**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC, 20549**

 

**FORM 10-KSB**

 

**(Mark One)**

| **ý**                                                                                                                                                                                                                                          | **ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934**     |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                |                                                                                    |
| **For the fiscal year  ended  September 30, 2003**                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                |                                                                                    |
| **o**                                                                                                                                                                                                                                               | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                |                                                                                    |
| **For the transition period  from                   to                 ** |
|                                                                                                                                                                                                                                                |
| **Commission File Number  0-19632**                                                                                                                                                                                                       |

 

**4-DNEUROIMAGING**

(Exact name of registrant as specified in itscharter)

 

| **California**                                                       |   | **95-2647755**                       |
|----------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)      |   | (IRS Employer Identification Number) |
|                                                                 |   |                                 |
| **9727 Pacific Heights Boulevard, San Diego,  California**           |   | **92121-3719**                       |
| (Address of principal executive offices)                             |   | (zip code)                           |
|                                                                 |
| Issuer’s telephone  number,   **(858) 453-6300** |

 

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

 

| **Title of  each class** |   | **Name of  each exchange on which registered** |
|--------------------------|--------|------------------------------------------------|
|                     |   |                                           |

 

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

 

Common Stock, No Par Value Per Share

(Title of class)

 

Check whether the issuer: (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.   ý  Yes       o  No

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B is not contained in this form, and no disclosurewill be contained, to the best of registrant’s knowledge, in definitive proxyor information statements incorporated by reference in Part III of this Form10-KSB or any amendment to this Form 10-KSB. o

 

The issuer’s revenues for the fiscal year ended September 30, 2003 were$2,808,000.

 

The aggregate market value of the voting stock held by non-affiliatesof the issuer’s common stock as of November 6, 2003 as reported on the NasdaqOver the Counter Bulletin Board was approximately $944,000.  Shares of common stock held by each officer,director and holder of 10% or more of the outstanding common stock have beenexcluded in that such persons may be deemed to be affiliates. Thisdetermination of affiliate status is not necessarily a conclusive determinationfor other purposes.

 

 

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The number of shares outstanding of the registrant’s common stock, nopar value, as of November 6, 2003 was 221,859,748 shares.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Certain exhibits filed with the registrant’s prior filings, as listedbelow, are incorporated by reference into Part III ofthis Form 10-KSB:

 

•        Registration Statement onForm S-1 (33-29095 and 33-81294)

•        Schedule 14A as filed withthe Commission on January 18, 2002

•        Form 10-K for the fiscalyears ended September 30, 1992, September 30, 1998, December 30, 2000, December30, 2001 and December 30, 2002

•        Form 10-Q for each of thequarters ended June 30, 2000 and March 31, 2002

•        Form 10-QSB for each ofthe quarters ended December 31, 2002 and March 31, 2003

•        Form 8-K as filed with theCommission on May 11, 2001 and October 18, 2002

•        Form 8-K/A as filed withthe Commission on June 20, 2001

 

Transitional Small Business Disclosure Format (check one):  Yes  o  No  ý

 

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**4-DNEUROIMAGING**

 

**FORM10-KSB**

 

**FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2003**

**INDEX**

 
| **PART I**   |                                                                                             |   |
|--------------|--------------------------------------------------------------------------------------------------|--------|
|         |                                                                                             |   |
| Item 1.      | Business                                                                                         |   |
| Item 2.      | Properties                                                                                       |   |
| Item 3.      | Legal  Proceedings                                                                               |   |
| Item 4.      | Submission  of Matters to a Vote of Security Holders                                             |   |
|         |                                                                                             |   |
| **PART II**  |                                                                                             |   |
|         |                                                                                             |   |
| Item 5.      | Market  for Registrant’s Common Stock and Related Shareholder Matters                       |   |
| Item 6.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations      |   |
| Item 7.      | Financial  Statements and Supplementary Data                                                     |   |
| Item 8.      | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure            |   |
| Item  8A.    | Controls  & Procedures                                                                       |   |
|         |                                                                                             |   |
| **PART III** |                                                                                             |   |
|         |                                                                                             |   |
| Item 9.      | Directors,  Executive Officers and Control Persons of the Registrant                             |   |
| Item  10.    | Executive  Compensation                                                                          |   |
| Item  11.    | Security  Ownership of Certain Beneficial Owners and Management and Related Shareholder  Matters |   |
| Item  12.    | Certain  Relationships and Related Transactions                                                  |   |
| Item  13.    | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                                 |   |
| Item 14.     | Principal  Accountant Fees and Services                                                          |   |
|         | Signatures                                                                                       |   |

 

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**PART I**

 

This annual report on Form 10-KSB may contain forward-lookingstatements that involve risks and uncertainties.  Actual results could differ materially from any forward-lookingstatements and from past performance as a result of such risks anduncertainties.  See the “Factors ThatMay Affect Future Results” section of this report.

 

**ITEM 1.****          BUSINESS.**

 

Company Overview

 

4-D Neuroimaging, (formerly Biomagnetic Technologies, Inc.), or 4-D, aCalifornia corporation originally founded in 1970 to produce equipment forphysics labs, currently develops, produces, markets and sells medicalinstrumentation that allows physicians to monitor how the body is functioning,and provides an important tool to neuroscientists, helping them to unravel howthe brain functions.  The basictechnology is referred to as Magnetoencephalography, or MEG (sometimes MagneticSource Imaging or MSI).   MEG systemsmeasure and locate magnetic fields generated by the human body, and assist inthe noninvasive diagnosis of a potentially broad range of medicaldisorders.  These measurements provideuseful information about the normal and abnormal functioning of the brain,heart, spine and other organs. Currently, we are focusing our efforts on MEG applications for thebrain.

 

MEG systems use advanced superconducting technology to noninvasivelydetect and characterize naturally occurring magnetic fields that are onebillion times smaller than the earth’s magnetic field.  This capability is used to measure themagnetic fields, from the brain or body thousands of times a second.  Physician are employing this ability to aidin the evaluation and planning for surgical treatment of epilepsy, or Epilepsy,and the identification of important functional areas of the brain (e.g. motorand language-related cortex) that can be at risk during neurological surgeryfor tumors and other brain lesions, also referred to as pre-surgical functionalmapping, or PSFM.   The neuroscienceresearch community is employing MEG to help them unravel the functionalcomplexity of the brain.

 

A major step was taken in 2001 in the commercialization of MEG.  The American Medical Association, or AMA,issued Current Procedural Terminology, or CPT, codes for both Epilepsy and PSFMusing MEG.   While Epilepsy and PSFM bemay relatively small markets in and of themselves, the issuance of CPT codesfor these uses of MEG represent a major step forward in the market developmentof MEG.  They form the foundation forother applications currently in development. A further step was taken in November 2002 when the Center for Medicareand Medicaid Services, or CMS, issued their recommended reimbursement levelsfor the use of MEG in Epilepsy and PSFM. The level of reimbursement established can provide an economic basis forthe purchase and use of MEG systems.  These reimbursement levels became effective January 1, 2003.  In November 2003, CMS again increased thelevels for reimbursement of MEG.  Thesenew, higher levels become effective January 1, 2004.

 

The Company and certain of our customers are continuing to investigatethe value of the technology for the diagnosis of other disorders of the brain,such as dyslexia, stroke, mild head trauma, schizophrenia, depression and otherneuropsychiatric disorders, as well as for problems of the heart, spine, andgastrointestinal system.

 

MEG differs significantly from other anatomical and functional imagingmethods.  Traditional medical imagingtechnologies such as X-ray, magnetic resonance imaging, or MRI, and computedtomography, or CT, provide valuable anatomical detail but no direct functionalinformation.  Functional imaging methodssuch as electroencephalography or EEG, positron emission tomography or PET,single photon emission tomography or SPECT, and functional MRI or fMRI, havelimited spatial or temporal resolution, or require invasive procedures, such asthe injection of radioactive isotopes or surgical placement of electrodes intothe brain, to locate normally or abnormally functioning areas of thebrain.  We believe that MEG is currentlythe only method that can noninvasively characterize the normal and abnormal functionof the brain with the high temporal and spatial resolution necessary to beclinically useful in a potentially wide range of applications.  A MEG system, when used in conjunction withCT and MRI images, 

 

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provides the clinician with information that links anatomy withfunction to provide a more complete picture of the patient’s condition withoutthe use of radioactive isotopes or invasive procedures, the majority of whichare inherently costly.

 

Product and Market Development

 

After developing our core technology for the scientific research marketfor physics we looked to expand our markets with other applications.  We determined that the market for the use ofMEG systems in the diagnosis of neurological and neuropsychiatric disordersmight be very large. Since focusing on this market, we have pursued bothtechnical and market development strategies intended to create a commercialclinical market for MEG.  We havedeveloped and released a series of products leading up to the product line weare currently offering. The current main product line consists of twowhole-head systems - the Magnes® 2500 WH, the Magnes 3600 WH - and the Magnes1300C, a system designed for non-brain measurements including fetal, cardiac,spinal and gastrointestinal studies. All of the products are available through common distribution channelsthroughout the world. As part of our ongoing commitment to the research market,any of these systems can be customized for the specific needs of a givenresearch project.  We market the Magnes2500WH as our principle clinical system, while the Magnes 3600 WH is primarilymarketed to the research market.

 

As part of our market development strategy, we have targeted theevaluation of patients with Epilepsy, and the pre-surgical functional mappingof patients who are candidates for surgery that would endanger importantfunctional areas of the brain, as near-term clinical applications for MEG.  With the issuance by the AMA of CPT codesfor these indications in 2001, the issuance by CMS of reimbursement levels forthese applications in 2002 and their subsequent increase in 2003, MEG has takensignificant steps forward in its commercialization.

 

In the U.S. alone there are over 100 tertiary care epilepsy centersthat we have identified and believe could benefit from the use of MEGtechnology.  We are currently directingour marketing and sales efforts towards these centers as potential customersfor MEG systems in the U.S. These centers are typically affiliated withacademic medical institutions with large neurosurgical programs that would alsobenefit from the PSFM application.  Inaddition, we believe there are an equivalent number of Epilepsy/PSFM centerswith similar needs throughout the rest of the world.  In addition to direct sales channels we are pursuing possiblealliances or other distribution relationships that could expand our access tothe commercial market, which is expected to emerge following the issuance ofCPT codes and the establishment of reimbursement levels.

 

Currently, we are aware of at least 5 centers in the U.S. using andreceiving reimbursement for MEG on a routine basis for these indications:University of California, San Francisco, the University of Texas, Houston,Texas, Henry Ford Hospital in Detroit, Michigan, Scripps Research Institute inSan Diego, California, and University of Alabama, Birmingham.

 

MEG Technology

 

MEG is based on fundamental properties of electromagnetism.  Electrical currents produce magnetic fieldsthat are perpendicular to the flow of current; these fields can be detected byour technology.  A MEG instrumentdetects the magnetic fields produced by intracellular electrical activity thatare associated with many of the body’s most critical functions.  Unlike electrical potentials generated bythe body, upon which EEG and the electrocardiogram, or ECG, are based, thecorresponding magnetic fields pass through surrounding body tissue undistorted,without obscuring the location of the source. MEG can non-invasively provide information about the timing and thelocation of the origin of normal and abnormal functional activity, by measuringand analyzing these magnetic fields. MEG can do this with a combination of millimeter spatial resolution andmillisecond time resolution that has not been previously available without theuse of surgically implanted electrodes, introducing radioactive or other tracersubstances into the body, or the use of other costly, invasive procedures.

 

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Current Medical Imaging Technology

 

The clinical value of MEG is found primarily in assessing thefunctional state of organs of the body, both normal and abnormal. Manydebilitating or life threatening disorders of the body, such as stroke,seizures, dementia, mental illness, movement disorders, cardiac arrhythmia andgastrointestinal disorders involve a disruption of function and MEG can play animportant role in assessing the status of crucial body organs.

 

Numerous medical imaging technologies have been developed in responseto this need.  These include imagingtechnologies oriented toward organ structure and anatomy, such as CT and MRI,and imaging technologies oriented toward function, such as PET, SPECT and fMRI.

 

CT and MRI produce anatomical images and aid in locating structuralmalformations.  Their utility forfunctional disorders can be quite limited if there is no associated structuralproblem or there are multiple structural problems of which only a small numberare causing the functional problem.

 

PET, SPECT and fMRI provide the physician with some functionalinformation based on measurements of secondary effects of the body’sactivity.  For PET and SPECT this is theuptake of certain radioactively labeled substances by the active tissue of thebody, and for fMRI it is the change in blood flow due to the activity.  All three techniques have relatively longphysiological response times of one to five seconds, severely limiting theirability to follow function at the milli-second time scale, where MEG excels,and which is often required for functional disorder such a epilepsy.  In addition, the use of radioactivelylabeled substances limits the ability of PET and SPECT to be used inlongitudinal measurements. MEG, which provides a totally non-invasivefunctional measure with milli-second time resolution, is able to capture thebrain’s activity as it occurs, thereby allowing the physician to know preciselyboth when and, unlike EEG, where the activity occurred.

 

The 4-D MEG Systems

 

Our MEG systems – the Magnes 2500 WH and 3600 WH whole-head systems,and the Magnes 1300 C that is designed for the rest of the body – are systemsemploying superconducting detection coils and amplifiers called SuperconductingQuantum Interference Devices or SQUIDs. Integrated with each system are a patient support chair/bed, patientmonitoring systems, and stimulus delivery systems, all isolated fromenvironmental magnetic fields within a Magnetically Shielded Room, or MSR.  Also integrated in the system are a controlconsole, electronic components, stimulus generating devices and analysisworkstations in a surrounding suite. These systems, as well as the Magnes I and Magnes II, have been used inboth neurological and cardiac applications and incorporate a number of uniquetechnologies, which are discussed below in more detail under the caption“Patents, Know How and Proprietary Rights.”

 

Medical Applications  

 

We believe our Magnes systems have commercial potential in thediagnosis and treatment of a variety of neurological and other disorders.  In developing MEG technology as a diagnostictechnology we must create the appropriate economic incentives to enable acommercial success.  Among theseincentives, we continue to pursue the creation of sufficient numbers ofdiagnostic applications capable of generating cost savings or improved patientcare so that large numbers of hospitals and clinics would consider purchasingMEG systems. This has facilitated the implementation of routine reimbursementfor MEG procedures from third party payors and provided an increasing volume ofevidence of routine approvals of reimbursements for clinical MEG procedures bythird party payors.

 

There are currently two clinically accepted applications for our MEGsystems as evidenced by the issuance of CPT codes and reimbursement levels:planning of surgical treatment for epilepsy and presurgical functional mappingof the brain.

 

To continue to develop the potential market for MEG, we will continueto work with our customers and other physicians and researchers to encourageand sponsor the clinical research needed to establish that 

 

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the MEG applications described below, other than surgical planning forepilepsy and pre-surgical functional mapping, are medically useful andreimbursable.

 

We are pursing a sales and marketing strategy to fully exploit thenewly established CPT codes and reimbursement levels for MEG.  While the commercial acceptance of MEG maystill be uncertain, we are developing a strategy, which is expected to includeboth our current direct-sales approach and the formation of strategic alliancesto help accelerate the penetration of our MEG technology into our targetmarkets of neurosurgeons, neurologists, and epileptologists.

 

*Epilepsy Surgery*

 

As of 1995 there wereapproximately 2.3 million people in the U.S. with recurrent epileptic seizures,and approximately 181,000 new cases emerge each year.  The seizures for many of these people can be controlled with drugs,but a number require alternative treatments. It is estimated that at least 25 percent of the total epilepsypopulation have persistent seizures despite medical treatment, and couldpossibly benefit from surgical intervention. In 1993 about 2,500 such procedureswere performed.  While, to ourknowledge, there has been no subsequent reliable data published, we believe,based on discussions with practitioners in the field, the rate of surgicalinterventions has steadily increased and will continue to do so in the nearfuture.

 

Over the past decade, a numberof research studies have demonstrated that MEG can noninvasively locate braintissue suspected of triggering epileptic seizures.  It is this tissue that is the target of epilepsy surgery.  In the absence of a noninvasive method, itis often necessary to implant an array of electrodes directly on or into thebrain to locate this tissue.  Theinvasive evaluation approach requires lengthy hospitalization in facilitiesthat are equipped for long-term intensive monitoring of patients, 24 hournursing care and participation of a highly trained team of specialists.  To date, the cost and relative scarcity ofappropriate facilities for this long-term monitoring procedure severely limitthe number of patients who can benefit from a surgical approach to epilepsytreatment.

 

Recent medical literature showsthat the information provided by MEG could, in many cases, improve or even helpavoid invasive evaluation procedures. We believe this information can be obtained with our MEG systems in aclinically acceptable time frame, and at a cost that will allow for routine usein evaluating patients for epilepsy surgery.

 

*PresurgicalFunctional Mapping*

 

Approximately 110,000 brainsurgeries are performed annually in the U.S. These procedures include tumor resection, surgical correction ofepilepsy and removal of vascular malformations.  The precise locations of important functional regions of thebrain vary among healthy individuals and even more widely among patients with largebrain lesions, therefore the locations of these regions often cannot bereliably determined solely from anatomical imaging, such as MRI.  However, by relating information about theprimary sensory function areas provided by our MEG systems to MRI-generatedanatomical images, a functional map of the brain can be obtained and presentedon a screen or recorded on film.  Imagesthus produced with our MEG systems allow the surgeon to reliably estimate therisk of damage to the identified functional areas that might arise from thesurgery itself.  These images also helpthe surgeon to select an appropriate surgical approach, such as where to openthe skull, and from which direction to access the targeted area, to minimizethe surgical risk.

 

Using our MEG systems, reliableand practical methods of providing a functional map of the brain have beendeveloped and verified.  The functionalareas of the brain that can be localized by MEG include somatosensory cortex,motor cortex, language-related cortex, visual cortex, and auditory cortex.  These results have been reported in a numberof peer-reviewed medical journals.

 

*NeuropsychiatricApplications*

 

Potential neuropsychiatric applications of MEG include the diagnosis ofschizophrenia and depression. It is currently estimated that approximately3,000,000 people (1 percent of the U.S. population) will develop 

 

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schizophrenia during the course of their lives, and at any given timeapproximately 100,000 people are hospitalized in public institutions in the U.S.for this disease.  A number of studiesindicate that MEG can detect differences in the brain activity in schizophrenicsubjects compared to normal subjects. The variety and robustness of the differences suggest that MEG mayeventually provide an objective indicator of the disease and be useful formonitoring treatment.  Likewise,depressive illness affects more than 19,000,000 adults within the U.S. eachyear.  Preliminary studies suggest thatMEG may provide an objective indicator of the disease and lead to moreeffective treatment.  In August 2003, weinstalled a Magnes 3600 WH system in the Department of Psychiatry at theUniversity of Colorado where researchers will pursue the development of suchapplications.

 

*Applications toLearning Disorders*

 

Potential applications in learning disorders include the diagnosis ofdyslexia and autism.  Dyslexia affectsbetween 4 and 10 percent of the population throughout the world.  PET and fMRI studies have indicateddifferences in metabolic activity in dyslexic adults compared to normalsubjects, however direct evidence of abnormal neurological function in dyslexiais lacking. Recently, evidence has been presented from research groups in theU.S. and Europe that MEG may provide a sensitive and specific objective indicatorof the reading disability in dyslexia. Autism is the third most common developmental disorder and affectsnearly 400,000 people in the U.S. Recently, a sub-population of children with autism has been identifiedthat have normal early development, followed by an autistic regression and whoshow a distinct MEG pattern of brain activity. The preliminary data suggest that identification of such patients by MEGmay lead to therapeutic strategies that lead to significant improvement inlanguage and autistic features.

 

*Other NeurologicalApplications*

 

Other applications areas in which MEG may have clinical value includeischemic disease and stroke, mild brain trauma and Alzheimer’s disease.

 

Ischemia and stroke are common neurological disorders resulting fromthe disruption of blood supply to the brain. Each year in the U.S., more than 700,000 people suffer a majorcerebrovascular event.  The total directcost to the U.S. health care system for treatment and rehabilitation of strokeexceeds $30 billion per year.  MEG maypotentially assist physicians treating stroke by identifying damaged brainareas before they are detectable by CT or MRI scans.  As an indicator of neurological function, MEG may be useful tomonitor rehabilitation and treatment of stroke patients.

 

It is estimated that approximately 1,000,000 people experiencetraumatic brain injury each year in the U.S., of which approximately 400,000seek medical attention.  In mild braintrauma, significant structural changes are rarely seen, and functional EEGchanges are typically mild and diffuse. MEG may be more sensitive than EEG and MRI in identifying braindysfunction in such patients and may correlate well with symptomatic recovery.

 

Alzheimer’s disease affects an estimated 4,000,000 million people inthe U.S. Current diagnostic technologies; PET, SPECT and EEG are not widelyaccepted as being valid diagnostic or prognostic indicators of thedisease.  Preliminary indicationssuggest that MEG may show altered responses to sensory stimuli in Alzheimer’spatients, thus providing a tool for diagnosis and treatment.

 

*Applications inother areas of the body*

 

Preliminary studies indicate that MEG could be beneficial in evaluatingorgans of the body outside the brain. Although the potential for a commercial market in these areas remainsunknown the various parts of the body that might be evaluated with MEG includethe gastrointestinal tract (gastrointestinal ischemia), spinal cord function(lower back pain) and adult and fetal heart monitoring (cardiac arrhythmia andfetal development).

 

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Sales to Date

 

Our primary near term objective is to cooperate with researchers andphysicians at key medical centers to accelerate the development, use andcommercialization of our MEG systems. The use of our MEG systems must continue to be validated by clinicalresearchers as an effective tool for mainstream clinical applications in orderto establish a commercial market. Accordingly, the early clinical research sales and collaborations withclinical sites are strategically important to our overall market developmentplan.

 

As of December 2003, we have 32systems installed throughout the world. Installations are distributed among the U.S., Germany, Austria, Spain,France, Japan and China.  Fourteen (14)sites operate Magnes 2500 WH systems. Four (4) sites operate Magnes 3600 WH systems.  Ten (10) sites operate Magnes I and Magnes II systems.  Two (2) sites operate Magnes 1300 C systemsand two (2) sites operate custom equipment made by us.

 

Marketing, Sales and Distribution

 

*Market Description*

 

The overall market for our MEG systems can be divided into threeoverlapping markets: the basic research market, the clinical research marketand the commercial clinical market. Customers in each of these markets are identified by the focus of theirwork, the source of purchase funds, and other characteristics, as describedbelow.

 

The basic research marketconsists of scientists working in university and government laboratories todiscover new information about organ function and to make fundamental advancesin their scientific fields.  Patienttreatment is not their principal concern. Equipment used by these scientists is generally purchased with fundsprovided by government and private research grants.  The basic research market has been to date, and continues torepresent, the majority of our sales.

 

The clinical research market consists primarily of university medicalcenters where the majority of clinical applications development work for newmedical technologies and procedures is normally conducted.  Because of their size, buying power,prestige, and early involvement in assessing and using new medicaltechnologies, university medical centers continue to be the primary focus ofour near-term marketing plans.  We haveidentified more than 150 key members of this group in the U.S., Europe and Asiathat are centers of excellence in neurosurgery, neurology, neurophysiology,neuroradiology and psychiatry.

 

With the issuance of the first CPT codes for MEG and the establishmentof reimbursement levels, it becomes feasible for clinical users of MEG systemsto create an MEG installation that is economically self-supporting.  With our MEG systems, users with theappropriate neurosurgical patient populations can now begin to operate MEGsystems with the potential for an economic return.  While this model continues to need more demonstratedapplications, we believe that the issuance of new CPT codes and reimbursementlevels opens new sales opportunities in the commercial clinical market.  We believe that we are uniquely positionedwith our broad base of clinical users and clinical knowledge to take advantageof the issuance of CPT codes and work with both current and new users to createa commercial MEG market.

 

The National Institute of Health, or NIH, has estimated that there areapproximately 90 million cases annually of neurological and mental illnessdisorders in the U.S.  Each caserepresents a separate incident of such disorders, but not necessarily separatepatients.  In most cases, diagnosticmethods for these disorders remain inadequate. According to NIH estimates, the annual cost associated with theseneurological and mental illness disorders in the U.S. is more than $285 billion.  This amount includes the direct cost ofhealth care and, in the case of neurological disorders, the indirect cost ofincome lost due to illness.  Themajority of these disorders is functional in nature and is a major cause ofdisability and death.  In most cases, nononinvasive test exists to help physicians diagnose or effectively monitor thefunctional activity associated with these neurological and mentaldisorders.  Our MEG systems are designedto address this need.

 

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There is substantial medical evidence supporting the view that asignificant percentage of mental disorders have a physiological origin that canbe treated by pharmaceuticals or other methods.  Currently there are few objective measures of these physiologicalproblems, making diagnosis and treatment, including measuring the effectivenessof the treatment, problematic.  MEG hasdemonstrated the ability to provide accurate spatio-temporal maps of neurophysiologicalfunction that might serve as an objective measure, thereby improving theclinical process.  We believe the MEGsystems could fulfill a major need of physicians dealing with mentaldisorders.  Researchers are in the earlystages of investigating MEG applications for mental disorders such asschizophrenia and depression.  Otherresearchers are investigating learning and behavioral disorders, such asdyslexia and autism.  As yet, noreliable estimates can be made of the number of patients in these categorieswho might be aided by information provided by our MEG systems.

 

*Marketing Programs*

 

The currently active market for MEG systems consists primarily of thebasic research market and the clinical research market, with the clinicalmarket now emerging.  We promote ourproducts to all markets by attendance and exhibits at medical and scientificmeetings.  Because of our historicallydominant position among MEG researchers, we maintain close contacts withpotential customers in the basic research market.  In order to promote sales in the clinical research market and todevelop the commercial clinical market, our fundamental marketing strategy isto accelerate clinical applications development for our systems bycollaborating with and promoting the work of a core group of influential medicalcenters engaged in medical applications development.  We plan to continue implementation of this strategy by (i)encouraging physicians developing applications for our MEG systems to publishtheir results in professional journals, (ii) participating in key medicalmeetings to generate interest among targeted medical specialists, (iii)encouraging communication and collaborative projects between research groupsworking with the MEG systems, (iv) initiating site visits by key customers and(v) co-sponsoring education programs with our customers.  We are also actively involved withprofessional medical societies, such as the American Academy of Neurology, orAAN, in efforts to obtain and extend reimbursement for clinical MEG studies,and involved with patient advocacy groups, such as the Epilepsy Foundation ofAmerica and its local affiliates, to increase awareness of the technology andencourage its use.

 

We will continue our efforts to seek out new clinical applications forMEG.  Scientific publications by ourcustomers in Europe, Japan and the U.S. have reported positive findingssuggesting that MEG may be useful in the diagnosis and management of a numberof neurological, neuropsychiatric and learning disorders.  We will devote a significant portion of ouravailable resources in the next year to verify and support such efforts.  In addition, we will be expanding ourmarketing efforts into the neuropsychiatric and learning disorders fields byattending and exhibiting at appropriate medical and scientific meetings.

 

*Distribution*

 

We have a small direct-sales organization with the specialized skillsneeded to sell our MEG systems in the U.S. Our branch office in Aachen, Germany serves the European market.   In September 2003 we terminated our Chinadistribution contract with Beijing Medi-Therm Instruments, Inc. based onnon-performance.   We currently handledistribution of our product in Asia through a combination of direct sales, withone sales person, and a network of local distributors.  We are currently in arbitration with Elektaover our distribution contracts in the U.S. and Japan.  See “Legal Proceedings”**in Item 3 of this annualreport.  We continue to explore otherpossible relationships that would enhance our ability to distribute and sellMEG systems throughout the world.  Ourrevenues from sales in our North American, European and Asian markets arediscussed in Note 6 to our financial statements.

 

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*Long-Lived Assets*

 

We have long-lived assets in Europe, as well as North America.  Our long-lived assets consist primarily ofvarious fixed assets.  Additional detailregarding our long-lived assets is provided in Note 6 to our financialstatements.

 

*Reimbursement*

 

Our long-term commercial success in the U.S. is dependent uponobtaining routine approval of reimbursement for clinical MEG procedures bythird-party payors.  The Centers forMedicare and Medicaid Services, or CMS, formerly known as the Health CareFinancing Administration which is responsible for the administration ofMedicare, and the AMA that administers the use of CPT codes by most third-partypayors, follow similar guidelines for determining whether a specific procedureor health care technology is “reasonable” and “necessary”, and therefore reimbursableunder Medicare or private insurance coverage. These guidelines generally include consideration of whether (i) theprocedure or technology is more or less costly than an alternative alreadycovered by insurance, (ii) the added benefit of the procedure or technology issignificant enough to justify the expense, and (iii) the procedure ortechnology provides significant medical benefits not otherwise available fromother procedures or technologies.

 

We have worked for several years with our customers and the AAN toobtain CPT codes for MEG.  These effortscame to a successful fruition in February 2001 when the AMA announced that itwould assign the first three CPT specific codes for the use of MEG.  The codes for MEG were published in theFederal Register on November 1, 2001. These codes are:

 

**95965**    Magnetoencephalography(“MEG”), recording and analysis: for spontaneous brain magnetic activity (e.g.,epileptic cerebral cortex localization).

 

**95966**    Magnetoencephalography(“MEG”), recording and analysis: for evoked magnetic fields, single modality(e.g., sensory, motor, language, or visual cortex localization).

 

**95967**    Magnetoencephalography(“MEG”), recording and analysis: for evoked magnetic fields, each additionalmodality (e.g., sensory, motor, language, or visual cortex localization) (Listseparately in addition to code for primary procedure).

 

These codes were established in the neurology section of the CPT codelisting.  The reimbursement levelsrecommended provide for payments to the physician who interprets the study dataare currently among the highest in the neurology section.   Reimbursement levels are stated in relativevalue units or RVUs.   These units arethen assigned a dollar value depending on the specific hospital andlocation.  For an Epilepsy study (95965)the recommended RVU level is 11.39. This RVU level is currently among the highest assigned reimbursementlevels in the neurology section.  ForPSFM two levels were assigned, 5.78 units for the first exam on a patient and5.07 for subsequent exams for the same patient on the same visit.  We believe that these levels will enable anincreasing number of referring physicians to utilize MEG.

 

In the publication of the CPT codes on November 1, 2001, thereimbursement level to be paid for the use of the equipment, also known as theTechnical Component fee, was designated to be carrier based.  This means that each insurance carrier willindependently assign a payment level. We work with each of our customers and prospects to establish appropriatereimbursement levels with the carriers used by their patients.  This has been the method of reimbursementthat our customers have been using for up to eight years and, with our help,have been able to obtain satisfactory levels of reimbursement.  We will continue to work with our customers,with the added advantage of having the CPT code available.

 

In November 2002, the CMS published the Ambulatory Patient Cost, orAPC, codes.  APC codes are cost-basedcodes that set the technical fee that Medicare will pay for ambulatory patientsbeing treated within the hospital.  Thispublication provided for reimbursement levels from $850 to $2,250 for the threedifferent CPT codes that have been established for MEG.  This rule went into effect January 1, 2003.   This rate was further modified in November2003, increasing the levels to between $925 and $5,250.  This rule goes into effect on January 1,2004.

 

11

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The CPT codes became available for use starting in January 2002 and thereimbursement levels established by the CMS became available January 1, 2003and were revised upward effective January 1, 2004. They provide the potentialbasis for the economic operation of MEG installations. Our sales strategies in theU.S. will be continue to focus more on the development of commercially viablesales to clinical users.  It is alwaysdifficult to predict the adoption rate of a new modality, but with theassignment of CPT codes and higher reimbursement rates we believe that we havea new and powerful sales tool.

 

In Europe, the current MEG customers have concentrated primarily onbasic research, and have not actively pursued governmental or private approvalfor reimbursement of MEG procedures. However, several European institutions are currently investigatingmechanisms for obtaining reimbursement for MEG examinations.  We are actively cooperating in theseinitiatives.  There is no assurance atthis time that these efforts will be successful, nor do we have an accurate estimateof the time frame.

 

*Product Prices andTerms of Sale*

 

The current prices for our MEG systems range from approximately$1.0-$2.5 million, depending upon system configuration.  Standard terms of sale provide for paymentsof 30-40% of the purchase price upon placement of the order, 40-50% uponshipment and the remaining 20% when installation is completed and finalacceptance is obtained from the customer. For European customers who receive their funding from governmentalagencies, we are generally required to provide a bank guarantee for the amountof the deposit.  That guarantee isusually released upon shipment and/or acceptance by the customer.  The time between placement of an order andinstallation typically ranges between six and twelve months.  We also enter into special collaboration andsale arrangements with certain medical centers to promote clinical applicationsdevelopment.  These standard terms ofsale may change to accommodate customer requirements.

 

*Installation,Service and Training*

 

In the medical device market the ability to provide comprehensive andtimely service is a key competitive advantage and is important for establishingcustomer confidence.  Installation andservice for our products worldwide is provided from our San Diego, Californiaheadquarters and from our branch office in Aachen, Germany, both of whichmaintain customer service departments capable of performing sophisticatedsystems installation and equipment maintenance.  Elekta provides service to MEG systems in Japan.

 

Installation and a service agreement for the first year are included aspart of the standard terms of sale in the U.S. and Europe.  Thereafter, service and maintenance areavailable on a time and materials basis or pursuant to a yearly serviceagreement for an annual fee.

 

Initial customer training in the operation of our MEG systems isprovided by our personnel at the customer’s site and is included in the sellingprice of the system.  Physician trainingin interpreting the clinical significance of MEG information is currentlyprovided at our cooperating U.S. clinical sites.

 

Competition 

 

We operate in an industry characterized by rapid technological change.New products using other technologies or improvements to existing competingproducts may reduce the size of the potential markets for our products, and mayrender them obsolete or non-competitive. Competitors may develop new or different products using technology orimaging modalities that may provide or be perceived as providing greater valuethan our products.  Any such developmentcould have a material adverse effect on our financial position and results ofoperations.

 

Additionally, there continues to be significant price competition fromour main competitors for the limited number of purchases of whole head systemsworldwide.  This aggressive competitionhas and 

 

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may continue to affect profit margins on sales of our whole headsystem, the extent of which is not presently determinable.

 

Companies we know that currently manufacture an integrated large-arrayMEG system are CTF Systems Inc., a Canadian company, Yokagawa Electric workingin conjunction with Eagle Technologies, both Japanese companies, Shimadzu, aJapanese company, Daikin, a Japanese company and Neuromag, our former Finnishsubsidiary.

 

Many of our current or potential future competitors have significantlygreater financial, manufacturing, distribution and technical resources than ourcompany. Our success will depend upon various factors, including our ability tocontinue our technological and market development leadership role, and theability to raise necessary capital for further development andcommercialization.

 

Backlog

 

As of September 30, 2003, theaggregate amount of revenue backlog from firm orders for Company products andservices was approximately $5,200,000, compared to approximately $5,100,000 asof September 30, 2002, of which we expect to fill approximately $3,500,000before September 30, 2004.  The revenuebacklog is composed primarily of orders for two Magnes 3600 WH systems anddeferred service revenues on systems accepted before September 30, 2003. Theamount of cash yet to be generated from backlog at September 30, 2003 isapproximately $1,700,000 compared to approximately $2,300,000 as of September30, 2002.  As sales of our systemstypically involve transactions of $1 million or more, backlog is expected tofluctuate significantly from year to year depending upon timing of ordersreceived, installations completed and customer acceptances received during thereporting period.

 

Research and Development

 

We have recently funded our product research and development primarilythrough private sales of stock, and revenues from product sales.  We spent $883,000 and $1,022,000, in fiscalyears 2003 and 2002 respectively.  Thecontinued reduction in expenditures represents the maturity of the currentproduct offered combined with the delay of the emergence of a clinical,commercial market for MEG.  We have beenable to shift our research and development focus from system development tosupport of applications development through incremental improvements in ourhardware systems and improvements in our software systems to support both newresearch activities of our customers and increasing the efficiency of oursoftware for clinical applications.

 

Manufacturing and Materials

 

We engineer and manufacture the major component of our Magnes systems,other than the host computer and its peripherals, the MSR which houses thesensor, and the sensor position indicator hardware used to determine how thesensor is oriented to the body. We are also currently purchasing our MagnesSQUID amplifiers from an outside source. However, through our joint ownership of Magnesensors, Inc., we have theability to provide for fabrication of our SQUID amplifier requirements shouldsuch a need arise.

 

Of the major components of the MEG systems we do not manufacture, thehost computer and peripherals are widely available standard items.  Other major purchased components areconstructed in accordance with Company specifications that ensure compatibilitywith our MEG systems.  Three Europeanmanufacturers currently supply the MSRs for MEG systems sold in the U.S.,Europe and China.  A separate Japanesesupplier provides MSRs for the Japanese market.   We believe we have adequate alternate sources of supply for thismajor system component from these sources.

 

Certain product engineering designs are performed by the manufacturer,as are certain software and hardware components.  We believe our use of outside designers is appropriate for theproven and mature state of the current systems, and has reduced the need forextensive in-house products engineering efforts.  To date, the use of outside designers has not limited our abilityto produce competitive systems.

 

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We believe our current manufacturing and testing capacity in the U.S.is sufficient to satisfy present demand. In order to achieve our long-term objectives, however, we will berequired to expand production capabilities, mainly through additionalmanufacturing personnel and by potentially subcontracting assembly ofadditional system components.  Webelieve that our control over the development and manufacture of our MEGsystems will enable us to modify our devices to address specific needs ofanticipated clinical applications without significant dependence upon outsidesuppliers, manufacturers or providers of technology.

 

Governmental Regulation; Regulatory Approvals

 

We are subject to various regulations of the FDA and California HealthServices.  In particular, the FDA andCalifornia Health Services have promulgated regulations to which we mustadhere, including, but not limited to, minimum manufacturing standards, productoperating effectiveness and functional safety of our diagnostic products.  The FDA regulates marketing of medicaldevices, requiring pre-market clearance or pre-market approval based uponreview of information submitted by us relating to intended product use,labeling, safety and efficacy.  Thepre-market clearance or approval processes are based upon risk class and degreeof equivalence to devices already marketed that are proven to be safe andeffective.  We are also compliant withISO 9001.

 

Our continued compliance with applicable governmental regulations areassessed by internal audits and by audits of manufacturing operations andprocedures conducted by the FDA and California Health Services.  These agencies have the authority, amongother rights, to limit or stop product shipments and require product recallshould a failure to comply with regulations be observed.  We have registered with the FDA andCalifornia Health Services as a medical device manufacturer.  California Health Services has completed aninspection of our facilities and manufacturing processes and has issued us alicense that permits it to manufacture, sell and ship the Magnes systems asmedical devices for diagnostic purposes. The FDA conducted an audit of us for compliance with federal currentGood Manufacturing Practices, or cGMP, regulation requirements in July1996.  We have updated our internalquality systems to be compliant with the current Quality System Regulations, orQSRs, of the FDA.  Based on internalaudits we believe we are in full compliance with the FDA QSRs.  In addition, we have been certified ascompliant with ISO 9001, an internationally recognized quality system that iscompatible with the FDA QSR’s and will aid in our ability to ship systemsworldwide, especially to the European Union.

 

In order to export our products, we must comply with U.S. exportcontrol regulations, which restrict the export of devices containing certain ofour technology to certain foreign nations. Although the export control regulations have not prohibited us fromexporting our MEG systems to foreign nations, there can be no assurance that wewill continue to be able to obtain the necessary export licenses in thefuture.  We are currently allowed toexport the Magnes systems to many foreign countries, including all WesternEuropean countries and Japan, under a general license that requires noadditional approval prior to shipment.

 

Medical devices are placed in one of three classes, depending upontheir use or the degree to which they provide functions critical to sustaininglife.  Class I devices, such as tonguedepressors, are subject to general controls, including Quality SystemRegulations or QSR.  Class II devices,to which MEG systems belong, are subject to general performance standards notyet established by regulation.  Generalcontrols of Class I devices presently apply to Class II devices, because noperformance standards have been developed or promulgated by the FDA for ClassII devices.  Other examples of Class IIdevices are the ECG and EEG instruments. Class III devices consist of “critical devices,” those represented to belife sustaining or life supporting, implanted in the body or presentingpotential unreasonable risk of illness or injury. Examples are kidney dialysissystems and cardiac pacemakers.  Class Iand II devices may be marketed by demonstration of “substantial equivalence” toexisting devices via a Section 510(k) pre-market notification, and subsequentFDA clearance to market.  Under thisprocess the Magnes I and Magnes II systems have been determined to besubstantially equivalent to our prior Model 607 Neuromagnetometer and toEEG.  The Magnes 2500 WH system has beenfound to be substantially 

 

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equivalent to the Magnes II system. The Magnes 3600 WH system has been found to be substantially equivalentto the Magnes 2500 WH.

 

While Western Europe and Japan have regulatory agencies that aresomewhat similar to the FDA, each country’s regulatory requirements for productacceptance are unique and will require the expenditure of substantial time,money and effort to obtain and maintain regulatory acceptance for marketing forclinical use.  There can be no assurancethat we will be able to obtain and maintain such approvals.  The Magnes I, Magnes II, and Magnes 2500 WHsystems have all received JMHW approval.

 

Patents, Know How and Proprietary Rights

 

We rely on proprietarytechnology and seek to maintain confidentiality of our trade secrets,un-patented proprietary know how and other proprietary information, and seek toobtain patent protection when appropriate. As of September 30, 2003, we hold 37 patents in the U.S. of which 22pertain to our current whole head system product line.  11 of the 37 patents had counterpart patentsissued in certain member countries of the European Patent Organization, inCanada and in Japan. These patents will expire at the earlier of 17 years afterthe issue date or twenty years after the priority date of record; these dates ofexpiration vary over the range from 2007 to 2019.  As of September 30, 2003 we had filed one U.S. patentapplication.  We have also filed twoapplications with the European Patent Organization for patent protection inWestern Europe and three applications in Japan.  We anticipate that patents, if issued, will be issued (i) within2 to 20 months, with respect to the pending patent applications in the U.S. and(ii) within 3 years, with respect to the pending patent applications in WesternEurope.  We have reserved our prioritywith respect to receiving patents on our applications in Japan, and are eithercurrently pursuing or may pursue those applications in the future.

 

Our patents protect several fundamental aspects of the technology usedin our products.  Patents have beenissued with respect to superconducting devices, ultra-low-noise electronicscircuits, biomagnetometer design, biomagnetic signal processing, magneticshielding techniques, noise suppression methodologies, cryogenic apparatusconstruction techniques, and system design concepts.  Patent applications have been filed with respect to a new processfor fabrication of electronic devices using high-temperature superconductingmaterials, superconducting device designs, magnetic shielding technology,cryogenic refrigeration, ultra-low-noise electronic circuits, patient handlingequipment and biomagnetic signal processing and data analysis.  We are currently considering additionalpatent applications covering inventions already made in these and relatedfields of technology. Rights to certain of our patents associated with theapplication of so-called high temperature superconductors have been assigned toMagnesensors, Inc., partially owned by us, Quantum Magnetics and certain of ourofficers.  Our President and ChiefExecutive Officer, D. Scott Buchanan, is also a member of the board ofdirectors of Magnesensors.

 

4-D Neuroimaging® with and without the logo, the 4-D logo alone,Biomagnetic Technologies® with the logo and Neuromagnetometer® are registeredtrademarks of the Company by registration with the U.S. Patent and TrademarkOffice.  MSI® and Magnetic SourceImaging® are registered trademarks in the State of California.

 

We have pioneered the development of technologies associated withMEG.  Several core technologies thathave been developed by and represent proprietary know how to the Companyinclude superconducting magnetic field detectors, magnetic noise reduction,data analysis and clinically useful temporal and overlay displays.  Many of these techniques and technologiesare patented.  As a result, we believewe have established an industry leadership position in MEG.

 

On or about November 5, 2002, we pledged our portfolio of U.S. patentsas collateral against a line of credit from AIG Bank in the amount of$1,000,000 (see Note 4 of the consolidated financial statements).

 

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Human Resources

 

As of November 6, 2003, we employed a total of 34 permanent full-timeand part-time employees, eight of whom hold Ph.D. degrees.  There are 25 employees based at ourfacilities in San Diego, California and nine in Aachen, Germany.  None of our employees are covered by acollective bargaining agreement and we have experienced no work stoppages.  We believe our relationships with ouremployees to be good.

 

Factors That May Affect Future Results 

 

This annual report on Form 10-KSB may contain forward-lookingstatements that involve risks and uncertainties.  Such statements include, but are not limited to, statementscontaining the words “believes”, “anticipates”, “expects”, “estimates”, andwords of similar import.  Our resultscould differ materially from any forward-looking statements, which reflectmanagement’s opinions only as of the date hereof, as a result of factors, suchas those more fully described under “Risks and Uncertainties” as well asdescribed in this annual report.  Weundertake no obligation to revise or publicly release the results of anyrevisions to these forward-looking statements. Readers should carefully review the risk factors set forth below as wellas other factors addressed in this report and other documents we file from timeto time with the SEC.  This caution ismade under safe harbor provisions of the Private Securities Litigation ReformAct of 1995.

 

Risks and Uncertainties

 

We face the following risks associated with our business operations:

 

*We have historically reported significant netlosses and negative cash flows from operations.  If we continue to incur operating losses and negative cash flowsfrom operations, we may be unable to continue our operations.  As a result, there is substantial doubtabout our ability to continue to operate as a going concern.*

 

Our financial position reflects that we have been focused on researchand development and that a commercial MEG market has not developed, resultingin low volume sales to medical research institutions.  Our net losses in the last two years have been as follows:

 

•      $3,708,000 of losses infiscal year 2003 and

 

•      $10,038,000 of losses infiscal year 2002

 

In the last two years, our negative cash flows from operations havebeen as follows:

 

•      $3,409,000 in fiscal year2003 and

 

•      $2,757,000 in fiscal year2002

 

Our total assets have also decreased in the last two fiscal years to$4,760,000 in 2003 compared to $8,514,000 in 2002.  As of September 30, 2003, our accumulated deficit was$124,689,000, the shareholders’ deficit was $3,920,000 and we had negativeworking capital of $1,717,000.

 

Historically, we have raised additional capital through our majorityshareholders and related parties to fund continuing operations.  There can be no assurance that these sourcesof capital will continue to be available on terms acceptable to us, if at all.  We are uncertain with respect to additionalfunding and may be unable to meet our future capital needs.  As a result, there is substantial doubtabout our ability to continue to operate as a going concern.

 

*Our management and controlling shareholders,which together control in excess of a majority our common stock, may controlour operations and make decisions that other shareholders do not consider intheir best interest.*

 

Our present directors, executive officers and principal shareholdersand their affiliates beneficially own a majority of our outstanding commonstock.  As a result, if all or some ofthese shareholders were to act together, they could exercise significantinfluence over all matters requiring shareholder approval, including theelection of directors and approval of significant corporate transactions.  Such concentration of ownership may alsohave the effect of delaying or preventing a change in our control that may befavored by other shareholders.

 

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*If we are unable to satisfy customerperformance and service requirements we may be unable to compete effectively.*

 

Our success may be limited by our ability to satisfy customerperformance requirements for our systems, as well as by our ability tocomplete, in a timely fashion, product developments and enhancements to satisfycustomer requirements.  In addition, ifwe or our distributors are not able to respond in a timely manner to servicerequirements, our competitiveness may be adversely impacted.

 

*Our vendors may not continue providingfavorable credit terms.*

 

Due to our liquidity issues, we have extended vendor payments beyondnormal credit terms.  If our majorvendors were to decline further credit or require cash on delivery payments,our financial position, results of operations and cash flows would be adverselyimpacted.

 

*Our current arrangements for distribution ofour products in the U.S. and Japan are uncertain and may adversely impact ourrate of sales in those regions.*

 

In March 2003, Elekta AB, the parent company of Elekta Instruments Inc.and Elekta KK, our distribution partners in the United States and Japanrespectively, announced their acquisition of 4-D Oy (also known as NeuromagOy), our former subsidiary, which had been sold to Vaandramolen Holding BV inOctober 2002.  This acquisition may havean adverse impact on the distribution of our products in theseterritories.  We are currently indispute regarding our distribution agreements with Elekta Instruments andElekta KK and arbitration proceedings were commenced on or about April 30,2003, and June 16, 2003, before the American Arbitration Association andInternational Chamber of Commerce, respectively.  Elekta Instruments is seeking termination of our distributionagreement as well as unspecified monetary damages and costs.  We are seeking unspecified monetary damagesand certain other equitable remedies in our claims and counterclaims againstElekta KK and Elekta Instruments.  Thesedisputes may result in, among other things, a change in our distributors or thetermination or a change in the structure of our distribution agreements.  We intend to vigorously pursue our rightsunder the distribution agreements and we expect to incur significant additionalfees for professional services as a result of these disputes.  We are unable to predict the outcome ofthese proceedings.

 

*If we are unable to identify additionalclinical applications for our MEG systems, there will be limited commerciallyviable markets for our products.*

 

Currently, there are only a few established diagnostic uses for MEGsystems known by the medical industry. A commercial market may never develop for multiple uses of ourproducts.  A lack of additional clinicalapplications may limit the commercial market for our MEG systems and will havea material adverse impact on our financial position, results of operations andcash flows.

 

*If foreign currency exchange rates fluctuate,our return on sales in U.S. dollars may suffer.*

 

Significant portions of our sales to date have been in foreignmarkets.  Revenues from internationalsales represented 24% of our revenues from MEG systems for the fiscal yearending September 30, 2003.  We expectthat revenues from international sales will continue to represent a significantportion of our annual revenues.  Becausewe sell in foreign markets, we are exposed to potential risks of increases anddecreases in foreign currency exchange rates. Fluctuations may reduce thereturn in U.S. dollars that we actually receive on our sales.  Although as of September 30, 2003 and 2002we did not have any open forward exchange contracts, upon occasion, we mayenter into forward exchange contracts to partially hedge (or protect) againstsuch foreign currency exchange risks.

 

*If we fail to compete successfully, ourrevenues and operating results will be adversely affected.*

 

Historically, our industry has been characterized by ongoing pricecompetition.  Our competitors competewith us for the limited number of whole head systems currently being purchasedworldwide.  The future profitability ofour systems may be negatively impacted by this competition.

 

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*If we are unable to develop additionalproducts, our ability to commercialize our products will be adversely impacted.*

 

Our success may be limited by our dependence on our current line of MEGsystems.  We are currently dependent onsales of our MEG systems to basic research institutions that represent a marketof limited size.  Our current productline may not fully meet the needs of a commercial clinical market and we may berequired to develop additional products directly suited to an emerging set ofneeds from this market.  Our financialresults may be materially adversely affected if our current line of MEGproducts does not fully meet the commercial applications that emerge, or we arenot able to offer new products in a timely and cost effective manner.

 

*If new government legislation is enacted orunfavorable medical industry trends arise, we may be unable to sell ourproducts and our revenues will suffer.*

 

We cannot predict what adverse effect, if any, future legislation orFDA regulations may have on the MEG market and our financial results.  Medical industry cost containment trends mayimpose restrictions on sizeable third-party reimbursements for diagnosticprocedures, limiting the market opportunity. Further, if federal government agencies or any state legislature enactslegislation or guidelines relating to our business or the health care industrythat create additional business hurdles, including legislation relating tothird party reimbursement, our financial position and results of operationscould be negatively affected.

 

*Our success is dependent upon our ability toattract and retain qualified scientific and management personnel.*

 

The loss of services of any one of our executive management or keyscientific personnel would delay our ability to execute our business plans andreduce our ability to successfully develop and commercialize products, maintaingood customer relationships and compete in the marketplace.  There can be no assurance that we will beable to hire, train or retain such qualified personnel.

 

In addition, the loss of the services of Dr. Buchanan, who currentlyserves as our President, Chief Executive Officer and Principal FinancialOfficer would have a material adverse effect on our prospects.  Currently none of our executive officershave an employment agreement or contract with us.  All of our executive officers are “at-will” employees and underno specified term arrangements.

 

*If discoveries or developments of newtechnologies occur, our products and technology may become obsolete.*

 

Our industry is characterized by rapid technological change, which mayalso impact our commercial success. Competitors may develop products using other technologies or may improveexisting products.  This competition mayreduce the size of the potential market for our products or make them obsoleteor non-competitive.  Competitors mayalso develop new or different products using technology or imaging modalitiesthat provide, or are perceived as providing, greater value than ourproducts.  Our financial position andresults of operations will be materially adversely affected if such competitivedevelopments occur.

 

*Our stock price is highly volatile andsubject fluctuations and other market conditions.*

 

The market prices for securities of companies with newly emergingmarkets have historically been highly volatile, and their stock price from timeto time has experienced significant price and volume fluctuations that areunrelated to the operating performance of such companies.  Moreover, our relatively low trading volumeincreases the likelihood and severity of volume fluctuations, which likely willresult in a corresponding increase in the volatility of our common stockprice.  Factors such as announcements ofrecapitalizations, complex technological innovations or new sales, governmentalregulations, developments in patent or other proprietary rights, developmentsin our relationships with collaborative partners, general market conditions andthe timing of decisions by our existing shareholders to sell large positions ofour common stock may have a significant effect on the market price of ourcommon stock.  Fluctuations in financialperformance from period to period, or acceleration of any of our debt by ourlenders, also may have a significant impact on the market price of our commonstock.

 

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**ITEM 2.****          PROPERTIES.**

 

Our executive offices and manufacturing facilities are located in a55,000 square foot facility at 9727 Pacific Heights Boulevard, San Diego,California.  All U.S. operations areconducted from this facility, which was first occupied in December 1989.  In February 2003, we signed a new five-yearlease agreement with the owners of the property.  The lease expires in February 2008.  The leased space has been reduced to approximately 46,000 squarefeet and the average monthly lease payment for the first year and over the termof the lease will be approximately $35,000 and $52,000 respectively.  We sublease approximately 450 square feet ofthe leased facility on a month-to-month basis to one company for a net monthlyrent of approximately $425.

 

The branch office in Germany leases approximately 3,000 square feet atGruener Weg 82, D-5100 Aachen, Germany pursuant to a year-to-year leaseagreement expiring in December 2003. Monthly lease payments are approximately $2,000.  Sales and service for the Europeanoperations are conducted from the German facility.

 

**ITEM 3.****          LEGALPROCEEDINGS.**

 

In March 2003, Elekta AB, the parent company of Elekta Instruments Inc.and Elekta KK, our distribution partners in the United States and Japanrespectively, announced their acquisition of 4-D Neuroimaging Oy, (also knownas Neuromag Oy) our former subsidiary, which had been sold to VaandramolenHolding BV in October 2002.  Thisacquisition may have an adverse impact on the distribution of our products inthese territories.  We are currently in dispute regarding our distributionagreements with Elekta Instruments and Elekta KK and arbitration proceedingswere commenced on or about April 30, 2003 and June 16, 2003 before the AmericanArbitration Association and International Chamber of Commerce, respectively.  Elekta Instruments is seeking termination ofour distribution agreement as well as unspecified monetary damages andcosts.  We are seeking unspecifiedmonetary damages and certain other equitable remedies in our claims andcounterclaims against Elekta KK and Elekta Instruments.  These disputes may result in, among otherthings, a change in our distributors or the termination or a change in thestructure of our distribution agreements. We intend to vigorously pursue our rights under the distribution agreementsand we expect to incur significant additional fees for professional services asa result of these disputes.  We areunable to predict the outcome of these proceedings.

 

**ITEM 4.****          SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

None.

 

Subsequent Event

 

On December 16, 2003, our board of directors approved and on December17, 2003, the holders of 83.4% or 185,118,845 of the outstanding shares of ourcommon stock executed written consents approving, among other things, anamendment to our Seventh Amended and Restated Articles of Incorporation which,upon filing with the Secretary of State of the State of California, will giveeffect to a 1-for-1,200 reverse split of our common stock.  The actions to be taken pursuant to thewritten consents shall not be deemed to be effective until at least 20 daysafter the mailing of our Information Statement.  Our board of directors retains the right to abandon the reversesplit, even though approved, if it determines prior to the effective date thatthe reverse split is not then in our best interest or the best interest of ourshareholders.

 

**PART II**

 

**ITEM 5.****          MARKETFOR REGISTRANT’S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.**

 

Our common stock is currently trading on the Nasdaq Over the CounterBulletin Board, or OTCBB, under the symbol “FDNX.OB.”  The following table sets forth the range of high and low closingsales prices by quarter for our common stock as reported by the OTCBB for thelast two fiscal years. Such quotations represent inter-dealer prices without retailmarkup, markdown or commission and may not necessarily represent actualtransactions.

 

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Fiscal Year 2003

 
|                                 |   | **High** |   | **Low** | ** ** |
|--------------------------------------|--------|----------|--------|---------|------------|
| 1st Quarter ended December 31, 2002  |   | $        | 0.14   |    | $          | 0.03 |   |
| 2nd Quarter ended March 31, 2003     |   | $        | 0.11   |    | $          | 0.06 |   |
| 3rd Quarter ended June 30, 2003      |   | $        | 0.16   |    | $          | 0.06 |   |
| 4th Quarter ended September 30, 2003 |   | $        | 0.09   |    | $          | 0.04 |   |

 

Fiscal Year 2002

 
|                                 |   | **High** |   | **Low** | ** ** |
|--------------------------------------|--------|----------|--------|---------|------------|
| 1st Quarter ended December 31, 2001  |   | $        | 0.16   |    | $          | 0.08 |   |
| 2nd Quarter ended March 31, 2002     |   | $        | 0.20   |    | $          | 0.09 |   |
| 3rd Quarter ended June 30, 2002      |   | $        | 0.13   |    | $          | 0.08 |   |
| 4th Quarter ended September 30, 2002 |   | $        | 0.11   |    | $          | 0.04 |   |

 

As of November 6, 2003, there were approximately 389 holders of recordof our common stock and 221,859,748 shares of common stock outstanding.  The reported closing price for our commonstock on the OTCBB on November 6, 2003 was $0.05 per share.

 

We have never declared or paid dividends on our common stock.  We do not anticipate declaring any dividendson our common stock in the foreseeable future and intend to retain futureearnings, if any, for the development of our business. There are no contractualobligations, preferences or restrictions related to the declaration ordistribution of dividends.

 

The following table sets forth information as of September 30, 2003regarding compensation plans under which equity securities of our company areauthorized for issuance.

 
| **Plan category**                                           |   | **Number of  securities  to be issued upon  exercise of  outstanding options,  warrants and rights** |   | **Weighted-  average exercise  price of  outstanding  options, warrants  and rights** |       | **Number of  securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** |       |
|-------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |   | **(a)**                                                                                              |   | **(b)**                                                                               |       | **(c)**                                                                                                                                               |       |
| Equity compensation plans approved by  security holders     |   | 4,857,519                                                                                            |   | $                                                                                     |  0.37 |                                                                                                                                                  | 73,704,629 |   |
| Equity compensation plans not approved by  security holders |   | 0                                                                                                    |   | $                                                                                     |  0.00 |                                                                                                                                                  | 0          |   |
|                                                        |   |                                                                                                 |   |                                                                                  |       |                                                                                                                                                  |       |
| Total                                                       |   | 4,857,519                                                                                            |   | $                                                                                     |  0.37 |                                                                                                                                                  | 73,704,629 |   |

 

See Note 12 to our financial statements the material features of ourequity compensation plans.

 

**ITEM 6.****          MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

The following information should be read in conjunction with theconsolidated financial statements and Notes in Part II, Item 7 of this Form10-KSB.  See “Risks and Uncertainties”regarding factors known to us that could cause reported financial informationnot to be necessarily indicative of future results.

 

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Overview****

 

We are engaged primarily in the business of developing, manufacturingand selling innovative medical imaging systems to medical institutions.  The MEG systems that we developed measuresmagnetic fields created by the human body for the non-invasive diagnosis ofcertain medical disorders, primarily in the brain.  We are focusing on the use of our technology for potentialcommercial market applications such as the diagnosis and planning for surgicaltreatment of epilepsy, and the functional mapping of areas of the brain at riskduring surgery.  We continue toinvestigate the potential applications of our technology for neuro-psychiatricdisorders of the brain such as schizophrenia, as well as for problems of theheart, spine and other organs.

 

As of September 2003, thirty-two (32) of our MEG systems have beeninstalled in medical and research institutions worldwide.  Related findings by us and our collaboratorshave been published in more than 240 scientific and medical papers.

 

Our current Magnes product line consists of the Magnes 2500 WH, theMagnes 3600 WH, and the Magnes 1300C, pricing for which ranges fromapproximately $1.0 to $2.5 million, depending on the configuration.  Major portions of our sales have been inforeign markets.  Our European saleshave been made in the currency of the country in which the product wassold.  Thus, the prices of such productsin dollars varied as the value of the dollar fluctuated against the quotedforeign currency price.  There can be noassurances that currency fluctuations will not reduce the dollar return to uson such future European sales.  Althoughas of September 30, 2003 and 2002, we do not have any open forward exchangecontracts, we may in the future enter into forward exchange contracts topartially hedge against such foreign currency exposure, if appropriate.

 

In October 2002, we sold 100% of our shares in Neuromag Oy toVaandramolen Holding BV, or VHBV, for $4,000,000, which is discussed in moredetail in Note 3 of the consolidated financial statements.  We used $3,694,000 of the proceeds from thesale to fully repay the loan from AIG, which had been used to fund ouracquisition of Neuromag in December 1999. At that time we had acquired all of the issued and outstanding capitalstock, or Shares, of Neuromag Oy pursuant to the terms of a share purchaseagreement by and between 4-D and Marconi Medical Systems, Inc.(“Marconi”).  Under the terms of theshare purchase agreement, we paid a total of $10 million in cash to Marconi forthe purchase of the Shares.  We alsoagreed to pay an interest-free minimum royalty obligation of $312,500 per year(totaling $2,500,000) to Marconi under an ancillary royalty agreement over thenext 8 years.  We retain responsibilityfor the royalty agreement after the sale of Neuromag.

 

We believe that to date the relatively small number of proven medicalapplications for MEG systems, the lack of routine reimbursement for MEGprocedures, and the uncertainty of product acceptance in the U.S. market havelimited system sales through fiscal 2003. With the issuance of CPT codes for MEG the clinical acceptance of MEGsystem has begun to increase but it is not possible to reliably predict thetiming and extent of future product sales due to the long sales cycles and theuncertainties in the rate of impact the CPT codes will have on the market.  We do not anticipate multiple sales to thesame end-user at current sales volumes, and the sale of one MEG system maystill have a significant impact on our financial position and results of operationsduring any reporting period.  As aresult, quarterly and annual operating performance will continue to fluctuatesignificantly.

 

Liquidity and Capital Resources 

 

We continued to experience substantial losses of $3,708,000 in fiscalyear 2003.  We had negative cash flowsfrom operations of $3,409,000 in fiscal year 2003.

 

In December 1999, we acquired all of the issued and outstanding capitalstock, or Shares, of Neuromag Oy pursuant to the terms of a share purchaseagreement with Marconi.  Under the termsof the share purchase agreement, we paid Marconi a total of $10,000,000 in cashfor the purchase of the Shares and agreed to pay Marconi between a minimum of$2,500,000 and a maximum of $5,000,000 in royalties under 

 

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an ancillary royalty agreement over an eight-year period.  As of September 30, 2003, we have paid atotal of $625,000 under the royalty agreement.

 

The acquisition of Neuromag Oy was funded by a loan from AIG in theprincipal amount of $11,000,000.  Mr.Egli, a member of our board of directors, is also a member of the board ofdirectors of AIG.  Interest under theAIG loan accrued at the rate of 6.8% per annum until April 26, 2002, at whichtime the interest rate was reduced to 4.4% per annum for the remainder of theloan term.  On May 15, 2002 the accruedinterest in the amount of $232,000 was capitalized increasing the principalloan balance to $3,590,000.  The AIGloan matured in July 2002.

 

In October 2002, we sold our Finnish subsidiary, Neuromag Oy, toVaandramolen Holdings, BV, a Dutch company, for $4,000,000 in cash.  $3,694,000 of these funds we used to payback the $3,590,000 of principal and $94,000 of interest due on our loan from AIGand to pay the  $10,000 bank service fee.We retain responsibility for the royalty agreement by and between the Companyand Marconi.  See Note 3 of theconsolidated financial statements for additional information with regard to thesale of Neuromag Oy.

 

In November 2002, we entered into another line of credit with AIG Bankfor $1,000,000.  The interest on theline of credit is 4.17% and initially the line of credit was due and payableNovember 5, 2003.  In January 2003 thematurity of the line of credit was extended until May 5, 2004.  Proceeds were used to pay off the two$125,000 unsecured loans from Enrique Maso and Swisspartners and the two$100,000 unsecured loans from MATRUST, S.L. and International SequoiaInvestment Ltd.  Each loan had aninterest rate of 8% per annum.  Accruedinterest for Enrique Maso was recorded as a gain upon the extinguishment of thedebt and is reflected in “Other Income” on the statement of operations.  The accrued interest for Swisspartners wasdue and payable in March 2003 and paid in April 2003.  Proceeds were also used to pay accounts payable in the amount of$120,000 to Dr. Galleon Graetz, a member of our board of directors and aconsultant.  The respective parties thenpledged all of these amounts, totaling $570,000 as collateral against theloan.  The remaining amount was used forgeneral corporate purposes.

 

As additional collateral against the loan, Mr. Egli, a member of ourboard of directors, provided a personal guarantee of $500,000 and we pledgedour U.S. patent portfolio and a Magnes 2500 WH system, currently installed atthe University of Alabama, to which we retain title.

 

In December 2002, we were authorized to offer and issue up to anadditional 60,000,000 shares of common stock at a price not less than $0.05 pershare.  During December 2002 an additional60,000,000 shares were issued to Swisspartners Investment Network AG in aprivate placement transaction in accordance with Rule 506 of Regulation D andSection 4(2) of the Securities Act of 1933, as amended, in exchange for cash inthe aggregate sum of $3,000,000.

 

Capital equipment expenditures totaled $23,000 in fiscal year 2003compared to $164,000 in fiscal year 2002, of which $127,000 is related todiscontinued operations.  The decreasein fiscal year 2003 can be attributed principally to a decrease in purchasesduring the year.  Capital expenditureswill continue to remain low due to our focus on the marketing of our currentproduct line to the emerging clinical market.

 

In February 2003, we signed a new five-year lease agreement with theowners of the property on which our headquarters are located in San Diego.  The lease expires in February 2008.  The leased space has been reduced toapproximately 46,000 square feet and the average monthly lease payment for thefirst year and over the term of the lease will be approximately $35,000 and$52,000 respectively.  We subleaseapproximately 450 square feet of the leased facility on a month-to-month basisto one company for a net monthly rent of approximately $425.

 

The branch office in Germany leases approximately 3,000 square feet atGruener Weg 82, D-5100 Aachen, Germany pursuant to a year-to-year leaseagreement expiring in December 2003. Monthly lease payments are approximately $2,000.  Sales and service for the Europeanoperations are conducted from the German facility.

 

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In March 2003, Elekta AB, the parent company of Elekta Instruments Inc.and Elekta KK, our distribution partners in the United States and Japanrespectively, announced their acquisition of 4-D Oy (also known as NeuromagOy), our former subsidiary, which had been sold to Vaandramolen Holding BV inOctober 2002.  This acquisition may havean adverse impact on the distribution of our products in theseterritories.  We are currently indispute regarding our distribution agreements with Elekta Instruments andElekta KK and arbitration proceedings were commenced on or about April 30,2003, and June 16, 2003, before the American Arbitration Association andInternational Chamber of Commerce, respectively.  Elekta Instruments is seeking termination of our distributionagreement as well as unspecified monetary damages and costs.  We are seeking unspecified monetary damagesand certain other equitable remedies in our claims and counterclaims againstElekta KK and Elekta Instruments.  Thesedisputes may result in, among other things, a change in our distributors or thetermination or a change in the structure of our distribution agreements.  We intend to vigorously pursue our rightunder the distribution agreements and we expect to incur significant additionalfees for professional services as a result of these disputes.  We are unable to predict the outcome ofthese proceedings.

 

The accompanying consolidated financial statements have been preparedassuming that we will continue as a going concern.  As discussed above and as shown in the accompanying consolidatedfinancial statements, we have operating and liquidity concerns that raisesubstantial doubt about our ability to continue as a going concern.  There can be no assurance that we will beable to successfully improve our operating results or that our liquidity andcapital resources will be sufficient to maintain normal operation.  The financial statements do not include anyadjustments relating to the recoverability and classification of asset carryingamounts or the amount and classification of liabilities that might resultshould we be unable to continue as a going concern.

 

Results of Operations

 

The consolidated financial statements and notes thereto referenced inItem 7 should be read in conjunction with the following review:

 

Total revenues for fiscal year 2003 were $2,808,829, including $891,561of service revenues, compared to $5,302,589 of total revenues, including$812,020 of service revenues, for fiscal year 2002.  This decrease in total revenues was due primarily to therecognition of  revenue for one MSIsystem sale in fiscal year 2003 as compared to two new and one refurbishedsystem sales in fiscal year 2002.  Therevenues for fiscal year 2003 were due primarily to the recognition of revenueassociated with the completion of a previous contract, the recognition of onemagnetically shielded room and the recognition of one MSI system sale.

 

Cost of revenues for fiscal year 2003 were $3,097,195, compared to$5,157,509 for fiscal year 2002.  Thisdecrease in total cost of revenues was due primarily to the recognition ofrevenue for one MSI system sales in fiscal year 2003 as compared to two new andone refurbished system sales in fiscal year 2002.  The cost of revenues for fiscal year 2003 were due primarily tocosts associated with the completion of a previous contract, one MSI systemsale and related unabsorbed overhead.

 

Research and development expenses for fiscal year 2003 amounted to$882,763, compared to $1,022,178 fiscal year 2002.  The reduction of research and development expenses for fiscalyear 2003 as compared to fiscal year 2002 was due to continued, incrementalcost reductions in our overhead structure and is consistent with our increasedfocus on marketing and sales.

 

Marketing and sales expenses amounted to $1,520,416 for fiscal year2003, compared to $1,747,460 for fiscal year 2002.  The decrease in marketing and sales expenses in fiscal year 2003,compared to fiscal year 2002, was due to the reduction of trade shows and otherrelated expenses and cost reductions in our overhead structure.

 

General and administrative expenses totaled $1,623,762 for fiscal year2003, compared to $1,616,210 for fiscal year 2002.  The increase in general and administrative expenses in fiscalyear 2003 as compared to the same prior year period was primarily due toincreased legal fees associated with arbitration with Elekta regarding ourdistribution agreements with Elekta Instruments and Elekta KK.

 

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Interest expense totaled $391,035 for fiscal year 2003, compared to$24,726 during fiscal year 2002.  Theincrease in interest expense in fiscal year 2003, as compared to fiscal year2002 was due primarily to the interest paid on the line of credit weestablished with AIG Private Bank and the interest we accrued on certainoutstanding payables.

 

Other income totaled $540,767 in fiscal year 2003, compared to $24,004in fiscal year 2002.  The increase inother income was due primarily to foreign currency exchange effects and revenuesharing payments from certain installed systems.

 

Net loss for the fiscal year ended September 30, 2003 amounted to$3,707,503 compared to a net loss of $10,038,122 for the comparable period inthe prior fiscal year.  The decrease innet loss in fiscal year 2003 was primarily due to the sale of our Finnishsubsidiary in October 2002, the resolution of liability obligations directlyrelated to the sale of our Finnish subsidiary in October 2002 and other costcutting reasons we implemented.

 

Discontinued Operations

 

In December 1999, we acquired Neuromag Oy, located in Helsinki Finlandfor $10 million in cash and an interest-free minimum royalty obligation of$312,500 per year for eight years (totaling $2.5 million) to Marconi MedicalSystems, Inc., Cleveland, Ohio. The funds for the purchase were provided by aloan from AIG Private Bank Ltd. (“AIG”) totaling $11 million secured by 100% ofthe outstanding and issued capital stock of Neuromag Oy and guaranteed by anunaffiliated entity.

 

In April 2001, $8,951,000 of the debt to AIG was cancelled in exchangefor 42,623,810 shares of our common stock as part of a private placementtransaction with specified investors in accordance with Rule 506 of RegulationD and Section 4(2) of the Securities Act of 1933, as amended.  The common stock was issued at a per-shareprice of $0.21.

 

The remainder of the AIG bank loan was restructured.  The restructured AIG loan in the principalamount of $3,357,000 matured in July 2002, at which time we defaulted on theloan.

 

Due to changes in the business environment and to satisfy the debt toAIG we decided to sell our Finnish subsidiary, Neuromag Oy.  The subsidiary was sold to VaandramolenHolding BV, or VHBV, in October 2002, for a total of $4,000,000 in cash.  $3,694,000 of the proceeds were used tofully pay the AIG bank debt, $100,000 were used to pay part of the existingintercompany debt and the remainder for general corporate purposes.

 

We adopted SFAS No. 142 in fiscal year 2002, which requires thatgoodwill and certain intangibles no longer be amortized, but instead tested forimpairment at least annually. Therefore, there was no goodwill amortization in fiscal year 2002,compared to $1,319,000 in fiscal year 2001. In our consolidated financial statements dated September 30, 2002, werecognized a goodwill impairment of $5,974,000 due to the sale of our Finnishsubsidiary in October 2002.  We retainresponsibility for the royalty obligations to Marconi after the sale ofNeuromag Oy.

 

We adopted SFAS No. 144 in fiscal year 2002, which requires thatadjustments to amounts previously reported in discontinued operations that aredirectly related to the disposal of component of an entity in a prior period beclassified separately in the current period in discontinued operations.  Pursuant to the sale of Neuromag Oy inOctober 2002, the resolution of liability obligations directly related to thesale resulted in our recognizing a net recorded gain of $455,000 on the sale ofour Finnish subsidiary for the fiscal year ended September 30, 2003.

 

Critical Accounting Policies

 

Our annual financial statements are prepared in conformity withgenerally accepted accounting principles in the United States (“GAAP”).  The preparation of financial statements inconformity with GAAP requires our management to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, disclosure ofcontingent assets and liabilities at the date of the financial statements and 

 

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the reported amounts of revenues and expenses during the reportingperiod.  Actual results could differfrom these estimates.  Results for thefiscal years presented in this report are not necessarily indicative of resultsthat may be reported for any interim period or for any other fiscal year.

 

We have identified a number of accounting policies that we believe arecritical to an understanding of our financial statements and our discussion andanalysis.  Critical accounting policiesare those that are most important to the portrayal of a company’s financialcondition and results, and that require management’s most difficult, subjectiveor complex judgments, often as a result of the need to make estimates about theeffect of matters that are inherently uncertain.

 

*Revenue Recognition*.  Standard terms for product sales generallyprovide for payment of 30%-40% of the contracted purchase price upon placementof the order, 40%-50% upon shipment, and the remaining balance is due uponfinal customer acceptance.  We recognizerevenue at the time of customer acceptance. Service revenues following a sale are deferred and recognized over theone-year service period.  Productservice and contract revenues are recognized as the services are performed.

 

*Goodwill andImpairment of Long-Lived Assets*.  We assess potential impairments to ourlong-lived assets when there is evidence that events or changes incircumstances have made recovery of the asset’s carrying value unlikely.  An impairment loss would be recognized whenthe sum of the expected future net cash flows is less than the carrying amountof the asset.  Should an impairmentexist, the impairment loss would be measured based on the excess of thecarrying amount of the asset over the asset’s fair value.  We have recorded a goodwill asset that arosefrom the acquisition of Neuromag Oy in 1999. This asset is tested for possible impairment at least on an annual basisin accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”  In fiscal year 2002, we recorded animpairment of goodwill for $5,974,000 due to the sale of our Finnishsubsidiary, Neuromag Oy.  See Note 1 ofour consolidated financial statements for further discussion of SFAS No.142.  We had no goodwill at September30, 2003

 

Recently Issued Accounting Standards 

 

In connection with our adoption of FASB interpretation No. 45 (FIN 45),“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingGuarantees of indebtedness of Others,” the following disclosures are made withrespect to our product warranties.

 

We provide a limited warranty for our products.  A provision for the estimated warranty costis recorded at the time revenue is recognized. Costs of repair or replacement are established and charged to cost ofsales at the time the related service is rendered.  The amount of liability to be recorded is based on management’sbest estimates of future warranty costs after considering historical andprojected product failure rates and product repair costs.  Our standard product warranties are for oneyear, although in some agreements, it may warrant products for periods inexcess of one year.  We have $258,000warranty accruals at September 30, 2002. The following table summarizes the activity related to product warrantyaccruals for the year ended September 30, 2003:

 
|                                                   |   | **(in  thousands)** |   |
|--------------------------------------------------------|--------|---------------------|--------|
|                                                   |   |                |   |
| Balance at September 30, 2002                          |   | $                   | 258    |   |
| Increase in warranties related to system  installation |   | 512                 |   |
| Warranty activity in the period                        |   | (216                | )      |
| Balance at September 30, 2003                          |   | $                   | 554    |   |

 

We also undertake indemnification obligations in the ordinary course ofbusiness related to our products, the licensing of our software, and theissuance of securities.  Under thesearrangements, we may indemnify other parties such as business partners,customers, and underwriters, for certain losses suffered, claims ofintellectual property infringement, negligence and intentional acts in theperformance of services, and violations of laws including certain violations ofsecurities laws.  Our obligation toprovide such indemnification in such circumstances would arise if, for example,a third party sued a customer for intellectual property infringement and weagreed to indemnify the customer against such claims.  We are unable to estimate with any reasonable accuracy theliability that may be incurred 

 

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pursuant to our indemnification obligations.  Some of the factors that would affect this assessment include,but are not limited to, the nature of the claim asserted, the relative meritsof the claim, the financial ability of the parties, the nature and amount ofdamages claimed, insurance coverage that we may have to cover such claims, the willingnessof the parties to reach settlement, if any. Because of the uncertainty surrounding these circumstances, ourindemnification obligations could range from immaterial to having a materialadverse impact on our financial position and our ability to continue in theordinary course of business.

 

In June 2002, the FASB issued SFAS No. 145, “Rescission of FASBStatements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.”  This statement requiresthe classification of gains or losses from the extinguishments of debt to meetthe criteria of Accounting Principles Board, or APB, Opinion No. 30 “Reportingthe Results of Operations – Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions” before they can be classified as extraordinary in the incomestatement.  Those companies that usedebt extinguishments as a part of their risk management strategy are requiredto classify the gain or loss from extinguishments of debt as a part ofoperating income in the income statement. We adopted SFAS No. 145 during the quarter ended December 31, 2002 withno material impact.

 

In September 2002, the FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities.” This statement addresses financial accounting and reporting for costsassociated with exit or disposal activities. This statement requires that a liability for a cost associated with anexit or disposal activity be recognized when the liability is incurred.  The provisions of this statement areeffective for exit or disposal activities that are initiated after December 31,2002.  We adopted SFAS No. 146 duringthe quarter ended December 31, 2002. There were no additional costs associated with the sale of Neuromag Oyother than the costs reflected in the financial statements and disclosed inNote 3, Sale of Finnish Subsidiary Neuromag Oy.

 

In November 2002, the FASB issued FASB Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others.”  This interpretation addresses the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder guarantees.  This interpretationalso clarifies the requirements related to the recognition of a liability by aguarantor at the inception of a guarantee for the obligations that theguarantor has undertaken in issuing that guarantee.  Management has assessed the impact of this interpretation andbelieves it has no material impact.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure.”  This statement amends FASB statement No. 123to provide accounting guidance related to stock based employeecompensation.  SFAS No. 123, as amended,encourages, but does not require, companies to record compensation cost forstock-based employee compensation plans at fair value.  We have chosen to continue to account forstock-based compensation using the intrinsic value method prescribed in APBOpinion No. 25, “Accounting for Stock Issued to Employees”, and relatedinterpretations for all periods presented. Accordingly, compensation cost for stock options is measured as theexcess, if any, of the fair value of our stock at the date of the grant overthe amount an employee must pay to acquire the stock.

 

The following table summarizes the impact on our net loss hadcompensation cost been determined based upon the fair value at the grant datefor awards under the stock option plans consistent with the methodologyprescribed under SFAS No. 123 (in thousands, except per share data):

 
|                              |                                                                                                                                 | **Years  Ended September 30,** |   |
|-----------------------------------|--------------------------------------------------------------------------------------------------------------------------------------|--------------------------------|--------|
|                              |                                                                                                                                 | **2003**                       |   | **2002** |   |
| Net loss, as reported             |                                                                                                                                 | $                              | (3,708 | ) | $ | (10,038 | ) |
| Add:                              | Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |                           | 10     |   | 109 |   |
| Pro forma net loss                |                                                                                                                                 | $                              | (3,718 | ) | $ | (10,147 | ) |
| Basic and diluted loss per share: |                                                                                                                                 |                           |   |   |   |
|                              | As reported                                                                                                                          |                           | $      | (0.018 | ) | $ | (0.066 | ) |
|                              | Pro forma                                                                                                                            |                           | $      | (0.018 | ) | $ | (0.066 | ) |

 

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We account for stock options granted to non-employees using the fairvalue method.  Compensation expense foroptions granted to non-employees has been determined in accordance withEmerging Issues Task Force, or EITF, No. 96-18, “Accounting for EquityInstruments that are Issued to Other than Employees for Acquiring, or inConjunction with Selling, Goods or Services”, as the fair value of the considerationreceived or the fair value of the equity instruments issued, whichever is morereliably measurable.  Compensationexpense for options granted to non-employees is periodically remeasured as theunderlying options vest and is recorded as expense and deferred compensation inthe financial statements.

 

Holders of common stock are entitled to one vote per share.  Basic earnings per share are computed bydividing net income or loss by the weighted average of common sharesoutstanding during the period.  Dilutedearnings per share reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock (warrants to purchasecommon stock and common stock options using the treasury stock method) wereexercised or converted into common stock. Potential common shares in the diluted earnings per share computationare excluded when their effect would be antidilutive.

 

In January 2003, the FASB issued FASB Interpretation No. 46.“Consolidation of Variable Interest Entities.” This interpretation clarifies the application of Accounting ResearchBulletin No. 51, “Consolidated Financial Statement”, to certain entities inwhich equity investors do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties.  It further clarifieswhether an entity shall be subject to consolidation according to the provisionsof this interpretation, if by design, certain conditions exist.  Management has assessed the impact of thisinterpretation and believes it has no material impact.

 

*AuthoritativePronouncements*

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristic of both Liabilities andEquities.”  This statement establishesstandards for how an issuer classifies and measures in its statement offinancial position certain financial instruments with characteristics of bothliabilities and equity.  It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances) because that financial instrumentembodies an obligation of the issuer. Management has assessed the impact of this statement and believes it hasno material impact.

 

**ITEM 7.****          FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.**

 

See our discussion under “Risks and Uncertainties - A substantialportion of our revenues comes for international customers” under Part I, Item 1above.

 

Our consolidated financial statements as of September 30, 2003 and2002, and for each of the two years in the period ended September 30, 2003 and2002 and the reports of independent auditors are included in this report aslisted in Item 13 (a) of this Form 10-KSB. Our selected quarterly financial data for our last two fiscal years ispresented in Note 13 to our financial statements.

 

**ITEM 8.****               CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.**

 

None

 

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**ITEM 8A.****       CONTROLS AND PROCEDURES.**

 

Evaluation of Disclosure Controls and Procedures

 

Our chief executive and principal financial officer has evaluated theeffectiveness of our disclosure controls and procedures (as defined in ExchangeAct Rules 13a-14(c) and 15d-14(c)) as of the end of the period covered by thisannual report on Form 10-KSB (the “Evaluation Date”). Based on such evaluation,he has concluded that, as of the Evaluation Date, our disclosure controls andprocedures are effective in alerting him on a timely basis to materialinformation relating to our company (including our consolidated subsidiaries)required to be included in reports filed or submitted under the Exchange Act.

 

Changes in Internal Controls

 

Since the Evaluation Date, there have not been any significant changesin our internal controls, or in other factors that could significantly affectsuch controls. Therefore, no corrective actions were taken.

 

**PART III**

 

**ITEM 9.****          DIRECTORS,EXECUTIVE OFFICERS AND CONTROL PERSONS OF THE REGISTRANT.**

 

Directors and Executive Officers

 

*D. Scott Buchanan,Ph.D*. (age 45) is the Company’s president and chiefexecutive officer and has served as a member of the board of directors since1997.  He joined the Company in1986.  He served as vice president,product operations from February 1992 through December 1996 and has served aspresident since December 1996, chief executive officer since March 1997 andprincipal financial officer since November 2000.  Dr. Buchanan has been involved with product and applicationsdevelopment since joining the Company as a staff physicist.  Dr. Buchanan received a B.S. in Physics fromLehigh University in Pennsylvania and an M.S. and Ph.D. in Physics from theUniversity of Illinois.  Dr. Buchanan waselected to the Company’s board of directors in 1997.  Dr. Buchanan is a citizen of the United States.

 

*Martin P. Egli*(age 51) is the chairman of the Company’s board of directors and a member ofthe Company’s audit committee.  He hasserved since 1993 as a partner and principal of Swisspartners InvestmentNetwork AG (“Swisspartners”), a company that provides investment management,corporate finance and trust services. Swisspartners is a principal shareholder of 4-D.  Mr. Egli is a director of several privately-heldcompanies and was elected to the Company’s board of directors in 1995.  Mr. Egli is a citizen of Switzerland.

 

*Dr. Galleon Graetz*(age 49) is a member of the Company’s board of directors.  He served as clinical consultant andco-director of the internal medicine division of the Swiss Hospital School ofNursing from 1990 to 1997.  Dr. Graetzis currently a senior partner of Care Net AG, a health consulting company, andcurrently involved as part of the management team at Medizinisches Zentrum Romerhof,a unique health care provider located in Zurich.  Dr. Graetz was educated in internal medicine and radiology inSwitzerland and Israel.  Dr. Graetz waselected to the Company’s board of directors in 1998.  Dr. Graetz is a citizen of Switzerland.

 

*Eugene C.Hirschkoff, Ph.D*. (age 61) is the Company’s vicepresident, engineering.  He joined theCompany in 1971, and has served in many capacities in engineering, technologydevelopment and manufacturing.  From1990 through 1996, he served as director of clinical applications, managing theCompany’s research and development programs with its collaboration partners atthe Scripps Clinic and Research Foundation and the University of California atSan Francisco among others.  Dr.Hirschkoff is responsible for the Company’s FDA compliance programs.  In December 1997 he was appointed vicepresident, engineering and in November 2000 he was appointed corporatesecretary.  Dr. Hirschkoff received hisB.A. in Physics and Mathematics at Reed College in Oregon; M.A. in Physics atHarvard University; Ph.D. in Physics from the University of California, SanDiego; MBA from the State University of California, San Diego and his J.D. fromthe University of San Diego.  Dr.Hirschkoff is a citizen of the United States.

 

*Hans-Ueli Rihs*(age 60) is a member of the Company’s board of directors.  He served as international sales directorand board member of PHONAK Holding, Ltd., Hearing Instruments and Systems forthe Hard 

 

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of Hearing, in Stafa, Switzerland from 1976 to 1999.  Since 2000 he has been an independententrepreneur and investor.  He currentlyserves as a board member of PHONAK, Swisspartners and Mespas Ltd.  He was elected to the Company’s board ofdirectors in 2001 in connection with the purchase by Swisspartners of14,751,153 shares of the Company’s common stock in a private placementtransaction.  Mr. Rihs is a citizen ofSwitzerland.

 

*Kenneth C. Squires,Ph.D*. (age 59) is the Company’s vice president,marketing.  He joined the Company inSeptember 1988.  Since that time he hasheld various positions as director of clinical applications and director ofneuroscience applications–marketing and was appointed vice president, marketingin December 1996.  Dr. Squires receivedhis B.S. and M.S. degrees in Aeronautical Engineering at the University ofMinnesota and his Ph.D. in Experimental Psychology from the University ofCalifornia, San Diego.  Dr. Squires is acitizen of the United States.

 

*Martin Velasco*(age 48) is a member of the Company’s board of directors and auditcommittee.  He is an entrepreneur with extensive experience inthe electronic communications industry, combining the experience of largeinternational companies with high-tech start-ups. In the last three years healso has developed significant activities in the medical and biotech areas.Martin Velasco holds an engineering degree in electronics, a postgraduatedegree in computer science from the EPFL Lausanne and an MBA from INSEAD.Martin Velasco serves on several boards of high-tech start-ups in Europe andUnited States, as well as venture and investment funds. Mr. Velasco was electedto our board of directors in 2000. He is a member of the Business SteeringCommittee of the Global Business Dialog for Electronic Commerce, member of theWorld Economic Forum Digital Divide Task Force and Chairman of theInvestment Committee of the Positive Fund. Mr. Velasco is also the Chairman of thecharity Infantia Foundation he founded in 1999, which has the objective to helpchildren in the developing world.  Mr.Velasco is a citizen of Spain.

 

Audit Committee Financial Expert

 

We have one financial expert serving on ourAudit Committee, Martin Egli.  Mr. Egliis an affiliate of the Company through control of over 10% of our shares ofcommon stock.

 

Section 16(a) Beneficial Ownership ReportingCompliance

 

Section 16(a) of the Securities Exchange Actof 1934 requires our officers, directors and persons who own more than 10% of aregistered class of our equity securities, to file reports of ownership andchanges in ownership with the SEC and the NASDAQ.  Officers, directors and greater than 10% shareholders arerequired by SEC regulation to furnish us with copies of all Section 16(a) formsthey file.

 

Based solely on review of the copies of Forms3, 4 and 5 and amendments thereto furnished to us, we believe that, during theperiod from October 1, 2002 through September 30, 2003, all Section 16(a)filing requirements applicable to its officers, directors and greater than 10%beneficial owners were met, though not in a timely manner as set forth asfollows.

 
| **Name**               |   | **# of Late Reports** |   | **# of Transactions** |   | **Required Forms Filed** |   |
|------------------------|--------|-----------------------|--------|-----------------------|--------|--------------------------|--------|
| Martin  P. Egli        |   | 3                     |   | 3                     |   | Yes                      |   |
| Swisspartners          |   | 2                     |   | 2                     |   | Yes                      |   |
| Martin  Velasco        |   | 2                     |   | 2                     |   | Yes                      |   |
| Sequoia  International |   | 1                     |   | 1                     |   | Yes                      |   |
| Rose  Graetz           |   | 1                     |   | 1                     |   | Yes                      |   |
| Enrique  Maso          |   | 1                     |   | 1                     |   | Yes                      |   |

 

Code of Ethics

 

We have adopted and attached, in Exhibit 99 of this Form 10-KSB, ourCode of Ethics consistent with disclosure required by section 406 of theSarbanes-Oxley Act of 2002.

 

29

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**ITEM 10.****       EXECUTIVE COMPENSATION.**

 

Summary of Cash and Certain Other Compensation

 

The following table provides certain summary information concerning thecompensation earned by the named executive officers in Item 9 (determined as ofthe end of the last fiscal year) for services rendered in all capacities to theCompany and its subsidiaries for the fiscal years ended September 30, 2003,2002 and 2001:

 
| **Name and  Principal Position**                          |     | **Summary  Compensation Table  Annual Compensation** |           | **All  Other  Compensation  ($)** |          |
|-----------------------------------------------------------|----------|------------------------------------------------------|----------------|-----------------------------------|---------------|
|                                                      | **Year** |                                                 | **Salary ($)** |                              | **Bonus ($)** |
| D. Scott Buchanan (1)  President, Chief Executive Officer |     | 2003                                                 |           | $                                 | 165,000       |   | $ | 7,000 |   | $ | 5,792 |   |
|                                                      | 2002     |                                                 | $              | 190,000                           |          | $ | 0 |   | $ | 5,792 |   |
|                                                      | 2001     |                                                 | $              | 190,000                           |          | $ | 0 |   | $ | 5,792 |   |
| Eugene C. Hirschkoff (2)  Vice President, Engineering     |     | 2003                                                 |           | $                                 | 130,000       |   | $ | 12,000 |   | $ | 1,576 |   |
|                                                      | 2002     |                                                 | $              | 144,000                           |          | $ | 5,000 |   | $ | 1,576 |   |
|                                                      | 2001     |                                                 | $              | 136,500                           |          | $ | 0 |   | $ | 1,576 |   |
| Kenneth C. Squires (3)  Vice President, Marketing         |     | 2003                                                 |           | $                                 | 134,000       |   | $ | 12,000 |   | $ | 1,701 |   |
|                                                      | 2002     |                                                 | $              | 155,000                           |          | $ | 10,000 |   | $ | 1,701 |   |
|                                                      | 2001     |                                                 | $              | 137,200                           |          | $ | 19,000 |   | $ | 1,701 |   |

 

----

(1)   “Bonus” in 2003 for Dr. Buchanan represents apayment earned under an incentive bonus program.  “All Other Compensation” for Dr. Buchanan represents premiumspaid by the Company on Dr. Buchanan’s behalf for life and long-term disabilityinsurance.

 

(2)   “Bonus” in 2003 and 2002 for Dr. Hirschkoffrepresents a payment earned under an incentive bonus program. “All OtherCompensation” for Dr. Hirschkoff represents premiums paid by the Company on Dr.Hirschkoff’s behalf for life and long-term disability insurance.

 

(3)   “Bonus” in 2003, 2002 and 2001 for Dr. Squires’represents a payment earned under an incentive bonus program. “All OtherCompensation” for Dr. Squires represents premiums paid by the Company on Dr.Squires’ behalf for life and long-term disability insurance.

 

Stock Options and Stock Appreciation Rights

 

No stock options or stock appreciation rights were granted to the namedexecutive officers during the 2003 fiscal year.

 

Option Exercises and Holdings

 

The following table provides information, with respect to the namedexecutive officers, concerning the exercise of stock options during the 2003fiscal year and unexercised options held as of the end of that fiscal year.  No shares were acquired on exercise ofoptions by the named executive officers during the fiscal year ended September30, 2003.  None of the named executiveofficers exercised any stock appreciation rights during the 2003 fiscal yearand no stock appreciation rights were held by the named executive officers atthe end of the 2003 fiscal year.  Noneof the stock options held by the named executive officers were in-the-money atthe end of the 2003 fiscal year.

 

Aggregated Option/SAR Exercises in Last FiscalYear and FY-End Option/SAR Values

 
|                 |   |                                   |   |                     |   | **Number of  Unexercised Options  at FY-End (#)** |      | **Value of  Unexercised  in-the-Money Options/SARs  at FY-End ($) (1)** |   |
|----------------------|--------|----------------------------------------|--------|--------------------------|--------|---------------------------------------------------|-----------|-------------------------------------------------------------------------|--------|
| **Name**             |   | **Shares  Acquired  on  Exercise (#)** |   | **Value  Realized  ($)** |   | **Exercisable**                                   |      | **Unexercisable**                                                       |   | **Exercisable** |   | **Unexercisable** |   |
| D. Scott Buchanan    |   | 0                                      |   | $                        | 0      |                                              | 1,673,709 |                                                                    | 0      |   | $ | 0 |   | $ | 0 |   |
| Eugene C. Hirschkoff |   | 0                                      |   | $                        | 0      |                                              | 740,000   |                                                                    | 0      |   | $ | 0 |   | $ | 0 |   |
| Kenneth C. Squires   |   | 0                                      |   | $                        | 0      |                                              | 725,400   |                                                                    | 0      |   | $ | 0 |   | $ | 0 |   |

 

30

----

 

----

(1)   Calculated on the basis of the fair market value ofthe underlying securities at fiscal year end on September 30, 2003 ($.06) minusthe exercise price.

 

Long-Term Incentive Plan

 

No shares or other rights were granted under a long-term incentive planto the named executive officers during the 2003 fiscal year.

 

**ITEM 11.****       SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERSAND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.**

 

Principal Shareholders and their Security Ownership

 

The following are the only persons known to 4-D to own beneficially, asof November 6, 2003, more than five percent (5%) of the outstanding shares ofour common stock.

 

*Rose Rita Graetz*,a private investor, is a Swiss citizen where she has resided all of her lifeand has been retired since 1980. Mrs. Graetz has no active role at 4-D.

 

*Enrique Maso*,a private investor, is a former large industrialist in Europe and the formermayor of Barcelona.  He is currently thechairman of the board of Electronic Data Systems in Spain, a position he hasheld since 1983.  He received a mastersdegree in Industrial Engineering Management from New York University and adoctorate in Engineering from the Politechnic College of Barcelona.  Dr. Maso was elected to the Company’s boardof directors in 1995 and served as chairman of the board of directors fromSeptember 1997 to March 2001.

 

*SwisspartnersInvestment Network AG*, a Swiss company, providesinvestment management, corporate finance and trust services.  Its principal place of business is locatedat Am Schanzengraben 23, Zurich, Switzerland.

 

*InternationalSequoia Investments Ltd.* is a private equityinvestment company.  Its principal placeof business is located at St James Court, Suite 308, St Denis Street, PortLouis, Republic of Mauritius.

 
|                                                                                                                                |   | **Shares  Beneficially Owned** |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
| **Name and Address  of Beneficial Owner (1)**                                                                                       |   | **Number (1)**                 |   | **Percent  (2)** |   |
| Enrique Maso  Europa Residence  Place des Moulins  98 000 Montecarlo, Monaco                                                        |   | 63,961,696                     | (3)    | 28.83 | % |
| Rose Rita Graetz  Im Grut  Meilen, CH-8706, Switzerland                                                                             |   | 62,187,713                     | (4)    | 28.03 | % |
| Swisspartners Investment Network AG  Postfach 970  Am Schanzengraben 23  Zurich, CH-8039, Switzerland  +41-1-285-7600               |   | 35,456,394                     | (5)    | 15.98 | % |
| International Sequoia Investments Ltd.  St. James Court, Suite 308, St. Denis Street  Port Louis, Rep. of Mauritius  +23-0-211-6242 |   | 22,882,273                     | (6)    | 10.31 | % |

 

----

(1)   Except as indicated in the footnotes to this table,the persons named in the table have sole voting and investment power withrespect to all shares of common stock shown as beneficially owned by them,subject to community property laws, where applicable.

(2)   Percentage of ownership is calculated pursuant toSEC Rule 13d-3(d)(1).

 

31

----

 

(3)   Consists of 62,890,863 shares beneficially owned byDr. Maso and 1,070,833 shares owned by MATRUST, S.L. Dr. Maso is a majorityshareholder in MATRUST.

(4)   Consists of 61,587,713 shares beneficially owned byMrs. Graetz and options to purchase 600,000 shares of common stock held by herson, Galleon Graetz, which are exercisable or exercisable within 60 days afterNovember 6, 2003.

(5)   Consists of 28,982,120 shares owned by SwisspartnersInvestment and 6,474,274 shares owned by Mr. Egli. Mr. Egli is a managingdirector of Swisspartners Investment Network AG.

(6)   Consists of 22,882,273 shares owned by InternationalSequoia Investments Ltd.  Mr. Velasco isa major investor in Sequoia.

 

Management and their Security Ownership

 

The following table sets forth the beneficial ownership of common stockof the Company as of November 6, 2003 by each director and by our current chiefexecutive officer, each of the other two executive officers whose compensationexceeded $100,000 during fiscal year 2003 and by all current directors andexecutive officers of the Company as a group. No other executive officer’s compensation exceeded $100,000 duringfiscal year 2003.  All shares aresubject to the named person’s sole voting and investment power except whereotherwise indicated. 

 
|                                                                                                         |   | **Shares  Beneficially Owned** |   |
|--------------------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
| **Name and Address of Beneficial  Owner (1)**                                                                |   | **Number (1)**                 |   | **Percent  (2)** |   |
| D. Scott Buchanan, Ph.D.  9727 Pacific Heights Blvd  San Diego, CA 92121  (858) 453-6300                     |   | 1,706,501                      | (3)    |   | * |
| Martin P. Egli  Am Schanzengraben 23   Zurich, CH-8039, Switzerland  +41-1-285-7600                          |   | 35,456,394                     | (4)    | 15.98 | % |
| Martin Velasco  Cours Des Bastions, 6  Geneva, CH-1205, Switzerland  +41-22-310-9542                         |   | 22,882,273                     | (5)    | 10.3 | % |
| Galleon Graetz  Klosbachstrasse 116  Zürich, CH-8032, Switzerland  +41-43-244-8686                      |   | 62,187,713                     | (6)    |   | * |
| Eugene C. Hirschkoff, Ph.D.  9727 Pacific Heights Blvd  San Diego, CA 9212  (858) 453-6300                   |   | 807,050                        | (7)    |   | * |
| Kenneth C. Squires, Ph.D.  9727 Pacific Heights Blvd  San Diego, CA 9212  (858) 453-6300                     |   | 794,735                        | (8)    |   | * |
| Hans-Ueli Rihs       Am Schanzengraben 23   Zurich, CH-8039, Switzerland  +41-1-285-7600 |   | 1,230,769                      |   |   | * |
| All current directors and executive  officers as a group (7 persons) (9)                                |   | 125,065,435                    |   | 54.94 | % |

 

----

*      Less than 1%.

(1)   Except as indicated in the footnotes to this table,the persons named in the table have sole voting and investment power withrespect to all shares of common stock shown as beneficially owned by them,subject to community property laws, where applicable.  Share ownership in each case includes shares issuable on exerciseof certain outstanding options as described in the footnotes below.

(2)   Percentage of ownership is calculated pursuant toSEC Rule 13d-3d(1).

(3)   Shares beneficially owned include options topurchase 1,673,709 shares of common stock held by Dr. Buchanan, 

 

32

----

 

which are now exercisable or exercisable within 60 days after November6, 2003.

(4)   Consists of 6,474,274 shares owned by Mr. Egli and28,982,120 shares owned by Swisspartners. Mr. Egli is a managing director of Swisspartners Investment Network AG.

(5)   Consists of 22,882,273 shares owned by InternationalSequoia Investments Ltd.  Mr. Velasco isa major investor in Sequoia.

(6)   Shares beneficially owned include options topurchase 600,000 shares of common stock held by Dr. Graetz, which are nowexercisable or exercisable within 60 days after November 6, 2003 and 61,587,713shares held by his mother, Rose Rita Graetz.

(7)   Shares beneficially owned include options topurchase 740,000 shares of common stock held by Dr. Hirschkoff, which are nowexercisable or exercisable within 60 days after November 6, 2003.

(8)   Shares beneficially owned include options topurchase 725,400 shares of common stock held by Dr. Squires, which are nowexercisable or exercisable within 60 days after November 6, 2003.

(9)   Shares beneficially owned include all shares held byentities affiliated with certain directors as described in the footnotes aboveand options to purchase 3,739,109 shares of common stock held by directors andexecutive officers as a group which are now exercisable or exercisable within60 days after November 6, 2003.

 

**ITEM 12.****       CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.**

 

In March 2001, we entered into a consultancyagreement with Mr. Fernandez Atela, who was then serving as chairman of ourboard of directors.  Under the originalagreement terms, Mr. Fernandez Atela was entitled to receive a consultancy feeof $250,000 per year, payable monthly, an administration reimbursement expenseof up to $60,000 per year, payable monthly, up to 3% of the net financing wereceived as a result of Mr. Atela’s services and up to 5% of the net sales wereceived for concluding any MEG sales in Spain.  The agreement had an initial term of one year and could becancelled monthly by written notice. Under the original agreement terms, Mr. Fernandez Atela was alsoentitled to receive a termination fee of $187,500 at the termination of theagreement.  In April 2002Mr. Fernandez reduced his billing for administration reimbursement to $0per year.  Mr. Fernandez Atela receivedcompensation in the amount of $314,291 representing consulting fees during thefiscal year ended September 30, 2002. Effective October 2002 Mr. Fernandez resigned from the board ofdirectors.  In January 2003 we reachedan agreement with Mr. Fernandez in which he accepted a settlement of $80,000cash plus 1,500,000 shares of our common stock in exchange for cancellation ofhis contract and all payments owed totaling approximately $66,000.

 

In November 2002, we sold 100% of our shares in our wholly-ownedsubsidiary, Neuromag Oy, to Vaandramolen Holding BV for $4,000,000.  We used $3,694,000 of the proceeds from thesale to fully pay the remaining debt outstanding under a loan from AIG Bank,which had been used to fund our acquisition of Neuromag in December 1999.  Martin Egli, a member of our board ofdirectors, also serves on AIG Bank’s board of directors.

 

In April 2002, an additional 6,153,845 shares of our common stock wereissued on terms previously authorized in a private placement in accordance withSection 4(2) of the Securities Act of 1933, as amended, in exchange for cash inthe aggregate sum of $800,000.  Theparticipating investors included International Sequoia Investments Ltd., ofwhich our board member Martin Velasco is a major investor, SwisspartnersInvestment Network AG, of which our board member Martin Egli is a seniorpartner, and our board members Enrique Maso and Hans-Ueli Rihs.

 

In December 2002, an additional 60,000,000 shares of our common stockwas issued to Swisspartners Investment Network AG in a private placementtransaction pursuant to Rule 506 of Regulation D and Section 4(2) of theSecurities Act of 1933, as amended, in exchange for cash in the aggregate sumof $3,000,000, or $0.05 per share.

 

We have entered into an arrangement with Dr. Graetz, a member of ourboard of directors, pursuant to which, in addition to expenses incurred, he isto receive a $10,000 retainer per month in exchange for his services inestablishing insurance reimbursement and market development for MEG inEurope.  This 

 

33

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arrangement is on a month-to-month basis and may be cancelled at anytime at our sole discretion.  Dr. Graetzreceived compensation in the amount of $180,000 during the fiscal year endedSeptember 30, 2003.

 

On or about November 5, 2002, we obtained a new line of credit with AIGBank for $1,000,000.  The interest onthe line of credit is 4.17%.  Originallythe line of credit was due and payable November 5, 2003; however, in January2003 the maturity of the line of credit was extended to May 5, 2004.  The proceeds were used to pay off fourunsecured loans we obtained during fiscal year 2003 as described below, and anaccounts payable in the amount of $120,000 due to Carenet AG, a company ownedby Dr. Galleon Graetz, a member of our board of directors.  The four unsecured loans included: (a) twounsecured loans from MATRUST, S.L. a shareholder of the Company, for$225,000.  (Dr. Enrique Maso, aprincipal shareholder of the Company and a former member of our board ofdirectors, is a majority shareholder of MATRUST, S.L.); (b) an unsecured loanfrom a principal shareholder of the Company, Swisspartners Investment NetworkAG, for $100,000 (Mr. Egli, a member of our board of directors, is a seniorpartner of Swisspartners Investment network AG); and (c) an unsecured loan fromanother principal shareholder of the Company, International Sequoia InvestmentLtd., for $100,000.  All four loans wererepaid in full with no interest charged. Mr. Velasco, a member of our board of directors, is a major investor inInternational Sequoia Investment Ltd. In addition to Mr. Egli’s personalguarantee of $500,000, the respective parties pledged the sum of these amounts,or $570,000, as collateral against the loan from AIG Bank.  The remaining $430,000 from the AIG line ofcredit was used for general corporate purposes.

 

**ITEM 13.****       EXHIBITS, FINANCIAL STATEMENT SCHEDULES ANDREPORTS ON FORM 8-K.**

 

(a)     Thefollowing documents are filed as part of this report:

 
| (1)    | Financial Statements                                                                                                                                              |   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   | Report of Independent Accountants                                                                                                                                 |   |
|   | Consolidated Balance Sheets at September 30, 2003 and 2002                                                                                                        |   |
|   | Consolidated Statements of Operations for  the two years ended September 30, 2003                                                                                 |   |
|   | Consolidated Statements of Shareholders’  Equity (Deficit) for the two years ended September 30, 2003                                                        |   |
|   | Consolidated Statements of Cash Flows for  the two years ended September 30, 2003                                                                                 |   |
|   | Notes to Consolidated Financial Statements                                                                                                                        |   |
|   |                                                                                                                                                              |   |
| (2)    | Financial Statement Schedule                                                                                                                                      |   |
|   |                                                                                                                                                              |   |
|   | Schedule  II - Consolidated Valuation and Qualifying Accounts                                                                                                     |   |
|   |                                                                                                                                                              |   |
|   | All other schedules are omitted because they are not applicable or  the required information is shown in the consolidated financial statements or  notes thereto. |   |
|   |                                                                                                                                                              |   |
| (3)    | Exhibits                                                                                                                                                          |   |
|   |                                                                                                                                                              |   |
|   | The Exhibits listed in the accompanying Exhibit Index are filed or  incorporated by reference as part of this report.                                             |   |

 

(b)     Reportson Form 8-K during the fourth quarter:

 
|   | None. |   |
|--------|-------|--------|

 

(c)     Exhibits

 
|   | The following documents are exhibits to this Form 10-KSB: |   |
|--------|-----------------------------------------------------------|--------|

 
| **Exhibit  No.** |   | **Description  of Document**                                                                                                                                                                        |
|------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                |
| 3.1              |   | Seventh Amended and Restated Articles of Incorporation                                                                                                                                              |
|             |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 3.1 in the Quarterly  Report on Form 10-QSB for period ended March 31, 2003, filed May 15, 2003. |

 

34

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| 3.2    |   | Restated By-Laws                                                                                                                                                                                                                                                                                                                                                                              |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 3.2 in the  Registration Statement filed pursuant to the Securities Act of 1933 on Form  S-1 Registration Statement No. 33-29095, filed June 7, 1989, as amended by  Amendment No. 1, filed June 13, 1989, Amendment No. 2, filed July 21, 1989  and Amendment No. 3, filed July 28, 1989. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.1   |   | Loan Agreement dated June 28, 2000 between 4-D and BDN, a company  based in Spain.                                                                                                                                                                                                                                                                                                            |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.1 in the Quarterly  Report on Form 10-Q for period ended June 30, 2000, filed August 14, 2000.                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2   |   | Loan Agreement dated June 28, 2000 between 4-D and BDN, a company  based in Spain.                                                                                                                                                                                                                                                                                                            |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.2 in the Quarterly  Report on Form 10-Q for period ended June 30, 2000, filed August 14, 2000.                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.3   |   | The Company’s 1997 Stock Option Plan, as amended.                                                                                                                                                                                                                                                                                                                                        |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, the appendix of the Proxy  Statement filed pursuant to Section 14(a) of the Securities Exchange Act of  1934 on Schedule 14A dated January 18, 2002 filed on January 22, 2002.                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.4   |   | The Company’s 1987 Stock Option Plan, as amended.                                                                                                                                                                                                                                                                                                                                        |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.6 in the Fiscal  1992 Form 10-K.                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.5   |   | Form of Incentive Stock Option and related exercise documents.                                                                                                                                                                                                                                                                                                                                |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.7 in the Fiscal  1992 Form 10-K.                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.6   |   | The Company’s 2002 Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                                                                         |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, the appendix of the Proxy  Statement filed pursuant to Section 14(a) of the Securities Exchange Act of  1934 on Schedule 14A dated January 18, 2002 filed on January 22, 2002.                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.7   |   | Form of Common Stock Purchase Agreement.                                                                                                                                                                                                                                                                                                                                                      |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.1 in our current  report on Form 8-K filed on May 11, 2001, as subsequently amended.                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.8   |   | Letter Agreement dated on or about April 25, 2001 between 4-D and AIG  Private Bank, Ltd.                                                                                                                                                                                                                                                                                                     |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.2 in our current  report on Form 8-K filed on May 11, 2001, as subsequently amended.                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.9   |   | Amendment to Loan Agreement dated on or about April 26, 2001 between  4-D and AIG Private Bank, Ltd.                                                                                                                                                                                                                                                                                          |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.3 in our current  report on Form 8-K filed on May 11, 2001, as subsequently amended.                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10  |   | Full Cancellation of Indebtedness effective as of April 26, 2001  between 4-D and Swisspartners Investment Network Ltd.                                                                                                                                                                                                                                                                       |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.4 in our current  report on Form 8-K filed on May 11, 2001, as subsequently amended.                                                                                                                                                                                                    |

 

35

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| 10.11  |   | Full Cancellation of Indebtedness effective as of April 26, 2001  between 4-D and Swisspartners Investment Network Ltd.                                                                                                                                     |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.5 in our current  report on Form 8-K filed on May 11, 2001, as subsequently amended.                                                                  |
|   |   |                                                                                                                                                                                                                                                        |
| 10.12  |   | Full Cancellation of Indebtedness effective as of April 26, 2001  between 4-D and MATRUST, S.L.                                                                                                                                                             |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.6 in our current  report on Form 8-K filed on May 11, 2001, as subsequently amended.                                                                  |
|   |   |                                                                                                                                                                                                                                                        |
| 10.13  |   | Full Cancellation of Indebtedness effective as of April 26, 2001  between 4-D and International Sequoia Investments Limited.                                                                                                                                |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.7 in our current  report on Form 8-K filed on May 11, 2001, as subsequently amended.                                                                  |
|   |   |                                                                                                                                                                                                                                                        |
| 10.14  |   | Full Cancellation of Indebtedness effective as of April 26, 2001  between 4-D and Amaldos, S.A.                                                                                                                                                             |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.8 in our current  report on Form 8-K/A filed on June 20, 2001, as subsequently amended.                                                               |
|   |   |                                                                                                                                                                                                                                                        |
| 10.15  |   | Real Estate Lease dated February 18, 2003, between the Company and  The Irvine Company.                                                                                                                                                                     |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.2 in the Quarterly  Report on Form 10-QSB for period ended March 31, 2003, filed May 15, 2003.                                                        |
|   |   |                                                                                                                                                                                                                                                        |
| 10.16  |   | Form of Purchase Option Agreement, as amended.                                                                                                                                                                                                              |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.64 in the  Registration Statement filed pursuant to the Securities Act of 1933 on Form  S-1, Registration Statement No. 33-81294, filed July 8, 1994. |
|   |   |                                                                                                                                                                                                                                                        |
| 10.17  |   | Joint Venture Agreement with Magnesensors.                                                                                                                                                                                                                  |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.77 in Fiscal 1998  Form 10-K**.**                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                        |
| 10.18  |   | Real estate lease dated March 3, 2000 between Neuromag Oy and  Instrumentarium and an English language summary of such lease.                                                                                                                               |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.78 in Fiscal 2000  Form 10-K.                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                        |
| 10.19  |   | Consultancy Agreement between Felipe Fernandez Atela and 4-D dated  April 2, 2001.                                                                                                                                                                          |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.79 in Fiscal 2001  Form 10-K.                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                        |
| 10.20  |   | Form of Common Stock Purchase Agreement.                                                                                                                                                                                                                    |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.1 in the Quarterly  Report on Form 10-Q for period ended March 31, 2002, filed May 15, 2002.                                                          |
|   |   |                                                                                                                                                                                                                                                        |
| 10.21  |   | Elekta Agreement dated February 1, 2002 (with certain confidential  portions omitted).                                                                                                                                                                      |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.2 in the Quarterly  Report on Form 10-Q for period ended March 31, 2002, filed May 15, 2002.                                                          |
|   |   |                                                                                                                                                                                                                                                        |
| 10.22  |   | Description of Purchase of Services of Dr. Galleon Graetz                                                                                                                                                                                                   |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.23 in Fiscal 2002  Form 10-K.                                                                                                                         |

 

36

----

 
| 10.23  |   | Share Purchase Agreement dated October 18, 2002 between 4-D and  Vaandramolen Holding BV                                                                                                                      |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 99.1 to the Company’s  Current Report on Form 8-K, filed October 30, 2002.                            |
|   |   |                                                                                                                                                                                                          |
| 10.24  |   | Form of Common Stock Purchase Agreement.                                                                                                                                                                      |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.2 in the Quarterly  Report on Form 10-QSB for period ended December 31, 2002, filed February 14,  2003. |
|   |   |                                                                                                                                                                                                          |
| 10.25  |   | Letter Agreement dated on or about November 5, 2003 between 4-D and  AIG Private Bank, Ltd.                                                                                                                   |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.2 in the Quarterly  Report on Form 10-QSB for period ended December 31, 2002, filed February 14,  2003. |
|   |   |                                                                                                                                                                                                          |
| 10.26  |   | Letter Agreement dated on or about January 16, 2003 between 4-D and  AIG Private Bank, Ltd.                                                                                                                   |
|   |   | This exhibit was previously filed as part  of, and is hereby incorporated by reference to, Exhibit 10.1 in the Quarterly  Report on Form 10-QSB for period ended March 31, 2003, filed May 15, 2003.          |
|   |   |                                                                                                                                                                                                          |
| 14     |   | Code of Ethics                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                          |
| 23     |   | Consent of Swenson Advisors, LLP.                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                          |
| 24     |   | Certified Power of Attorney                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                          |
| 31     |   | Rule 13a-14(a)/15d-14(a) Certification (Section 1350 Certification)                                                                                                                                           |
|   |   |                                                                                                                                                                                                          |
| 32     |   | Section 906 Certification of Chief Executive Officer and Principal  Financial Officer                                                                                                                         |

 

**ITEM 14.****       PRINCIPAL ACCOUNTANT FEES AND SERVICES.**

 

Audit Fees

 

The aggregate fees billed by Swenson Advisors, LLP for professionalservices rendered for the audit of the Company’s annual financial statementsfor fiscal years 2003 and 2002 and the reviews of the financial statementsincluded in the Company’s Form 10-QSB and Form 10-Q for such fiscal years were$53,000 and 79,000, respectively.

 

Audit Related Fees

 

There were no fees billed by Swenson Advisors, LLP for professionalservices described in Paragraph (c)(4)(ii) of Rule 2-01 of Regulation S-X forfiscal years 2003 and 2002.

 

Tax Fees

 

The aggregate fees billed for fiscal years 2003 and 2002 forprofessional services rendered by Swenson Advisors, LLP for tax compliance, taxservice and tax planning were $10,000 and $9,000, respectively.

 

All Other Fees

 

The aggregate fees billed by Swenson Advisors, LLP for professionalservices rendered, other than as stated under the captions Audit Fees, AuditRelated Fees and Tax Fees above, were $9,000 and $7,000 for fiscal years 2003and 2002, respectively.  The AuditCommittee considers the provision of these services to be compatible withmaintaining the independence of Swenson Advisors, LLP.

 

37

----

 

**SIGNATURES**

 

In accordance with Section 13 or 15(d) of the Exchange Act, theregistrant has caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| By     | /s/D. Scott Buchanan                                            |   | December 19, 2003 |   |
|--------|-----------------------------------------------------------------|--------|-------------------|--------|
|   | D. Scott Buchanan                                               | Date   |
|   | President, Chief Executive Officer, Principal Financial Officer |   |

 

In accordance with the Exchange Act, this report has been signed belowby the following persons on behalf of the registrant and in the capacities andon the dates indicated.

 

 
| By     | /s/D. Scott Buchanan                                                       |   | December 19, 2003 |   |
|--------|----------------------------------------------------------------------------|--------|-------------------|--------|
|   | D. Scott Buchanan                                                          | Date   |
|   | President, Chief Executive Officer, Principal Financial Officer,  Director |   |
|   |                                                                       |   |
| By     | /s/Reynaldo G. Lontok                                                      |   | December 19, 2003 |   |
|   | Reynaldo G. Lontok                                                         | Date   |
|   | Controller                                                                 |   |
|   |                                                                       |   |
| By     | *                                                                          |   | December 19, 2003 |   |
|   | Martin P. Egli, Chairman of the Board, Director                            | Date   |
|   |                                                                       |   |
| By     | *                                                                          |   | December 19, 2003 |   |
|   | Galleon Graetz, Director                                                   | Date   |
|   |                                                                       |   |
| By     | *                                                                          |   | December 19, 2003 |   |
|   | Han-Ueli Rihs, Director                                                    | Date   |
|   |                                                                       |   |
| By     | *                                                                          |   | December 19, 2003 |   |
|   | Martin Velasco, Director                                                   | Date   |
|   |                                                                       |   |
| *By    | /s/D. Scott Buchanan                                                       |   | December 19, 2003 |   |
|   | D. Scott Buchanan                                                          | Date   |
|   | (Attorney-in-Fact)                                                         |   |

 

 

**SupplementalInformation to be furnished with reports filed pursuant to Section 15(d) of theExchange Act by Non-reporting Issuers.**

 

**The Company’s annualreport and proxy materials shall be furnished to shareholders subsequent to thefiling of this Form 10-KSB.**

 

38

----

 

***REPORT OFINDEPENDENT ACCOUNTANTS***

 

 

Board of Directors and Shareholders

4-D Neuroimaging

 

We have audited the accompanying consolidated balance sheets of 4-DNeuroimaging (a California corporation) and subsidiary as of September 30, 2003and 2002, and the related consolidated statements of operations, shareholders’equity (deficit), and cash flows for the years ended September 30, 2003 and2002, respectively.  Our audit alsoincluded the consolidated financial statement schedule.  These consolidated financial statements andschedule are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audit.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the consolidated financial statements arefree of material misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the consolidated financial positionof 4-D Neuroimaging and subsidiary as of September 30, 2003 and 2002,respectively, and the results of its operations and its cash flows for theyears ended September 30, 2003 and 2002, respectively, in conformity withaccounting principles generally accepted in the United States of America.  Also, in our opinion, the related consolidatedfinancial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, present fairly in allmaterial respects the information set forth therein.

 

The accompanying consolidated financial statements have been preparedassuming that the Company will continue as a going concern.  As discussed in Note 2 to the consolidatedfinancial statements, the Company has historically reported significant netlosses and negative working capital and serious liquidity concerns.  These matters raise substantial doubt aboutthe Company’s ability to continue as a going concern.  The Company may not be able to acquire adequate funding for itscontinued operations.  The consolidated financialstatements do not include any adjustments as to the recoverability andclassification of assets and liabilities that might result should the Companybe unable to continue as a going concern.

 

 
| /s/ SWENSON ADVISORS, LLP |   |
|---------------------------|--------|
| San Diego, California     |
| December 17, 2003         |

# ** **

39

----

 

# **4-D NEUROIMAGING**

## ***CONSOLIDATED BALANCE SHEETS***

 
|                                                                                                                                                     |   | **September  30,** |      |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|
|                                                                                                                                                     |   | **2003**           |      | **2002** |   |
| **ASSETS**                                                                                                                                               |   |               |      |   |   |
| Cash and cash equivalents                                                                                                                                |   | $                  | 681,376   |   | $ | 166,697 |   |
| Restricted cash                                                                                                                                          |   | —             |      | 17,310 |   |
| Accounts receivable, less allowance for  doubtful accounts of  $284,452 in 2003  and $216,124 in 2002                                          |   | 422,255            |      | 365,917 |   |
| Inventories                                                                                                                                              |   | 2,935,520          |      | 4,137,919 |   |
| Prepaid expenses and other current assets                                                                                                                |   | 507,904            |      | 200,399 |   |
|                                                                                                                                                     |   |               |      |   |   |
| Total current assets                                                                                                                                     |   | 4,547,055          |      | 4,888,242 |   |
|                                                                                                                                                     |   |               |      |   |   |
| Property and equipment, net                                                                                                                              |   | 155,542            |      | 607,062 |   |
| Goodwill, net                                                                                                                                            |   | —             |      | 2,203,549 |   |
| Deferred income taxes                                                                                                                                    |   | —             |      | 588,175 |   |
| Other assets                                                                                                                                             |   | 57,314             |      | 226,615 |   |
| TOTAL ASSETS                                                                                                                                             |   | $                  | 4,759,911 |   | $ | 8,513,643 |   |
|                                                                                                                                                     |   |               |      |   |   |
| **LIABILITIES AND SHAREHOLDERS’ DEFICIT**                                                                                                           |   |               |      |   |   |
| Notes payable                                                                                                                                            |   | $                  | 1,000,000 |   | $ | 4,040,000 |   |
| Accounts payable                                                                                                                                         |   | 1,780,544          |      | 1,903,159 |   |
| Accrued liabilities                                                                                                                                      |   | 996,930            |      | 1,110,685 |   |
| Accrued salaries and employee benefits                                                                                                                   |   | 375,136            |      | 498,311 |   |
| Customer deposits                                                                                                                                        |   | 1,640,835          |      | 535,749 |   |
| Deferred revenues                                                                                                                                        |   | 150,715            |      | 341,843 |   |
| Current portion of royalty obligation                                                                                                                    |   | 312,000            |      | 312,000 |   |
| Current portion of capital lease  obligations                                                                                                            |   | 7,637              |      | 13,952 |   |
|                                                                                                                                                     |   |               |      |   |   |
| Total current liabilities                                                                                                                                |   | 6,263,797          |      | 8,755,699 |   |
|                                                                                                                                                     |   |               |      |   |   |
| Note payable                                                                                                                                             |   | —             |      | 521,614 |   |
| Royalty obligation, net of current portion                                                                                                               |   | 1,128,041          |      | 1,025,706 |   |
| Customer deposits                                                                                                                                        |   | 1,107,518          |      | 1,107,518 |   |
| Deferred revenues                                                                                                                                        |   | 180,417            |      | 376,727 |   |
| Capital lease obligations, net of current  portion                                                                                                       |   | —             |      | 7,637 |   |
| Total liabilities                                                                                                                                        |   | 8,679,773          |      | 11,794,901 |   |
|                                                                                                                                                     |   |               |      |   |   |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                        |   |               |      |   |   |
|                                                                                                                                                     |   |               |      |   |   |
| **SHAREHOLDERS’ DEFICIT**                                                                                                                           |   |               |      |   |   |
| Common stock — no par value; 500,000,000  shares authorized; 221,859,748 and 160,338,589 are issued and outstanding in  2003 and 2002, respectively |   | 117,761,884        |      | 114,692,985 |   |
| Additional paid-in capital                                                                                                                               |   | 3,007,500          |      | 3,007,500 |   |
| Accumulated deficit                                                                                                                                      |   | (124,689,246       | )         | (120,951,599 | ) |
| Accumulated other comprehensive loss                                                                                                                     |   | —             |      | (30,144 | ) |
| Total shareholders’ deficit                                                                                                                         |   | (3,919,862         | )         | (3,281,258 | ) |
| TOTAL LIABILITIES & SHAREHOLDERS’  DEFICIT                                                                                                      |   | $                  | 4,759,911 |   | $ | 8,513,643 |   |

 

See Notes to Consolidated FinancialStatements

 

40

----

 

**4-DNEUROIMAGING**

## ***CONSOLIDATED STATEMENTS OF OPERATIONS***

 
|                                                                    |   | **Years  Ended September 30,** |       |
|-------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                    |   | **2003**                       |       | **2002** |   |
| **REVENUES**                                                            |   |                           |       |   |   |
| Product sales                                                           |   | $                              | 1,917,268  |   | $ | 4,490,569 |   |
| Product services                                                        |   | 891,561                        |       | 812,020 |   |
|                                                                    |   | 2,808,829                      |       | 5,302,589 |   |
|                                                                    |   |                           |       |   |   |
| **COST OF REVENUES**                                                    |   |                           |       |   |   |
| Product                                                                 |   | 2,468,737                      |       | 4,316,833 |   |
| Product services                                                        |   | 628,458                        |       | 840,676 |   |
|                                                                    |   | 3,097,195                      |       | 5,157,509 |   |
|                                                                    |   |                           |       |   |   |
| **GROSS MARGIN**                                                        |   | (288,366                       | )          | 145,080 |   |
|                                                                    |   |                           |       |   |   |
| **OPERATING EXPENSES**                                                  |   |                           |       |   |   |
| Research and development                                                |   | 882,763                        |       | 1,022,178 |   |
| Marketing and sales                                                     |   | 1,520,416                      |       | 1,747,460 |   |
| General and administration                                              |   | 1,623,762                      |       | 1,616,210 |   |
|                                                                    |   | 4,026,941                      |       | 4,385,848 |   |
|                                                                    |   |                           |       |   |   |
| **OPERATING LOSS**                                                      |   | (4,315,307                     | )          | (4,240,768 | ) |
|                                                                    |   |                           |       |   |   |
| Interest expense                                                        |   | (391,035                       | )          | (24,726 | ) |
| Interest income                                                         |   | 3,779                          |       | 4,054 |   |
| Other income, net                                                       |   | 540,767                        |       | 24,004 |   |
|                                                                    |   |                           |       |   |   |
| **LOSS BEFORE PROVISION FOR INCOME TAXES AND  DISCONTINUED OPERATIONS** |   | (4,161,796                     | )          | (4,237,436 | ) |
| Provision for income taxes                                              |   | 800                            |       | 800 |   |
|                                                                    |   |                           |       |   |   |
| **NET LOSS FROM OPERATIONS**                                            |   | (4,162,596                     | )          | (4,238,236 | ) |
|                                                                    |   |                           |       |   |   |
| **DISCONTINUED OPERATIONS**                                             |   |                           |       |   |   |
| Income (loss) from discontinued operations                              |   | 455,093                        |       | (5,799,886 | ) |
| **NET LOSS**                                                            |   | $                              | (3,707,503 | ) | $ | (10,038,122 | ) |
|                                                                    |   |                           |       |   |   |
| **BASIC AND DILUTED NET INCOME (LOSS) PER  SHARE**                      |   |                           |       |   |   |
| Loss from operations                                                    |   | $                              | (0.020     | ) | $ | (0.028 | ) |
| Earnings (loss) from discontinued  operations                           |   | 0.002                          |       | (0.038 | ) |
| Loss per share                                                          |   | $                              | (0.018     | ) | $ | (0.066 | ) |
| Weighted average number of common shares  outstanding                   |   | 206,518,249                    |       | 152,788,459 |   |
|                                                                    |   |                           |       |   |   |
| COMPREHENSIVE LOSS:                                                     |   |                           |       |   |   |
| Net loss                                                                |   | $                              | (3,707,503 | ) | $ | (10,038,122 | ) |
| Cumulative translation adjustment                                       |   | —                         |       | 204,639 |   |
| Comprehensive loss                                                      |   | $                              | (3,707,503 | ) | $ | (9,833,483 | ) |

 

SeeNotes to Consolidated Financial Statements

 

41

----

 

**4-DNEUROIMAGING**

## ***CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)***

 
|                                 |   | **Common  Shares** |   | **Stock  Amount** |        | **Additional  Paid-In  Capital** |   | **Accumulated  Deficit** |   | **Accumulated  Other  Comprehensive  Loss** |         | **Total**   |   |
|--------------------------------------|--------|--------------------|--------|-------------------|-------------|----------------------------------|--------|--------------------------|--------|---------------------------------------------|--------------|-------------|--------|
|                                 |   |               |   |              |        |                             |   |                     |   |                                        |         |        |   |
| **BALANCE, SEPTEMBER 30, 2001** |   | 145,018,629        |   | $                 | 112,699,555 |                             | $      | 3,007,500                |   | $                                           | (110,913,477 | )           | $      | (234,783 | ) | $ | 4,558,795 |   |
|                                 |   |               |   |              |        |                             |   |                     |   |                                        |         |        |   |
| Exercise of stock  options           |   | 200,000            |   | 30,000            |        |                             |   |                     |   |                                        |         | 30,000      |   |
| Sale of stock under ESPP             |   | 43,038             |   | 3,430             |        |                             |   |                     |   |                                        |         | 3,430       |   |
| Sale of stock                        |   | 15,076,922         |   | 1,960,000         |        |                             |   |                     |   |                                        |         | 1,960,000   |   |
| Net loss                             |   |               |   |              |        |                             |   | (10,038,122              | )      |                                        |         | (10,038,122 | )      |
| Translation adjustments              |   |               |   |              |        |                             |   |                     |   | 204,639                                     |         | 204,639     |   |
| Comprehensive loss                   |   |               |   |              |        |                             |   |                     |   |                                        |         | (9,833,483  | )      |
|                                 |   |               |   |              |        |                             |   |                     |   |                                        |         |        |   |
| **BALANCE, SEPTEMBER 30, 2002** |   | 160,338,589        |   | $                 | 114,692,985 |                             | $      | 3,007,500                |   | $                                           | (120,951,599 | )           | $      | (30,144 | ) | $ | (3,281,258 | ) |
|                                 |   |               |   |              |        |                             |   |                     |   |                                        |         |        |   |
| Exercise of stock  options           |   | 1,500,000          |   | 68,000            |        |                             |   |                     |   |                                        |         | 68,000      |   |
| Sale of stock under ESPP             |   | 21,159             |   | 899               |        |                             |   |                     |   |                                        |         | 899         |   |
| Sale of stock                        |   | 60,000,000         |   | 3,000,000         |        |                             |   |                     |   |                                        |         | 3,000,000   |   |
| Net loss                             |   |               |   |              |        |                             |   | (3,707,503               | )      |                                        |         | (3,707,503  | )      |
| Translation adjustments              |   |               |   |              |        |                             |   | (30,144                  | )      | 30,144                                      |         | —      |   |
| Comprehensive loss                   |   |               |   |              |        |                             |   |                     |   |                                        |         | (3,707,503  | )      |
|                                 |   |               |   |              |        |                             |   |                     |   |                                        |         |        |   |
| **BALANCE, SEPTEMBER 30, 2003** |   | 221,859,748        |   | $                 | 117,761,884 |                             | $      | 3,007,500                |   | $                                           | (124,689,246 | )           | $      | — |   | $ | (3,919,862 | ) |

 

See Notes to Consolidated Financial Statements

 

42

----

 

**4-DNEUROIMAGING**

## ***CONSOLIDATED STATEMENTS OF CASH FLOWS***

 
|                                                                                       |   | **Years  ended September 30,** |       |
|--------------------------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                                       |   | **2003**                       |       | **2002** |   |
| **OPERATING  ACTIVITIES**                                                                  |   |                           |       |   |   |
| Net loss                                                                                   |   | $                              | (3,707,503 | ) | $ | (10,038,122 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |   |                           |       |   |   |
| Impairment of goodwill                                                                     |   | —                         |       | 5,973,850 |   |
| Depreciation                                                                               |   | 99,550                         |       | 285,553 |   |
| Amortization of minimum royalty obligation                                                 |   | 102,335                        |       | 97,795 |   |
| Gain on sale of Neuromag Oy                                                                |   | (455,093                       | )          | — |   |
| Changes in operating assets and  liabilities, excluding effects of acquisition:            |   |                           |       |   |   |
| Restricted cash                                                                            |   | 17,310                         |       | 528,344 |   |
| Accounts receivable                                                                        |   | (56,338                        | )          | 2,769,679 |   |
| Inventories                                                                                |   | 527,399                        |       | 3,172,816 |   |
| Prepaid expenses and other current assets                                                  |   | (307,505                       | )          | 698,066 |   |
| Payment of royalty obligation                                                              |   | —                         |       | (194,317 | ) |
| Other assets                                                                               |   | (5,007                         | )          | 34,849 |   |
| Accounts payable                                                                           |   | (104,794                       | )          | (453,914 | ) |
| Accrued liabilities                                                                        |   | (220,540                       | )          | (161,581 | ) |
| Accrued salaries and employee benefits                                                     |   | (123,175                       | )          | (60,130 | ) |
| Customer deposits                                                                          |   | 1,105,086                      |       | (5,923,736 | ) |
| Deferred revenue                                                                           |   | (387,438                       | )          | 480,258 |   |
| Interest payable                                                                           |   | 106,785                        |       | 33,403 |   |
| Net cash used in operating activities                                                      |   | (3,408,928                     | )          | (2,757,187 | ) |
|                                                                                       |   |                           |       |   |   |
| **INVESTING  ACTIVITIES**                                                                  |   |                           |       |   |   |
| Payments on capital leases                                                                 |   | (13,952                        | )          | (11,281 | ) |
| Payments for property and equipment                                                        |   | (23,340                        | )          | (164,487 | ) |
| Proceeds from sale of Neuromag Oy                                                          |   | 4,000,000                      |       | — |   |
| Net cash provided by (used in) investing activities                                        |   | 3,962,708                      |       | (175,768 | ) |
|                                                                                       |   |                           |       |   |   |
| **FINANCING  ACTIVITIES**                                                                  |   |                           |       |   |   |
| Proceeds from issuance of common stock                                                     |   | 3,000,000                      |       | 1,993,430 |   |
| Proceeds from notes payable                                                                |   | 1,000,000                      |       | 723,244 |   |
| Proceeds from employee stock purchase plan                                                 |   | 899                            |       | — |   |
| Repayment of notes payable                                                                 |   | (4,040,000                     | )          | — |   |
| Net cash provided by (used in) financing  activities                                       |   | (39,101                        | )          | 2,716,674 |   |
|                                                                                       |   |                           |       |   |   |
| Effect of exchange rate changes                                                            |   | —                         |       | 204,639 |   |
|                                                                                       |   |                           |       |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                                  |   | 514,679                        |       | (11,642 | ) |
|                                                                                       |   |                           |       |   |   |
| **CASH AND CASH EQUIVALENTS AT BEGINNING OF  YEAR**                                        |   | 166,697                        |       | 178,339 |   |
|                                                                                       |   |                           |       |   |   |
| **CASH AND CASH EQUIVALENTS AT END OF YEAR**                                               |   | $                              | 681,376    |   | $ | 166,697 |   |

 

See Notes to Consolidated Financial Statements

 

43

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**4-DNEUROIMAGING**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 

SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

 
|                                     |   | **Years  ended September 30,** |   |
|------------------------------------------|--------|--------------------------------|--------|
|                                     |   | **2003**                       |   | **2002** |   |
|                                     |   |                           |   |   |   |
| Stock exchange for professional services |   | $                              | 68,000 |   | $ | — |   |
|                                     |   |                           |   |   |   |
| SUPPLEMENTAL DISCLOSURES:                |   |                           |   |   |   |
| Cash paid for interest                   |   | $                              | 93,239 |   | $ | — |   |
| Cash paid for income sales               |   | $                              | 800    |   | $ | 800 |   |

 

See Notes to ConsolidatedFinancial Statements

 

44

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**4-D Neuroimaging**

**Notes to Consolidated Financial Statements**

 

# **Note1.**       Summary of Organization and SignificantAccounting Policies

* *

*Organization*

 

4-D Neuroimaging was founded in 1970 as a California corporation and isengaged primarily in the business of developing, manufacturing and sellingmedical imaging systems to medical institutions.  The magnetic source imaging, or MSI, systems the Company hasdeveloped measure magnetic fields created by the human body for the noninvasivediagnosis of certain medical disorders. The Company’s operations are located in the United States and Germanyand formerly Finland.

* *

*Principles ofConsolidation*

 

The consolidated financial statements include the accounts of theCompany, Biomagnetic Technologies GmbH, a wholly owned foreign subsidiarylocated in Germany, and Neuromag Oy, a wholly owned foreign subsidiary locatedin Finland.  All material intercompanybalances and transactions have been eliminated in consolidation.

* *

*Cash and CashEquivalents*

 

The Company considers all unrestricted highly liquid investmentspurchased with an original maturity of three months or less to be cashequivalents.  The carrying value of cashequivalents approximates fair value.

* *

*Credit Risk*

 

It is the Company’s practice to place its cash equivalents in highquality money market securities with one major banking institution.  Periodically, the Company maintains cashbalances at this institution that exceed the Federal Deposit InsuranceCorporation insurance limit of $100,000 per bank.  The Company considers its credit risk associated with cash andcash equivalents to be minimal.

* *

*Fair Value ofFinancial Instruments*

 

The carrying amounts of cash and cash equivalents, accounts receivable,accounts payable and accrued expenses approximate fair market value because ofthe short maturity of those instruments. Notes payable approximate fair value due to the risk adjusted marketrate of interest.

* *

*Accounts Receivable*

 

Accounts receivable consists primarily of amounts due under contractualsales agreements.

* *

*Inventories*

 

Inventories are carried at the lower of cost or market.  Cost is determined on the first-in,first-out basis and includes material, labor and manufacturing overheadcosts.  Technological changes couldresult in excess or obsolete inventory. To minimize this risk, the Company evaluates inventory levels and expectedusage on a periodic basis and records adjustments as required.

* *

*Property andEquipment*

 

Property and equipment is valued at cost.  Depreciation is generally computed using the straight-line methodover estimated useful lives of three to ten years.  Improvements to leased properties are amortized over theirestimated useful lives or lease periods whichever is shorter.  Maintenance and repairs are charged toexpense as incurred and the costs of additions and betterments that increasethe useful lives of related assets are capitalized.  Depreciation expense was approximately $100,000 and $286,000 forfiscal years 2003 and 2002, respectively.

 

45

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*Goodwill*

 

In June 2001, the Financial Accounting Standards Board, or FASB, issuedStatement of Financial Accounting Standards, or SFAS, No. 142, “Goodwill andOther Intangible Assets.”

 

The Company adopted SFAS No. 142 in fiscal year 2002, as of October 1,2001.  The value of goodwill was$2,204,000 and $8,177,000 as of September 30, 2002 and 2001, respectively.  Goodwill recognized in the acquisition ofNeuromag Oy was being amortized on a straight-line basis over eight years.  The goodwill amortization was approximately$1,319,000 and $1,141,000 for the years ended September 30, 2001 and 2000,respectively.

 

The Company recorded an impairment of goodwill for $5,974,000 in fiscalyear 2002.  The impairment of goodwillresulted from the sale of Neuromag Oy, for $4,000,000 less shareholder’s equityof $1,796,000 as of September 30, 2002 (see Note 3 of the consolidatedfinancial statements).

* *

*Long-Lived Assets*

 

The Company assesses potential impairments to its long-lived assetswhen there is evidence that events or changes in circumstances have maderecovery of the asset’s carrying value unlikely.  An impairment loss is recognized when the sum of the expectedfuture net cash flows is less than the carrying amount of the asset.

* *

*Income Taxes*

 

Income taxes are accounted for using the liability method.  Deferred income tax assets or liabilitiesare recognized based on the temporary differences between financial statementand income tax bases of assets and liabilities using enacted tax rates ineffect for the years in which the differences are expected to reverse.  Valuation allowances are recorded when therealization of deferred tax assets are uncertain.

* *

*Revenue Recognition*

 

Standard terms for product sales generally provide for payment of30%-40% of the contracted purchase price upon placement of the order, 40%-50%upon shipment, and the remaining balance is due upon final customeracceptance.  The Company recognizesrevenue at the time of customer acceptance. Service revenues, from a one-year service period following a sale, aredeferred and recognized over the related service period.

 

Product service and contract revenues are recognized as the servicesare performed.

* *

*Research andDevelopment*

 

Research and development costs are expensed as incurred.

* *

*Software DevelopmentCosts*

 

Costs relating to the development of software, after technologicalfeasibility is established, are required to be capitalized.  The Company has expensed all softwaredevelopment costs as incurred as technological feasibility is not reached untilproduct testing is complete, which generally coincides with product release.

* *

*Stock-BasedCompensation Accounting*

 

The Company has elected to measure compensation expense for itsstock-based employee compensation plans using the intrinsic value methodprescribed by Accounting Principle Board Opinion No. 25, “Accounting for StockIssued to Employees,” and have provided pro forma disclosures as if the fairvalue based method prescribed by the Statement of Financial AccountingStandards No. 123 “Accounting for Stock-Based Compensation” had been utilized.

 

46

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*Net Loss per Share*

 

Basic and diluted net loss per share is computed in accordance withStatement of Financial Accounting Standards No. 128 “Earnings Per Share,” basedupon the weighted average number of common shares outstanding.  Potentially dilutive securities, consistingof stock options, are anti-dilutive and are excluded from the computation ofdiluted net loss per share.

* *

*Foreign CurrencyRemeasurement and Translation*

 

The functional currency of the Company’s German subsidiary is the U.S.dollar.  The monetary assets andliabilities of the German subsidiary are remeasured into the U.S. dollar at theexchange rate in effect at the balance sheet date while nonmonetary items areremeasured at historical rates. Revenues and expenses are remeasured at average exchange rates for theperiod.  Remeasurement gains or lossesof the foreign subsidiary are recognized currently in consolidatedoperations.  For the years endedSeptember 30, 2003 and 2002, such gains and losses have not been significant.

 

The functional currency of the Company’s Finnish subsidiary is theEurodollar.  The functional currency ofthe Company’s Finnish subsidiary changed as of October 1, 2001 to theEurodollar from the Finnish Marka as required by local regulations.  This change in currency has had nosignificant impact on the Company’s financial position, results of operationsor its cash flow.  Assets and liabilitiesof the Finnish subsidiary are translated into U.S. dollars at the exchange ratein effect at the balance sheet date and revenues and expenses are translated ataverage exchange rates for the period. Translation gains and losses are reflected as a component of accumulatedother comprehensive loss in shareholders’ deficit.

* *

*Recent AuthoritativePronouncements*

 

In connection with the Company’s adoption of FASB interpretation No. 45(FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Guarantees of indebtedness of Others,” the following disclosures aremade with respect to the Company’s product warranties.

 

The Company provides a limited warranty for its products.  A provision for the estimated warranty costis recorded at the time revenue is recognized. Costs of repair or replacement are established and charged to cost ofsales at the time the related service is rendered.  The amount of liability to be recorded is based on management’sbest estimates of future warranty costs after considering historical andprojected product failure rates and product repair costs.  The Company’s standard product warrantiesare for one year, although in some agreements, it may warrant products forperiods in excess of one year.  The Companyhad $258,000 warranty accruals at September 30, 2002.  The following table summarizes the activity related to productwarranty accruals for the year ended September 30, 2003:

 
|                                                   |   | **(in  thousands)** |   |
|--------------------------------------------------------|--------|---------------------|--------|
|                                                   |   |                |   |   |
| Balance at September 30, 2002                          |   | $                   | 258    |   |
| Increase in warranties related to system  installation |   | 512                 |   |
| Warranty activity in the period                        |   | (216                | )      |
| Balance at September 30, 2003                          |   | $                   | 554    |   |

 

The Company also undertakes indemnification obligations in the ordinarycourse of business related to its products, the licensing of its software, andthe issuance of securities.  Under thesearrangements, the Company may indemnify other parties such as businesspartners, customers, and underwrites, for certain losses suffered, claims ofintellectual property infringement, negligence and intentional acts in theperformance of services, and violations of laws including certain violations ofsecurities laws.  The Company’sobligation to provide such indemnification in such circumstances would ariseif, for example, a third party sued a customer for intellectual propertyinfringement and the Company agreed to indemnify the customer against suchclaims.  The Company is unable toestimate with any reasonable accuracy the liability that may be incurredpursuant to its indemnification obligations. Some of the factors that would affect this assessment include, but arenot limited to, the nature of the claim asserted, the relative merits of theclaim, the financial ability of the parties, the nature and amount of damagesclaimed, insurance coverage that the Company may have to cover such claims, thewillingness of the

 

47

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parties to reach settlement, if any. Because of the uncertainty surrounding these circumstances, theCompany’s indemnification obligations could range from immaterial to having amaterial adverse impact on its financial position and its ability to continuein the ordinary course of business.

 

In June 2002, the FASB issued SFAS No. 145, “Rescission of FASBStatements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.”  This statement requiresthe classification of gains or losses from the extinguishments of debt to meetthe criteria of Accounting Principles Board, or APB, Opinion No. 30 “Reportingthe Results of Operations – Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions” before they can be classified as extraordinary in the incomestatement.  Those companies that usedebt extinguishments as a part of their risk management strategy are requiredto classify the gain or loss from extinguishments of debt as a part ofoperating income in the income statement. The Company adopted SFAS No. 145 during the quarter ended December 31,2002 with no material impact.

 

In September 2002, the FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities.” This statement addresses financial accounting and reporting for costsassociated with exit or disposal activities. This statement requires that a liability for a cost associated with anexit or disposal activity be recognized when the liability is incurred.  The provisions of this statement areeffective for exit or disposal activities that are initiated after December 31,2002.  The Company adopted SFAS No. 146during the quarter ended December 31, 2002. There were no additional costs associated with the sale of Neuromag Oyother than the costs reflected in the financial statements and disclosed inNote 3, Sale of Finnish Subsidiary Neuromag Oy.

 

In November 2002, the FASB issued FASB Interpretation No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others.”  This interpretation addresses the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder guarantees.  This interpretationalso clarifies the requirements related to the recognition of a liability by aguarantor at the inception of a guarantee for the obligations that theguarantor has undertaken in issuing that guarantee.  Management has assessed the impact of this interpretation andbelieves it has no material impact.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure.”  This statement amends FASB statement No. 123to provide accounting guidance related to stock based employeecompensation.  SFAS No. 123, as amended,encourages, but does not require, companies to record compensation cost forstock-based employee compensation plans at fair value.  The Company has chosen to continue toaccount for stock-based compensation using the intrinsic value methodprescribed in APB Opinion No. 25, “Accounting for Stock Issued to Employees”,and related interpretations for all periods presented.  Accordingly, compensation cost for stockoptions is measured as the excess, if any, of the fair value of the Company’sstock at the date of the grant over the amount an employee must pay to acquirethe stock.

 

The following table summarizes the impact on the Company’s net loss hadcompensation cost been determined based upon the fair value at the grant datefor awards under the stock option plans consistent with the methodologyprescribed under SFAS No. 123 (in thousands, except per share data):

 
|                                                                                                                                      |   | **Years  Ended September 30,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                                                                                      |   | **2003**                       |   | **2002** |   |
| Net loss, as reported                                                                                                                     |   | $                              | (3,708 | ) | $ | (10,038 | ) |
| Add:Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |   | 10                             |   | 109 |   |
| Pro forma net loss                                                                                                                        |   | $                              | (3,718 | ) | $ | (10,147 | ) |
| Basic and diluted loss per share:                                                                                                         |   |                           |   |   |   |
| As reported                                                                                                                               |   | $                              | (0.018 | ) | $ | (0.066 | ) |
| Pro forma                                                                                                                                 |   | $                              | (0.018 | ) | $ | (0.066 | ) |

 

48

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The Company accounts for stock options granted to non-employees usingthe fair value method.  Compensationexpense for options granted to non-employees has been determined in accordancewith Emerging Issues Task Force, or EITF, No. 96-18, “Accounting for EquityInstruments that are Issued to Other than Employees for Acquiring, or inConjunction with Selling, Goods or Services”, as the fair value of theconsideration received or the fair value of the equity instruments issued,whichever is more reliably measurable. Compensation expense for options granted to non-employees isperiodically remeasured as the underlying options vest and is recorded asexpense and deferred compensation in the financial statements.

 

Holders of common stock are entitled to one vote per share.  Basic earnings per share are computed by dividingnet income or loss by the weighted average of common shares outstanding duringthe period.  Diluted earnings per sharereflects the potential dilution that could occur if securities or othercontracts to issue common stock (warrants to purchase common stock and commonstock options using the treasury stock method) were exercised or converted intocommon stock.  Potential common sharesin the diluted earnings per share computation are excluded when their effectwould be antidilutive.

 

In January 2003, the FASB issued FASB Interpretation No. 46.“Consolidation of Variable Interest Entities.” This interpretation clarifies the application of Accounting ResearchBulletin No. 51, “Consolidated Financial Statement”, to certain entities inwhich equity investors do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties.  It further clarifieswhether an entity shall be subject to consolidation according to the provisionsof this interpretation, if by design, certain conditions exist.  Management has assessed the impact of thisinterpretation and believes it has no material impact.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristic of both Liabilities andEquities.”  This statement establishesstandards for how an issuer classifies and measures in its statement offinancial position certain financial instruments with characteristics of bothliabilities and equity.  It requiresthat an issuer classify a financial instrument that is within its scope as aliability (or an asset in some circumstances) because that financial instrumentembodies an obligation of the issuer. Management has assessed the impact of this statement and believes it hasno material impact.

* *

*Use of Estimates*

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities, anddisclosure of contingent assets and liabilities, at the date of these financialstatements, and the reported amounts of revenues and expenses during the reportingperiod.  Actual results could differfrom those estimates.

* *

*Reclassifications*

 

Certain prior year balances have been reclassified to conform to thecurrent year presentation.

* *

*Risks andUncertainties*

 

The Company is dependent on continued financing from investors andobtaining new customers to sustain operations and other activities necessary tocommercialize their products.  Inaddition to current working capital, management is seeking additional financingin order to fund its future activities. There is no assurance, however, that such financing will be available,if and when needed, or if available, such financing will be completed oncommercially favorable terms, nor that development and other activities inconnection with its products will be successful.

 

49

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# **Note 2.**       Liquidity and Going Concern

 

These financial statements have been prepared assuming that the Companywill continue as a going concern.  TheCompany has operating and liquidity concerns, has incurred a loss of $3,708,000for the year ended September 30, 2003, an accumulated deficit of $124,689,000through the fiscal year ended September 30, 2003, and as of that date, currentliabilities exceeded current assets by $1,717,000.  These factors, among others, create substantial doubt about theCompany’s ability to continue as a going concern.  There can be no assurance that the Company will be able tosuccessfully acquire the necessary capital to continue their operations.  Management’s plans to acquire future fundinginclude additional product sales and seeking additional equity investmentsthrough private placements.

# ** **

# **Note3.**       Sale of Finnish Subsidiary Neuromag OY

 

In December 1999, the Company acquired Neuromag Oy, located in HelsinkiFinland for $10 million in cash and an interest-free minimum royalty obligationof $312,500 per year for eight years (totaling $2.5 million) to Marconi MedicalSystems, Inc., Cleveland, Ohio.  Thefunds for the purchase were provided by a loan from AIG Private Bank Ltd.(“AIG”) totaling $11 million secured by 100% of the outstanding and issuedcapital stock of Neuromag Oy and guaranteed by an entity unaffiliated with theCompany.

 

In April 2001, $8,951,000 of the debt to AIG was cancelled in exchangefor 42,623,810 shares of common stock of the Company as part of a privateplacement transaction with specified investors in accordance with Rule 506 ofRegulation D and Section 4(2) of the Securities Act of 1933, as amended.  The common stock was issued at a per-shareprice of $0.21.

 

The remainder of the AIG bank loan was restructured.  As restructured, the loan in the principalamount of $3,357,000 from AIG matured in July 2002 at which time the Companydefaulted on the loan.

 

Due to changes in the business environment and to satisfy the debt toAIG the Company decided to sell its Finnish subsidiary, Neuromag Oy.  The subsidiary was sold to VaandramolenHolding BV, or VHBV, in October 2002, for a total of $4,000,000 in cash.  $3,694,000 of the proceeds were used tofully pay the AIG bank debt, $100,000 were used to pay part of the existingintercompany debt and the remainder for general corporate purposes.

 

The Company adopted SFAS No. 142 in fiscal year 2002, which requiresthat goodwill and certain intangibles no longer be amortized, but insteadtested for impairment at least annually. Therefore, there was no goodwill amortization in fiscal year 2002,compared to $1,319,000 in fiscal year 2001. In the Company’s consolidated financial statements dated September 30,2002, the Company recognized a goodwill impairment of $5,974,000 due to thesale of the Company’s Finnish subsidiary in October 2002.  The Company retains responsibility for theroyalty obligations to Marconi after the sale of Neuromag Oy.

 

The Company adopted SFAS No. 144 in fiscal year 2002, which requiresthat adjustments to amounts previously reported in discontinued operations thatare directly related to the disposal of component of an entity in a priorperiod be classified separately in the current period in discontinuedoperations.  Pursuant to the sale ofNeuromag Oy in October 2002, the resolution of liability obligations directlyrelated to the sale resulted in the Company recognizing a net recorded gain of$455,000 on the sale of the Company’s Finnish subsidiary for the fiscal yearended September 30, 2003.

** **

# **Note 4.**       Financing and Equity Arrangements

 

For the past two years the Company has had significant liquidityconcerns.  The Company incurred a lossof $3,708,000 for the year ended September 30, 2003, had an accumulated deficitof $124,689,000 through the fiscal year ended September 30, 2003, and as ofthat date, current liabilities exceeded current assets by $1,717,000.

 

On or about November 5, 2002, the Company entered into another line ofcredit with AIG Bank for $1,000,000. Proceeds were used to pay off two unsecured loans from members of theCompany’s board of directors, each in the amount of $125,000 to pay off theunsecured loan from MATRUST, S.L., for $100,000, no interest was charged, to payoff the unsecured loan from International Sequoia Investment Ltd. for $100,000,no interest was charged and to pay off certain accounts payable in the amountof

 

50

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$120,000 to Dr. Galleon Graetz, a member of the board of directors anda consultant for the Company.  All ofthese amounts, totaling $570,000, were then pledged by the respective partiesas collateral against the loan.  Theremaining amount was used for general corporate purposes.

 

Additionally, Mr. Egli, a member of the Company’s board of directors,provided a personal guarantee of $500,000 and the Company pledged its patentportfolio and a Magnes 2500 WH system, currently installed at the University ofAlabama, to which the Company retains title.

 

Also, the Company issued 60,000,000 shares of its common stockrepresenting approximately 29% of its outstanding voting securities in aprivate placement transaction with Swisspartners Investment Network AG inaccordance with Rule 506 of Regulation D and Section 4(2) of the Securities Actof 1933, as amended, which was consummated on or about December 27, 2002**. **Thecommon stock was issued at a per-share price of $0.05, in exchange for cash inthe amount of $3,000,000.

# ** **

# **Note5.**       Debt

 

In January 2002, 4-D Neuroimaging obtained two $125,000 unsecuredloans, one from Enrique Maso and one from Swisspartners Investment Network Ltd., or Swisspartners,****withan interest rate of 8% per annum.  InAugust 2002, 4-D Neuroimaging obtained two $100,000 unsecured loans, one from MATRUST, S.L. and one from InternationalSequoia Investment Ltd.**,**with an interest rate of 8% perannum.  The principal amounts of theloans were repaid in November 2002, accrued interest for Enrique Maso wasrecorded as a gain on extinguishment of debt and is reflected in other incomeon the statement of operations.  Theaccrued interest for Swisspartners was due and payable in March 2003 and paidin April 2003.

 

In November 2002, the Company entered into another line of credit withAIG Bank for $1,000,000.  The intereston the line of credit is 4.17% and initially the line of credit was due andpayable November 5, 2003.  In January2003 the maturity of the line of credit was extended until May 31, 2004.  Proceeds were used to pay off the two $125,000unsecured loans from Enrique Maso and Swisspartners, the two $100,000 unsecuredloans from MATRUST, S.L. and International Sequoia Investment Ltd. and to paycertain accounts payable in the amount of $120,000 to Dr. Galleon Graetz, amember of the board of directors and a consultant for the Company.  All of these amounts, totaling $570,000,were then pledged by the respective parties as collateral against theloan.  The remaining amount was used forgeneral corporate purposes.

 

As additional collateral against the loan, Mr. Egli, a member of theCompany’s board of directors, provided a personal guarantee of $500,000 and theCompany pledged its patent portfolio and a Magnes 2500 WH system, currentlyinstalled at the University of Alabama, to which the Company retains title.

# ** **

# **Note6.**       Segment and Geographic Information

 

The Company operates in one segment that includes developing,manufacturing and selling MSI products. The Company’s operations can be divided into three markets: the basicresearch market, the clinical applications development market, and thecommercial clinical market. Substantially all of its revenues have been derived from, andsubstantially all its assets have been devoted to, the basic researchmarket.  The following table summarizesthe Company’s continuing operations of its revenues and long-lived assets,excluding intangible, deferred tax and prepaid assets.

 

In October 2002, the Company sold its Finnish subsidiary, Neuromag Oy,and these operations have been accounted for as discontinued operations for allof the periods presented and are not included in the segment data.

 

51

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|               |   | **Years  Ended September 30,** |      |
|--------------------|--------|--------------------------------|-----------|
|               |   | **2003**                       |      | **2002** |   |
| Revenues:          |   |                           |      |   |   |
| North America      |   | $                              | 2,148,162 |   | $ | 4,149,604 |   |
| Europe             |   | 557,011                        |      | 983,905 |   |
| Asia               |   | 103,656                        |      | 169,080 |   |
|               |   | $                              | 2,808,829 |   | $ | 5,302,589 |   |
| Long-Lived assets: |   |                           |      |   |   |
| North America      |   | 116,956                        |      | 193,033 |   |
| Europe             |   | 38,586                         |      | 40,029 |   |
|               |   | $                              | 155,542   |   | $ | 233,062 |   |

 

# **Note7.**       Concentrations of Risk

 

*CustomerConcentrations*

 

On average, the Company’s MEG systems generally sell for approximately$1.0 - $2.5 million, resulting in significant concentrations of revenues andaccounts receivable.  For the year endedSeptember 30, 2003 two customers represented 49% and 14% of product revenues,respectively.  For the year endedSeptember 30, 2002 seven customers represented 18%, 18%, 18%, 11%, 9%, 9% and5% of product revenues, respectively.

* *

*Distributor andVendor Concentrations*

 

In January 2000, the Company entered into an exclusive distributoragreement to market, sell, distribute and service its MEG products in certainregions of Asia, including Japan, for an initial period of three years.

** **

# **Note 8.**       Consolidated Financial Statement Information

 

In October 2002, the Company sold its Finnish subsidiary, Neuromag Oy,and these operations have been accounted for as discontinued operations for allof the periods presented and are not included in the segment data.

 

Inventories consist of the following as of September 30:

 
|            |   | **2003**  |      | **2002**  |   |
|-----------------|--------|-----------|-----------|-----------|--------|
| Finished goods  |   | $         | 803,005   |      | $      | 1,278,005 |   |
| Work-in-process |   | 1,976,501 |      | 2,006,716 |   |
| Raw materials   |   | 156,014   |      | 246,607   |   |
|            |   | $         | 2,935,520 |      | $      | 3,531,328 |   |

 

Net property and equipment consists of the following as of September30:

 
|                           |   | **2003**   |      | **2002**   |   |
|--------------------------------|--------|------------|-----------|------------|--------|
| Machinery and equipment        |   | $          | 1,481,778 |       | $      | 3,700,194 |   |
| Office furniture and equipment |   | 1,082,437  |      | 1,416,235  |   |
| Leasehold improvements         |   | 1,401,798  |      | 1,401,798  |   |
|                           |   | 3,966,013  |      | 6,518,227  |   |
| Less accumulated depreciation  |   | (3,810,471 | )         | (6,285,362 | )      |
|                           |   | $          | 155,542   |       | $      | 232,865 |   |

 

Accrued liabilities consist of the following as of September 30:

 
|                        |   | **2003** |    | **2002** |   |
|-----------------------------|--------|----------|---------|----------|--------|
| Warranty allowance          |   | $        | 554,167 |     | $      | 258,333 |   |
| Accrued interest            |   | 303,152  |    | 114,267  |   |
| Collaboration Agreement-MGH |   | —   |    | 130,417  |   |
| Other                       |   | 139,611  |    | 124,140  |   |
|                        |   | $        | 996,930 |     | $      | 627,157 |   |

 

52

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# **Note 9.**       Income Taxes

 

The components of deferred tax assets at September 30, 2003 and 2002are as follows:

 
|                                        |   | **2003**    |       | **2002**    |   |
|---------------------------------------------|--------|-------------|------------|-------------|--------|
| Net operating loss carryforwards            |   | $           | 16,175,000 |        | $      | 15,462,000 |   |
| Tax credits                                 |   | 1,096,000   |       | 1,096,000   |   |
| Capitalized research and development costs  |   | 216,000     |       | 372,000     |   |
| Allowances                                  |   | 1,095,000   |       | 869,000     |   |
| Capital loss and contribution carryforwards |   | 2,992,000   |       | —      |   |
| Other                                       |   | 239,000     |       | 310,000     |   |
|                                        |   | 21,813,000  |       | 18,109,000  |   |
| Valuation allowance                         |   | (21,813,000 | )          | (17,521,000 | )      |
| Net deferred tax assets                     |   | $           | —     |        | $      | 588,000 |   |

 

A valuation allowance for substantially all of the deferred tax assetshas been provided because realization of such future tax benefits cannot beassured.  The fiscal year 2002 netdeferred tax assets are attributable to the operations of Neuromag Oy.  The Company’s provision for income taxes infiscal years 2003 and 2002 consists of $800 of minimum state taxes.  The Company has approximately $44,400,000and $18,400,000 of Federal and State net operating loss carryforwards whichwill expire at various dates through 2022. As a result of ownership changes (as defined by Section 382 of theInternal Revenue Code of 1986, as amended) which occurred in fiscal year 1995and fiscal year 1997, the Company’s Federal tax loss carryforwards generatedprior to fiscal year 1997 have been limited to a total of approximately$14,039,000 of which approximately $930,000 can be utilized per year as ofSeptember 30, 2003.  Any additionalownership changes may further limit the utilization of the net operating losscarryforwards.

 

The provision for income taxes reconciles to the amount computed byapplying the federal statutory rate to loss before provision for income taxesas follows:

 
|                                  |   | **2003**   |       | **2002**  |   |
|---------------------------------------|--------|------------|------------|-----------|--------|
| Computed expected federal tax benefit |   | $          | (1,243,878 | )         | $      | (3,412,961 | ) |
| State taxes, net of federal benefit   |   | (213,289   | )          | (585,723  | )      |
| Change in valuation reserve           |   | 4,292,000  |       | 1,351,800 |   |
| Impairment of goodwill                |   | —     |       | 2,379,385 |   |
| Tax loss on subsidiary sale           |   | (2,987,918 | )          | —    |   |
| Other                                 |   | 153,885    |       | 268,299   |   |
| Provision for income taxes            |   | $          | 800        |      | $      | 800 |   |

 

# **Note 10.**     Commitments and Contingencies

* *

*Lease Commitments*

 

Cost of equipment under capital leases included in property andequipment in the accompanying consolidated balance sheets totaled $69,363 withrelated accumulated depreciation of $57,803 as of September 30, 2003.

 

The Company leases its facility pursuant to a five-year leaseagreement.  In February 2003, we signeda new five-year lease agreement with the owners of the property where ourheadquarters are located in San Diego. The lease expires in February 2008. The leased space has been reduced to approximately 46,000 square feetand the average monthly lease payment for the first year and over the term ofthe lease will be approximately $35,000 and $52,000 respectively.  We sublease approximately 450 square feet ofthe leased facility on a month-to-month basis to one company for a net monthlyrent of approximately $425.

 

The branch office in Germany leases approximately 3,000 square feet atGruener Weg 82, D-5100 Aachen, Germany pursuant to a year-to-year leaseagreement expiring in December 2003. Monthly lease payments are approximately $2,000.  Sales and service for the Europeanoperations are conducted from the German facility.

 

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Approximate minimum future lease payments excluding Neuromag Oy, (netof sub-lease payments) as of September 30, 2003 are as follows:

 
| **Year Ending September 30,**                      |   | **Capital  Leases** |   | **Operating  Leases** |      |
|----------------------------------------------------|--------|---------------------|--------|-----------------------|-----------|
| 2004                                               |   | $                   | 7,893  |                  | $         | 438,192 |   |
| 2005                                               |   | —              |   | 520,208               |      |
| 2006                                               |   | —              |   | 596,205               |      |
| 2007                                               |   | —              |   | 616,028               |      |
| 2008                                               |   | —              |   | 260,520               |      |
| Thereafter                                         |   | —              |   | —                |      |
|                                               |   | 7,893               |   | $                     | 2,431,153 |   |
| Less amount representing interest                  |   | (256                | )      |                  |      |
| Present value of obligations under capital  leases |   | 7,637               |   |                  |      |
| Current portion                                    |   | (7,637              | )      |                  |      |
|                                               |   | $                   | — |                  |      |   |

 

Total rent expense was approximately $576,000 and $772,000 for theyears ended September 30, 2003 and 2002, respectively.

* *

*ClinicalCollaborations*

 

The Company is currently involved with clinical collaborationagreements with certain medical institutions utilizing the Company’s MEGsystems for research.  Under terms ofthe agreements, the Company provided certain services, product and technicalsupport and under one agreement is entitled to revenue sharing from medicalreimbursements received.  During fiscalyears 2003 and 2002, the Company incurred $19,000 and $65,000, respectively, ofexpenses related to those agreements and at September 30, 2003, the Company hadno further commitments of this type. During fiscal years 2003 and 2002, revenue sharing of $177,000 and$141,000, respectively, was recognized.

* *

*Legal Matters*

 

In the ordinary course of business, the Company is subject to claimsand, from time to time, is named in various legal proceedings.  In the opinion of management, the amount ofultimate liability, if any, with respect to any actions will not materiallyaffect the financial position or results of operations of the Company.

 

# **Note 11.**     Shareholders’ Equity

* *

*Common Stock*

** **

For fiscal year ended 2003, the common sharesauthorized increased from 300,000,000 to 500,000,000 shares.

 

On or about April 26, 2001, the Companyissued 59,549,081 shares of its common stock representing approximately 41% ofits outstanding voting securities in a private placement transaction withspecified investors in accordance with Rule 506 of Regulation D and Section4(2) of the Securities Act of 1933, as amended.  The common stock was issued at a per-share price of $0.21, inexchange for cancellations of indebtedness in the aggregate amount of$10,505,307 and cash in the aggregate sum of $2,000,000.

 

The $10,505,307 in cancellations ofindebtedness consisted of a partial cancellation of indebtedness in the amountof $8,951,000 by AIG Bank according to a letter agreement dated on or aboutApril 25, 2001 between AIG Bank and 4-D Neuroimaging, full cancellations ofindebtedness in the amounts of $872,867 and $224,875 by Swisspartners, a fullcancellation of indebtedness in the amount of $224,875 by MATRUST, S.L., a fullcancellation of indebtedness by Sequoia, in the amount of $224,875, and a fullcancellation of indebtedness in the amount of $6,815 from Amaldos, S.A.  The full cancellations of indebtedness enteredinto between the Company and each of Amaldos, S.A., MATRUST, S.L., Sequoia

 

54

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and Swisspartners represent the portion ofthe debt assigned to each such entity by BDN upon its reduction ofcapital.  Martin Egli, a member of theCompany’s board of directors, is also a member of the board of directors of AIGBank and is a managing partner of Swisspartners.  Dr. Maso, a member of the Company’s board of directors, is amajority shareholder in MATRUST, S.L. Mr. Velasco, a member of the Company’s board of directors, is a majorinvestor in Sequoia.

* *

*Stock Option Plans*

 

The Company has various incentive and non-qualified stock option planswhich provide that options to purchase shares of common stock may be granted tokey employees and others at an option price of at least fair market value atthe date of grant and vest over a maximum period of four years from the date ofgrant.  The exercise period for eachoption is not to exceed 10 years from the date of grant.  On December 31, 1996, the Company’s 1987Incentive Stock Option Plan that provided options to purchase up to 5,000,000shares of common stock expired.  AtJanuary 1, 1997, the 1997 Incentive Stock Option Plan was approved by the boardof directors authorizing options to purchase 3,000,000 shares of commonstock.  In May 1999, March 2000, March2002 and March 2003 shareholders approved amendments of the 1997 IncentiveStock Option Plan, increasing the number of shares authorized for issuance to80,000,000 shares of common stock.

 

The following table summarizes option plan activity:

 
|                              |   | **Options** |   | **Weighted  Average  Exercise Price** |   |
|-----------------------------------|--------|-------------|--------|---------------------------------------|--------|
| Outstanding at September 30, 2001 |   | 5,483,119   |   | $                                     | 0.38   |   |
| Granted                           |   | 250,000     |   | $                                     | 0.14   |   |
| Canceled                          |   | (69,700     | )      | $                                     | 0.27   |   |
| Exercised                         |   | (200,000    | )      | $                                     | 0.15   |   |
|                              |   |        |   |                                  |   |
| Outstanding at September 30, 2002 |   | 5,463,419   |   | $                                     | 0.37   |   |
| Granted                           |   | 1,540,000   |   | $                                     | 0.05   |   |
| Canceled                          |   | (645,900    | )      | $                                     | 0.30   |   |
| Exercised                         |   | (1,500,000  | )      | $                                     | 0.05   |   |
| Outstanding at September 30, 2003 |   | 4,857,519   |   | $                                     | 0.37   |   |

 

The following table summarizes stock options outstanding as ofSeptember 30, 2003:

 
|                          |       | **Outstanding** |      | **Vesting**                                              |   |
|-------------------------------|------------|-----------------|-----------|----------------------------------------------------------|--------|
| **Range of  Exercise Prices** |       | **Options**     |      | **Weighted-Avg.  Remaining  Contractual  Life In Years** |   | **Weighted  Average  Exercise Price** |   | **Options** |   | **Weighted  Average  Exercise Price** |   |
| $                             | 0.06- 0.20 |            | 142,000   |                                                     | 6.71   |   | $ | 0.13 |   | 134,500 |   | $ | 0.13 |   |
| $                             | 0.21- 0.28 |            | 1,776,050 |                                                     | 5.69   |   | $ | 0.23 |   | 1,776,050 |   | $ | 0.23 |   |
| $                             | 0.32- 0.37 |            | 45,000    |                                                     | 5.40   |   | $ | 0.34 |   | 45,000 |   | $ | 0.34 |   |
| $                             | 0.42- 0.50 |            | 2,875,569 |                                                     | 3.53   |   | $ | 0.47 |   | 2,875,569 |   | $ | 0.47 |   |
| $                             | 0.59- 0.75 |            | 18,900    |                                                     | 4.74   |   | $ | 0.69 |   | 18,275 |   | $ | 0.69 |   |
|                          |       | 4,857,519       |      | 4.43                                                     |   | $ | 0.37 |   | 4,849,394 |   | $ | 0.37 |   |

 

If the Company had elected to recognize stock-based employeecompensation costs (including the Company’s Employee Stock Purchase Plan) basedon the fair value on the date of grant consistent with the provisions of SFASNo. 123, net loss and basic and diluted net loss per share would have beenincreased to the following amounts:

 
|                                            |   | **2003** |       | **2002** |   |
|-------------------------------------------------|--------|----------|------------|----------|--------|
| Pro forma net loss                              |   | $        | (3,717,200 | )        | $      | (10,147,390 | ) |
| Pro forma basic and diluted net loss per  share |   | $        | (0.018     | )        | $      | (0.066 | ) |

 

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As required by SFAS No. 123, the Company provides the followingdisclosure of hypothetical values for their outstanding stock options.  The options are valued between $0.02 and$0.03 for the years ended September 30, 2003 and 2002.  This value was estimated using theBlack-Scholes option pricing model with the following weighted-averageassumptions for fiscal years ended September 30, 2003 and 2002: expecteddividend yield of 0%, expected volatility is between 2.50 and 2.61, risk freeinterest rate of 2.51% to 6.88% and expected life between 5 and 10 years.

 

The Black-Scholes option valuation model was developed for use inestimating the fair value of traded options that have no vesting restrictionsand are fully transferable.  Optionvaluation models also require the input of highly subjective assumptions suchas expected option life and expected stock price volatility.  Because the employee stock-basedcompensation plans have characteristics significantly different from those oftraded options and because changes in the subjective input assumptions canmaterially affect the fair value estimate, the Company believes that theexisting option valuation models do not necessarily provide a reliable singlemeasure of the fair value of awards from those plans.

* *

*Employee StockPurchase Plan*

 

In January 2002 the Company established another Employee Stock PurchasePlan in which eligible employees may use funds from accumulated payrolldeductions to purchase shares of common stock at the end of designated purchaseperiods.  Employees may contribute up to15% of their base salary toward such purchases, not to exceed $25,000 percalendar year.  The purchase price isthe lesser of 85% of the fair market value of common stock determined at thebeginning or end of the purchase period. In October 2003 the Company elected to discontinue the plan, due to thelow participation and high administrative costs.

 

# **Note 12.**     Employee Benefit Plans

 

The Company maintains a defined contribution 401(k) plan (the “Plan”)for substantially all of its U.S. employees. Those employees who participate in the Plan are entitled to makecontributions up to the IRS statutory contribution limits.  Company contributions to the Plan are discretionaryas determined by the board of directors and the Company did not contribute anyfunds to the Plan in fiscal years 2003 or 2002.

 

# **Note 13.**     Selected Quarterly Data (Unaudited)

 

Unaudited quarterly data for fiscal years 2003 and 2002 is summarized below:(In thousands, except per share data)

 
|                                           |   | **First  Quarter** |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   |
|------------------------------------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|
| 2003                                           |   |               |   |                |   |               |   |                |   |
| Net revenues                                   |   | $                  | 704    |                | $      | 202                |   | $                   | 193    |   | $ | 1,709 |   |
| Gross margin                                   |   | $                  | 17     |                | $      | (147               | )      | $                   | (56    | ) | $ | (103 | ) |
| Net income (loss)                              |   | $                  | 676    |                | $      | (1,093             | )      | $                   | (1,879 | ) | $ | (1,412 | ) |
| Basic and diluted net income (loss) per  share |   | $                  | 0.004  |                | $      | (0.005             | )      | $                   | (0.008 | ) | $ | (0.006 | ) |
|                                           |   |               |   |                |   |               |   |                |   |
| 2002                                           |   |               |   |                |   |               |   |                |   |
| Net revenues                                   |   | $                  | 745    |                | $      | 2,211              |   | $                   | 2,109  |   | $ | 238 |   |
| Gross margin                                   |   | $                  | (119   | )                   | $      | 380                |   | $                   | 622    |   | $ | (738 | ) |
| Net income (loss)                              |   | $                  | (1,216 | )                   | $      | (826               | )      | $                   | 254    |   | $ | (8,250 | ) |
| Basic and diluted net income (loss) per  share |   | $                  | (0.01  | )                   | $      | (0.01              | )      | $                   | 0.002  |   | $ | (0.05 | ) |

 

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**4-D NEUROIMAGING**

 

**SCHEDULE II** –**VALUATIONAND QUALIFYING ACCOUNTS**

 
| **Description**                 |   | **Balance at  Beginning  of Period** |    | **Charged to  Costs and  Expenses** |   | **Deductions** |   | **Balance at  End of  Period** |   |
|---------------------------------|--------|--------------------------------------|---------|-------------------------------------|--------|----------------|--------|--------------------------------|--------|
|                            |   |                                 |    |                                |   |           |   |                           |   |
| Allowance for doubtful accounts |   |                                 |    |                                |   |           |   |                           |   |
|                            |   |                                 |    |                                |   |           |   |                           |   |
| Fiscal Year 2003                |   | $                                    | 216,124 |                                | $      | 68,328         |   | $                              | — |   | $ | 284,452 |   |
|                            |   |                                 |    |                                |   |           |   |                           |   |
| Fiscal Year 2002                |   | $                                    | 210,000 |                                | $      | 6,124          |   | $                              | — |   | $ | 216,124 |   |

 

(A)     Collection of previouslyreserved amounts

 

Allowance for obsolete and slow moving inventory

 
| Fiscal Year 2003 |   | $      | 1,487,707 |   | $      | 190,000 |   | $      | 1,468  | (B) | $ | 1,676,239 |   |
|------------------|--------|--------|-----------|--------|--------|---------|--------|--------|--------|-----|---|-----------|--------|
|             |   |   |      |   |   |    |   |   |   |
| Fiscal Year 2002 |   | $      | 1,334,997 |   | $      | 170,000 |   | $      | 17,290 | (B) | $ | 1,487,707 |   |

 

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(B)      Sale or disposal of itemsunder allowance

 

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