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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON D.C. 20549

FORM 10-K

FOR
ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934xAnnual report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year
ended December 31, 2003oTransition report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934for the transition period from to .Commission file no. 0-23791

SONOSITE, INC.(Exact name of registrant as specified in its charter)

|Washington                                                                                                                                  |  | 91-1405022                               
|------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------
|(State or other jurisdiction
  of incorporation or organization)                                                                            |  | (I.R.S. Employer
  Identification Number)
|21919 30th Drive S.E.
  Bothell, WA 98021-3904
  (425) 951-1200(Address and
  telephone number of registrants principal executive offices)

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

|Title of each class |  | Name of exchange on which registered
|------------------- |  | ------------------------------------
|None                |  | Not
  applicable                    

Securities registered pursuant to Section
12(g) of the Act:
Common stock, $0.01 par value

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

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. o

Indicate by
check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yes x No o

The
aggregate market value of the voting stock held by nonaffiliates of the
registrant, based on the closing sale price of the registrants Common Stock on
June 30, 2003 as reported on the Nasdaq National Market, was $247,535,054.

As of March
5, 2004, there were 14,668,784 shares of the registrants Common Stock
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The
information required by Part III of this report, to the extent not set forth
herein, is incorporated by reference from the registrants definitive proxy
statement relating to the annual meeting of shareholders to be held in 2004,
which definitive proxy statement shall be filed with the Securities and
Exchange Commission within 120 days after the end of the fiscal year to which
this report relates.

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SONOSITE, INC.ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

|         |                                                                                                 | Page No.
|-------- | ----------------------------------------------------------------------------------------------- | --------
|         |                                                                                                 |         
|PART I   | 2                                                                                              
|         | Item 1. Business                                                                                | 2       
|         | Important
  Factors That May Affect Our Business, Our Results of Operations and Our Stock Price | 10      
|         | Item 2. Properties                                                                              | 22      
|         | Item 3. Legal Proceedings                                                                       | 22      
|         | Item 4. Submission of Matters to a Vote of Security
  Holders                                   | 23      
|PART II  | 24                                                                                             
|         | Item 5. Market for Registrants Common Equity and
  Related Stockholder Matters                 | 24      
|         | Item 6. Selected Financial Data                                                                 | 26      
|         | Item 7. Managements Discussion and Analysis of
  Financial Condition and Results of Operations | 27      
|         | Item 7A. Quantitative and Qualitative Disclosures
  about Market Risk                           | 33      
|         | Item 8. Financial Statements and Supplementary Data                                             | 35      
|         | Item 9. Changes in and Disagreements with
  Accountants on Accounting and Financial Disclosure  | 55      
|         | Item 9A. Controls and Procedures                                                                | 55      
|PART III | 56                                                                                             
|         | Item 10. Directors and Executive Officers of the
  Registrant                                   | 56      
|         | Item 11. Executive Compensation                                                                 | 56      
|         | Item 12. Security Ownership of Certain Beneficial
  Owners and Management                       | 56      
|         | Item 13. Certain Relationships and Related
  Transactions                                       | 56      
|         | Item 14. Principal Accountant Fees and Services                                                 | 56      
|PART IV  | 57                                                                                             
|         | Item 15. Exhibits, Financial Statement Schedules, and
  Reports on Form 8-K                     | 57      

Trademarks

SonoSite®,
the stylized SonoSite logo, iLook®, SonoHeart®, SonoKnowledge®,
SiteStand®, SitePack® and SiteCharge® are all registered trademarks of
SonoSite, Inc.  TITAN, SonoSite
180PLUS, OnSite and The Imaging Physical are trademarks of
SonoSite, Inc. All other brand names, trademarks or service marks referred to
in this report are the property of their owners.

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PART I

Our
disclosure and analysis in this report and in our 2003 Annual Report to
shareholders, of which this report is a part, contain forward-looking
statements. Forward-looking statements provide our current expectations or
forecasts of future events. Forward-looking statements in this report include,
without limitation:

     information
concerning possible or assumed future results of operations, trends in
financial results and business plans, including                those relating to earnings
growth and revenue growth;

     statements
about the level of our costs and operating expenses relative to our revenues,
and about the expected composition of our                revenues;

     statements
about our future capital requirements and the sufficiency of our cash, cash
equivalents, investments and available bank                borrowings to meet these
requirements;

     other
statements about our plans, objectives, expectations and intentions; and

     other
statements that are not historical facts.

Words such
as believe, anticipate, expect and intend may identify forward-looking
statements, but the absence of these words does not necessarily mean that a
statement is not forward-looking. Forward-looking statements are subject to
known and unknown risks and uncertainties, and are based on potentially
inaccurate assumptions that could cause actual results to differ materially
from those expected or implied by the forward-looking statements. You should
not unduly rely on these forward-looking statements, which speak only as of the
date of this report.

We
undertake no obligation to publicly update any forward-looking statement,
whether as a result of new information, future events or otherwise. You are
advised, however, to consult any further disclosures we make on related
subjects in our future quarterly reports on Form 10-Q, current reports on Form
8-K and annual reports on Form 10-K. Also note that we provide a cautionary
discussion of risks, uncertainties and possibly inaccurate assumptions relevant
to our business under the caption Important Factors That May Affect Our
Business, Our Results of Operations and Our Stock Price in this report. These
are risks that could cause our actual results to differ materially from those
anticipated in our forward-looking statements or from our expected or
historical results. Other factors besides the risks, uncertainties and possibly
inaccurate assumptions described in this report could also affect actual
results.

ITEM 1. BUSINESS

Overview

We are a
leading worldwide developer of high-performance, hand-carried ultrasound
imaging systems for use in a variety of clinical applications and settings. Our
proprietary technologies have enabled us to design hand-carried diagnostic
ultrasound systems that combine all-digital, high-resolution imaging with
advanced features and capabilities traditionally found on cart-based ultrasound
systems. We believe that the mobility, high clinical utility, durability, ease
of use and cost-effectiveness of our products are expanding existing markets
and will create new markets for ultrasound imaging by bringing ultrasound out
of the imaging center to other clinical settings and to the point-of-care such
as the patients bedside or the physicians examining table.

The size
and complexity of traditional cart-based ultrasound systems typically require a
physician or highly trained clinician to perform the examination in a
centralized imaging department, such as a hospitals radiology department. By
providing ultrasound at the primary point-of-care, our easy-to-use systems can
eliminate delays associated with the referral process and enable physicians to
use ultrasound more frequently and in a wider variety of clinical settings.
This increased accessibility creates the potential for enhanced patient care
through earlier diagnosis of diseases and conditions.

Our
products are used for imaging in a variety of medical specialties, such as
radiology, obstetrics and gynecology, emergency medicine, surgery, cardiology,
internal medicine and vascular medicine. Our current products include the SonoSite
TITAN system, for general imaging and cardiology applications, the SonoSite
180PLUS system, for
general ultrasound imaging, and the SonoHeart ELITE, specifically configured
for cardiovascular applications. The iLook 25 imaging tool is designed to
provide visual guidance for physicians and nurses while performing vascular
access procedures and the iLook 15 imaging tool is designed to provide visual
imaging of the chest and abdomen for physicians and nurses while performing
other procedures and examinations. Our TITAN, SonoSite 180PLUS and SonoHeart
ELITE products are used together with any of our transducers that are designed
for specific clinical applications. Our iLook

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products each have a single transducer for specific clinical
applications. We first shipped our newest product, the SonoSite TITAN,
in June 2003.

We were
formerly a division of ATL Ultrasound, Inc., or ATL. On April 6, 1998, we were
spun-off as an independent, publicly owned Washington corporation to further
the development and commercialization of high-performance, hand-carried
ultrasound imaging systems. ATL retained no ownership in us following the
spin-off. We entered into a technology transfer and license agreement with ATL
pursuant to which we took ownership of certain ultrasound technology developed
as part of a government grant and also patent rights, which had been
established or were being pursued for that technology.  As part of this agreement, we also entered
into a cross-license whereby we had the exclusive right to use certain ATL
technology existing on April 6, 1998 or developed by ATL during the three-year
period following April 6, 1998 in ultrasound systems weighing 15 pounds or
less, and ATL had the exclusive right to use our technology existing on April
6, 1998 or developed by us during the same three-year period in ultrasound
systems weighing more than 15 pounds. On April 6, 2003, this cross-license
became nonexclusive and, except for the patented technology of each party, now
extends to all ultrasound systems regardless of weight. We sold our first
products in September 1999.

Industry Background

Ultrasound
emerged as a safe and noninvasive method to provide real-time, dynamic images
for medical, soft-tissue imaging purposes in the late 1950s. Initially,
ultrasound was used to assess the general shape, size and structure of internal
soft tissues and organs. As ultrasound technology evolved, leading to improved
functionality and image quality, ultrasound imaging expanded as a diagnostic
tool in radiology, obstetrics and gynecology and cardiology. In recent years,
technological advances have greatly improved the image quality of ultrasound
systems and substantially increased their diagnostic utility, encouraging
growth in ultrasound procedure volume. Our products enable high-performance
ultrasound imaging by traditional users in the clinic and at the point-of-care
and expand hand-carried ultrasound to emergency medicine, surgery and vascular
medicine. Prior to our products availability, however, high quality images
could be produced only by physicians or highly trained clinicians using heavier
and more expensive traditional cart-based ultrasound imaging systems.

Ultrasound
uses low power, high frequency sound waves to provide noninvasive, real-time
images of the bodys soft tissue, organs and blood flow. Ultrasound can be cost
effective by eliminating the need for more invasive and expensive procedures
and allowing for earlier diagnosis of diseases and conditions. To generate an
ultrasound image, a clinician places the transducer on the skin or in a body
cavity near the targeted area. Tissues and bodily fluids reflect the sound
waves emitted by the transducer, which also receives these reflections. Based
on these reflections, the ultrasound systems beamformer measures and organizes
the sound waves and produces an image for visual examination, using digital or
analog signal processing or a combination of the two. Digital signal processing
technology, such as that used by our products, allows an ultrasound system to
obtain and process greater amounts of information. Accordingly, digital
ultrasound systems produce higher resolution images than analog and hybrid
analog/digital ultrasound machines.

Standard
ultrasound imaging produces a two-dimensional image that physicians use to
diagnose and monitor disease states and conditions by analyzing the relative
shading and texture of tissues and organs. This is known as grayscale imaging
or two-dimensional imaging. Color Doppler technology expands standard
ultrasound imaging by generating a colorized image showing the presence,
direction and velocity of blood flow through the body, including the chambers
and valves of the heart.

Our Markets

According
to a study published by Klein Biomedical Consultants, Inc. for 2003, the
worldwide ultrasound market is approximately $3.5 billion.  Radiology or general imaging is the largest
clinical segment and accounts for approximately 40% of this market.  Cardiology and obstetrics/gynecology account
for approximately 25% and 20%, respectively. 
Vascular medicine and other applications account for the remaining
15%.  The U.S. market represents
approximately 35% of the total $3.5 billion worldwide market.  Another important clinical segment
identified as shared services exists within the international market.  This market is comprised of systems
configured to perform both radiology and cardiology examinations and accounts
for approximately 20% of the international market, or an estimated $460
million.  We believe that lower cost,
high-performance hand-carried systems, such as ours, will increasingly be used
to replace higher-priced cart-based ultrasound systems for existing users as
well as to accelerate the proliferation of ultrasound to new users.

In 2003,
for the first time, industry analysts began to separately track the market for
hand-carried ultrasound (HCU). 
According to 2003 estimates from Klein Biomedical Consultants, Inc. and
Frost & Sullivan, SonoSite is recognized as the leader of this new HCU
market that is considered to be the fastest growing segment of the worldwide
market.  HCU products are defined as
approximately laptop size weighing 10 pounds or less.  Worldwide sales of HCU products have

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grown from approximately $10 million in 1999, when SonoSite began
shipping the first HCU products to estimated sales of $160 million in 2003.  In
2003, the United States accounted for over half of these sales, Europe for
approximately 20%, and Japan for 15%. 
Assuming the growth rate for the HCU market internationally is similar
to that estimated by Frost & Sullivan for the U.S. in their 2003 published
study, we expect the HCU worldwide market to reach $550 million by 2010.  Although some of this growth may come at the
expense of cart-based systems, we believe the majority of the growth will come
from new clinical applications and new users of ultrasound due to the mobility
and ease-of-use of HCU products.  HCU is
making possible new clinical uses of ultrasound in settings such as the
physicians office, the emergency room and the surgical suite where the size,
weight and complexity of cart-based systems made them difficult to use.

We see our
clinical market opportunities in three major sectors  mobile diagnostic,
visual procedure assist and the Imaging Physical.  The mobile diagnostic market accounted for approximately 80% of
the HCU market in 2003 and includes the use of HCU for diagnostic examinations
in radiology, cardiology, obstetrics/gynecology and vascular applications.  It also includes emerging applications such
as emergency medicine and surgery.  Visual
procedures accounted for approximately 20% of this market and consist of using
ultrasound to guide medical interventions such as biopsies or line insertions
in the operating room, critical care unit or physicians office.  The third category, the Imaging Physical, is
a market that is beginning to evolve. 
The Imaging Physical involves the use of ultrasound in the routine
physical examination to screen for the early detection of disease.  With an estimated 225,000 primary care
physicians in the U.S., we believe that the imaging physical sector represents
a significant additional market opportunity for SonoSite.

Our Strategy

Our goal is
to lead in the design, development and commercialization of high-performance,
hand-carried ultrasound imaging systems. Our strategy to reach that goal
consists of the following key elements:

     Build upon and maintain product and technology
leadership. We believe our products represent the most advanced
technology in high-performance, hand-carried ultrasound systems. We are
committed to continuing to build upon this technological advantage by
continuing to enhance our existing products and to create new ones. As of
December 31, 2003, we employed over 50 people in research and development.
Since our inception, we have introduced two generations of ASIC, or application
specific integrated circuit, technology, which have improved performance and
expanded diagnostic capabilities. We are working on our third generation of
ASIC technology, which will allow us to provide products customized for
specific clinical applications.

     Maximize the productivity of our direct sales force in
the U.S. and key international markets. As of December 31, 2003, we
employed approximately 60 direct sales representatives in the United States,
United Kingdom, France, Germany and Spain. We expect to grow this team over the
next 12 months and recently announced plans to open subsidiaries in Japan,
Australia and Canada. We also employ clinical application specialists who, by
assuming responsibility for product demonstrations and customer support, have
enabled our sales representatives to improve their efficiency. To further
enhance the productivity of our direct sales force, we will continue to:

 invest in training and educating our sales
force;
                  expand our direct sales and clinical
application specialist staff; and
                  expand our corporate account relationships.

     Improve and expand our sales distribution channels.
Outside of our core markets, we have also sold products to many other clinical
segments and countries. We believe that these other markets offer opportunity
for growth but will require enhancements to our sales distribution channels.
Specifically, we intend to expand our tele-sales capability, enter into new
third party distributor arrangements and explore strategic partnerships to
develop new markets within ultrasound or with ultrasound-dependent
technologies. We will also explore establishing sales offices in other key
international markets.

     Expand into new clinical markets. We
believe that the mobility, high quality and cost effectiveness of our products
will result in the creation of new clinical markets for us. We are bringing ultrasound
out of the imaging center directly to the patient at the primary point-of-care,
such as the emergency room, the physicians office and other nontraditional
ultrasound settings. We anticipate the development of an imaging
physicalthe use of ultrasound imaging in routine physical examinations.
We believe that these new users and new applications of ultrasound offer us a
significant potential for growth.

     Raise market awareness of the SonoSite platform and
brand name. We will continue to invest to build the SonoSite name
into a global brand synonymous with high-performance, hand-carried ultrasound
imaging. Our products are relative newcomers to the ultrasound market, the
first having been introduced in September 1999. To raise market awareness of
our brand and our technology, we intend to:

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 focus marketing efforts by clinical segment;
                  implement targeted local marketing efforts;
                  market to potential new users by promoting innovative
uses and clinical applications of ultrasound; and
                  expand training and education offerings.

Our Products

We offer
five types of hand-carried ultrasound imaging systems: the SonoSite TITAN, the
180PLUS, the SonoHeart ELITE, the iLook 15 and the iLook 25. All SonoSite
ultrasound systems consist of a digital beamformer, integrated color display,
control panel, including navigational trackpad (TITAN), trackball (180PLUS and
ELITE) or D-controller (iLook), alphanumeric keyboard and measurements. Each of
the five SonoSite systems supports image storage, image documentation to video
printer or VCR and direct personal computer connectivity. The following is a
summary of our five ultrasound imaging products and their major features:

| | SonoSite TITAN:   The
  TITAN system, first shipped in June 2003, is our newest product and
  represents our second generation of digital technology. The TITAN system
  combines the high performance of cart-based systems with the speed,
  flexibility and durability of mobile ultrasound devices. The TITAN can be
  used for stationary applications in its Mobile Docking Station (MDS), which
  supports connectivity to hospital PACS and HIS systems, multiple transducer
  connections and on-board documentation devices, yet the modular design of the
  TITAN system enables it to be taken out of the MDS to rapidly deliver imaging
  at the point-of-care. The modularity of the TITAN system enables the user to
  easily and economically expand or upgrade to new features through a standard
  flashcard or interchangeable hardware. The following features are offered:
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

| |  | SonoSite 180PLUS.    The
  SonoSite 180PLUS is a point-of-care ultrasound system for general diagnostic
  imaging and offers the following major features:
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                          

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|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | M-mode
        imaging, providing a display of depth versus time. M-mode is particularly
        useful for evaluation of fast-moving structures, such as valves within
        the heart;                                                                                                                                                                                                                                
|--------------------------------------------------------------------------------------------------------------------------------------------------- | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | pulsed
        wave, or PW, Doppler imaging. PW Doppler imaging uses short, pulsing bursts
        of ultrasound waves to provide a quantitative assessment of the velocity
        of blood flow. The name of the technology refers to the Doppler effect,
        which is an apparent change in the frequency of the reflected ultrasound
        wave due to the relative motion between the reflector and transducer;
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | color
        power Doppler and directional color power Doppler, allowing two-dimensional
        visualization of blood flow patterns;                                                                                                                                                                                                                                                                                   
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | ability
        to store up to 119 images for off-line printing and review;                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | image
        documentation capabilities, including connection to printers or VCRs and
        downloading to personal computers;                                                                                                                                                                                                                                                                                         
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | tissue
        harmonic imaging, or THI, a signal processing technique providing enhanced
        image quality by using high frequency information to enhance image resolution;
        and                                                                                                                                                                                                                              
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | basic
        electrocardiogram, or ECG, capability. When visualizing the heart, it
        is often useful to visualize basic relationships between cardiac motion
        and cardiac electrical activity. ECG provides this capability.                                                                                                                                                                                
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |  | SonoHeart
        ELITE.    The SonoHeart ELITE is a point-of-care
        ultrasound system intended for use by cardiologists and other healthcare
        providers in the cardiology market. The SonoHeart ELITE has all the product
        features of the SonoSite 180PLUS, as well as the following:
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                            |                                                                                                                 | continuous
        wave, or CW, Doppler imaging. CW Doppler imaging uses continuous, reflected
        ultrasound waves to provide a quantitative assessment of the velocity
        of blood flow. CW Doppler, because it relies on a continuous stream of
        information, enables assessments of blood flow moving at speeds higher
        than PW Doppler is capable of assessing.                               
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |  | ILook
        15.    The iLook 15, with its fixed curved array
        transducer, provides imaging for focused abdominal and cardiac applications.                                                                                                                                                        
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |  | ILook
        25.    The iLook 25, with its fixed linear transducer,
        provides superb image quality of a patients vessels to aid in vascular
        access applications.                                                                                                                          
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             | Both
        of these iLook products, which each weigh approximately three pounds,
        offer the following:
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|The
        TITAN, 180PLUS and SonoHeart ELITE utilize seven transducers which are
        designed for use in the following clinical applications:
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                 |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                    |   |                                                                                                                                                                                                                                                                                                             |                                                                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                           

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| |  |  | We also
  offer the following related accessories and educational programs:
| |  |  | ---------------------------------------------------------------------------
| |  |  |                                                                            
| |  |  |                                                                           
| |  |  |                                                                            
| |  |  |                                                                           

Sales
and Marketing

Initially,
we sold and marketed our products through third-party medical product
distributors worldwide. Currently, we have moved to a direct sales model in the
United States, the United Kingdom, France, Germany and Spain. In 2004, we plan
to establish direct sales operations in Japan, Canada, and Australia. We rely
on third-party distributors in those markets where we do not have a direct
sales staff.

In the
United States, we have complemented our direct sales efforts by entering into
group purchasing agreements with major healthcare group purchasing
organizations, or GPOs. Typically, a GPO negotiates with medical suppliers,
such as us, on behalf of the GPOs member healthcare facilities, providing such
members with uniform pricing and terms and conditions. In exchange, the GPO
identifies us as a preferred supplier for its members. Member facilities
participating in the GPOs purchasing program can consist of hospitals, medical
group practices, nursing homes, surgery centers, managed care organizations,
long term care facilities, clinics and integrated delivery networks. Currently,
we have GPO supply agreements with AmeriNet, Inc., Novation, LLC, Premier,
Inc., Broadlane, Inc. (includes Kaiser Permanente, Tenet Healthcare and others)
and Consorta, Inc.

In the
United Kingdom, we have a supply agreement with the Purchasing and Supply
Agency of the National Health Service, or NHS, which contracts on a national
basis for products and services purchased by the NHS.

We derived
approximately $52.4 million, or 62%, of our revenue from domestic sales in
2003. This compares to approximately $42.6 million, or 58%, and approximately
$23.8 million, or 52%, in 2002 and 2001.

We derived
approximately $32.4 million, or 38%, of our revenue from international sales in
2003. This compares to approximately $30.4 million, or 42%, and approximately
$21.9 million, or 48%, in 2002 and 2001. Japan accounted for approximately $1.6
million, or 1.9%, of our revenue in 2003. This compares to approximately $7.5
million, or 10%, and approximately $7.8 million, or 17%, in 2002 and 2001. No
single customer or distributor accounted for more than 10% of our revenue in 2003. We
attribute revenue to a foreign country based on the location to which we ship
our products. However, products sold to the U.S. government but deployed in a
foreign country are attributed to domestic revenue. For information regarding
revenues and long-lived assets by geography, please refer to note 13 to our consolidated financial
statements.

Our
revenues from international sales may be adversely affected by a number of
risks, including competition, currency rate fluctuations, reduced protection
for intellectual property rights and longer receivables collection periods. Our
revenues from international sales may also be adversely affected by the cost or
difficulty of localizing products for foreign markets and complying with export
laws, including license requirements, trade restrictions and tariff increases.

We have one
reporting segment.  For information
regarding revenues from external customers, profits and total assets for each
of our last three fiscal years, please refer to our consolidated financial statements.

Patents and Intellectual Property Rights

We rely on
a combination of patent, copyright, trademark and trade secret laws and other
agreements with employees and third parties to establish and protect our
proprietary rights. We require our officers, employees and consultants to enter
into standard agreements containing provisions requiring confidentiality of
proprietary information and assignment to us of all inventions made during the
course of their employment or consulting relationship. We also seek to enter
into nondisclosure agreements with our commercial counterparties and limit
access to, and distribution of, our proprietary information.

7

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We are
committed to developing and protecting our intellectual property and, where
appropriate, file patent applications to protect our technology. We hold 17
U.S. patents relating to various aspects of our products, including the weight
of digital beamformers, beamforming capabilities, digital conversion circuitry,
transceiver circuitry and circuit integration. We hold two foreign patents
relating to our products, and we currently have numerous patent applications
pending both in the U.S. and abroad. We consider all of our patents to be
significant to our business.

We license
ultrasound technology from our former parent, ATL, under a Technology Transfer
and License Agreement executed at the time of our spin-off as a public company.
Under that agreement, we took ownership of certain ultrasound technology
developed as part of a government grant and also patent rights, which had been
established or were being pursued for that technology. As part of this
agreement, we also entered into a cross-license whereby we had the exclusive
right to use certain ATL technology existing on April 6, 1998 or developed by
ATL during the three-year period following April 6, 1998 in ultrasound systems
weighing 15 pounds or less, and ATL had the exclusive right to use our
technology existing on April 6, 1998 or developed by us during the same
three-year period in ultrasound systems weighing more than 15 pounds. On April
6, 2003, this cross-license became nonexclusive and, except for the patented
technology of each party, now extends to all ultrasound systems regardless of
weight.

We hold a
number of registered and unregistered trademarks, service names and domain
names that are used in our business in the United States and overseas.
Generally, federally registered trademarks offer protection for renewable terms
of 10 years so long as the mark continues to be used in commerce.

On
July 24, 2001, Neutrino Development Corporation filed a complaint against us in
U.S. District Court, Southern District of Texas, Houston Division, alleging
infringement of U.S. Patent 6,221,021, or the 021 patent, by SonoSite as a
result of our use, sale and manufacture of the SonoSite 180, SonoSite 180 PLUS,
SonoHeart and SonoHeart PLUS devices. The complaint asserts claims for
preliminary and permanent injunctive relief enjoining all alleged acts of
infringement, compensatory and enhanced damages, attorneys fees and costs, and
pre- and post-judgment interest. On August 14, 2001, we filed an answer
asserting affirmative defenses of non-infringement and patent invalidity, and
included a counterclaim seeking a declaratory judgment of non-infringement and
invalidity regarding Neutrinos patent. On October 4, 2001, the court denied a
request by Neutrino for preliminary injunctive relief to prevent us from
manufacturing and selling our products pending the ultimate disposition of the
litigation. On February 20, 2002, in what is known as a Markman hearing, the
parties presented their arguments regarding the proper construction of
Neutrinos patent claims.

On
August 20, 2003, the U.S. District Court in the Southern District of Texas
issued a decision interpreting certain terms used in the 021 patent. This
decision does not discuss whether the patent is valid or whether the patent
would apply to any of our products. In the order, the court, in resolving
disputed terms in the Markman hearing, adopted our construction of the term a
portable body designed to be hand held, and adopted Neutrinos construction of
the terms the moveably connected transducer mounting assembly and ultrasound
emitter. The court denied our motion for summary judgment.  We subsequently filed a new summary judgment
motion using the courts construction of the claim language that the 021
patent is invalid based on prior art. Neutrino has filed a summary judgment
motion based on its allegations of infringement.

We
also have asked the Texas court to stay proceedings in Neutrinos suit filed in
the Middle District of Florida on August 19, 2003 against a former SonoSite
distributor alleging that the sale of SonoSites products by such distributor
infringes the 021 patent, and to enjoin Neutrino from filing similar suits
against other sellers of SonoSite products. Neutrino had previously filed such
a suit in the Middle District of Tennessee against another medical device
distributor for selling a SonoSite product. That Tennessee case has been
dismissed based on a final judgment and permanent injunction filed a month
after the case was filed. The Tennessee judgment has no effect on the Texas
proceedings. In the Florida action, we have filed a motion to stay the
proceedings in the Florida court pending a final resolution of the patent suit
in Texas. We have also filed a motion to strike certain counts of Neutrinos
complaint.

We
believe that we have good and sufficient defenses to the claims of patent
infringement asserted against us by Neutrino and we are vigorously defending
ourselves in these matters. If we are not successful in our defense of these
claims, we could be forced to modify or discontinue selling our products or may
enter into royalty or licensing agreements, which may not be available on terms
acceptable to us, if at all, and which could adversely affect our financial
condition, results of operations and cash flow. Sales of the allegedly infringing products represented the majority
of our revenue for the years ended December 31, 2003, 2002 and 2001.

We do not
consider a negative litigation outcome to be probable and have not accrued any
amounts for potential losses related to these proceedings. Because of
uncertainties related to both the amount and range of loss on the pending
litigation, management is unable to make a reasonable estimate of the liability
that could result from an unfavorable outcome. As additional information
becomes available, we will assess the potential liability related to its
pending

8

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litigation. We will record accruals for losses if and when we determine
the negative outcome of such matters to be probable and reasonably estimable.
Our estimates regarding such losses could differ from actual results. Revisions
in our estimates of the potential liability could materially impact our results
of operations, financial position and cash flow.

Competition

We
currently face competition from companies that manufacture cart-based and
portable ultrasound systems. The dominant competitors in this industry are GE
Medical Systems, a unit of General Electric Company, Siemens AG and Philips
Medical Systems, a unit of Koninklijke Philips Electronics, N.V. that acquired
two other competitors, Agilent Healthcare Solutions Group and ATL, our former
parent company. In addition, as the market for high-performance, hand-carried
ultrasound systems develops, we expect competition to increase as potential and
existing competitors enter the hand-carried market or modify their existing
products to more closely approximate the combined portability, quality,
performance and cost of our products. Our current competitors in the
point-of-care market include GE Medical Systems, Agilent/Philips Medical
Systems, Biosound Esaote, Inc., Medison America Inc., a subsidiary of Medison
Company, Ltd., and Terason, a division of TeraTech Corporation. Other potential
entrants to the point-of-care market include ZONARE Medical Systems, Inc.
(formerly Novasonics, Inc.).

Research and Development and Technology

We
currently employ over 50 people in research and development. In 2003, 2002 and
2001, expenses attributable to research and development for our business
totaled $11.2 million, $12.1 million and $12.7 million. We believe our products
represent the most advanced technology in high-performance, hand-carried
ultrasound imaging systems. We believe our technology gives us a competitive
advantage, and we are committed to maintaining this advantage by continuing to
enhance our existing products and create new ones. Accordingly, we intend to
maintain our research and development expenses at levels we believe necessary
to maintain this competitive advantage.

Manufacturing

We
manufacture our products in our facility in Bothell, Washington. We depend on
suppliers, including some single-source suppliers, to provide highly
specialized parts, such as custom-designed integrated circuits, cable
assemblies and transducer components. We also depend on single-source suppliers
to provide other components such as image displays, batteries, capacitors and
cables. We maintain inventories of components to meet near term production
requirements. While our suppliers have generally produced our components with
acceptable quality, quantity and cost in the past, they have experienced
periodic problems that have caused us delays in production. To date, these
problems have not resulted in lost sales or lower demand.

Governmental Regulation

The
manufacture and sale of our products are subject to extensive regulation by
numerous governmental authorities, principally the U.S. Food and Drug
Administration, or FDA, as well as several other state and foreign agencies.
The FDA requires that we obtain a pre-market notification clearance under
Section 510(k) of the Federal Food, Drug & Cosmetic Act prior to
introducing our products to the market. By granting 510(k) clearance, the FDA
indicates agreement with an applicants determination that the product for
which clearance has been sought is substantially equivalent to medical devices
that were on the market prior to 1976 or have subsequently received clearance.
The process of obtaining 510(k) clearance typically takes approximately two to
three months. To date, all of our products have received 510(k) clearance. We
believe that our future generation hand-carried ultrasound systems will also
require only 510(k) clearance. Foreign regulatory agencies also require similar
pre-market clearance or registration before our products can be marketed or
offered for sale in their countries. Such foreign regulatory approvals may take
up to 6-9 months to obtain. Any delays, or failures, in obtaining such
clearances may result in lost sales and revenue.

In
August 2001, the FDA classified as a class II field action a May 2000 software
upgrade we issued to correct an error in an algorithm contained in one
of our products. In September
2000, we provided purchasers of our products with a software upgrade to correct
this error, and at the FDAs request, we recently sent two additional letters
to these purchasers to provide them with a final opportunity to upgrade the
software at no charge.  We expect that
when this action is completed, we will receive final written closure from the
FDA on this matter.

Our products and our product components are also subject to various
domestic and foreign manufacturing standards and electrical safety and emission
standards, such as those of Underwriters Laboratories and the ISO 9001
standards, described below. We and our suppliers are subject to FDA regulations
governing registration of manufacturing facilities and compliance with the
FDAs Quality System Regulations, or QSR. The FDA performs periodic on-site
inspections to determine compliance with such regulations. The FDA inspected
our manufacturing facility in September 2003. In

9

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addition, the British Standards Institution (BSI) performs periodic
management systems assessments of our manufacturing processes. SonoSite also
complied with the new Canadian Medical Device Regulation requirements for an
independent audit in December 2002. We met the requirements defined in the
Canadian Medical Device Conformity Assessment Scheme (CMDCAS) and BSI has
issued a certification to these requirements. These inspections resulted in our
submitting and implementing corrective action responses, and we believe those responses
have been accepted by those agencies. We believe that we are currently in
compliance with applicable QSR.

Our
regulatory compliance programs encompass verification of our compliance with
international standards for medical device design, manufacture, installation
and servicing, known as ISO 9001:1994, ISO 13485:1996 and EN 46001:1996
standards. On September 13, 1999, we received Conformite Europeenne, or CE,
Marking approval, signifying European Certification to the international
quality system standards and to the European Medical Device Directive, which
encompass ISO 9001 standards. The Certification allows us to distribute the
SonoSite 180, 180PLUS, SonoHeart, SonoHeart PLUS, SonoHeart ELITE, iLook 15,
iLook 25 and TITAN systems to the 19 countries of the European Union and the
European Free Trade Association. The FDA harmonized in June 1998 its QSR for
the United States with ISO 9001 and EN 46001 standards.

Compliance
with the regulations of agencies, including the Environmental Protection Agency
and the Occupational Safety and Health Administration, may require us to incur
substantial costs and may delay or prevent the introduction of new or improved
products. If we fail to comply with the laws and regulations pertaining to our
business, we may be subject to fines, sanctions, including the temporary or
permanent suspension of operations, product field actions, criminal prosecution
and marketing restrictions.  Our
third-party medical device manufacturers may also be subject to the same
sanctions if they fail to comply with the laws and regulations, and, as a
result, may fail to supply us with components required to manufacture our
products.

Our current
products do not require any U.S. export control licenses in order to be sold
overseas.

Service and Warranty

Our typical
warranty period is one year and is included with the original purchase of our
ultrasound imaging systems.  The
warranty liability is summarized as follows (in thousands):

|                               |  | Balance
        at
        beginning of
        year |   | Charged to
  cost of revenue |  | Applied to 
  liability |  | Balance at 
        end of year |    
|------------------------------ |  | ---------------------------------------------------- | - | ---------------------------- |  | ----------------------- |  | ------------------------------- | ---
|                               |  |                                                      |   |                              |  |                         |  |                                 |    
|Year ended
  December 31, 2003 |  |                                                      | $ | 331                          |  |                         |  | $                               | 351
|Year ended
  December 31, 2002 |  |                                                      | $ | 281                          |  |                         |  | $                               | 300

Employees

As of
December 31, 2003, we had approximately 340 employees, of which approximately
16% were engaged in research and product development, 23% in manufacturing, 49%
in sales and marketing activities and the remaining 12% in administrative
capacities, including executive, finance, legal, human resources, regulatory
and information services and technology. Of these, approximately 290 are U.S.
employees. There has never been a work stoppage and no employees are covered by
collective bargaining agreements. We believe our employee relations are good.

Available Information

We were
incorporated in the state of Washington in July 1986 and were spun off from ATL
as an independent, publicly owned company in April 1998. We make available,
free of charge, on our website copies of our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, or Exchange Act, as soon as reasonably
practicable after filing or furnishing the information to the Securities and
Exchange Commission. The Internet address for the information is
http://investor.sonosite.com/edgar.cfm. Our Code of Conduct, which is our written
Code of Ethics under Section 406 of the Sarbanes-Oxley Act of 2002, is also
available on our website.

Important Factors That May Affect Our
Business, Our Results of Operations and Our Stock Price

If our products, including our new TITAN modular ultrasound
system, do not gain market acceptance, we will fail to generate sufficient
revenue to maintain our business.

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The market
for high-performance, hand-carried ultrasound systems is relatively new and
largely undeveloped.    We seek to sell our
products to current users of ultrasound, as well as to physicians and other
healthcare providers who do not currently use ultrasound.  The success of our products depends on their
acceptance by the medical community, patients and third-party payers as medically
useful, safe and cost-effective.

In June
2003, we began shipping to customers our newest product, the SonoSite TITAN
ultrasound system.  Sales of TITAN
accounted for approximately 28% of our revenue for the year ended December 31,
2003.  The TITAN system has a modular
design allowing both stationary and mobile usage and is based on the next
generation of our proprietary ASIC, or application specific integrated circuit,
technology.  Along with the
point-of-care market, we have positioned the TITAN system to compete in the
traditional stationary ultrasound cart market.

Users of
stationary ultrasound carts may not accept the TITAN system, which could
discourage widespread new users and uses for the TITAN.  Our new or existing customers may not accept
the TITAN due to pricing and functionality differences.  If demand for the TITAN differs from our
projections, we may experience excess inventory levels or inventory shortages
and may be unable to generate sufficient revenue to grow our business.  If we are unable to gain market acceptance
for our products generally, we will fail to generate sufficient revenue to
maintain our business.

If we are unable to compete effectively, we will fail to
generate sufficient revenue to maintain our business.

We
currently face competition from companies that manufacture cart-based and
portable ultrasound systems. The dominant competitors in this industry are GE
Medical Systems, a unit of General Electric Company, Siemens AG and Philips
Medical Systems, a unit of Koninklijke Philips Electronics, N.V. that owns two
other competitors, Agilent Healthcare Solutions Group and ATL, our former
parent company. These competitors are very large, global organizations and have
the following advantages over us:

| |  |  | greater
  financial and infrastructure resources;                         
| |  | - | --------------------------------------------------------------------------
| |  |  | larger
  research and development staffs;                                 
| |  |  | greater
  experience in product manufacturing, marketing and distribution;
| |  |  | greater
  brand name recognition; and                                     
| |  |  | long-standing
  relationships with many of our potential customers.       

These
manufacturers of cart-based and portable ultrasound systems could use their
greater resources to increase and withstand competition through various means,
including price and payment terms, product quality, market penetration,
employee compensation, hospital systems integration and complementary services
such as warranty protection, maintenance and product training. Existing product
supply relationships between these companies and our potential customers could
discourage widespread adoption of our products due to brand loyalty or
preferred customer discounts. Competition from these companies for employees
with experience in the primary point-of-care market could result in higher
turnover of our employees. If we are unable to respond to competitive pressures
from the cart-based and portable ultrasound markets, we could experience
delayed or reduced market acceptance of our products, higher expenses and lower
revenue.

In
addition, as the market for high-performance, hand-carried ultrasound systems
develops, we expect competition to increase as potential and existing
competitors enter the point-of-care market or modify their existing products to
more closely approximate the combined portability, quality, performance and
cost of our products. Our current competitors in the point-of-care market
include GE Medical Systems, Agilent/Philips Medical Systems, Biosound Esaote,
Inc., Medison America Inc., a subsidiary of Medison Company, Ltd., and Terason,
a division of TeraTech Corporation. Other potential entrants to the
point-of-care market include ZONARE Medical Systems, Inc. (formerly Novasonics,
Inc.). These competitors may develop highly portable or point-of-care
ultrasound systems that offer the same or greater reliability and quality,
perform greater or more useful functions, or are more cost-effective than our
products. Some of these competitors may also be able to use their marketing
resources to gain a competitive advantage by more effectively building brand
awareness of their products. If we are unable to compete effectively with new
entrants to the high-performance, hand-carried ultrasound market, we will be
unable to generate sufficient revenue to maintain our business.

If our competitors develop and market medical
imaging devices that render our products obsolete or noncompetitive, we will be
unable to compete.

The life
cycles of our products are difficult to estimate. Our products could become
obsolete or unmarketable if:

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| |  |  | our
  competitors introduce ultrasound systems that are superior to ours;
| |  | - | -------------------------------------------------------------------------
| |  |  | other
  products using new technologies emerge; or                       
| |  |  | industry
  standards exceed our products capabilities.                  

If
we fail to enhance our existing products or develop and market new products,
our products will become obsolete and we will be unable to compete.

Changes in the health
care industry could result in a reduction in the size of the market for our
products or may require us to decrease the selling price for our products, each
of which could have a negative impact on our financial performance.

Trends
toward managed care, health care cost containment, and other changes in
government and private sector initiatives in the United States and other
countries in which we do business are placing increased emphasis on the
delivery of more cost-effective medical therapies, which could adversely affect
the sale and/or the prices of our products. For example:

| |  |  | Major
  third-party payers of hospital and pre-hospital services, including Medicare,
  Medicaid and private health care insurers, have substantially revised their
  payment methodologies during the last few years which has resulted in
  stricter standards for reimbursement of hospital and pre-hospital charges for
  certain medical procedures;
| |  | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |   |                                                                                                                                                                                                                                                                                                                                                          
| |  |  | Numerous
  legislative proposals have been considered that would result in major reforms
  in the U.S. health care system that could have an adverse effect on our
  business;                                                                                                                                                                           
| |  |   |                                                                                                                                                                                                                                                                                                                                                          
| |  |  | There has
  been a consolidation among health care facilities and purchasers of medical
  devices in the United States who prefer to limit the number of suppliers from
  whom they purchase medical products, and these entities may decide to stop
  purchasing our products or demand discounts on our prices;                                        
| |  |   |                                                                                                                                                                                                                                                                                                                                                          
| |  |  | There is
  economic pressure to contain health care costs in international markets; and                                                                                                                                                                                                                                                                  
| |  |   |                                                                                                                                                                                                                                                                                                                                                          
| |  |  | There are
  proposed and existing laws and regulations in domestic and international
  markets regulating pricing and profitability of companies in the health care
  industry.                                                                                                                                                                          

These
trends could lead to pressure to reduce prices for our products and could cause
a decrease in the size of the market or a potential increase in competition
that could adversely affect our levels of revenue and profitability of sales,
which could have a material adverse effect on our business.

If healthcare
reimbursement practices or reform restricts coverage available to our customers
for the use of our products, we may experience limited market acceptance of our
products.

Market
acceptance of our products depends in part on the extent to which our customers
receive reimbursement for the use of our products from third party payers such
as Medicare, Medicaid and private health insurers. Our customers generally have
received reimbursement for ultrasound procedures performed using our products
consistent with reimbursement criteria applicable to ultrasound procedures
generally. The continuing efforts of third party payers to contain or reduce
the costs of healthcare through various means may, however, result in
unfavorable reimbursement policies or payments that would limit market
acceptance of our products.

Reimbursement
policy has the potential to influence the adoption of our products in several
ways.  Payment for specific ultrasound
procedures could be greatly reduced or eliminated all together.  If that procedure was critical to the
acceptance of our products in a given market segment, such a policy change
could reduce the demand for our products in that particular market.

Payment for
ultrasound procedures when performed by specific types of health care providers
could be restricted.  This too could
depress demand in a particular market segment. 
Such a policy change as well as the one previously mentioned would
affect all ultrasound manufacturers attempting to do business in an affected
market segment.

Alternatively,
specific types of ultrasound products could be targeted for exclusion from
coverage under the existing ultrasound codes. 
As an example, in the first half of 2003, six Medicare carriers adopted
policies that precluded Part B Medicare reimbursement for ultrasound procedures
conducted with hand-carried ultrasound units described as lightweight
ultrasound machines with Doppler capability. The notices restricted coverage
for devices that allow only a

12

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limited view of structures. These policies applied to Medicare
reimbursement of health care providers in 22 states, including California and
upstate New York.

In
all states, these policies have been revised to allow payment for studies
performed with hand-carried ultrasound units. The new policies, recognizing
that many hand-carried ultrasound systems have functionality equal to that of
cart-based ultrasound systems, define the requirements of medical necessity,
completeness and documentation required of all ultrasound services, regardless
of the equipment that is used to supply the service. In all states, there are
no longer any billing restrictions in place for hand-carried ultrasound that do
not also exist for cart-based ultrasound and that were not in place prior to
the adoption of these original policies.

Additionally,
to the extent that the use of future products that SonoSite may develop is not
described by existing CPT codes, there is a risk that reimbursement for studies
performed with such products could not be attained at all or within a
reasonable timeframe.

International
markets too are in the process of responding to increases in health care
spending by adjusting their reimbursement policies.  These responses, like those in the United States, could similarly
affect reimbursement for our products and thereby reduce demand for our
products.  As an example, in Germany,
recent health care reform introduced a Diagnosis Related Group system that
changes health care reimbursements from a per day reimbursement to a per
case reimbursement. This change caused hospital administrators to delay
capital equipment purchases as they evaluate the impact of the new system.
Although revenue from Germany increased in 2003 compared to 2002, this delay
negatively impacted our actual results against our sales expectations in
Germany in 2003. If similar changes in healthcare reimbursement are adopted in
other countries, they could affect our ability to successfully market our
products.

If traditional
providers of ultrasound examinations discourage potential new users from
adopting our products, we could experience limited demand for our products.

The size
and complexity of traditional cart-based ultrasound systems typically require a
physician or highly trained clinician to perform the examination in a
centralized imaging department, such as a hospitals radiology department.
Although our products are currently used by radiologists, our products also
enable the delivery of ultrasound examinations at the primary point of care by
the examining physician or healthcare provider. Radiologists and other
ultrasound specialists have a professional and financial interest in
maintaining traditional ultrasound practices. If these traditional providers of
ultrasound examinations discourage other healthcare providers from adopting our
products, we could experience limited demand for our products.

If the training and
education necessary to conduct ultrasound examinations is not adequate or not
readily available, this could discourage new users from adopting our products,
which could affect demand for our products.

We seek to
sell our products to customers already experienced in ultrasound procedures, as
well as to physicians and other healthcare providers who do not currently use
ultrasound imaging systems or administer ultrasound examinations. Although
customers who are experienced in ultrasound procedures will need little, if
any, specialized training to use our products, any new users of ultrasound will
require training and education to properly administer ultrasound examinations.
If these potential customers are unable or unwilling to be trained due to cost,
time constraints, unavailability of courses or other reasons, we could
experience limited demand for our products.

If our suppliers,
including our single-source suppliers, fail to supply us with the components
that we need to manufacture our products on a timely basis, we could experience
production delays, cost increases and lost sales.

We depend
on suppliers, including some single-source suppliers, to provide highly
specialized parts, such as custom-designed integrated circuits, cable assemblies
and transducer components. We also depend on single-source suppliers to provide
other components, such as image displays, batteries, capacitors and cables. We
do not maintain significant inventories of components, and may experience an
interruption of supply if a supplier is unable or unwilling to meet our time,
quantity and quality requirements. There are relatively few alternative sources
of supply for some of these components. An increase in demand for some parts by
other companies could also interrupt our supply of components. We have in the
past experienced supply problems in timeliness and quality, but to date these
problems have not resulted in lost sales or lower demand. Nevertheless, if we
experience an interruption of supply or are required to switch suppliers, the
manufacture and delivery of our products could be interrupted, our
manufacturing costs could substantially increase and we could lose substantial
amounts of product sales.

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In March
2003, one of our component suppliers, Philips Semiconductor, or Philips,
informed us that, commencing in September 2003, it would discontinue production
of our integrated circuit chips using 0.35-micron technology. We have designed
and implemented a new chip using 0.2-micron technology that will continue to be
produced by Philips to replace all but one of the discontinued chips. We expect
to design and implement an additional new chip to replace the remaining
0.35-micron chip by early 2005. In the second quarter of 2003, we entered into a
purchase commitment totaling approximately $3.6 million for supplies of
0.35-micron chips from Philips for our anticipated manufacturing needs until
new chips have been incorporated in all of our products. We pay for these chips
at the time deliveries are made to us. As of December 31, 2003, our remaining
purchase commitment was approximately $3.4 million. On December 31, 2004, we
are required to take possession of, and pay for, the balance of the undelivered
chips. Demand for our products, however, may exceed our forecasts, in which
case we would require additional 0.35-micron chips to manufacture additional
products. Conversely, if demand for our products falls short of our forecasts,
we may experience excess inventory of 0.35-micron chips. If our actual demand
for these chips varies significantly from our forecasted demand, we may
experience delays in manufacturing, lost sales, a write-down of inventory or a
deterioration in gross margin.

In
addition, we have transferred the production of our main circuit board to one
of the worlds largest electronic manufacturing services suppliers who will
produce the board in their Thailand manufacturing facility.  We expect this transfer to be completed by
the end of the first quarter of 2004 with production deliveries beginning in
the following quarter.  If, as a result
of this transfer, we experience delays in the receipt of this component, a
deterioration in product yields or an increase in costs, we may experience
delays in manufacturing, lost sales or a deterioration in gross margin.

If our suppliers or
we fail to comply with U.S. and foreign governmental regulations applicable to
our products and manufacturing practices, we could experience product
introduction delays, production delays, cost increases and lost sales.

Our
products, our manufacturing activities and the manufacturing activities of our
third-party medical device manufacturers are subject to extensive regulation by
a number of governmental agencies, including the FDA and comparable
international agencies. Our third-party manufacturers and we are or will be
required to:

| |  |  | obtain prior
  clearance or approval from these agencies before we can market and sell our
  products;
| |  | - | ------------------------------------------------------------------------------------------------------
| |  |   |                                                                                                       
| |  |  | undergo
  rigorous inspections by domestic and international agencies; and                            
| |  |   |                                                                                                       
| |  |  | satisfy
  content requirements for all of our sales and promotional materials.                        

The
manufacture and sale of our products are subject to extensive regulation by
numerous governmental authorities, principally the FDA, as well as several
other state and foreign agencies. The FDA requires that we obtain a pre-market
notification clearance under Section 510(k) of the Federal Food, Drug &
Cosmetic Act prior to introducing our products to the market. By granting
510(k) clearance, the FDA indicates agreement with an applicants determination
that the product for which clearance has been sought is substantially
equivalent to medical devices that were on the market prior to 1976 or have
subsequently received clearance. The process of obtaining 510(k) clearance
typically takes approximately two to three months. To date, all of our products
have received 510(k) clearance.  In
addition, foreign regulatory agencies also require similar pre-market clearance
or registration before our products can be marketed or offered for sale in
their countries. Such foreign
regulatory approvals may take up to 6-9 months to obtain. Any delays, or
failures, in obtaining such clearances may result in lost sales.

In
addition, the FDA requires us and our key medical device suppliers to
demonstrate and maintain compliance with the FDAs Quality System Regulation,
or QSR, which covers the methods and documentation of the design, testing,
production, control, quality assurance, labeling, packaging, shipping and
servicing of our products. The FDA enforces the QSR through periodic
inspections; the FDA inspected our manufacturing facility in September
2003.  In addition, the British
Standards Institution has performed several management systems assessments of
our manufacturing processes. These inspections resulted in observations to
which we submitted responses, and we believe these responses have been accepted
by those agencies. Any failure to take corrective action in response to a QSR
inspection could force a shutdown of our manufacturing operations, and a recall
of, or field action relating to, our products. Also, in August 2001, the FDA
classified as a class II field action a May 2000 software upgrade we issued to
correct an error in an algorithm contained in one of our products. In
September 2000, we provided purchasers of our products with a software upgrade
to correct this error, and at the FDAs request, we recently sent two
additional letters to these purchasers to provide them with a final opportunity
to upgrade the software at no charge. 
We expect that when this action is completed, we will receive final
written closure from the FDA on this matter.

14

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Compliance
with the regulations of these agencies, including the Environmental Protection
Agency and the Occupational Safety and Health Administration, may require us to
incur substantial costs and may delay or prevent the introduction of new or
improved products. Although to date these actions by regulatory bodies have not
required us to incur substantial costs or delay product shipments, we expect to
experience further inspections and incur additional costs as a result of
governmental regulation. If we fail to comply with the laws and regulations
pertaining to our business, we may be subject to fines, sanctions, including
the temporary or permanent suspension of operations, product field actions,
criminal prosecution and marketing restrictions.  Our third-party medical device manufacturers may also be subject
to the same sanctions if they fail to comply with the laws and regulations,
and, as a result, may fail to supply us with components required to manufacture
our products.

Our reliance on a
single manufacturing facility may impair our ability to respond to natural
disasters or other unforeseen catastrophic events.

Our sole
manufacturing facility is located in a single building in Bothell, Washington.
Despite precautions taken by us, a natural disaster such as an earthquake or
other unanticipated catastrophic events at this building could significantly
impair our ability to manufacture our products and operate our business. Our
facility and certain manufacturing equipment would be difficult to replace and
could require substantial replacement lead-time. Such catastrophic events may
also destroy any inventory of product or components. While we carry insurance
for natural disasters and business interruption, the occurrence of such an
event could result in losses that exceed the amount of our insurance coverage,
which would impair our financial results.

We have a history of
losses, we expect future losses and we may never achieve sustained
profitability.

With the
exception of the fiscal quarters ended December 31, 2002 and December 31, 2003,
we have incurred net losses in each quarter since we commenced operations. As
of December 31, 2003, we had an accumulated deficit of approximately $87.4
million. We achieved a profitable fiscal quarter ended December 31, 2003 and
expect to achieve one or more profitable quarters within the next several
quarters. Even if we do achieve one or more profitable quarters, however, we
may be unable to sustain or increase future profitability on a quarterly or
annual basis. Additionally, our losses may increase if we cannot increase or
sustain our revenue. With the exception of the fiscal quarters ended December
31, 2002 and December 31, 2003, our revenue from product sales has been
insufficient to cover our expenses. We expect that our operating expenses will
increase in the foreseeable future as we expand our sales and marketing
infrastructure, our administrative support and our product development
activities. Our expansion efforts, to be successful, may require more funding
than we currently anticipate. Accordingly, we will need to generate significant
additional revenue in the future before we will be able to sustain or increase
profitability. If we cannot generate such revenue, we may never be profitable.
If we fail to achieve sustained profitability, the market price for our common
stock will likely fall.

A failure to manage
our growth could impair our ability to achieve our business objectives.

We have
experienced rapid growth since our inception as a stand-alone company. Our
revenue increased from $45.7 million in 2001 to $73.0 million in 2002 and $84.8
million in 2003. We expect continued significant growth as we continue to
develop, manufacture, market and sell our products. Our growth could strain our
existing management, operational and financial resources. In order to manage
our growth effectively, we will need to expand our manufacturing and quality
assurance staff, our sales staff and our manufacturing capabilities. In
addition, we will need to improve the productivity and efficiency of our
existing operational, financial and management resources and information
systems. We may be unable to hire and retain the personnel necessary to operate
and expand our business. We also may be unable to increase the productivity and
efficiency of our existing resources. If we fail to timely improve or augment
our existing resources in response to our growth, we may be unable to
effectively manage our business and achieve our objectives.

Our foreign
distributors may be unwilling or unable to devote sufficient resources to
market and sell our products, which could delay or reduce market acceptance and
sales of our products outside the United States.

We
currently depend on foreign distributors to help promote market acceptance and
demand for our products in countries in which we do not have a direct sales
force. Foreign distributors that are in the business of distributing other
medical products may not devote the resources and support required within these
countries to generate awareness of our products and grow or maintain product sales.
If these distributors are unwilling or unable to market and sell our products,
we could experience delayed or reduced market acceptance and sales of our
products outside the United States.

15

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Sales to
our distributor in Japan, Olympus, decreased from 10% of our revenue in 2002 to
1.9% of our revenue in 2003. In late 2002, we examined the market for our
product and confirmed a significant market opportunity that was not being
realized by Olympus and their dealer network. In an effort to develop this
market opportunity, we have been working on securing additional distribution
relationships in Japan. We expect these relationships to become operational in
the first half of 2004. The Olympus organization has undergone significant
organizational changes, which have affected its ability to provide sufficient
sales and marketing focus on our products. In addition to the licenses held by Olympus,
 we have received licenses in our name to sell the 180 Series and TITAN Systems,
and the iLook license approval is in process.
 As a result, this transition has
resulted in a significant reduction in revenue from Japan in fiscal 2003
compared with fiscal 2002.

Our lack of customer purchase commitments and
our limited order backlog make it difficult to predict sales and plan manufacturing
requirements, which can lead to lower revenues, higher expenses and reduced
margins.

We do not
generally have volume purchase commitments with our customers, who typically
order products on a purchase order basis. In limited circumstances, customer
orders may be cancelled, changed or delayed on short notice. Lack of
significant order backlog makes it difficult for us to forecast future sales
with certainty. Varying sales cycles with our customers make it difficult to
accurately forecast component and product requirements. These factors expose us
to a number of risks:

     if
we overestimate our requirements, we may be obligated to purchase more
components or third-party products than is required;

     if
we underestimate our requirements, our third-party manufacturers and suppliers
may have an inadequate product or product                component inventory, which could
interrupt manufacturing of our products and result in delays in shipments and
revenues;

     we
may also experience shortages of product components from time to time, which
also could delay the manufacturing of our                products; and

     over
or under production can lead to higher expense, lower than anticipated
revenues, and reduced margins.

Our creation,
maintenance and expansion of direct sales and distribution operations will
require a significant investment of our financial and management resources and
may fail to generate a substantial increase in sales.

We have
historically relied on third-party distributors to sell our products in Europe
and Asia. In 2001, we commenced operations in the United Kingdom and France,
and in 2002, we commenced operations in Germany and Spain to sell our products
directly in each of those countries. In 2003, we entered into a joint venture
with a partner in China to sell our products there. We recently hired a vice
president for international sales and, as a result, we expect our foreign
direct sales operations to grow. In 2004, we plan to establish direct sales
operations in Japan, Canada, and Australia. 
Establishing, maintaining and expanding these operations will require us
to:

| |  |  | substantially
  increase our costs of operations;                                                            
| |  | - | -------------------------------------------------------------------------------------------------------------
| |  |  | temporarily
  divert existing management resources;                                                          
| |  |  | establish an
  efficient and self-reliant local infrastructure;                                              
| |  |  | attract,
  hire and train qualified local sales and administrative personnel;                                
| |  |  | comply with
  additional local regulatory requirements; and                                                  
| |  |  | expand our
  information, financial, distribution and control systems to manage expanded
  global operations.

Our
movement into international markets has required, and will continue to require,
substantial financial and management resources. The costs of this expansion are
unpredictable, difficult to control and may exceed budgeted amounts. We have
experienced some operating challenges with our European operations.  In Germany, recent health care reform caused
hospital administrators to delay capital equipment purchases as they evaluate
the impact of the new system. Although revenue from Germany increased in 2003
compared to 2002, this delay negatively impacted our actual results against our
sales expectations in Germany in 2003. In France and Spain, we have experienced
challenges related to the performance of certain sales representatives. Despite
our expenditures and efforts, we may not generate a substantial increase in
European or Asian revenue, which would impair our operating results.

16

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Our foreign revenue is subject to currency
fluctuation and other risks associated with doing business outside the United
States.

The
percentage of our revenue originating outside the United States equaled 38% in
2003 and 42% in 2002. Total sales for the year ended December 31, 2003
denominated in a currency other than USDs were approximately $15.5 million, or
18% of total consolidated revenues. Our revenue from international sales may be
adversely affected by any of the following risks:

| |  | currency
  rate fluctuations;                                                                            
| | - | ---------------------------------------------------------------------------------------------------------
| |  | adverse
  political or economic conditions;                                                              
| |  | reduced
  protection for intellectual property rights;                                                   
| |  | longer
  receivables collection periods and greater difficulty in receivables
  collection;              
| |  | localizing
  products for foreign markets; and                                                           
| |  | compliance
  with export laws, including license requirements, trade restrictions and
  tariff increases.

As
of December 31, 2003, 52% of our outstanding accounts receivable balance was
from international customers.  We
regularly review our receivable positions in foreign countries for any
indication that collection may be at risk. For example, due to economic events
in Argentina during 2002, including the decision to allow the Argentine peso to
float against the U.S. dollar, we wrote off $400,000 of our Argentine
receivables in 2002, for which we had already established an allowance.

We use and
may continue to use forward foreign exchange contracts and other instruments to
reduce our exposure to exchange rate fluctuations from intercompany balances
denominated in foreign currencies, and we may not be able to reduce this
exposure successfully. Accordingly, we may experience economic loss and a
negative impact on our results of operations and equity as a result of foreign
currency exchange rate fluctuations.

Our efforts to integrate the business and
technology of any future acquisition, even if successful, may result in
significant costs or create significant disruptions that outweigh the benefits
of any such acquisition.

As part of
our business strategy, we may acquire other companies, products or
technologies. We may fail in our attempt to successfully integrate into our
business the operations, technology, products, customers, suppliers and
personnel of any such acquired business or technology. Even if integration is
successful, any such acquisition may include costs for:

| |  | integration
  of operations, including combining teams and processes in various functional
  areas;
| | - | ---------------------------------------------------------------------------------------------------
| |  | integration
  of new technology into our products;                                                 
| |  | fees and
  expenses of professionals involved in completing the integration process; and           
| |  | potential
  existing liabilities of any future acquisition target.                                 

Additionally,
our efforts to consummate an acquisition or to successfully integrate any such
acquisition could place a significant burden on our management and internal
resources, disrupting our business. If we fail in our attempts to integrate any
acquired business or technology, or if the costs and burdens of such acquisition
or integration outweigh the benefits of such acquisition, our financial
resources or financial results could be impaired.

The loss of any
principal member of our management team or product development staff, on whom
we rely heavily, could impair our ability to compete.

Our success
depends heavily on our ability to retain the services of the principal members
of our management team and product development staff. Competition among medical
device companies for qualified employees is intense. We may fail to retain
these key employees, and we may fail to attract qualified replacements if they
do leave. We do not maintain key-person insurance on any of our employees. We
do not have employment agreements with any of our employees, except in certain
countries outside the United States. The loss of any of our key employees could
significantly delay or prevent the achievement of our product development or
business objectives.

If we are unable to
protect and enforce our intellectual property rights, we may be unable to
compete effectively.

17

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Much of our
value arises out of our proprietary technology and intellectual property for
the design, manufacture and use of point-of-care ultrasound imaging systems.
Our success and ability to compete effectively depend on our ability to protect
our proprietary information. We rely on patent, copyright, trade secret and
trademark laws to protect our proprietary technology and limit the ability of
others to compete with us using the same or similar technology.

We
currently hold 19 patents relating to our technology. A number of other patents
are pending in the United States and in foreign jurisdictions. Additionally, we
have a license from our former parent, ATL, to use certain ATL technology and
ATL technological developments in our point-of-care products. This license was
exclusive through April 5, 2003, and became nonexclusive after that date. We
also enter into confidentiality or license agreements with our employees,
consultants and corporate partners, and generally control access to, and the
distribution of, our product designs, documentation and other proprietary
information, as well as the designs, documentation and other information that
we license from others.

Our efforts
afford only limited protection and may not adequately protect our rights to the
extent necessary to sustain any competitive advantage we may have. Despite our
efforts to protect our intellectual property, we may experience:

| |  |  | unauthorized
  use of our technology by competitors;                                                                                                         
| |  | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | independent
  development of the same or similar technology by a competitor, coupled with a
  lack of enforceable patents on our part;                       
| |  |  | failure of
  our pending patent applications to result in issued patents;                                                                                    
| |  |  | successful
  interference actions to our patents, successful patent infringement lawsuits
  or successful oppositions to our patents and patent applications;
| |  |  | unauthorized
  disclosure or use of our proprietary information by former employees or
  affiliates; and                                                     
| |  |  | failure by
  our commercial partners to comply with their obligations to share technology
  or use our technology in a limited manner.                       

Policing
unauthorized use of our intellectual property will be difficult and may be
cost-prohibitive. We may fail to prevent misappropriation of our technology,
particularly in countries where the laws may not protect our proprietary rights
to the same extent as do the laws of the United States. If we cannot prevent
other companies from using our proprietary technology or if our patents are
found invalid or otherwise unenforceable, we may be unable to compete
effectively against other manufacturers of ultrasound systems, which could
decrease our market share.

Existing or potential intellectual property claims
and litigation may divert our resources and subject us to significant liability
for damages, substantial litigation expense and the loss of our proprietary
rights.

In order to
protect or enforce our patent rights, we may initiate patent litigation. In
addition, others may initiate patent litigation against us. We may become
subject to interference proceedings conducted in patent and trademark offices
to determine the priority of inventions. There are numerous issued and pending
patents in the ultrasound field. The validity and breadth of medical technology
patents may involve complex legal and factual questions for which important
legal principles may remain unresolved. In addition, because patent
applications can take many years to result in issued patents and are maintained
in confidence by the U.S. Patent and Trademark Office while pending, there may
be currently pending applications of which we are unaware, which may later
result in issued patents that our products may infringe. There could also be
existing patents of which we are not aware that one or more of our products may
infringe. Litigation may be necessary to:

| |  |  | assert or
  defend against claims of infringement;                                     
| |  | - | ---------------------------------------------------------------------------------------
| |  |  | enforce our
  issued and licensed patents;                                             
| |  |  | protect our
  trade secrets or know-how; or                                            
| |  |  | determine
  the enforceability, scope and validity of the proprietary rights of others.

We
may become involved in the defense and prosecution, if necessary, of
intellectual property suits, patent interferences, opposition proceedings and
other administrative proceedings. For example, on July 24, 2001,
Neutrino Development Corporation filed a complaint against us in U.S. District
Court, Southern District of Texas, Houston Division, alleging infringement of
U.S. Patent 6,221,021, or the 021 patent, by SonoSite as a result of our use,
sale and

18

---

---

manufacture of the SonoSite
180, SonoSite 180 PLUS, SonoHeart and SonoHeart PLUS devices. The complaint
asserts claims for preliminary and permanent injunctive relief enjoining all
alleged acts of infringement, compensatory and enhanced damages, attorneys
fees and costs, and pre- and post-judgment interest. On August 14, 2001, we
filed an answer asserting affirmative defenses of non-infringement and patent
invalidity, and included a counterclaim seeking a declaratory judgment of
non-infringement and invalidity regarding Neutrinos patent. On October 4,
2001, the court denied a request by Neutrino for preliminary injunctive relief
to prevent us from manufacturing and selling our products pending the ultimate
disposition of the litigation. On February 20, 2002, in what is known as a
Markman hearing, the parties presented their arguments regarding the proper
construction of Neutrinos patent claims.

On August
20, 2003, the U.S. District Court in the Southern District of Texas issued a
decision interpreting certain terms used in the 021 patent. This decision does
not discuss whether the patent is valid or whether the patent would apply to
any of our products. In the order, the court, in resolving disputed terms in
the Markman hearing, adopted our construction of the term a portable body
designed to be hand held, and adopted Neutrinos construction of the terms
the moveably connected transducer mounting assembly and ultrasound emitter.
The court denied our motion for summary judgment.  We subsequently filed a new summary judgment motion using the
courts construction of the claim language that the 021 patent is invalid
based on prior art. Neutrino has filed a summary judgment motion based on its
allegations of infringement.

We
also have asked the Texas court to stay proceedings in Neutrinos suit filed in
the Middle District of Florida on August 19, 2003 against a former SonoSite
distributor alleging that the sale of SonoSites products by such distributor
infringes the 021 patent, and to enjoin Neutrino from filing similar suits
against other sellers of SonoSite products. Neutrino had previously filed such
a suit in the Middle District of Tennessee against another medical device
distributor for selling a SonoSite product. That Tennessee case has been
dismissed based on a final judgment and permanent injunction filed a month
after the case was filed. The Tennessee judgment has no effect on the Texas
proceedings.  In the Florida action, we
have filed a motion to stay the proceedings in the Florida court pending a
final resolution of the patent suit in Texas. We have also filed a motion to
strike certain counts of Neutrinos complaint.

We
believe that we have good and sufficient defenses to the claims of patent
infringement asserted against us by Neutrino and we are vigorously defending
ourselves in these matters. If we are not successful in our defense of these
claims, we could be forced to modify or discontinue selling our products or may
enter into royalty or licensing agreements, which may not be available on terms
acceptable to us, if at all, and which could adversely affect our financial
condition, results of operations and cash flow. Sales of the allegedly infringing products represented the majority
of our revenue for the years ended December 31, 2003, 2002 and 2001.

We
do not consider a negative litigation outcome to be probable and have not
accrued any amounts for potential losses related to these proceedings. Because
of uncertainties related to both the amount and range of loss on the pending
litigation, management is unable to make a reasonable estimate of the liability
that could result from an unfavorable outcome. As additional information
becomes available, we will assess the potential liability related to its
pending litigation. We will record accruals for losses if and when we determine
the negative outcome of such matters to be probable and reasonably estimable.
Our estimates regarding such losses could differ from actual results. Revisions
in our estimates of the potential liability could materially impact our results
of operations, financial position and cash flow.

Our
involvement in intellectual property claims and litigation could:

| |  |  | divert existing
  management, scientific and financial resources;                                                                
| |  | - | ---------------------------------------------------------------------------------------------------------------------------------
| |  |  | subject us
  to significant liabilities;                                                                                         
| |  |  | allow our
  competitors to market competitive products without obtaining a license from
  us;                                    
| |  |  | cause
  product shipment delays and lost sales;                                                                                  
| |  |  | require us
  to enter into royalty or licensing agreements, which may not be available on
  terms acceptable to us, if at all; or
| |  |  | force us to
  modify or discontinue selling our products, or to develop new products.                                            

The termination or other loss of our license
to use certain ATL technology would significantly impair our ability to
manufacture, market and sell our products.

19

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---

We license
certain technology from ATL that is incorporated into our single technology
platform, and we use this ATL technology in all of our point-of-care ultrasound
imaging systems. Virtually all of our revenue is attributable to products
incorporating this ATL technology.

ATL may
terminate our license in the event of an uncured material default by us in our
obligations under the license agreement. Although many key aspects of our
technology platformincluding the high level of miniaturization that allows us
to manufacture our systemsare independently owned by us under the terms of our
spin-off from ATL, the termination or other loss of our license to use ATL
technology would significantly impair our ability to manufacture, market and
sell our products. If this happens, we may be unable to generate sufficient
revenue to maintain our business.

Product liability and
other claims and product field actions could increase our costs, delay or
reduce our sales and damage our reputation, which could significantly impair
our financial condition.

Our
business exposes us to the risk of product liability, malpractice or warranty
claims inherent in the sale and support of medical device products, including
those based on claims that the use or failure of one of our products resulted
in a misdiagnosis or harm to a patient. Such claims may damage our reputation
by raising questions about our products safety and efficacy, and could
interfere with our efforts to market our products. Although to date we have not
been involved in any medical malpractice or product liability litigation, we
may incur significant liability if such litigation were to occur. We may also
face adverse publicity resulting from product field actions or regulatory
proceedings brought against us. Although we currently maintain liability
insurance in amounts we believe are commercially reasonable, any product
liability we incur may exceed our insurance coverage. Liability insurance is
expensive and may cease to be available on acceptable terms, if at all. A
product liability or other claim or product field action not covered by our insurance
or exceeding our coverage could significantly impair our financial condition.
In addition, a product field action or a liability claim against us could
significantly harm our reputation and make it more difficult to obtain the
funding and commercial relationships necessary to maintain our business.

If our stock price
continues to be volatile, your shares may decline in value.

The market
price for our common stock, as well as for securities of emerging growth
companies generally, has been volatile in the past and is likely to continue to
be volatile. You may be unable to resell your shares at or above the price you
paid due to a number of factors, many of which are beyond our control,
including:

| |  |  | the
  difference between quarterly operating results and those expected by
  investors or securities analysts;
| |  | - | --------------------------------------------------------------------------------------------------------------
| |  |  | changes in
  earnings estimates by analysts;                                                                  
| |  |  | the loss of
  significant orders;                                                                             
| |  |  | announcements
  of technological innovations or new products by our competitors;                              
| |  |  | changes in
  the structure of healthcare financing and payment systems;                                       
| |  |  | general
  conditions in the medical industry or global economy;                                               
| |  |  | a lack of
  liquidity in the market for our stock; and                                                        
| |  |  | a
  significant sale or sales of our common stock by one or more of our
  shareholders.                       

Our future capital-raising activities or
acquisition of businesses or assets could involve the issuance of equity
securities, which would dilute your investment and could result in a decline in
the trading price of our common stock.

To meet our
long-term funding requirements, we may sell securities in the public or private
equity markets if and when conditions are favorable, even if we do not have an
immediate need for additional capital at that time. For example, in May 2002,
we raised net proceeds of $42.6 million through the sale of 2,700,000 shares of
our common stock. Furthermore, we may enter into financing transactions at
prices that represent a substantial discount to market price. In addition, we
may issue a significant amount of our securities in connection with our
purchase of, or strategic investment in, other businesses or assets. Raising
funds or paying for acquisitions through the issuance of equity securities will
dilute the ownership of our existing shareholders. A negative reaction by
investors and securities analysts to any sale or issuance of our equity
securities could result in a decline in the trading price of our common stock.

20

---

---

The concentrated
ownership of our common stock could delay or prevent a change of control, which
could cause a decline in the market price of our common stock.

As of
December 31, 2003, our executive officers, directors and affiliated entities
together beneficially owned approximately 5.6% of the outstanding shares of our
common stock. Based on currently available information, seven other
shareholders owned in the aggregate approximately 49.5% of the outstanding
shares of our common stock. Among these shareholders, the State of Wisconsin Investment
Board, or SWIB, owned approximately 13.2% of the outstanding shares of our
common stock and WM Advisors owned approximately 8.9%. As a result, these
shareholders or any other concentrated owner may be able to exert significant
influence over all matters requiring shareholder approval, including the
election of directors, matters relating to the attraction and retention of
employees, such as stock option plans, and approval of significant corporate
transactions that could include certain matters relating to future financing
arrangements and unsolicited tender offers. This concentration of ownership may
delay, deter or prevent a third party from acquiring control over us at a
premium over the then-current market price of our common stock, which could result
in a decline in our stock price.

Our restated articles
of incorporation, our bylaws, Washington law and some of our agreements contain
provisions that could discourage a takeover and prevent shareholders from
receiving a premium for their shares.

There are
provisions in our restated articles of incorporation, our bylaws and Washington
law that make it more difficult for a third party to obtain control of us, even
if doing so would be beneficial to our shareholders.

Additionally,
our acquisition may be made more difficult or expensive by the following:

| |  | change of
  control provisions in our license agreement with ATL, which require us to pay
  ATL $75 million if, at any time between April 6, 2003 and April 6, 2006, any
  single person or entity engaged in the medical diagnostic imaging business,
  other than through the sale or manufacture of our products, obtains, directly
  or indirectly, voting control of a majority of our common stock or the power
  to elect our entire board of directors;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | acceleration
  provisions in benefit plans and change-in-control agreements with our
  employees; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |  | our
  shareholder rights plan, which is designed to dilute a hostile acquirors
  interest so that the acquisition becomes prohibitively expensive. Under our
  rights plan, each of our shareholders has one share purchase right for each
  share of common stock held, with each right having an exercise price
  approximating our board of directors estimate of the long-term value of one
  share of our common stock. The rights are triggered if an acquiror acquires,
  or successfully makes a tender offer for, 20% or more of our outstanding
  common stock. In such event, each shareholder other than the acquiror would
  have the right to purchase, at the exercise price, a number of newly issued
  shares of our capital stock at a 50% discount. If the acquiror were to
  acquire 50% or more of our assets or earning power, each shareholder would
  have the right to purchase, at the exercise price, a number of shares of acquirors
  stock at a 50% discount. Our board of directors may redeem the rights at a
  nominal cost at any time before a person acquires 20% or more of our
  outstanding common stock, which allows board-approved transactions to
  proceed. In addition, our board of directors may exchange all or part of the
  rights (other than rights held by the acquiror) for such number of shares of
  our common stock equal in value to the exercise price. Such an exchange
  produces the desired dilution without actually requiring our shareholders to
  purchase shares.

If we incur a tax liability in connection
with our spin-off from ATL, we would be required to pay a potentially
significant expense, which would diminish our financial resources.

Our
spin-off was treated by ATL as a tax-free spin-off under Section 355 of the
Internal Revenue Code of 1986. If ATL were to recognize taxable gain from the
spin-off, the Internal Revenue Service, or IRS, could impose that liability on
any member of the ATL consolidated group as constituted prior to the spin-off,
including us. Generally, the IRS may assert that our spin-off from ATL is a
taxable transaction until the expiration of the statute of limitations
applicable to ATL with respect to the spin-off transaction. The expiration of
the statute of limitations with respect to the spin-off transaction depends
upon the actions and tax filings of ATL and the special rules applicable to
spin-offs in general, which special rules could result in the extension of the
general statute of limitations for an indefinite period of time. In the event
of a tax liability, ATL has agreed to cover 85% of any such liability, unless
the tax is imposed due to our actions solely or by ATL solely, in which case,
we have agreed with ATL that the party who is solely at fault shall bear all of
the tax liability. We are unaware of any actions that would result in a tax
liability to us under the indemnity agreement regarding the spin-off
transaction. We are aware that ATL was acquired in a transaction subsequent to
the spin-off transaction, which could potentially result in the spin-off being
treated as a taxable transaction, but which resulting tax liability in our

21

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view would be the sole responsibility of ATL pursuant to our agreement
with ATL. ATL may refuse, however, to indemnify us for a tax liability arising
out of the spin-off transaction or may argue that it did not cause the tax
liability to be imposed. In such event, we may incur a significant expense for
all or a portion of the taxes related to the spin-off.

ITEM 2. PROPERTIES

Our
principal offices are located in Bothell, Washington, where we lease
approximately 65,000 square feet. The facility includes approximately 30,000
square feet of office space, 30,000 square feet of manufacturing space and 5,000
square feet for other uses, such as reception and meeting rooms. The lease runs
through 2007. Our warehouse is located in a nearby 18,000 square foot building.
The lease on this building runs through 2006. We believe that these facilities
will be adequate to meet our needs for the foreseeable future. Additionally, we
lease smaller office facilities at each subsidiary location.

ITEM 3. LEGAL PROCEEDINGS

On July 24,
2001, Neutrino Development Corporation filed a complaint against us in U.S. District
Court, Southern District of Texas, Houston Division, alleging infringement of
U.S. Patent 6,221,021, or the 021 patent, by SonoSite as a result of our use,
sale and manufacture of the SonoSite 180, SonoSite 180 PLUS, SonoHeart and
SonoHeart PLUS devices. The complaint asserts claims for preliminary and
permanent injunctive relief enjoining all alleged acts of infringement,
compensatory and enhanced damages, attorneys fees and costs, and pre- and
post-judgment interest. On August 14, 2001, we filed an answer asserting
affirmative defenses of non-infringement and patent invalidity, and included a
counterclaim seeking a declaratory judgment of non-infringement and invalidity
regarding Neutrinos patent. On October 4, 2001, the court denied a request by
Neutrino for preliminary injunctive relief to prevent us from manufacturing and
selling our products pending the ultimate disposition of the litigation. On
February 20, 2002, in what is known as a Markman hearing, the parties
presented their arguments regarding the proper construction of Neutrinos
patent claims.

On August
20, 2003, the U.S. District Court in the Southern District of Texas issued a
decision interpreting certain terms used in the 021 patent. This decision does
not discuss whether the patent is valid or whether the patent would apply to
any of our products. In the order, the court, in resolving disputed terms in
the Markman hearing, adopted our construction of the term a portable body
designed to be hand held, and adopted Neutrinos construction of the terms
the moveably connected transducer mounting assembly and ultrasound emitter.
The court denied our motion for summary judgment.  We subsequently filed a new summary judgment motion using the
courts construction of the claim language that the 021 patent is invalid
based on prior art. Neutrino has filed a summary judgment motion based on its
allegations of infringement.

We also
have asked the Texas court to stay proceedings in Neutrinos suit filed in the
Middle District of Florida on August 19, 2003 against a former SonoSite
distributor alleging that the sale of SonoSites products by such distributor
infringes the 021 patent, and to enjoin Neutrino from filing similar suits
against other sellers of SonoSite products. Neutrino had previously filed such
a suit in the Middle District of Tennessee against another medical device
distributor for selling a SonoSite product. That Tennessee case has been
dismissed based on a final judgment and permanent injunction filed a month
after the case was filed. The Tennessee judgment has no effect on the Texas
proceedings. In the Florida action, we have filed a motion to stay the
proceedings in the Florida court pending a final resolution of the patent suit
in Texas. We have also filed a motion to strike certain counts of Neutrinos
complaint.

We believe
that we have good and sufficient defenses to the claims of patent infringement
asserted against us by Neutrino and we are vigorously defending ourselves in
these matters. If we are not successful in our defense of these claims, we
could be forced to modify or discontinue selling our products or may enter into
royalty or licensing agreements, which may not be available on terms acceptable
to us, if at all, and which could adversely affect our financial condition, results of operations and cash flow.
Sales of the allegedly infringing products represented the majority of our
revenue for the years ended December 31, 2003, 2002 and 2001.

We do not
consider a negative litigation outcome to be probable and have not accrued any
amounts for potential losses related to these proceedings. Because of
uncertainties related to both the amount and range of loss on the pending
litigation, management is unable to make a reasonable estimate of the liability
that could result from an unfavorable outcome. As additional information
becomes available, we will assess the potential liability related to its
pending litigation. We will record accruals for losses if and when we determine
the negative outcome of such matters to be probable and reasonably estimable.
Our estimates regarding such losses could differ from actual results. Revisions
in our estimates of the potential liability could materially impact our results
of operations, financial position and cash flow.

22

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

No matters
were submitted to a vote of our shareholders during the fourth quarter of the
year ended December 31, 2003.

23

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PART II

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

Market Information

Our common
stock is traded on the Nasdaq National Market under the symbol SONO. The high
and low sales prices for our common stock for each quarter are listed below.
These prices reflect interdealer prices, without retail mark-up, mark-down or
commission, and may not necessarily represent actual transactions.

|Year           |  | High |       | Low |  
|-------------- |  | ---- | ----- | --- | -
|               |  |      |       |     |  
|2003           |  |      |       |     |  
|Fourth quarter |  | $    | 22.20 |     | $
|Third quarter  |  | $    | 22.68 |     | $
|Second quarter |  | $    | 22.75 |     | $
|First quarter  |  | $    | 15.84 |     | $
|2002           |  |      |       |     |  
|Fourth quarter |  | $    | 16.17 |     | $
|Third quarter  |  | $    | 15.65 |     | $
|Second quarter |  | $    | 19.68 |     | $
|First quarter  |  | $    | 28.01 |     | $

We
have not declared or paid cash dividends on our common stock. We currently
intend to retain all earnings, if any, for future growth and, therefore, do not
intend to pay cash dividends on our common stock in the foreseeable future.

Holders

As of
February 27, 2004, there were 3,330 holders of record of the common stock. This
figure does not include the number of shareholders whose shares are held of
record by a broker or clearing agency, but does include each such brokerage
house or clearing agency as a single holder of record.

Equity Compensation Plans

The
following table provides information regarding our existing compensation plans
and individual compensation arrangements pursuant to which our equity
securities may be issued to employees, directors, consultants, advisors or
other persons in exchange for consideration in the form of services.

|Plan Category                                                    |  | Number of securities to be 
  issued upon exercise of 
  outstanding options, 
  warrant and rights 
  (a) |           | Weighted-average exerciseprice of outstandingoptions, warrants andrights
  (b) |  | Number of securities remaining available for future issuance under 
  equity compensation plans 
  (excluding securities reflected in column (a))
  (c) |  
|---------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------- | --------- | ------------------------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------------------------------------------------- | -
|                                                                 |  |                                                                                                            |           |                                                                                |  |                                                                                                                                                         |  
|                                                                 |  |                                                                                                            |           |                                                                                |  |                                                                                                                                                         |  
|Equity
  compensationplans approved by 
  security holders       |  |                                                                                                            | 1,388,434 | (1)                                                                            |  |                                                                                                                                                         | $
|                                                                 |  |                                                                                                            |           |                                                                                |  |                                                                                                                                                         |  
|Equity
  compensation
  plans not approved
  by security holders |  |                                                                                                            | 1,531,239 | (2)                                                                            |  |                                                                                                                                                         | $
|                                                                 |  |                                                                                                            |           |                                                                                |  |                                                                                                                                                         |  
|Total                                                            |  |                                                                                                            | 2,919,673 |                                                                                |  |                                                                                                                                                         | $

|(1) | Issuable
  under our 1998 Plan, Management Incentive Compensation Plan, Nonemployee
  Director Stock Option Plan and Adjustment Plan.
|--- | -------------------------------------------------------------------------------------------------------------------------------------

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|(2) | Issuable under our 1998 Nonofficer Employee Stock Option Plan as
  described in Note 8 to the Consolidated Financial Statements in our Annual
  Report on Form 10-K for the fiscal year ended December 31, 2003.  Also includes 95,000 options outside of
  all plans issued to corporate officers in 2000 and 35,000 options outside of
  all plans issued to corporate officers in 2003.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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ITEM 6.          SELECTED
FINANCIAL DATA

The
selected financial data should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations and
the Consolidated Financial Statements and Notes thereto included elsewhere in
this report.

|                                                                                                                   |                                             | For the Years Ended December 31,      |       
|------------------------------------------------------------------------------------------------------------------ | ------------------------------------------- | ------------------------------------- | ------
|                                                                                                                   |                                             |                                       |       
|                                                                                                                   |                                             | 2003                                  |       
|                                                                                                                   |                                             |                                       |       
|                                                                                                                   |                                             | (in thousands, except per share data) |       
|Statement of Operations Data                                                                                       |                                             |                                       |       
|Sales
  revenues                                                                                                   |                                             | $                                     | 84,770
|Cost of
  sales revenue                                                                                            |                                             |                                       | 30,918
|                                                                                                                   |                                             |                                       |       
|Gross margin                                                                                                       |                                             |                                       | 53,852
|Grant
  revenue                                                                                                    |                                             |                                       |      
|Operating
  expenses:                                                                                              |                                             |                                       |       
|                                                                                                                   | Research and
  development                  |                                       |       
|                                                                                                                   | Sales and
  marketing                       |                                       |       
|                                                                                                                   | General and
  administrative                |                                       |       
|                                                                                                                   |                                             |                                       |       
|Total
  operating expenses                                                                                         |                                             |                                       | 56,968
|Other income
  (loss):                                                                                             |                                             |                                       |       
|                                                                                                                   | Interest
  income                           |                                       |       
|                                                                                                                   | Interest
  expense                          |                                       |       
|                                                                                                                   | Equity in
  (losses) earnings of affiliates |                                       |       
|                                                                                                                   | Other gain
  (loss)                         |                                       |       
|                                                                                                                   |                                             |                                       |       
|Total other
  income                                                                                               |                                             |                                       | 1,332 
|                                                                                                                   |                                             |                                       |       
|Net loss                                                                                                           |                                             | $                                     | (1,784
|                                                                                                                   |                                             |                                       |       
|Basic and
  diluted net loss per share                                                                             |                                             | $                                     | (0.12 
|                                                                                                                   |                                             |                                       |       
|Weighted
  average common and potential common shares 
     used in computing basic and diluted net loss per share |                                             |                                       | 14,335

|                                              |  | As of December 31, |        
|--------------------------------------------- |  | ------------------ | -------
|                                              |  |                    |        
|                                              |  | 2003               |        
|                                              |  |                    |        
|                                              |  | (in thousands)     |        
|Balance Sheet Data                            |  |                    |        
|Cash and
  cash equivalents                   |  | $                  | 13,683 
|Working
  capital                             |  |                    | 54,809 
|Total assets                                  |  |                    | 109,090
|Long-term
  obligations, less current portion |  |                    |       
|Total
  shareholders equity                  |  |                    | 95,330 

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

Overview

We are a
leading worldwide developer of high-performance, hand-carried ultrasound
imaging systems for use in a variety of clinical applications and settings. Our
proprietary technologies have enabled us to design hand-carried diagnostic
ultrasound systems that combine all-digital, high-resolution imaging with
advanced features and capabilities traditionally found on cart-based ultrasound
systems. We believe that the mobility, high clinical utility, durability, ease
of use and cost-effectiveness of our products are expanding existing markets
and will create new markets for ultrasound imaging by bringing ultrasound out
of the imaging center to other clinical settings and to the point-of-care such
as the patients bedside or the physicians examining table.

The size
and complexity of traditional cart-based ultrasound systems typically require a
physician or highly trained clinician to perform the examination in a centralized
imaging department, such as a hospitals radiology department. By providing
ultrasound at the primary point-of-care, our easy-to-use systems can eliminate
delays associated with the referral process and enable physicians to use
ultrasound more frequently and in a wider variety of clinical settings. This
increased accessibility creates the potential for enhanced patient care through
earlier diagnosis of diseases and conditions.

Our
products are used for imaging in a variety of medical specialties, such as
radiology, obstetrics and gynecology, emergency medicine, surgery, cardiology,
internal medicine and vascular medicine. Our current products include the SonoSite
TITAN system, for general imaging and cardiology applications, the SonoSite 180PLUS
system, for general ultrasound imaging, and the SonoHeart ELITE, specifically
configured for cardiovascular applications. The iLook 25 imaging tool is
designed to provide visual guidance for physicians and nurses while performing
vascular access procedures and the iLook 15 imaging tool is designed to provide
visual imaging of the chest and abdomen for physicians and nurses while
performing other procedures and examinations. Our TITAN, SonoSite 180PLUS and
SonoHeart ELITE products are used together with any of our transducers that are
designed for specific clinical applications. Our iLook products each have a
single transducer for specific clinical applications. We first shipped our
newest product, the SonoSite
TITAN, in June 2003.

We were
formerly a division of ATL Ultrasound, Inc., or ATL. On April 6, 1998, we were
spun-off as an independent, publicly owned Washington corporation to further
the development and commercialization of high-performance, hand-carried
ultrasound imaging systems. ATL retained no ownership in us following the
spin-off. We entered into a technology transfer and license agreement with ATL
pursuant to which we took ownership of certain ultrasound technology developed
as part of a government grant and also patent rights, which had been
established or were being pursued for that technology.  As part of this agreement, we also entered
into a cross-license whereby we had the exclusive right to use certain ATL
technology existing on April 6, 1998 or developed by ATL during the three-year
period following April 6, 1998 in ultrasound systems weighing 15 pounds or
less, and ATL had the exclusive right to use our technology existing on April
6, 1998 or developed by us during the same three-year period in ultrasound
systems weighing more than 15 pounds. On April 6, 2003, this cross-license
became nonexclusive and, except for the patented technology of each party, now
extends to all ultrasound systems regardless of weight. We sold our first
products in September 1999.

Critical Accounting Policies and Estimates

The
discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States of America. The preparation of these financial statements requires us 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 ongoing basis, we evaluate our estimates, including
those related to product returns, bad debts, inventories, investments, warranty
obligations, service contracts, contingencies and litigation. We base our
estimates on historical experience and on 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.

Our
critical accounting policies include accounts receivable, revenue recognition,
valuation of inventories and treatment of warranty expense.

Accounts
receivable. We maintain an allowance for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. We determine the adequacy of this allowance by
regularly reviewing the aging of our accounts receivable and evaluating
individual customer receivables, considering customers financial

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condition, historical experience, credit history and current economic
condition. Losses can be difficult to anticipate. For example, in 2002, we
wrote off approximately $400,000 of our Argentine receivables due to adverse
economic conditions in Argentina. An increase in losses beyond those expected
by management would reduce earnings when they become known.

Revenue
recognition. We recognize revenue on products and accessories
when goods are shipped under an agreement with a customer, risk of loss and
title have passed to the customer and collection of any resulting receivable is
reasonably assured. For service contracts, revenue is recognized over the term
of the contract. Revenue is recorded net of estimated returns. Sales discounts
are recorded as a reduction in revenue.

In
connection with sales to certain specific international customers, we sometimes
conclude that full collection of the related accounts receivable is not
reasonably assured due to extended payment terms or the financial condition of
our customer and, consequently, we do not recognize revenue or cost of revenue
at the time of title transfer. In instances where collection is not reasonably assured,
revenue and cost of revenue are recorded when cash is received.

Our sales
arrangements may contain multiple elements, which include hardware and software
products. Revenue from the sale of software in these arrangements is recognized
in accordance with the American Institute of Certified Public Accountants
Statement of Position 97-2, Software Revenue Recognition, as amended. In
general, we have vendor specific objective evidence, or VSOE, of fair value for our
products.  Accordingly, for transactions
that have undelivered elements for which we have VSOE of the elements, revenue equal to the total fair value of the
undelivered elements is deferred and is not recognized until the element is
delivered to the customer.

Valuation
of inventories. Inventories are stated at the lower of
cost or market on a first-in, first-out method. Included in our inventories
balance are demonstration products used by our sales representatives and
marketing department and items that have been shipped to customers for which
revenue recognition requirements have not been met. Cost adjustments are
recorded for obsolete material, earlier generation products and used product
held either as saleable inventory or as demonstration product.  The adjustments reduce their carrying values
to amounts not lower than that which is expected to result in approximately normal profit
margins upon sale. Inventory items for which title has passed to customers are
evaluated for recoverability based on the same process we use to evaluate
collection of accounts receivable.

We make
judgments regarding the carrying value of our inventory based on current market
conditions. Market conditions may change depending upon competitive product
introductions, consumer demand and reimbursement criteria in the medical
community. If market conditions change or if the introduction of new products
by us impacts the market for our previously released products, we may be
required to write down the cost of our inventory.

Warranty
expense. We accrue estimated warranty expenses at the
time of sale for costs expected to be incurred under our product warranties.
This provision for warranty expenses is made based upon our historical
experience and managements judgment. We have limited history with some of our
products. Any unexpected increase in defects would result in an increase in
warranty expense and a reduction in earnings.

Results of Operations

Revenue

Overview

Revenue
increased to $84.8 million in 2003, compared to $73.0 million in 2002 and $45.7
million in 2001. The increase in revenue in 2003 compared to 2002 was primarily
due to an increase in sales in the United States and Europe, which was somewhat
offset by a decline in sales to our distributor in Japan. The increase in
revenue was primarily due to sales of our latest product introduction, the
TITAN system. The first shipments of the TITAN system occurred in June 2003 and
accounted for approximately 28% of our worldwide revenue for the year ended
December 31, 2003.

Approximately
69% of the increase in revenue in 2002 compared to 2001 was in the United
States.  The increase resulted from
having a fully staffed direct sales force for the entire year 2002, new product
introductions and our increased average selling price. Sales representatives
increased productivity as they became more experienced and were assisted by a
team of clinical application specialists. These specialists performed product
demonstrations and customer support, enabling sales representatives to focus on
sales calls. Additionally, the average selling price per system increased due
to an increase in sales of higher priced features. Approximately 21% of the
increase was in Europe, where we opened two new sales offices in Germany and
Spain in 2002 and had a full year of operation in the United Kingdom and France
compared to the prior year.

28

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United States

U.S.
revenue increased to $52.4 million in 2003, compared to $42.6 million in 2002,
due to sales of the TITAN system, increased government and military sales and
higher sales force productivity.  Sales
of the TITAN system accounted for approximately 30% of U.S. revenue in 2003.
U.S. revenue increased to $42.6 million in 2002, compared to $23.8 million in
2001, due to an increase in U.S. direct sales representatives, new product
introductions and increased average selling prices.

Rest of the world

Revenue
from Europe, Africa and the Middle East increased to $21.3 million in 2003 from
$14.8 million in 2002 primarily due to an increase in revenue from direct sales
in the United Kingdom, France and Germany. Sales of the TITAN system accounted
for approximately 30% of such revenue in 2003. Changes in exchange rates
accounted for approximately $2.1 million of the increase in revenue. In
Germany, recent health care reform introduced a Diagnosis Related Group system
that changes health care reimbursements from a per day reimbursement to a
per case reimbursement. This change caused hospital administrators to delay
capital equipment purchases as they evaluate the impact of the new system.
Although revenue from Germany increased on a comparable basis, this delay
negatively impacted our actual results against our sales expectations in
Germany in 2003.  The increase to $14.8
million in 2002 from $9.1 million in 2001 was primarily due to an increase in
direct sales in the United Kingdom and France along with sales from our direct
sales operations in Germany and Spain, which opened in 2002.

Revenue
from Canada, Australia, South America, Latin America and Asia (excluding Japan)
increased to $9.5 million in 2003 from $8.1 million in 2002 primarily due to a
large sale to the government of Argentina. 
The increase to $8.1 million in 2002 from $5.0 million in 2001 was
primarily due to an increase in orders from our distributors in China and
Mexico.

Revenue
from Japan decreased to $1.6 million in 2003 from $7.5 million in 2002
primarily due to a decrease in orders from our distributor, Olympus.  The Olympus organization underwent
significant organizational changes, which affected its ability to provide
sufficient sales and marketing focus on our products. As a result, we are
working to establish additional distribution relationships in Japan.  We expect these relationships to become operational
in the first half of 2004.  The decrease
of revenue in Japan to $7.5 million in 2002 from $7.8 million in 2001 was due
to the timing of orders received from Olympus and the delay in approval of our
new products.

We
anticipate that revenue will increase in 2004 compared to prior years due to
continued expansion of our direct selling efforts in the United States and
Europe, the establishment of direct sales operations in Japan, Canada and
Australia, introduction of new product features, and the overall expansion of
market awareness and acceptance of our products. However, increased competition
may impact the extent of the increase in our anticipated growth in revenue. We
currently face competition from larger companies that manufacture cart-based
and portable ultrasound systems and have greater financial and other resources.
Some of these competitors are introducing hand-carried ultrasound products. In
2004, we anticipate improvement in our revenue from Japan due to the
establishment of direct sales operation there and the expected establishment of
additional distributor relationships. 
However, regulatory approval of our new products in Japan could be
delayed, which could impact our anticipated revenue.

Gross margin

Gross
margin increased to 64% in 2003, compared to 59% in 2002 and 52% in 2001. The
increase in gross margin in 2003 was primarily due to improved manufacturing
efficiencies and increased average selling prices. The increased average
selling prices resulted primarily from initial sales of the TITAN system, an
increase in the percentage of direct sales compared with distributor sales and
an increase in sales with advanced-feature configurations. Direct sales
accounted for approximately 80% of total sales in 2003 compared to 69% in 2002.

The increase
in gross margin in 2002 from 2001 was primarily due to an increase in the
percentage of direct sales compared with distributor sales, increased average
selling prices due to the sale of higher-priced features and improved
manufacturing efficiencies. Direct sales accounted for approximately 69% of
total sales in 2002 compared to 54% in 2001.

We expect
our gross margin percentage in 2004 to increase slightly from
our gross margin in 2003. Nevertheless, increased competition from existing and
new competitors in the highly portable ultrasound system market could result in
lower average realized prices and could lower our gross margin. Our gross
margin can be expected to fluctuate in future periods based on the mix of
business between direct and distributor sales and our product and accessories
sales mixes. Changes in our cost of inventory also may impact our gross margin.
Included in our inventories are demonstration products, refurbished products
and products held by our customers, which are valued by us at amounts not lower than that which is expected
to result in approximately normal margins upon sale. If market conditions change or the
introduction of new products by us impacts the market for our previously
released products, we may be required to write down the cost of our inventory,

29

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resulting in a negative impact on gross margins. Additionally, we rely
on our sales forecasts by product to determine production volume. To the extent
our sales forecasts or product mix estimates are inaccurate, we may produce
excess inventory or experience inventory shortages, which may result in an
increase in our costs of revenue and a decrease in our gross margin.

Operating expenses

Research
and development expenses were $11.2 million in 2003, compared to $12.1 million
in 2002 and $12.7 million in 2001. Research and development expenses decreased
in 2003 compared to 2002 primarily due to expenses incurred in 2002 associated
with the development of the TITAN system and the iLook products combined with a
reduction in product development costs in 2003 due to the completion of the
TITAN system, which first shipped to customers in June 2003.

The
decrease in 2002 research and development expenses compared to 2001 was
primarily due to a reduction in product development costs after the completion
and introduction of the SonoHeart ELITE and iLook products during the first
nine months of 2002.

We
anticipate that research and development expenses will increase in 2004 due to
increased development of new products using newly-designed integrated circuit
chips. However, should our competitors develop products with features that
equal or exceed the features that exist in our products, we may incur higher
than anticipated research and development costs in order to accelerate existing
programs and compete more effectively.

Sales and
marketing expenses increased to $38.5 million in 2003, compared to $33.6
million in 2002 and $22.3 million in 2001. The $4.9 million increase in
expenses in 2003 compared to 2002 was primarily due to increased expenses in
Europe. Expenses in Europe increased due to the increase, year over year, in
the number of sales representatives there and expenses associated with the
TITAN product launch. In addition, expenses increased due to the increase, year
over year, in the number of clinical application specialists in the United
States, and expenses associated with the reconfiguration of our United States
sales territories in early 2003. 
Changes in exchange rates accounted for approximately $1.4 million of
the increase in expenses.

The
increase in sales and marketing expenses in 2002 compared to 2001 was primarily
due to our direct sales activities in the United States, where for the first
time we had a fully operational sales force for an entire year. Approximately
22% of the increase was related to the addition of clinical application
specialists in the United States, who assisted sales representatives with
product demonstrations and customer support. Approximately 38% of the increase
was related to our direct sales activities in Europe where we opened two new
sales office and increased headcount in our two existing offices.

We
anticipate that sales and marketing expenses in 2004 will increase primarily
due to sales force expansion in the U.S. and the establishment of direct sales
operations in Japan, Canada and Australia.

General and
administrative expenses were $7.3 million in 2003, compared to $6.0 million in
2002 and $5.3 million in 2001. The increase in general and administrative
expenses in 2003 was related primarily to supporting our business
growth and to legal and consulting expenses associated with medical
reimbursement activities.  The increase
in 2002 was primarily due to supporting our business growth and to
legal expenses incurred to defend our intellectual property rights.

We
anticipate that general and administrative expenses will increase in 2004 in
order to support our increased business activity. We may incur additional
substantial legal expenses as we continue to defend our patent rights in the
existing Neutrino patent infringement litigation. In addition, we may incur
unanticipated legal expenses if we become involved in any new litigation.

Other income (loss)

For other
income and loss, we reported income of $1.3 million in 2003 compared to
$698,000 in 2002. The increase in 2003 compared to 2002 was primarily due to
foreign currency transaction gains of approximately $346,000 and net realized
gains on investments of approximately $117,000 in 2003.

We reported
income of $698,000 in 2002, compared to $96,000 in 2001. The increase in 2002
compared to 2001 was primarily due to a decrease in equity investment losses
from our joint venture in China. In 2002, we began the process of terminating
our joint venture in China and have since entered into a new joint venture in
China with a new partner.

30

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Liquidity and Capital Resources

Our cash
and cash equivalents balance was $13.7 million as of December 31, 2003,
compared to $26.4 million as of December 31, 2002. Cash and cash equivalents
were primarily invested in money market accounts.

Operating
activities used cash of $5.8 million in 2003, compared to $8.3 million in 2002
and $17.8 million in 2001. The decrease in cash used in 2003 compared with 2002
was primarily due to a $5.9 million reduction in our net loss.  This was offset by increases in accounts
receivable and inventories to support our business growth.

The 2002
decrease in cash used in operations as compared with 2001 was primarily due to
a reduction of $8.7 million in our net loss. The decrease in cash used was also
due to changes in accounts receivable and accounts payable, both of which were
substantially offset by the change in inventories. The effect on cash from the
change in accounts receivable improved in 2002 compared to 2001 primarily due
to improved collection efforts. Accounts payable increased primarily due to the
timing of payments, increased inventory purchases and our overall growth.
Inventories increased to support increased business activity.

Investing
activities used cash of $10.6 million in 2003, compared to cash used of $42.3
million in 2002 and cash provided of $15.9 million in 2001. The decrease in
cash used in 2003 compared with 2002 reflects the fact that we used $8.7
million of cash in 2003 for net purchases of investment securities compared to
2002 when we had net purchases of investment securities of $39.5 million. In 2001,
we received $18.0 million on the net sales of investment securities.

We
anticipate using cash to invest in high quality investment instruments in 2004,
the extent of which will depend on the interest rate environment during the
period and the timing of cash flows from our operations during the period.

Financing
activities provided cash of $3.7 million in 2003, compared to $43.5 million in
2002 and $24.0 million in 2001. The main source of cash provided by financing
activities in 2003 was the exercise of stock options totaling $3.8 million,
compared to $1.0 million in 2002. In May 2002, we received net proceeds of
$42.6 million through the sale of 2,700,000 shares of our common stock at
$17.25 per share.  In August 2001, we
received net proceeds of $23.1 million through the sale of 1,666,667 shares of
our common stock at $15.00 per share.

We
anticipate that cash used in operations will decrease in 2004 compared to 2003
primarily due to anticipated decreases in our net loss. This decrease will
depend on our ability to successfully sell our products, collect our
receivables, control our inventories and manage our expenses.

We believe
that our existing cash and cash generated from operations will be sufficient to
fund our operations and planned capital expenditures in 2004.  Nevertheless, we may experience an increased
need for additional cash due to:

| |  | any
  significant decline in our revenues or gross margins;                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                       
| |  | any delay or
  inability to collect accounts receivable;                                                                                                                              
| |   |                                                                                                                                                                                       
| |  | any
  acquisition or strategic investment in another business;                                                                                                                        
| |   |                                                                                                                                                                                       
| |  | any
  significant increase in expenditures as a result of expansion of our sales
  and marketing infrastructure, our manufacturing capability or our product
  development activities;
| |   |                                                                                                                                                                                       
| |  | any
  significant increase in our sales and marketing expenditures as a result of
  our introduction of new products;  and                                                            
| |   |                                                                                                                                                                                       
| |  | any
  significant increase in expenditures related to the Neutrino patent
  infringement litigation.                                                                                  

Off-balance
sheet arrangements

As of
December 31, 2003, we had no off-balance sheet debt. Furthermore, except for
certain foreign exchange rate hedging transactions, discussed more fully under
Foreign currency risk in Item 7A below, we are not a party to any derivative
transaction.

We apply
the disclosure provisions of FIN 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others to our agreements that contain guarantee or indemnification clauses. We
provide (i) indemnifications of varying scope and size to our customers and
distributors against claims of intellectual property infringement made by third
parties arising from the use of our products; (ii) indemnifications of varying
scope and size to our customers against third party claims arising as a result
of defects in our products; (iii) indemnifications of varying scope and size to
consultants against third party claims arising from the services they provide
to us; and (iv) guarantees to support obligations of some of our subsidiaries
such as lease payments. These indemnifications and guarantees give rise only to
the disclosure provisions of FIN 45. To date, we have not incurred material
costs as a result of these obligations and do not expect to incur material
costs in the future.  Accordingly, we
have not accrued any liabilities in our financial statements related to these indemnifications or
guarantees.

31

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Contractual obligations

We have the
following contractual obligations as of December 31, 2003:

|                                     |  | Payments due by period |      
|------------------------------------ |  | ---------------------- | -----
|                                     |  |                        |      
|                                     |  | Total                  |      
|                                     |  |                        |      
|                                     |  | (in
  thousands)       |      
|Capital lease obligations            |  | $                      | 92   
|Operating leases                     |  |                        | 6,463
|Unconditional purchase
  obligations |  |                        | 3,443
|                                     |  |                        |      
|                                     |  | $                      | 9,998
|                                     |  |                        |      

Other commitments

As part of
our agreements with our suppliers, suppliers may procure resources and material
expected to be used for the manufacture of our product in accordance with our
production schedule provided to them. We may be responsible for compensating
our suppliers for these procurements in the event these items are not used in
the quantities submitted as part of the production schedule or material becomes
obsolete as a result of production timing, material changes or design changes.

As part of
obtaining our lease for our current facility, we were required to deposit
approximately $350,000, representing restricted cash with our bank. Also, we
were required to maintain a deposit of approximately $310,000 with our bank in
the United Kingdom as security for payment of customs and duties charges. Both
amounts are included in other long-term assets.

In March
2003, one of our component suppliers, Philips Semiconductor, or Philips,
informed us that, commencing in September 2003, it would discontinue production
of our integrated circuit chips using 0.35-micron technology. We have designed
and implemented a new chip using 0.2-micron technology that will continue to be
produced by Philips to replace all but one of the discontinued chips. We expect
to design and implement an additional new chip to replace the remaining
0.35-micron chip by early 2005. In the second quarter of 2003, we entered into
a purchase commitment totaling approximately $3.6 million for supplies of
0.35-micron chips from Philips for our anticipated manufacturing needs until
new chips have been incorporated in all of our products. We pay for these chips
at the time deliveries are made to us. As of December 31, 2003, our remaining
purchase commitment was approximately $3.4 million.  On December 31, 2004, we are required to take possession of, and
pay for, the balance of the undelivered chips.

Recent Accounting Pronouncements

In June
2001, the Financial Accounting Standards Board, or FASB, issued SFAS, No. 143,
Accounting for Asset Retirement Obligations, which provides the accounting
requirements for retirement obligations associated with tangible long-lived
assets. SFAS No. 143 requires entities to record the fair value of a liability
for an asset retirement obligation in the period in which it is incurred. SFAS
No. 143 is effective for our 2003 fiscal year and we adopted SFAS No. 143 on
January 1, 2003. The adoption of SFAS No. 143 did not have an impact on our
consolidated financial statements.

In November
2002, the FASB issued Interpretation No. 45, or FIN 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN 45 clarifies the requirements of Statement No. 5,
Accounting for Contingencies, relating to a guarantors accounting for, and
disclosure of, the issuance of certain types of guarantees. For certain
guarantees issued after December 31, 2002, FIN 45 requires a guarantor to
recognize, upon issuance of a guarantee, a liability for the fair value of the
obligations it assumes under the guarantee. Guarantees issued prior to January
1, 2003, are not subject to liability recognition, but are subject to expanded
disclosure requirements. The adoption of this interpretation did
not have a material impact on our consolidated financial statements.

In November
2002, the Emerging Issues Task Force, or EITF, reached a consensus on EITF
00-21, Revenue Arrangements with Multiple Deliverables, with respect to
determining when and how to allocate revenue from sales with multiple
deliverables. The EITF 00-21 consensus provides a framework for determining
when and how to allocate revenue from sales with multiple deliverables based on
a determination of whether the multiple deliverables qualify to be accounted
for as separate units of accounting. The consensus is effective prospectively
for arrangements entered into in

32

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fiscal periods beginning after June 15, 2003 and we adopted this
consensus on July 1, 2003. The adoption of this consensus did not have a
material impact on our consolidated financial statements.

In January
2003, the FASB issued Interpretation No. 46, or FIN 46, Consolidation of
Variable Interest Entities. Variable interest entities often are
created for a single specified purpose, for example, to facilitate
securitization, leasing, hedging, research and development, or other
transactions or arrangements. This interpretation of Accounting Research
Bulletin No. 51, Consolidated Financial Statements, defines what these
variable interest entities are and provides guidelines on how to identity them
and also on how an enterprise should assess its interests in a variable
interest entity to decide whether to consolidate that entity. Generally, FIN 46
applies to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after
that date. On October 8, 2003, the FASB deferred the implementation date
for the consolidation requirements of FIN 46 as it relates to variable interest
entities that existed before February 1, 2003. FIN 46 also requires
companies that expect to consolidate a variable interest entity they acquired
before February 1, 2003 to disclose the entitys nature, size, activities,
and the companys maximum exposure to loss in financial statements issued after
January 31, 2003. In December 2003, the FASB issued FIN 46R with respect
to variable interest entities created before January 31, 2003, which, among
other things, revised the implementation date to the fiscal year or interim
period ending after March 15, 2004 except for Special Purpose Entities. The
adoption of this interpretation did not have an impact on our consolidated financial statements nor do we expect that it
will have a material impact on our future consolidated financial statements.

In May
2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.  SFAS
No. 150 changes the accounting for certain financial instruments that, under
previous guidance, could be classified as equity or mezzanine equity, by now
requiring those instruments to be classified as liabilities (or assets in some
circumstances) in the balance sheet.  SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of SFAS No. 150 did not have an impact on our consolidated
financial statements.

ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk

We are
exposed to market risk relating to changes in interest rates, which could
adversely affect the value of our investments in marketable securities.

As of
December 31, 2003, our portfolio consisted of $13.1 million of interest-bearing
debt securities with maturities of less than one year and $34.2 million of
interest-bearing debt securities with maturities of more than one year. Our
intent is to hold these securities until maturity, but we have classified them
as available-for-sale in the event of unanticipated cash needs. The interest
bearing securities are subject to interest rate risk and will fall in value if
market interest rates increase. We believe that the impact on the fair market
value of our securities and related earnings for 2004 from a hypothetical 10%
increase in market interest rates would not have a material impact on the
investment portfolio.

Foreign currency risk

Except for
sales transacted by our wholly owned foreign subsidiaries, we transact all our sales in
United States dollars, or USDs; therefore, the obligations of many of our
international customers are in USDs. Our exposure to risk from fluctuations in
foreign currencies relates primarily to the strengthening of the USD against
the local currency of our international customers, which may impact our ability
to collect amounts owed by our international customers.

As of
December 31, 2003, 52% of our outstanding accounts receivable balance was from
international customers, of which 49%, or approximately $6.8 million, was
denominated in a currency other than USDs. Total sales for the year ended
December 31, 2003 denominated in a currency other than USDs were approximately
$15.5 million, or 18% of total consolidated revenues. The British Pound and the
Euro represented the majority of financial transactions executed in a currency
not denominated in USDs. Historically, the impact on us of changes in exchange
rates compared to the USD has been insignificant. We regularly review our
receivable positions in foreign countries for any indication that collection
may be at risk. In addition, we utilize letters of credit where they are
warranted in order to mitigate our collection risk.

We
periodically enter into foreign currency forward contracts to reduce the impact
of adverse fluctuations on earnings associated with foreign currency exchange
rate changes. The currencies hedged during 2003 were the British Pound and the
Euro. On December 31, 2003, we entered into foreign currency forward contracts
totaling $8.7 million. All of these contracts expire on March 31, 2004 and
serve as hedges of a substantial portion of our British Pound and
Euro-denominated intercompany balances.  A sensitivity analysis of a
change in the fair value of the contracts entered into on

33

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---

December 31, 2003 indicates that, if the USD weakened by 10% against
the British Pound and the Euro, the fair value of these contracts would
decrease by approximately $870,000. Conversely, if the USD strengthened by 10%
against the British Pound and the Euro, the fair value of these contracts would
increase by approximately $870,000. Any gains and losses on the fair value of
these contracts would be largely offset by losses and gains on the underlying
transactions. These offsetting gains and losses are not reflected in the
sensitivity analysis above. The fair value of these contracts as of December
31, 2003 was not material to our results of operations or our financial
position.

34

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ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA

SONOSITE, INC. 
INDEX TO FINANCIAL STATEMENTS

|                                                                         | Page
|------------------------------------------------------------------------ | ----
|                                                                         |     
|Independent
  Auditors Report                                           | 36  
|Consolidated
  Balance Sheets                                            | 37  
|Consolidated
  Statements of Operations                                  | 38  
|Consolidated
  Statements of Cash Flows                                  | 39  
|Consolidated
  Statements of Shareholders Equity and Comprehensive Loss | 40  
|Notes to
  Consolidated Financial Statements                             | 41  

35

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INDEPENDENT AUDITORS REPORT

The Board of Directors and Shareholders,
SonoSite, Inc.:

We have
audited the accompanying consolidated balance sheets of SonoSite, Inc. and
subsidiaries as of December 31, 2003 and 2002, and the related consolidated
statements of operations, cash flows and shareholders equity and comprehensive
loss for each of the years in the three-year period ended December 31, 2003. In
connection with our audits of the consolidated financial statements, we also
have audited the financial statement schedule listed in Item 15(a). These
consolidated financial statements and the financial statement schedule are the
responsibility of SonoSite, Inc.s management. Our responsibility is to express
an opinion on these consolidated financial statements and the financial
statement schedule based on our audits.

We
conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SonoSite, Inc. and
subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

| | /s/ KPMG LLP
| | ------------

Seattle, Washington
February 6, 2004

36

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SONOSITE, INC. 
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)

|                                              |                                                                                                                 | As of December 31, |        
|--------------------------------------------- | --------------------------------------------------------------------------------------------------------------- | ------------------ | -------
|                                              |                                                                                                                 |                    |        
|                                              |                                                                                                                 | 2003               |        
|                                              |                                                                                                                 |                    |        
|ASSETS                                        |                                                                                                                 |                    |        
|Current
  Assets                              |                                                                                                                 |                    |        
|                                              | Cash and
  cash equivalents                                                                                     |                    | $      
|                                              | Short-term
  investment securities                                                                              |                    |        
|                                              | Accounts
  receivable, less allowance for doubtful accounts of  $933 and $832                                   |                    |        
|                                              | Inventories                                                                                                     |                    |        
|                                              | Prepaid
  expenses and other current assets                                                                     |                    |        
|                                              |                                                                                                                 |                    |        
|Total
  current assets                        |                                                                                                                 |                    | 68,294 
|Property and
  equipment, net                 |                                                                                                                 |                    | 5,564  
|Investment
  securities                       |                                                                                                                 |                    | 34,239 
|Other assets                                  |                                                                                                                 |                    | 993    
|                                              |                                                                                                                 |                    |        
|Total assets                                  |                                                                                                                 | $                  | 109,090
|                                              |                                                                                                                 |                    |        
|                                              |                                                                                                                 |                    |        
|LIABILITIES AND SHAREHOLDERS EQUITY          |                                                                                                                 |                    |        
|Current
  Liabilities                         |                                                                                                                 |                    |        
|                                              | Accounts
  payable                                                                                              |                    | $      
|                                              | Accrued
  expenses                                                                                              |                    |        
|                                              | Current
  portion of long-term obligations                                                                      |                    |        
|                                              | Deferred
  revenue                                                                                              |                    |        
|                                              |                                                                                                                 |                    |        
|Total
  current liabilities                   |                                                                                                                 |                    | 13,485 
|Deferred
  rent                               |                                                                                                                 |                    | 275    
|Long-term
  obligations, less current portion |                                                                                                                 |                    | ---    
|                                              |                                                                                                                 |                    |        
|Total
  liabilities                           |                                                                                                                 |                    | 13,760 
|                                              |                                                                                                                 |                    |        
|                                              |                                                                                                                 |                    |        
|Commitments
  and contingencies               |                                                                                                                 |                    |        
|                                              |                                                                                                                 |                    |        
|Shareholders
  Equity                        |                                                                                                                 |                    |        
|                                              | Preferred
  stock, $1.00 par value
       Authorized shares6,000,000
       Issued and outstanding sharesnone |                    |        
|                                              | Common
  stock, $0.01 par value     Shares
  authorized50,000,000
       Issued and outstanding shares:        |                    |        
|                                              | As of
  December 31, 200314,572,524                                                                            |                    |        
|                                              | As of
  December 31, 200214,195,280                                                                            |                    |        
|                                              | Additional
  paid-in capital                                                                                    |                    |        
|                                              | Accumulated
  deficit                                                                                           |                    |        
|                                              | Accumulated
  other comprehensive income                                                                        |                    |        
|                                              |                                                                                                                 |                    |        
|Total
  shareholders equity                  |                                                                                                                 |                    | 95,330 
|                                              |                                                                                                                 |                    |        
|Total
  liabilities and shareholders equity  |                                                                                                                 | $                  | 109,090
|                                              |                                                                                                                 |                    |        
|                                              |                                                                                                                 |                    |        

See accompanying notes to the consolidated financial statements.

37

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SONOSITE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except loss per share)

|                                                                                                                     |                                  | For the Years Ended December 31, |       
|-------------------------------------------------------------------------------------------------------------------- | -------------------------------- | -------------------------------- | ------
|                                                                                                                     |                                  |                                  |       
|                                                                                                                     |                                  | 2003                             |       
|                                                                                                                     |                                  |                                  |       
|Revenue                                                                                                              |                                  | $                                | 84,770
|Cost of
  revenue                                                                                                    |                                  |                                  | 30,918
|                                                                                                                     |                                  |                                  |       
|Gross margin                                                                                                         |                                  |                                  | 53,852
|                                                                                                                     |                                  |                                  |       
|Operating
  expenses:                                                                                                |                                  |                                  |       
|                                                                                                                     | Research and
  development       |                                  |       
|                                                                                                                     | Sales and
  marketing            |                                  |       
|                                                                                                                     | General and
  administrative     |                                  |       
|                                                                                                                     |                                  |                                  |       
|Total
  operating expenses                                                                                           |                                  |                                  | 56,968
|                                                                                                                     |                                  |                                  |       
|Other income
  (loss):                                                                                               |                                  |                                  |       
|                                                                                                                     | Interest
  income                |                                  |       
|                                                                                                                     | Interest
  expense               |                                  |       
|                                                                                                                     | Equity in
  losses of affiliates |                                  |       
|                                                                                                                     | Other                            |                                  |       
|                                                                                                                     |                                  |                                  |       
|Total other
  income                                                                                                 |                                  |                                  | 1,332 
|                                                                                                                     |                                  |                                  |       
|Net loss                                                                                                             |                                  | $                                | (1,784
|                                                                                                                     |                                  |                                  |       
|                                                                                                                     |                                  |                                  |       
|Basic and
  diluted net loss per share                                                                               |                                  | $                                | (0.12 
|                                                                                                                     |                                  |                                  |       
|                                                                                                                     |                                  |                                  |       
|Weighted
  average common and potential common shares used in computing 
       basic and diluted net loss per share |                                  |                                  | 14,335
|                                                                                                                     |                                  |                                  |       

See accompanying notes to the consolidated financial statements.

38

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SONOSITE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS 
(in thousands)

|                                                               |                                                                               | For the Years Ended December 31, |        
|-------------------------------------------------------------- | ----------------------------------------------------------------------------- | -------------------------------- | -------
|                                                               |                                                                               |                                  |        
|                                                               |                                                                               | 2003                             |        
|                                                               |                                                                               |                                  |        
|Operating
  activities:                                        |                                                                               |                                  |        
|                                                               | Net loss                                                                      |                                  | $      
|                                                               | Adjustments
  to reconcile net loss to net cash used in operating activities: |                                  |        
|                                                               | Depreciation
  and amortization                                               |                                  |        
|                                                               | Net loss
  (gains) on investments                                             |                                  |        
|                                                               | Equity in
  losses of affiliates                                              |                                  |        
|                                                               | Amortization
  of premiums on investment securities                           |                                  |        
|                                                               | Stock-based
  compensation                                                    |                                  |        
|                                                               | Changes in
  operating assets and liabilities:                                |                                  |        
|                                                               | Accounts
  receivable                                                         |                                  |        
|                                                               | Inventories                                                                   |                                  |        
|                                                               | Prepaid
  expenses and other assets                                           |                                  |        
|                                                               | Accounts
  payable                                                            |                                  |        
|                                                               | Accrued
  expenses                                                            |                                  |        
|                                                               | Deferred
  liabilities                                                        |                                  |        
|                                                               |                                                                               |                                  |        
|                                                               | Net cash
  used in operating activities                                       |                                  |        
|                                                               |                                                                               |                                  |        
|Investing
  activities:                                        |                                                                               |                                  |        
|                                                               | Purchase of
  investment securities                                           |                                  |        
|                                                               | Proceeds
  from sales/maturities of investment securities                     |                                  |        
|                                                               | Purchase of
  property and equipment                                          |                                  |        
|                                                               | Increase in
  other assets                                                    |                                  |        
|                                                               |                                                                               |                                  |        
|                                                               | Net cash
  provided by (used in) investing activities                         |                                  |        
|                                                               |                                                                               |                                  |        
|Financing
  activities:                                        |                                                                               |                                  |        
|                                                               | Net proceeds
  from sale of common shares                                     |                                  |        
|                                                               | Exercise of
  stock options                                                   |                                  |        
|                                                               | Repayment of
  long-term obligations                                          |                                  |        
|                                                               |                                                                               |                                  |        
|                                                               | Net cash
  provided by financing activities                                   |                                  |        
|                                                               |                                                                               |                                  |        
|Effect of
  exchange rate changes on cash and cash equivalents |                                                                               |                                  | 15     
|                                                               |                                                                               |                                  |        
|Net change
  in cash and cash equivalents                      |                                                                               |                                  | (12,698
|Cash and
  cash equivalents at beginning of year               |                                                                               |                                  | 26,381 
|                                                               |                                                                               |                                  |        
|                                                               |                                                                               |                                  |        
|Cash and
  cash equivalents at end of year                     |                                                                               | $                                | 13,683 
|                                                               |                                                                               |                                  |        
|                                                               |                                                                               |                                  |        
|Supplemental
  disclosure of cash flow information:            |                                                                               |                                  |        
|                                                               | Cash paid
  for interest                                                      |                                  | $      
|                                                               |                                                                               |                                  |        
|                                                               |                                                                               |                                  |        

See accompanying notes to the consolidated financial statements.

39

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SONOSITE, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE
LOSS
(in thousands, except shares)

|                                                                                               |  |              |            | Additionalpaid-in
        capital |   | Accumulated
        deficit |  | Accumulatedother
        comprehensive
        income (loss) |         | Total
        shareholders
        equity | 
|---------------------------------------------------------------------------------------------- |  | ------------ | ---------- | --------------------------------- | - | --------------------------- |  | ------------------------------------------------------------ | ------- | ------------------------------------------ | 
|                                                                                               |  | Common stock |            |                                   |   |                             | 
|                                                                                               |  | Shares       |            | Amount                            |   |                             |  |                                                              |        
|                                                                                               |  |              |           
|Balance
        at December 31, 2000                                                           |  |              | 9,551,596  |                                   | $ | 96                          |  | $                                                            | 109,195 |                                            | 
|Comprehensive
        loss:                                                                    |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Net
        loss                                                                               |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Net
        unrealized loss on
           investment securities                                |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Less
        reclassification adjustment
           for losses included in
           net loss |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|                                                                                               |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Comprehensive
        loss                                                                     |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Sales
        of common shares, net of issuance costs of $1,853                                |  |              | 1,666,667  |                                   |   | 17                          |  |                                                              | 23,130  |                                            | 
|Exercise
        of stock options                                                              |  |              | 145,009    |                                   |   | 1                           |  |                                                              | 1,145   |                                            | 
|Cancellation
        of restricted stock                                                       |  |              | (41        | )                                 |   |                            |  |                                                              |        |                                            | 
|                                                                                               |  |              |           
|Balance
        at December 31, 2001                                                           |  |              | 11,363,231 |                                   |   | 114                         |  |                                                              | 133,470 |                                            | 
|Comprehensive
        loss:                                                                    |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Net
        loss                                                                               |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Net
        unrealized gain on
           investment securities                                |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Less
        reclassification adjustment
           for losses included in
           net loss |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Foreign
        currency translation
           adjustment                                     |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|                                                                                               |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Comprehensive
        loss                                                                     |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Sales
        of common shares, net of issuance costs of $3,964                                |  |              | 2,700,000  |                                   |   | 27                          |  |                                                              | 42,584  |                                            | 
|Exercise
        of stock options                                                              |  |              | 132,049    |                                   |   | 1                           |  |                                                              | 953     |                                            | 
|                                                                                               |  |              |           
|Balance
        at December 31, 2002                                                           |  |              | 14,195,280 |                                   |   | 142                         |  |                                                              | 177,007 |                                            | 
|Comprehensive
        loss:                                                                    |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Net
        loss                                                                               |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Net
        unrealized loss on 
           investment securities                               |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Less
        reclassification adjustment
           for gains included in
           net loss  |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|Foreign
        currency translation
           adjustment                                     |  |              |           |                                   |   |                            |  |                                                              |        |                                            | 
|                                                                                               |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Comprehensive
        loss                                                                     |  |              |            |                                   |   |                             |  |                                                              |         |                                            | 
|Exercise
        of stock options                                                              |  |              | 377,244    |                                   |   | 4                           |  |                                                              | 3,790   |                                            | 
|Stock-based
        non-employee compensation                                                  |  |              |           |                                   |   |                            |  |                                                              | 42      |                                            | 
|                                                                                               |  |              |           
|Balance
        at December 31, 2003                                                           |  |              | 14,572,524 |                                   | $ | 146                         |  | $                                                            | 180,839 |                                            | 
|                                                                                               |  |              |           

See
accompanying notes to the
consolidated financial statements.

40

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SONOSITE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Business Overview

SonoSite
commenced operations as a division of ATL Ultrasound, Inc., or ATL. We were
formed to develop the design and specifications for a high-performance,
hand-carried ultrasound imaging system and other mobile ultrasound products for
diagnostic imaging in a multitude of clinical and field settings. On April 6,
1998 (the Distribution Date), we became an independent, publicly owned
company through a distribution of one new share of our stock for every three
shares of ATL stock held as of that date. ATL retained no ownership in SonoSite
following the spin-off.

Initially,
we sold our products primarily through medical product distributors worldwide.
In February 2000, we established a contract direct sales force focused exclusively
on selling our products within the United States. In the first quarter of 2001,
we elected to convert our contract selling force to direct employees and to
expand the number of direct sales people domestically.

During
2001, we established wholly owned subsidiaries, SonoSite, Ltd., in the United
Kingdom, and SonoSite France SARL in France. During 2002, we established wholly
owned subsidiaries, SonoSite GmbH in Germany and SonoSite Iberica, S.L. in
Spain. Each subsidiary is chartered to develop direct selling operations within
their assigned territories.

2. Summary of Significant Accounting Policies

Basis of presentation

The
consolidated financial statements are prepared in conformity with accounting
principles generally accepted in the United States of America. The consolidated
financial statements include the accounts of SonoSite, Inc., and our wholly
owned subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation. In preparing the financial statements,
management must make estimates and make assumptions that affect 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.

Reclassification of prior period balances

Certain
amounts reported in previous periods have been reclassified to conform to
current period presentation.

Cash and cash equivalents

Cash and
cash equivalents consist of money market accounts with major U.S. banks and
highly liquid debt instruments with original or remaining maturities at
purchase of three months or less.

Investment securities

Investment
securities consist of high-grade U.S. government or corporate debt and
high-grade asset-backed securities. While our intent is to hold our securities
until maturity, we classify all securities as available-for-sale, as the sale
of such securities may be required prior to maturity to implement management
strategies. These securities are carried at fair value, with the unrealized
gains and losses reported as a component of other comprehensive income (loss)
until realized. Realized gains and losses from the sale of available-for-sale
securities, if any, are determined on a specific identification basis.

A decline
in market value of any available-for-sale security below cost that is
determined to be other than temporary results in a revaluation of its carrying
amount to fair value. The impairment is charged to earnings and a new cost
basis for the security is established. Premiums and discounts are amortized or
accreted over the life of the related security as an adjustment to yield using
the effective interest method. Interest income is recognized when earned.

Accounts receivable

In the
ordinary course of business, we grant credit to a broad customer base. Of the
accounts receivable balance at December 31, 2003, 52% and 48% were receivable
from international and domestic parties, prior to any allowance for

41

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doubtful accounts. The same percentages as of December 31, 2002 were
51% and 49% prior to any allowance for doubtful accounts.

The
following table presents individual customers whose outstanding receivable
balance as a percentage of total trade receivables and/or revenue as a
percentage of total revenue exceeded 10% as of, and for the year ended, December 31:

|                       |  | Accounts
  Receivable |   | Revenue | 
|---------------------- |  | --------------------- | - | ------- | 
|                       |  |                       |   |         | 
|                       |  | 2003                  |   | 2002    | 
|                       |  |                       |   |         | 
|Japanese
  distributor |  |                       |   |         | 
|U.S. direct
  customer |  |                       |   |         | 
|                       |  |                       |   |         | 
|Totals                 |  |                       |  | %       | 
|                       |  |                       |   |         | 

We
maintain allowances for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. When we determine
that amounts owed from customers are uncollectible, such amounts are charged
off against the allowances for doubtful accounts. If the financial condition of
our customers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances may be required.

Fair value of financial instruments

The
carrying value of our financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and certain long-term other
assets, approximates fair value. Cash and cash equivalents, accounts receivable
and accounts payable approximate fair value due to their short-term nature.
Other long-term assets approximate fair value as interest rates on these items
approximate market. Investment securities are carried at fair value.

We utilize
foreign currency forward contracts to reduce our exposure to foreign currency
risk due to fluctuations in exchange rates underlying the value of intercompany
accounts receivable denominated in foreign currencies. We recognize all
derivative financial instruments (foreign currency forward contracts) in
accordance with Statement of Financial Accounting Standards, or SFAS, No. 133
Accounting for Derivative Instruments and Hedging Activities, as amended.
Changes in the fair value of derivative instruments are recorded in earnings
unless hedge accounting criteria are met. For derivative instruments designated
as fair value hedges, the changes in fair value of both the derivative
instrument and the hedged item are recorded in earnings. For derivative
instruments designed as cash flow and net investment hedges, the effective
portions of changes in the fair value of the derivative are recorded in other
comprehensive income. The ineffective portions are recognized in earnings.

Inventories

Inventories
are stated at the lower of cost or market on a first-in, first-out method.
Included in our inventories balance are demonstration products used by our
sales representatives and marketing department, and items that have been
shipped to customers for which revenue recognition requirements have not been
met including products whose title and custody have passed to the customer.
Adjustments to cost are recorded for obsolete material, earlier generation
products and refurbished product held either as saleable inventory or as
demonstration product. The adjustments reduce their carrying values to amounts
not lower than that which is expected to result in approximately normal profit margins
upon sale. Inventory items for which title has passed to customers are
evaluated for recoverability based on the same process we use to evaluate
collection of accounts receivable. If market conditions are less favorable than
those projected by management, additional downward inventory cost adjustments
may be required.

Property and equipment

Property
and equipment are stated at historical cost, less accumulated depreciation and
amortization. Maintenance and repair costs are expensed as incurred, with
additions and improvements to property and equipment capitalized.

Depreciation
and amortization are calculated using the straight-line method over estimated
useful lives as follows:

|Asset                            | Estimated Useful Lives                                            
|-------------------------------- | ------------------------------------------------------------------
|                                 |                                                                   
|Equipment, other than
  computer | 37 years                                                         
|Software                         | 3 years                                                           
|Computer equipment               | 35 years                                                         
|Furniture and fixtures           | 5 years                                                           
|Leasehold improvements           | Lesser of estimated useful
  life or expected remaining lease term

42

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Direct
internal and external costs for computer software developed for internal use
are capitalized in accordance with American Institute of Certified Public
Accountants Statement of Position, or SOP, 98-1, Accounting for Costs of
Computer Software Developed or Obtained for Internal Use. Capitalized costs
are amortized using the straight-line method over the estimated useful lives
beginning when each module is complete and ready for use. Such costs are
insignificant for all periods presented.

The
carrying value of long-lived assets is evaluated for impairment when events or
changes in circumstances occur, which may indicate the carrying amount of the
asset may not be recoverable. We evaluate the carrying value of the assets by
comparing the estimated future undiscounted cash flows generated from the use
of the asset and its eventual disposition with the assets reported net book
value.

Investment in and receivable from affiliates

When we
have investments in companies where we have the ability to exercise influence
over, but not control, operating and financial policies, these investments are
accounted for under the equity method. Accordingly, our share in the net income
or loss in these investees is included in other income or loss.

We have a
40% ownership interest in a joint venture in China that is currently inactive
and is in the process of being dissolved. At December 31, 2003, our carrying
values for both our investment in this joint venture and receivable from this
joint venture were zero.  In 2003, we
entered into a new joint venture in China with a new partner in which we have a
30% ownership interest.  At December 31,
2003, the carrying value of this investment was approximately $4,000, which is included in other long-term assets, and the
receivable from this investee was approximately $246,000, which is included in accounts receivable. At December 31, 2003,
we owed the investee approximately $54,000 for commissions related to sales of
our products.

Concentration of credit and supply risk

Financial
instruments that potentially subject us to concentrations of credit risk
consist principally of cash equivalents, investments and accounts receivable.

We depend
on some single-source suppliers to provide highly specialized parts and other
components, and may experience an interruption of supply if a supplier is
unable or unwilling to meet our time, quantity and quality requirements. There
are relatively few alternative sources of supply for some of these items. A
change in demand for some parts by other companies in our industry could also
interrupt our supply of components. For example, in March 2003, one of
our component suppliers, Philips Semiconductor, or Philips, informed us that,
commencing in September 2003, it would discontinue production of our integrated
circuit chips using 0.35-micron technology. 
We have designed and implemented a new chip using 0.2-micron technology
that will continue to be produced by Philips to replace all but one of the
discontinued chips.  We expect to design
and implement an additional new chip to replace the remaining 0.35-micron chip
by early 2005.  In the second quarter of
2003, we entered into a purchase commitment totaling approximately $3.6 million
for supplies of 0.35-micron chips from Philips for our anticipated
manufacturing needs until new chips have been incorporated in all of our
products.  We pay for these chips at the
time deliveries are made to us. As of December 31, 2003, our remaining purchase
commitment was approximately $3.4 million. On December 31, 2004, we are
required to take possession of, and pay for, the balance of the undelivered
chips. Demand for our products, however, may exceed our forecasts, in which
case we would require additional 0.35-micron chips to manufacture additional
products.  Conversely, if demand for our
products falls short of our forecasts, we may experience excess inventory of
0.35-micron chips.  If our actual demand
for these chips varies significantly from our forecasted demand, we may
experience delays in manufacturing, lost sales, a write-down of inventory or a
deterioration in gross margin.

In
addition, we have transferred the production of our main circuit board to one
of the worlds largest electronic manufacturing services suppliers who will
produce the board in their Thailand manufacturing facility.  We expect his transfer to be completed in
the first quarter of 2004.  If, as a
result of this transfer, we experience delays in the receipt of this component,
a deterioration in product yields or an increase in costs, we may experience
delays in manufacturing, lost sales or a deterioration in gross margin.

Revenue recognition

We
recognize revenue on products and accessories when goods are shipped under an
agreement with a customer, risk of loss and title have passed to the customer
and collection of any resulting receivable is reasonably assured. For service
contracts, revenue is recognized over the term of the contract. Sales discounts
are recorded as a reduction of revenue. Deferred revenue primarily represents
unearned revenue from service contracts made under agreements with customers.
Our typical warranty period is one year and is included with the original
purchase of our ultrasound imaging systems. However, the customer can purchase
a service contract from us to extend the original warranty period or enhance
its

43

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coverage. We accrue charges for related product warranty expenses based
upon estimated costs to repair or replace products sold. These expenses to date
have not been significant.

In
connection with sales to certain specific international customers, we sometimes
conclude that full collection of the related accounts receivable is not
reasonably assured due to extended payment terms or the financial condition of
our customer and, consequently, we do not recognize revenue or cost of revenues
at the time of title transfer. In instances where collection is not reasonably
assured, revenue and cost of revenue is recorded when cash is received. Additionally,
in cases of nonstandard delivery and acceptance criteria, we will not recognize
revenue at shipment, but rather when the delivery and acceptance criteria have
been satisfied.

Our sales
arrangements may contain multiple elements, which include hardware and software
products.  Revenue from the sale of
software in these arrangements is recognized in accordance with SOP 97-2,
Software Revenue Recognition, as amended by SOP 98-9, Software Revenue
Recognition with Respect to Certain Arrangements. In general, we have vendor
specific objective evidence, or VSOE, of fair value for our hardware and software
products. Accordingly, for transactions that have undelivered elements for which we have VSOE of the elements, revenue
equal to the total fair value of the undelivered elements is deferred and is
not recognized until the element is delivered to the customer.

Research and development

Research
and development costs are expensed as incurred.

Advertising costs

We expense
costs for advertising and promotional activities as incurred. Advertising and
promotional expenses for the years ended December 31, 2003, 2002 and 2001 were
$5.0 million, $4.7 million and $4.3 million.

Income taxes

Deferred
income taxes are provided based on the estimated future tax effects of
temporary differences between financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and operating loss and
tax credit carryforwards arising subsequent to the Distribution Date.

Deferred
tax assets and liabilities are measured using enacted tax rates that are
expected to apply to taxable income in the years in which those temporary
differences and carryforwards are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A
valuation allowance is established when necessary to reduce deferred tax assets
to the amount, if any, expected to be realized.

Stock-based compensation

At December
31, 2003, we had five stock-based employee compensation plans, which are
described in Note 8. We account for those plans under the intrinsic value
method in accordance with the provisions of Accounting Principles Board, or
APB, Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly,
compensation cost related to stock option grants to employees has been
recognized only to the extent that the fair market value of the stock exceeds
the exercise price of the stock option at the date of the grant. The following
table illustrates the effect on net loss and net loss per share if we had
applied the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, to stock-based employee compensation (in thousands,
except per share data):

|                                                                                           |  | 2003 |        | 2002 |   | 2001    |  
|------------------------------------------------------------------------------------------ |  | ---- | ------ | ---- | - | ------- | -
|                                                                                           |  |      |        |      |   |         |  
|Net loss, as reported                                                                      |  | $    | (1,784 | )    | $ | (7,731  | )
|Less: Stock-based employee
  compensation expense determined under fair value based method |  |      | (5,508 | )    |   | (7,429  | )
|                                                                                           |  |      |        |      |   |         |  
|Pro forma net loss                                                                         |  | $    | (7,292 | )    | $ | (15,160 | )
|                                                                                           |  |      |        |      |   |         |  
|Basic and diluted net loss
  per share:                                                    |  |      |        |      |   |         |  
|As reported                                                                                |  | $    | (0.12  | )    | $ | (0.59   | )
|                                                                                           |  |      |        |      |   |         |  
|Pro forma                                                                                  |  | $    | (0.51  | )    | $ | (1.16   | )
|                                                                                           |  |      |        |      |   |         |  

We
account for non-employee stock-based compensation in accordance with SFAS No.
123 and FASB Emerging Issues Task Force, or EITF, Issue No. 96-18,  Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services.

44

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Net loss per share

Basic and
diluted net loss per share was computed by dividing the net loss by the
weighted average common shares outstanding exclusive of unvested restricted
shares.

As more
fully described in Note 8, we have an Adjustment Plan, which includes options
granted in connection with the spin-off distribution occurring on April 6,
1998. As part of this distribution, existing ATL option holders received one of
our options for every six ATL options held. Outstanding Adjustment Plan options
to purchase our shares, our unvested restricted shares issued by ATL and
options issued by us were not included in the computations of diluted net loss
per share because to do so would be antidilutive. As of December 31, 2003,
outstanding Adjustment Plan options totaled 52,840 and outstanding options we
issued totaled 2,866,833. As of December 31, 2002 outstanding Adjustment Plan
options totaled 86,645 and outstanding options we issued totaled 2,815,101. As
of December 31, 2001, outstanding Adjustment Plan options and unvested
restricted shares issued by ATL through the Distribution Date totaled 115,537
and 459 and outstanding options we issued totaled 2,505,651.

The
following is a reconciliation of the numerator and denominator of the basic and diluted
loss per share calculations (in thousands, except loss per share):

|                                           |  | 2003 |        | 2002   |  | 2001   | 
|------------------------------------------ |  | ---- | ------ | ------ |  | ------ | 
|                                           |  |      |        |        |  |        | 
|                                           |  | Loss |        | Shares |  | LPS    | 
|                                           |  |      |        |        |  |        | 
|Weighted average shares outstanding        |  |      |        |        |  | 14,335 | 
|Weighted average unvested restricted stock |  |      |        |        |  |       | 
|                                           |  |      |        |        |  |        | 
|Basic and diluted loss per share           |  | $    | (1,784 | )      |  | 14,335 | 
|                                           |  |      |        |        |  |        | 

Accumulated
Other Comprehensive Income

Unrealized
gains or losses on our available-for-sale securities and foreign currency
translation adjustments are included in accumulated other comprehensive income.

The
following are the components of accumulated other comprehensive income at
December 31 (in thousands):

|                                     |  | 2003 |       | 2002 |  
|------------------------------------ |  | ---- | ----- | ---- | -
|                                     |  |      |       |      |  
|Net unrealized gain on
  investments |  | $    | 101   |      | $
|Cumulative translation
  adjustments |  |      | 1,660 |      |  
|                                     |  |      |       |      |  
|                                     |  | $    | 1,761 |      | $
|                                     |  |      |       |      |  

Foreign
currency translation

The
functional currencies of our international subsidiaries are the local currency
of the country in which the subsidiary is located. Assets and liabilities
denominated in foreign currencies are translated at the exchange rate on the
balance sheet date. Revenues, costs and expenses of international operations
are translated at average rates of exchange prevailing during the period. Net
realized and unrealized gains on currency transactions were $346,000 for the
year-ended December 31, 2003 and none for the years ended December 31, 2002 and
2001.

Recent accounting pronouncements

In June
2001, the Financial Accounting Standards Board, or FASB, issued SFAS No. 143,
Accounting for Asset Retirement Obligations, which provides the accounting
requirements for retirement obligations associated with tangible long-lived
assets. SFAS No. 143 requires entities to record the fair value of a liability
for an asset retirement obligation in the period in which it is incurred. SFAS
No. 143 is effective for our 2003 fiscal year and we adopted SFAS No. 143 on
January 1, 2003. The adoption of SFAS No. 143 did not have an impact on our
consolidated financial statements.

In November
2002, the FASB issued Interpretation No. 45, or FIN 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN 45 clarifies the requirements of Statement No. 5,
Accounting for Contingencies, relating to a guarantors accounting for, and
disclosure of, the issuance of certain types of guarantees. For certain
guarantees issued after December 31, 2002, FIN 45 requires a guarantor to
recognize, upon issuance of a guarantee, a liability for the fair value of the
obligations it assumes under the guarantee. Guarantees issued prior to January
1, 2003, are not subject to liability recognition, but are subject to expanded
disclosure requirements. The adoption of this interpretation did
not have a material impact on our consolidated financial statements.

45

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In November
2002, the EITF reached a consensus on EITF 00-21, Revenue Arrangements with
Multiple Deliverables, with respect to determining when and how to allocate
revenue from sales with multiple deliverables. The EITF 00-21 consensus
provides a framework for determining when and how to allocate revenue from
sales with multiple deliverables based on a determination of whether the
multiple deliverables qualify to be accounted for as separate units of
accounting. The consensus is effective prospectively for arrangements entered
into in fiscal periods beginning after June 15, 2003 and we adopted this consensus
on July 1, 2003. The adoption of this consensus did not have a material impact
on our consolidated financial
statements.

In
January 2003, the FASB issued Interpretation No. 46, or FIN 46, Consolidation
of Variable Interest Entities. Variable interest entities often are created
for a single specified purpose, for example, to facilitate securitization,
leasing, hedging, research and development, or other transactions or
arrangements. This interpretation of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, defines what these variable interest entities are and
provides guidelines on how to identity them and also on how an enterprise
should assess its interests in a variable interest entity to decide whether to
consolidate that entity. Generally, FIN 46 applies to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. On October 8,
2003, the FASB deferred the implementation date for the consolidation
requirements of FIN 46 as it relates to variable interest entities that existed
before February 1, 2003. FIN 46 also requires companies that expect
to consolidate a variable interest entity they acquired before February 1,
2003 to disclose the entitys nature, size, activities, and the companys
maximum exposure to loss in financial statements issued after January 31,
2003. In December 2003, the FASB issued FIN46R with respect to variable
interest entities created before January 31, 2003, which, among other things,
revised the implementation date to the fiscal year or interim period ending
after March 15, 2004, except for Special Purpose Entities. The adoption of this
interpretation did not have an impact on our consolidated financial
statements nor do we expect that it will have a material impact on our
future consolidated financial statements.

In May
2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.  SFAS
No. 150 changes the accounting for certain financial instruments that, under
previous guidance, could be classified as equity or mezzanine equity, by now
requiring those instruments to be classified as liabilities (or assets in some
circumstances) in the balance sheet.  SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150 did not have an impact on our
consolidated financial statements.

3. Arrangements with ATL

We entered
into several agreements with ATL effective as of the Distribution Date. These
agreements were negotiated between our chief executive officer and the chief
executive officer of ATL. Both parties considered the terms of these agreements
competitive with the cost of obtaining such rights and services in arms-length
negotiations with third parties. The following is a summary of the significant
agreements:

OEM Supply Agreement

During 1999
and the first half of 2000, ATL produced many of our products, including our
systems and most of our transducers. During the fourth quarter of 2000, we
completed the transitioning of our manufacturing operations from ATL to our own
facility. This included transferring equipment, personnel and inventory. We do
not expect any further payments to be made to ATL as a result of this contract.

Technology Transfer and License Agreement

We entered
into a technology transfer and license agreement with ATL pursuant to which we
took ownership of certain ultrasound technology developed as part of a
government grant and also patent rights, which had been established or were
being pursued for that technology. As part of this agreement, we also entered
into a cross-license whereby we had the exclusive right to use certain ATL
technology existing on April 6, 1998 or developed by ATL during the three-year
period following April 6, 1998 in ultrasound systems weighing 15 pounds or
less, and ATL had the exclusive right to use our technology existing on April
6, 1998 or developed by us during the same three-year period in ultrasound
systems weighing more than 15 pounds. On April 6, 2003, this cross-license became
nonexclusive and, except for the patented technology of each party, now extends
to all ultrasound systems regardless of weight.

Our
license from ATL bears a royalty equivalent to a percentage of the net sales of
ultrasound products under fifteen pounds that use ATL technology. Royalty
payments are required through September 2007. If prior to April 6, 2006, any
single person or entity engaged in the medical diagnostic imaging business,
other than through the sale or manufacture of our products, obtains, directly
or indirectly, voting control of a majority of our common stock or the power to
elect our

46

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entire board of directors, we will be required to pay $75 million to
ATL. For the years ended December 31, 2003, 2002 and 2001, we incurred a
royalty expense to ATL of $2.2 million, $1.8 million and $1.3 million, which is
included in cost of revenue.

4. Cash, cash equivalents and investment
securities

The
following table summarizes our cash, cash equivalents and investment securities
at fair value (in thousands):

|                                  |                       | As of December 31, |       
|--------------------------------- | --------------------- | ------------------ | ------
|                                  |                       |                    |       
|                                  |                       | 2003               |       
|                                  |                       |                    |       
|Cash                              |                       | $                  | 4,147 
|Cash equivalents:                 |                       |                    |       
|                                  | Money market accounts |                    |       
|                                  |                       |                    |       
|Total cash and cash
  equivalents |                       | $                  | 13,683
|                                  |                       |                    |       
|Investment securities:            |                       |                    |       
|                                  | Short-term            |                    | $     
|                                  |                       |                    |       
|                                  | Long-term             |                    | $     
|                                  |                       |                    |       

The
amortized cost, gross unrealized holding gains and losses and fair value of
investment securities classified as available-for-sale securities as of
December 31, 2003 were as follows (in thousands):

|                               |                            | Amortized cost |   | Gross unrealized
  holding gains |        | Gross unrealized
  holding losses |  | Fair
  value |   
|------------------------------ | -------------------------- | -------------- | - | -------------------------------- | ------ | --------------------------------- |  | ------------ | --
|                               |                            |                |   |                                  |        |                                   |  |              |   
|Short-term:                    |                            |                |   |                                  |        |                                   |  |              |   
|                               | Corporate bonds            |                |   | $                                | 2,755  |                                   |  |              | $ 
|                               | US Government and agencies |                |   |                                  | 10,327 |                                   |  |              |   
|                               |                            |                |   |                                  |        |                                   |  |              |   
|Total short-term
  investments |                            |                | $ | 13,082                           |        |                                   |  | $            | 13
|                               |                            |                |   |                                  |        |                                   |  |              |   
|Long-term:                     |                            |                |   |                                  |        |                                   |  |              |   
|                               | Asset-backed securities    |                |   | $                                | 20,651 |                                   |  |              | $ 
|                               | Corporate bonds            |                |   |                                  | 1,798  |                                   |  |              |   
|                               | US Government and agencies |                |   |                                  | 11,701 |                                   |  |              |   
|                               |                            |                |   |                                  |        |                                   |  |              |   
|Total long-term investments    |                            |                | $ | 34,150                           |        |                                   |  | $            | 89
|                               |                            |                |   |                                  |        |                                   |  |              |   

The
following table summarizes our realized gains and losses on investments for the
years ended December 31, (in thousands):

|                   |  | 2003 |     | 2002 |   | 2001 |  
|------------------ |  | ---- | --- | ---- | - | ---- | -
|                   |  |      |     |      |   |      |  
|Gains              |  | $    | 169 |      | $ | 7    |  
|Losses             |  |      | (52 | )    |   | (44  | )
|                   |  |      |     |      |   |      |  
|Net gains (losses) |  | $    | 117 |      | $ | (37  | )
|                   |  |      |     |      |   |      |  

5. Financial statement detail as of December
31,

Inventories
consisted of the following (in thousands):

|                        |  | 2003 |        | 2002 |  
|----------------------- |  | ---- | ------ | ---- | -
|                        |  |      |        |      |  
|Raw material            |  | $    | 4,479  |      | $
|Work-in-process         |  |      | 48     |      |  
|Demonstration inventory |  |      | 2,578  |      |  
|Finished goods          |  |      | 7,043  |      |  
|                        |  |      |        |      |  
|Total inventories       |  | $    | 14,148 |      | $
|                        |  |      |        |      |  

At December
31, 2003, and 2002, finished goods included approximately $0.2 million and $0.5
million of inventory whose title had passed to the customer and for which
revenue has not yet been recognized.

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Property
and equipment consisted of the following (in thousands):

|                                                 |  | 2003 |         | 2002 |  
|------------------------------------------------ |  | ---- | ------- | ---- | -
|                                                 |  |      |         |      |  
|Equipment, other than
  computer                 |  | $    | 7,517   |      | $
|Software                                         |  |      | 3,657   |      |  
|Computer equipment                               |  |      | 3,115   |      |  
|Furniture and fixtures                           |  |      | 1,391   |      |  
|Leasehold improvements                           |  |      | 932     |      |  
|                                                 |  |      |         |      |  
|                                                 |  |      | 16,612  |      |  
|Less accumulated
  depreciation and amortization |  |      | (11,048 | )    |  
|                                                 |  |      |         |      |  
|Total property and
  equipment                   |  | $    | 5,564   |      | $
|                                                 |  |      |         |      |  

Depreciation
expense for the years ended December 31, 2003, 2002 and 2001 was $2.5 million,
$2.6 million and $2.3 million.

Assets
acquired under capital leases, included above (in thousands):

|                                   |  | 2003 |      | 2002 |  
|---------------------------------- |  | ---- | ---- | ---- | -
|                                   |  |      |      |      |  
|Computer equipment                 |  | $    | 350  |      | $
|Software                           |  |      | 47   |      |  
|                                   |  |      |      |      |  
|                                   |  |      | 397  |      |  
|Less accumulated
  amortization    |  |      | (397 | )    |  
|                                   |  |      |      |      |  
|Total assets under capital
  lease |  | $    |     |      | $
|                                   |  |      |      |      |  

Accrued
expenses consisted of the following (in thousands):

|                       |  | 2003 |       | 2002 |  
|---------------------- |  | ---- | ----- | ---- | -
|                       |  |      |       |      |  
|Payroll and related    |  | $    | 3,641 |      | $
|Outside services       |  |      | 935   |      |  
|Warranty               |  |      | 381   |      |  
|Royalties              |  |      | 706   |      |  
|Other                  |  |      | 840   |      |  
|                       |  |      |       |      |  
|Total accrued expenses |  | $    | 6,503 |      | $
|                       |  |      |       |      |  

The warranty liability is summarized as follows (in thousands):

|                               |  | Beginningof year |   | Charged tocost of revenue |  | Applied toliability |  | Endof year |    
|------------------------------ |  | ---------------- | - | ------------------------- |  | ------------------- |  | ---------- | ---
|                               |  |                  |   |                           |  |                     |  |            |    
|Year ended December 31,
  2003 |  |                  | $ | 331                       |  |                     |  | $          | 351
|Year ended December 31,
  2002 |  |                  | $ | 281                       |  |                     |  | $          | 300

6. Investments in and receivables from
affiliates

In 1999, we
made an initial capital contribution of $400,000 in the form of inventory into
SonoSite China Limited (SonoSite China) for a 40% ownership interest. We
accounted for this investment under the equity method of accounting.   SonoSite China is currently in the process
of being dissolved. As of December 31, 2003, our net investment balance in
SonoSite China was zero. For the years ended December 31, 2003, 2002 and 2001,
we recognized revenue from sales to SonoSite China in the amount of $0,
$262,000 and $303,000.

In 2000, we
invested $500,000 for a 19.9% common stock investment in a company from which
we were also contracting for direct sales services. We used the equity method
of accounting for this investment. In the fourth quarter of 2000, we decided to
terminate our business relationship with this affiliate when we decided to
discontinue the direct sales contract and hire the contractors as employees in
early 2001. We then accelerated our amortization of excess acquisition cost of
$475,000 to fully amortize the remaining balance in the fourth quarter of 2000
when we made this decision. We paid $1.0 million in 2001 for contract direct
sales service expenses and fees to transfer their direct sales representatives
to us. We paid them $3.4 million in 2000 for direct sales contract services. In
2002, we sold our ownership in the entity for a nominal amount.

In 2003, we
invested $90,000 into SonoSite China Medical Limited (SonoSite China Medical)
for a 30% ownership interest.  We
account for this investment under the equity method of accounting.  As of December 31, 2003, our net

48

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investment balance in SonoSite China Medical was approximately $4,000.
For the year ended December 31, 2003, we recognized revenue from sales to
SonoSite China Medical in the amount of $329,000.

7. Hedging activities

We
periodically enter into foreign currency forward contracts to reduce the impact
of adverse fluctuations on earnings associated with foreign currency exchange
rate changes. We do not enter into any derivative transaction for speculative
purposes. These contracts are not designated as cash flow, fair value or net
investment hedges under SFAS No. 133 and therefore, are marked-to-market with
changes in fair value recorded to earnings. These contracts are entered into
for periods consistent with the currency transaction exposures, generally three
months. Any gains and losses on the fair value of these contracts would be
largely offset by losses and gains on the underlying transactions.

The
currencies hedged during 2003 were the British Pound and the Euro. On December
31, 2003, we entered into foreign currency forward contracts totaling $8.7
million. All of these contracts expire on March 31, 2004 and serve as hedges of
a substantial portion of our British Pound and Euro-denominated intercompany
balances. The fair value of these contracts as of December 31, 2003 was
nominal.

Net
recognized losses from foreign currency forward contracts totaled $729,000
during 2003 and are included in other income or loss in the consolidated
statements of operations. We did not enter into any derivative instruments in
2002 or 2001.

8. Shareholders equity

Stock option plans

As of
December 31, 2003, we had the following stock compensation plans: the 1998
Nonofficer Employee Stock Option Plan (1998 NOE Plan), the 1998 Stock Option
(1998 Plan), the Nonemployee Director Stock Option Plan (Director Plan),
the Management Incentive Compensation Plan (MIC Plan), and the Adjustment
Plan. Additionally, in 2000 and 2003, we granted 95,000 options and 35,000
options outside of these plans to corporate officers, which are included within
the information presented herein and contain similar provisions to our 1998
Plan. We account for stock options issued to employees under provisions of APB
25 and therefore, to the extent the fair value of the underlying stock is equal
to or less than the exercise price on the measurement date, no compensation
expense is recognized for employee stock option grants.

If we
accounted for the costs relating to all option grants under the provisions of
SFAS No. 123, our net loss would have been $7.3 million, or $0.51 per pro forma
diluted share, in 2003, $15.2 million, or $1.16 per pro forma diluted share, in
2002 and $23.5 million, or $2.29 per pro forma diluted share, in 2001 (see Note
2).

Pro forma
compensation expense is recognized for the fair value of each option estimated
on the date of grant using the Black-Scholes multiple option pricing model. The
following assumptions were used for option grants in 2003, 2002 and 2001:
expected volatility of 58%, 60% and 63%; risk-free interest rates of 2.7%, 3.8%
and 4.5%; expected terms of 6.5 years; and zero dividend yield.

Under the
1998 NOE Plan, 1998 Plan, MIC Plan and option grants outside our stock option
plans, as of December 31, 2003, 3,092,800 total shares of common stock were
authorized primarily for issuance upon exercise of stock options at prices
equal to the fair market value of our common shares at the date of grant. As of
December 31, 2003, 335,967 shares were available for grant under these stock
option plans. In most cases, stock options issued prior to October 22, 2002 are
exercisable at 25% each year over a four-year vesting period and have a
ten-year term from the grant date. In October 2002, our Board of Directors
approved a change in the vesting schedule for employee option grants made after
October 22, 2002 so that first-time grants issued to new employees vest 25%
after one year of employment and then monthly over the next three years, and
grants made to employees after their first year of employment vest monthly over
four years. However, provisions for 377,000 options granted in 1999 allowed for
potential early vesting to occur upon the achievement of certain financial
targets in 1999 and 2000. In 1999, these financial targets were met and, as a
result, 188,500 options vested effective February 2000. These targets were not
met in 2000 and therefore the unvested portion, 188,500 options, vest four
years from their date of grant.

Under the
Director Plan, as of December 31, 2003, 110,000 shares of common stock were
authorized for issuance of stock options at prices equal to the fair market
value of our common shares at the date of grant. At December 31, 2003, there
were no shares available for grant under this Plan. Stock options are
exercisable and vest in full one year following their grant date provided the
optionee has continued to serve as our director. Each option expires on the
earlier of ten years from the grant date or 90 days following the termination
of a directors service as our director.

49

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We also
have an Adjustment Plan, which includes options granted in connection with the
dividend distribution occurring on April 6, 1998. As part of this distribution,
existing ATL option holders received one of our options for every six ATL
options held. There was no change to the intrinsic value of the option grant,
ratio of exercise price to market value, vesting provisions or option period as
a result of the distribution. As of December 31, 2003, 52,840 shares of common
stock were authorized primarily for issuance upon exercise of stock options at
prices equal to the fair market value of our common shares at the date of
grant.

Prior to
the Distribution Date, we had no stock option plans specifically identified as
our plans. All stock options granted through that date were part of ATL option
plans.

Also as
part of the distribution, restricted shares totaling zero, zero, and 459, as
determined using the exchange ratio of one of our restricted shares for every
three ATL restricted shares, were outstanding as of December 31, 2003, 2002 and
2001.

In 2003, we
granted 10,000 options to a non-employee and, in accordance with the provisions
of SFAS No. 123, calculated the fair value of the options using the
Black-Scholes valuation model based on the following assumptions for the year
ended December 31, 2003: expected volatility of 60%, risk-free interest rate of
4.2%, expected term of 10 years and zero dividend yield. For the year ended
December 31, 2003, we recorded stock-based compensation expense related to
these options of $42,000 in accordance with the accelerated methodology
described in FASB Interpretation No. 28, Accounting for Stock Appreciation
Rights and Other Variable Stock Option or Award Plans.

Summary of stock option activity

The
following table presents summary stock option activity for the years ended
December 31 (shares presented in thousands):

|                                                                        |  | 2003   |       | 2002                                  |   | 2001   | 
|----------------------------------------------------------------------- |  | ------ | ----- | ------------------------------------- | - | ------ | 
|                                                                        |  |        |       |                                       |   |        | 
|                                                                        |  | Shares |       | Weighted
  average
  exercise
  price |   | Shares | 
|                                                                        |  |        |       |                                       |   |        | 
|Outstanding,
  beginning of year                                        |  |        | 2,902 |                                       | $ | 15.18  | 
|Granted                                                                 |  |        | 628   |                                       | $ | 17.50  | 
|Exercised                                                               |  |        | (377  | )                                     | $ | 10.06  | 
|Cancelled                                                               |  |        | (233  | )                                     | $ | 18.31  | 
|                                                                        |  |        |       |                                       |   |        | 
|Outstanding,
  end of year                                              |  |        | 2,920 |                                       | $ | 16.09  | 
|                                                                        |  |        |       |                                       |   |        | 
|Exercisable,
  end of year                                              |  |        | 1,734 |                                       | $ | 15.33  | 
|                                                                        |  |        |       |                                       |   |        | 
|Weighted average fair value of options granted during
       the period |  |        |       |                                       | $ | 11.39  | 
|                                                                        |  |        |       |                                       |   |        | 

The
following is a summary of stock options outstanding as of December 31, 2003
(shares presented in thousands):

|                            |  | Options outstanding  |       | Options exercisable                                 | 
|--------------------------- |  | -------------------- | ----- | --------------------------------------------------- | 
|                            |  |                      |       |                                                     | 
|Range of 
  exercise prices |  | Number
  outstanding |       | Weighted
  average
  remaining
  contractual
  life | 
|                            |  |                      |       |                                                     | 
|$2.82 
  $6.94             |  |                      | 448   |                                                     | 
|$6.97 
  $14.47            |  |                      | 659   |                                                     | 
|$14.50 
  $16.03           |  |                      | 718   |                                                     | 
|$16.17 
  $19.70           |  |                      | 580   |                                                     | 
|$19.78 
  $34.97           |  |                      | 515   |                                                     | 
|                            |  |                      |       |                                                     | 
|                            |  |                      | 2,920 |                                                     | 
|                            |  |                      |       |                                                     | 

Stock purchase rights

On April 6,
1998, we and First Chicago Trust Company of New York (First Chicago) entered
into a Rights Agreement. The Rights Agreement was subsequently amended on
October 24, 2001 to reflect that EquiServe Trust Company, N.A. had succeeded
First Chicago as the rights agent. The Rights Agreement has certain
anti-takeover provisions, which will cause substantial dilution to a person or
group that attempts to acquire us.  
Under the Rights Agreement, each of our shareholders has one share
purchase right for each share of common stock held, with each right having an
exercise price approximating our board of directors estimate of the long-term
value of one share of our common stock. The rights are triggered if an acquiror
acquires, or successfully makes a tender offer for, 20% or more of our
outstanding common stock. In such event, each shareholder other than the
acquiror would have the right to purchase, at the exercise price, a number of
newly issued shares of our capital stock at a 50% discount. If the acquiror
were to acquire 50% or more of our assets or earning power, each shareholder
would have the right to purchase, at the exercise

50

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price, a number of shares of acquirors stock at a 50% discount. Our
board of directors may redeem the rights at a nominal cost at any time before a
person acquires 20% or more of our outstanding common stock, which allows
board-approved transactions to proceed. In addition, our board of directors may
exchange all or part of the rights (other than rights held by the acquiror) for
such number of shares of our common stock equal in value to the exercise price.
Such an exchange produces the desired dilution without actually requiring our
shareholders to purchase shares.

Warrants

In 1999, we
issued 15,000 warrants to non-employee consultants in connection with marketing
work performed. These warrants had exercise prices of $11.44 and vested one
year from their date of grant. During 2000, all these warrants were exercised
through a cashless exercise, which resulted in the issuance of 8,877 shares of
common stock. As of December 31, 2003, no warrants were outstanding.

9. Financing

In May
2002, we sold 2,700,000 shares of common stock at a price of $17.25 per share.
Net proceeds from this sale were $42.6 million. In August 2001, we sold
1,666,667 shares of common stock at a price of $15.00 per share to selected
institutional and other accredited investors. Net proceeds from this private
placement were $23.1 million.

10. Income taxes

For income
tax purposes, our results through the Distribution Date were included in the
consolidated federal income tax return of ATL and, accordingly, the net
operating loss generated prior to the Distribution Date is not available to us
for use in periods subsequent to the Distribution Date. During the period from
the Distribution Date through December 31, 2003, we accumulated domestic net
operating loss carryforwards of approximately $65.2 million, foreign net
operating loss carryforwards of approximately $8.9 million and research and experimentation
tax credit carryforwards of approximately $2.5 million. These carryforwards
begin expiring in 2018 and will be fully expired in 2023. Approximately $8.9
million of the domestic net operating loss carryforwards result from stock
option deductions which, when and if realized, would result in a credit to
shareholders equity.

Because we
have incurred losses since inception, a valuation allowance entirely offsetting
deferred tax assets has been established, thereby eliminating any deferred tax
benefit. The increase in the valuation allowance of $0.2 million in 2003,
$2.1 million in 2002, and $6.9 million in 2001 is primarily the result of
increasing net operating loss carryforwards. Under certain provisions of the
Internal Revenue Code of 1986, as amended, the availability of our net
operating loss and tax credit carryforwards may be subject to limitation if it
should be determined that there has been a change in ownership of more than
50%. Such determination could limit the utilization of net operating loss and
tax credit carryforwards.

The tax
effects of temporary differences and carryforwards that give rise to
significant portions of deferred tax assets and deferred tax liabilities at
December 31 are as follows (in thousands):

|                                                          |              | 2003 |         | 2002 |  
|--------------------------------------------------------- | ------------ | ---- | ------- | ---- | -
|                                                          |              |      |         |      |  
|Deferred tax assets:                                      |              |      |         |      |  
|Domestic net operating loss
  carryforwards               |              | $    | 22,065  |      | $
|Foreign net operating loss
  carryforwards                |              |      | 3,011   |      |  
|Research and
  experimentation tax credit carryforwards   |              |      | 2,517   |      |  
|Capital loss carryforwards                                |              |      | 88      |      |  
|Allowances and accruals not
  recognized for tax purposes |              |      | 649     |      |  
|Other                                                     |              |      | 494     |      |  
|                                                          |              |      |         |      |  
|Gross deferred tax assets                                 |              |      | 28,824  |      |  
|Valuation allowance                                       |              |      | (28,634 | )    |  
|                                                          |              |      |         |      |  
|                                                          |              |      | 190     |      |  
|Deferred tax liabilities:                                 |              |      |         |      |  
|                                                          | Depreciation |      |         | (190 | )
|                                                          |              |      |         |      |  
|Net deferred tax assets                                   |              | $    |        |      | $
|                                                          |              |      |         |      |  
|                                                          |              |      |         |      |  

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11. Employee Benefit Plan

401(k) Retirement Savings Plan

All our
employees in the United States are eligible to participate in our 401(k) Plan.
Terms of the 401(k) Plan permit an employee to contribute up to a maximum of
16% of an employees annual compensation on a post-tax or pre-tax basis, up to
the maximum permissible by the Internal Revenue Service (IRS) during any plan
year. We match each employees contribution in increments equivalent to 100%
for the first 3% and 50% for the second 3% of the employees contribution
percentage. In 2003, 2002 and 2001, we contributed $859,000, $802,000 and
$540,000 in matching contributions to the 401(k) Plan in accordance with the
plans terms. Employees immediately vest in the contributions the employee
makes. Vesting in our contribution on behalf of the employee occurs at equal
increments at the end of each year of the first five years of an employees
service with us.

12. Commitments and contingencies

Indemnification Obligations and Guarantees

We apply
the disclosure provisions of FIN 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others to our agreements that contain guarantee or indemnification clauses. We
provide (i) indemnifications of varying scope and size to our customers and
distributors against claims of intellectual property infringement made by third
parties arising from the use of our products; (ii) indemnifications of varying
scope and size to our customers against third party claims arising as a result
of defects in our products; (iii) indemnifications of varying scope and size to
consultants against third party claims arising from the services they provide
to us; and (iv) guarantees to support obligations of some of our subsidiaries
such as lease payments. These indemnifications and guarantees give rise only to
the disclosure provisions of FIN 45.

To date, we
have not incurred material costs as a result of these obligations and do not
expect to incur material costs in the future. 
Accordingly, we have not accrued any liabilities in our financial statements related to these
indemnifications or guarantees.

Operating leases

We
currently lease office and manufacturing space under operating leases. As of
December 31, 2003, future minimum lease payments are as follows (in thousands):

|2004       |  | $ | 1,513 | 
|---------- |  | - | ----- | 
|2005       |  |   | 1,524 | 
|2006       |  |   | 1,426 | 
|2007       |  |   | 815   | 
|2008       |  |   | 241   | 
|Thereafter |  |   | 944   | 
|           |  |   |       | 
|           |  | $ | 6,463 | 
|           |  |   |       | 

Rent
expense for the years ended December 31, 2003, 2002, and 2001 was $1.4 million,
$1.1 million and $1.0 million.

Capital lease obligations

We entered
into certain long-term obligations to finance the purchase of capital equipment
as part of our normal business operations. Original terms of the obligations
range from 18 to 48 months and have imputed interest rates ranging between 10%
and 15%. Obligations are secured by underlying assets. The following is a
summary of the capital lease obligations and the related future minimum
payments as of December 31, 2003 (in thousands):

|Total lease payments due in
  2004                              |  | $ | 92 |  
|--------------------------------------------------------------- |  | - | -- | -
|Less amount representing
  interest                             |  |   | (4 | )
|                                                                |  |   |    |  
|Present value of net
  minimum capital lease payments - current |  | $ | 88 |  
|                                                                |  |   |    |  

Other commitments

As part of
our agreements with our suppliers, suppliers may procure resources and material
expected to be used for the manufacture of our product in accordance with our
production schedule provided to them. In the event these items are not used in
the quantities submitted as part of the production schedule or material becomes
obsolete as a result of production

52

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---

timing, material changes or design changes, we may be responsible for
compensating our suppliers for these procurements. As of December 31, 2003,
these commitments were not significant.

As part of
obtaining our lease for our current facility, we were required to deposit
approximately $350,000, representing restricted cash with our bank. Also, we
were required to maintain a deposit of approximately $310,000 with our bank in
the United Kingdom as security for payment of customs and duties charges. Both
amounts are included in other long-term assets.

In the
United States, we have complemented our direct sales efforts by entering into
group purchasing agreements with major healthcare group purchasing
organizations, or GPOs. Typically, a GPO negotiates with medical suppliers,
such as us, on behalf of the GPOs member healthcare facilities, providing such
members with uniform pricing and terms and conditions. In exchange, the GPO
identifies us as a preferred supplier for its members. Member facilities participating
in the GPOs purchasing program can consist of hospitals, medical group
practices, nursing homes, surgery centers, managed care organizations, long
term care facilities, clinics and integrated delivery networks. Currently, we
have GPO supply agreements with AmeriNet, Inc., Novation, LLC, Premier, Inc.,
Broadlane, Inc. (includes Kaiser Permanente, Tenet Healthcare and others) and
Consorta, Inc. We recorded sales and marketing expenses related to these
agreements in the amounts of approximately $568,000 in 2003, $512,000 in 2002
and $236,000 in 2001.

Contingencies

We have
obtained approval from the U.S. Food and Drug Administration (FDA) to sell
and distribute our product domestically. However, we cannot assure you that the
FDA will approve future product submissions by us. Additionally, international
sales and distribution are dependent upon our obtaining approval of certain
foreign regulatory agencies. We have obtained approval from many of these
agencies; however, we cannot assure you that we will obtain approval from other
foreign regulatory agencies from which we seek approval in the future, on a
timely basis, or if at all.

On
July 24, 2001, Neutrino Development Corporation filed a complaint against us in
U.S. District Court, Southern District of Texas, Houston Division, alleging
infringement of U.S. Patent 6,221,021, or the 021 patent, by SonoSite as a
result of our use, sale and manufacture of the SonoSite 180, SonoSite 180 PLUS,
SonoHeart and SonoHeart PLUS devices. The complaint asserts claims for
preliminary and permanent injunctive relief enjoining all alleged acts of
infringement, compensatory and enhanced damages, attorneys fees and costs, and
pre- and post-judgment interest. On August 14, 2001, we filed an answer asserting
affirmative defenses of non-infringement and patent invalidity, and included a
counterclaim seeking a declaratory judgment of non-infringement and invalidity
regarding Neutrinos patent. On October 4, 2001, the court denied a request by
Neutrino for preliminary injunctive relief to prevent us from manufacturing and
selling our products pending the ultimate disposition of the litigation. On
February 20, 2002, in what is known as a Markman hearing, the parties
presented their arguments regarding the proper construction of Neutrinos
patent claims.

On August
20, 2003, the U.S. District Court in the Southern District of Texas issued a
decision interpreting certain terms used in the 021 patent. This decision does
not discuss whether the patent is valid or whether the patent would apply to
any of our products. In the order, the court, in resolving disputed terms in
the Markman hearing, adopted our construction of the term a portable body
designed to be hand held, and adopted Neutrinos construction of the terms
the moveably connected transducer mounting assembly and ultrasound emitter.
The court denied our motion for summary judgment.  We subsequently filed a new summary judgment motion using the
courts construction of the claim language that the 021 patent is invalid
based on prior art. Neutrino has filed a summary judgment motion based on its
allegations of infringement.

We
also have asked the Texas court to stay proceedings in Neutrinos suit filed in
the Middle District of Florida on August 19, 2003 against a former SonoSite
distributor alleging that the sale of our products by such distributor
infringes the 021 patent, and to enjoin Neutrino from filing similar suits
against other sellers of SonoSite products. Neutrino had previously filed such
a suit in the Middle District of Tennessee against another medical device
distributor for selling a SonoSite product. That Tennessee case has been
dismissed based on a final judgment and permanent injunction filed a month
after the case was filed. The Tennessee judgment has no effect on the Texas
proceedings. In the Florida action, we have filed a motion to stay the
proceedings in the Florida court pending a final resolution of the patent suit
in Texas. We have also filed a motion to strike certain counts of Neutrinos
complaint.

We
believe that we have good and sufficient defenses to the claims of patent
infringement asserted against us by Neutrino and we are vigorously defending
ourselves in these matters. If we are not successful in our defense of these
claims, we could be forced to modify or discontinue selling our products or may
enter into royalty or licensing agreements, which may not be available on terms
acceptable to us, if at all, and which could adversely affect our financial

53

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---

condition, results of operations and cash flow.
Sales of the allegedly infringing products represented the majority of our
revenue for the years ended December 31, 2003, 2002 and 2001.

We do not
consider a negative litigation outcome to be probable and have not accrued any
amounts for potential losses related to these proceedings. Because of
uncertainties related to both the amount and range of loss on the pending
litigation, management is unable to make a reasonable estimate of the liability
that could result from an unfavorable outcome. As additional information
becomes available, we will assess the potential liability related to its
pending litigation. We will record accruals for losses if and when we determine
the negative outcome of such matters to be probable and reasonably estimable.
Our estimates regarding such losses could differ from actual results. Revisions
in our estimates of the potential liability could materially impact our results
of operations, financial position and cash flow.

13. Segment reporting

We
currently have one reporting segment. We market our products in the United
States and internationally through our direct sales force and our indirect
distribution channels. Our chief operating decision maker evaluates resource allocation
decisions and our performance based upon revenue recorded in geographic regions
and does not receive financial information about expense allocation on a
disaggregated basis. Geographic regions are determined by the shipping
destination. Revenue by geographic location for the years ended December 31 is
as follows (in thousands):

|                                                           |  | 2003 |        | 2002 |   | 2001   | 
|---------------------------------------------------------- |  | ---- | ------ | ---- | - | ------ | 
|                                                           |  |      |        |      |   |        | 
|United States                                              |  | $    | 52,369 |      | $ | 42,586 | 
|Europe, Africa and the
  Middle East                       |  |      | 21,327 |      |   | 14,849 | 
|Japan                                                      |  |      | 1,622  |      |   | 7,464  | 
|Other Asia (a)                                             |  |      | 4,367  |      |   | 4,468  | 
|Canada, Australia, South America and
        Latin America |  |      | 5,085  |      |   | 3,668  | 
|                                                           |  |      |        |      |   |        | 
|Total revenue                                              |  | $    | 84,770 |      | $ | 73,035 | 
|                                                           |  |      |        |      |   |        | 

(a)  Other Asia includes primarily China, Taiwan, India and
Korea.

Long-lived
assets, excluding financial instruments, by geographic location as of December
31 are as follows (in thousands):

|                        |  | 2003 |       | 2002 |   | 2001  | 
|----------------------- |  | ---- | ----- | ---- | - | ----- | 
|                        |  |      |       |      |   |       | 
|Long-lived assets:      |  |      |       |      |   |       | 
|United States           |  | $    | 5,374 |      | $ | 5,889 | 
|International           |  |      | 520   |      |   | 315   | 
|                        |  |      |       |      |   |       | 
|Total long-lived assets |  | $    | 5,894 |      | $ | 6,204 | 
|                        |  |      |       |      |   |       | 

Net assets
of our international operations were approximately $17.4 million and $10.0
million at December 31, 2003 and 2002.

54

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14. Quarterly resultsunaudited

|      |                                                                     | For the three months ended,              |  
|----- | ------------------------------------------------------------------- | ---------------------------------------- | -
|      |                                                                     |                                          |  
|      |                                                                     | March 31                                 |  
|      |                                                                     |                                          |  
|      |                                                                     | (in thousands, except per share amounts) |  
|2003: |                                                                     |                                          |  
|      | Revenue                                                             |                                          | $
|      | Cost of
  revenue                                                   |                                          |  
|      |                                                                     |                                          |  
|      | Gross margin                                                        |                                          |  
|      | Operating
  expenses                                                |                                          |  
|      | Other income                                                        |                                          |  
|      |                                                                     |                                          |  
|      | Net income
  (loss)                                                 |                                          | $
|      |                                                                     |                                          |  
|      | Basic net
  income (loss) per share                                 |                                          | $
|      |                                                                     |                                          |  
|      | Diluted net
  income (loss) per share                               |                                          | $
|      |                                                                     |                                          |  
|      | Shares used
  in computation of basic net income (loss) per share   |                                          |  
|      |                                                                     |                                          |  
|      | Shares used
  in computation of diluted net income (loss) per share |                                          |  
|      |                                                                     |                                          |  
|2002: |                                                                     |                                          |  
|      | Revenue                                                             |                                          | $
|      | Cost of
  revenue                                                   |                                          |  
|      |                                                                     |                                          |  
|      | Gross margin                                                        |                                          |  
|      | Operating
  expenses                                                |                                          |  
|      | Other income
  (loss)                                               |                                          |  
|      |                                                                     |                                          |  
|      | Net income
  (loss)                                                 |                                          | $
|      |                                                                     |                                          |  
|      | Basic net
  income (loss) per share                                 |                                          | $
|      |                                                                     |                                          |  
|      | Diluted net
  income (loss) per share                               |                                          | $
|      |                                                                     |                                          |  
|      | Shares used
  in computation of basic net income (loss) per share   |                                          |  
|      |                                                                     |                                          |  
|      | Shares used
  in computation of diluted net income (loss) per share |                                          |  
|      |                                                                     |                                          |  

The
quarterly information presented above reflects, in the opinion of management,
all adjustments necessary (which are of a normal and recurring nature) for a
fair presentation of the results for the interim period presented.

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

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and
procedures

The term
disclosure controls and procedures is defined in Rules 13a-15(e) and
15d-15(e) of the Exchange Act. These rules refer to the controls and other
procedures of a company that are designed to ensure that the information
required to be disclosed by a company in the reports that it files under the
Exchange Act is recorded, processed, summarized and reported within required
time periods. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed in our Exchange Act reports is accumulated and communicated to management,
including our principal executive officer and our chief financial officer, as
appropriate to allow timely decisions regarding required disclosure.

Our chief
executive officer and our chief financial officer have evaluated the
effectiveness of our disclosure controls and procedures as of December 31,
2003, and they have concluded that our disclosure controls and procedures were
effective.

Changes in internal controls

There were
no significant changes in SonoSites internal controls over financial reporting
or, to SonoSites knowledge, in other factors that could significantly affect
SonoSites disclosure controls and procedures during the quarter ended December
31, 2003.

55

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF
THE REGISTRANT

The
information required by this Item is included in our proxy statement for our
2004 annual meeting of shareholders and is incorporated by reference. The
information appears in the proxy statement under the headings Election of Directors
and Executive Officers. We will file the proxy statement within 120 days of
December 31, 2003.

ITEM 11. EXECUTIVE COMPENSATION

The
information required by this Item is included in our proxy statement for our
2004 annual meeting of shareholders and is incorporated by reference. The
information appears in the proxy statement under the heading Executive
Compensation. We will file the proxy statement within 120 days of December 31,
2003.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT

The
information required by this Item is included in our proxy statement for our
2004 annual meeting of shareholders and is incorporated by reference. The
information appears in the proxy statement under the heading Security
Ownership of Certain Beneficial Owners and Management. We will file the proxy
statement within 120 days of December 31, 2003.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS

The
information required by this Item is included in our proxy statement for our
2004 annual meeting of shareholders and is incorporated by reference. The
information appears in the proxy statement under the heading Certain
Relationships and Related Transactions. We will file the proxy statement
within 120 days of December 31, 2003.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES

The
information required by this Item is included in our proxy statement for our
2004 annual meeting of shareholders and is incorporated by reference. The
information appears in the proxy statement under the heading Fee Disclosures.
We will file the proxy statement within 120 days of December 31, 2003.

56

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PART IV

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

| | (a)
  Documents filed as part of this report:                                                
| | ---------------------------------------------------------------------------------------------
| |                                                                                              
| | (1)   Financial
  StatementsSee Index to Financial Statements under Item 8 of this Report.
| |                                                                                              
| | (2)   Financial
  Statement Schedule.                                                        
| |                                                                                              

Schedule II
Valuation and Qualifying Accounts

|                                  |  | Balance at
  beginning
  of year |       | Additions charged
  to general and
  administrative
  expense |  | Deductions |     | Balance at
  end of year | 
|--------------------------------- |  | -------------------------------- | ----- | ------------------------------------------------------------- |  | ---------- | --- | ------------------------ | 
|                                  |  |                                  |       |                                                               |  |            |     |                          | 
|                                  |  | (in thousands)                   |      
|Year ended
  December 31, 2003:   |  |                                  |       |                                                               |  |            |     |                          | 
|Allowance for doubtful
  accounts |  | $                                | 832   |                                                               |  | $          | 141 |                          | 
|Year ended
  December 31, 2002:   |  |                                  |       |                                                               |  |            |     |                          | 
|Allowance for doubtful
  accounts |  | $                                | 1,034 |                                                               |  | $          | 412 |                          | 
|Year ended
  December 31, 2001:   |  |                                  |       |                                                               |  |            |     |                          | 
|Allowance for doubtful
  accounts |  | $                                | 723   |                                                               |  | $          | 486 |                          | 

| | (3)   Exhibits.
| | ---------------

|Exhibit
  No. |  | Description                                                                                                                                                                 
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|              |  |                                                                                                                                                                             
|3.1(A)        |  | Restated Articles of
  Incorporation of the registrant (exhibit 3.1)                                                                                                        
|3.3(E)        |  | Amended and Restated Bylaws
  of the registrant (exhibit 3.1)                                                                                                               
|4.1(A)        |  | Rights Agreement between
  First Chicago Trust Company and the registrant, dated April 6, 1998 (exhibit
  4.1)                                                              
|4.2(E)        |  | Amendment to Rights
  Agreement, dated August 8, 2001 (exhibit 4.2)                                                                                                         
|4.3(F)        |  | Amendment to Rights
  Agreement, dated October 24, 2001 (exhibit 4.3)                                                                                                       
|4.4(I)        |  | Amendment to Rights
  Agreement, dated August 25, 2003 (exhibit 4.1)                                                                                                        
|10.1(G)       |  | 1998 Stock Option, as
  amended and restated (exhibit 10.1)                                                                                                                 
|10.2(A)       |  | Terms of Stock Option Grant
  Program for Nonemployee Directors under the SonoSite, Inc. 1998 Stock Option
  Plan (exhibit 10.2)                                            
|10.3(H)       |  | 1998 Nonofficer Employee
  Stock Option Plan, as amended and restated (exhibit 10.1)                                                                                        
|10.4(E)       |  | Nonemployee Director Stock
  Option Plan, as amended and restated (exhibit 10.3)                                                                                            
|10.5(C)       |  | Management Incentive
  Compensation Plan (exhibit 10.5)                                                                                                                     
|10.6(B)       |  | Adjustment Plan (exhibit
  10.6)                                                                                                                                            
|10.7(A)       |  | Form of Senior Management
  Employment Agreement between the registrant and each of Kevin M. Goodwin,
  Michael J. Schuh and Bradley G. Garrett (exhibit 10.7)              
|10.8(A)       |  | Technology Transfer and
  License Agreement between ATL Ultrasound, Inc. and the registrant, effective
  as of April 6, 1998, as amended (exhibit 10.9)                     
|10.9(F)       |  | Third Amendment to
  Technology Transfer and License Agreement between ATL Ultrasound, Inc. and
  the registrant, dated as of March 10, 2000 (exhibit 10.9)                 
|10.10(D)      |  | Lease Agreement between
  Riggs & Company, a division of Riggs Bank N.A., and the registrant, dated
  December 28, 1999 (exhibit 10.14)                                     
|10.11(D)*     |  | Distribution Agreement
  between Olympus Optical Co. Ltd. and the registrant, dated August 1, 1999
  (exhibit 10.15)                                                        
|10.12(F)      |  | Assignment of Distribution
  Agreement by and among Olympus Optical Co., Ltd., Olympus Promarketing, Inc.
  and the registrant, effective September 18, 2001 (exhibit 10.12)
|10.13(J)      |  | Option Notice Agreement,
  dated July 17, 2000, between the registrant and Daniel Walton (exhibit 99.1)                                                                     
|10.14(J)      |  | Option Notice Agreement,
  dated July 24, 2000, between the registrant and Michael J. Shuh (exhibit
  99.2)                                                                 
|10.15(K)      |  | Option Notice Agreement,
  dated September 11, 2003, between the registrant and Henry (Skip) Krause
  (exhibit 99.1)                                                        

57

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---

|10.16(K) |  | Option Notice Agreement,
  dated September 22, 2003, between the registrant and Marla Koreis (exhibit
  99.2)                      
|-------- |  | -----------------------------------------------------------------------------------------------------------------------------------
|21.1    |  | Subsidiaries of the
  registrant                                                                                                   
|23.1    |  | Consent of KPMG LLP,
  independent auditors                                                                                        
|24.1    |  | Power of attorney
  (contained on signature page)                                                                                  
|31.1    |  | Certification
  of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
  Act of 2002                         
|31.2    |  | Certification
  of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
  Act of 2002                         
|32.1    |  | Certification
  of Principal Executive Officer pursuant to 18 U.S.C. Section 1350 (Section
  906 of the Sarbanes-Oxley Act of 2002)
|32.2    |  | Certification
  of Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (Section
  906 of the Sarbanes-Oxley Act of 2002)

|   | Filed herewith.                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*   | Confidential treatment
  requested.                                                                                                                                                               
|(A) | Incorporated by reference
  to the designated exhibit included in SonoSites Registration Statement on
  Form S-1 (Registration No. 333-74157) filed on October 3, 1999.                          
|(B) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 10 (SEC File
  No. 000-23791) filed on March 19, 1998.                                                
|(C) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 10-K for the
  year ended December 31, 1998 (SEC File No. 000-23791) filed on March 22,
  1999.       
|(D) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 10-K for the
  year ended December 31, 1999 (SEC File No. 000-23791) filed on March 30,
  2000.       
|(E) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 10-Q for the
  quarter ended September 30, 2001 (SEC File No. 000-23791) filed on November
  13, 2001.
|(F) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 10-K for the year
  ended December 31, 2001 (SEC File No. 000-23791) filed on February 22, 2002.      
|(G) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 10-Q for the
  quarter ended March 31, 2002 (SEC File No. 000-23791) filed on May 13, 2002.           
|(H) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 10-Q for the
  quarter ended June 30, 2002 (SEC File No. 000-23791) filed on August 13,
  2002.       
|(I) | Incorporated by reference
  to the designated exhibit included in SonoSites report on Form 8-K (SEC File
  No. 000-23791) filed on August 26, 2003.                                              
|(J) | Incorporated by reference
  to the designated exhibit included in SonoSites registration statement on
  Form S-8 (Registration No. 333-51820) filed on December 14, 2000.                        
|(K) | Incorporated by reference
  to the designated exhibit included in SonoSites registration statement on
  Form S-8 (Registration No. 110913) filed on December 4, 2003.                            

(b) Reports on Form 8-K

On
October 14, 2003, we
furnished a Current Report on Form 8-K, dated October 13, 2003, (a)
furnishing under Item 12 thereof certain preliminary results of our operations
for the quarter ended September 30, 2003 and (b) furnishing as exhibits
under Item 7 thereof the related press release dated October 13, 2003.

On
October 16, 2003, we furnished a Current Report on Form 8-K, dated October 14, 2003,
(a) reporting under Item 12 thereof that a conference call was held on October
14, 2003 announcing certain preliminary results of our operations for the
quarter ended September 30, 2003 and (b) furnishing as exhibits
under Item 7 thereof the related transcript for the conference call and the
related transcript of the question and answer session from the conference call.

On
October 30, 2003, we furnished a Current Report on Form 8-K, dated October 30,
2003, (a) furnishing under Item 12 thereof the results of our operations for
the quarter ended September 30, 2003 and (b) furnishing as exhibits under Item
7 thereof the related press release dated October 30, 2003.

58

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SIGNATURES

Pursuant to
the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

| | SONOSITE,
  INC.
| | ----------------
| |                 
| | By              
| |                 
| |                 

Date: March
12, 2004

POWER OF ATTORNEY

Each person
whose individual signature appears below hereby authorizes and appoints Kevin
M. Goodwin and Michael J. Schuh, and each of them, with full power of
substitution and resubstitution and full power to act without the other, as his
true and lawful attorney-in-fact and agent to act in his name, place and stead
and to execute in the name and on behalf of each person, individually and in
each capacity stated below, and to file, any and all amendments to this report,
and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing, ratifying and
confirming all that said attorneys-in-fact and agents or any of them or their
or his substitute or substitutes may lawfully do or cause to be done by virtue
thereof.

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 Company and in the
capacities indicated below on the 12th day of March 2004.

|/S/    KIRBY L. CRAMER             |  | Chairman of
  the Board                                                                                              
|---------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------
|                                   |  |                                                                                                                      
|Kirby L. Cramer                    |  |                                                                                                                      
|                                   |  |                                                                                                                      
|                                  
|/S/    KEVIN M. GOODWIN            |  | President,
  Chief Executive Officer and Director 
      (Principal Executive Officer)                               
|                                   | 
|Kevin M. Goodwin                   | 
|                                   |  |                                                                                                                      
|                                  
|/S/    MICHAEL J. SCHUH            |  | Vice
  President-Finance, Chief Financial Officer, and
      Treasurer (Principal Financial and Accounting
  Officer)
|                                   | 
|Michael J. Schuh                   | 
|                                   |  |                                                                                                                      
|                                  
|/S/  EDWARD V. FRITZKY             |  | Director                                                                                                             
|                                   |  |                                                                                                                      
|Edward V. Fritzky                  |  |                                                                                                                      
|                                  
|                                   |  |                                                                                                                      
|/S/    STEVEN R. GOLDSTEIN, M.D.   |  | Director                                                                                                             
|                                   |  |                                                                                                                      
|Steven R. Goldstein, M.D.          |  |                                                                                                                      
|                                  
|                                   |  |                                                                                                                      
|/S/    Robert G. Hauser, M.D.      |  | Director                                                                                                             
|                                   |  |                                                                                                                      
|Robert G. Hauser, M.D.             |  |                                                                                                                      
|                                  
|                                   |  |                                                                                                                      
|/S/    WILLIAM G. PARZYBOK, JR.    |  | Director                                                                                                             
|                                   |  |                                                                                                                      
|William G. Parzybok, Jr.           |  |                                                                                                                      
|                                  
|                                   |  |                                                                                                                      
|/S/    JEFFREY PFEFFER, PH.D.      |  | Director                                                                                                             
|                                   |  |                                                                                                                      
|Jeffrey Pfeffer, Ph.D.             |  |                                                                                                                      
|                                  
|                                   |  |                                                                                                                      
|/S/    RICHARD S. SCHNEIDER, PH.D. |  | Director                                                                                                             
|                                   |  |                                                                                                                      
|Richard S. Schneider, Ph.D.        |  |                                                                                                                      
|                                  
|                                   |  |                                                                                                                      
|/S/    JACQUES SOUQUET, PH.D.      |  | Director                                                                                                             
|                                   |  |                                                                                                                      
|Jacques Souquet, Ph.D.             |  |                                                                                                                      

59

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INDEX
TO EXHIBITS

|Exhibit 
  No. |  | Description                                                                                                                                                                                  
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|               |  |                                                                                                                                                                                              
|3.1(A)         |  | Restated Articles of
  Incorporation of the registrant (exhibit 3.1)                                                                                                                         
|3.3(E)         |  | Amended and Restated Bylaws
  of the registrant (exhibit 3.1)                                                                                                                                
|4.1(A)         |  | Rights Agreement between
  First Chicago Trust Company and the registrant, dated April 6, 1998 (exhibit
  4.1)                                                                               
|4.2(E)         |  | Amendment to Rights
  Agreement, dated August 8, 2001 (exhibit 4.2)                                                                                                                          
|4.3(F)         |  | Amendment to Rights
  Agreement, dated October 24, 2001 (exhibit 4.3)                                                                                                                        
|4.4(I)         |  | Amendment to Rights Agreement,
  dated August 25, 2003 (exhibit 4.1)                                                                                                                         
|10.1(G)        |  | 1998 Stock Option, as
  amended and restated (exhibit 10.1)                                                                                                                                  
|10.2(A)        |  | Terms of Stock Option Grant
  Program for Nonemployee Directors under the SonoSite, Inc. 1998 Stock Option
  Plan (exhibit 10.2)                                                             
|10.3(H)        |  | 1998 Nonofficer Employee
  Stock Option Plan, as amended and restated (exhibit 10.1)                                                                                                         
|10.4(E)        |  | Nonemployee Director Stock
  Option Plan, as amended and restated (exhibit 10.3)                                                                                                             
|10.5(C)        |  | Management Incentive
  Compensation Plan (exhibit 10.5)                                                                                                                                      
|10.6(B)        |  | Adjustment Plan (exhibit
  10.6)                                                                                                                                                             
|10.7(A)        |  | Form of Senior Management
  Employment Agreement between the registrant and each of Kevin M. Goodwin,
  Michael J. Schuh and Bradley G. Garrett (exhibit 10.7)                               
|10.8(A)        |  | Technology Transfer and
  License Agreement between ATL Ultrasound, Inc. and the registrant, effective
  as of April 6, 1998, as amended (exhibit 10.9)                                      
|10.9(F)        |  | Third Amendment to
  Technology Transfer and License Agreement between ATL Ultrasound, Inc. and
  the registrant, dated as of March 10, 2000 (exhibit 10.9)                                  
|10.10(D)       |  | Lease Agreement between
  Riggs & Company, a division of Riggs Bank N.A., and the registrant, dated
  December 28, 1999 (exhibit 10.14)                                                      
|10.11(D)*      |  | Distribution Agreement
  between Olympus Optical Co. Ltd. and the registrant, dated August 1, 1999
  (exhibit 10.15)                                                                         
|10.12(F)       |  | Assignment of Distribution
  Agreement by and among Olympus Optical Co., Ltd., Olympus Promarketing, Inc.
  and the registrant, dated effective October 5September 18, 2001 (exhibit
  10.12)
|10.13(J)       |  | Option Notice Agreement,
  dated July 17, 2000, between the registrant and Daniel Walton (exhibit 99.1)                                                                                      
|10.14(J)       |  | Option Notice Agreement,
  dated July 24, 2000, between the registrant and Michael J. Shuh (exhibit
  99.2)                                                                                  
|10.15(K)       |  | Option Notice Agreement,
  dated September 11, 2003, between the registrant and Henry (Skip) Krause
  (exhibit 99.1)                                                                         
|10.16(K)       |  | Option Notice Agreement,
  dated September 22, 2003, between the registrant and Marla Koreis (exhibit
  99.2)                                                                                
|21.1          |  | Subsidiaries of the
  registrant                                                                                                                                                             
|23.1          |  | Consent of KPMG LLP,
  independent auditors                                                                                                                                                  
|24.1          |  | Power of attorney
  (contained on signature page)                                                                                                                                            
|31.1          |  | Certification
  of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
  Act of 2002                                                                                   
|31.2          |  | Certification
  of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
  Act of 2002                                                                                   
|32.1          |  | Certification
  of Principal Executive Officer pursuant to 18 U.S.C. Section 1350 (Section
  906 of the Sarbanes-Oxley Act of 2002)                                                          
|32.2          |  | Certification
  of Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (Section
  906 of the Sarbanes-Oxley Act of 2002)                                                          

|   
|---
|  
|*  
|(A)
|(B)
|(C)
|(D)
|(E)
|(F)
|(G)
|(H)

60

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|    | 000-23791) filed on August
  13, 2002.                                                                                                                                                    
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(I) | Incorporated by reference
  to the Exhibit 4.1designated exhibit included in SonoSites report on Form
  8-K filed on August 26, 2003 (SEC File No. 000-23791) filed on August 26,
  2003.
|(J) | Incorporated by reference
  to the designated exhibit included in SonoSites registration statement on
  Form S-8 (Registration No. 333-51820) filed on December 14, 2000.                
|(K) | Incorporated by reference
  to the designated exhibit included in SonoSites registration statement on
  Form S-8 (Registration No. 110913) filed on December 4, 2003.                    

61

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