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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 1934

||X| |  | Annual report pursuant
to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended
December 31, 2002
|--- |  | --------------------------------------------------------------------------------------------------------------------------------

||_| |  | Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|--- |  | ----------------------------------------------------------------------------------------

# for the transition period from ____________ to ____________.

# Commission file no. 0-23791

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

|Washington(State or other jurisdictionof
incorporation or organization) | 91-1405022(I.R.S. EmployerIdentification Number)
|----------------------------------------------------------------------- | ------------------------------------------------

21919 30th Drive SEBothell,
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 classNone | Name of exchange on which registeredNot 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 |_|

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

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

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 28, 2002, as reported on the Nasdaq National Market, was
$169,485,083.

As
of March 21, 2003, there were 14,216,446 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 2003,
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-KTABLE OF CONTENTS

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|Item 3.  |         
|Item 4.  |         
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|PART II  |         
|Item 5.  |         
|Item 6.  |         
|Item 7.  |         
|         |         
|Item 7A. |         
|Item 8.  |         
|Item 9.  |         
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|        
|PART III |         
|Item 10. |         
|Item 11. |         
|Item 12. |         
|Item 13. |         
|Item 14. |         
|        
|PART IV  |         
|Item 15. |         

## Trademarks

SonoSite®
is the registered trademark of SonoSite, Inc. The stylized SonoSite logo,
iLook, SonoHeart ELITE, SonoSite 180PLUS, SiteStand,
SiteLink, S.I.T.E., OnSite and SonoKnowledge are
trademarks of SonoSite, Inc. All other brand names, trademarks or service marks
referred to in this report are the property of their owners.

1

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# PART I

Our
disclosure and analysis in this report and in our 2002 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 provider of point-of-care, high performance, all-digital
ultrasound imaging systems for use in a variety of clinical applications and
settings. Our proprietary technologies have enabled us to design point-of-care
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 portability, high quality 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 the point of care such as the patients bedside or the physicians
examining table.

The
size and complexity of traditional ultrasound systems typically compel
physicians to refer patients to a highly trained sonographer employed by an
imaging center, 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.

We
currently focus on six key market segments: radiology, obstetrics and
gynecology, emergency medicine, surgery, cardiology and vascular medicine. Our
current products include the SonoSite 180PLUS, for general ultrasound imaging,
the SonoHeart ELITE, specifically configured for cardiovascular applications,
and our newest products, the iLook 15, intended for quick look
diagnostics in areas such as emergency medicine, radiology, surgery or intensive
care, and the iLook 25, designed to provide visual imaging for physicians and
nurses while performing vascular access procedures. Our SonoSite 180PLUS and
SonoHeart ELITE products are used together with any of our seven interchangeable
handheld components, or transducers, that are designed for specific clinical
applications. Our iLook products each have a single transducer for specific
clinical applications.

2

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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 point-of-care, high
performance, all-digital 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 have 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 has 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 becomes nonexclusive and, except for the patented
technology of each party, 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. 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
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 of tissues or organs. This is known as grayscale imaging or
two-dimensional imaging. Colorization technology expands standard ultrasound
imaging by generating an image showing the direction and extent of the relative
velocity of blood flow through the body, including the chambers and valves of
the heart.

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 at the point-of-care and expand point-of-care
ultrasound to emergency medicine, surgery, anesthesiology and vascular medicine.
Prior to our products availability, however, high quality images could be
produced only by highly trained sonographers using heavier and more expensive
traditional cart-based ultrasound imaging systems.

## Our
Strategy

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

| |  |  | Maximize
the productivity of our direct sales force in the U.S. and key European markets. As of
December 31, 2002, we employed 50 direct sales representatives in the United States. We
established direct sales operations in the United Kingdom and France in 2001, and in
Germany and Spain in 2002. As of December 31, 2002, we had 19 direct sales representatives
in Europe, and we expect to grow this team over the next 24 months. 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:
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

3

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| |  |  | invest
in training, educating and mentoring our sales force;
| | - |  | ------------------------------------------------------------

| |  |  | expand
our clinical application specialist staff;
| | - |  | -------------------------------------------------

| |  |  | expand
our corporate account relationships; and
| | - |  | -----------------------------------------------

| |  |  | organize
our sales force by clinical markets and geographic regions.
| | - |  | --------------------------------------------------------------------

| |  |  | Raise
market awareness of the SonoSite platform and brand name. We believe the opportunity
exists to build the SonoSite name into a global brand synonymous with point-of-care, high
performance, all-digital ultrasound imaging. Although we have sold over 10,000 units to
date, 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:
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | 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
| | - |  | -------------------------------------------------------------------------------------------------------

| |  |  | utilize
education to market our products.
| | - |  | -----------------------------------------

| |  |  | Maintain
product and technology leadership. We believe our products represent the most advanced
technology in point-of-care, high performance, all-digital ultrasound systems. We are
committed to maintaining this technological advantage by continuing to enhance our
existing products and to create new ones. As of December 31, 2002, we employed over 50
people in research and development dedicated to creating the next generation of SonoSite
products.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | 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 improve our distribution channel in
Japan, establish a 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Expand
into new ultrasound markets. We believe that the portability, high quality and cost
effectiveness of our products will result in the creation of new 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, vascular access procedures, 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.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

## Our
Products

We
offer four types of point-of-care ultrasound imaging systems: the SonoSite
180PLUS, the SonoHeart ELITE, the iLook 15 and the iLook 25. The 180PLUS and
Elite imaging systems each consist of an integrated color display, control
panel, including navigational trackball, and alphanumeric keyboard. Both systems
are built on the same hardware platform, which provides internal storage for
over 100 images, clinical analysis packages, measurement tools and direct
personal computer connectivity. The SonoSite 180PLUS and the SonoHeart Elite
imaging systems weigh less than six pounds with a single transducer attached.
The following is a summary of our four ultrasound imaging products and their
major features:

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

| |  |  | two
dimensional, or B-mode, imaging, allowing real-time two-dimensional visualization of
anatomic structures within the body;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------

4

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| |  |  | M-mode
imaging, providing a display of motion versus time. M-mode is particularly useful for
evaluation of fast-moving structures, such as valves within the heart;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | pulsed
wave, or PW, Doppler technology. 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;
| | - |  | -----------------------------------------------------------------------------------------------------------------------

| |  |  | tissue
harmonic imaging, or THI, a signal processing technique providing enhanced image quality
by using high frequency information to enhance image resolution; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | basic
echocardiogram, 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 technology. 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 at the
patients bedside 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:

| |  |  | a
touch screen for data input;
| | - |  | ------------------------------

| |  |  | a
single point-to-point measurement tool;
| | - |  | -----------------------------------------

| |  |  | ability
to store over 70 images for off-line printing and review;
| | - |  | -----------------------------------------------------------------

| |  |  | cine
loop retains images for frame-by-frame review;
| | - |  | ---------------------------------------------------

| |  |  | connectivity
to a PC for image download through a docking station;
| | - |  | ------------------------------------------------------------------

| |  |  | 2D
and color power Doppler; and
| | - |  | -------------------------------

| |  |  | The
iLook 15 offers directional color power Doppler and harmonic imaging.
| | - |  | -------------------------------------------------------------------------

We
offer seven types of transducers. Each of our transducers may be used with
either the SonoSite 180PLUS or SonoHeart Elite Systems. This interchangeability
allows our customers to purchase a single point-of-care ultrasound system that
can be used in a variety of clinical applications.

| |  |  | Transducers.
Our seven transducers are designed for use in the following clinical
applications:
| | - |  | -----------------------------------------------------------------------------------------------

| |  |  | general
abdominal and obstetrics imaging;
| | - |  | -----------------------------------------

| |  |  | intracavitary
and gynecological ultrasound imaging;
| | - |  | ---------------------------------------------------

| |  |  | neonatal,
vascular and pediatric imaging;
| | - |  | -----------------------------------------

| |  |  | cardiac,
thoracic and abdominal imaging, and trauma assessment;
| | - |  | ---------------------------------------------------------------

| |  |  | breast,
musculoskeletal, vascular, interventional and small-parts imaging;
| | - |  | --------------------------------------------------------------------------

| |  |  | intraoperative
and superficial vascular imaging; and
| | - |  | ----------------------------------------------------

| |  |  | musculoskeletal,
obstetric and urological imaging for veterinarian applications.
| | - |  | --------------------------------------------------------------------------------

5

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We
also offer the following related accessories and educational programs:

| |  |  | Accessories.
We sell the SiteStand mobile docking station and the SiteLink imaging software, both of
which enable communication between our products and third-party output devices, such as
printers, storage devices and networks. We also offer a high resolution, 12.1-inch flat
panel monitor that may be physically connected with our SiteStand to increase the image
size and allow easy consultation among healthcare providers.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | Specialized
training and education. We promote educational courses for physicians and other
healthcare providers who currently do not use ultrasound imaging in order to educate them
in the general use of ultrasound and the fundamental operation of our products. We offer
an internal program, OnSite, as well as accredited programs developed by third-party
providers. In addition, as we develop new and emerging markets, we continue to develop new
accredited and market specific training materials, produced by leaders in ultrasound
education.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

## 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. We rely on
third-party distributors in those markets where we do not have a direct sales
staff.

At
December 31, 2002, we had 50 direct sales representatives in the United States
along with 27 clinical application specialists, who provide product
demonstration and support to our sales representatives. In addition, we focused
our sales representatives on specific clinical markets in addition to geographic
regions.

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., Kaiser
Permanente, Novation, LLC, Premier, Inc., Broadlane, Inc., Consorta, Inc. and
Aurora Health Care.

Elsewhere
outside the United States, we continue to sell to other potential markets
through third-party foreign distributors, such as Olympus Optical, our exclusive
distributor in Japan. In the first half of 2003, Olympus will modify its
distribution network to improve its sales of our products. They plan to add
direct resources and redirect their dealer network in order to focus their
efforts on the clinical segments with the greatest sales opportunities. 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 $42.6 million, or 58%, of our revenue from domestic sales
in 2002. This compares to approximately $23.8 million, or 52%, and approximately
$15.2 million, or 47%, in 2001 and 2000.

We
derived approximately $30.4 million, or 42%, of our revenue from international
sales in 2002. This compares to approximately $21.9 million, or 48%, and
approximately $16.9 million, or 53%, in 2001 and 2000. Japan accounted for
approximately $7.5 million, or 10%, of our revenue in 2002. This compares to
approximately $7.8 million, or 17%, and approximately $8.3 million, or 26%, in
2001 and 2000. Other than Olympus, no other single customer or distributor
accounts for more than 10% of our revenue. 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.

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.

## 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.

6

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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 eleven
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 have 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 has 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 becomes nonexclusive and, except for the patented
technology of each party, extends to all ultrasound systems regardless of
weight.

Additionally,
under the terms of our spin-off from ATL, the point-of-care ultrasound
technology assigned to us by ATL remains subject to rights reserved or acquired
by the U.S. government in connection with the original research funding provided
to ATL by the U.S. Office of Naval Research to develop that technology.
Specifically, under the standard patent rights afforded the U.S. government in
connection with government-funded scientific research and included in ATLs
original development agreement with the Office of Naval Research, the U.S.
government holds what are commonly known as march-in rightsa
nonexclusive, nontransferrable, irrevocable, fully paid worldwide license to
manufacture or have manufactured for use by the U.S. government any inventions
conceived or first reduced to practice by ATL during the course of its
government-funded research. As we expect to be able to fulfill anticipated
purchases of our products by the U.S. government, we do not currently expect any
exercise by the U.S. government of its march-in rights.

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,
which alleged that our sale and manufacture of our point-of-care ultrasound
systems infringed upon a patent held by Neutrino. We responded to the claim,
asserting alternative defenses of noninfringement and patent invalidity. In
addition, we filed a counterclaim seeking a declaratory judgment of
noninfringement and invalidity regarding Neutrinos patent. We defeated
Neutrinos request for a preliminary injunction preventing 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. The court has not yet ruled on the issues
presented in that hearing. On October 10, 2002, the court granted our motion to
stay the proceedings until it issues its Markman order and rules on
our summary judgment motion. Although we continue to vigorously defend ourselves
against this claim, this litigation may result in an adverse judgment against
us. Sales of the allegedly infringing products represented virtually all of our
revenue for the years ended December 31, 2002, 2001 and 2000. We have been
forced to incur substantial expenses in defense of this claim, and we may incur
additional substantial litigation expenses until the claim is resolved.

## 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 point-of-care, high performance
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.).

7

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## Research and Development and
Technology

We
currently employ over 50 individuals in product development dedicated to the
enhancement of existing products and development of new products. In 2002, 2001
and 2000, expenses attributable to research and development for our business
totaled $12.1 million, $12.7 million and $11.8 million. We believe our products
represent the most advanced technology in point-of-care, high performance,
all-digital 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 all medical devices introduced to the market be preceded
either by pre-market notification clearance under Section 510(k) of the Federal
Food, Drug & Cosmetic Act, or an approved pre-market approval application,
or PMA. 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. A PMA is filed when the
FDA has determined the company must submit clinical trial data and manufacturing
quality assurance information to prove it is safe and effective for its labeled
indications. The process of obtaining 510(k) clearance typically takes
approximately two to three months, while the PMA process typically takes more
than a year. To date, all our products have received 510(k) clearance and we
have not been required to file any PMAs. We believe that our future generation
point-of-care 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. 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. We appealed the FDAs classification and have received verbal
confirmation from the FDA that we satisfied their requirements to complete the
field action. We are seeking final written closure of this matter from the FDA.

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 unannounced
on-site inspections to determine compliance with such regulations. The FDA
inspected our manufacturing facility in August 2001. In addition, the British
Standards Institution (BSI) performed a management systems assessment of our
manufacturing processes in May 2000, February 2001, June 2001, November 2001,
January 2002 and July 2002.

8

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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 will be issuing 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 and SonoHeart ELITE 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.

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. However, the customer can purchase a service
contract from us to extend the original warranty period or enhance its coverage.
All returned products are diagnosed for cause of failure and for possible design
improvements to incorporate in future products.

## Employees

As
of December 31, 2002, we had approximately 350 full-time employees, of which
approximately 14% were engaged in research and product development, 33% in
manufacturing, 43% in sales and marketing activities and the remaining 10% in
administrative capacities, including executive, finance, legal, human resources,
regulatory and information services and technology. Of these, approximately 320
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.

## Website Access to Reports

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.

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

If our products do not
gain market acceptance, we will fail to generate sufficient revenue to maintain
our business.

The
market for point-of-care, high performance ultrasound systems is new and largely
undeveloped. Our products represent a new technological alternative to
traditional ultrasound examinations. 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, and our success will depend on the acceptance
of our products by the medical community, patients and third-party payors as
medically useful, safe and cost-effective. Competing point-of-care or
traditional cart-based ultrasound systems may be more cost-effective than our
products. Physicians and other healthcare providers may adopt our products at a
slow rate, if at all. If the market fails to accept our products, we will be
unable to generate sufficient revenue to maintain our business.

9

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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 point-of-care, high performance 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
or 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
point-of-care, high performance ultrasound market, we will be unable to generate
sufficient revenue to maintain our business.

If our competitors
develop and market medical imaging systems 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:

| |  |  | 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.

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
will receive reimbursement for the use of our products from governmental
authorities such as Medicare, private health insurers and other third-party
payors. 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
governmental authorities, private health insurers and other third-party payors
to contain or reduce the costs of healthcare through various means may, however,
limit market acceptance of our products and, therefore, may affect our ability
to market our current products, commercialize our potential products and become
profitable. Reimbursement coverage, to the extent available, may not be adequate
to enable us to achieve market acceptance of our products. In addition, we
believe that third-party payors will attempt to reduce healthcare costs by
limiting both coverage and level of reimbursement for new products cleared by
the FDA or comparable foreign agencies. Our products enable new kinds of medical
procedures involving novel ultrasound applications for which there is no
reimbursement history. The efforts of government and third-party payors to
contain or reduce the cost of healthcare could restrict physicians and
other healthcare providers willingness to select our products and
implement new ultrasound procedures, which could delay or reduce market
acceptance of our products.

10

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We
have recently become aware of notices issued by three state Medicare carriers to
their clients in fifteen states that limits reimbursement under various Part B
Medicare ultrasound CPT codes for certain ultrasound procedures conducted with
hand-carried ultrasound systems. We are seeking clarification from
these carriers of the meaning of these policy changes in an effort to determine
the extent to which they may potentially impact our business. If such
reimbursement practices continue in force or are adopted by additional health
insurance providers, market acceptance of our products may be limited.

Additionally,
there has been and will likely continue to be a number of federal and state
proposals to implement government controls on pricing. The existence and
adoption of these proposals could affect our ability to successfully market our
current products and commercialize new products.

Changes in the health
care industry may require us to decrease the selling price for our products or
could result in a reduction in the size of the market 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.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Both
the pressure to reduce prices for our products in response to these trends and
the decrease in the size of the market as a result of these trends could
adversely affect our levels of revenues and profitability of sales, which could
have a material adverse effect on our business.

Our single
technological platform renders us less able to withstand adverse changes in the
ultrasound market.

Although
we market our products for use in a variety of clinical applications and
settings, we have only a single technological platform upon which all our
ultrasound systems are based. Any attempt to design a new platform for
ultrasound imaging will require substantial amounts of time and money, and may
not be successful.

11

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If our platform becomes
obsolete, unmarketable or unaccepted by the ultrasound market for any reason,
and we are unable or slow to develop a new platform to replace it, we will be
unable to generate sufficient revenue to maintain our business.

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

In
traditional ultrasound practice, physicians and other healthcare providers
typically refer patients to centralized locations where radiologists and other
specialized personnel provide ultrasound examinations. 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
practice. 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 discourage new users from
adopting our products, we could experience limited 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.

In
March 2003, one of our component suppliers, Philips Semiconductor
(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. Prior to the
discontinuance, we expect to obtain supplies of 0.35-micron chips from Philips
in an amount sufficient to supply us with enough components for our anticipated
manufacturing needs until new chips have been incorporated in all of our
products. 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, a
deterioration in gross margin or lower revenue.

12

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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 all medical devices introduced
to the market be preceded either by pre-market notification clearance under
Section 510(k) of the Federal Food, Drug & Cosmetic Act, or an approved
pre-market approval application, or PMA. 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, we have not been required to file any PMAs and 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. Any delays, or
failures, in obtaining such clearances may result in lost sales and revenue.

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 August 2001. 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. We appealed the FDAs classification and have received verbal
confirmation that we satisfied the requirements to complete the field action. We
are seeking final written closure of this matter from the FDA.

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.

13

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

With
the exception of the fiscal quarter ending December 31, 2002, we have incurred
net losses in each quarter since we commenced operations. As of December 31,
2002, we had an accumulated deficit of approximately $86 million. Although we
expect to continue to incur additional losses in the fiscal quarter ending March
31, 2003, we expect to achieve profitability on an annual basis in 2003. Even if
we do achieve one or more profitable periods, 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 quarter ending December 31, 2002, our
revenue from product sales has been insufficient to cover our expenses. We
expect that our operating expenses will substantially increase in the
foreseeable future as we expand our sales and marketing infrastructure, our
administrative support and possibly 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 $32.0 million in 2000 to $45.7 million in 2001 and $73.0
million in 2002. During 2002, we added over 100 new employees, primarily in
manufacturing and sales and marketing. During 2002, we introduced five new
products and continued our expansion into Europe. 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. For example, sales to our distributor in Japan, Olympus, represented 10%
of our revenue in 2002 and 17% of our revenue in 2001. 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.

In
Japan, we have not achieved revenue growth the past two fiscal years. 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, Olympus will add direct resources
and redirect the efforts of its dealers in the first half of 2003. We expect
that this transition will result in reduced revenues in Japan in the first half
of fiscal 2003 compared with the same period in 2002.

14

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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 in Europe
and Asia 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 2002, we began the process of
terminating a joint venture that distributed our products in China, which we
expect to have completed in 2003 along with the formation of a joint venture
with a new partner that has greater financial and marketing resources. We expect
our foreign direct sales operations to grow. 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 Europe and Asia 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. Despite our
expenditures and efforts, we may not generate a substantial increase in European
or Asian revenue, which would impair our operating results.

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 42% in
2002 and 48% in 2001. Of this foreign revenue, approximately 25% originated in
Japan in 2002 and 35% in 2001. Total sales for the year ended December 31, 2002
denominated in a currency other than USDs were approximately $9.8 million, or
13% 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;
| | - |  | -----------------------------------------

15

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| |  |  | 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, 2002, 51% of our outstanding accounts receivable balance was
from international customers. Our distributor in Japan was indebted to us for
approximately $2.5 million, representing 12% of our outstanding accounts
receivable balance. We regularly review our receivable positions in foreign
countries for any indication that collection may be at risk. For example, due to
recent economic events in Argentina, 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.

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.

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 eleven 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 is exclusive through April 5, 2003, and 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.

16

---



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, which alleged that our
sale and manufacture of our point-of-care ultrasound systems infringed upon a
patent held by Neutrino. We responded to the claim, asserting alternative
defenses of noninfringement and patent invalidity. In addition, we filed a
counterclaim seeking a declaratory judgment of noninfringement and invalidity
regarding Neutrinos patent. We defeated Neutrinos request for a
preliminary injunction preventing us from manufacturing and selling our products
for the duration 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. The court has not yet
ruled on the issues presented in that hearing, and may issue a ruling at any
time. On October 10, 2002, the court granted our motion to stay the proceedings
until it issues its Markman order and rules on our summary judgment
motion. Although we continue to vigorously defend ourselves against this claim,
this litigation may result in an adverse judgment against us. Sales of the
allegedly infringing products represented virtually all of our revenue for the
years ended December 31, 2002, 2001 and 2000. We have been forced to incur
substantial expenses in defense of this claim, and we may incur additional
substantial litigation expenses until the claim is resolved.

17

---



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.

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.

Compliance with
governmental regulation of our business could be costly and time-consuming, and
could prevent us from introducing new products in a timely manner.

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.
| | - |  | ----------------------------------------------------------------------------

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. We may be subject to fines, sanctions, including the
temporary or permanent suspension of operations, product field actions, criminal
prosecution and marketing restrictions, if we fail to comply with the laws and
regulations pertaining to our business. Our third-party medical device
manufacturers may also be subject to the same sanctions and, as a result, may
fail to supply us with components required to manufacture our products.

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.

18

---



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.

If we incur 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 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.

19

---



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 February 28, 2003, our executive officers, directors and affiliated entities
together beneficially owned approximately 4.4% of the outstanding shares of our
common stock. Seven other shareholders owned in the aggregate approximately
50.5% of the outstanding shares of our common stock. Among these shareholders,
the State of Wisconsin Investment Board, or SWIB, owned approximately 16.1% of
the outstanding shares of our common stock and WM Advisors owned approximately
10.2%. 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:
| | - |  | --------------------------------------------------------------------------------------------

| |  |  | $150
million if, prior to April 6, 2003, any single person or entity obtains, directly or
indirectly, voting control of a majority of our common stock or the power to elect our
entire board of directors; or
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |  | $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, 15% 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 15% 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. Our rights plan excludes SWIBs ownership of our
common stock so long as such ownership does not reach 20% of our outstanding common
stock.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

20

---



## 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 as a result of our use, sale and
manufacture of the SonoSite 180, SonoSite 180PLUS, SonoHeart and SonoHeart PLUS
systems. 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 alternative defenses of
noninfringement and patent invalidity, and included a counterclaim seeking a
declaratory judgment of noninfringement 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. The court has not yet ruled on the issues presented in that hearing. On
October 10, 2002, the court granted our motion to stay the proceedings until it
issues its Markman order and rules on our summary judgment motion.
We believe we have good and sufficient defenses to the claims of patent
infringement asserted against us by Neutrino and we are vigorously defending
ourselves in this matter, however this litigation may result in an adverse
judgment.

## 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, 2002.

21

---



# PART II

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

Our
common stock is traded on the Nasdaq National Market under the symbol SONO. As
of February 28, 2003, there were 3,534 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.

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   | 
|-------------- |  | ---- | - | ----- | 
|2002           |  |      |   |       | 
|Fourth quarter |  |      | $ | 16.17 | 
|Third quarter  |  |      | $ | 15.65 | 
|Second quarter |  |      | $ | 19.68 | 
|First quarter  |  |      | $ | 28.01 | 
|              
|2001           |  |     
|Fourth quarter |  |      | $ | 27.50 | 
|Third quarter  |  |      | $ | 27.85 | 
|Second quarter |  |      | $ | 20.00 | 
|First quarter  |  |      | $ | 17.38 | 
|               |  |      |   |       | 

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.

22

---



## 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 Form 10-K.

|                                          | For the Years Ended December 31, | 
|----------------------------------------- | -------------------------------- | 
|
|
|Statement of Operations Data              |                                  | 
|Sales revenues                            |                                  | 
|Cost of sales revenue                     |                                  | 
|                                          |                                  | 
|Gross margin                              |                                  | 
|Grant revenue                             |                                  | 
|Operating expenses:                       |                                  | 
|Research and development                  |                                  | 
|Sales and marketing                       |                                  | 
|General and administrative                |                                  | 
|                                          |                                  | 
|Total operating expenses                  |                                  | 
|Other income (loss):                      |                                  | 
|Interest income                           |                                  | 
|Interest expense                          |                                  | 
|Equity in (losses) earnings of affiliates |                                  | 
|Other loss                                |                                  | 
|                                          |                                  | 
|Total other income (loss)                 |                                  | 
|                                          |                                  | 
|Net loss                                  |                                  | 
|                                          |                                  | 
|Basic and diluted net loss per share (1)  |                                  | 
|                                          |                                  | 
|Weighted average common and potential     |                                  | 
|common shares used in computing basic     |                                  | 
|and diluted net loss per share (1)        |                                  | 

|                                            | As of December 31, | 
|------------------------------------------- | ------------------ | 
|
|
|Balance Sheet Data                          |                    | 
|Cash and cash equivalents                   |                    | 
|Working capital                             |                    | 
|Total assets                                |                    | 
|Long-term obligations, less current portion |                    | 
|Total shareholders equity                  |                    | 

| | (1) |  | Net loss per share amounts are computed on the basis described in Note 2 of
Notes to the Consolidated Financial Statements for periods subsequent to the
April 6, 1998 Distribution Date. For the periods prior to the Distribution Date,
weighted average shares outstanding represent ATL weighted average shares as
adjusted for the exchange ratio established on the Distribution Date of one of
our shares for every three shares of ATL.
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

23

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

## Overview

We
are a leading provider of point-of-care, high performance, all-digital
ultrasound imaging systems for use in a variety of clinical applications and
settings. Our proprietary technologies have enabled us to design point-of-care
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 portability, high quality 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 the point of care such as the patients bedside or the physicians
examining table.

The
size and complexity of traditional ultrasound systems typically compel
physicians to refer patients to a highly trained sonographer employed by an
imaging center, 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.

We
currently focus on six key market segments: radiology, obstetrics and
gynecology, emergency medicine, surgery, cardiology and vascular medicine. Our
current products include the SonoSite 180PLUS, for general ultrasound imaging,
the SonoHeart ELITE, specifically configured for cardiovascular applications,
and our newest products, the iLook 15, intended for quick look
diagnostics in areas such as emergency medicine, radiology, surgery or intensive
care, and the iLook 25, designed to provide visual imaging for physicians and
nurses while performing vascular access procedures. Our SonoSite 180PLUS and
SonoHeart ELITE products are used together with any of our seven interchangeable
handheld components, or transducers, that are designed for specific clinical
applications. Our iLook products each have a single transducer for specific
clinical applications.

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 point-of-care, high
performance, all-digital 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 have 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 has 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 becomes nonexclusive and, except for the patented
technology of each party, extends to all ultrasound systems regardless of
weight.

## 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,
revenues 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.

We
believe the following critical accounting policies require our more significant
judgments and estimates used in the preparation of our consolidated financial
statements:

24

---



Accounts
receivable. We provide an allowance for doubtful accounts based upon
specific customer risks and a general provision based upon historical trends.
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. 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.
Additionally, in cases of nonstandard delivery and acceptance criteria, we do
not recognize revenue at shipment, but rather when the delivery and acceptance
criteria have been satisfied.

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, if necessary to reduce their
carrying values to amounts not lower than that which will 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 our products. Any
unexpected increase in defects would result in an increase in warranty expense
and a reduction in earnings.

## Results of Operations

## Revenue

Revenue
increased to $73.0 million in 2002, compared to $45.7 million in 2001 and $32.0
million in 2000. Approximately 69% of the 2002 increase was in the United
States. The increase in revenue in 2002 compared to 2001 was primarily due to an
increase in sales in the United States resulting from having a fully staffed
direct sales force for an entire year, our new product introductions and our
increased average selling price. Sales representatives increased productivity as
they became more experienced and were assisted by 27 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.

The
increase in revenue in 2001 compared to 2000 was primarily due to an increase in
sales in the United States resulting from an increase in the number of direct
sales representatives to 51 at the end of 2001, compared to 26 at the end of
2000. The increase was also due to an increased average selling price.

U.S.
revenues increased to $42.6 million in 2002, compared to $23.8 million in 2001, due to
the increase in  U.S. direct sales representatives, our new product introductions and our
increased average selling prices. U.S.  revenues increased to $23.8 million in 2001,
compared to $15.2 million in 2000, due to the increase in U.S.  direct sales
representatives and increased average selling prices.

25

---



Revenue
from Japan decreased to $7.5 million in 2002 from $7.8 million in 2001 primarily
due to the timing of orders received from our distributor in Japan and the delay
in approval of our new products. The decrease of revenue in Japan to $7.8
million in 2001 from $8.3 million in 2000 was due to initial distributor orders
received in the prior year.

Revenue
from Europe, Africa and the Middle East increased to $14.8 million in 2002 from
$9.1 million in 2001 primarily due to an increase in direct sales in the United
Kingdom and France along with sales from our recently established direct sales
operations in Germany and Spain. The increase to $9.1 million in 2001 from $3.8
million in 2000 was primarily due to an increase in direct sales in the United
Kingdom and a large multi-order system sale in the first quarter of 2001.

Revenue
from Canada, Australia, South and Latin America and other Asia increased to $8.1
million in 2002 from $5.0 million in 2001 primarily due to an increase in orders
from our distributors in China and Mexico. Revenue from Canada, Australia, South
and Latin America and other Asia increased slightly to $5.0 million in 2001 from
$4.8 million in 2000.

We
anticipate that revenue will increase in 2003 compared to prior years due to
continued expansion of our direct selling efforts in the United States and
Europe, introduction of new products and 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 highly portable and
point-of-care ultrasound products. In 2003, we do not anticipate any increase in
our revenue from Japan due to the changes in the distribution network of our
partner, Olympus, in the first half of the year. Additionally, regulatory
approval of our new products in Japan may experience delays, which could impact
our anticipated revenue.

## Gross margin

Gross
margin increased to 59% in 2002, compared to 52% in 2001 and 42% in 2000. The
increase in gross margin 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.

The
increase in gross margin in 2001 from 2000 was primarily due to a combination of
increased selling prices and improved manufacturing efficiencies. The increased
average selling prices resulted from an increase in the number of transducers
and accessories sold with each system and an increase in the percentage of our
direct sales compared with distributor sales. Costs as a percentage of sales
decreased in 2001 because costs on a per unit basis decreased as our production
volumes increased.

We
expect gross margin in 2003 to increase slightly from gross margin achieved in
2002. 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 expected to result in a
normal margin 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 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 goods sold
and a decrease in our gross margin.

26

---



## Operating expenses

Research
and development expenses were $12.1 million in 2002, compared to $12.7 million
in 2001 and $11.8 million in 2000. Research and development expenses decreased
in 2002 compared to 2001 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.

The
increase in 2001 research and development expenses compared to 2000 was
primarily due to increased activities surrounding the final design, verification
and validation of the PLUS platforms and related transducers and continued
engineering design and development of new products, including the SonoHeart
ELITE system and its features which was released in March 2002.

We
anticipate that research and development expenses will be level in 2003 as
compared to 2002. 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 $33.6 million in 2002, compared to $22.3
million in 2001 and $17.4 million in 2000. Of the $11.3 million increase in
expenses in 2002 compared to 2001, approximately 22% was related 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.

The
increase in sales and marketing expenses in 2001 compared to 2000 was primarily
due to an increase in direct selling expenses in the United States and Europe.
U.S. direct selling expenses increased by $3.2 million to $10.3 million,
compared to $7.1 million in 2000. This increase was primarily due to costs
associated with the increase in the number of sales representatives and sales
management. Our expansion into Europe in 2001 resulted in additional expenses
due to the addition of our direct selling operation. Offsetting these increases
was a decrease in marketing expenses due to market research expenses incurred at
the end of 2000 that were not incurred in 2001.

We
anticipate that sales and marketing expenses in 2003 will increase primarily due
to increased expenses in Europe resulting from the expansion of our European
direct sales offices.

General
and administrative expenses were $5.8 million in 2002, compared to $5.2 million
in 2001 and $4.6 million in 2000. The increases in general and administrative
expenses in 2002 and 2001 were related primarily 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 2003 due to
increased insurance, accounting and legal expenses in addition to general
expenses to support the growth of our infrastructure. We may incur additional
substantial legal expenses as we continue to defend our patent rights in the
existing patent 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 $539,000 in 2002 compared to a loss
of $18,000 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, which we expect
to have completed in 2003 along with the formation of a joint venture with a new
partner that has greater financial and marketing resources.

We
reported other loss of $18,000 in 2001, compared to other income of $1.5 million
in 2000. The decrease in 2001 compared to 2000 was primarily due to decreased
interest income of $1.4 million as a result of our decreased average investment
balance and lower interest rates.

## Liquidity and Capital
Resources

Operating
activities used cash of $8.3 million in 2002, compared to $17.8 million in 2001
and $22.2 million in 2000. The decrease in cash used in 2002 compared with 2001
was primarily due to a reduction in our net loss of $8.7 million. 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.

27

---



The
2001 decrease in cash used in operations as compared with 2000 was primarily due
to a reduction in inventories, which related to our consumption of raw material
that we obtained from ATL as part of the transfer of the manufacturing
operations in-house, a reduction in our net loss and an increase in deferred
liabilities resulting from extended service contracts. These items were
partially offset by increases in accounts receivable due to significant sales
volume in December 2001 as compared to the prior year and a reduction in
accounts payable primarily related to payments to ATL for the raw material
inventory noted above.

Investing
activities used cash of $42.3 million in 2002, compared to cash provided of
$15.9 million in 2001 and cash used of $2.5 million in 2000. The cash used in
2002 was primarily due to net purchases of investment securities. The cash
provided in 2001 was primarily due to net sales/maturities of investment
securities.

We
anticipate continuing to use cash to invest in high quality investment
instruments in 2003, the extent of which will be dependent upon the interest
rate environment during the year and the timing of cash flows from our
operations during the year.

Financing
activities provided cash of $43.5 million in 2002, compared to $24.0 million in
2001 and $2.5 million in 2000. 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 2003 compared to 2002
primarily due to anticipated decreases in our net loss. This decrease will be
dependent upon 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 capital expenditure requirements through
2003. 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.
| | - |  | ------------------------------------------------------------------------------------------------

Additionally,
we have the following contractual obligations and commitments as of December 31,
2002:

|     | OperatingLeases |  | CapitalLeases |       | Total |  
|---- | --------------- |  | ------------- | ----- | ----- | -
|
|2003 |                 |  | $             | 1,130 |       | $
|2004 |                 |  |               | 1,202 |       |  
|2005 |                 |  |               | 1,243 |       |  
|2006 |                 |  |               | 1,154 |       |  
|2007 |                 |  |               | 557   |       |  
|     |                 |  |               |       |       |  
|     |                 |  | $             | 5,286 |       | $
|     |                 |  |               |       |       |  

28

---



## 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 timing, material changes or design
changes, we may be responsible for compensating our suppliers for these
procurements.

As
part of obtaining our lease for our current facility, we were required to
deposit approximately $330,000, representing restricted cash with our bank.
Also, we were required to maintain a deposit of approximately $270,000 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.

## New Accounting Pronouncements

In
June 2001, the 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. The adoption of this statement is not expected to have a
material impact on our financial statements.

In
August 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes Statement
No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of. Statement No. 144 retains many of the
fundamental provisions of Statement No. 121 and provides a single method of
accounting for long-lived assets to be disposed of. We adopted the provisions of
Statement No. 144 for the fiscal year beginning January 1, 2002. The adoption of
this statement for long-lived assets held for use did not have any impact on our
financial statements. The provisions of the statement for assets held for sale
or other disposal generally are required to be applied prospectively after the
adoption date to newly initiated disposal activities. Therefore, we cannot
determine the potential future effects that the adoption of this statement for
assets held for sale or other disposal will have on our financial statements.

In
July 2002, the FASB issued Statement No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses financial accounting and reporting for
costs  associated with exit or disposal activities. Statement No. 146 nullifies EITF
Issue No.  94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to  Exit an Activity (including Certain Costs Incurred in a
Restructuring). The principal  difference between Statement No. 146 and Issue No.
94-3 relates to the recognition of a  liability for a cost associated with an exit or
disposal activity. Statement No. 146  requires that a liability be recognized for those
costs only when the liability is  incurred, that is, when it meets the definition of a
liability in the FASBs conceptual  framework. In contrast, under Issue No. 94-3, a
company recognized a liability for an exit  cost when it committed to an exit plan.
Statement No. 146 also establishes fair value as  the objective for initial measurement
of liabilities related to exit or disposal  activities. The Statement is effective for
exit or disposal activities that are initiated  after December 31, 2002 although earlier
application is encouraged. The adoption of this  statement is not expected to have a
material impact on our financial statements.

In
November 2002, the FASB issued Interpretation No. 45 (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 statement is not expected to have a material impact on our financial
statements.

In
November 2002, the Emerging Issues Task Force (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. We do
not expect that the adoption of this consensus will have a material impact on
our financial statements.

29

---



In
December 2002, the FASB issued Statement of Financial Accounting Standards No.
148, Accounting for Stock-Based CompensationTransition and
Disclosure (SFAS 148), which provides for alternative methods to
transition to the fair value method of accounting for stock options in
accordance with provisions of FASB Statement No. 123, Accounting for Stock
Based Compensation. In addition, SFAS 148 requires disclosure of the
effects of an entitys accounting policy with respect to stock-based
compensation on reported net income and earnings per share in annual and interim
financial statements. We adopted the annual disclosure provisions of SFAS 148 in
the financial statements for our fiscal year ended December 31, 2002 and will
adopt the interim disclosure requirements beginning in the first quarter of
2003. The transition provisions of SFAS 148 are currently not applicable to us
as we continue to account for stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25.

In
January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). 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. Formerly Consolidation of Certain Special
Purpose Entities in its draft form, 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. For existing variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003,
the provision of this interpretation will apply no later than the beginning of
the first interim or annual reporting period beginning after June 15, 2003.
Currently, we do not have any variable interest entities, and we do not expect
that the adoption of FIN 46 will have a material impact on our 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, 2002, our portfolio consisted of $10.0 million of
interest-bearing debt securities with maturities of less than one year and $29.4
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 2003 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 subsidiaries, we transact all our sales
in U.S. 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, 2002, 51% of our outstanding accounts receivable balance was
from international customers, of which 40%, or approximately $4.2 million was
denominated in a currency other than USDs. Our distributor in Japan was indebted
to us for approximately $2.5 million, representing 12% of our outstanding
accounts receivable balance. Total sales for the year ended December 31, 2002
denominated in a currency other than USDs were approximately $9.8 million, or
13% of total consolidated revenues. The British pound and the Euro represented
the majority of financial transactions executed in a currency not denominated in
USDs. A change in exchange rates compared to the USD of 10% would not have a
significant impact on our statement of financial position or results of
operations. 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. As of December 31, 2002, we did not have any
foreign currency hedging contracts.

30

---



## ITEM 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA

# SONOSITE, INC.

# INDEX TO FINANCIAL STATEMENTS

|                                                                       | Page |   
|---------------------------------------------------------------------- | ---- | --
|Independent Auditors Report                                           |      | 32
|Consolidated Balance Sheets                                            |      | 33
|Consolidated Statements of Operations                                  |      | 34
|Consolidated Statements of Cash Flows                                  |      | 35
|Consolidated Statements of Shareholders Equity and Comprehensive Loss |      | 36
|Notes to Consolidated Financial Statements                             |      | 37

31

---



# 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, 2002 and 2001, 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, 2002. 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, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002, 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, WashingtonFebruary 12, 2003

32

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# SONOSITE, INC.

# CONSOLIDATED BALANCE SHEETS(in thousands, except share data)

|                                                             | As of December 31, | 
|------------------------------------------------------------ | ------------------ | 
|
|ASSETS                                                       |                   
|Current Assets                                               |                    | 
|Cash and cash equivalents                                    |                    | 
|Short-term investment securities                             |                    | 
|Accounts receivable, less allowance for doubtful accounts of |                    | 
|$832 and $1,034                                              |                    | 
|Inventories                                                  |                    | 
|Prepaid expenses and other assets                            |                    | 
|                                                             |                    | 
|Total current assets                                         |                    | 
|Property and equipment, net                                  |                    | 
|Receivable from affiliate                                    |                    | 
|Investment securities                                        |                    | 
|Other assets                                                 |                    | 
|                                                             |                    | 
|Total assets                                                 |                    | 
|                                                             |                    | 
|                                                            
|LIABILITIES AND SHAREHOLDERS EQUITY                         |                   
|Current Liabilities                                          |                    | 
|Accounts payable                                             |                    | 
|Accrued expenses                                             |                    | 
|Current portion of long-term obligations                     |                    | 
|Deferred revenue                                             |                    | 
|                                                             |                    | 
|Total current liabilities                                    |                    | 
|Deferred rent                                                |                    | 
|Long-term obligations, less current portion                  |                    | 
|                                                             |                    | 
|Total liabilities                                            |                    | 
|                                                             |                    | 
|                                                            
|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, 200214,195,280                           |                    | 
|As of December 31, 200111,363,231                           |                    | 
|Additional paid-in capital                                   |                    | 
|Accumulated deficit                                          |                    | 
|Accumulated other comprehensive income                       |                    | 
|                                                             |                    | 
|Total shareholders equity                                   |                    | 
|                                                             |                    | 
|Total liabilities and shareholders equity                   |                    | 
|                                                             |                    | 

See accompanying
notes to the consolidated financial statements

33

---



# SONOSITE, INC.

# CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except loss per share)

|                                                         | For the Years Ended December 31, | 
|-------------------------------------------------------- | -------------------------------- | 
|
|Revenue                                                  |                                  | 
|Cost of revenue                                          |                                  | 
|                                                         |                                  | 
|Gross margin                                             |                                  | 
|                                                        
|Operating expenses:                                      |                                  | 
|Research and development                                 |                                  | 
|Sales and marketing                                      |                                  | 
|General and administrative                               |                                  | 
|                                                         |                                  | 
|Total operating expenses                                 |                                  | 
|                                                        
|Other income (loss):                                     |                                  | 
|Interest income                                          |                                  | 
|Interest expense                                         |                                  | 
|Equity in losses of affiliates                           |                                  | 
|Other                                                    |                                  | 
|                                                         |                                  | 
|Total other income (loss)                                |                                  | 
|                                                         |                                  | 
|                                                        
|Net loss                                                 |                                  | 
|                                                         |                                  | 
|                                                        
|Basic and diluted net loss per share                     |                                  | 
|                                                         |                                  | 
|                                                        
|Weighted average common and potential common shares used |                                  | 
|in computing basic and diluted net loss per share        |                                  | 
|                                                         |                                  | 

See accompanying notes to the consolidated financial statements

34

---



# SONOSITE, INC.

# CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)

|                                                                            | For the Years Ended December 31, | 
|--------------------------------------------------------------------------- | -------------------------------- | 
|
|Operating activities:                                                       |                                  | 
|Net loss                                                                    |                                  | 
|Adjustments to reconcile net loss to net cash used in operating activities: |                                  | 
|Depreciation and amortization                                               |                                  | 
|Loss on disposition of plant and equipment                                  |                                  | 
|Net loss on investments                                                     |                                  | 
|Equity in losses of affiliates                                              |                                  | 
|Amortization of premiums on investment securities                           |                                  | 
|Amortization of deferred stock compensation                                 |                                  | 
|Changes in operating assets and liabilities:                                |                                  | 
|Accounts receivable                                                         |                                  | 
|Inventories                                                                 |                                  | 
|Receivable from affiliate                                                   |                                  | 
|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                     |                                  | 
|Investment in affiliate                                                     |                                  | 
|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                                                   |                                  | 
|New borrowings                                                              |                                  | 
|Repayment of long-term obligations                                          |                                  | 
|                                                                            |                                  | 
|Net cash provided by financing activities                                   |                                  | 
|                                                                           
|Effect of exchange rate changes on cash and cash equivalents                |                                  | 
|                                                                            |                                  | 
|Net change in cash and cash equivalents                                     |                                  | 
|Cash and cash equivalents at beginning of year                              |                                  | 
|                                                                            |                                  | 
|Cash and cash equivalents at end of year                                    |                                  | 
|                                                                            |                                  | 
|                                                                           
|Supplemental disclosure of cash flow information:                           |                                  | 
|Cash paid for interest                                                      |                                  | 
|                                                                            |                                  | 
|                                                                           
|Supplemental disclosure of non-cash investing and financing activities:     |                                  | 
|Equipment acquired through long-term obligations                            |                                  | 
|                                                                            |                                  | 

See accompanying notes to the consolidated financial statements

35

---



# SONOSITE, INC.

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

|                                 | Common stock |  | Additionalpaid-in |            | Deferredstock |  | Accumulated |     | Accumulatedcomprehensiveother |  | Totalshareholders
|-------------------------------- | ------------ |  | ----------------- | ---------- | ------------- |  | ----------- | --- | ----------------------------- |  | ------------------
|
|Balance at December 31, 1999     |              |  |                   | 9,209,633  |               |  | $           | 92  |                               |  |                   
|Comprehensive loss:              |              |  |                   |            |               |  |             |     |                               |  |                   
|Net loss                         |              |  |                   |           |               |  |             |    |                               |  |                   
|Net unrealized gain on           |              |  |                   |            |               |  |             |     |                               |  |                   
|investment securities            |              |  |                   |           |               |  |             |    |                               |  |                   
|                                 |              | 
|Comprehensive loss               |              |  |                   |            |               |  |             |     |                               |  |                   
|Exercise of warrants             |              |  |                   | 8,877      |               |  |             |    |                               |  |                   
|Exercise of stock options        |              |  |                   | 334,126    |               |  |             | 4   |                               |  |                   
|Cancellation of restricted Stock |              |  |                   | (1,040     | )             |  |             |    |                               |  |                   
|Amortization of deferred stock   |              |  |                   |            |               |  |             |     |                               |  |                   
|compensation                     |              |  |                   |           |               |  |             |    |                               |  |                   
|                                 |              |  |                   |            |               |  |             |     |                               |  |                   
|Balance at December 31, 2000     |              |  |                   | 9,551,596  |               |  |             | 96  |                               |  |                   
|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  |                               |  |                   
|Exercise of stock options        |              |  |                   | 145,009    |               |  |             | 1   |                               |  |                   
|Cancellation of restricted stock |              |  |                   | (41        | )             |  |             |    |                               |  |                   
|                                 |              |  |                   |            |               |  |             |     |                               |  |                   
|Balance at December 31, 2001     |              |  |                   | 11,363,231 |               |  |             | 114 |                               |  |                   
|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  |                               |  |                   
|Exercise of stock options        |              |  |                   | 132,049    |               |  |             | 1   |                               |  |                   
|                                 |              |  |                   |            |               |  |             |     |                               |  |                   
|Balance at December 31, 2002     |              |  |                   | 14,195,280 |               |  | $           | 142 |                               |  |                   
|                                 |              |  |                   |            |               |  |             |     |                               |  |                   

See accompanying notes to the consolidated financial statements

36

---



# 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 highly portable ultrasound
system and other highly portable 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.

Internationally,
we address other large potential markets through our relationship with Olympus
in Japan, and dedicated distributors in other traditionally large ultrasound
markets. 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.

## Financial instruments

## 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. 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.

37

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

## Accounts receivable

In
the ordinary course of business, we grant credit to a broad customer base. Of
the accounts receivable balance at December 31, 2002, 51% and 49% were
receivable from international and domestic parties, prior to any allowance for
doubtful accounts. The same percentages as of December 31, 2001 were 58% and 42%
prior to any allowance for doubtful accounts, of which approximately $283,000
was included in other long-term assets.

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 December 31:

|                     | AccountsReceivable |  | Revenue |    
|-------------------- | ------------------ |  | ------- | ---
|
|Japanese distributor |                    |  |         | 12%
|U.S. direct customer |                    |  |         | 12%
|U.S. distributor     |                    |  |         |    
|                     |                    |  |         |    
|Totals               |                    |  |         | 24%
|                     |                    |  |         |    

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, certain long-term other
assets and debt, 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 and debt approximate fair value as interest rates
on these notes approximate market. Investment securities are carried at fair
value.

## 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 will 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:

38

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

|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 | 
|                               |  |                                                                  | 

Direct
internal and external costs for computer software developed for internal use are
capitalized in accordance with 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 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 in a joint venture in China that is currently inactive and
is in the process of being dissolved. At December 31, 2002, our carrying values
for both our investment in this joint venture and receivable from this joint
venture were zero.

## 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. An
increase in demand for some parts by other companies in our industry could also
interrupt our supply of components.

## 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
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.

39

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

## 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, 2002, 2001
and 2000 were $4.7 million, $4.3 million and $4.2 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, 2002, we have five stock-based employee compensation plans, which
are described in Note 7. We account for those plans under the intrinsic value
method in accordance with the provisions of Accounting Principles Board (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):

|                                                | 2002 |  | 2001 |         | 2000 |  
|----------------------------------------------- | ---- |  | ---- | ------- | ---- | -
|Net loss, as reported                           |      |  | $    | (7,731  | )    | $
|Less: Stock-based employee compensation expense |      | 
|determined under fair value based method        |      |  |      | (7,429  | )    |  
|                                                |      |  |      |         |      |  
|Pro forma net loss                              |      |  | $    | (15,160 | )    | $
|                                                |      |  |      |         |      |  
|Basic and diluted net loss per share:           |      | 
|As reported                                     |      |  | $    | (0.59   | )    | $
|                                                |      |  |      |         |      |  
|Pro forma                                       |      |  | $    | (1.16   | )    | $
|                                                |      |  |      |         |      |  

## 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 7, 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, 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. As of December 31, 2000, outstanding Adjustment Plan options and
unvested restricted shares issued by ATL through the Distribution Date totaled
146,320 and 2,185 and outstanding options we issued totaled 2,153,926.

40

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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

|                                     | 2002 |  | 2001 |        | 2000 | 
|------------------------------------ | ---- |  | ---- | ------ | ---- | 
|
|Weighted average shares outstanding  |      |  |      |        |      | 
|Weighted average unvested restricted |     
|stock                                |      |  |      |        |      | 
|                                     |      |  |      |        |      | 
|Basic and diluted loss per share     |      |  | $    | (7,731 | )    | 
|                                     |      |  |      |        |      | 

## 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):

|                                   | 2002 |  | 2001 |      
|---------------------------------- | ---- |  | ---- | -----
|Net unrealized gain on investments |      |  | $    | 309  
|Cumulative translation adjustments |      |  |      | 788  
|                                   |      |  |      |      
|                                   |      |  | $    | 1,097
|                                   |      |  |      |      

## 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. Net sales, costs and expenses of international operations
are translated at average rates of exchange prevailing during the period.
Realized and unrealized gains and losses on currency transactions were
immaterial in all periods presented.

## New accounting pronouncements

In
June 2001, the 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. The adoption of this statement is not expected to have a
material impact on our financial statements.

In
August 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes Statement
No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of. Statement No. 144 retains many of the
fundamental provisions of Statement No. 121 and provides a single method of
accounting for long-lived assets to be disposed of. We adopted the provisions of
Statement No. 144 for the fiscal year beginning January 1, 2002. The adoption of
this statement for long-lived assets held for use did not have any impact on our
financial statements. The provisions of the statement for assets held for sale
or other disposal generally are required to be applied prospectively after the
adoption date to newly initiated disposal activities. Therefore, we cannot
determine the potential future effects that the adoption of this statement for
assets held for sale or other disposal will have on our financial statements.

In
July 2002, the FASB issued Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses financial
accounting and reporting for costs associated with exit or disposal activities.

41

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Statement No. 146 nullifies EITF
Issue No. 94-3, Liability Recognition for Certain  Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs  Incurred in a
Restructuring). The principal difference between Statement No. 146 and  Issue No.
94-3 relates to the recognition of a liability for a cost associated with an  exit or
disposal activity. Statement No. 146 requires that a liability be recognized for  those
costs only when the liability is incurred, that is, when it meets the definition of  a
liability in the FASBs conceptual framework. In contrast, under Issue No. 94-3, a
company recognized a liability for an exit cost when it committed to an exit plan.
Statement No. 146 also establishes fair value as the objective for initial measurement of
liabilities related to exit or disposal activities. The Statement is effective for exit
or  disposal activities that are initiated after December 31, 2002 although earlier
application is encouraged. The adoption of this statement is not expected to have a
material impact on our financial statements.

In
November 2002, the FASB issued Interpretation No. 45 (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 statement is not expected to have a material impact on our financial
statements.

In
November 2002, the Emerging Issues Task Force (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. We do
not expect that the adoption of this consensus will have a material impact on
our financial statements.

In
December 2002, the FASB issued Statement of Financial Accounting Standards No.
148, Accounting for Stock-Based CompensationTransition and
Disclosure (SFAS 148), which provides for alternative methods to
transition to the fair value method of accounting for stock options in
accordance with provisions of FASB Statement No. 123, Accounting for Stock
Based Compensation. In addition, SFAS 148 requires disclosure of the
effects of an entitys accounting policy with respect to stock-based
compensation on reported net income and earnings per share in annual and interim
financial statements. We adopted the annual disclosure provisions of SFAS 148 in
the financial statements for our year ended December 31, 2002 and will adopt the
interim disclosure requirements beginning in the first quarter of 2003. The
transition provisions of SFAS 148 are currently not applicable to us as we
continue to account for stock-based compensation in accordance with Accounting
Principles Board Opinion No. 25.

In
January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). 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. Formerly Consolidation of Certain Special
Purpose Entities in its draft form, 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. For existing variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003,
the provision of this interpretation will apply no later than the beginning of
the first interim or annual reporting period beginning after June 15, 2003.
Currently, we do not have any variable interest entities, and we do not expect
that the adoption of FIN 46 will have a material impact on our financial
statements.

42

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

## 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 have 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 has 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 becomes
nonexclusive and, except for the patented technology of each party, 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, 2003, any
single person or entity obtains, directly or indirectly, voting control of a
majority of our common stock or the power to elect our entire board of
directors, we will be required to pay $150 million to ATL. 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, we will be required to pay $75 million to ATL. For the years ended
December 31, 2002, 2001 and 2000, we incurred a royalty expense to ATL of $1.8
million, $1.3 million and $0.9 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, | 
|------------------------------- | ------------------ | 
|
|Cash                            |                    | 
|Cash equivalents:               |                    | 
|Money market accounts           |                    | 
|                                |                    | 
|Total cash and cash equivalents |                    | 
|                                |                    | 
|Investment securities:          |                    | 
|Short-term                      |                    | 
|                                |                    | 
|Long-term                       |                    | 
|                                |                    | 

43

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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, 2002 were as follows (in thousands):

|                             | Amortized cost |  | Gross unrealizedholding gains |   | Gross unrealizedholding losses |  | Fairvalue | 
|---------------------------- | -------------- |  | ----------------------------- | - | ------------------------------ |  | --------- | 
|Short-term:                  |                |  |                               |   |                                |  |           | 
|Corporate bonds              |                |  |                               | $ | 1,800                          |  |           | 
|US Government and agencies   |                |  |                               |   | 8,170                          |  |           | 
|                             |                |  |                               |   |                                |  |           | 
|Total short-term investments |                |  |                               | $ | 9,970                          |  |           | 
|                             |                |  |                               |   |                                |  |           | 
|Long-term:                   |                | 
|Corporate bonds              |                |  |                               | $ | 7,526                          |  |           | 
|US Government and agencies   |                |  |                               |   | 21,635                         |  |           | 
|                             |                |  |                               |   |                                |  |           | 
|Total long-term investments  |                |  |                               | $ | 29,161                         |  |           | 
|                             |                |  |                               |   |                                |  |           | 

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

|           | 2002 |  | 2001 |     | 2000 |  
|---------- | ---- |  | ---- | --- | ---- | -
|Gains      |      |  | $    | 7   |      | $
|Losses     |      |  |      | (44 | )    |  
|           |      |  |      |     |      |  
|Net losses |      |  | $    | (37 | )    | $
|           |      |  |      |     |      |  

## 5. Financial statement detail as of
December 31,

Inventories
consisted of the following (in thousands):

|                        | 2002 |  | 2001 |       
|----------------------- | ---- |  | ---- | ------
|Raw material            |      |  | $    | 4,678 
|Work-in-process         |      |  |      | 120   
|Demonstration inventory |      |  |      | 2,680 
|Finished goods          |      |  |      | 4,309 
|                        |      |  |      |       
|Total inventories       |      |  | $    | 11,787
|                        |      |  |      |       

At
December 31, 2002, and 2001, finished goods includes approximately $0.5 million
and $0.8 million of inventory whose title had passed to the customer and for
which revenue has not yet been recognized.

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

|                                               | 2002 |  | 2001 |       
|---------------------------------------------- | ---- |  | ---- | ------
|Equipment, other than computer                 |      |  | $    | 6,260 
|Software                                       |      |  |      | 3,201 
|Computer equipment                             |      |  |      | 2,941 
|Furniture and fixtures                         |      |  |      | 1,286 
|Leasehold improvements                         |      |  |      | 928   
|                                               |      |  |      |       
|                                               |      |  |      | 14,616
|Less accumulated depreciation and amortization |      |  |      | (8,524
|                                               |      |  |      |       
|Total property and equipment                   |      |  | $    | 6,092 
|                                               |      |  |      |       

44

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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

|                                 | 2002 |  | 2001 |     
|-------------------------------- | ---- |  | ---- | ----
|Computer equipment               |      |  | $    | 350 
|Software                         |      |  |      | 47  
|                                 |      |  |      |     
|                                 |      |  |      | 397 
|Less accumulated amortization    |      |  |      | (387
|                                 |      |  |      |     
|Total assets under capital lease |      |  | $    | 10  
|                                 |      |  |      |     

Accrued
expenses consisted of the following (in thousands):

|                       | 2002 |  | 2001 |      
|---------------------- | ---- |  | ---- | -----
|Payroll and related    |      |  | $    | 3,320
|Outside services       |      |  |      | 790  
|Warranty               |      |  |      | 331  
|Royalties              |      |  |      | 531  
|Other                  |      |  |      | 432  
|                       |      |  |      |      
|Total accrued expenses |      |  | $    | 5,404
|                       |      |  |      |      

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

|                             | Beginningof year |      | Charged tocost of revenue |      | Applied toliability |        | Endof year |     
|---------------------------- | ---------------- | ---- | ------------------------- | ---- | ------------------- | ------ | ---------- | ----
|Year ended December 31, 2002 |                  | $281 |                           | $300 |                     | $(250) |            | $331

## 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. Receivables from affiliate represented the outstanding amount owed
to us by SonoSite China for purchases of inventory less our equity losses in
earnings of SonoSite China that exceeded our initial capital contribution.
SonoSite China is currently in the process of being dissolved. As of December
31, 2002, our net investment balance in SonoSite China was zero.

For
the years ended December 31, 2002, 2001 and 2000, we recognized revenue from
sales to SonoSite China in the amount of $262,000, $303,000 and $298,000.

During
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.

## 7. Shareholders equity

## Stock option plans

As
of December 31, 2002, 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, we
granted 95,000 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 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.

45

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

If
we accounted for the costs relating to all option grants under the provisions of
SFAS 123, our net loss would have been $15.1 million, or $1.16 per pro forma
diluted share, in 2002, $23.5 million, or $2.29 per pro forma diluted share, in
2001 and $24.6 million, or $2.61 per pro forma diluted share, in 2000 (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 2002, 2001 and
2000: expected volatility 60%, 63% and 63%; risk-free interest rates 3.8%, 4.5%
and 4.9%; 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, 2002, 3,401,163 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, 2002, 701,062 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, 2002, 115,000 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, 2002, 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.

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, 2002, 86,645 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 none, 459 and 2,185, as
determined using the exchange ratio of one of our restricted shares for every
three ATL restricted shares, were outstanding as of December 31, 2002, 2001 and
2000.

46

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

## Summary of stock option
activity

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

|                                  | 2002 |  | 2001 |       | 2000 |  
|--------------------------------- | ---- |  | ---- | ----- | ---- | -
|
|Outstanding, beginning of year    |      |  |      | 2,621 |      | $
|Granted                           |      |  |      | 530   |      | $
|Exercised                         |      |  |      | (132  | )    | $
|Cancelled                         |      |  |      | (117  | )    | $
|                                  |      |  |      |       |      |  
|Outstanding, end of year          |      |  |      | 2,902 |      | $
|                                  |      |  |      |       |      |  
|Exercisable, end of year          |      |  |      | 1,456 |      | $
|                                  |      |  |      |       |      |  
|Weighted average fair value of    |      | 
|options granted during the period |      |  |      |       |      | $
|                                  |      |  |      |       |      |  

The
following is a summary of stock options outstanding as of December 31, 2002
(shares presented in thousands):

|                | Options outstanding |  | Options exercisable | 
|--------------- | ------------------- |  | ------------------- | 
|
|$  1.64$  6.94 |                     |  | 636                 | 
|$  6.97$12.88  |                     |  | 637                 | 
|$12.97$15.47   |                     |  | 618                 | 
|$15.51$23.63   |                     |  | 606                 | 
|$23.70$34.97   |                     |  | 405                 | 
|                |                     |  |                     | 
|                |                     |  | 2,902               | 
|                |                     |  |                     | 
|                |                     |  |                     | 

## 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. Our board of
directors may redeem the rights at a nominal cost at any time before a person
acquires 15% or more of our outstanding common stock, which allows
board-approved transactions to proceed.

Under
the terms of the Rights Agreement, holders of our common stock also hold rights
exercisable in certain circumstances discussed below. Holders of these rights
may purchase 1/100th of a share of our Series A Participating Cumulative
Preferred Stock, par value of $1.00, at a price equal to four times the average
high and low sales prices of our common stock quoted on the Nasdaq National
Market for each of the 10 trading days commencing on the sixth trading day
following April 6, 1998. Circumstances under which these rights are exercisable
involve acquisition or knowledge of expected acquisition or tender of 15% or
more of our outstanding common stock. In addition, the board of directors may
redeem all, but not part, of the rights outstanding for consideration in cash or
common stock at a price equal to $0.01 per right.

47

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Separate
certificates for rights will not be distributed. Our common stock certificates
serve as evidence of the rights. Prior to exercise of the rights and in
accordance with the terms of the Rights Agreement, the rights have no voting or
dividend value. If the rights are not exercised prior to April 5, 2008, they
expire, with no consideration for the expiration being provided to the holder of
the right.

In
connection with the sale of common stock described below under
Financing, the Rights Agreement was amended on August 8, 2001. The
amendment provided an exemption to one of the acquirors of the common stock from
the 15% ownership threshold described above, provided that the acquiror is the
beneficial owner of less than 20% of our common stock.

## 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, 2002, no warrants were outstanding.

## 8. 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.

## 9. 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, 2002, we accumulated a net operating
loss carryforward of approximately $69.0 million and research and
experimentation tax credit carryforwards of approximately $2.4 million. These
carryforwards begin expiring in 2018 and will be fully expired in 2022.
Approximately $5.5 million of the net operating loss carryforward results from
stock option deductions which, when and if realized, would result in a credit to
shareholders equity.

Because
we 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 $2.7 million in 2002, $6.9
million in 2001, and $7.7 million in 2000 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):

48

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

|                                                        | 2002 |  | 2001 |        
|------------------------------------------------------- | ---- |  | ---- | -------
|Deferred tax assets:                                    |      |  |      |        
|Domestic net operating loss carryforwards               |      |  | $    | 23,003 
|International net operating loss carryforwards          |      |  |      | 1,995  
|Research and experimentation tax credit carryforwards   |      |  |      | 2,430  
|Capital loss carryforwards                              |      |  |      | 490    
|Allowances and accruals not recognized for tax purposes |      |  |      | 549    
|Other                                                   |      |  |      | 584    
|                                                        |      |  |      |        
|Gross deferred tax assets                               |      |  |      | 29,051 
|Valuation allowance                                     |      |  |      | (29,035
|                                                        |      |  |      |        
|                                                        |      |  |      | 16     
|Deferred tax liabilities:                               |      | 
|Depreciation                                            |      |  |      | (16    
|                                                        |      |  |      |        
|Net deferred tax assets                                 |      |  | $    |       
|                                                        |      |  |      |        

## 10. 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 2002, 2001 and 2000, we contributed $802,000,
$540,000 and $369,000 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.

## 11. Commitments and
contingencies

## Operating leases

We
currently lease office and manufacturing space under operating leases. As of
December 31, 2002, future minimum lease payments are as follows (in thousands):

|     | 
|---- | 
|2003 | 
|2004 | 
|2005 | 
|2006 | 
|2007 | 
|     | 
|     | 
|     | 

Rent
expense for the years ended December 31, 2002, 2001, and 2000 was $1.1 million,
$1.0 million and $0.7 million.

49

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

## 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, 2002 (in thousands):

|                                                    | 
|--------------------------------------------------- | 
|2003                                                | 
|2004                                                | 
|                                                    | 
|Total lease payments                                | 
|Less amount representing interest                   | 
|                                                    | 
|Present value of net minimum capital lease payments | 
|Less current portion                                | 
|                                                    | 
|Long-term obligations, excluding current portion    | 
|                                                    | 

## 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 timing, material changes or design
changes, we may be responsible for compensating our suppliers for these
procurements. As of December 31, 2002, these commitments were not significant.

As
part of obtaining our lease for our current facility, we were required to
deposit approximately $330,000, representing restricted cash with our bank.
Also, we were required to maintain a deposit of approximately $270,000 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.

We
entered into several corporate purchasing agreements, including AmeriNet Inc., Kaiser
Permanente, Novation LLC, Broadlane, Inc., Premier Inc., Consorta, Inc. and Aurora Health
Care. These agreements provide for favorable pricing, preferential availability and
notification periods. We recorded sales and marketing expenses related to these agreements
in the amounts of approximately $512,000 in 2002, $236,000 in 2001 and $22,000 in
2000.

## 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 by SonoSite as a result of our use, sale
and manufacture of the SonoSite 180, SonoSite 180 PLUS, SonoHeart and SonoHeart
PLUS systems. 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 alternative defenses
of non-infringement and patent invalidity, and filed 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. The court has not yet ruled on the issues
presented in that hearing. On October 10, 2002, the court granted our motion to
stay the proceedings until it issues its Markman order and rules on
our summary judgment motion. We believe we have good and sufficient defenses to
the claims of patent infringement asserted against us by Neutrino and we are
vigorously defending ourselves in this matter, however this litigation may
result in an adverse judgment. Sales of the allegedly infringing products
represented virtually all of our revenue for the years ended December 31, 2002,
2001 and 2000.

50

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

## 12. 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):

|                                           | 2002 |  | 2001 |        | 2000 |  
|------------------------------------------ | ---- |  | ---- | ------ | ---- | -
|United States                              |      |  | $    | 42,586 |      | $
|Europe, Africa and the Middle East         |      |  |      | 14,849 |      |  
|Japan                                      |      |  |      | 7,464  |      |  
|Other Asia (a)                             |      |  |      | 4,468  |      |  
|Canada, Australia, South and Latin America |      |  |      | 3,668  |      |  
|                                           |      |  |      |        |      |  
|Total revenue                              |      |  | $    | 73,035 |      | $
|                                           |      |  |      |        |      |  

---

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

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

|                        | 2002 |  | 2001 |       | 2000 |  
|----------------------- | ---- |  | ---- | ----- | ---- | -
|Long-lived assets:      |      |  |      |       |      |  
|United States           |      |  | $    | 5,889 |      | $
|International           |      |  |      | 315   |      |  
|                        |      |  |      |       |      |  
|Total long-lived assets |      |  | $    | 6,204 |      | $
|                        |      |  |      |       |      |  

Net
assets of our European operations were approximately $10.0 million and $2.8
million at December 31, 2002 and 2001.

51

---



# SONOSITE, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

## 13. Quarterly
results--unaudited

|                                          | For the three months ended, | 
|----------------------------------------- | --------------------------- | 
|
|
|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                   |                             | 
|                                          |                             | 
|2001:                                     |                             | 
|Revenue                                   |                             | 
|Cost of revenue                           |                             | 
|                                          |                             | 
|Gross margin                              |                             | 
|Operating expenses                        |                             | 
|Other income (loss)                       |                             | 
|                                          |                             | 
|Net loss                                  |                             | 
|                                          |                             | 
|Basic and diluted net loss per share      |                             | 
|                                          |                             | 
|Shares used in computation of basic and   |                             | 
|diluted net 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.

52

---



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

None.

53

---



# 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
2003 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, 2002.

## ITEM 11. EXECUTIVE
COMPENSATION

The
information required by this Item is included in our proxy statement for our
2003 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, 2002.

## ITEM 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT

The
information required by this Item is included in our proxy statement for our
2003 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, 2002.

## ITEM 13. CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS

The
information required by this Item is included in our proxy statement for our
2003 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, 2002.

## ITEM 14. CONTROLS AND
PROCEDURES

## Evaluation of disclosure controls and
procedures

The
term disclosure controls and procedures is defined in Rules
13a-14(c) and 15d-14(c) 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 a date, or
evaluation date, within 90 days before the filing of this annual report, and
they have concluded that, as of the evaluation date, our disclosure controls and
procedures were effective.

## Changes in internal controls

There
were no significant changes in SonoSites internal controls or, to
SonoSites knowledge, in other factors that could significantly affect
SonoSites disclosure controls and procedures subsequent to the evaluation
date.

54

---



# 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 atbeginningof year |  | Additions chargedto general andadministrativeexpense |       | Deductions |  | Balance atend of year
|------------------------------- | -------------------------- |  | ---------------------------------------------------- | ----- | ---------- |  | ---------------------
|
|Year ended December 31, 2002:   |                            |  |                                                      |       |            |  |                      
|Allowance for doubtful accounts |                            |  | $                                                    | 1,034 |            |  |                      
|                               
|Year ended December 31, 2001:   |                            |  |                                                      |       |            |  |                      
|Allowance for doubtful accounts |                            |  | $                                                    | 723   |            |  |                      
|                               
|Year ended December 31, 2000:   |                            |  |                                                      |       |            |  |                      
|Allowance for doubtful accounts |                            |  | $                                                    | 96    |            |  |                      

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

|Exhibit No. |  | Description
|----------- |  | -----------

|3.1(A) |  | Restated
Articles of Incorporation of the registrant
|------ |  | ----------------------------------------------------

|3.3(E) |  | Bylaws
of the registrant
|------ |  | ------------------------

|4.1(A) |  | Rights
Agreement between First Chicago Trust Company and the registrant, dated April 6, 1998
|------ |  | --------------------------------------------------------------------------------------------

|4.2(E) |  | Amendment
to Rights Agreement, dated August 8, 2001
|------ |  | ---------------------------------------------------

|4.3(F) |  | Amendment
to Rights Agreement, dated October 24, 2001
|------ |  | -----------------------------------------------------

|10.1(G) |  | 1998
Stock Option, as amended and restated
|------- |  | ------------------------------------------

|10.2(A) |  | Terms
of Stock Option Grant Program for Nonemployee Directors under the SonoSite, Inc. 1998
Stock Option Plan
|------- |  | -------------------------------------------------------------------------------------------------------------

|10.3(H) |  | 1998
Nonofficer Employee Stock Option Plan, as amended and restated
|------- |  | -------------------------------------------------------------------

|10.4(E) |  | Nonemployee
Director Stock Option Plan, as amended and restated
|------- |  | ---------------------------------------------------------------

|10.5(C) |  | Management
Incentive Compensation Plan
|------- |  | --------------------------------------

|10.6(B) |  | Adjustment
Plan
|------- |  | ---------------

|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
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|10.8(A) |  | Technology
Transfer and License Agreement between ATL Ultrasound, Inc. and the registrant, effective
as of April 6, 1998, as amended
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------

|10.9(F) |  | Third
Amendment to Technology Transfer and License Agreement between ATL Ultrasound, Inc. and
the registrant, dated as of March 10, 2000
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------

55

---



|Exhibit No. |  | Description
|----------- |  | -----------

|10.10(D) |  | Lease
Agreement between Riggs & Company, a division of Riggs Bank N.A., and registrant,
dated December 28, 1999
|-------- |  | ---------------------------------------------------------------------------------------------------------------

|10.11(D) |  | Distribution
Agreement between Olympus Optical Co. Ltd. and the registrant, dated August 1, 1999
|-------- |  | ------------------------------------------------------------------------------------------------

|10.12(F) |  | Assignment
of Distribution Agreement by and among Olympus Optical Co., Ltd., Olympus Promarketing,
Inc. and the registrant, dated October 5, 2001
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|21.1+ |  | Subsidiaries
of the registrant
|----- |  | ------------------------------

|23.1+ |  | Consent
of KPMG LLP, independent auditors
|----- |  | -----------------------------------------

|24.1 |  | Power
of attorney (contained on signature page)
|----- |  | -----------------------------------------------

|99.1 |  | Section
906 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350
|----- |  | -------------------------------------------------------------------------------------------

|99.2 |  | Section
906 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350
|----- |  | -------------------------------------------------------------------------------------------

---

 Filed herewith.

|(A) |  | Incorporated
by reference to the designated exhibit included in SonoSites Registration Statement
on Form S-1 (Registration No. 333-71457).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|(B) |  | Incorporated
by reference to the designated exhibit included in SonoSites report on Form 10 (SEC
File No. 000-23791).
|--- |  | ----------------------------------------------------------------------------------------------------------------------

|(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).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

(b) Reports on Form 8-K

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

56

---



# 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.

| | By: | /s/ Michael J. Schuh
Michael J. SchuhVice President-Finance,
Chief Financial Officer, and Treasurer |  | 
| | --- | --------------------------------------------------------------------------------------------------- |  | 

Date: March 28, 2003

# 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 28th day of March 2003.

|                                                          
|----------------------------------------------------------
|/s/ Kirby L. CramerKirby L. Cramer                        
|                                                          
|/s/ Kevin M. GoodwinKevin M. Goodwin                      
|                                                          
|/s/ Michael J. SchuhMichael J. Schuh                      
|                                                          
|/s/ Edward V. FritzkyEdward V. Fritzky                    
|                                                          
|/s/ Steven R. Goldstein, M.D.Steven R. Goldstein, M.D.    
|                                                          
|/s/ Ernest Mario, Ph.D.Ernest Mario, Ph.D.                
|                                                          
|/s/ William G. Parzybok, Jr.William G. Parzybok, Jr.      
|                                                          
|/s/ Jeffrey Pfeffer, Ph.D.Jeffrey Pfeffer, Ph.D.          
|                                                          
|/s/ Dennis A. Sarti, M.D.Dennis A. Sarti, M.D.            
|                                                          
|/s/ Richard S. Schneider, Ph.D.Richard S. Schneider, Ph.D.
|                                                          
|/s/ Jacques Souquet, Ph.D.Jacques Souquet, Ph.D.          

---



# CHIEF EXECUTIVE
OFFICER CERTIFICATION

I, Kevin M. Goodwin, Chief Executive Officer, certify that:

|1. |  | I
have reviewed this annual report on Form 10-K of SonoSite, Inc.;
|-- |  | ------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

| |  | /s/ Kevin M. Goodwin

Kevin M. GoodwinPresident and Chief Executive Officer(Principal Executive Officer)
| |  | --------------------------------------------------------------------------------------------------------------------------

March 28, 2003

59

---



# CHIEF FINANCIAL OFFICER CERTIFICATION

I, Michael J. Schuh, Chief Financial Officer, certify that:

|1. |  | I
have reviewed this annual report on Form 10-K of SonoSite, Inc.;
|-- |  | ------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

| |  | /s/ Michael J. Schuh

Michael J. SchuhVice President-Finance,Chief Financial Officer and Treasurer(Principal Financial Officer)
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------

March 28, 2003

60

---



# INDEX TO EXHIBITS

|Exhibit No. |  | Description
|----------- |  | -----------

|3.1(A) |  | Restated Articles of
Incorporation of the registrant
|------ |  | ----------------------------------------------------

|3.3(E) |  | Bylaws of the
registrant
|------ |  | ------------------------

|4.1(A) |  | Rights
Agreement between First Chicago Trust Company and the registrant, dated April 6,
1998
|------ |  | --------------------------------------------------------------------------------------------

|4.2(E) |  | Amendment to Rights
Agreement, dated August 8, 2001
|------ |  | ---------------------------------------------------

|4.3(F) |  | Amendment to Rights
Agreement, dated October 24, 2001
|------ |  | -----------------------------------------------------

|10.1(G) |  | 1998 Stock Option, as
amended and restated
|------- |  | ------------------------------------------

|10.2(A) |  | Terms
of Stock Option Grant Program for Nonemployee Directors under the SonoSite, Inc. 1998
Stock Option Plan
|------- |  | -------------------------------------------------------------------------------------------------------------

|10.3(H) |  | 1998 Nonofficer
Employee Stock Option Plan, as amended and restated
|------- |  | -------------------------------------------------------------------

|10.4(E) |  | Nonemployee Director
Stock Option Plan, as amended and restated
|------- |  | ---------------------------------------------------------------

|10.5(C) |  | Management Incentive
Compensation Plan
|------- |  | --------------------------------------

|10.6(B) |  | Adjustment
Plan
|------- |  | ---------------

|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
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|10.8(A) |  | Technology
Transfer and License Agreement between ATL Ultrasound, Inc. and the registrant, effective
as of April 6, 1998, as amended
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------

|10.9(F) |  | Third
Amendment to Technology Transfer and License Agreement between ATL Ultrasound, Inc. and
the registrant, dated as of March 10, 2000
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------

|10.10(D) |  | Lease
Agreement between Riggs & Company, a division of Riggs Bank N.A., and registrant, dated
December 28, 1999
|-------- |  | ---------------------------------------------------------------------------------------------------------------

|10.11(D) |  | Distribution
Agreement between Olympus Optical Co. Ltd. and the registrant, dated August 1,
1999
|-------- |  | ------------------------------------------------------------------------------------------------

|10.12(F) |  | Assignment
of Distribution Agreement by and among Olympus Optical Co., Ltd., Olympus Promarketing,
Inc. and the registrant, dated October 5, 2001
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------

|21.1 |  | Subsidiaries of the
registrant
|----- |  | ------------------------------

|23.1 |  | Consent of KPMG LLP,
independent auditors
|----- |  | -----------------------------------------

|24.1 |  | Power of attorney
(contained on signature page)
|----- |  | -----------------------------------------------

|99.1 |  | Section
906 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section
1350
|----- |  | -------------------------------------------------------------------------------------------

|99.2 |  | Section
906 Certification of Principal Financial Officer pursuant to 18 U.S.C. Section
1350
|----- |  | -------------------------------------------------------------------------------------------

---

| |  Filed
herewith.
| | -----------------

| | (A) |  | Incorporated
by reference to the designated exhibit included in SonoSites Registration Statement
on Form S-1 (Registration No. 333-71457).
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------

| | (B) |  | Incorporated
by reference to the designated exhibit included in SonoSites report on Form 10 (SEC
File No. 000-23791).
| | --- |  | ----------------------------------------------------------------------------------------------------------------------

| | (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).
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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).
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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).
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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).
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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).
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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).
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

61