<PAGE>
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
 
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549
 
                               ----------------
 
                                   FORM 10-K
 
                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
   ACT OF 1934
 
                                      OR
 
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
   EXCHANGE ACT OF 1934
 
                  For the fiscal year ended December 31, 1998
                        Commission File Number 0-23791
 
                               ----------------
 
                                SONOSITE, INC.
            (Exact Name of Registrant as Specified in its Charter)
 
<TABLE>
<S>                                            <C>
                 Washington                                      91-1405022
        (State or Other Jurisdiction                (I.R.S. Employer Identification No.)
      of Incorporation or Organization)
    19807 North Creek Parkway, Suite 200,
             Bothell, Washington                                 98011-8214
  (Address of Principal Executive Offices)                       (Zip Code)
</TABLE>
 
                                (425) 951-1200
             (Registrant's Telephone Number, Including Area Code)
 
       Securities Registered Pursuant To Section 12(b) of the Act: None.
 
          Securities Registered Pursuant to Section 12(g) of the Act:
 
                    COMMON STOCK, $.01 PAR VALUE PER SHARE
              SERIES A PARTICIPATING CUMULATIVE PREFERRED STOCK,
                           PAR VALUE $1.00 PER SHARE
 
   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. [_]
 
   The aggregate market value of the voting and nonvoting stock held by
nonaffiliates of the registrant at March 10, 1999 was approximately $47.5
million.
 
   The number of shares of the registrant's Common Stock outstanding at March
10, 1999 was 4,872,484.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
   The information required by Part III of this Report, to the extent not set
forth herein, is incorporated herein by reference from the Registrant's
definitive proxy statement relating to the annual meeting of shareholders to
be held in 1999, 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.
 
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
<PAGE>
 
                                     PART I
 
   Our disclosure and analysis in this Report contain some forward-looking
statements. When used in this discussion, the words "believes," "anticipates"
and "intends" and similar expressions are intended to identify forward-looking
statements, but the absence of such words does not necessarily mean that a
statement is not forward-looking. Such statements include, but are not limited
to, statements about our plans, objectives, expectations and intentions and are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those expected or implied by these forward-looking
statements. See "--Important Factors Regarding Forward-Looking Statements."
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. Our actual results could
differ materially from those anticipated in these forward-looking statements
for many reasons, including the factors described under "--Important Factors
Regarding Forward-Looking Statements" and elsewhere in this report. The Company
undertakes no obligation to publicly release any revisions to these forward-
looking statements that may be made to reflect events or circumstances after
the date hereof or to reflect the occurrence of unanticipated events. Readers
are urged, however, to review the factors set forth in reports the Company
files from time to time with the Securities and Exchange Commission.
 
ITEM 1. BUSINESS
 
Overview
 
   SonoSite is the leader in the design and development of miniaturized, high-
performance, digital ultrasound imaging devices. Our first hand-carried
devices, based on our SonoSite Leap platform, will weigh less than six pounds
and generate high-quality images comparable to those produced by larger, more
expensive ultrasound machines. We expect our devices to expand access to high-
quality ultrasound imaging as we target the replacement market for lower-priced
ultrasound machines characterized by low-quality images. In addition, our
devices will make high-quality ultrasound imaging available as a diagnostic
tool to physicians at the point of care, enabling physicians to bring
ultrasound directly to the patient, instead of referring them to an ultrasound
specialist. Our first product suite will target gynecologists and obstetricians
who currently use ultrasound imaging within a well-established reimbursement
framework.
 
   We received Section 510(k) clearance for a prototype of our SonoSite Leap
platform in May 1998. We have applied for Section 510(k) clearance for the
commercial version of our SonoSite Leap product platform and expect to launch
our first product suite prior to the end of 1999 following receipt of this
approval. Subsequent product suites based on the SonoSite Leap platform will
target markets for emergency medicine, cardiology and whole body ultrasound
imaging.
 
   Physicians utilize ultrasound imaging as an effective tool for the
noninvasive visual examination of soft tissue. However, they do not have
immediate point-of-care access to high-quality ultrasound imaging due to the
cost, size and complexity of existing high-quality ultrasound machines. These
machines are typically operated in centralized locations by specialists who
produce ultrasound images on a referral basis. We intend to put the power of
high-quality ultrasound imaging directly in the hands of the front-line
physicians who currently utilize ultrasound as part of their diagnostic
procedures but either outsource ultrasound imaging or are required to rely on
lower-quality ultrasound imaging performed at the point of care. We believe our
product suites will offer the following advantages:
 
  . easy-to-use, affordable high-quality ultrasound imaging at the point of
    care;
 
  . physicians can use ultrasound imaging more frequently to identify earlier
    those patients requiring more comprehensive diagnostic procedures or
    specialist intervention;
 
  . physicians can improve patient healthcare by beginning any required
    treatments earlier;
 
  . patients will not experience the "waiting trauma" effect associated with
    the delay in obtaining ultrasound image results conducted on a referral
    basis; and
 
  . for patients with symptoms, physicians can utilize existing reimbursement
    codes.
 
 
                                       2
<PAGE>
 
Just as personal computers expanded the power of computing beyond the mainframe
computer and computer technicians, we believe our devices will expand the use
of high-quality ultrasound imaging beyond the centralized facility and
radiology specialists to front-line physicians and new clinical settings.
 
   According to industry sources, the annual worldwide market for all
ultrasound imaging devices is approximately $2.5 billion. Initially, we will
target our product suites at current users of ultrasound imaging who purchase
lower-end ultrasound machines and would be attracted to the high image quality
and low cost of our products. We estimate that this segment represents
approximately 22% of the existing market, or $540 million annually. In
addition, our product suites should be attractive to physicians, such as
cardiologists and emergency care physicians, who seek portable ultrasound
imaging with high image quality. Our product suites should also be attractive
to physicians, such as gynecologists, internists and pediatricians, who
currently outsource ultrasound imaging because existing high-performance
devices are too costly and difficult to use.
 
   In anticipation of the commercial launch of our initial product suites, we
have built a worldwide sales and distribution network. We have entered into
agreements with each of PSS World Medical, Inc. and its subsidiary, Diagnostic
Imaging, Inc., for domestic distribution of our products. Internationally, we
have entered into distribution agreements covering more than 50 countries.
 
   We were formerly the hand-held ultrasound device division of ATL Ultrasound,
a leader in high-end, digital ultrasound machines. We were spun off as a
separate company in April 1998 to focus on further development and
commercialization of high-performance, miniaturized ultrasound devices. Our
products are based on research and development begun at ATL Ultrasound. Most of
the key engineers responsible for the development of our technology at ATL
Ultrasound have joined SonoSite. Under an agreement with ATL Ultrasound, we
have exclusive rights through 2003, which become nonexclusive thereafter, to
use all applicable ATL Ultrasound technology in the area of miniaturized
digital ultrasound imaging. In addition, ATL Ultrasound has agreed to
manufacture our products through 2003; however, we may assume some of the
manufacture of our products prior to that time.
 
Industry Background
 
   The Use of Ultrasound Imaging
 
   Medical imaging has been an important element of medical diagnosis since the
introduction of X-ray technology. As imaging technology has advanced in recent
decades, applications of medical imaging have expanded to address increasingly
complex disease states and conditions involving soft tissues and internal body
organs. While X-ray technology is the dominant method used for visual analysis
of hard tissue, such as bone material, the most widely used imaging methods for
visual analysis of soft tissues and organs include computed tomography (CT),
magnetic resonance imaging (MRI), nuclear medicine, X-ray angiography and
ultrasound. Each method of soft tissue imaging requires specialized equipment
and has different patterns of use and applications. A physician selects the
soft tissue imaging method to be used based on a variety of factors, including:
 
  . the particular disease state or condition to be studied;
 
  . the status of the patient;
 
  . image quality; and
 
  . the cost of the procedure.
 
   Ultrasound was introduced for medical imaging purposes in the late 1950s as
a safe and noninvasive method to provide real-time, dynamic images of most
major soft tissues and organs. Initially, physicians used ultrasound imaging to
assess the general shape, size and structure of internal soft tissues and
organs. Obstetricians were among the first physicians outside of radiologists
to adopt widespread use of ultrasound imaging. As advances in technology
improved the image quality of ultrasound devices, the use of ultrasound imaging
expanded to other clinical applications, including examinations for
gynecological abnormalities.
 
                                       3
<PAGE>
 
   Ultrasound systems use low-power, high-frequency sound waves emitted by a
transducer to produce soft tissue images. The physician places the transducer
on the skin or in a body cavity near the targeted area. Tissues and fluids
reflect these sound waves and the transducer detects these reflections. Based
on these reflections, the ultrasound system's beamformer 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 allows an ultrasound device to process with greater signal fidelity.
As such, digital ultrasound machines produce higher resolution images than
analog and 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 (2D) imaging when used in cardiology applications. Power
Doppler allows physicians to use ultrasound imaging to detect the presence of
blood flow through the body. Color Doppler ultrasound imaging expands standard
ultrasound imaging further to enable physicians to image the direction and
velocity of blood flow.
 
   Physicians currently use ultrasound imaging in a variety of clinical
applications. In addition to obstetric and gynecological applications,
ultrasound imaging is increasingly used in cardiac imaging. Ultrasound imaging
for cardiac function indications, otherwise known as echocardiography, provides
the physician an enhanced real-time image of the internal heart structure,
including the valves and chambers. The physician uses this image to diagnose
coronary artery disease, valvular disease and congenital heart defects. In
vascular medicine, physicians determine the presence of a disease state or
condition using color Doppler ultrasound to image blood flow in soft tissues,
organs and the vascular system.
 
   According to industry estimates, in the United States approximately 63.5
million ultrasound imaging procedures were conducted in 1997; approximately 73%
were conducted in centralized imaging centers on a referral basis.
Approximately 85% of all ultrasound imaging procedures in the United States
were conducted by radiology specialists, cardiologists and gynecologists and
obstetricians.
 
   Limitations of Current Ultrasound Technology
 
   Current users of ultrasound imaging face a tradeoff between image quality on
the one hand and price and portability on the other. High-performance machines
are based on digital signal processing technology and provide a high-quality
image, but they require a large capital investment of greater than $100,000,
plus significant operating costs. These ultrasound machines typically weigh
approximately 200-300 pounds and require specially trained technologists to
operate them. Ultrasound machines based on the less precise analog/digital
hybrid imaging technology are less expensive, but they typically produce lower-
quality images. They are not easily portable and cost from $30,000 to $100,000.
"Luggable" analog ultrasound machines are even less expensive, but they also
produce lower-quality images that limit their diagnostic utility.
 
   Advances in technology have greatly improved the image quality of ultrasound
systems and substantially increased their diagnostic utility, resulting in the
growth in the use of ultrasound. However, high-quality images currently are
typically produced by large, high-performance, digital ultrasound systems.
Because of the high cost, size and complexity of these systems, ultrasound
imaging is generally performed in diagnostic imaging centers and radiology
departments in hospitals. These imaging centers typically have several high-
performance ultrasound systems operated by a team of specially trained
technologists and radiology specialists who interpret the ultrasound images.
Patients requiring ultrasound imaging are generally referred to these centers.
The physicians who make these referrals lose reimbursement income and
relinquish control of their patients during primary diagnosis. The patient must
schedule a separate appointment for the ultrasound imaging procedure, travel to
the diagnostic center and experience the "waiting trauma" effect caused by the
uncertainty of a delayed primary diagnosis.
 
   We believe patient care would be improved significantly if high-quality
ultrasound imaging were readily available at the point of care. Primary
diagnosis, and thus the beginning of any required treatment, would be more
immediate. In addition, physicians could easily and more frequently monitor
patient progress during
 
                                       4
<PAGE>
 
subsequent office visits, readily obtaining the information necessary to enable
more timely adjustments to treatment. Patient care also would be improved
significantly if high-quality ultrasound imaging were available in settings
where the use of high-end ultrasound systems generally is not feasible due to
their high cost, complexity of operation and limited portability. These
unserved or underserved settings include emergency rooms and vehicles, athletic
arenas, battlefields, rural areas and even the patients' bedsides.
 
The SonoSite Solution
 
   In much the same way that today's personal computers provide the computing
power of earlier-generation mainframe computers, we are designing our product
suites to achieve the high performance of existing, larger ultrasound machines
on a hand-carried platform. Our product suites feature high-quality, digitally
formed imaging comparable to that generated by larger, significantly more
expensive, ultrasound machines in a hand-carried device that is easy to use.
Our product suites are designed to offer the following advantages to physicians
and their patients:
 
<TABLE>
 <C>                     <S>
 High-Quality            Our product suites break out of the traditional
 Ultrasound Imaging in   continuum of ultrasound systems where cost and size
 an Affordable Hand-     are directly related to image quality. We possess
 Carried Device          proprietary technology in three important areas: (1)
                         custom-designed computer chips that achieve high
                         performance while enabling reduced size and power
                         consumption, (2) process technology that allows the
                         production of transducers with performance comparable
                         to high-performance devices at significantly reduced
                         costs, and (3) ergonomic and design-engineering
                         advances that enable physicians to use our product
                         suites with little effort and training and to
                         integrate our product suites into their existing
                         workflow.
 
 Substantial Value for   For current diagnostic ultrasound procedures with
 Existing Users of       established third-party reimbursement codes, our
 Ultrasound Imaging      product suites will provide a low-cost, high-quality
                         alternative. For example, our first product suite, the
                         SonoSite Gynecology and Obstetrics Suite, targets the
                         gynecologists and obstetricians who together currently
                         perform or refer 12.3 million ultrasound procedures
                         annually in the United States, typically performed
                         with large, expensive ultrasound machines.
 
 Substantial             The combination of image quality, portability, ease of
 Opportunity to Expand   use and affordability of our products will also allow
 Uses of Ultrasound      physicians to perform established ultrasound
 Imaging                 examinations more routinely. The SonoSite Cardiology
                         Suite will be used by cardiologists, who we believe
                         can use our device to conduct echocardiography more
                         frequently to increase the efficiency of primary
                         diagnosis. Our products will also facilitate the use
                         of ultrasound in other clinical settings that can
                         benefit from point-of-care imaging, such as emergency
                         medicine and internal medicine.
 
 Improved Patient Care   Our product suites will enable physicians to deliver
 Through Earlier         more immediate primary diagnoses by avoiding the delay
 Diagnosis               associated with the referral of ultrasound imaging
                         procedures. The more immediate primary diagnosis in
                         turn results in earlier detection and treatment cycles
                         when appropriate. In addition, the reduced time to
                         diagnosis will substantially reduce the "waiting
                         trauma" effect resulting from the delay in obtaining
                         ultrasound imaging results.
 
 Superior Efficiency for Our product suites will enable physicians and
 Healthcare Providers    healthcare providers to (1) more efficiently use
                         downstream ultrasound referral services, (2) shorten
                         patient care cycle times, and (3) increase the quality
                         of patient care. Front-line physicians can use our
                         products to reduce the number of patients
                         unnecessarily referred for additional testing.
                         Healthcare organizations can use our product suites to
                         increase their diagnostic imaging capacity at low
                         incremental cost, without expanding existing
                         facilities and personnel. As a result, these
                         organizations will be able to more efficiently use
                         existing personnel responsible for the delivery of
                         ultrasound services.
</TABLE>
 
                                       5
<PAGE>
 
Strategy
 
   Our objective is to maintain our position as the leader in the design and
development of miniaturized, high-performance, digital ultrasound imaging
devices and to successfully commercialize their use. To achieve this objective,
we have developed a strategy with the following key elements:
 
<TABLE>
 <C>                     <S>
 Capitalize on Our       We intend to build on the significant technological
 Technology Advantage    lead we have achieved in developing miniaturized,
                         high-performance, digital ultrasound imaging devices.
                         Our proprietary technology is the subject of two
                         issued and two pending patents. We intend to utilize
                         our advantage in combining ultrasound performance,
                         size and cost to develop additional, innovative
                         products for new and existing markets and
                         applications.
 
 Position Our Products   We intend to penetrate existing markets by positioning
 as a Superior Value     our product suites as a superior value alternative to
 Alternative to Existing machines that lack high image quality and higher-
 Ultrasound Products     priced machines that lack portability and ease of use.
                         To facilitate early and rapid market acceptance, we
                         will target our initial product suites for traditional
                         use within existing clinical applications for
                         ultrasound imaging, including:
 
                            . gynecology and obstetrics;
 
                            . cardiology; and
 
                            . radiology.
 
 Offer Customized        We will offer a customized education program to teach
 Education to Increase   physicians not currently utilizing ultrasound imaging
 Users of Ultrasound     the various clinical applications of our products. We
 Imaging                 intend to work with clinical opinion leaders to
                         demonstrate and communicate the efficacy and cost-
                         effectiveness of our ultrasound technology. We intend
                         to target physicians who can benefit from our
                         products, including:
 
                            . emergency medicine physicians;
 
                            . general practitioners;
 
                            . sports orthopedists;
 
                            . general and specialty surgeons; and
 
                            . gastroenterologists.
 
 Establish Strategic     We intend to form strategic partnerships with
 Partnerships in Key     companies in established leadership positions and with
 Clinical Segments       distribution channels in clinical segments where our
                         products and proprietary technology may benefit new
                         users. These clinical segments may include surgery,
                         cardiology, emergency medicine and gastroenterology.
 
 Utilize ATL Ultrasound  We will use ATL Ultrasound to initially manufacture
 Manufacturing           our products. This relationship enables us to benefit
 Expertise               from ATL Ultrasound's established ultrasound
                         production experience and manufacturing facilities
                         that comply with International Standards Organization
                         (ISO) requirements. This arrangement will also
                         significantly reduce risks and capital costs usually
                         encountered during the start-up phase of a new
                         manufacturing facility.
 
 Leverage Third-Party    We have established alliances with leading independent
 Distribution            medical equipment distributors. We intend to utilize
 Capabilities            their expertise to reach both customary purchasers of
                         ultrasound systems and a wide variety of medical
                         practitioners who do not currently use ultrasound
                         imaging.
</TABLE>
 
                                       6
<PAGE>
 
Our Product Suites
 
  SonoSite Leap Product Platform
 
   General Specifications. The SonoSite Leap product platform is comprised of a
hand-carried display unit consisting of an integrated color display and control
panel, together with the application-specific transducer. Products based on
this platform will be able to store images in memory and allow simulated stored
real-time motion images, a diagnostic capability that is used in many
ultrasound examinations. Products based on the SonoSite Leap platform will
provide 2D and power Doppler imaging and a proprietary auto-focus capability
which enables the user to quickly complete the ultrasound examination. These
products can be powered by conventional alternating current or by a
rechargeable lithium ion battery.
 
   Ultrasound Signal Processing and Display Unit. Our hand-carried display unit
will weigh less than five pounds and measure 13 inches long, 7.5 inches wide
and 2.5 inches high. The display unit houses four custom-designed computer
chips and circuitry with digital signal processing. The real-time images
generated by the display unit can be transmitted to industry-standard monitors
and printers or shown on the five-inch articulated high-resolution liquid
crystal display panel integrated in the display unit. Imaging functions are
controlled through a small alphanumeric keyboard immediately below the display
panel and a navigational trackball. We use injection molded plastic for the
outer shell of the display unit. We designed the display unit to be durable,
visually appealing and easy to handle.
 
   Transducers. We will offer a variety of transducers specific to particular
clinical applications. Initially, we will offer an abdominal transducer and a
transvaginal transducer. The abdominal transducer will be a curved array
broadband transducer for general abdominal and obstetrics applications. The
transvaginal transducer will be a broadband transducer for gynecological
ultrasound scanning. Each transducer will be produced through a proprietary
manufacturing process. Transducers are attached to the display unit by a cable.
We are currently developing transducers for additional clinical applications.
Within the next 12 months, we anticipate releasing a transducer unit capable of
imaging internal organs between the ribs and a linear array unit that will have
utility for the radiologist and internist in shallow ultrasound imaging
applications.
 
  SmartStand
 
   To enhance the utility and efficiency of our product suites, we are
developing the SmartStand. The SmartStand is designed to:
 
  . provide storage of our products when not in use and a stand for our
    products when they are in use;
 
  . recharge the battery in the base unit;
 
  . provide enhanced interface capabilities between our products and third-
    party output devices, such as printers and storage devices; and
 
  . be portable and minimize space requirements.
 
  Customized Education and Training
 
   We intend to provide training in the product operation and clinical
interpretation necessary to enable physicians who do not currently use
ultrasound to be fully competent in both the fundamental operation of our
products and in the clinical skills required to use them effectively. We
anticipate that renowned ultrasound physicians will deliver a focused offering
of educational curricula. Utilizing leading-edge multimedia technology, we plan
to deliver innovative programs in multiple languages for (1) ultrasound
knowledge assessments, (2) product operation training, and (3) Continuing
Medical Education (CME) accredited clinical education.
 
                                       7
<PAGE>
 
  Product Suites
 
   Products based on the SonoSite Leap platform will be offered in suites
consisting of a display unit, transducers and other essential accessories. We
have designed our product suites to target the following clinical applications:
 
 
<TABLE>
<CAPTION>
    Product                                                          Expected
     Suite                      Clinical Segment                    Launch Date
 
-------------------------------------------------------------------------------
 
  <C>          <S>                                                  <C>
  [Gynecology  The SonoSite Gynecology and Obstetrics Suite of        Fourth
  & Obstetrics products and accessories will offer a convenient,      Quarter
  icon]        effective means of incorporating ultrasound in           of
               gynecologic and obstetric office examinations. It       1999
               will include both the abdominal and transvaginal
               transducers for both currently reimbursable
               routine and symptomatic imaging procedures.
   Gynecology
  & Obstetrics
 
-------------------------------------------------------------------------------
 
  [Emergency   The SonoSite Emergency Medicine Suite of products      Fourth
  Medicine     and accessories will provide the capability to         Quarter
  icon]        perform high-quality ultrasound imaging at trauma        of
               scenes or in emergency transport vehicles or            1999
               facilities. The portability, high-image quality
               and battery power of this product suite enables
               trauma-scene diagnosis and patient triage that are
               not currently available.
   Emergency
    Medicine
 
-------------------------------------------------------------------------------
 
   [Cardiology The SonoSite Cardiology Suite of products and           First
   icon]       accessories will augment the cardiologist's             Half
               current use of ultrasound imaging to aid in the          of
               rapid assessment of conditions or symptoms in an        2000
               office or hospital setting. The initial product
               suite will provide 2D imaging of the heart and
               will later be enhanced to include color flow
               mapping capability and image quality improvements.
   Cardiology
 
-------------------------------------------------------------------------------
 
   [Body       The SonoSite Body Imaging Suite of products and         First
   Imaging     accessories will allow the radiologist to go            Half
   icon]       directly to the patient to provide ultrasound            of
               imaging services with a full complement of              2000
               specially designed transducers and functional
               capabilities.
  Body Imaging
</TABLE>
 
 
  Additional Product Development
 
   We intend to continue to invest heavily in further research and development,
focused on (1) expansion of the SonoSite Leap product platform to product
suites targeted at additional clinical applications, (2) further enhancing
image quality, and (3) further reducing the size and manufacturing costs of our
products. By accomplishing these objectives, we hope to both extend the range
of our current product platform and develop other, potentially smaller product
platforms for our ultrasound imaging technology, in order to further expand the
use of ultrasound imaging and our products.
 
                                       8
<PAGE>
 
Technology
 
   Our product development efforts have enabled us to achieve the performance
of a large, high-quality ultrasound imaging system in a smaller, less expensive
device that is easy to use. Our proprietary technology is the subject of two
issued and two pending patents. The key components in our technology platform
include the following:
 
   Custom-Designed Computer Chips. We have built on extensive ATL Ultrasound
experience in high-end digital ultrasound and Application Specific Integrated
Circuit (ASIC) technology to develop four proprietary custom-designed computer
chips that implement most of the functions required in a completely digital
ultrasound imaging system. We have made significant advances in the integration
of ultrasound functions onto customized chip designs, including the integration
of a complete ultrasound beamformer onto a single computer chip. Our
proprietary chip technology allows our products to share many of the
architectural and signal-processing attributes of a high-end ultrasound imaging
system in a significantly smaller device.
 
   Transducers. Using proprietary technology, we have developed high-
performance transducers. We have designed our display units to also utilize
transducers manufactured by a variety of third-party suppliers, increasing the
versatility of our platform.
 
   Modular Design. Our products are being developed in a building-block
fashion, which allows us to develop future products based on a single platform,
with each product possessing specific attributes for particular clinical
applications. This modular design enables us to integrate new technological
advances into our platform by modifying only a part of the platform, rather
than the entire platform itself.
 
   Human Factors Engineering. We have conducted research regarding the utility
of our products and their use in clinical settings. Based on these
observations, we have designed our products to be compatible with a variety of
printing, recording and support devices. We are developing the SmartStand and
the SonoCase in response to the particular needs of physicians who will use our
products.
 
   Development Infrastructure. We possess a sophisticated infrastructure to
facilitate rapid development of new high-performance products and features.
Specific features of this infrastructure include:
 
  . Advanced acoustic beam simulation. We have developed the ability to
    simulate the emission, propagation, reflection and reception of simulated
    acoustic waves in a Computer Aided Design (CAD) environment. This allows
    us to evaluate the characteristics of acoustic waveforms and to test
    various product configurations and transducer geometrics without having
    to produce physical prototypes.
 
  . Transducer finite element modeling. We use sophisticated finite element
    modeling techniques to model the detailed physical characteristics and
    acoustic performance of selected transducer designs. This enables rapid
    product development, changes and improvements without having to produce
    hardware prototypes.
 
  . Fully integrated system simulation. We use advanced engineering CAD tools
    to assess the performance of a proposed ultrasound system solution
    relative to its design targets. Based on this assessment, we can rapidly
    simulate design revisions to attain targeted performance levels.
 
  . High-speed ASIC behavioral modeling. We have developed sophisticated,
    proprietary engineering design software to simulate the architecture and
    performance of our custom computer chip designs. We are able to test and
    debug our computer chip designs before committing to their manufacture,
    which reduces development time and the cost of materials.
 
  . Object-oriented system and software. We utilize sophisticated system and
    software development practices that include the use of object-oriented
    building blocks to eliminate time and cost during software development
    and to allow for more robust and reusable software designs.
 
                                       9
<PAGE>
 
Research and Development
 
   Product development activities have comprised the majority of our activities
and expenditures since we were formed as a division within ATL Ultrasound. We
continue to conduct extensive research, development and engineering activities
and, as of December 31, 1998, we employed 37 engineers and support staff
dedicated to the technical development of our hand-carried ultrasound products.
The majority of these individuals joined us from ATL Ultrasound. We expect
research and development expenditures to increase during 1999 in anticipation
of the commercial launch of the SonoSite Leap product platform and as we begin
to manufacture products based on that platform. We invested $9.5 million, $7.1
million and $2.6 million in research and development for the years ended
December 31, 1998, 1997 and 1996, respectively.
 
Sales, Marketing and Distribution
 
   We intend to sell and distribute our product suites through third-party
distributors. We also intend to establish strategic partnerships in certain
clinical segments. We plan to compete in all the major clinical and geographic
segments of the existing ultrasound imaging market by reaching a diverse
customer base, including physicians in private practice, hospitals, clinics,
private and governmental institutions and healthcare agencies. We will support
our domestic third-party distribution network with a small staff of territory
sales directors.
 
   Within the United States, we have entered into an agreement with PSS World
Medical, Inc. under which they will serve as our exclusive third-party
distributor in the private practice segment. PSS World Medical serves more than
100,000 clients nationwide. In addition, we have entered into an agreement with
Diagnostic Imaging, Inc., a subsidiary of PSS World Medical, under which they
will serve as our exclusive U.S. distributor for hospitals and diagnostic
imaging centers. Under our agreement with Diagnostic Imaging, we have reserved
the right to sell directly to hospitals, diagnostic imaging centers and other
institutional providers. As a result, we will have the flexibility we need to
manage our domestic sales organization and respond to changes in this market
over time.
 
   Internationally, we have entered into agreements with distributors covering
more than 50 countries. We intend to rely exclusively on these distributors for
overseas sales, focusing primarily on Japan, members of the European Community
and other developed countries, coordinated by our own sales directors in Europe
and Asia.
 
Manufacturing
 
   Agreement With ATL Ultrasound. All our products will initially be
manufactured by ATL Ultrasound under an OEM supply agreement. Under this
agreement, ATL Ultrasound has agreed to manufacture many of our product
components and assemble our final products for distribution through 2003.
However, we intend to assume the manufacture of some components, including
transducers, prior to 2003. ATL Ultrasound has agreed to manufacture and
assemble our products in accordance with its own standard of care for the
manufacture of its own products. As a result, we believe our products will be
of the highest quality and produced in accordance with federal good
manufacturing practices and International Standards Organization (ISO)
standards. During the term of the agreement, our products will be produced by
ATL Ultrasound on its campus in Bothell, Washington. All equipment and other
capital assets used by ATL Ultrasound exclusively in the manufacture of our
products have been purchased by us and are owned by us. As a result, all or
some of these assets will be transferred to us if we assume production of our
products or they may be used by a new third-party manufacturer.
 
   Suppliers. We depend on other vendors to provide components for our
products, such as the high-resolution color displays, certain transducers,
batteries and our custom-designed computer chips. A number of these components
have limited or single sources of supply. For example, VLSI Technology and
Harris Semiconductor supply us with the custom-designed computer chips that are
integral to the functionality of our products. We believe that we could
ultimately develop alternate sources for all of our product components, but
that sales could be lost or deferred as a result of doing so. In addition,
these components generally have long order lead times, restricting our ability
to respond quickly to changing market conditions.
 
                                       10
<PAGE>
 
Patents, Trademarks and Licenses
 
   We are committed to developing and protecting our intellectual property. We
file patent applications to protect innovative technology, inventions and
innovative improvements that are significant to the development of our
business. We have filed a number of patent applications in the United States
and other countries directed to proprietary technology used in our hand-carried
ultrasound devices. We hold two patents directed to our technology. In March
1998, we received our first patent (U.S. patent No. 5,722,412), which is
directed to hand-carried ultrasound systems with digital signal processing that
weigh less than 10 pounds. This patent expires on June 28, 2016. In October
1998, we received our second patent (U.S. patent No. 5,817,024), which is
directed to hand-held ultrasonic devices and integrated circuits that
incorporate analog-to-digital conversion circuitry and ultrasound beamforming
capability on the same integrated circuit. This second patent also expires on
June 28, 2016. We also have an exclusive license from ATL Ultrasound through
April 5, 2003, which becomes nonexclusive thereafter, to use specified ATL
Ultrasound technology in existence at the time of our spinoff, such as ASIC
technology in the products we are developing. Under this license, we also have
the right to use further advances made by ATL Ultrasound that have been made by
them prior to April 5, 2001.
 
   We intend to register the trademarks and trade names through which we will
conduct our business in the United States and abroad. To date, we have applied
for registration in the United States of the mark "SonoSite" and our logo.
 
   We also intend to seek protection for the software contained in our
ultrasound products under patent, copyright, and trade secret laws where, in
our judgment, significant advantage may be obtained from such protection.
Patent, copyright and trade secret protection is subject to limitations and
uncertainties and may not provide us any significant competitive advantage.
 
   We do not know of any infringement by our products on any intellectual
property rights of others, nor have we received notice from any third party of
any claimed infringement. We are unaware of any competitive products that
infringe on our intellectual property rights.
 
Competition
 
   The existing medical imaging industry in general, and the existing
ultrasound market specifically, is very competitive. The primary bases of
competition are image quality, price and ease of use. Our products will be
competing with existing ultrasound systems offered by a number of established
companies and their international affiliates. These companies include Acuson
Corporation, Aloka Co., Ltd., ATL Ultrasound, ESAOTE S.p.A., General Electric
Company, Hewlett-Packard Company, Hitachi Corporation, Medison Co., Siemens
Medical Systems, Inc. and Toshiba Medical Systems, Inc. All these competitors
have significantly greater financial and other resources than we do. In
addition, they also generally compete with more than one type of medical
imaging device and are already established in many of the market segments and
countries that we intend to enter. While we believe that our products provide
high-quality images and advanced capabilities and features, the products
offered to date by these competitors in some cases include features and
capabilities that we are not currently able to offer. Any established or new
competitor may introduce new systems or upgrades to existing systems that are
equal to or superior to our products in terms of quality or performance. We
therefore cannot assure you that our products will be competitive with existing
or future products or that we will be able to develop competitive products in
the future.
 
   A number of companies offer portable ultrasound systems, typically in the
form of analog desktop units resembling tabletop television sets. In addition,
we believe that there are at least two other companies developing ultrasound
systems constructed around a laptop computer. There are also a number of groups
that are being, or have been, funded by government grants to develop small
ultrasound devices that could directly compete with our products. We also
anticipate that other companies may be planning to develop highly portable
devices to address the market opportunity that we believe exists for hand-
carried ultrasonic imaging products. New product offerings in recent years have
made the ultrasound market increasingly competitive, as customers can choose
from a broad range of ultrasound products. The breadth of new products from
many
 
                                       11
<PAGE>
 
companies appears to have lengthened the time required for customers to make
decisions to purchase, since customers have many products to consider before
making a purchase decision. In addition to portability, we compete primarily on
the basis of the major clinical benefits of the imaging performance,
versatility, reliability, upgradability, ease of use and price. We believe
these factors will allow us to be competitive. However, we cannot assure you
that this will be the case.
 
Governmental Regulation
 
   Our products are subject to extensive regulation by numerous governmental
authorities, principally the U.S. Food and Drug Administration, as well as
numerous state and foreign agencies. We need to obtain clearance of our
products by the U.S. Food and Drug Administration before we can begin marketing
the products in the United States. Similar approvals are also required before
we can begin marketing our products in most other countries. Our products are
also subject to various domestic and foreign electrical safety and emission
standards. The U.S. Food and Drug Administration has broad regulatory powers
with respect to preclinical and clinical testing of new medical products and
the manufacturing, marketing and advertising of medical products. The
manufacture of our products will be subject to U.S. Food and Drug
Administration regulations governing registration of manufacturing facilities
and compliance with the U.S. Food and Drug Administration's Quality System
Regulations. The U.S. Food and Drug Administration has adopted the ISO
standards as the basis for its Quality System Regulations for the United
States, and these standards went into full effect for U.S. manufacturers of
medical devices in June 1998. We will also be subject to periodic on-site
inspection from the U.S. Food and Drug Administration for compliance with such
regulations.
 
   The U.S. Food and Drug Administration requires that all medical devices
introduced to the market be preceded either by a premarket notification
clearance order under Section 510(k) of the Federal Food, Drug & Cosmetics Act
or an approved premarket approval application. A Section 510(k) premarket
notification clearance order indicates U.S. Food and Drug Administration
agreement with an applicant's determination that the product for which
clearance has been sought is substantially equivalent to medical devices on the
market prior to 1976 or has subsequently received clearance. The U.S. Food and
Drug Administration requires a premarket approval when it has determined that a
company must submit clinical trial data and manufacturing quality assurance
information to prove that a product is safe and effective for its labeled
indications. The process of obtaining Section 510(k) clearance through the
U.S. Food and Drug Administration is targeted at 30 days but typically can take
up to nine months, while the premarket approval process typically lasts more
than a year.
 
   We received Section 510(k) clearance for a prototype of our SonoSite Leap
platform in May 1998 for 10 clinical applications, based upon substantial
equivalence to current ultrasound products being marketed by ATL Ultrasound.
Based on advances we have made since that approval, we have applied for a new
Section 510(k) clearance for the commercial version of the SonoSite Leap
product platform that covers enhanced performance features and one additional
clinical application. We believe that any future generation hand-carried
ultrasound product platforms will also require only Section 510(k) clearance.
We design our products to comply with applicable electrical safety standards,
such as those of Underwriters Laboratories and non-U.S. safety standards
authorities.
 
   In order to market our product suites in those countries that are members of
the European Union and the European Free Trade Association, we must obtain the
conformite europeenne (CE) mark for these product suites. In addition to basic
directives applicable to all products, our products are subject to the Medical
Device Directive which requires us to receive a certification from an approved
body that our product meets certain quality and safety standards. Examples of
these standards include ISO 9001-1994 requirements and European Norm (EN)
46001-1997 requirements. We have applied for approval to affix the CE mark to
our products and expect to receive approval in the third quarter of 1999. We
will rely on ATL Ultrasound and their ISO-compliant manufacturing procedures to
meet the ISO requirements for our products. We expect to comply with all EN
certification requirements for our products. Individual members of the European
Union and European Free Trade Association and other local governmental
authorities in Europe may also require further premarket approvals for our
products.
 
                                       12
<PAGE>
 
   Several countries have, in recent years, changed the electronic emission
requirement that must be met by ultrasound equipment. We cannot assure you that
we will be able to continue to respond to these continually changing regulatory
requirements in a timely manner. Our regulatory compliance programs are being
developed to encompass verification of our compliance with domestic and
international standards for medical device design, manufacture, installation
and servicing.
 
   While we anticipate receiving needed approvals in time for our current plans
for product introduction, the process of obtaining regulatory approvals can be
lengthy, expensive and uncertain. Failure to obtain the necessary clearances
and approvals will delay marketing of our products. Failure to comply with U.S.
Food and Drug Administration regulations and ISO quality requirements could
result in sanctions being imposed, including shutting down our operations,
restricting our marketing efforts or recalling our products. We cannot assure
you that we will be able to obtain necessary regulatory approvals in the
future. Delays or failures to receive such approvals, the loss of previously
obtained approvals or failure to comply with regulatory requirements could have
a material adverse effect on our business.
 
Reimbursement
 
   Physicians may seek reimbursement from third-party payors for all or some of
the services they provide while using our products. In the United States, the
third-party payors include Medicare, Medicaid and private health insurance
plans. Reimbursement from these organizations is subject to the regulations and
policies of governmental agencies and other third-party payors. For example,
the Medicare program, which reimburses hospitals and physicians for services
provided to a significant percentage of hospital patients, places certain
limitations on the methods and levels of reimbursement of hospitals for
procedure costs and for capital expenditures made to purchase equipment, such
as the products we intend to sell. Currently, reimbursement is authorized for a
number of the uses of our hand-carried ultrasound devices but not for all
planned procedures for which our devices may be suitable.
 
   The Medicare program also limits the level of reimbursement to physicians
for diagnostic tests. The state-administered Medicaid programs and private
payors also place limitations on the reimbursement of both facilities and
physicians for services provided in connection with diagnostic and clinical
procedures. Reduced governmental expenditures in the United States and many
other countries continue to put pressure on diagnostic procedure reimbursement.
We cannot predict what changes may be forthcoming in these policies and
procedures, or the effect of any such changes on our business.
 
   Third-party payors worldwide, including governmental agencies, are under
increasing pressure to contain medical costs. Limits on reimbursement or other
cost-containment measures imposed by third-party payors may adversely affect
the financial condition and ability of hospitals and other users to purchase
products, such as ours, by reducing funds available for capital expenditures or
otherwise. We cannot forecast what additional legislation or regulation, if
any, relating to the healthcare industry or third-party reimbursement may be
enacted in the future or what effect such legislation or regulation would have
on us.
 
Employees
 
   As of December 31, 1998, we had 61 full-time employees. Of these employees,
37 were engaged in research and product development activities, 12 in sales and
marketing activities and 12 in administrative capacities. We have never had a
work stoppage and no employees are covered by collective bargaining agreements.
We believe our employee relations are good.
 
Important Factors Regarding Forward-Looking Statements
 
   You should carefully consider the following factors and other information
included in this Report. The risks and uncertainties described below are not
the only ones we face. Additional risks and uncertainties not presently known
to us or that we currently deem immaterial also may impair our business
operations. If any of the following events actually occur, our business,
financial condition and operating results could be materially adversely
affected.
 
                                       13
<PAGE>
 
We Have a Limited Operating History
 
   We commenced operations as a separate company in April 1998. Prior to that,
we operated as a business unit of ATL Ultrasound. Accordingly, we have a
limited operating history. You should consider our business and prospects in
light of the risks and uncertainties encountered by development-stage
technology companies in evaluating whether to invest in our common stock. There
are many reasons why we may not be successful in implementing our strategy,
including:
 
  . any inability to complete the design and manufacture of our products;
 
  . any inability to achieve market acceptance of our products;
 
  . our dependence on a new platform for ultrasound imaging procedures;
 
  . our reliance on third-party manufacturing of our products;
 
  . our need to maintain and expand distribution networks;
 
  . any loss of key personnel;
 
  . any inability to respond effectively to competitive pressures;
 
  . any inability to manage rapid growth and expanding operations; and
 
  . any failure to comply with governmental regulations.
 
We Have Incurred Losses and Expect Future Losses
 
   As a development-stage company, we have incurred net losses in each quarter
since we started operations. As of December 31, 1998, we had an accumulated
deficit of approximately $20.9 million, including approximately $10.3 million
that was accumulated prior to our commencing operations as a separate company
in April 1998. We expect to incur substantial additional expenses in the future
as we attempt to complete the development of our products and introduce our
products into the market. As a result, we will need to generate significant
revenues in the future before we will be able to achieve and maintain
profitability. Our business strategies may not be successful and we may not be
profitable in any future period. If we do become profitable, we cannot be
certain that we can sustain or increase profitability on a quarterly or annual
basis.
 
Physicians and Other Healthcare Providers May Not Purchase Our Products
 
   The products we are developing represent a new platform for ultrasound
imaging procedures and we have not sold any of our products commercially. The
market for hand-carried, high-performance ultrasound devices is new and
untested. We do not know if physicians or other healthcare providers will
accept our products or purchase them when available. Acceptance of our products
by physicians, including physicians who do not currently use ultrasound, is
essential to our success and may require us to overcome resistance to a new
platform for ultrasound imaging. Use of our products will require training for
physicians who currently do not use ultrasound imaging instruments. The time
required to complete such training may be substantial and could result in a
delay or decrease in market acceptance. Currently, patients requiring an
ultrasound examination are generally referred to a centralized testing
location. Radiologists and other specialized providers of ultrasound at these
locations may have an incentive to discourage market acceptance for our
products in order to maintain these referrals.
 
   Physicians and other healthcare providers will not purchase our products
unless they determine that it is preferable to other means of obtaining an
ultrasound examination and that the benefits to the patient and physician
outweigh the costs of purchasing our products. This determination will depend
on our products' image quality, cost effectiveness, ease of use, reliability,
portability and level of third-party reimbursement. Acceptance of our products
by physicians and other healthcare providers may be more difficult if they are
not able to obtain adequate reimbursement from third-party payors for tests
performed using our products. In addition, we have not yet determined the
pricing for our products. Our pricing policies could limit market acceptance
compared to competing products or alternative testing methods.
 
                                       14
<PAGE>
 
We Rely on ATL Ultrasound for Manufacturing Our Products and for Engineering
Services
 
   We depend on our relationship with ATL Ultrasound. We have contracts with
ATL Ultrasound for manufacturing and engineering services. These services are
critical to the success of our product development efforts and our ability to
deliver our products to customers. ATL Ultrasound may be unable to provide all
the manufacturing capacity we will need to meet our planned objectives.
Although we believe that we could ultimately develop alternative sources for
the services provided by ATL Ultrasound, we may lose future sales and incur
additional expenses as a result of any interruption or delay by ATL Ultrasound
in manufacturing our products or in providing engineering services.
Additionally, ATL Ultrasound has the right to terminate our engineering service
agreement on 90 days' notice.
 
We Have No Manufacturing Experience or Capability
 
   In the future, we intend to assume some or all of the manufacture and
assembly of our products. If we do, we will be required to develop our own
manufacturing capability. We may be unable to comply with regulations
applicable to manufacturers of ultrasound devices or manufacture our products
at a cost or in quantities necessary to achieve or maintain profitability. In
addition to compliance with regulatory requirements, we may encounter
difficulties in scaling up production of our products, including problems
involving manufacturing yields, quality control and assurance and shortages of
qualified personnel. We may be unable to successfully meet these challenges.
 
We Rely on Third-Party Vendors to Supply Highly Specialized Components for Our
Products
 
   We depend on third-party vendors to supply highly specialized parts, such as
custom-designed computer chips and some transducer components. These vendors
may experience difficulty in manufacturing these parts, or in meeting our high
quality standards. In addition, these parts generally have long order lead
times which restrict our ability to respond quickly to changing market
conditions. If we are required to switch vendors, the manufacture and delivery
of our products could be interrupted for an extended period.
 
We Depend on Single-Source Vendors for Some of Our Components
 
   We depend on single-source vendors for some key components for our products,
including custom-designed integrated circuits, image displays, batteries,
capacitors and transformers. There are relatively few alternative sources of
supply for some of these components. While these vendors have produced our
components with acceptable quality, quantity and cost in the past, they may be
unable to meet our future demands. Establishing additional or replacement
suppliers for these components may take a substantial amount of time. If we
have to switch to a replacement vendor, the manufacture and delivery of our
products could be interrupted for an extended period.
 
We May Experience Difficulties Managing Our Growth
 
   We expect significant growth in all areas of operations as we develop and
market our products. We will need to add personnel and expand our capabilities,
which may strain our existing management, operational, financial and other
resources. To compete effectively and manage future growth, we must:
 
  . accurately forecast demand for our products;
 
  . train, manage and motivate a growing employee base; and
 
  . improve existing operational, financial and management information
    systems.
 
   We may be unable to complete necessary improvements to our systems,
procedures and controls to support our future operations in a timely manner. In
addition, we may be unable to attract or retain required personnel and our
management may be unable to develop the additional expertise required to manage
any future growth.
 
                                       15
<PAGE>
 
Future Operating Results Are Uncertain and Likely to Fluctuate
 
   Our future operating results will depend on numerous factors, many of which
we do not control, including:
 
  . demand for our products;
 
  . product and price competition;
 
  . changes in the costs of components;
 
  . success of our indirect sales and distribution channels;
 
  . successful development and commercialization of new and enhanced products
    on a timely basis;
 
  . timing of new product introductions and product enhancements by us or our
    competitors; and
 
  . timing and magnitude of our expenditures.
 
   Changes in any or all of these factors could cause our operating results to
fluctuate. In addition, we intend to have our products manufactured based on
forecasts of sales in future periods. Our forecast in any particular period
may prove inaccurate, which could cause fluctuations in our manufacturing
costs and our operating results. Our future operating results could fall below
the expectations of securities analysts or investors and reduce the market
price of our stock. We believe that there may be some fluctuations caused by
year-end budgetary pressures on our customers, customer buying patterns and
the efforts of our indirect sales and distribution network to meet or exceed
annual sales quotas. These factors make it difficult to forecast our revenues
and operating results. Fluctuations in our operating results may increase the
volatility of our stock price.
 
Our Products May Become Obsolete
 
   Our competitors may develop and market ultrasound products that render our
products obsolete or non-competitive. In addition, although diagnostic
ultrasound imaging products may have price and/or performance advantages over
competing medical imaging equipment, such as computed tomography and magnetic
resonance imaging, any price or performance advantages may not continue. For
example, our products could become obsolete or unmarketable if other products
utilizing new technologies are introduced or new industry standards emerge. As
a result, the life cycles of our products are difficult to estimate. To be
successful, we will need to continually enhance our products and to design,
develop and market new products that successfully respond to any competitive
developments. In addition, because our products are based on a single
platform, we may be more vulnerable to adverse events affecting the healthcare
industry generally, and the medical ultrasound market specifically, than we
would be if we offered products based on more than one platform.
 
The Market for Ultrasound Imaging Products Is Highly Competitive
 
   The existing market for ultrasound imaging products is well established and
intensely competitive. In addition, we are seeking to develop new markets for
our hand-carried ultrasound imaging products. In response, we expect
competition to increase as potential and existing competitors begin to enter
these new markets and/or modify their existing products to compete directly
with ours. Our primary competitors have:
 
  . better name recognition;
 
  . significantly greater financial resources; and
 
  . existing relationships with some of our potential customers.
 
   Our competitors may be able to use their existing relationships to
discourage customers from purchasing our products. In addition, our
competitors may be able to devote greater resources to the development,
promotion and sale of new or existing products, thereby allowing them to
respond more quickly to new or emerging technologies and changes in customer
requirements.
 
We May Be Unable to Maintain and Expand Our Indirect Sales and Distribution
Networks
 
   We have established an indirect sales and distribution network to sell our
products domestically and internationally. Our future revenue growth will
depend in large part on our success in maintaining and
 
                                      16
<PAGE>
 
expanding these indirect sales and distribution channels. We will depend on
these distributors to help promote market acceptance and demand for our
products. However, many of these distributors will be in the business of
distributing other, sometimes competing, medical products. As a result, our
products may not receive the resources and support required within this network
to meet our sales objectives.
 
   We intend to manage our third-party distribution network with several sales
directors. These sales directors will need a high level of technical expertise
and knowledge regarding our products' capabilities and ultrasound imaging
products in general and their use. We face intense competition for qualified
sales directors and may be unable to attract and retain such personnel, which
would adversely affect our ability to expand and maintain our third-party
distribution network.
 
   If we fail to maintain or expand our third-party distribution network, we
will need to develop our own distribution capabilities, which would be
expensive and time-consuming. We may be unable to develop our own distribution
capabilities in a timely manner, if at all, which would have an adverse effect
on our ability to sell our products.
 
We Depend on Key Employees and the Availability of Highly Skilled Employees
 
   Our future performance will depend largely on the efforts and abilities of
our key technical, marketing and managerial personnel and our ability to retain
them. Our success depends on our ability to attract and retain additional key
personnel in the future. The loss of any of our key employees could adversely
affect our business, particularly the loss of any of our key engineering
personnel. We do not have any employment agreements with any of our employees.
We do not maintain key person insurance on any of our employees.
 
We May Be Unable to Adequately Protect Our Intellectual Property Rights
 
   Our success and ability to compete depend on our licensed and internally
developed technology. We protect our proprietary technology through a
combination of patent, copyright, trade secret and trademark law. 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 we license from others.
Despite our efforts to protect these proprietary rights, unauthorized parties
may copy, develop independently or otherwise obtain and use our products or
technology.
 
   We cannot be sure that our pending patent applications will be issued. In
addition, our issued patents or pending applications may be challenged or
circumvented by our competitors. Policing unauthorized use of our intellectual
property will be difficult and we cannot be certain that we will be able to
prevent misappropriation of our technology, particularly in countries where the
laws may not protect our proprietary rights as fully as in the United States.
 
Our Products May Infringe on the Intellectual Property Rights of Others
 
   Many of our competitors in the ultrasound imaging business have filed, or
may file, patent applications. Our competitors may claim our technology or
products infringe upon the technology covered by these applications. Any such
claims, with or without merit, could:
 
  . be time-consuming to defend;
 
  . result in costly litigation;
 
  . divert management's attention and resources;
 
  . cause product shipment delays; or
 
  . require us to enter into royalty or licensing agreements.
 
   Any required royalty or licensing agreements may not be available to us on
acceptable terms, if at all. If a third party makes a successful claim of
patent infringement against us, we may be unable to license the infringed or
similar technology on acceptable terms, if at all. In addition, we could be
prevented from manufacturing or selling some or all of our products and/or be
liable to a third-party patent holder.
 
                                       17
<PAGE>
 
We May Incur Tax Liability in Connection with our Spinoff from ATL Ultrasound
 
   Our spinoff was treated by ATL Ultrasound as a tax-free spinoff under
Section 355 of The Internal Revenue Code of 1986. However, if ATL Ultrasound
were to recognize taxable gain from the spinoff, the Internal Revenue Service
could impose that liability on any member of the ATL Ultrasound consolidated
group as constituted prior to the spinoff, including SonoSite. ATL Ultrasound
has agreed to cover 85% of any such liability (unless the tax is imposed due to
the actions by ATL Ultrasound solely or SonoSite solely, in which case ATL
Ultrasound and SonoSite have agreed that the party who is solely at fault shall
bear all of the tax liability). We cannot guarantee that ATL Ultrasound would
indemnify us or agree that it caused the liability to be imposed. If we were
required to pay all or a portion of any taxes related to the spinoff, our
business would be adversely affected.
 
We Are Subject to Substantial Governmental Regulation
 
   All of our planned products and manufacturing activities are subject to
extensive regulation by a number of governmental agencies, including the U.S.
Food and Drug Administration and comparable international agencies. We will be
required to:
 
  . undergo rigorous inspections by domestic and international agencies;
 
  . obtain the prior approval of these agencies before we can market and sell
    our products; and
 
  . satisfy content requirements for all of our sales and promotional
    materials.
 
   Compliance with the regulations of these agencies may delay or prevent us
from introducing new or improved products. We may be subject to sanctions,
including the temporary or permanent suspension of operations, product recalls
and marketing restrictions, if we fail to comply with the laws and regulations
pertaining to our business.
 
We Face Risks From Expansion of Our International Operations
 
   Our current business strategy depends on our ability to establish
international markets for our products. We will need to devote significant
management attention and financial resources to obtain any necessary foreign
governmental approvals. International sales are subject to inherent risks,
including:
 
  . the costs of localizing products for foreign markets;
 
  . longer receivables collection periods and greater difficulty in
    receivables collection, as compared to those experienced in the United
    States;
 
  . reduced protection for intellectual property rights in some countries;
    and
 
  . fluctuations in the value of the U.S. dollar relative to other
    currencies.
 
We May Face Product Liability and Warranty Claims
 
   The sale and support of our products entails the risk of product liability
or warranty claims, based upon claims that the failure of one of our products
resulted in a misdiagnosis. The medical instrument industry in general has been
subject to significant medical malpractice litigation. We may incur significant
liability in the event of such litigation. Although we maintain product
liability insurance, we cannot be sure that this coverage is adequate or that
it will continue to be available on acceptable terms, if at all.
 
   We also may face warranty exposure, which could adversely affect our
operating results. We anticipate that our products will carry a one-year
warranty against defects in materials and workmanship. We will be responsible
for all claims, actions, damages, liens, liabilities, costs and expenses under
our manufacturing contract with ATL Ultrasound for all product recalls, returns
and defects attributable to manufacturing. We intend to establish reserves for
the liability associated with product warranties. However, any unforeseen
warranty exposure could adversely affect our operating results.
 
 
                                       18
<PAGE>
 
We May Require Additional Funding to Satisfy Our Future Capital Expenditure
Needs
 
   Our future revenues may not be sufficient to support the expenses of our
operations and the expansion of our business. We may therefore need additional
equity or debt capital to finance our operations as we develop our products and
expand our sales internationally. To date, our capital requirements have been
met primarily by contributions by ATL Ultrasound in connection with our spinoff
and by grant revenue from the U.S. Office of Naval Research under a U.S.
Government Defense Advanced Research Projects Agency grant. ATL Ultrasound's
funding obligations have been met and any future grant revenue is expected to
be immaterial. As such, if we need additional financing we would need to
explore other sources of financing, including public equity or debt offerings,
private placements of equity or debt and collaborative or other arrangements
with corporate partners. Financing may not be available when needed or may not
be available on acceptable terms. If we are unable to obtain financing, we may
be required to delay, reduce or eliminate some or all of our research and
development and/or sales and marketing efforts.
 
Our Stock Price Has Been and Is Likely to Continue to Be Volatile
 
   The market price for our common stock and for securities of medical
technology companies generally has been volatile in the past and is likely to
continue to be volatile in the future. Our stock price may fluctuate in
response to a number of events and factors including:
 
  . actual or anticipated variations in quarterly operating results;
 
  . the loss of significant orders;
 
  . changes in earnings estimates by analysts;
 
  . announcements of technological innovations or new products by our
    competitors;
 
  . changes in the structure of the healthcare financing and payment systems;
 
  . general conditions in the medical industry; and
 
  . significant sales of our common stock by one or more of our principal
    shareholders.
 
Our Restated Articles of Incorporation, Our Bylaws, Washington Law and Some of
Our Agreements Contain Provisions That Could Discourage a Takeover
 
   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 SonoSite, even if doing so would be beneficial to our shareholders.
Additionally, the acquisition of SonoSite may be made more difficult or
expensive by the following:
 
  . a provision in our license agreement with ATL Ultrasound requiring a
    significant cash payment to ATL Ultrasound upon a change in control of
    SonoSite;
 
  . a shareholder rights agreement; and
 
  . acceleration provisions in benefit plans and change-in-control agreements
    with some of our employees.
 
We Face "Year 2000" Risks
 
   Many currently installed computer systems are not capable of distinguishing
21st century dates from 20th century dates. As a result, beginning on January
1, 2000, computer systems and software used by many companies and organizations
in a wide variety of industries will produce erroneous results, or fail, unless
they are modified or upgraded to process date information correctly. Based on
our design process and assessment to date, we believe the current versions of
our products are "Year 2000 compliant"--that is, they are capable of adequately
distinguishing 21st century dates from 20th century dates.
 
   Our greatest potential exposure with respect to the Year 2000 problem stems
from the possibility that some computer systems used by us and third parties
with whom we do business will be unable to distinguish 21st century dates from
20th century dates, which may significantly delay or limit our ability to
market our products.
 
 
                                       19
<PAGE>
 
ITEM 2. PROPERTIES
 
   Our principal offices are in approximately 20,000 square feet of leased
space in Bothell, Washington. These facilities include approximately 5,000
square feet used for research and laboratory space with the remainder used for
administrative offices. The facilities are leased through July 2003 with
options to renew for two three-year terms. We believe that these facilities
will be adequate to meet our needs through 1999 and that we will be able to
find additional space for manufacturing and research and administrative offices
as needed, without an adverse impact on our operations.
 
ITEM 3. LEGAL PROCEEDINGS
 
   There are no suits or claims pending against us, nor are we aware of any
threatened suits or claims.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
   No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of the fiscal year ended December 31, 1998.
 
                                       20
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
 
   The Company's Common Stock is traded on The Nasdaq National Market under the
symbol SONO. The number of shareholders of record of the Company's Common Stock
at March 10, 1999, was 5,609. 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 one holder of
record.
 
   The high and low sales price per share for the Company's Common Stock for
each of the second, third and fourth quarters of 1998 are as follows. Such
prices reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions. Our common
stock began trading on April 7, 1998.
 
<TABLE>
<CAPTION>
                                                                   Stock Price
                                                                   ------------
                                  Year                              High   Low
                                  ----                             ------ -----
       <S>                                                         <C>    <C>
       Fiscal 1998 (ended December 31, 1998)
         Second Quarter (from April 7, 1998)...................... $14.00 $6.13
         Third Quarter............................................   8.13  4.50
         Fourth Quarter...........................................  13.75  5.88
</TABLE>
 
   The Company has never declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain all future
earnings for use in the expansion and operations of its business and does not
anticipate paying cash dividends in the foreseeable future.
 
                                       21
<PAGE>
 
ITEM 6. SELECTED FINANCIAL DATA
 
   The tables that follow present portions of our financial statements and
should be read in conjunction with our financial statements and the notes
relating to these financial statements, as well as "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
in this Report.
 
<TABLE>
<CAPTION>
                               February 1994
                                  through       Years Ended December 31,
                               December 31,  ----------------------------------
                                   1994       1995    1996     1997      1998
                               ------------- ------  -------  -------  --------
                                   (in thousands, except per share data)
<S>                            <C>           <C>     <C>      <C>      <C>
Statement of Operations Data:
 Grant revenues..............     $   --     $   --  $ 1,029  $ 2,948  $    973
 Operating expenses:
  Research and development...         39         75    2,576    7,064     9,474
  Sales and marketing........         --         --       --    1,268     3,120
  General and
   administrative............          2          9      217      610     1,904
                                  ------     ------  -------  -------  --------
   Total operating expenses..         41         84    2,793    8,942    14,498
 
 Interest income.............         --         --       --       --       541
 Interest expense............         --         --       --       --        41
                                  ------     ------  -------  -------  --------
 Net loss....................     $  (41)    $  (84) $(1,764) $(5,994) $(13,025)
                                  ======     ======  =======  =======  ========
 Basic and diluted net loss
  per share(1)...............     $(0.01)    $(0.02) $ (0.38) $ (1.28) $  (2.72)
                                  ======     ======  =======  =======  ========
 Shares used in computation
  of basic and diluted net
  loss per share(1)..........      4,393      4,409    4,633    4,684     4,796
                                  ======     ======  =======  =======  ========
<CAPTION>
                                                           December 31,
                                                     --------------------------
                                                      1996     1997      1998
                                                     -------  -------  --------
                                                          (in thousands)
<S>                            <C>           <C>     <C>      <C>      <C>
Balance Sheet Data(2):
 Cash and cash equivalents........................   $    --  $    --  $  7,526
 Working capital (deficiency)(3)..................       (53)    (170)   16,934
 Total assets.....................................       157      410    23,290
 Long-term obligations, less current portion......        --       --       481
 Total shareholders' equity.......................       104      240    19,833
</TABLE>
--------
(1)  See Note 2 of Notes to the Financial Statements for information regarding
     the determination of basic and diluted net loss per share amounts.
(2)  Balance sheet data prior to 1996 is not meaningful.
(3)  The amount reported for December 31, 1998 includes a receivable from ATL
     Ultrasound of $12.0 million, which was paid on January 15, 1999.
 
                                       22
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS
 
   This discussion and analysis should be read in conjunction with "Selected
Financial Data" and the Company's Financial Statements, including the Notes
thereto, included elsewhere in this Report. In addition to historical
information, the following "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contains certain forward-looking
statements that involve known and unknown risks and uncertainties. The
Company's actual results could differ significantly from those anticipated in
these forward-looking statements as a result of certain factors, including
those discussed in Item 1. "Business--Important Factors Regarding Forward-
Looking Statements" and elsewhere in this Report.
 
Overview
 
   SonoSite, a development-stage enterprise, commenced operations in 1994 as a
project of ATL Ultrasound. We were formed to develop the design and
specifications for miniaturized ultrasound products for diagnostic imaging in a
variety of clinical settings. From the time we started on this project until we
became an independent company on April 6, 1998, we were organized as a separate
division within ATL Ultrasound. On February 2, 1998, the ATL Ultrasound board
of directors approved a plan to spin off our division as an independent,
publicly owned company. This transaction was completed through the tax-free
distribution of one new share of SonoSite common stock for every three shares
of ATL Ultrasound common stock held on April 6, 1998, and options to purchase
one share of SonoSite common stock for every six shares of ATL Ultrasound
common stock subject to outstanding options on April 6, 1998. ATL Ultrasound
retained no ownership in us following the spinoff. In an unrelated event,
Philips Medical Products Division of Philips Electronics, B.V. of the
Netherlands acquired ATL Ultrasound later in 1998.
 
   To date, our capital requirements have been met primarily by contributions
from ATL Ultrasound in connection with our spinoff and by funding from the U.S.
Office of Naval Research under a U.S. Government Defense Advanced Research
Projects Agency grant. ATL Ultrasound's funding obligations have been met and
any future grant revenue is expected to be immaterial. Future revenues will
depend on product and accessory sales, which we do not anticipate until the
latter part of 1999 at the earliest. At that time, we expect to have completed
product development activities on our initial product platform and to be in a
position to commence customer delivery of our initial ultrasound devices and
accessories. We will continue to incur operating losses until our product sales
generate sufficient revenue to fund our continuing operations. We may not
generate sufficient revenue to fund our operations in future periods.
 
Results of Operations
 
   Grant revenues. We have received grant revenues from a contract with the
U.S. Office of Naval Research that have been generally tied to the achievement
of technological milestones. Grant revenues in 1998 were $973,000, compared to
$2.9 million in 1997 and $1.0 million in 1996. We anticipated the changes in
grant revenues from year to year since the changes in revenues are due to our
achieving varying levels of technological milestones as specified in the
contract. As of June 30, 1998, we had completed most of the project work and
achieved most of the technological milestones established in the contract. As a
result, as of that date we had received substantially all of the payments
agreed to in the contract.
 
   Research and Development Expense. Research and development expense for 1998
was $9.5 million, compared to $7.1 million for 1997 and $2.6 million for 1996.
The increase in research and development expense from year to year is due
primarily to additional personnel and personnel-related expenses and product
development expenses, including Application Specific Integrated Circuit tools
and masks used to develop our custom-designed computer chips, production-parts
tooling expenses and increases in engineering services payments to ATL
Ultrasound. We anticipate that spending levels in research and development in
1999 will increase as we complete development, design validation and
verification of our first product platform and commence manufacturing activity
of our initial products.
 
                                       23
<PAGE>
 
   Sales and Marketing Expense. Sales and marketing expense for 1998 was $3.1
million, compared to $1.3 million in 1997. We had no sales and marketing
activities or expenses in 1996 or earlier periods. The increase in sales and
marketing expense is a result of increases in sales and marketing personnel and
increases in consulting and travel expenditures in 1998 compared to 1997. We
plan to add sales and marketing personnel, add to our sales infrastructure and
undertake significant outside promotional and communications agency activities
in the upcoming quarters. These activities are in anticipation of the
introduction of our initial products. We expect that selling and marketing
expense will increase significantly as a result of the above.
 
   General and Administrative Expense. General and administrative expense in
1998 was $1.9 million, versus $610,000 in 1997 and $218,000 in 1996. The
increase in general and administrative expense resulted primarily from an
increase in personnel in the general management, administration, finance,
accounting, information service and human resources functions. We added these
employees in anticipation and as a result of our becoming an independent
publicly owned company. We will add administrative personnel and infrastructure
in 1999. We therefore anticipate that general and administrative expense will
increase during 1999.
 
   Net Loss. Net loss for 1998 was $13.0 million, up significantly from $6.0
million in 1997 and $1.8 million in 1996. These increases are due to the
increases in expenses, as noted above, in combination with the reduction in
grant revenues in the 1997 to 1998 period. We expect to incur significant net
losses in the near term as our expenses increase in advance of the commercial
launch of our initial products.
 
Liquidity and Capital Resources
 
   On April 6, 1998, the day we became an independent public company, ATL
Ultrasound contributed $18.0 million in cash and was obligated, without
contingency, to contribute an additional $12.0 million in cash on January 15,
1999. That payment was received on schedule. The $30.0 million cash transfer
from ATL Ultrasound, development grant revenues from the U.S. Office of Naval
Research of $4.9 million and lease financing of $1.1 million have funded our
capital requirements. As of December 31, 1998, cash and cash equivalents
totaled $7.5 million. Our cash requirements have increased in recent quarters
due to continued product development activities, accelerated marketing and
distribution development activities, and maintenance of the management and
administrative infrastructure necessary to function effectively as an
independent publicly owned company. As described above, our cash requirements
are expected to continue to increase in 1999.
 
   We believe that our existing cash and cash equivalents, including the $12.0
million in cash received from ATL Ultrasound in January 1999 and available
lease financing, together with the net proceeds from this offering and interest
on these proceeds, in addition to anticipated product revenue, should be
sufficient to fund our operations at least through 2000. However, it is
difficult to accurately predict the amount of cash that we may require in the
future. The amount required will depend, in part, upon factors beyond our
control. Capital requirements could exceed our estimates as a result of a
variety of factors. These factors include technical obstacles, delays in
product development or introduction, cost overruns in research and development
programs or establishing manufacturing activities, greater than anticipated
administrative expenses or lower than anticipated customer demand or revenues
after product introduction. From time to time, we may seek additional financing
from various sources. Adequate financing may not be available on a timely
basis, on favorable terms, or at all. If we are unable to meet our cash needs,
we will be required to significantly alter our operating plans. Activities that
may be affected could include our research and development programs, overall
spending levels, marketing initiatives or product introductions. We also may be
required to seek to obtain funds through arrangements with collaborative
partners or others that may require us to relinquish rights to aspects of our
technology or products.
 
Year 2000 Compliance
 
   Many computer programs have been written using two, rather than four, digits
to define the applicable year. Unless corrected, those systems that have time-
sensitive software may recognize a date using "00" as the
 
                                       24
<PAGE>
 
year 1900 rather than the year 2000, potentially resulting in system failures
or miscalculations. This problem has been dubbed the "Year 2000 Problem." The
Year 2000 Problem is complex and pervasive in the general economy, as virtually
every computer operation will be affected in some way by the rollover of the
two-digit year value to 00.
 
   We have conducted a review of our existing information technology
infrastructure and computer systems. Based on representations made by our
software and hardware suppliers, we believe that our existing information
technology infrastructure and computer systems are year 2000 compliant. We are
developing a list of other vendors to contact, making Internet contacts,
preparing hard-copy communications and reviewing services and systems to
provide a detailed and accurate database of contacts that we make and responses
we receive.
 
   We are also conducting a review of our products in development. We believe
that these products will be year 2000 compliant due to the design process
employed in their specifications and development. As one of the functional
requirements of our products, we state that they will "perform date recording
and computations accurately through and beyond the year 2000 and accommodate
the leap year for the year 2000 and beyond." We also state as one of the
functional requirements that "there will be no system hardware or software
failures due to the year 2000."
 
   In assessing our overall risks related to the Year 2000 Problem, we believe
our greatest potential exposures involve development activities relating to our
products. Additional areas of risk include equipment and materials that will be
used in manufacturing our products and accessories, vendors providing
distribution functions, and software and hardware support for these and other
administrative functions. If the Year 2000 Problem exists in these areas, it
could significantly delay or eliminate our ability to bring our products to
market, which would have a material adverse effect on our business. Because
these areas of risk involve third parties, over whom we have little or no
control, a contingency plan for these risks does not exist and we cannot assure
you that we will be able to develop one. We are not able to estimate the full
cost, if any, of correcting any potential Year 2000 Problems at this time. Full
estimated costs, if any, will not be known until we complete the survey and
review all responses received from vendors. To date, we have not incurred any
material costs directly associated with our Year 2000 compliance efforts.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
   Not material.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           Page
                                                                           ----
<S>                                                                        <C>
Financial Statements
  Report of KPMG LLP, Independent Auditors................................  26
  Balance Sheets at December 31, 1997 and 1998............................  27
  Statements of Operations for the years ended December 31, 1996, 1997 and
   1998 and for the period from February 1994 (inception) through December
   31, 1998...............................................................  28
  Statements of Cash Flows for the years ended December 31, 1996, 1997 and
   1998 and for the period from February 1994 (inception) through December
   31, 1998...............................................................  29
  Consolidated Statements of Shareholders' Equity for the period from
   February 1994 (inception) through December 31, 1994 and for each of the
   years ended December 31, 1995, 1996, 1997 and 1998.....................  30
  Notes to the Financial Statements.......................................  31
</TABLE>
 
   All financial statement schedules have been omitted since the information is
not required or because the information required is included in the Financial
Statements or the notes thereto.
 
                                       25
<PAGE>
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors and Shareholders,
SonoSite, Inc.
 
   We have audited the accompanying balance sheets of SonoSite, Inc. (a
development stage enterprise) as of December 31, 1997 and 1998, and the related
statements of operations, cash flows and shareholders' equity for each of the
years in the three-year period ended December 31, 1998 and for the period from
February 1994 (inception) through December 31, 1998. These financial statements
are the responsibility of SonoSite, Inc.'s management. Our responsibility is to
express an opinion on these financial statements based on our audits.
 
   We conducted our audits in accordance with generally accepted auditing
standards. 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 financial statements referred to above present fairly,
in all material respects, the financial position of SonoSite, Inc. (a
development stage enterprise) as of December 31, 1997 and 1998, and the results
of its operations and its cash flows for each of the years in the three-year
period ended December 31, 1998 and for the period from February 1994
(inception) through December 31, 1998, in conformity with generally accepted
accounting principles.
 
                                          KPMG LLP
 
Seattle, Washington
January 27, 1999
 
                                       26
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                                 Balance Sheets
 
<TABLE>
<CAPTION>
                                                          At December 31,
                                                      -------------------------
                                                         1997          1998
                                                      -----------  ------------
<S>                                                   <C>          <C>
Assets
Current assets
  Cash and cash equivalents.......................... $       --   $  7,525,762
  Receivable from ATL Ultrasound.....................         --     12,000,000
  Prepaid expenses and other current assets..........         --        304,599
                                                      -----------  ------------
Total current assets.................................         --     19,830,361
Property and equipment, net..........................     409,967     3,379,815
Other assets.........................................         --         80,057
                                                      -----------  ------------
Total assets......................................... $   409,967  $ 23,290,233
                                                      ===========  ============
Liabilities
Current liabilities
  Checks drawn in excess of bank balances............ $       --   $    601,629
  Accounts payable...................................         --        781,999
  Accrued expenses...................................     169,839     1,123,948
  Current portion of long-term obligations...........         --        388,795
                                                      -----------  ------------
Total current liabilities............................     169,839     2,896,371
Deferred rent........................................         --         79,923
Long-term obligations, less current portion..........         --        480,964
                                                      -----------  ------------
Total liabilities....................................     169,839     3,457,258
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, 1997 -- None
      As of December 31, 1998 -- 4,872,193...........         --         48,722
  Additional paid-in capital.........................         --     40,693,195
  Net advances from ATL Ultrasound...................   8,124,018           --
  Deficit accumulated during the development stage...  (7,883,890)  (20,908,942)
                                                      -----------  ------------
Total shareholders' equity...........................     240,128    19,832,975
                                                      -----------  ------------
Total liabilities and shareholders' equity........... $   409,967  $ 23,290,233
                                                      ===========  ============
</TABLE>
 
               See accompanying notes to the financial statements
 
                                       27
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                            Statements of Operations
 
<TABLE>
<CAPTION>
                                                                    February
                                                                      1994
                                                                  (inception)
                            For the Years Ended December 31,        through
                          --------------------------------------  December 31,
                             1996         1997          1998          1998
                          -----------  -----------  ------------  ------------
<S>                       <C>          <C>          <C>           <C>
Grant revenues..........  $ 1,028,895  $ 2,947,700  $    973,107  $  4,949,702
Operating expenses:
  Research and
   development..........    2,575,719    7,063,842     9,474,074    19,227,489
  Sales and marketing...          --     1,268,272     3,120,238     4,388,510
  General and
   administrative.......      217,635      610,037     1,903,883     2,742,681
                          -----------  -----------  ------------  ------------
Total operating
 expenses...............    2,793,354    8,942,151    14,498,195    26,358,680

Interest income.........          --           --        541,100       541,100
Interest expense........          --           --         41,064        41,064
                          -----------  -----------  ------------  ------------
Net loss................  $(1,764,459) $(5,994,451) $(13,025,052) $(20,908,942)
                          ===========  ===========  ============  ============
Basic and diluted net
 loss per share.........  $     (0.38) $     (1.28) $      (2.72)
                          ===========  ===========  ============
Shares used in computing
 basic and diluted net
 loss per share.........    4,633,333    4,683,667     4,796,264
                          ===========  ===========  ============
</TABLE>
 
 
 
 
               See accompanying notes to the financial statements
 
                                       28
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                            Statements of Cash Flows
 
<TABLE>
<CAPTION>
                                                                    February
                                                                      1994
                                                                  (inception)
                            For the Years Ended December 31,        through
                          --------------------------------------  December 31,
                             1996         1997          1998          1998
                          -----------  -----------  ------------  ------------
<S>                       <C>          <C>          <C>           <C>
Operating activities:
Net loss................  $(1,764,459) $(5,994,451) $(13,025,052) $(20,908,942)
Adjustments to reconcile
 net loss to net cash
 used in operating
 activities:
  Depreciation and
   amortization.........       23,964      110,698       410,613       545,275
  Amortization of
   deferred stock
   compensation.........          --           --         58,914        58,914
Changes in operating
 assets and liabilities:
  Increase in prepaid
   expenses and other
   current assets.......          --           --       (304,599)     (304,599)
  Increase in accounts
   payable..............          --           --        781,999       781,999
  Increase in accrued
   expenses.............       52,854      116,985       954,109     1,123,948
  Increase in deferred
   rent.................          --           --         79,923        79,923
                          -----------  -----------  ------------  ------------
    Net cash used in
     operating
     activities.........   (1,687,641)  (5,766,768)  (11,044,093)  (18,623,482)
Investing activities:
  Purchase of
   equipment............     (180,667)    (363,962)   (2,320,468)   (2,865,097)
  Increase in deposits..          --           --        (80,057)      (80,057)
                          -----------  -----------  ------------  ------------
    Net cash used in
     investing
     activities.........     (180,667)    (363,962)   (2,400,525)   (2,945,154)
Financing activities:
  Increase in checks
   drawn in excess of
   bank balances........          --           --        601,629       601,629
  Repayment of long-term
   obligations..........          --           --       (190,234)     (190,234)
  Exercise of stock
   options..............          --           --          6,728         6,728
  Contributions from ATL
   Ultrasound...........    1,868,308    6,130,730    20,552,257    28,676,275
                          -----------  -----------  ------------  ------------
    Net cash provided by
     financing
     activities.........    1,868,308    6,130,730    20,970,380    29,094,398
Net change in cash......          --           --      7,525,762     7,525,762
Cash and cash
 equivalents at
 beginning of period....          --           --            --            --
                          -----------  -----------  ------------  ------------
Cash and cash
 equivalents at end of
 period.................  $       --   $       --   $  7,525,762  $  7,525,762
                          ===========  ===========  ============  ============
Supplemental disclosure
 of cash flow
 information:
Cash paid for interest..  $       --   $       --   $     41,064  $     41,064
                          ===========  ===========  ============  ============
Supplemental disclosure
 of non-cash investing
 and financing
 activities:
Equipment acquired
 through long-term
 obligations............  $       --   $       --   $  1,059,993  $  1,059,993
                          ===========  ===========  ============  ============
Contribution recorded as
 a receivable from ATL
 Ultrasound.............  $       --   $       --   $ 12,000,000  $ 12,000,000
                          ===========  ===========  ============  ============
</TABLE>
 
               See accompanying notes to the financial statements
 
                                       29
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                       Statements of Shareholders' Equity
 
<TABLE>
<CAPTION>
                                                Deficit
                                              Accumulated
                                  Additional   During the   Net Advances      Total
                          Common    Paid-in   Development     from ATL    Shareholders'
                           Stock    Capital      Stage       Ultrasound      Equity
                          ------- ----------- ------------  ------------  -------------
<S>                       <C>     <C>         <C>           <C>           <C>
Balance at February 1994
 (inception)............  $   --  $       --  $        --   $        --   $        --
Net advances from ATL
 Ultrasound.............      --          --           --         41,429        41,429
Net loss................      --          --       (41,429)          --        (41,429)
                          ------- ----------- ------------  ------------  ------------
Balance at December 31,
 1994...................      --          --       (41,429)       41,429           --
Net advances from ATL
 Ultrasound.............      --          --           --         83,551        83,551
Net loss................      --          --       (83,551)          --        (83,551)
                          ------- ----------- ------------  ------------  ------------
Balance at December 31,
 1995...................      --          --      (124,980)      124,980           --
Net advances from ATL
 Ultrasound.............      --          --           --      1,868,308     1,868,308
Net loss................      --          --    (1,764,459)          --     (1,764,459)
                          ------- ----------- ------------  ------------  ------------
Balance at December 31,
 1996...................      --          --    (1,889,439)    1,993,288       103,849
Net advances from ATL
 Ultrasound.............      --          --           --      6,130,730     6,130,730
Net loss................      --          --    (5,994,451)          --     (5,994,451)
                          ------- ----------- ------------  ------------  ------------
Balance at December 31,
 1997...................      --          --    (7,883,890)    8,124,018       240,128
Net advances from ATL
 Ultrasound from January
 1, 1998 through
 April 6, 1998..........      --          --           --      2,491,086     2,491,086
Issuance of 4,870,178
 common shares..........   48,702  40,627,573          --    (10,615,104)   30,061,171
Exercise of 2,015 stock
 options................       20       6,708          --            --          6,728
Amortization of deferred
 stock compensation of
 $214,550...............      --       58,914          --            --         58,914
Net loss................      --          --   (13,025,052)          --    (13,025,052)
                          ------- ----------- ------------  ------------  ------------
Balance at December 31,
 1998...................  $48,722 $40,693,195 $(20,908,942) $        --   $ 19,832,975
                          ======= =========== ============  ============  ============
</TABLE>
 
 
 
               See accompanying notes to the financial statements
 
                                       30
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                       Notes to the Financial Statements
 
1. Business Overview
 
   SonoSite, Inc. ("SONO" or the "Company"), a development stage enterprise,
began operations in 1994 as a project of ATL Ultrasound, Inc. ("ATL"). The
project was chartered to develop the design and specifications for a hand-
carried ultrasound device. During the period from inception (February 1994)
through April 6, 1998, the project was organized as a separate division of ATL.
On February 2, 1998, the ATL Board of Directors approved a plan to spin off
SONO as an independent, publicly owned company. This transaction was effected
through a tax-free dividend distribution of SONO's shares to ATL shareholders
(the "Distribution") as of April 6, 1998 (the "Distribution Date"). ATL
shareholders received one share of SONO common stock for each three shares of
ATL common stock held. In addition, ATL option holders were granted one option
to purchase SONO shares for every six options to purchase ATL shares. In
connection with the Distribution, SONO received $18.0 million in cash from ATL,
net advances made by ATL through the Distribution Date, and an agreement by ATL
to contribute an additional $12.0 million in cash on January 15, 1999 to SONO,
all as a contribution of capital.
 
   SONO, as an independent public company, continues to use its technology to
develop and design hand-carried, diagnostic ultrasound devices for use by
physicians in private practice, hospitals, clinics, private and governmental
institutions and healthcare agencies. In addition, the Company is establishing
distribution and selling networks and education and marketing programs to
support the hand-carried ultrasound devices developed. SONO's future growth
will largely depend on its ability to market and sell hand-carried ultrasound
products. To date, the Company has not generated revenue from product sales.
Since inception, funding from ATL and the U.S. Navy has been used to finance
the development of SONO's technologies. U.S. Navy funding was received as part
of a development contract ("Development Contract") with the Office of Naval
Research. The Development Contract involved a consortium of collaborators,
including the University of Washington, Harris Semiconductor and VLSI
Technology, Inc. The Application Specific Integrated Circuits ("ASICs")
developed as part of the collaboration are essential to SONO developing a
commercial hand-carried ultrasound device and SONO is relying on VLSI
Technology, Inc. and Harris Semiconductor to manufacture ASICs which
incorporate technology of the consortium. The Company expects to continue to
incur operating losses unless and until the hand-carried product sales generate
sufficient revenue to fund its continuing operations.
 
2. Summary of Significant Accounting Policies
 
Basis of presentation
 
   The financial statement information for periods prior to the Distribution
Date represents the combination of the handheld ultrasound division of ATL and
the corporate entity, SonoSite, Inc.
 
   Such information has been derived from the historical books and records of
ATL and reflects the assets, liabilities, revenues and expenses of SONO, as it
was operated as a division of ATL, at historical cost. Financial statement
information for subsequent periods consists solely of SONO's activity as a
separate company.
 
   For periods prior to the Distribution Date, the statement of operations
included allocations for facilities and certain support services, such as
engineering overhead, administration, accounting, finance, human resources and
regulatory functions. These allocations were based on estimates of personnel
time and effort spent by ATL on behalf of SONO. Management believes these
allocations were made on a reasonable basis. Subsequent to the Distribution
Date, items noted above were incorporated into agreements with ATL and charges
were based upon actual time spent by ATL on behalf of SONO. Refer to Note 3.
 
                                       31
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
 
   The portion of SONO's financing requirements funded by ATL prior to the
Distribution Date are shown as net advances from ATL in shareholders' equity.
Activity in the net advances from ATL equity account relates to net cash
received from ATL through intercompany advances to fund SONO's operating
deficits. ATL did not acquire additional financing to fund these advances and
no interest has been charged to SONO.
 
   The financial information included herein is not necessarily indicative of
the financial position, results of operations or cash flows of SONO in the
future or what the financial position, results of operations or cash flows
would have been if SONO had been a separate, independent public company during
all periods presented.
 
Cash and cash equivalents
 
   Cash and cash equivalents consist of money market instruments with original
maturities of three months or less. Cash equivalents are entirely held in money
market funds with Provident Institutional Funds.
 
Property and equipment
 
   Property and equipment are stated at cost, less accumulated depreciation and
amortization. The costs of significant additions and improvements to property
and equipment are capitalized. Maintenance and repair costs are expensed as
incurred.
 
   Depreciation and amortization are calculated using the straight-line basis
over the estimated useful lives as follows:
 
<TABLE>
<CAPTION>
                                                         Useful Life
                                             -----------------------------------
   <S>                                       <C>
   Furniture and fixtures...................               5 years
   Computer equipment.......................             3 - 5 years
   Software.................................               3 years
   Equipment, other than computer...........            5 - 10 years
   Leasehold improvements................... Lesser of the lease term or 5 years
</TABLE>
 
   Equipment held under capital leases are amortized using the straight-line
method over the shorter of the lease term or the estimated useful life of the
underlying asset.
 
   For long-lived assets, including property and equipment, the Company
evaluates the carrying value of the assets by comparing the estimated future
cash flows generated from the use of the asset and its eventual disposition
with the assets' reported net book value. The carrying value of 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.
 
   Property and equipment as of December 31 consist of the following:
 
<TABLE>
<CAPTION>
                                                           1997        1998
                                                         ---------  ----------
   <S>                                                   <C>        <C>
   Furniture and fixtures............................... $ 172,025  $  368,170
   Computer equipment...................................   321,299     957,664
   Software.............................................    51,305   1,403,195
   Equipment, other than computer.......................       --      914,176
   Leasehold improvements...............................       --      281,885
                                                         ---------  ----------
                                                           544,629   3,925,090
   Less -- Accumulated depreciation and amortization....  (134,662)   (545,275)
                                                         ---------  ----------
     Total.............................................. $ 409,967  $3,379,815
                                                         =========  ==========
</TABLE>
 
                                       32
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
 
   Included above are assets acquired under capital leases at December 31, 1998
as follows:
 
<TABLE>
     <S>                                                             <C>
     Software....................................................... $  991,814
     Equipment, other than computer.................................     68,179
                                                                     ----------
                                                                      1,059,993
     Less -- Accumulated amortization...............................   (123,837)
                                                                     ----------
       Total........................................................ $  936,156
                                                                     ==========
</TABLE>
 
   As of December 31, 1997, there were no capital leases.
 
Revenue
 
   Revenue since inception of the Company consists of grant revenue under a
United States Government Defense Advanced Research Projects Administrative
(DARPA) grant (the "Development Contract"). Grant revenue is recognized
consistent with the terms of the Development Contract and is generally tied to
the achievement of technological milestones, the majority of which were
achieved by the second quarter of 1998. Revenue recognition has been limited to
amounts representing assured realization of contractual funding.
 
   SONO has not generated revenue from product sales and there can be no
assurances that there will be sufficient revenue generated from future product
sales to fund the Company's operations.
 
Research and development
 
   Research and development costs are expensed as incurred.
 
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 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.
 
   SONO was not a separate taxpayer prior to the Distribution Date. During this
period, it was the Company's policy to record its tax expenses and benefits as
if it were a separate taxpayer and consequently due to its development stage
status and its cumulative losses since inception, no current or deferred tax
benefit was reported.
 
Stock-based compensation
 
   SONO applies the principles of APB Opinion No. 25 (APB 25), "Accounting for
Stock Issued to Employees" and related interpretations when measuring
compensation costs for its employee stock option
 
                                       33
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
plans. Pro forma net loss and net loss per share are presented as if
compensation cost had been determined in accordance with Statement of Financial
Accounting Standard No. 123 (FAS 123), "Accounting for Stock-Based
Compensation".
 
Net loss per share
 
   Basic and diluted net loss per share was computed by dividing the net loss
by the weighted average shares outstanding.
 
   Weighted average shares outstanding represent weighted average shares of
SONO common shares outstanding from the Distribution Date forward and 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 SONO share for every three shares
of ATL. All periods presented have been restated to reflect this distribution.
 
   Options to purchase SONO shares and unvested restricted SONO shares issued
by ATL and options issued by SONO after the Distribution, which were
outstanding, were not included in the computations of diluted net loss per
share because to do so would be antidilutive. As of December 31, 1998,
outstanding SONO options and unvested restricted shares issued by ATL through
the Distribution totaled 270,453 and 60,930, respectively, and outstanding
options issued by SONO totaled 1,277,365. As of December 31, 1997, outstanding
ATL issued options and unvested restricted shares totaled 307,833 and 51,788,
respectively. As of December 31, 1996, outstanding ATL issued options and
unvested restricted shares totaled 359,667 and 38,242, respectively. The ATL
issued and outstanding options as of December 31, 1997 and 1996 were adjusted
for the exchange ratio of one SONO option for every six options of ATL and the
restricted stock was adjusted for the exchange ratio of one SONO restricted
share for every three restricted shares of ATL.
 
   The following is a reconciliation of the numerator and denominator of the
basic loss per share calculations:
 
<TABLE>
<CAPTION>
                                 1996                     1997                      1998
                         -----------------------  -----------------------  ------------------------
(in thousands, except     Loss    Shares   LPS     Loss    Shares   LPS      Loss    Shares   LPS
LPS)                     -------  ------  ------  -------  ------  ------  --------  ------  ------
<S>                      <C>      <C>     <C>     <C>      <C>     <C>     <C>       <C>     <C>
Weighted average shares
 outstanding............          4,675                    4,726                     4,853
Weighted average
 unvested restricted
 stock..................            (42)                     (42)                      (57)
                         -------  -----   ------  -------  -----   ------  --------  -----   ------
Basic and diluted loss
 per share.............. $(1,764) 4,633   $(0.38) $(5,994) 4,684   $(1.28) $(13,025) 4,796   $(2.72)
                         =======  =====   ======  =======  =====   ======  ========  =====   ======
</TABLE>
 
Use of estimates
 
   The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
Financial instruments
 
   The Company has financial instruments consisting of cash and cash
equivalents, receivable from ATL and accounts payable. The fair value of these
financial instruments approximates their carrying amount due to their short-
term nature.
 
                                       34
<PAGE>
 
                                SonoSite, Inc.
                       (A Development Stage Enterprise)
 
                Notes to the Financial Statements--(Continued)
 
 
Reclassification of prior period balances
 
   Certain amounts reported in previous years have been reclassified to
conform to the 1998 presentation.
 
Liquidity
 
   As of December 31, 1998, the Company had cash and cash equivalents of $7.5
million. In addition, the Company collected its additional $12.0 million
receivable from ATL on January 15, 1999. SONO expects its cash needs to
increase in future periods as it continues to fund its research and
development activity and increases spending to accommodate its manufacturing,
distribution, education and marketing plans. The Company believes that its
existing cash will be sufficient to fund its operations through the third
quarter of 1999. Within this period, the Company will seek additional funding,
through public or private sources, to meet its future requirements. There can
be no assurance such funds will be available as needed or on terms that are
acceptable to the Company. If the Company is unable to obtain sufficient funds
to satisfy its cash requirements, the Company will be forced to delay, reduce
or eliminate some or all of its research and development activities, planned
clinical trials and manufacturing and administrative programs, or dispose of
assets or technology.
 
 
3. Agreements with ATL
 
   The Company has entered into several agreements with ATL effective as of
the Distribution Date. These agreements were negotiated between the CEO of
SONO and the CEO of ATL. ATL was assisted in these discussions by ATL's in-
house counsel. Outside counsel was obtained for SONO by ATL in connection with
the Distribution. SONO and ATL consider 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:
 
 Service Agreement
 
   SONO and ATL have an agreement pursuant to which ATL provides certain
engineering design and development services to SONO in exchange for payment of
actual expenses incurred, including an overhead component, plus a markup on
the actual expense and overhead costs for these services. ATL has also agreed
to provide to SONO, at SONO's request and expense, services for limited
periods of time ranging up to five years, including financial, human resource,
engineering, information, facilities and regulatory services. Termination of
any of these services may occur with 90 days' prior written notice by either
party.
 
 OEM Supply Agreement
 
   ATL has agreed to manufacture highly portable ultrasound devices
exclusively for SONO for a period up to five years. In return for the
manufacturing services, SONO has agreed to compensate ATL for manufacturing
expenses incurred, including, but not limited to, indirect and direct labor,
materials and nonrecurring engineering expenses, plus a markup, until SONO
notifies ATL that the product is within ninety days of final production status
("start-up phase"). After the start-up phase is complete, or if SONO elects,
until final product production begins, the manufacturing expenses will be
factored into a cost model, based upon material and labor, at a rate of ATL's
cost per unit plus a markup percentage. This agreement may be terminated for
any of the following reasons: unremedied material default by either party,
acquisition of or by a competitor without written consent of the other party,
insolvency, or no product purchase orders for a period of six months after
SONO's initial product order. In addition, SONO may terminate this agreement
without cause upon 180 days written notice or ATL may terminate this agreement
after the exclusive five-year period without cause upon 180 days written
notice.
 
                                      35
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
 
 Technology Transfer and License Agreement
 
   SONO and ATL have agreed to a Technology Transfer and License Agreement
pursuant to which SONO owns certain highly portable ultrasound technology
developed while it was a division of ATL and has access to certain ATL
technology which is necessary or useful in the development and manufacture of
highly portable ultrasound products. Under this agreement, SONO has taken
ownership of the technology developed as part of the DARPA Development Contract
and also patent rights which have been established or are being pursued for
that technology. In addition, SONO received a nonexclusive license to use any
other ATL technology in existence or developed during the period ending three
years after the Distribution Date in its handheld ultrasound products.
 
   This license bears a royalty equivalent to a percentage of the net sales of
handheld ultrasound products under fifteen pounds that use ATL technology. The
license will become paid-in-full by a lump-sum payment which is due ATL if SONO
ceases to be an independent stand-alone company during the eight year period
following the Distribution Date. The lump-sum payment is $150 million during
the five years following the Distribution Date and $75 million for the next
three years.
 
   SONO and ATL have also entered into a cross-license agreement whereby SONO
has the right to use technology developed by ATL during the three year period
following the Distribution Date in its handheld products and ATL has the right
to use developments of SONO made during the same period in its full-size
ultrasound system products. SONO and ATL have also agreed that SONO will not
engage in full-size ultrasound business and ATL will not engage in the handheld
ultrasound device business for five years following the Distribution Date.
After this five year period, each party's ongoing obligation with respect to
the technology of the other will be to respect the patent and copyright rights
of the other, although SONO will retain a license to use the previously-
licensed ATL technology in handheld systems and ATL will retain a license to
use the previously licensed SONO technology in full-size ultrasound systems.
 
   From the Distribution Date, April 6, 1998, through December 31, 1998, SONO
has incurred expenses relating to work performed by ATL totaling $2.2 million.
In addition, as of December 31, 1998, included in accounts payable are amounts
owed to ATL totaling $523,000.
 
4. Accrued Expenses
 
   Accrued expenses as of December 31 include the following:
 
<TABLE>
<CAPTION>
                                                              1997      1998
                                                            -------- ----------
     <S>                                                    <C>      <C>
     Payroll and related................................... $169,839 $  480,580
     Research and development tooling......................      --     350,820
     Outside services......................................      --     142,550
     Other.................................................      --     149,998
                                                            -------- ----------
       Total............................................... $169,839 $1,123,948
                                                            ======== ==========
</TABLE>
 
5. Shareholders' Equity
 
 Stock option plans
 
   At December 31, 1998, SONO had the following stock compensation plans: the
1998 Nonofficer Employee Stock Option Plan ("1998 NOE Plan"), the 1998 Option,
Stock Appreciation Right, Restricted
 
                                       36
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
Stock, Stock Grant and Performance Unit Plan ("1998 Plan"), the Nonemployee
Director Stock Option Plan ("Director Plan"), the Management Incentive
Compensation Plan ("MIC Plan") and the Adjustment Plan. SONO accounts for
employee 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, no compensation expense is recognized for employee stock option grants.
 
   As of December 31, 1998, 27,500 options had been issued to nonemployees.
This resulted in net deferred compensation of $156,000 as of December 31, 1998
and compensation expense of $59,000 for the year ended 1998. There was no
similar charge to SONO for the period prior to the Distribution Date.
 
   Prior to the Distribution Date, all option information represents the
outstanding and issued options of ATL. Financial data presented relating to
option grants represents the exchange ratio calculated as one SONO option for
every six ATL options outstanding. This exchange ratio provides the basis for
the pro forma presentation for 1996 and 1997.
 
   If the Company had accounted for the costs relating to all option grants
under the provisions of FAS 123, the Company's net loss and net loss per share
would have been the following pro forma amounts:
 
<TABLE>
<CAPTION>
                                                        1996    1997    1998
                                                       ------  ------  -------
                                                       (in thousands, except
                                                          per share data)
   <S>                                                 <C>     <C>     <C>
   Net loss:
     As reported.....................................  $1,764  $5,994  $13,025
     Pro forma.......................................  $1,860  $6,141  $14,946
   Basic and diluted net loss per share:
     As reported.....................................  $(0.38) $(1.28) $ (2.72)
     Pro forma.......................................  $(0.40) $(1.31) $ (3.12)
</TABLE>
 
   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 1996,
1997 and 1998, respectively: expected volatility 33%, 39% and 67%; risk-free
interest rates 6.7%, 6.3% and 4.8%; expected terms of 4.25, 4.25 and 9.16
years; and zero dividend yield. The preceding assumptions for 1996 and 1997
were based on facts and circumstances directly related to ATL.
 
   Under the 1998 NOE Plan, 1998 Plan, and MIC Plan, 1,700,000 total shares of
common stock are authorized primarily for issuance upon exercise of stock
options at prices equal to the fair market value of the Company's common shares
at the date of grant. As of December 31, 1998, 507,635 shares were available
for grant under the aforementioned plans. Stock options are exercisable at 25%
each year over a four-year vesting period and have a ten-year term from the
grant date.
 
   Under the Director Plan, 125,000 shares of common stock are authorized for
the issuance of stock options at prices equal to the fair market value of the
Company's common shares at the date of grant. Option grants under the Director
Plan occurred during the months of June and July 1998. At December 31, 1998,
40,000 shares were 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 a SONO Director. Each option expires on the
earlier of ten years from the grant date or ninety days following the
termination of a director's service as a SONO Director.
 
   SONO also has an Adjustment Plan, which includes options granted in
connection with the dividend distribution occurring on April 6, 1998. As part
of the Distribution, existing ATL option holders received one
 
                                       37
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
SONO option 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. Total
options to purchase shares outstanding under this plan as of December 31, 1998
are 270,453.
 
   Also as a result of the Distribution, restricted shares totaling 38,242,
51,788 and 60,930, as determined using the exchange ratio of one SONO
restricted share for every three ATL restricted shares, were outstanding as of
December 31, 1996, 1997 and 1998, respectively.
 
 Summary of stock option activity
 
   Prior to the Distribution Date, SONO had no stock option plans specifically
identified as SONO plans. All stock options granted through that date were part
of ATL options and therefore shares and weighted average exercise prices as of
December 31, 1996 and 1997 are not included in the disclosure herein because it
would not be meaningful. The following table presents summary stock option
activity for the year ended December 31, 1998:
 
<TABLE>
<CAPTION>
                                                              Weighted average
                                                      Shares   exercise price
                                                      ------  ----------------
                                                       (Shares presented in
                                                            thousands)
   <S>                                                <C>     <C>
   Outstanding, beginning of year....................   --           --
     Adjustment Plan grants..........................   289        $5.39
     Non-Adjustment Plan grants...................... 1,290        $7.28
     Exercised.......................................    (2)       $3.34
     Cancelled.......................................   (29)       $6.56
                                                      -----
   Outstanding, end of year.......................... 1,548        $6.95
   Exercisable, end of year..........................   185
   Weighted average fair value of options granted
    (excludes Adjustment Plan)....................... $5.58
</TABLE>
 
   The following is a summary of stock options outstanding:
 
<TABLE>
<CAPTION>
                             Options outstanding           Options exercisable
                     ----------------------------------- -----------------------
                                     Weighted
                                      average   Weighted                Weighted
                         Number      remaining  average      Number     average
      Range of        outstanding   contractual exercise  exercisable   exercise
   exercise prices   (in thousands)    life      price   (in thousands)  price
   ---------------   -------------- ----------- -------- -------------- --------
   <S>               <C>            <C>         <C>      <C>            <C>
   $ 1.64 - $ 6.89         260         6.35      $4.67        147        $3.70
   $ 6.94 - $ 6.94       1,026         9.34      $6.94         20        $6.94
   $ 6.97 - $12.78         262         9.57      $9.26         18        $8.52
                         -----                                ---
                         1,548         8.88      $6.95        185        $4.52
                         =====                                ===
</TABLE>
 
 Stock Purchase Rights
 
   On April 6, 1998, SONO and first Chicago Trust Company of New York entered
into a Rights Agreement. The Rights Agreement has certain antitakeover effects
which will cause substantial dilution to a person or
 
                                       38
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
group that attempts to acquire SONO, however, it will not interfere with any
merger or other business combination approved by the SONO Board of Directors
("Board").
 
   Under the terms of the Rights Agreement, holders of SONO common stock also
hold Rights exercisable in certain circumstances discussed below. Holders of
these Rights may purchase 1/100th of a share of 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 SONO common stock quoted on the Nasdaq
National Market for each of the ten 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 the outstanding SONO common stock. In addition, the Board may
redeem all, but not part, of the Rights outstanding for consideration in cash
or common stock at a price equal to $.01 per Right.
 
   Separate certificates for Rights will not be distributed. SONO 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.
 
6. Income Taxes
 
   For income tax purposes, SONO's 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 will not be
available to SONO for use in periods subsequent to the Distribution Date. For
the period from the Distribution Date through December 31, 1998, SONO has
accumulated a net operating loss carryforward of approximately $10.3 million.
Utilization of this carryforward expires in 2018.
 
   Because SONO is a development stage enterprise and has incurred losses since
its inception, a valuation allowance entirely offsetting deferred tax assets
has been established, thereby eliminating any deferred tax benefit for the year
ended December 31, 1998.
 
   The tax effects of temporary differences and carryforwards that give rise to
significant portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 are as follows:
 
 
<TABLE>
<CAPTION>
                                                                  (in thousands)
     <S>                                                          <C>
     Deferred tax assets
       Net operating loss carryforwards..........................    $ 3,508
       Other.....................................................         75
                                                                     -------
     Gross deferred tax assets...................................      3,583
     Valuation allowance.........................................     (3,583)
                                                                     -------
     Net deferred tax assets.....................................    $   --
                                                                     =======
</TABLE>
 
   As of December 31, 1997, tax effects of temporary differences, which
individually and in aggregate were not significant, as SONO's net operating
losses were included in ATL, were entirely offset by a valuation allowance.
 
7. Employee Benefit Plans
 
 401(k) Retirement Savings Plan ("401k Plan")
 
   All employees of SONO are eligible to participate in the 401k Plan. Terms of
the 401k Plan permit an employee to contribute up to a maximum of 16% of an
employee's annual compensation on a post-tax or
 
                                       39
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
pretax basis, up to the maximum permissible by the Internal Revenue Service
(IRS) during any plan year. Contributions exceeding the IRS limitation may be
made only on a post-tax basis. SONO matches each employee's contribution in
increments equivalent to 100% for the first 3% and 50% for the second 3% of the
contribution. For the year ended December 31, 1998, the Company contributed
$98,000 to the 401k Plan in accordance with the Plan's terms. Employees
immediately vest in the contributions the employee makes. Vesting in SONO's
contribution on behalf of the employee occurs at equal increments at the end of
the first five years of an employee's service with the Company or ATL.
 
8. Commitments and contingencies
 
 Operating leases
 
   The Company leases office space and certain equipment under noncancelable
operating leases. Future minimum payments under these leases as of December 31,
1998 are as follows:
 
<TABLE>
     <S>                                                              <C>
     1999............................................................ $  294,442
     2000............................................................    305,907
     2001............................................................    318,660
     2002............................................................    312,694
     2003............................................................    183,554
     Thereafter......................................................        --
                                                                      ----------
                                                                      $1,415,257
                                                                      ==========
</TABLE>
 
   Prior to November 1998, SONO utilized facility space within ATL and was
charged rent expense for the space occupied. Subsequently, SONO vacated the ATL
facility and moved into a separate facility. Rent expense for the year-ended
December 31, 1998 was $243,000, which represents ATL charges of $128,000 and
the current location charges of $115,000. The Company did not incur any rent
expense prior to the Distribution Date as its operations were in ATL's owned
facility. In addition, rent expense for the year ended 1998 is not indicative
of future rent expense as SONO no longer occupies the shared ATL space.
 
 Capital lease obligations
 
   The Company has entered into certain long-term obligations to finance the
purchase of capital equipment as part of its normal business operations. Terms
of the obligations range from eighteen to thirty-six months and have interest
rates ranging between 12% and 16%. Obligations are secured by underlying
assets. The following is a summary of the capital lease obligations and future
minimum payments under capital lease obligations as of December 31, 1998:
 
<TABLE>
     <S>                                                             <C>
     1999........................................................... $  476,198
     2000...........................................................    443,488
     2001...........................................................    139,567
                                                                     ----------
     Total lease payments...........................................  1,059,253
     Less amount representing interest..............................   (189,494)
                                                                     ----------
     Present value of net minimum capital lease payments............    869,759
     Less -- current portion........................................   (388,795)
                                                                     ----------
     Long-term obligations -- excluding current portion............. $  480,964
                                                                     ==========
</TABLE>
 
 
                                       40
<PAGE>
 
                                 SonoSite, Inc.
                        (A Development Stage Enterprise)
 
                 Notes to the Financial Statements--(Continued)
 
 Other Commitments
 
   As part of the Company's agreements with ATL, ATL may procure resources and
material expected to be used for the manufacture of SONO products in accordance
with a production schedule provided by SONO. 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, SONO would be responsible
for compensating ATL for these procurements.
 
 Contingencies
 
   SONO is a development stage enterprise and has obtained Section 510(k)
clearance for a prototype of its initial product from the U.S. Food and Drug
Administration ("FDA"). SONO has applied for Section 510(k) clearance from the
FDA for the commercial version of its initial product. However, there is no
guarantee the FDA will grant Section 510(k) clearance on this pending or any
future applications. Additionally, international sales and distribution are
dependent upon the Company obtaining approvals from certain foreign regulatory
agencies. There are no guarantees that such approvals will be attained on a
timely basis, if at all.
 
9. Segment Reporting
 
   SONO currently has no revenue from operations. All revenue to date is
related to the DARPA project. Expenses incurred to date are reported according
to their expense category. No further segment segregation is considered
meaningful at this point in time.
 
10. Subsequent Event
 
 Receipt of $12.0 million from ATL Ultrasound
 
   On January 15, 1999, SONO received $12.0 million cash in accordance with the
Distribution Agreement between the Company and ATL. No further funding from ATL
in connection with the Distribution is provided for.
 
                                       41
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE
 
   None.
 
                                    PART III
 
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT
 
   Information called for by Part III, Item 10, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 6, 1999, and is incorporated herein by reference. The information
appears in the Proxy Statement under the captions "Election of Directors" and
"Executive Officers." Such Proxy Statement will be filed within 120 days of
December 31, 1998, the Company's fiscal year end.
 
ITEM 11. EXECUTIVE COMPENSATION
 
   Information called for by Part III, Item 11, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 6, 1999, and is incorporated herein by reference. The information
appears in the Proxy Statement under the caption "Executive Compensation." Such
Proxy Statement will be filed within 120 days of December 31, 1998, the
Company's fiscal year end.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
   Information called for by Part III, Item 12, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 6, 1999, and is incorporated herein by reference. The information
appears in the Proxy Statement under the caption "Security Ownership of Certain
Beneficial Owners and Management." Such Proxy Statement will be filed within
120 days of December 31, 1998, the Company's fiscal year end.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
   Information called for by Part III, Item 13, is included in the Company's
Proxy Statement relating to the Company's annual meeting of shareholders to be
held on May 6, 1999, and is incorporated herein by reference. The information
appears in the Proxy Statement under the caption "Certain Relationships and
Related Transactions." Such Proxy Statement will be filed within 120 days of
December 31, 1998, the Company's fiscal year end.
 
                                       42
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, 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 Schedules.
 
      All financial statement schedules have been omitted because either
      they are not applicable or not required, or the required information
      is included in the financial statements or notes thereto.
 
    (3) Exhibits.
 
<TABLE>
<CAPTION>
 Exhibit
   No.                                 Description
 -------                               -----------
 <C>     <S>
  3.1*   Restated Articles of Incorporation of the registrant
  3.2**  Certificate of Designation of Series A Participating Cumulative
         Preferred Stock
  3.3**  Bylaws of the registrant
  4.1*   Rights Agreement between First Chicago Trust Company and the
         registrant, dated April 6, 1998
 10.1*   Amended and Restated 1998 Option, Stock Appreciation Right, Restricted
         Stock, Stock Grant and Performance Unit Plan
 10.2*   Terms of Stock Option Grant Program for Nonemployee Directors under
         the Sonosite, Inc. 1998 Option, Stock Appreciation Right, Restricted
         Stock, Stock Grant and Performance Unit Plan
 10.3    1998 Nonofficer Employee Stock Option Plan
 10.4**  Nonemployee Director Stock Option Plan
 10.5    Management Incentive Compensation Plan
 10.6**  Adjustment Plan
 10.7*   Form of Senior Management Employment Agreement between the registrant
         and each of Kevin M. Goodwin, Allen W. Guisinger, David H. Gusdorf,
         Jens U. Quistgaard, Ph.D., Donald F. Seaton III and Douglas W. Tefft
 10.8*   Distribution Agreement between ATL Ultrasound, Inc. and the
         registrant, effective as of April 6, 1998
 10.9*   Technology Transfer and License Agreement between ATL Ultrasound, Inc.
         and the registrant, effective as of April 6, 1998, as amended
 10.10*  OEM Supply Agreement between ATL Ultrasound, Inc. and the registrant,
         effective as of April 6, 1998, as amended
 10.11*  Employee Benefits Agreement between ATL Ultrasound, Inc. and the
         registrant, effective as of April 6, 1998
 10.12*  Service Agreement between ATL Ultrasound, Inc. and the registrant,
         effective as of April 6, 1998
 10.13*  Lease Agreement between TMT-Bothell, LLC and the registrant, dated May
         9, 1998
 23.1    Consent of KPMG LLP, independent auditors
</TABLE>
--------
*  Incorporated by reference to the designated exhibit included in the
   Company's Registration Statement on Form S-1 (Registration No. 333-71457).
** Incorporated by reference to the designated exhibit included in the
   Company's report on Form 10 (SEC File No. 000-23791).
 
  (b) Reports on Form 8-K:
 
    No reports on Form 8-K were filed during the quarter ended December 31,
    1998.
 
                                       43
<PAGE>
 
                                   SIGNATURES
 
   Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
                                         SONOSITE, INC.
<TABLE>
<S>                                   <C> 

Date: March 19, 1999                   By:       /s/ Donald F. Seaton III
                                          _____________________________________
                                                   Donald F. Seaton III
                                          Vice President--Business Development,
                                                 Chief Financial Officer,
                                                 Secretary and Treasurer

</TABLE>
 
   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 nineteenth day of March, 1999.

<TABLE>
<S>                                     <C> 
       /s/ Kirby L. Cramer               Chairman of the Board
_____________________________________
           Kirby L. Cramer
 
      /s/ Kevin M. Goodwin               President, Chief Executive Officer 
_____________________________________     and Director (Principal Executive 
          Kevin M. Goodwin                Officer)                           
 
    /s/ Donald F. Seaton III             Vice President--Business
_____________________________________     Development, Chief Financial
          Donald F. Seaton                Officer, Secretary and Treasurer
                                          (Principal Financial and Accounting
                                          Officer)
 
     /s/ Edward V. Fritzky               Director
_____________________________________
         Edward V. Fritzky            
                                      
  /s/ Steven R. Goldstein, M.D.          Director
_____________________________________  
      Steven R. Goldstein, M.D.        
 
  /s/ William G. Parzybok, Jr.           Director 
_____________________________________
      William G. Parzybok, Jr.

   /s/ Jeffrey Pfeffer, Ph.D.            Director 
_____________________________________
       Jeffrey Pfeffer, Ph.D.
                                          
    /s/ Dennis A. Sarti, M.D.            Director 
_____________________________________
        Dennis A. Sarti, M.D.
                                          
   /s/ Jacques Souquet, Ph.D.            Director 
_____________________________________
       Jacques Souquet, Ph.D.
</TABLE>
 
                                       44
<PAGE>
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
 Exhibit
   No.                                 Description
 -------                               -----------
 <C>     <S>
  3.1*   Restated Articles of Incorporation of the registrant
  3.2**  Certificate of Designation of Series A Participating Cumulative
         Preferred Stock
  3.3**  Bylaws of the registrant
  4.1*   Rights Agreement between First Chicago Trust Company and the
         registrant, dated April 6, 1998
 10.1*   Amended and Restated 1998 Option, Stock Appreciation Right, Restricted
         Stock, Stock Grant and Performance Unit Plan
 10.2*   Terms of Stock Option Grant Program for Nonemployee Directors under
         the Sonosite, Inc. 1998 Option, Stock Appreciation Right, Restricted
         Stock, Stock Grant and Performance Unit Plan
 10.3    1998 Nonofficer Employee Stock Option Plan
 10.4**  Nonemployee Director Stock Option Plan
 10.5    Management Incentive Compensation Plan
 10.6**  Adjustment Plan
 10.7*   Form of Senior Management Employment Agreement between the registrant
         and each of Kevin M. Goodwin, Allen W. Guisinger, David H. Gusdorf,
         Jens U. Quistgaard, Ph.D., Donald F. Seaton III and Douglas W. Tefft
 10.8*   Distribution Agreement between ATL Ultrasound, Inc. and the
         registrant, effective as of April 6, 1998
 10.9*   Technology Transfer and License Agreement between ATL Ultrasound, Inc.
         and the registrant, effective as of April 6, 1998, as amended
 10.10*  OEM Supply Agreement between ATL Ultrasound, Inc. and the registrant,
         effective as of April 6, 1998, as amended
 10.11*  Employee Benefits Agreement between ATL Ultrasound, Inc. and the
         registrant, effective as of April 6, 1998
 10.12*  Service Agreement between ATL Ultrasound, Inc. and the registrant,
         effective as of April 6, 1998
 10.13*  Lease Agreement between TMT-Bothell, LLC and the registrant, dated May
         9, 1998
 23.1    Consent of KPMG LLP, independent auditors
</TABLE>
--------
*  Incorporated by reference to the designated exhibit included in the
   Company's Registration Statement on Form S-1 (Registration No. 333-71457).
** Incorporated by reference to the designated exhibit included in the
   Company's report on Form 10 (SEC File No. 000-23791).
 
                                       45