30, 2002**
**December 31, 2002**
**December 31, 2002**
**March 31,2003**
**March 31, 2003**
**June 30, 2003**
**June 30, 2003****As previously reported**
**As restated**
**As previously reported**
**As restated**
**As previously reported**
**As restated**
**As previously reported**
**As restated****Operating Data:**Income (loss) per share - basic
$        0.45
$       (0.27)
$        0.01
$       (0.03)
$       (0.01)
$       (0.03)
$       (0.02)
$       (0.04)**September 30, 2003**
**September 30, 2003**
**December 31, 2003**
**December 31, 2003**
**March 31, 2004**
**March 31, 2004**
**June 30, 2004**
**June 30, 2004****As previously reported**
**As restated**
**As previously reported**
**As restated**
**As previously reported**
**As restated**
**As previously reported**
**As restated****Operating Data (in thousands, except****per share amounts):**Net income (loss)
$      201.8
$      345.0
$      286.0
$      430.0
$      258.8
$      401.0
$      859.4
$    1,001.4Net income (loss) per share - basic
0.01
(0.02)
0.01
(0.02)
0.01
(0.02)
0.04
0.01
 ****
 23
 **ITEM 7.** **MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL** **CONDITION AND RESULTS OF OPERATIONS**
 
 As discussed in Note 15 to the consolidated financial statements, the Companys June 30, 2004 financial statements have been restated. The accompanying managements discussion and analysis give effect that that restatement
****
 **Overview**
  This Overview is intended to provide a context for the following Management's Discussion and Analysis of Financial Condition and Results of Operation. Management's Discussion and Analysis of Financial Condition and Results of Operation should be read in conjunction with our audited consolidated financial statements for the fiscal year ended June 30, 2004 including the notes thereto. We have attempted to identify the most important matters on which our management focuses in evaluating our financial condition and operating performance and the short-term and long-term opportunities, challenges and risks (including material trends and uncertainties) which we face. We also discuss the actions we are taking to address these opportunities, challenges and risks. The Overview is not intended as a summary, or a substitute for review, of either the Management's Discussion and Analysis of Financial Condition and Results of Operation section nor of this Report as a whole.
 ****
 **Business Segments**
  We are a specialty medical products sales, marketing, manufacturing and service company. We sell a broad portfolio of high quality, differentiated specialty medical products, some of which we manufacture, to hospitals and surgery centers nationwide through a dedicated organization of sales and marketing professionals.
  The Company is organized into three operating segments based on operating criteria. These segments are Specialty Manufactured Products, Specialty Medical Distribution - Surgical, and Specialty Medical Distribution - Critical Care. A description of each segment and principal products and operations are as follows:
  *Specialty Manufactured Products* - This segment includes the Luxtec division which we acquired in March 2001. Luxtec designs and manufactures surgical headlight systems, including light sources, fiber optic cables and other custom-made surgical equipment for the medical industry.
  *Specialty Medical Distribution - Surgical* - The surgical segment is a regional sales and marketing organization that markets and distributes specialty surgical products primarily to hospitals and surgery centers. The primary specialty areas include gynecology, cardiovascular, endoscopy and general surgery. These products and services are used extensively in hospital operating rooms and in outpatient surgery centers. This segment does business as PrimeSource Surgical, Inc.
  *Specialty Medical Distribution - Critical Care* - The critical care segment is a regional sales and marketing organization that markets and distributes products primarily to hospitals in the southeastern United States. This segment does business as Bimeco, Inc. Within this segment, the primary specialties include intensive, neonatal and maternal care.
 24
 **Business Strategy**
  We differentiate our business from commodity healthcare product sales organizations by offering "consultative" marketing. The Companys sales force spends substantial time teaching, training and advising surgeons, physicians, nurses and hospital staff in the proper use of their products.
  We believe small to medium sized manufacturers of specialty medical devices often prefer regional distributors to reduce the risk involved in exclusive national distribution relationships. We maintain three regional distribution groups, two for surgical products (Southeast and Mid-Atlantic/Central) and one for critical care products (primarily focused on the Southeast). All of the Company's sales representatives are our employees, averaging 15 years experience, and are compensated almost entirely on commissions.
  Our goal is to be a leading supplier of specialty medical products to hospitals and surgery centers. We intend to continue to grow by:
  ·
hiring experienced territory sales representatives;  ·
securing additional specialty product lines to our product offerings; and  ·
selectively acquiring specialty medical products manufacturers. We expect to benefit from the acquisition of select specialty medical products manufacturers by increasing sales of acquired product lines through use of our direct specialty medical products sales force.  Our Luxtec division continues to lead the surgical headlamp business and focuses its research and development efforts on new and innovative products which can be sold through our distribution segment.
  We believe we are well positioned to continue our growth within the specialty medical products industry. We expect to experience sales growth in the specialty medical products industry as a result of:
  ·
favorable industry demographics;  ·
sustaining or increasing our market share;  ·
the acquisition of other specialty medical products manufacturers;  ·
expanding margin opportunities in our manufactured products business;  ·
further penetration of existing customer accounts due to our introduction of new products and services;  ·
entrance into new specialty medical markets and expansion into international markets; and  ·
marketing efforts which foster partnerships with other medical products companies to widen the customer base for our products.  
 25
 
 ****
 **Business Opportunities**
  The Company's historically aggressive distribution growth strategy strained its financial and managerial resources, leading the Board of Directors to initiate and implement a restructuring plan in November 2001. The restructuring plan included replacing senior management, refocusing the Company's strategy on its core business and consolidating under-performing sales regions. In January 2002, the Company ceased distribution of most products west of the Rocky Mountains. A portion of the Company's critical care segment was divested in late 2002, with the remainder sold in June 2003. During the past two years, the Company has achieved several significant milestones; strengthening its core business with the renewal of several key vendor contracts, attracting new product lines, simplifying its capital structure and consolidating its senior debt facilities. The Company believes it has validated the restructuring plan it began in 2001 by improving its operating income (loss) from a loss of $5.6 million in 2002 to income of $1.4 million in 2003 and $2.5 million in 2004 and by reducing its senior secured debt from $9.9 million in 2002 to $5.2 million in 2004.
  We believe that we are well positioned to leverage our existing distribution capabilities with additional proprietary products. In addition to the opportunity for margin expansion, the sales force has incentives to market proprietary or "corporate" products since those products become an owned component of their portfolio. The sales force is then able to have a more active role in product development, resulting in product lines that are better suited for their customer base. We believe that within the specialty surgical and critical care markets, there exists numerous quality, high growth acquisition targets, including several in its current product portfolio.
 ****
 **Business Risks**
  We believe that the following represent our primary business risks:
  *Our Business Will Suffer if We Fail to Attract and Retain Experienced Sales Representatives* . The success and growth of our business depends on our ability to attract and retain qualified and experienced sales representatives. There is significant competition for experienced specialty medical products sales representatives. It is uncertain whether we can continue to attract and retain qualified personnel. If we cannot attract, retain and motivate qualified sales personnel, we will not be able to expand our business and our ability to perform under our existing contracts will be impaired, which would negatively affect our results of operations.
  *Our Business Would Suffer if We Lost Key Suppliers.* Our success is partly dependent on our ability to successfully predict and adjust production capacity to meet demand, which is partly dependent upon the ability of external suppliers to deliver components at reasonable prices and in a timely manner. Capacity or supply constraints could adversely affect our future operating results. We cannot assure that we will be able to maintain our existing supplier relationships or secure additional suppliers as needed.
  26
 *If Suppliers Terminate Their Agreements with Us, Our Product Offerings May Suffer.* Following an initial one-year term, many of our standard supplier agreements may be terminated by either party on 90 days' notice or upon a change in control of the Company. After expiration of the initial term, such suppliers may terminate or seek to renegotiate their agreements. If a significant number of suppliers terminate their agreements with us, the range of products we will be able to offer would be adversely affected. The ability of suppliers to terminate their agreements may result in new agreement terms that are less favorable to us, which could have a material adverse effect on our earnings.
  *Our Major Stockholder Has Substantial Control of Us and Could Delay or Present a Change In Control that Stockholders May Believe Would Improve Management and/or Our Business.* As a result of its ownership of Series G Preferred Stock and common stock , GE Capital Equity Investments, Inc., is able to exercise substantial control over the election of our directors and determine the outcome of most corporate actions requiring stockholder approval, including a merger with or into another company, the sale of all or substantially all of our assets and amendment to our Articles of Organization.
 
 The Company's capital structure at June 30, 2004 is summarized below:
 
 **Series G (1)**
****

**Common Stock****Shareholder**
**Shares**

**Options (2)**


**Shares**
**Options (3)**
**Warrants**
**Total CSE**
**%**GE Capital Equity
12,500,000




7,967,374
3,721
9,398,639
29,869,734
41.5 %Coleman Swenson Booth
7,718,750




3,573,089
23,721
4,380,356
15,695,916
21.8 %Robert Fisher Entities
1,484,375




1,963,953
7,442
1,456,876
4,912,646
6.8 %William H. Lomicka
546,875




621,328
30,605
186,694
1,385,502
1.9 %Brad Walker
100

749,900


50
3,249,950

4,000,000
5.6 %PSHC Management






2,511,046

2,511,046
3.5 %Others





8,249,350
3,961,445
1,352,203
13,562,998
18.9 %Total
22,250,100

749,900


22,375,144
9,787,930
16,774,768
71,937,842 
 Note: All figures shown in common stock equivalents (CSE).
  (1) Series G Preferred Stock carries liquidation and redemption preferences of two times original price per share ($0.64 per CSE) plus accrued dividends, and participates in additional proceeds as common stock.
  (2) Series G Preferred Stock options have an exercise price of $0.16 per CSE.
  (3) Common Stock options and warrants have an average exercise price of $0.49 and $0.02 per CSE, respectively.
   27   We are a reporting company under the Securities Exchange Act of 1934, but not traded on a recognized stock exchange. The Company had approximately 1,400 shareholders as of June 30, 2004.
  As a result of its ownership of Series G Preferred Stock and common stock, GE Capital Equity Investments, Inc., is able to exercise substantial control over the election of our directors and many corporate actions require the prior approval of such stockholder.
  This analysis of our financial condition, capital resources and results of operations should be read in conjunction with the accompanying consolidated financial statements, including the notes thereto.
  **Application of Critical Accounting Policies**
  Our discussion and analysis of financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. During preparation of these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to goodwill and other intangible assets, income taxes and revenue recognition. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances. The results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
  The following critical accounting policies require us to make significant judgments and estimates used in the preparation of our financial statements.
  *Inventory Reserves for Obsolescence*
  We write down our inventory for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions prove to be less favorable than those projected by management, additional inventory write-downs may be required. ****
  *Goodwill and Other Intangible Assets*
  We evaluate goodwill and other intangible assets for impairment at least annually, in accordance with Statement of Financial Accounting Standard No. 142, *Goodwill and Other Intangible Assets* (SFAS No. 142). For goodwill, we first compare the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds the fair value of a reporting unit, additional tests would be used to measure the amount of impairment loss, if any. We use a present value technique to measure reporting unit fair value. If the carrying amount of any other intangible asset exceeds its fair value, we would recognize an impairment loss for the difference between fair value and the carrying amount. We recognized impairment losses totaling $671,531 and
 
 28
 $657,776 in the years ended June 30, 2003 and 2002 upon the disposition of subsidiaries and an impairment loss effective July 1, 2002 totaling $4,454,656 upon completion of SFAS No. 142 implementation. If other events occur and circumstances change, causing the fair value of a reporting unit to fall below its carrying amount, impairment losses may be recognized in the future. In accordance with SFAS No. 142, the Company has performed its annual impairment test in July 2003 and found no further impairment in its existing goodwill balances.
  *Deferred Tax Assets*
  We estimate our actual current tax exposure obligations together with the temporary differences that have resulted from the differing treatment of items dictated by accounting principles generally accepted in the United States of America versus U.S. tax laws. These temporary differences result in deferred tax assets and liabilities. On an on-going basis, we then assess the likelihood that our deferred tax assets will be recovered from future taxable income. If we believe the recovery to be less than likely, we establish a valuation allowance against the deferred tax asset and charge the amount as an income tax expense in the period in which such a determination is made.
  *Sales Recognition Policy*
  The Companys policy is to recognize revenues from product sales when earned, as defined by accounting principles generally accepted in the United States of America. Specifically, product and commissions revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable, and collectibility is reasonably assured.
 
 Product sales are recognized as revenue when the title transfers, which is generally when shipped
 
 Revenues earned under agency agreements are recognized when the customer has received the product. Amounts are recorded as commissions in net revenues at the net amount retained by the Company.
 
 Provisions for vendor discounts and product returns are provided for at the time the related sales are recorded, and are reflected as a reduction of product sales. The Company estimates customer discounts and product returns at the time of sale based on historical experience. These estimates are reviewed periodically and, if necessary, revised, with any revisions recognized immediately as adjustments to product sales.
  The Company periodically and systematically evaluates the collectibility of accounts receivable and determines the appropriate allowance for doubtful accounts. In determining the amount of the allowance, management considers historical credit losses, the past due status of receivables, payment history and other customer-specific information, and any other relevant factors or considerations.
  29
 ****
 **Results of Operations**
  The following table sets forth certain consolidated financial data as a percentage of net revenues for the fiscal years ended June 30, 2004, 2003 and 2002.
 
 **2004**
**2003**
**2002**Net revenues
100.0 %
100.0 %
100.0 %Cost of products sold
63.6 %
63.2 %
65.8 %Gross profit
36.4 %
36.8 %
34.2 %Selling expenses
16.7 %
16.1 %
16.6 %General and administrative expenses
13.4 %
15.1 %
16.1 %Depreciation and amortization expenses
1.0 %
1.8 %
4.6 %Restructuring expenses
0.0 %
0.7 %
7.4 %Interest expense
1.5 %
1.8 %
1.3 %Net income (loss)
4.5 %
(7.8)%
(11.5)%
 
 **Fiscal** **Year Ended June 30,** **2004 Compared with Fiscal** **Year Ended June 30,** **2003**
 
 ***Net Revenues*** Net revenues increased $2,402,987, or 5.2%, in fiscal 2004 compared to fiscal 2003 primarily due to higher product sales volume from existing product lines and additional selling territory for our proprietary products provided by the Luxtec division. Sales in the new territory for the year ended June 30, 2004 totaled $1,114,401. In March 2004, we ended a key vendor relationship in our Surgical division, which contributed approximately 15% of Surgical divisions sales for the twelve months ended June 31, 2004. This vendor made a decision to sell its product directly to its customers, thereby ending all of their independent distributor contracts. Although we have replaced this product line with another in the affected territories as of June 2004, our Surgical division sales did underperform historical levels in the fourth quarter. Any decrease in sales due to the loss of this vendor has had a corresponding impact on cost of sales, gross profit, selling expense and net income after the date the relationship terminated; however, we expect to recover lost revenue as we progress through fiscal 2005. Gross profit from our agency business for fiscal 2004 was approximately $492,000 more than in fiscal 2003.
  ***Cost of Products Sold*** Cost of products sold increased to 68.0% of net product sales for fiscal 2004 from 67.1% of net product sales for fiscal 2003. The increase of $1,734,128, or 5.9%, in fiscal 2004 relative to fiscal 2003 was primarily the result of the corresponding increase in net product sales, as discussed above. The increase in the percentage of cost of products sold as a percentage of net product sales in fiscal 2004 relative to fiscal 2003 is due is due to the effects of a large, lower margin, Critical Care division capital equipment sale of $775,000 to a single customer in March 2004 offset by a difference in product mix between Luxtec and Specialty Medical Distribution products.
 
 30
 
 ***Gross Profit*** Gross profit decreased to 38.8% of net product sales in fiscal 2004 compared to 39.1% of net product sales in fiscal 2003. The increase in gross profit of $668,859, or 3.9%, in fiscal 2004 compared to fiscal 2003 was primarily due to higher sales volume from existing product lines and the addition of a new selling territory for our proprietary products provided by the Luxtec division. The decrease in gross profit margins, as a percentage of net product sales in fiscal 2004 compared to fiscal 2003, was due to the effects of a large, lower margin, Critical Care division capital equipment sale as discussed in cost of sales offset by a difference in product mix sold as discussed above.
  ***Selling Expenses*** **** Selling expenses increased $709,812 in fiscal 2004 compared to fiscal 2003. The increase is primarily due to higher sales volume and is also attributable to a sales representative commission program to sell through any remaining Surgical division inventory for the discontinued key vendor discussed in net sales above. As a result of this program, we liquidated the discontinued inventory and created an additional incentive for the sales representatives most impacted by the loss of the vendor. Selling commissions are paid on agency sales at approximately the same percentage as stocking sales, and as a result, sales commissions as a percent of net sales revenue do not fluctuate when the product mix of agency and stocking sales varies.
  ***General and Administrative Expenses*** **** General and administrative expenses were 13.4% of net sales, for fiscal 2004, compared to 15.1% for fiscal 2003. The decrease of $474,192, or 6.8%, is a result of lower salaries and wages related to reduced headcount by obtaining further overhead efficiencies and reduced legal fees, primarily related to the settled legal complaint with the Companys former officers as mentioned in Note 12 to the consolidated financial statements.
  ***Depreciation and Amortization Expenses*** **** Depreciation and amortization expenses decreased to 1.0% for fiscal 2004 compared to 1.8% for fiscal 2003. The decrease of $349,975, or 41.5%, in depreciation and amortization expenses is primarily the result of certain assets and intangible assets becoming fully depreciated prior to the year ended June 30, 2004.
  ***Restructuring Expenses:*** Restructuring expense decreased $340,690 in fiscal 2004 compared to fiscal 2003. The decrease is due to the lack of any restructuring activities initiated in fiscal 2004 and the continued payments under the existing restructuring plans. The expenses recorded in fiscal 2004 related to the June 30, 2003 final closing fees related to the sale of Ruby, Inc.
 
 ***Interest Expense*** The decrease in interest expense of $102,467, or 12.2%, is the result of lower interest rates and fees on the Companys senior debt, as compared to the prior year, as a result of the refinancing of the Companys senior debt in the quarter ended December 31, 2003.
 
 31
 ***Income Tax Provision*** We recorded no income tax expense in fiscal 2004 and a $19,700 income tax benefit in fiscal 2003. Our current year taxable income for federal and certain states can offset by the use of net operating loss carryforwards to offset federal and state income tax liabilities in addition to certain tax credit carryovers.
  ***Net Income (Loss)*** Net income increased $5,806,012 in fiscal 2004 compared to the fiscal 2003 net loss. The increase resulted primarily from the goodwill impairment charge of $4,454,656 recorded in July 2002 as a result of SFAS No. 142 implementation. In addition, we recorded other income of approximately $370,000 resulting from the resolution of certain disputed distribution costs which had been previously accrued for. This increase is offset by the write off of deferred financing fees of approximately $190,000 for previously outstanding debt related to the refinancing of our banking facilities during December 2003.
  **Fiscal** **Year Ended June 30,** **2003 Compared with Fiscal** **Year Ended June 30,** **2002**
 
 ***Net Revenues*** ****** Net revenues decreased $7,335,698, or 13.7%, in fiscal 2003 compared to fiscal 2002. The decrease in net product sales in fiscal year 2003 was primarily due to the closure of our western sales territory as a result of the Companys restructuring plan initiated in November 2001 and the divesture of PEC in June 2002. Remaining decreases were due to a shift in the companys distribution sales mix from stocking to agency-based sales, lost lines and other effects of the 2002 restructuring. The western sales territory closure resulted in approximately $2,542,000 of the decrease and the divesture of PEC resulted in approximately $1,327,000 of the decrease.
 
 ***Cost of Products Sold*** Cost of products sold decreased to 67.1% for fiscal 2003 from 68.8% for fiscal 2002. The decrease in cost of products sold of $6,031,556, or 17.1%, was primarily due to lower sales levels related to the closure of the western sales territory and the divesture of PEC. The remaining decreases are due to a shift in our distribution sales mix from stocking to agency-based sales, lost lines and other effects of the 2002 restructuring. The western sales territory closure resulted in approximately $1,810,000 of the decrease and the divesture of PEC resulted in approximately $683,000 of the decrease. The decrease in cost of products sold as a percentage of net sales in 2003 compared to 2002 is due to the difference in the product mix sold and the non-recurring prior year inventory reserve adjustments.
  ***Gross Profit*** Gross profit increased to 39.1% of net product sales for fiscal 2003 from 35.8% of net product sales for fiscal 2002. The $1,304,142 decrease in gross profit was primarily due to lower sales levels related to the closure of the western sales territory and the divesture of PEC. The western sales territory closure resulted in approximately $732,000 of the decrease and the divesture of PEC resulted in approximately $644,000 of the decrease. The increase in gross profit margins is due to a favorable change in product mix and the non-recurring prior year inventory reserve adjustment from 2002 which caused a higher cost of products sold.
  ***Selling Expenses*** Selling expenses decreased $1,439,986 in fiscal 2003 compared to fiscal 2002. The decrease in selling expense is primarily due to the closure of the western sales territory as a result of the Companys restructuring plan initiated in November 2001 and the divesture of PEC in June 2002. Decreased salaries, commissions, benefits and travel expenses related to the western sales territory account for approximately $502,000 of the decrease and the PEC divesture resulted in approximately $500,000 of the decrease.
  32
 ***General and Administrative Expenses*** General and administrative expenses decreased to $7,015,217 for fiscal 2003, from $8,625,555 for fiscal 2002, a decrease of $1,610,338, or 18.7%. The decrease is primarily a result of the Companys restructuring plan initiated in November 2001 and the divesture of PEC in June 2002. The restructuring plan decreased general and administrative expenses by narrowing the focus of the Companys operations and reducing corporate overhead through workforce reductions. Non-recurring reserve adjustments for inventory and accounts receivable recorded in December 2001 of approximately $474,000 also contributed to the decrease. The PEC divesture resulted in approximately $268,000 of the decrease.
  ***Depreciation and Amortization Expenses*** Depreciation and amortization expenses decreased to $843,500 for fiscal 2003, from $2,455,081 for fiscal 2002, a decrease of $1,611,581, or 65.6%. The decrease in depreciation and amortization expense in fiscal 2003 is primarily due to the implementation of SFAS No. 142 *Goodwill and Other Intangible Assets* effective July 2002. As a result of this adoption, goodwill was no longer amortized in fiscal 2003.
  ***Restructuring Expenses*** Restructuring expense decreased to $345,507 for fiscal 2003, from $3,954,498 for fiscal 2002. Fiscal 2003 restructuring expenses include a reserve recorded for the former Presidents severance agreement for $195,507 and other restructuring expenses of $150,000. Fiscal 2002 restructuring expenses relate to the restructuring plan which began i n early November 2001, involving narrowing the focus of our operations, the consolidation of certain under performing sales regions, the reduction of corporate overhead through workforce reductions, the restructuring of our balance sheet through a recapitalization and refinancing of the PrimeSource Healthcare and the PrimeSource Surgical senior bank debt and a reduction of debt levels through projected improved earnings and potential asset sales. From November 2001 through August 2002 significant aspects of our new business model, including a reduction in workforce and executive staff, exit of the western sales region, recapitalization of equity and a refinancing of our existing debt, were completed. As a result of this, restructuring expense of $ 2,915,67 5 was recorded for fiscal 2002. In addition, during 2002, a decision was made to dispose of the PEC division, and the write-off of PEC goodwill and other impaired assets totaled $1,038,823 which was included in restructuring expenses.
  ***Interest Expense*** Interest expense increased $159,999, or 23.6%. Our interest cost increased as a result of increased interest rates and fees incurred related to the restructuring of the PrimeSource Healthcare and PrimeSource Surgical debt.
  ***Income Tax Benefit*** Income tax benefit decreased to $19,700 during fiscal 2003, compared to $61,700 during fiscal 2002. The decrease is the result of decreased taxable net income (loss) at state levels.
  ***Net Loss*** Net loss decreased $ 2,561,764, or 41.4%. The decrease in net loss resulted primarily from expense reductions related to our fiscal 2002 restructuring and decreased amortization expense. These expense decreases were offset by goodwill impairment expense of $4,454,656 recorded in fiscal 2003, resulting from the Companys implementation of SFAS No. 142 in July 2002.
  33
 **Liquidity and Capital Resources**
  At June 30, 2004, we had working capital of $1,688,823 compared to a deficit of $793,154 at June 30, 2003. The increase in our working capital was primarily the result of decreased accounts payable, accrued expenses, lines of credit and current obligations for long-term debt, offset by decreased receivable and inventory balances. Accounts payable, accrued expenses and obligations for long-term debt were paid with the increased cash generated from operations and the increased availability of the line of credit, as discussed below.
  In December 2003, we consolidated our senior debt facilities into a $7,500,000 revolving demand note (the PrimeSource Healthcare Line of Credit) from Wells Fargo under the PrimeSource Healthcare Credit and Security Agreement, dated as of December 10, 2003, by and among the Company, PrimeSource Surgical, Bimeco and Wells Fargo (the Credit and Security Agreement). Pursuant to the Credit and Security Agreement, the maximum amount available to borrow under the PrimeSource Healthcare Line of Credit is limited to the lesser of $7,500,000 or a certain percentage of accounts receivable and inventory, as defined by the Credit and Security Agreement ($6,757,524 at June 30, 2004). As of June 30, 2004, borrowings bore interest at Wells Fargos prime rate plus 3.0% (7.25% at June 30, 2004). Borrowings are secured by substantially all assets held by PrimeSource Healthcare and its subsidiaries. At June 30, 2004, there was $1,553,385 of availability under the PrimeSource Healthcare Line of Credit.
  The Credit and Security Agreement contains covenants that require the maintenance of defined income levels and capital expenditures. The Company was in compliance with these financial covenants as of June 30, 2004.
  The following table presents the Companys contractual obligations as of June 30, 2004:
  **Contractual Obligations**

**Payments due by period****Total**

**Less than 1 year**

**1 - 3 years**

**3-5 years**

**More than 5 years**Long-term debt obligations

$
105,696

$
16,713

$
45,733

$
43,250Capital lease obligations


50,226


26,124


19,691


4,411Operating lease obligations


882,320


606,293


274,382


1,645


-Total

$
1,038,242

$
649,130

$
339,806

$
49,306
 
 Series G Stock with a redemption value of $15,294,342 at June 30, 2004 are not included in the table above, however, not less than 60% of Series G stockholders may elect to redeem the Series G Stock any time after June 30, 2005.
  34
 **Recent Accounting Pronouncements**
  In May 2003, the Financial Accounting Standards Board (FASB) issued Statement 150, *Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity* (SFAS No. 150). SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in the fair value or the redemption amount, as applicable, in earnings. SFAS No. 150 was effective for the Company as of July 1, 2003. SFAS No. 150 does not apply to the Company as its Series G Stock is contingently redeemable at the option of the holders.
  In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition, which codifies, revises, and rescinds certain sections of SAB No. 101, Revenue Recognition, in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes in SAB No. 104 did not have a material impact on our financial position or results of operations.
  On March 31, 2004, the FASB issued an exposure draft, Share-Based Payment, an Amendment of SFAS No. 123 and 95. The exposure draft proposes to expense the fair value of share-based payments to employees beginning in July 2005. We are currently evaluating the impact of this proposed standard on our financial statements.
 35  **ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**
  PRIMESOURCE HEALTHCARE, INC. and Subsidiaries
  
 Consolidated Financial Statements
 as of June 30, 2004 and 2003,
 and for the Years Ended
 June 30, 2004, 2003 and 2002
  PageReport of Independent Registered Public Accounting Firm
F-1Consolidated Balance Sheets (As restated, see Note 15) as of June 30, 2004 and 2003
F-2 -F-3Consolidated Statements of Operations (As restated, see Note 15) for the Years Ended June 30, 2004, 2003 and 2002
F-4 - F-5Consolidated Statements of Stockholders Equity (Net Capital Deficiency) (As restated, see Note 15) for the Years
Ended June 30, 2004, 2003 and 2002
F-6Consolidated Statements of Cash Flows (As restated, see Note 15) for the Years Ended June 30, 2004, 2003 and 2002
F-7 - F-8Notes to Consolidated Financial Statements
F-9 - F-32
 36
   **REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
  Board of Directors
 PrimeSource Healthcare, Inc.
 Tucson, Arizona
   We have audited the accompanying consolidated balance sheets of PrimeSource Healthcare, Inc. and subsidiaries (the Company) as of June 30, 2004, and 2003, and the related consolidated statements of operations, stockholders equity (capital deficiency), and cash flows for each of the three years in the period ended June 30, 2004.  Our audits also included the financial statement schedule listed in the Index at Item 15.  These financial statements and financial statement schedule are the responsibility of the Companys management.  Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.
  We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
  In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PrimeSource Healthcare, Inc. and subsidiaries as of June 30, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2004 in conformity with accounting principles generally accepted in the United States of America.  Also, in our opinion, such 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.
  As discussed in Note 15 to the consolidated financial statements, the accompanying consolidated financial statements have been restated.
  
 DELOITTE & TOUCHE LLP
  Phoenix, Arizona
 September 28, 2004
 (February 22, 2005 as to the effects of the restatement discussed in Note 15)
  
 **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES****CONSOLIDATED BALANCE SHEETS**

****

******June 30,****ASSETS (Note 7)**

**2004**

**2003****(As restated,**

**(As restated,****see Note 15)**

**see Note 15)**CURRENT ASSETS:Cash and cash equivalents

$
98,903

$
489,911Accounts receivable - net of allowance for doubtful accountsof approximately $132,000 and $214,000 at June 30, 2004 and2003, respectively


5,718,346


6,111,062Inventories - net (Note 4)


6,732,542


7,517,965Income taxes receivable (Note 11)


129,913


67,800Prepaid expenses and other current assets


224,865


172,397Total current assets


12,904,569


14,359,135PROPERTY AND EQUIPMENT - Net (Note 5)


887,325


996,358GOODWILL - Net (Note 6)


15,956,883


15,956,883INTANGIBLE ASSETS - Net of accumulated amortizationof approximately $245,000 and $236,000 at June 30, 2004and 2003, respectively (Note 6)


60,273


118,290OTHER ASSETS - Net of accumulated amortization ofapproximately $782,000 at June 30, 2003


90,196


233,874TOTAL

$
29,899,246

$
31,664,540
   ****F-2   
 **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES****CONSOLIDATED BALANCE SHEETS**

****

******June 30,****LIABILITIES AND STOCKHOLDERS EQUITY**

**2004**

**2003****(As restated,**

**(As restated,****see Note 15)**

**see Note 15)**CURRENT LIABILITIES:Accounts payable

$
4,253,295

$
5,636,333Accrued expenses


1,509,432


2,240,770Accrued restructuring costs (Note 14)


43,726


690,968Customer deposits


166,873


72,895Lines of credit (Note 7)


5,204,139


5,926,021Current portion of long-term debt (Note 7)


16,713


559,877Current portion of capital lease obligations (Note 12)


21,568


25,425Total current liabilities


11,215,746


15,152,289CAPITAL LEASE OBLIGATIONS - Net of current portion (Note 12)


22,149


21,433LONG-TERM DEBT - Net of current portion (Note 7)


88,983


105,696TOTAL LIABILITIES


11,326,878


15,279,418COMMITMENTS AND CONTINGENCIES (Notes 7, 8, 9, 10 and 12)SERIES G REDEEMABLE, CONVERTIBLE PREFERREDSTOCK - No par value - authorized, 230,000 shares; issued andoutstanding, 222,501 and 222,500 shares at June 30, 2004 and 2003,respectively; aggregate liquidation value of $15,294,342 and $14,693,341at June 30, 2004 and 2003, respectively (Note 8)


12,534,619


9,166,371STOCKHOLDERS EQUITY:Common stock, $0.01 par value - authorized, 75,000,000 shares;issued and outstanding, 22,375,144 (2004) and 22,375,094 (2003)shares


223,751


223,750Additional paid-in capital


31,372,665


31,362,665Accumulated deficit


(25,558,667
)

(24,367,664
)Total stockholders equity


6,037,749


7,218,751TOTAL

$
29,899,246

$
31,664,540See notes to consolidated financial statements.





(Concluded
) 
  F-3   **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF OPERATIONS****YEARS ENDED JUNE 30, 2004, 2003 AND 2002**

****

****

******2004**

**2003**

**2002****(As restated,**

**(As restated,**

**(As restated,****see Note 15)**

**see Note 15)**

**see Note 15)**REVENUES:Net product sales

$
45,660,102

$
43,666,410

$
51,333,555Commissions and service revenues


3,102,904


2,693,609


2,362,162Net revenues


48,763,006


46,360,019


53,695,717COST OF PRODUCTS SOLD


31,031,700


29,297,572


35,329,128GROSS PROFIT


17,731,306


17,062,447


18,366,589OPERATING EXPENSES:Selling expenses


8,160,206


7,450,394


8,890,380General and administrative expenses


6,541,025


7,015,217


8,625,555Depreciation and amortization expenses


493,525


843,500


2,455,081Restructuring expenses (Note 14)


4,817


345,507


3,954,498Total operating expenses


15,199,573


15,654,618


23,925,514OPERATING INCOME (LOSS)


2,531,733


1,407,829


(5,558,925
)INTEREST EXPENSE


(736,776
)

(839,243
)

(679,244
)OTHER INCOME (EXPENSE)


382,256


189,704


(115,357
)INCOME (LOSS) FROM CONTINUING OPERATIONSBEFORE INCOME TAX BENEFIT


2,177,213


758,290


(6,353,526
)INCOME TAX BENEFIT (Note 11)





19,700


61,700INCOME (LOSS) BEFORE DISCONTINUED OPERATIONSAND CUMULATIVE EFFECT OF CHANGE INACCOUNTING PRINCIPLE


2,177,213


777,990


(6,291,826
)DISCONTINUED OPERATIONS:INCOME FROM DISCONTINUED OPERATIONS -Net of income tax





121,697


101,263LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS -Net of income tax





(73,830
)Total





47,867


101,263CUMULATIVE EFFECT OF CHANGE IN ACCOUNTINGPRINCIPLE - GOODWILL IMPAIRMENT (Note 6)





(4,454,656
)NET INCOME (LOSS)


2,177,213


(3,628,799
)

(6,190,563
)DIVIDENDS AND ACCRETION ON PREFERRED STOCK


(3,368,216
)

(2,549,681
)

(2,652,571
)EFFECT OF EQUITY RECAPITALIZATION





(270,136
)INCOME AVAILABLE (LOSS ATTRIBUTABLE) TOCOMMON STOCKHOLDERS

$
(1,191,003
)
$
(6,448,616
)
$
(8,843,134
)(Continued) 
 F-4
  **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF OPERATIONS****YEARS ENDED JUNE 30, 2004, 2003 AND 2002**

****

****

******2004**

**2003**

**2002****(As restated,**

**(As restated,**

**(As restated,****see Note 15)**

**see Note 15)**

**see Note 15)**LOSS PER SHARE BEFORE DISCONTINUEDOPERATIONS AND CUMULATIVE EFFECTOF CHANGE IN ACCOUNTING PRINCIPLE:Basic

$
(0.05
)
$
(0.10
)
$
(1.13
)Diluted

$
(0.05
)
$
(0.10
)
$
(1.13
)INCOME PER SHARE FROM DISCONTINUEDOPERATIONS - NET OF INCOME TAX EFFECT-DISPOSAL OF OPERATION:Basic




$
0.00

$
0.02Diluted




$
0.00

$
0.02LOSS PER SHARE FROM CUMULATIVE EFFECT OF CHANGEIN ACCOUNTING PRINCIPLE - GOODWILL IMPAIRMENT:Basic




$
(0.21
)Diluted




$
(0.21
)(LOSS) PER SHARE:Basic

$
(0.05
)
$
(0.31
)
$
(1.11
)Diluted

$
(0.05
)
$
(0.31
)
$
(1.11
)WEIGHTED AVERAGE SHARES USED INCOMPUTATION OF INCOME (LOSS) PER SHARE:Basic


22,375,130


21,059,853


7,975,208Diluted


22,375,130


21,059,853


7,975,208See notes to consolidated financial statements.








(Concluded
)  F-5
 **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)****YEARS ENDED JUNE 30, 2004, 2003 AND 2002** ************
******Total****Additional**



**Stockholders****Common Stock**

**Paid-in**

**Accumulated**

**Equity****Shares**

**Amount**

**Capital**

**Deficit**

**(Deficiency)**BALANCE, JULY 1, 2001


7,959,704

$
79,597

$
8,434,697

$
(9,075,914
)
$
(561,620
)Issuance of common stock


18,605


186


24,814





25,000Warrants and beneficial conversionfeatures of preferred stock








3,912,000





3,912,000Preferred stock dividends and accretion











(2,652,571
)

(2,652,571
)Restricted common stock vesting








118,709





118,709Refund fractional shares








(18
)




(18
)Net loss


-


-


-


(6,190,563
)

(6,190,563
)BALANCE, JUNE 30, 2002


7,978,309


79,783


12,490,202


(17,919,048
)

(5,349,063
)Equity recapitalization (As restated, see Note 15)


14,735,066


147,351


18,863,078


(270,136
)

18,740,293Preferred stock dividends and accretion (Asrestated, see Note 15)











(2,549,681
)

(2,549,681
)Cancellation of shares in legal settlement


(132,963
)

(1,330
)

(41,218
)




(42,548
)Cancellation of shares in sale of PEC assets


(201,067
)

(2,011
)

(62,330
)




(64,341
)Cancellation of shares in sale of Ruby Merger


(4,251
)

(43
)

(1,317
)




(1,360
)Issuance of compensatory stock options








110,000





110,000Restricted common stock vesting








4,250





4,250Net loss (As restated, see Note 15)


-


-


-


(3,628,799
)

(3,628,799
)BALANCE, JUNE 30, 2003 (As restated, seeNote 15)


22,375,094


223,750


31,362,665


(24,367,664
)

7,218,751Issuance of compensatory stock options








10,000





10,000Exercise of stock option


50


1








1Preferred stock dividends and accretion (Asrestated, see Note 15)











(3,368,216
)

(3,368,216
)Net income (As restated, see Note 15)


-


-


-


2,177,213


2,177,213BALANCE, JUNE 30, 2004 (As restated, seeNote 15)


22,375,144

$
223,751

$
31,372,665

$
(25,558,667
)
$
6,037,749 See notes to consolidated financial statements.
   F-6
 **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF CASH FLOWS****YEARS ENDED JUNE 30, 2004, 2003 AND 2002**

****

****

******2004**

**2003**

**2002****(As restated,**

****

******see Note 15)**CASH FLOWS FROM OPERATING ACTIVITIES:Net income (loss)

$
2,177,213

$
(3,628,799
)
$
(6,190,563
)Adjustments to reconcile net income (loss) to net cashprovided by (used in) operating activities:Depreciation and amortization expenses


493,525


849,657


2,462,411Loss on disposal of property and equipment


46,317


22,147


124,132Stock compensation expense


10,000


110,000


118,709Debt forgiveness


(150,000
)Goodwill impairment





4,454,656Loss on sale of division





73,830


1,038,823Issuance of common stock for services





4,250


25,000Gain on legal settlement





(42,548
)Change in fair value of warrant put obligation








(95,000
)Write-off of intangible assets








12,406Amortization of debt discount








28,600Changes in operating assets and liabilities - net ofeffect of business acquisitions and dispositions:Accounts receivable


392,716


(313,913
)

2,208,904Inventories


785,423


(397,713
)

1,978,659Income taxes receivable


(62,113
)

42,200


(119,500
)Prepaid expenses and other current assets


(52,468
)

(31,021
)

4,644Other assets


(9,688
)

(80,723
)

(181,504
)Accounts payable


(1,383,038
)

578,565


(5,235,025
)Accrued expenses


(717,878
)

(604,266
)

568,636Accrued restructuring costs


(647,242
)

(420,165
)

1,111,133Customer deposits


93,978


(148,006
)

(347,215
)Net cash provided by (used in) operating activities


976,745


468,151


(2,486,750
)CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment


(199,356
)

(255,320
)

(86,828
)Proceeds from sale of property and equipment


5,233


157


6,462Purchase of intangible assets








(64,166
)Acquisition of other assets








(31,904
)Proceeds from business disposition





1,000,000Net cash (used in) provided by investing activities


(194,123
)

744,837


(176,436
)(Continued)  F-7
  **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES****CONSOLIDATED STATEMENTS OF CASH FLOWS****YEARS ENDED JUNE 30, 2004, 2003 AND 2002**

****

****

******2004**

**2003**

**2002****(As restated,**

****

******see Note 15)**CASH FLOWS FROM FINANCING ACTIVITIES:Borrowings under lines of credit


38,844,614


16,785,191


19,506,353Repayments under lines of credit


(39,566,496
)

(18,390,045
)

(20,027,304
)Borrowings under long-term debt








600,000Repayment of long-term debt


(422,704
)

(2,731,323
)

(872,711
)Repayment on capital leases


(29,076
)

(36,666
)

(47,192
)Proceeds from issuance of common stock


32Proceeds from issuance of preferred stock - net of costs





3,364,031


3,167,170Stock repurchases








(18
)Net cash (used in) provided by financing activities


(1,173,630
)

(1,008,812
)

2,326,298NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS


(391,008
)

204,176


(336,888
)CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR


489,911


285,735


622,623CASH AND CASH EQUIVALENTS, END OF YEAR

$
98,903

$
489,911

$
285,735SUPPLEMENTAL DISCLOSURES OF CASHFLOW INFORMATION - Cash paid duringthe year for:Interest

$
728,358

$
698,685

$
741,905Income taxes

$
60,910

$
30,000

$
256,100SUPPLEMENTAL DISCLOSURES OF NONCASHTRANSACTIONS:Forgiveness of notes payable

$
(150,000
)Equipment acquired under capital lease

$
25,304




$
54,745Issuance of note payable for debt refinancing cost




$
250,000Discount on issuance of note payable for legal services

$
12,827

$
(12,827
)Fair value of common stock cancelled in sale of asset




$
64,341Fair value of common stock cancelled in legal settlement




$
42,548Common stock issued for services




$
4,250

$
25,000 
  
 F-8
 **PRIMESOURCE HEALTHCARE, INC. AND SUBSIDIARIES**
  **NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**
 **YEARS ENDED JUNE 30, 2004, 2003 AND 2002**
  **1.**
**NATURE OF BUSINESS**  PrimeSource Healthcare, Inc. (PrimeSource or the Company), a Massachusetts corporation formerly known as Luxtec Corporation (Luxtec), is a specialty medical products sales, marketing, manufacturing, and service company. The Company sells a broad portfolio of specialty medical products, some of which it manufactures, to hospitals and surgery centers nationwide through a dedicated organization of sales and marketing professionals.
  On June 30, 2003, PrimeSource Surgical, Inc., a wholly owned subsidiary of the Company (PrimeSource Surgical), sold all of the issued and outstanding capital stock of Ruby Merger Sub, Inc., an indirect wholly owned subsidiary (Ruby) for cash proceeds of $1,000,000 to New England Medical Specialties, Inc., (NMSI) a newly formed entity. The Company recognized a loss of $73,830 on the sale. The cash proceeds were used to pay off a portion of the Companys outstanding long-term debt.
  Prior to the sale of Ruby, effective June 30, 2002 the Company sold all of the assets of Professional Equipment Corporation, a wholly owned subsidiary of Ruby (PEC), in exchange for the cancellation of previously issued stock to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business. Goodwill and other impaired assets were written off in 2002, resulting in a loss of $1,038,823, which is recorded as restructuring expenses in the consolidated statement of operations.
  **2.**
**SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**  ***Basis of Presentation*** - The accompanying consolidated financial statements have been prepared on the accrual basis of accounting.
  ***Principles of Consolidation*** *-* The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: PrimeSource Surgical; Ruby (See Note 3) and Bimeco, Inc. All intercompany balances and transactions have been eliminated.
  ***Cash and Cash Equivalents*** - The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
  ***Concentrations of Credit Risk*** - The Companys financial instruments that are exposed to concentrations of credit risk consist primarily of cash and accounts receivable. The Company primarily sells to hospitals and other healthcare providers, and ongoing customer credit
   F-9
 evaluations are performed with respect to the Companys customers. Collateral is generally not required. In addition, the Company does not routinely maintain cash in excess of $100,000 and, as a result, at June 30, 2004, the Company had no uninsured cash balances.
  ***Inventories*** consist of raw materials, work-in-process, and finished goods, stated at the lower of cost or market. Cost is recorded using the first-in first-out method for Luxtec and average costing for the remaining companies.
  ***Inventory Reserves for Obsolescence*** - Inventory is written down for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions prove to be less favorable than those projected by management, additional inventory write-downs may be required. ****
  ***Property and equipment*** are recorded at cost. Depreciation has been provided using the straight-line method over estimated useful lives, generally three to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.
  ***Long-Lived*** ***Assets*** - In accordance with Statement of Accounting Standards (SFAS) No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets* , the Company evaluates the recoverability of property, plant and equipment with definite lives not held for sale by comparing the carrying amount of the asset or group of assets against the estimated undiscounted future cash flows expected to result from the use of the asset or group of assets and their eventual disposition. If the undiscounted cash flows are less than the carrying value of the asset or group of assets being evaluated, an impairment loss is recorded. The loss is measured as the difference between the fair value and carrying value of the asset or group of assets being evaluated. Assets to be disposed of are reported at the lower of the carrying amount or the fair value less cost to sell. The estimated fair value is based on the best information available under the circumstances, including prices for similar assets or the results of valuation techniques, including the present value of expected future cash flows using a discount rate commensurate with the risks involved.
 
 ***Goodwill and Other Intangible Assets*** - Effective July 1, 2002 goodwill is no longer amortized but instead is subject to periodic impairment testing in accordance with SFAS No. 142,*Goodwill and Other Intangible Assets*(SFAS No. 142)*.*See Note 6. Intangible assets with finite lives are stated at cost, net of accumulated amortization and are tested for impairment in accordance with SFAS No. 144. These assets are amortized on the straight-line method over the estimated useful lives or periods of expected benefit, but not in excess of 20 years. The Company performs an annual impairment test in July of each year and has found no further impairment in its existing goodwill balances. Upon implementation of SFAS No. 142, the Company recognized impairment of $4,454,656 on its Luxtec division .
  F-10
  ***Other assets*** consist principally of deposits and deferred financing costs. Deferred financing costs were amortized over the life of the related debt using the effective interest method.
  ***Revenue Recognition******-*** The Companys policy is to recognize revenues from product sales when earned, as defined by accounting principles generally accepted in the United States of America. Specifically, product and commissions revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred (or services have been rendered), the price is fixed or determinable, and collectibility is reasonably assured.******

The Company recognizes revenues from product sales when the title transfers, generally when shipped.

Revenues earned under agency agreements are recognized when the customer has received the product, and amounts are recorded as commissions in net revenues, at the net amount retained by the Company.

Provisions for vendor discounts and product returns are provided for at the time the related sales are recorded and are reflected as a reduction of product sales. The Company estimates customer discounts and product returns at the time of sale based on historical experience.
 ***Shipping and handling costs*** ** are included in cost of products sold *.*
  ***Research and development costs*** are incurred by the Companys Luxtec division and are charged to operations as incurred. Total research and development costs for the years ended June 30, 2004, 2003 and 2002 were approximately $185,000, $253,000 and $87,000 respectively.
  ***Income Taxes*** - The Company accounts for income taxes in accordance with SFAS No. 109, *Accounting for Income Taxes* (SFAS No. 109). Under SFAS No. 109, income taxes are recognized for: (a) the amount of taxes payable or refundable for the current year, and (b) deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Companys financial statements or tax returns. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax asset will not be realized.
  ***Stock-Based Compensation*** - The Company accounts for stock-based awards to employees using the intrinsic-value method in accordance with Accounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees* . ** Common stock of the Company has been delisted since November 17, 2000 and does not trade on any exchange and is not quoted on any quotation system. Fair value of the Company's common stock is determined by the Company's Board of Directors based upon the most recent significant capital stock transaction adjusted by current major events affecting the Company's financial condition.
   F-11
 Had compensation expense for these employee stock option grants been determined based on the fair value at the grant dates, consistent with SFAS No. 123, the Companys loss attributable to common stockholders and per share amounts for fiscal years ending 2004, 2003 and 2002 would have been the pro forma amounts indicated below:
  **2004**

**2003**

**2002**Net income (loss), as reported

$
2,177,213

$
(3,628,799
)
$
(6,190,563
)Stock-based employee compensation expense determined under fair-value method


(142,588
)

(172,858
)

(401,185
)Proforma net income (loss)


2,034,625


(3,801,657
)

(6,591,748
)Divdends and accretion on preferred stock


(3,368,216
)

(2,549,681
)

(2,652,571
)Effect of equity recapitalization


0


(270,136
)

0Pro forma, loss attributable to common stockholders

$
(1,333,591
)
$
(6,621,474
)
$
(9,244,319
)Loss per share:Basic- as reported

$
(0.05
)
$
(0.31
)
$
(1.11
)Basic- pro forma

$
(0.06
)
$
(0.31
)
$
(1.16
)Diluted- as reported

$
(0.05
)
$
(0.31
)
$
(1.11
)Diluted- pro forma

$
(0.06
)
$
(0.31
)
$
(1.16
)Black-Scholes Assumptions:Risk-free interest rate


4.23
%

3.10
%

5.21
%Expected volatility


50
%

50
%

50
%Expected lives - in years


6


6


7Expected dividend yield


0
%

0
%

0
%
  ***Financial Instruments*** *-* Pursuant to SFAS No. 107,*Disclosures about Fair Value of Financial Instruments,*the Company is required to disclose the fair value of all financial instruments at June 30, 2004, 2003 and 2002. The Company generally considers the carrying value of such amounts in the financial statements to approximate their fair value due to the relatively short period of time between origination of the instruments and their expected realization or the variable interest rate nature of such instruments. At June 30, 2004, 2003 and 2002, the estimated fair value of the Companys long-term debt was approximately $106,000, $666,000 and $3,100,000, respectively. The Company estimates the fair value of its long-term debt generally using discounted cash flow analysis based on current interest rates for instruments with similar maturities .
  ***Use of Estimates in the Preparation of Financial Statements*** *-* The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
   F-12
  ***Loss per Share*** -  SFAS No. 128,*Earnings per Share,*requires the dual presentation of basic and diluted income (loss) per share on the face of the statement of operations and the disclosure of the reconciliation between the numerators and denominators of basic and diluted income (loss) per share calculations which consisted of the following for the fiscal years ended June 30 :
  **2004**

**2003**

**2002**Numerator:Net income

$
2,177,213

$
(3,628,799
)
$
(6,190,563
)Weighted average common shares for thepurpose of calculating diluted income per share


22,375,130


21,059,853


7,975,208
  Options and warrants to purchase common stock totaling 26,562,698, 25,440,818 and 5,713,342 were outstanding at June 30, 2004, 2003 and 2002, respectively, but were not included in the computation of diluted income per share because the effect would be antidilutive as the exercise price exceeded the estimated fair value of the Companys common stock. Put warrants totaling 282,022 for the year ended June 30, 2002 were not included in the computation of diluted income per share because the effect would also be antidilutive. The effect of conversion of preferred shares was also excluded for all periods presented as the effect would be anitdilutive.
 ***Recently Issued Accounting Pronouncements -*** In May 2003, the Financial Accounting Standards Board (FASB) issued Statement 150, *Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity* (SFAS No. 150). SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in the fair value or the redemption amount, as applicable, in earnings. SFAS No. 150 was effective for the Company as of July 1, 2003. SFAS No. 150 does not apply to the Company as its Series G Stock is contingently redeemable at the option of the holders, and not madatorily redeemable as defined in SFAS No. 150.
  In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, *Revenue Recognition,* which codifies, revises, and rescinds certain sections of SAB No. 101, *Revenue Recognition* , in order to make this interpretive guidance consistent with current authoritative accounting guidance and SEC rules and regulations. SAB No. 104 did not have a material impact on the Companys financial position or results of operations.
  On March 31, 2004, the FASB issued an exposure draft, *Share-Based Payment, an Amendment of SFAS No. 123 and 95* . The exposure draft proposes to expense the fair value of share-based payments to employees beginning in 2005. The Company is currently evaluating the impact of this proposed standard on its financial statements.
  **3.**
**ACQUISITIONS AND DISPOSALS**  ***PEC Disposal*** - As discussed in Note 1, effective June 30, 2002, Ruby sold all of the assets of the former PEC line of business in exchange for the cancellation of previously issued stock to the founder of PEC and the assumption of certain liabilities with respect to the PEC line of business. Goodwill and other impaired assets were written off in June 2002, resulting in a loss of $1,038,823, which is recorded in restructuring expense in the statement of operations.
   F-13
 ***New England Medical Specialties Disposal, Discontinued Operation -*** On June 30, 2003, PrimeSource Surgical sold all of the issued and outstanding capital stock of Ruby for cash proceeds of $1,000,000 to NMSI. The Company recognized a loss on disposal of $73,830. Ruby was reported in the critical care business segment.
  Revenues and income from the discontinued operation, net of income tax effect were as follows:
  **2003**
**2002**Net revenues
$5,740,135
$5,249,566Income from discontinued operation - net ofincome tax effect
$121,697
$101,263
 
  **4.**
**INVENTORIES**  Inventories consist of the following at June 30:
  **2004**

**2003**Raw materials

$
708,949

$
776,468Finished goods


6,693,999


7,847,729Reserve for obsolescence


(670,406
)

(1,106,232
)Inventories - net

$
6,732,542

$
7,517,965
 
  **5.**
**PROPERTY AND EQUIPMENT**  Property and equipment consist of the following at June 30:
  **2004**

**2003**Office equipment

$
656,859

$
466,598Furniture and fixtures


394,740


346,031Machinery and equipment


665,750


731,916Leasehold improvements


503,540


477,809Total


2,220,889


2,022,354Less accumulated depreciation and amortization


(1,333,564
)

(1,025,996
)Property and equipment - net

$
887,325

$
996,358
 
  F-14
 Depreciation expense totaled $321,596, $381,145 and $536,707 for the years ended June 30, 2004, 2003 and 2002, respectively. Property and equipment held under capital leases amounted to $82,178 and $46,291  less accumulated amortization of $33,548 and $30,456 at June 30, 2004 and 2003, respectively.
  **6.**
****GOODWILL AND OTHER INTANGIBLE ASSETS****
 In 2001, the FASB issued SFAS No. 141, *Accounting for Business Combinations,* and SFAS No. 142, *Goodwill and Other Intangible Assets.* SFAS No. 142 modified accounting for business combinations after June 30, 2001 and affected the Companys treatment of goodwill and other intangible assets effective July 1, 2002. SFAS No. 142 requires that goodwill and intangible assets existing at the date of adoption be reviewed for possible impairment and that impairment tests be performed at least annually. Additionally, intangible assets with finite lives must be assessed and classified consistent with the statements criteria. Intangible assets with finite lives will continue to be amortized over those periods. Amortization of goodwill and intangible assets with indefinite lives will cease.
  At June 30, 2004 and 2003, the Company had $15,956,883 of recorded goodwill. In accordance with FASB Statement No. 142, *Goodwill and Other Intangible Assets* (SFAS No. 142), the Companys goodwill is not subject to amortization.
  In accordance with SFAS No. 142, the Company performed its annual impairment tests in July 2004 and 2003 and found no impairment in its existing goodwill balances at those dates.
  At June 30, 2004 and 2003, the Company had intangible assets subject to amortization with useful lives of 4 to 20 years, primarily consisting of trademarks and patents with a total cost of $304,838 and accumulated amortization of $244,565 and $186,548, respectively.
  The Company also had other intangible assets included in other assets on the balance sheet consisting primarily of security deposits with a total cost of $90,196 at June 30, 2004. At June 30, 2003, the Companys other intangible assets included security deposits and deferred financing cost totaling $233,874, net of amortization of approximately $782,000.
  Intangible and other asset amortization expense for the years ended June 30, 2004 and 2003 was approximately $172,000 and $468,000, respectively. Estimated amortization expense remaining for the five succeeding fiscal years ending June 30 and thereafter is as follows:
  2005
$           8,8002006
8,8002007
8,4002008
8,4002009
8,400Thereafter
17,500Total
$         60,300
 
   F-15   The following table sets forth, for the year ended June 30, 2002, a reconciliation of net income to conform to the requirements of SFAS No. 142:
  **2002**Reported net loss

$
(6,190,563
)Add back -Goodwill amortization


1,722,256Adjusted net loss

$
(4,468,307
)Basic earnings per share:Reported net loss

$
(1.11
)Goodwill adjustments


0.21Adjusted net loss

$
(0.90
)Diluted earnings per share:Reported net loss

$
(1.11
)Goodwill adjustments


0.21Adjusted net loss

$
(0.90
)
 
  There were no changes in the carrying amount of goodwill for the year ended June 30, 2004.
  **7.**
****LINES OF CREDIT AND LONG-TERM DEBT****
 Lines of credit consisted of the following as of June 30:
  
 **2004**

**2003**Line of credit - PrimeSource Healthcare

$
5,204,139Line of credit - PrimeSource Surgical




$
4,654,436Line of credit - Luxtec





1,271,585Total line of credit$
5,204,139

$
5,926,021
   In December 2003, the Company consolidated its previously outstanding senior debt facilities. The Companys senior debt financing is now provided under a $7,500,000 revolving demand note (the PrimeSource Healthcare Line of Credit) from Wells Fargo Business Credit, Inc. (Wells Fargo) under the PrimeSource Healthcare Credit and Security Agreement, dated as of December 10, 2003, by and among the Company, PrimeSource Surgical, Bimeco and Wells Fargo (the Credit and Security Agreement). The Credit and Security Agreement has no stated maturity date, but remains in effect until the borrower terminates the credit facility or the lender demands payment. Although there is no stated maturity, if the PrimeSource Healthcare Line of Credit is terminated before certain dates, termination fees will be due Wells Fargo, as follows: on or before December 10, 2004, 3% of the maximum line, or $225,000; on or before December 10, 2005 2% of the maximum line, or $150,000; on or before December 10, 2006 1% of the maximum line, or $75,000. Pursuant to the Credit and Security Agreement, the maximum amount available to borrow under the PrimeSource Healthcare Line of Credit is limited to the lesser of $7,500,000 or a certain percentage of accounts receivable and inventory, as defined by the Credit and Security Agreement ($6,757,524 at June 30, 2004). As of June 30, 2004, borrowings bore interest at Wells Fargos prime rate plus 3.0% (7.25% at June 30, 2004). Borrowings are secured by substantially all assets held by PrimeSource Healthcare and its subsidiaries. At June 30, 2004, there was $1,553,385 of availability under the PrimeSource Healthcare Line of Credit.
  F-16
 The Credit and Security Agreement contains certain covenants, including covenants that require the maintenance of defined income levels and maximum capital expenditures. The Company was in compliance with these covenants as of June 30, 2004.
  Prior to December 2003, the Companys senior debt financing was provided under separate lines of credit at Luxtec and PrimeSource Surgical.
  The Companys Amended and Restated Security and Loan Agreement (the Luxtec Credit Agreement) provided for a $2,500,000 line of credit (the Luxtec Line of Credit) with ARK CLO 2000-1 LIMITED (ARK). On August 6, 2002, the Company amended the Luxtec Credit Agreement whereby ARK waived and amended certain provisions under the Luxtec Credit Agreement. Under the amendment, as of June 30, 2003, the maximum amount available to borrow under the Luxtec Line of Credit was limited to the lesser of $1,275,000 or a certain percentage of accounts receivable and inventory ($1,271,585 at June 30, 2003). As of June 30, 2003, borrowings bore interest at ARKs prime rate plus 3.0% (7.0% at June 30, 2003). Unused portions of the Luxtec Line of Credit accrued a fee at an annual rate of 1.00%. Borrowings were secured by substantially all of PrimeSource Healthcares assets, excluding the capital stock of, and assets held by, PrimeSource Surgical. Borrowings under the Luxtec Line of Credit were payable upon maturity on December 31, 2003. In December 2003, the Company refinanced its senior debt facilities, and paid off the Luxtec Line of Credit in the amount of $1,271,585.
  The Companys PrimeSource Surgical Amended and Restated Credit Agreement (the PrimeSource Surgical Credit Agreement) with Citizens Bank of Massachusetts (Citizens) provided for a line of credit (the PrimeSource Surgical Line of Credit) with a maturity date of March 31, 2004. Under the PrimeSource Surgical Credit Agreement, as amended, the maximum amount available to borrow under the PrimeSource Surgical Line of Credit was limited to the lesser of $8,000,000 or a certain percentage of accounts receivable and inventory, as defined by the PrimeSource Surgical Credit Agreement ($5,281,805 at June 30, 2003). As of June 30, 2003, borrowings bore a variable step interest rate at Citizens prime rate plus 4.50% (8.50% at June 30 , 2003). Unused portions of the PrimeSource Surgical Line of Credit accrued a fee at an annual rate of 0.375%. Borrowings were secured by substantially all of the assets directly held by PrimeSource Surgical. In December 2003, the Company refinanced its senior debt facility and paid off the PrimeSource Surgical Line of Credit in the amount of $4,793,944.
  On June 14, 1999, as part of the PrimeSource Surgical Credit Agreement, PrimeSource Surgical executed an Amended and Restated Term Note (the PrimeSource Surgical Term Loan) in the original amount of $5,000,000 with Citizens. On June 30, 2003, the Company paid off the entire outstanding balance of the PrimeSource Surgical Term Loan in connection with the sale of Ruby and additional sales of Series G Stock. The PrimeSource Surgical Term Loan was collateralized by substantially all the assets directly held by PrimeSource Surgical.
  The PrimeSource Surgical Term Loan was also subject to a term loan facility fee. In December 2003, in connection with the refinancing of its senior debt, the Company used proceeds from the refinancing with Wells Fargo to pay Citizens an $180,000 term loan facility fee.
  F-17  Long term debt includes notes payable as follows:
  **June 30,**

**June 30,****2004**

**2003**Luxtec tenant note

$
62,446

$
77,650PrimeSource legal counsel note, net of unamortizeddiscount of $12,827





357,173PrimeSource Citizens Bank note





187,500Other long-term note


43,250


43,250Total other notes payable


105,696


665,573Less current portion


(16,713
)

(559,877
)Total long-term debt

$
88,983

$
105,696
 
 The Luxtec tenant note is a note payable for tenant improvements to the lessor of Luxtecs leased premises in West Boylston, Massachusetts, which bears interest at 9.5% and is due September 19, 2005. Payments are interest only for the first 12 months, with remaining payments calculated on a 7-year amortization table with a balloon payment due on September 19, 2005.
  The PrimeSource legal counsel note was a non-interest bearing demand note payable with an original balance of $559,977 (net of original unamortized discount of $40,023 based on an imputed interest rate of 8%) to its special legal counsel for payment of prior accounts payable. This note matured on May 30, 2004. Special legal counsel reduced the balance of this note by $150,000 in November 2003. As of June 30, 2004 the note payable had been paid off.
  The PrimeSource Citizens Bank note was a $250,000 note payable to Citizens for the bank refinancing amendment fee. This note was paid off in December 2003 in connection with the refinancing of the Companys senior debt, as described above.
  **8.**
**PREFERRED STOCK**  ***Series G Redeemable, Convertible Preferred Stock*** - On August 6, 2002, the Company created a new series of preferred stock, Series G Convertible Redeemable Preferred Stock, no par value (the Series G Stock). The Series G Stock has 230,000 authorized shares and at June 30, 2004 and 2003, 222,501 and 222,500 shares were issued and outstanding, respectively. Each share of Series G Stock is convertible into 100 shares of common stock, subject to adjustment, at the option of the holder. Each share of Series G Stock has one vote for each share of common stock into which it would be convertible. In addition, Series G Stock ranks senior to all other outstanding stock of the Company. Series G Stock accrues dividends at the rate of 8% per year of the original issuance price of $32.00 per share, compounded annually, and has a liquidation value equal to $64.00 per share plus an amount equal to all accrued but unpaid dividends. The Series G Stock is redeemable at the election of not less than 60% of the Series G stockholders any time after June 30, 2005, and is redeemable at $64.00 per share plus accrued but unpaid dividends. The Series G Stock also has special consent rights to certain of the Companys activities, including, but not limited to, amendment of the Companys articles or bylaws and merger or consolidation of the Company. The difference between the original issuance price of $32.00 per share and the redemption value per share is being accreted over the period from issuance to first redemption. As of June 30, 2004, cumulative unpaid dividends on the Series G Stock totaled $1,054,278, and were included in the carrying amount of Series G Stock in the consolidated balance sheet.
 
 F-18
 
 The Companys Series G Stock, was initially issued August 6, 2002, in connection with a recapitalization of the Companys equity structure (the Recapitalization). Certain other classes of outstanding preferred stock, including Series C Redeemable, Convertible Preferred Stock and Series F Redeemable, Convertible Preferred Stock, were converted to common stock. Another class of outstanding preferred stock, Series F Redeemable, Convertible Preferred Stock, was exchanged for Series G Stock, and additional shares of Series G Stock were issued for cash consideration. Warrants to purchase common stock were issued to the Series C, F, E and G Stockholders, and previously issued warrants to purchase common stock held by these stockholders were repriced.
 
 The Series G Stock was originally recorded at the original issue price of $32.00 per share. The Series G Stock is being increased to its redemption value of $64.00 per share in periodic accretions from the date of original issuance through the first redemption date of June 30, 2005. At June 30, 2004, cumulative accretion totaled $4,538,776.
 
 During the year ended June 30, 2003, the Company granted options to purchase 7,500 shares of Series G Stock for $16 per share to an executive of the Company. Options vested one year from August 6, 2002, the date of grant, and have a 10 year life. Compensation expense totaling $10,000 and $110,000 was recognized for the years ended June 30, 2004 and 2003, respectively, related to these options.
 
 On October 15, 2003, an option for the purchase one share of Series G Stock was exercised for $16. At June 30, 2004, the remaining 7,499 options were vested and exercisable.
  **9.**
**STOCK OPTIONS AND WARRANTS**  ***Common Stock Options*** *-* In January 1997, PrimeSource Surgical adopted a stock option plan (the 1997 Plan) for the grant of stock options and other awards to certain officers, key employees, or other persons affiliated with the Company. The maximum number of shares of common stock that may be issued pursuant to the 1997 Plan is 12,000,000 shares. The 1997 Plan also provides for various vesting schedules, as determined by the compensation committee of the Board of Directors, and options have terms not to exceed 10 years. The vested options may be exercised at any time and generally expire 10 years from the date of grant.
  The Company issued equity-based options to certain employees during fiscal year 2003. The exercise price was at the deemed fair market value of the stock at the date of grant, except as discussed below.
  During fiscal year 2003, the Company also issued equity-based options to a certain employee as required under the executed employment agreement with the Company. The exercise price was below the deemed fair market value of the stock at the date of grant. In accordance with the requirements of APB Opinion No. 25, the Company has recorded compensation for the difference between the exercise price of the stock and the deemed fair market value of
 
 F-19
 the Companys stock at the date of grant. Compensation expense is amortized on a straight-line basis, over the one-year period during which the options become vested. As of June 30, 2004 and 2003, the Company had recorded compensation expense related to these options of $10,000 and $110,000, respectively.
  On October 15, 2003, options for the purchase of 50 shares of common stock at $0.01 per share were exercised for total proceeds of $16.
  In addition to the 1997 Plan, the Company has several stock option plans sponsored by Luxtec. The 1992 stock plan (the 1992 Plan) provides for the grant of incentive stock options, nonqualified stock options, stock awards, and direct sales of stock. Under the 1992 Plan, incentive stock options may be granted at an exercise price not less than the fair market value of the Companys common stock on the date of grant. The Board of Directors at its discretion may grant nonqualified options. The 1992 Plan also provides for various vesting schedules, as determined by the compensation committee of the Board of Directors, and have options terms not to exceed 10 years. Under the 1992 Plan, 500,000 total shares are authorized for issuance.
  The 1995 directors plan (the 1995 Director Plan) was adopted for non-employee directors and provides that an aggregate of up to 200,000 nonqualified options may be granted to non-employee directors, as determined by the compensation committee of the Board of Directors. Under the terms of the 1995 Director Plan, options are granted at not less than the fair market value of the Companys common stock on the date of grant. The 1995 Director Plan also provides that the options are exercisable at varying dates, as determined by the compensation committee of the Board of Directors, and that they have terms not to exceed 10 years. At both June 30, 2004 and June 30, 2003, there were 64,000 shares available for future grants under the 1995 Director Plan.
  ***Warrants*** *-* In connection with the issuance of its Series G Stock in August 2002, the Company granted warrants to purchase 3,300,000 shares of common stock at $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012.
  Prior to the issuance and sale of Series G Stock in August 2002, the Company converted outstanding shares of Series C Stock into shares of Company common stock. In connection with the conversion of the Series C Stock, the Company granted former holders of Series C Stock warrants to purchase 7,390,613 shares of common stock with an exercise price of $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012. Additionally, exercise prices on warrants to purchase 140,330 shares of common stock previously issued to certain preferred stockholders were repriced from $1.68 per share to $.01 per share.
  Simultaneously with the conversion of Series C Stock in August 2002, each outstanding share of Series F Stock was converted into shares of common stock. In connection with the conversion, the Company granted the former holders of Series F Stock warrants to purchase 1,614,560 shares of common stock with an exercise price of $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012. Additionally, the
 
 F-20
 exercise price on previously issued warrants to purchase 1,751,130 shares of common stock was adjusted from $1.00 per share to $.01 per share. The warrants vested immediately and expire in December 2010.
  Subsequent to the conversion of the Series C Stock and Series F Stock, each outstanding share of the Companys Series E Stock was exchanged for shares of Series G Stock. In connection with the exchange of the Series E Stock, the Company granted former holders of Series E Stock warrants to purchase 817,000 shares of the Companys common stock with an exercise price of $.01 per share. The warrants became exercisable on December 31, 2002 and expire in August 2012. Additionally, the exercise price on 1,625,000 warrants to purchase common stock previously issued to certain Series E Stock stockholders was repriced from $1.00 per share to $.01 per share. The warrants vested immediately and expire in July 2011.
  The warrants issued and repriced in connection with the issuance of the Companys Series G Stock were valued using the Black-Sholes model using the following assumptions: weighted average risk-free discount rate 1.68%; 0% expected dividend; 50% volatility; and an expected life of 3 years. As the exercise price exceeds the estimated fair value of the Companys common stock, zero value was assigned to the warrants.
  An additional 118,605 warrants were issued to certain other stockholders related to prior year grants with expiration dates of June 2011, and exercise prices of $1.00 and $2.35.
  Related to a private placement of its preferred stock in September 2000, the Company granted warrants to purchase 157,860 shares of the Companys common stock at $1.68 per share. These warrants vested immediately and expire in September 2011.
   F-21   Changes in shares under options and warrants for the years ended June 30, 2002, 2003 and 2004 are as follows:
  **Options**
**Warrants****Weighted**

**Weighted****Average**

**Average****Shares**
**Exercise**
**Shares**
**Exercise****Outstanding**
**Price**
**Outstanding**
**Price**Balance, July 1, 2001
3,393,030
$ 1.81
1,016,259
$ 3.15Grants
112,000
1.00
3,494,780
1.01Forfeited
(1,864,554)
1.72
(438,173)
5.70Balance, June 30, 2002
1,640,476
1.85
4,072,866
1.04Grants
7,487,000
0.32
13,122,173
0.01Forfeited
(525,212)
1.42
(356,485)
1.01Balance, June 30, 2003
8,602,264
0.53
16,838,554
0.02Grants
1,300,000
0.32Exercised
(50)
0.32Forfeited
(114,284)
1.86
(63,786)
1.18Balance, June 30, 2004
9,787,930
0.49
16,774,768
0.02Vested and exercisable, June 30, 2004
6,544,957

16,774,768Vested and exercisable, June 30, 2003
1,474,960

16,838,554Vested and exercisable, June 30, 2002
996,076

4,072,866
 
 The weighted-average per share fair value of option grants in fiscal 2004, 2003 and 2002 was approximately zero, zero and $0.5803, respectively.
   F-22  
 Outstanding stock options and warrants at June 30, 2004 consist of the following:
  **Options**
**Warrants****Weighted**


**Weighted****Average**
**Weighted**

**Average**
**Weighted****Remaining**
**Average**

**Remaining**
**Average****Range of**

**Contractual**
**Exercise**

**Contractual**
**Exercise****Exercise Prices**
**Shares**
**Life (Years)**
**Price**
**Shares**
**Life (Years)**
**Price**$0.00 - $1.60
9,077,745
6.8
$ 0.37
16,738,633
7.8
$ 0.02$1.61 - $3.20
693,185
5.3
1.98
36,135
6.5
2.03$3.21 - $4.80
17,000
0.5
4.579,787,930
6.7
0.49
16,774,768
7.8
0.02 
  Compensation expense in the amount of $10,000 and $110,000 for fiscal 2004 and 2003, respectively, has been recognized for certain employee stock options granted below market value. No compensation expense has been recognized for the remaining employee stock option grants.
  **10.**
**401(k) RETIREMENT PLAN**  The Company and PrimeSource Surgical separately maintain qualified 401(k) retirement plans. The plans cover substantially all employees who have over six months of service and have attained ages 18 and 21 for the Company and PrimeSource Surgical plans, respectively. The 401(k) plans provide for a contribution by the Company each year. The Company match totaled $145,426, $110,706 and $169,347, for the years ended June 30, 2004, 2003 and 2002, respectively.
  **11.**
**INCOME TAXES**  The benefit (provision) for income taxes for the years ended June 30 is based on the following components:
  **2004**

**2003**

**2002**Current income taxesFederal

$
-

$
1,600State


-


18,100

$
61,700Total current


-


19,700


61,700Deferred income taxes:Federal


(1,904,700
)

(172,700
)

1,458,900State


(407,100
)

(18,800
)

209,200Total deferred


(2,311,800
)

(191,500
)

1,668,100Change in valuation allowance


2,311,800


191,500


(1,668,100
)Total

$
-

$
19,700

$
61,700
 
 F-23
 
 A reconciliation of the provision for income taxes to the amount of income tax benefit (expense) that would result from applying the federal statutory rate (35%) to income (loss) before income tax benefit (provision) is as follows:
  **2004**

**2003**

**2002**Income tax (provision) benefit at statutory rate

$
(562,100
)
$
1,270,080

$
2,223,700Nondeductible warrant put expense (income)





66,500


(33,250
)State tax (expense) benefit, net of federal benefit


(73,500
)

112,700


202,350Meals and entertainment


(13,700
)

(20,100
)

(14,300
)Nondeductible goodwill


78,800


(1,448,700
)

(613,100
)Change in valuation allowance


2,311,800


191,500


(1,668,100
)Change in prior years estimates


(1,660,600
)General business credit





(13,200
)

(45,000
)Loss on sale of subsidiary





(18,100
)Expiration and adjustments of net operatinglosses and income tax credits


(85,800
)

(118,000
)Other


5,100


(2,980
)

9,400Total

$
-

$
19,700

$
61,700
 
  On an annual basis, the Company reviews its deferred tax assets based on open tax years, available net operating loss carryforwards and other factors. Based on its 2004 review, the Company decreased its deferred tax assets by $1,660,600, and decreased the offsetting valuation allowance by the same amount. In addition, the Company decreased income taxes payable and income tax expense by approximately $113,000, which offset estimated state income taxes due and payable for the year ended June 30, 2004.
   F-24   Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Companys deferred tax assets (liabilities) are as follows at June 30:
  **2004**

**2003**Current:Restructuring reserve

$
17,000

$
229,400Accrued vacation


59,800


62,400Inventory valuation adjustment


139,000


453,600Bad debt reserve


49,000


87,700Accrued distributor costs





205,000Other


25,300


46,400Total current


290,100


1,084,500Long-term:Depreciation and amortization


(39,800
)

114,600Credit carryforwards


165,800


243,600Capital loss carryforwards


516,200


300,100Charitable loss carryforwards


14,600


6,800Net operating loss carryforwards


5,254,600


6,763,700Total long-term


5,911,400


7,428,800Total


6,201,500


8,513,300Valuation allowance


(6,201,500
)

(8,513,300
)Total

$
-

$
-
 
  Certain of the Companys current deferred tax assets, including inventory valuation adjustment and bad debt reserve, are reduced due to limitations in deductible amounts relating to the Companys prior acquisition of these assets in stock transactions.
  At June 30, 2004, the Company had federal net operating loss carryforwards of approximately $13,266,700, pre-tax, and state net operating loss carry forwards of approximately $10,191,000, pre-tax. The Companys federal and state net operating losses expire in future tax years ending June 30, 2005 through 2024. At June 30, 2004, the Company had federal and state research and development credit carryforwards of approximately $154,800 and $11,000, respectively. The Companys federal and state credits will generally expire in future tax years ending June 30, 2005 through 2021. The Company also has a federal capital loss carryforward of approximately $1,326,900, pre-tax, that will begin to expire in the tax year ending June 30, 2006. Certain changes in stock ownership may result in a limitation on the amount of net operating loss carryforwards that can be utilized each year.
  A full valuation allowance has been provided against the Companys deferred tax assets as of June 30, 2004 and 2003, as it is more likely than not that sufficient taxable income will not be generated to realize these temporary differences. Any future reduction of the valuation allowance established at the dates of the acquisitions (see Note 3) will reduce the goodwill related to such acquisition.
  F-25
 **12.**
**COMMITMENTS AND CONTINGENCIES**  ***Leases*** - The Company leases office space and certain computer equipment and software under capital and noncancelable operating leases. Rent expense for the years ended June 30, 2004, 2003 and 2002 was $628,259, $654,116 and $726,455, respectively. Minimum annual lease payments under capital and noncancelable operating leases are as follows for the years ending June 30:
  **Capital**

**Operating****leases**

**leases**2005

$
26,124

$
606,2932006


19,691


266,2502007


4,411


8,1322008





1,645Total minimum lease payments


50,226

$
882,320Amount representing interest


(6,509
)Present value of future minimum lease payments


43,717Less current portion of capital lease obligations


(21,568
)Capital lease obligations - net of current portion

$
22,149
 
 ***Executive Compensation*** - At June 30, 2004, certain executive officers of the Company and its subsidiaries had employment agreements that provide for compensation and certain severance benefits. As a result of an employment agreement with the Companys former President/Chief Executive Officer certain benefits were accrued at June 30, 2003 in the amount of $195,507. All accrued amounts were paid as of June 30, 2004.
  ***Litigation*** - The Company is involved in litigation incidental to its business. Management does not believe the ultimate disposition of this litigation will have a material adverse effect on the Companys consolidated financial statements.  ****
  On September 5, 2002, former executive officers and directors of the Company filed a complaint in Arizona Superior Court, County of Pima. The complaint alleged a breach by the Company of the severance agreements with each of the officers. The complaint was settled in November 2003. The terms of the settlement included cash payments totaling $125,000 to the officers over a period of four months, ended in February 2004.
  During the quarter ended September 30, 2002, the Company resolved an outstanding matter relating to alleged non-compete violations with a former employee. Pursuant to the terms of the settlement, the former employee paid the Company a cash settlement in the amount of $168,099, net of costs of $71,901, and returned for cancellation 132,963 shares of Company common stock valued at $42,548.
  F-26  **13.**
**BUSINESS SEGMENTS**
 The Company is organized into three operating segments based on operating criteria. These segments are Specialty Medical Products Manufacturing, Specialty Distribution Services - Surgical, and Specialty Distribution Services - Critical Care. A description of each segment and principal products and operations are as follows:
 
 *Specialty Manufactured Products* - This segment includes the Luxtec division which designs and manufactures fiber optic headlight and video camera systems, light sources, cables, retractors, and custom-made and other surgical equipment for the medical and dental industries.
  *Specialty Medical Distribution - Surgical* - The surgical segment is a regional sales and marketing organization that markets and sells surgical products primarily to hospitals and surgery centers. The primary specialty areas include gynecology, cardiovascular, endoscopy, and general surgery. These products and services are primarily used in hospital operating rooms and in outpatient surgery centers. This segment does business as PrimeSource Surgical.
  *Specialty Medical Distribution - Critical Care* - The critical care segment is a regional sales and marketing organization that sells products primarily to hospitals and surgery centers in the southeastern and northeastern United States and includes the Bimeco, Inc. operations. Within this segment, the primary specialties include maternal and childcare and neonatal intensive care. The results of the NEMS and PEC operations are only included in fiscal years prior to their sales in 2003 and 2002, respectively.
  In June 2003, the Company sold the capital stock of Ruby which was included in the Critical Care segment. The segment information has been restated to reflect historical segment information as adjusted for the reclassification of the NEMS portion of Rubys operations as discontinued operations.
  Operations that are not included in any of the segments are included in the category Corporate/Other and consist primarily of corporate staff operations, including selling, general, and administrative expenses of $2,867,349, $3,527,516 and $4,194,680 for 2004, 2003, and 2002, respectively. The sales between segments are made at market prices and are eliminated in consolidation.
  The total assets of each segment consist primarily of net property and equipment, inventories, accounts receivable, and other assets directly associated with the segment's operations. Included in the total assets of the corporate operations are property and equipment and other assets.
   F-27   Certain products of the Specialty Medical Products Manufacturing segment are sold to the Specialty Medical Distribution - PrimeSource Surgical segment. Sales between these segments totaled $5,382,852, $5,055,400 and $5,178,351 for the years ended June 30, 2004, 2003 and 2002.
  Disclosures regarding the Companys reportable segments including a corporate management fee allocation with reconciliation to consolidated totals are presented below.
  **Distribution -**
**Distribution -****PrimeSource**
**PrimeSource**

**Corporate/****Surgical**
**Critical Care**
**Manufacturing**
**Other**
**Eliminations**
**Total**Net revenues2004
$           27,330,958
$      13,296,821
$      13,518,079

$        (5,382,852)
$        48,763,0062003
26,181,812
11,939,529
13,294,078

(5,055,400)
46,360,0192002
29,412,136
16,743,545
12,718,387

(5,178,351)
53,695,717Net income (loss)2004
$               774,776
$          383,550
$       1,576,755
$       (557,868)

$          2,177,2132003
137,765
260,978
(3,090,253)
(937,289)

(3,628,799)2002
448,525
(242,670)
913,610
(7,310,028)

(6,190,563)Total assets2004
$          23,524,547
$       3,290,404
$       2,899,675
$         184,620

$        29,899,2462003
25,041,081
3,361,430
2,935,095
326,934

31,664,5402002
14,827,268
6,895,708
15,406,712
457,080

37,586,768Restructuring expenses2004



$            4,817

$                 4,8172003



345,507

345,5072002

$      1,038,823

2,915,675

3,954,498Depreciation and amortization2004
$           133,736
$             1,058
$        186,802
$       171,929

$             493,5252003
195,959
24,048
155,984
467,509

843,5002002
243,350
170,495
1,344,814
696,422

2,455,081Interest expense2004
$           219,370
$         152,790
$        121,078
$       243,538

$             736,7762003
282,899
129,604
111,959
314,781

839,2432002
273,612
207,856
159,218
38,558

679,244Goodwill2004
$       12,660,950
$         607,981
$      2,687,952


$        15,956,8832003
12,660,950
607,981
2,687,952


15,956,8832002
13,749,367
607,981
7,142,608


21,499,956
 
  PrimeSource Surgical and its subsidiaries have no significant sales to foreign companies; however, Luxtec has several foreign customers. The Companys external sales, based upon the customers country of origin by geographic area for the years ended June 30, 2004, 2003 and 2002, totaled $46,065,000, $44,015,000 and $51,688,000 respectively for sales in the United States and $2,698,000, $2,345,000 and $2,008,000, respectively, for sales to foreign companies.
   F-28   **14.**
**RESTRUCTURING**
 In October 2001, PrimeSource engaged a restructuring agent to evaluate the Companys operations for possible reorganization. In November 2001, the Company commenced with a restructuring plan involving narrowing the focus of the Companys operations, the consolidation of certain underperforming sales regions, the reduction of corporate overhead through workforce reductions, the restructuring of the Companys balance sheet through the refinancing of the Companys senior bank debt and the reduction of debt levels through improved earnings.

As a result of the restructuring plan, during fiscal year 2002, the Company recorded restructuring costs of approximately $4.0 million consisting of $800,000 in specialized restructuring consultants fees, $500,000 related to a remaining lease liability for a facility that has been closed, $300,000 in costs for exited product lines related to the closure of the western sales region, $1.4 million in employee severance and $1.0 million attributable to the loss on disposal of a division. Approximately 29 administrative employees were released, and several members of the Companys senior management team resigned, including the Companys 2002 Chief Executive Officer, Chief Financial Officer and Chairman and Executive Vice President.

In fiscal year 2003, the Company recorded additional severance amounts for the resignation of its 2003 President and Chief Executive Officer, costs of probable legal settlement fortwo former executive officers and directors of the Company and the sale of NEMS. Activity consists of the following:
  **Employee related**

**Loss on disposal of division**

**Other contracts**

**Total**Estimated costs for 2002 restructuring

$
1,379,000

$
1,038,823

$
1,536,675

$
3,954,498Cash payments


(585,000
)

-


(901,000
)

(1,486,000
)Other adjustments


(141,000
)

(1,038,823
)

(177,542
)

(1,357,365
)Balance, June 30, 2002


653,000


-


458,133


1,111,133Estimated costs for 2003 restructuring


195,507





150,000


345,507Cash payments


(584,739
)




(166,320
)

(751,059
)Other adjustments


-


-


(14,613
)

(14,613
)Balance, June 30, 2003


263,768


-


427,200


690,968Cash payments


(263,768
)




(159,584
)

(423,352
)Other adjustments


-


-


(223,890
)

(223,890
)Balance, June 30, 2004

$
-

$
-

$
43,726

$
43,726
 
   F-29  ****
 **15.**
**RESTATEMENT OF FINANCIAL STATEMENTS**
 Subsequent to the issuance of the Companys financial statements for the year ended June 30, 2004, the Company determined that the Companys Series G Stock should not have been classified as a liability under SFAS No. 150,*Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity*(SFAS No. 150). In addition, the Company determined that the accounting treatment originally afforded to certain aspects of the recapitalization of the Companys equity at the time of the original issuance of the Series G Preferred Stock in August 2002 (the Recapitalization), including the issuance of warrants to purchase common stock, the repricing of previously issued warrants to purchase common stock and related accretion of these amounts was incorrect, as discussed below. The Company also determined that certain amounts included in net sales for the years ended June 30, 2002, 2003 and 2004 should have been recorded as commissions and service revenues in the statements of operations.

Effective July 1, 2003 the Company implemented SFAS No. 150, and at that time it changed the classification of its Series G Preferred Stock to a liability. However the Company subsequently determined that the Series G Preferred Stock did not meet the criteria of a mandatorily redeemable preferred stock that should be classified as a liability because redemption is at the option of the holders and requires the approval of not less than 60% of the Series G Stockholders at any time after June 30, 2005. Accordingly, the Company determined that it should have continued to classify the Series G Stock as mezzanine equity in the Companys balance sheet, and should not have included the dividends that accrue on the Companys Series G Stock in interest expense in the statements of income, but should have reflected them in dividends and accretion on preferred stock for all reporting periods after July 1, 2003.

The Company also determined that the historical accounting treatment afforded to the Series G Stock warrants that were issued and repriced in connection with the Recapitalization, the conversion and redemption features of the Series G Stock, and the fair values assigned to the Companys Series G Stock and common stock at the date of the Recapitalization was incorrect.

The Company originally accounted for the warrants issued and repriced in the Recapitalization using an estimate of the fair value of its common stock of $.32 per share. In connection with its reconsideration of the accounting for the Series G Stock, the Company also determined that the estimated fair value of its common stock that was used in determining the fair value of the warrants issued and repriced in connection with the Recapitalization should have been less than $.01 per share.
  F-30    The Company originally recorded a beneficial conversion feature relating to the Series G Stock based on its intrinsic value in accordance with EITF 00-27,*Application of Issue No. 98-5 to Certain Convertible Instruments*(EITF No. 00-27), and did not separately account for the conversion feature as an embedded derivative for the conversion and redemption features in accordance with SFAS No. 133,*Accounting for Derivative Instruments and Hedging Activities*(SFAS No. 133). The Company has now determined that the conversion feature represents an embedded derivative that should have been separated from the preferred stock based on its relative fair value and that it should not have recognized a beneficial conversion feature under EITF No. 00-27. The Company has valued the embedded derivative using the Black Scholes model with the following assumptions: weighted average risk-free discount rate 1.68%; 0% expected dividend; 50% volatility; and an expected life of 3 years, and determined that it had no value at the date of issuance, because the fair value of the common stock is less than $.01. Accordingly, the value originally assigned to the beneficial conversion feature has been adjusted to zero from date of issuance. Future changes in the fair value of the derivative will result in a charge or credit to income during the period of change.

The Company originally accounted for the Recapitalization in accordance with EITF No. 00-27, and the excess of consideration given up by the preferred stockholders over what they received was recorded as a credit to accumulated deficit, resulting in an increase in income available to (decrease in loss attributable to) common stockholders for purposes of calculating income (loss) per share. The Company has now determined that certain conversions of the preferred stock in the Recapitalization were induced conversions that should have been accounted for in accordance with EITF No. D-42,*The Effect on the Calculation of Earnings Per Share for the Redemption or Induced Conversion of Preferred Stock,*which results in the excess of the consideration transferred by the preferred stockholders over what they received being credited to additional paid-in capital instead of accumulated deficit.

Finally, the carrying value of the Series G Stock was originally recorded at the original issue price of $32 per share, net of issuance costs, the fair value of the warrants and the intrinsic value of the beneficial conversion feature discussed above. The Series G Stock was being accreted up to the $32 per share original issue price through the earliest redemption date of June 30, 2005, consistent with guidance in EITF D-98,*Classification and Measurement of Redeemable Securities*; however, the Company has now determined that, based on the redemption value of the Series G Stock of $64 per share, the Company should have recorded additional accretion of $32 per share.
  As a result, the Companys financial statements have been restated from the amounts previously reported to correct the accounting for these transactions. A summary of the significant effects of the restatement is as follows:
  F-31
  **As of June 30:****2004**

**2004**

**2003**

**2003****As previously reported**

**As restated**

**As previously reported**

**As restated**Total liabilities

$
19,465,811

$
11,326,878

$
15,279,418

$
15,279,418Series G redeemable, convertible preferredstock


8,138,933


12,534,619

$
5,699,121

$
9,166,370Additional paid-in capital


19,295,451


31,372,665


21,347,451


31,362,665Accumulated deficit


(9,085,767
)

(25,558,667
)

(10,885,200
)

(24,367,664
)Total stockholders' equity


10,433,435


6,037,749


10,686,001


7,218,752****

**For the years ended June 30:****2004**


**2004**


**2003**


**2003**


**2002**


**2002******


****As previously reported****


**As restated**


**As previously reported**


**As restated**


**As previously reported**


**As restated**Net product sales

$
-

$
45,660,102

$
-

$
43,666,410

$
-

$
51,333,555Commissions and service revenues


-


3,102,904


-


2,693,609


-


2,362,162Net sales


48,763,006


48,763,006


46,360,019


46,360,019


53,695,717


53,695,717Interest expense


1,307,940


736,776


839,243


839,243


679,244


679,244Income (loss) from continuing operationsbefore income tax benefit


1,606,049


2,177,213


758,290


758,290


(6,353,526
)

(6,353,526
)Income (loss) before discontinued operationsand cumulative effect of change inaccounting principle


1,606,049


2,177,213


777,990


777,990


(6,291,826
)

(6,291,826
)Net income (loss)


1,606,049


2,177,213


(3,628,799
)

(3,628,799
)

(6,190,563
)

(6,190,563
)Dividends and accretion on preferred stock


-


3,368,216


1,147,094


2,549,681


2,652,571


2,652,571Effect of equity recapitalization


-


-


(11,809,741
)

(270,136
)

-


-Income available (loss attributable) to commonstockholders


1,606,049


(1,191,003
)

7,033,848


(6,448,616
)

(8,843,134
)

(8,843,134
)Income (loss) per share before discontinuedoperations and cumulative effect of changein accounting principle:Basic


0.07


(0.05
)

0.54


(0.10
)

(1.13
)

(1.13
)Diluted


0.07


(0.05
)

0.24


(0.10
)

(1.13
)

(1.13
)Loss per share from cumulative effect ofchange in accounting principle- goodwillimpairment:Basic


-


-


(0.09
)

(0.21
)

-


-Diluted


-


-


(0.09
)

(0.21
)

-


-Income available (loss attributable) tocommon stockholdersBasic


0.07


(0.05
)

0.33


(0.31
)

(1.11
)

(1.11
)Diluted


0.07


(0.05
)

0.15


(0.31
)

(1.11
)

(1.11
)Weighted average shares used in computationof income (loss) per share - Basic andDiluted


22,375,130


22,375,130


53,024,512


21,059,853


7,975,208


7,975,208
    
 ******F-32
  **ITEM 9A.     CONTROLS AND PROCEDURES** .
 
 (a)  Disclosure Controls and Procedures. This section has been updated to give effect to the restatement as discussed in Note  15 to the consolidated financial statements.
As of June 30, 2004, the Company carried out an evaluation, under the supervision and with the participation of the Corporations management, including the Corporations Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Corporations Chief Executive Officer and Chief Financial Officer concluded that the Corporations disclosure controls and procedures were effective. The errors identified and discussed in Note 15  of the consolidated condensed financial statements were principally the result of the misapplication of the accounting guidance of  SFAS No. 150*Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity*to the Company's Series G Redeemable Convertible Preferred Stock ("Series G Stock"), and also the misapplication of EITF 00-27*Application of Issue No. 98-5 to Certain Convertible Instruments*and EITF D-42,*The Effect on the Calculation of Earnings Per Share for the Redemption or Induced Conversion of Preferred Stock*to the original accounting for the same Series G Stock as of August 6, 2002. The errors were identified during January 2005. In light of the facts and circumstances relating to the restatement, the Companys Chief Executive Officer and Chief Financial Officer concluded that the restatement is a material weakness (as defined under standards established by the Public Company Accounting Oversight Board) in the Companys internal controls. The material weakness was caused by an inadequate control over the review process of the implementation of new accounting guidance, and the application of accounting guidance to new transactions. The Company is evaluating steps to enhance the operation and effectiveness of our internal controls over new accounting guidance and new transactions.
Attached as exhibits to this annual report are certifications of the Chief Executive Officer and the Chief Financial Officer required in accordance with Rule 13a-14 of the Exchange Act. This portion of the Companys annual report includes the information concerning the controls evaluation referred to in the certifications and should be read in conjunction with the certifications for a more complete understanding of the topics presented.

(b)  Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period to which this report relates (the registrants fourth fiscal quarter in the case of our annual report) that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
64
 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.
 
 PRIMESOURCE HEALTHCARE, INC.
 
 
 by /s/Joseph H. Potenza
 Joseph H. Potenza, President and
 Chief Executive Officer
 
 
 February 22, 2005
 
  65   Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
 Signature  Title   Date
 
 
 /s/ William H. Lomicka    Director  February 22, 2005
 William H. Lomicka
 
 
 /s/ Larry H. Coleman  Director  February 22, 2005
 Larry H. Coleman
 
 
 /s/ Joseph H. Potenza  President, Chief Executive February 22, 2005
 Joseph H. Potenza  Officer, Director, (Principal
 Executive Officer)
 
 
 /s/ Shaun D. McMeans   Chief Operating Officer,  February 22, 2005
 Shaun D. McMeans  Chief Financial Officer
 and Treasurer, Director,
 (Principal Accounting
 Officer)
  66