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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2004oro
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission file number 0-21982 DIAMETRICS MEDICAL, INC.  MINNESOTA
    
    41-1663185(State or other jurisdiction of incorporation or organization)
    
    (IRS Employer Identification Number)3050 Centre Pointe Drive, Suite 150Roseville, Minnesota
    
    55113(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (651) 639-8035 Securities registered pursuant to Section 12(b) of the Act: None  Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ       No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. o Indicate by check mark whether the Registrant is an accelerated filer (as defined by Rule
12b-2 of the Act). Yes o       No þ The aggregate market value of voting stock held by non-affiliates of the Registrant as of June
30, 2004, (the last business day of the Registrants second fiscal quarter) was approximately
$8,400,000 (based upon the last sale price of such stock as quoted on the OTCBB ($0.24). As of May 2, 2005, the Registrant had 35,121,835 shares of Common Stock outstanding.




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DIAMETRICS MEDICAL, INC. Annual Report on Form 10-K
For the year ended December 31, 2004 PART I.Item 1. Business
    
    
    3Item 2. Properties
    
    
    9Item 3. Legal Proceedings
    
    
    9Item 4. Submission of Matters to a Vote of Security Holders
    
    
    9PART II.Item 5. Market for Registrants Common Equity and Related Stockholder Matters and Issuer Purchases of Equity
    
    
    9Item 6. Selected Financial Data
    
    
    10Item 7. Managements Discussion and Analysis of Results of Operations and Financial Condition
    
    
    12Item 7a. Quantitative and Qualitative Disclosures About Market Risk
    
    
    19Item 8. Financial Statements and Supplementary Data
    
    
    20Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    51Item 9a. Controls and Procedures
    
    
    52Item 9b. Other Information
    
    
    53PART III.Item 10. Directors and Executive Officers of the Registrant
    
    
    53Item 11. Executive Compensation
    
    
    55Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    58Item 13. Certain Relationships and Related Transactions.
    
    
    62Item 14. Principal Accountant Fees and Services
    
    
    62PART IV.Item 15. Exhibits, Financial Statement Schedules and Reports on For 8-K
    
    
    64Signatures
  2




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PART I 
 Item 1. Business Overview Unless the context otherwise indicates, all references to the Registrant, the Company, or
Diametrics in this Annual Report on Form 10-K are to Diametrics Medical, Inc., a Minnesota
corporation, incorporated in January 1990, and where the context requires, its former subsidiary,
Diametrics Medical, Ltd. (DML), or its subsidiary TGC Research Limited (TGC). From its inception in 1990 until September 2003, the Company developed, manufactured and
distributed intermittent blood testing products based on electrochemical sensor technology. That
business was located in Roseville, Minnesota. The Company had also acquired a continuous
monitoring business in 1996. That business, known as Diametrics Medical, Ltd, operated as a
wholly owned subsidiary of the Company until November 1, 2004, with operations located in High
Wycombe, England. The Companys continuous monitoring systems were based on fiber optic sensor
technology which measured color changes optically via light transmitted through plastic fibers
embedded with fluorescent dyes sensitive to chemicals in blood and tissue. Significant changes occurred in the business of Diametrics Medical, Inc. during the years
ended December 31, 2003 and 2004. On September 29, 2003, the Company sold its intermittent
blood testing business to International Technidyne Corporation (ITC). In October 2004, the Company
discontinued its only other line of business, the manufacture and distribution of continuous blood
and tissue monitoring products. At December 31, 2004, the only employees of the Company were its
three officers and its only activities related to the planned start-up of a new product research
project focused on the development of products aimed at continuous glucose monitoring and control
in critically ill patients, based in part on information obtained during its previous business
activities. The Companys historical operations never produced net income or positive cash flow necessary
to continue product and market development activities in either the intermittent and continuous blood
testing lines of business. External fund raising efforts became increasingly more difficult, and
the Board of Directors decided in early 2003 to dispose of one of its lines of business in order to
focus all resources on the other line of business. The sale of the intermittent testing business,
however, did not generate sufficient cash to meet all the product and market development
requirements of the continuous monitoring business. Although those products represented the only
continuous blood and tissue monitoring systems in the market, the medical procedures that utilized
them had not become the standard of care and market growth was slow. The Company did succeed in
raising additional capital for those efforts in January 2004 and May 2004, but its efforts to raise
another round in late 2004 were unsuccessful and the lack of funds left the Board of Directors no
choice other than ceasing operations at DML. On November 1, 2004, the Company terminated all of its
employees in the United Kingdom and all but four of its employees in the United States. On
November 22, 2004, a Meeting of Creditors was held in London, England for the purposes of
liquidating the assets of DML. In December 2004, the Company was able to raise additional funds through the issuance of $1.8
million of convertible debt and arranged an additional $1.2 million as part of the same financing
agreements, if it met certain requirements for increasing its authorized shares and registering for resale shares of its common stock
with the Securities and Exchange Commission. The funds raised in the first tranche are being used
in preparation for a new product development project for continuous glucose monitoring started
in early 2005. The Company did not meet all of the requirements for the second tranche, but has arranged an
additional loan of $150,000 under the same terms as the first tranche to continue the new product
planning process. Waivers of all events have been obtained with the understanding that
certain filings with the Securities and Exchange Commission would be complete by May 31, 2005. The Company has created a new wholly-owned subsidiary in the U.K., TGC Research Limited, for
the purpose of new product research and development, and a portion of the funds from the December
2004 financing were used to purchase certain equipment and intellectual property from the liquidator
of DML in early 2005. TGC will focus initially on the development of new products aimed at
continuous glucose monitoring and control in critically ill patients in a hospital setting. The
Company is aware that clinical practices in this area have changed dramatically in recent years.
The Company believes that clinical evidence has conclusively demonstrated that maintaining patients
within strict glycemic limits can dramatically reduce mortality, risk of infection and other
complications, and represents a significant business opportunity. The Company believes its
experience with in-vivo measurement systems positions it well to develop products that continuously
monitor glucose in intensive care units. The Company will have to raise substantial additional funds to complete its product
development activities, obtain regulatory clearance and implement a manufacturing and distribution
plan. 3




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The results of operations for the intermittent testing business have been reported as
discontinued operations for all periods presented in this report. Revenues of the intermittent
testing business totaled $4.8 million for the year ended December 31, 2003, and $12.3 million for
the year ended December 31, 2002. Net losses attributable to the intermittent testing business
during the same periods totaled $2.1 million and $1.9 million, respectively. The carrying value of
assets sold to ITC approximated $3 million and ITC assumed liabilities of the intermittent testing
business totaling $669,000. The results of operations for the continuous monitoring business have also been reported as
discontinued operations for all periods presented in this report. Revenues of the continuous
monitoring business totaled $2.4 million, $3.1 million and $5.5 million, respectively for the three
years ended December 31, 2004, 2003 and 2002. Net losses attributable to that business during
those periods were $4.1 million, $6.2 million and $2.4 million, respectively. The Companys principal executive office is located at 3050 Centre Pointe Drive, Suite 150,
Roseville, Minnesota 55113, and its telephone number is (651) 639-8035. The Companys website is
located at www.diametrics.com. Its Annual Report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and any amendments to those reports are made available to the public
free of charge as soon as reasonably practicable after such material is filed with the SEC. RISK FACTORS We may not be able to develop our new products successfully. Under our current business plan, our Companys future success initially will be dependent upon
our ability to successfully identify, develop, produce and market a new product line to
continuously monitor blood glucose levels in critically ill hospitalized patients. However, the
relevant technology is currently unproven and we may not be able to develop it through the
necessary clinical trial phases. In developing these new product(s) we will be incurring all costs of development, market
research, manufacturing, market development and sales and marketing expenses. Our success will be
dependent on our ability to successfully accomplish these goals in a timely fashion. There can be
no assurance that revenues, if any, from these new product(s) will be sufficient to recoup our
expenses in developing and marketing any new product offerings. Moreover, there is no assurance
that we can manufacture these new product(s) at a cost, or sell these product(s) at a price, that
will result in an acceptable rate of return for the Company. Market acceptance of these new
products may be slow or customers may not accept the new products at all. If we cannot
successfully develop and market new product(s), our financial performance and results of operations
will be adversely affected. We may not be able to establish market acceptance for our new products. Market acceptance of our product(s) will depend, in part, on the capabilities and operating
features of our product(s) compared to other alternatives available to critical care clinicians,
our ability to convince the medical community of the clinical efficiency of our products,
the timeliness of our product introductions and our ability to manufacture quality products
profitability and in sufficient quantities. Failure of our products to gain market acceptance
would have a material adverse effect on our business, financial condition and results of
operations. Furthermore, even if there is growth in the markets for our products, there can be no
assurance that we will participate in such growth. We have received a qualified opinion from our independent auditors, have a history of operating
losses, and may not achieve profitability sufficient to generate a positive return on your
investment. We have incurred net operating losses since our inception. We have prepared our consolidated
financial statements for the year ended December 31, 2004 on a going-concern basis, which
contemplates the realization of assets and satisfaction of liabilities and other commitments in the
normal course of business. The report of our independent registered public accounting firm
covering the December 31, 2004 consolidated financial statements contains an explanatory paragraph
expressing substantial doubt about our ability to continue as a going concern as a result of
recurring losses and negative cash flows. We incurred a consolidated net loss of $11,868,578 for
the year ended December 31, 2004 and consolidated net losses of $8,479,145 and $7,531,016 for the
years ended December 31, 2003 and 2002, respectively. For our discontinuing operations, we
incurred net losses of $6,007,660, $6,409,951 and $4,232,424 for the years ended December 31, 2004,
2003 and 2002, respectively. Our accumulated deficit as of December 31, 2004 was $167,882,627. We
expect to incur net operating losses at least through 2008. We do not have a history of operations
with our proposed new product line and are, in many respects, subject to all the risks inherent in
the establishment of a new business enterprise. You should view us as a start-up company with all
the associated risks and uncertainties. Start-up companies frequently incur losses before
achieving any degree of profitability and many of them never become profitable. Thus, our likelihood of success must be considered in light
of the problems, delays, expenses and difficulties frequently 4




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encountered in connection with the
launch of a new business, the utilization of new and developing technologies and the competitive
and regulatory environment in which we intend to operate. We cannot assure you that we will ever
generate substantial revenues or achieve profitability at a level sufficient to generate a positive
return on your investment. If we are unable to raise an adequate level of additional capital or
generate sufficient cash flows from operations, we may be unable to execute our business plan and
remain a going concern. We may be unable to raise additional funds or generate sufficient cash from operations to meet
our future capital requirements and execute our business plan. Our long-term capital requirements for the development of our continuous glucose monitoring
business will depend upon numerous factors, including the rate of market acceptance of our
products; the level of resources devoted to expanding our business and manufacturing capabilities;
and the level of research and development activities. Cash including restricted cash increased by
$204,000 during the year ended December 31, 2004 to $1.1 million. Cash on hand at December 31, 2004
was expected to provide five to six months of funding as we developed plans for our new product
development activities. An additional $150,000 was borrowed in May 2005 and additional amounts
will likely be required to complete the planning process. We are monitoring our cash position
carefully and evaluating our future operating cash requirements in the context of our strategy,
business plan and expected operating performance. As part of this, we have delayed certain project
spending and capital expenditures, and implemented other cost-cutting measures across all areas of
our operations. We will be required to raise additional capital in order to sustain and fund our operations
over the long term. Our initial projections indicated a need for $10 million to $15 million, which
may be adjusted as we develop our business plan and evaluate further the need for costs of product
enhancements and sales and marketing programs. We do not currently have any available lines of
credit or other credit facilities and we are not certain that we can obtain financing or, if it is
available, whether it will be on acceptable terms. We may pursue the issuance of additional equity
or debt securities to the extent funding raised from other business alternatives is not sufficient
to meet our funding requirements. If we raise additional funds through the issuance of equity or
equity-related securities, our shareowners may experience dilution of their ownership interests and
the newly issued securities may have rights superior to those of common stock. If we raise
additional funds by issuing debt, we may be subject to restrictive covenants that could limit our
operating flexibility. While we believe that we will be able to raise adequate funding to meet our
operational requirements, there can be no assurance that adequate funds will be available when
needed and on acceptable terms. If we are unable to obtain additional financing when needed, we
would be required to significantly scale back development plans and, depending upon cash flow from
our business, reduce the scope of our operations or cease operations entirely. We may make additional strategic changes to our product portfolio but our strategic changes
and restructuring programs may not yield the benefits that we expect. Since September 2003, we have divested or closed our two original product lines and businesses
because they were not profitable and embarked on our new strategic plan of developing a new product
line focused on continuous glucose monitoring. As necessary, we may make further changes to product
lines and business plans. We also may make strategic acquisitions. The impact of potential changes to our product portfolio and the effect of such changes on our
business, operating results and financial condition are unknown at this time. If we acquire other
businesses in our areas of strategic focus, we may have difficulty assimilating these businesses
and their products, services, technologies and personnel into our operations. These difficulties
could disrupt our ongoing business, distract our management and workforce, increase our expenses
and adversely affect our operating results and financial condition. In addition to these
integration risks, if we acquire new businesses we may not realize all of the anticipated benefits
of these acquisitions and we may not be able to retain key management, technical and sales
personnel after an acquisition. We face significant competition in the medical device industry that may have a negative impact on
our potential market share. Our industry is characterized by rapidly evolving technology and intense competition. Many of
our competitors have substantially greater capital resources, research and development staff and
facilities than we do and many of these companies also have greater experience in research and
development, obtaining regulatory approvals, manufacturing, and sales and marketing. We cannot
assure you that our competitors will not succeed in developing or marketing technologies and
products that are more effective or less expensive than ours and therefore make our products
obsolete or noncompetitive. Although we anticipate that our new products may offer certain
technological advantages over our competitors current products, earlier entrants in the market
often obtain and maintain significant market share. Our financial success will depend upon our ability to manage any growth in our business with
limited resources. If we are successful in developing and marketing a continuous glucose monitoring product or
other products, we may be required to expand our operations. Such expansion could result in new
and increased responsibilities for our management personnel and place significant strain on our
management, operating and financial systems and other resources. To accommodate any such growth
and compete effectively, 5




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we may be required to implement improved information systems, procedures
and controls, and to expand, train, motivate and manage our work force. Our future success will
depend to a significant extent on the ability of our current and future management personnel to
operate effectively both independently and as a group. We cannot assure you that our personnel,
systems, procedures and controls will be adequate to support our future operations. We depend on patents and proprietary technology, that we may not be able to protect in a manner
that will provide us any competitive advantage. Our success will depend in part on our ability to obtain patent protection for our products
and processes, to preserve our trade secrets and to operate without infringing the intellectual
property rights of others. The patent positions of medical device companies are uncertain and
involve complex and evolving legal and factual questions. We cannot assure you that any of our
future patent applications will result in issued patents; that any current or future patents will
not be challenged, invalidated or circumvented; that the scope of any of our patents will exclude
competitors; or that the patent rights granted to us will provide us any competitive advantage. In
addition, we cannot assure you that our competitors will not seek to apply for and obtain patents
that will prevent, limit or interfere with our ability to make, use or sell our products either in
the United States or in international markets. Further, the laws of certain foreign countries may
not protect our intellectual property rights to the same extent as do the laws of the United
States. In addition to patents, we rely on trade secrets and proprietary knowledge that we seek to
protect, in part through confidentiality agreements with employees, consultants and others. We
cannot assure you that our proprietary information or confidentiality agreements will not be
breached; that we will have adequate remedies for any breach; or that our trade secrets will not
otherwise become known to or independently developed by competitors. We may face intellectual property infringement claims, which would be costly to resolve and may
exceed our financial resources to assert or defend our claim. There has been substantial litigation regarding patent and other intellectual property rights
in the medical device industry and our competitors may resort to intellectual property litigation
as a means of competition. Intellectual property litigation is complex and expensive and the
outcome is difficult to predict. We cannot assure you that we will not become subject to patent
infringement claims or litigation. Litigation or regulatory proceedings may also be necessary to
enforce our patents or other intellectual property rights. We may not always have the financial
resources to assert patent infringement suits or to defend ourselves from claims. An adverse
result in any litigation could subject us to significant liabilities to, or require us to seek
licenses from or pay royalties to, others. Furthermore, we cannot assure you that the necessary
licenses would be available to us on satisfactory terms, if at all. The demand for and price of our products may depend in part on uncertain government health care
policies and reimbursement by third parties, and which could decline as a result of future health
care reform. The willingness of hospitals or others to purchase our products may depend on the extent to
which they limit their own capital expenditures due to existing or future cost reimbursement

regulations. In addition, sales volumes and prices of our products in certain markets will depend
in part on the level of reimbursement to hospitals for blood analysis from third-party payers, such
as government and private insurance plans, health maintenance organizations and preferred provider
organizations. Third-party payers are increasingly challenging the pricing of medical procedures
they consider unnecessary, inappropriate or not cost-effective. We cannot assure you that current
reimbursement amounts, if any, will not be decreased in the future, and that any decrease will not
reduce the demand for or the price of our products. Any federal or state health care reform
measures could adversely affect the price of medical devices in the United States, including our
products, or the amount of reimbursement available. We cannot predict whether any reform measures
will be adopted or what impact they may have on us. We must obtain and maintain regulatory approval in order to sell our products. Our business is regulated by the Food and Drug Administration. We will need to obtain
pre-market notification clearances under Section 510(k) to market a continuous glucose monitoring
system or other medical device products we develop. Obtaining FDA clearance can be a lengthy and
expensive process with an uncertain outcome. A Section 510(k) clearance is subject to continual
review and later discovery of previously unknown problems may result in restrictions on marketing
or withdrawal of the product from the market. We will also market our products in several foreign
markets. Requirements vary widely from country to country, ranging from simple product
registrations to detailed submissions such as those required by the FDA. Our manufacturing
facilities will also be subject to FDA inspection on a periodic basis and we and our contract
manufacturers will need to demonstrate compliance with current Quality System Regulations
promulgated by the FDA. Violations of the applicable regulations at our manufacturing facilities
or the manufacturing facilities of our contract manufacturers could prevent us from marketing our
products. 6




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International operations will expose us to additional risks that could have an adverse effect on
our ability to market our products abroad. We expect that distributors would sell our products globally, including international markets,
subject to receipt of required foreign regulatory approvals. We cannot assure you that such
distributors would devote adequate resources to selling our products internationally. Doing
business outside of the United States also exposes us to various risks that could have a material
and adverse effect on our ability to market our products internationally, including:  
    changes in overseas economic and political conditions,
    currency exchange rate fluctuations,
    foreign tax laws, or
    tariffs or other trade regulations. Our business is also expected to subject us and our representatives, agents and distributors
to laws and regulations of the foreign jurisdictions in which they operate or our products are
sold. We may depend on foreign distributors and agents for compliance and adherence to foreign
laws and regulations. We have no control over most of these risks and may be unable to anticipate
changes in international economic and political conditions, and may be unable to alter our business
practices in time to avoid any adverse effects. Compliance with changing regulation of corporate governance and public disclosure may result
in additional expenses. Changing laws, regulations and standards relating to corporate governance and public
disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and stock market rules
are creating uncertainty for companies such as ours. These new or changed laws, regulations and
standards are subject to varying interpretations in many cases due to their lack of specificity
and, as a result, their application in practice may evolve over time as new guidance is provided by
regulatory and governing bodies, which could result in continuing uncertainty regarding compliance
matters and higher costs necessitated by ongoing revisions to disclosure and governance practices.
We are committed to maintaining high standards of corporate governance and public disclosure. As a
result, our efforts to comply with evolving laws, regulations and standards have resulted in, and
are likely to continue to result in increased general and administrative expenses and a diversion
of management time and attention from revenue-generating activities to compliance activities. In
particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the
related regulations regarding our required assessment of our internal controls over financial
reporting and our external auditors audit of that assessment will require the commitment of
significant resources. We expect these efforts to require the continued commitment of significant
resources, both financial and managerial. Further, our board members, chief executive officer and
chief financial officer could face an increased risk of personal liability in connection with the
performance of their duties. As a result, we may have difficulty attracting and retaining
qualified board members and executive officers, which could harm our business. Failure to achieve and maintain effective internal controls could have a material adverse
effect on our business, operating results and stock price. Although we currently qualify as a non-accelerated filer for purposes of filing required
reports under the Securities Exchange Act of 1934, prior to December 31, 2004 we were deemed to be
an accelerated filer. As a result, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,
beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2004 we are
required to furnish a report by our management on our internal control over financial reporting.
Such report will contain, among other matters, an assessment of the effectiveness of our internal
control over financial reporting as of the end of our fiscal year, including a statement as to
whether or not our internal control over financial reporting is effective. This assessment must
include disclosure of any material weaknesses in our internal control over financial reporting
identified by management. Such report will also contain a statement that our auditors have issued
an attestation report on managements assessment of such internal controls. In late November 2004, the Securities and Exchange Commission issued an exemptive order
providing a 45 day extension for the filing of these reports and attestations by eligible
companies. We intended to utilize this 45 day extension. Because of the change in our independent
auditors and the significant change in our business operations during 2004 and the resulting delay
in the completion of our audit for the fiscal year ended December 31, 2004, we have not yet been able to complete the
process of documenting and testing our internal control procedures in order to satisfy the
requirements of Section 404 of the Sarbanes-Oxley Act and have not been able to meet the deadline
currently imposed on us, potentially subjecting us to regulatory sanctions. We intend to provide
the required management and auditor attestation reports in an amendment to our Form 10-K as soon as
practicable. During the course of our testing, we may identify deficiencies which we may not be
able to remediate adequately for compliance with the requirements of Section 404. In addition, if
we fail to achieve and maintain the adequacy 7




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of our internal controls, as such standards are
modified, supplemented or amended from time to time, we may not be able to ensure that we can
conclude on an ongoing basis that we have effective internal controls over financial reporting in
accordance with Section 404 of the Sarbanes-Oxley Act of 2002. Moreover, effective internal
controls are necessary for us to produce reliable financial reports and are important to helping
prevent financial fraud. If we cannot provide reliable financial reports or prevent fraud, our
business and operating results could be harmed, investors could lose confidence in our reported
financial information and the trading price of our stock could drop. Our common stock is traded on the Over-the-Counter Bulletin Board which may result in reduced
liquidity for our common stock. On July 1, 2003, we announced that we received a notice from The Nasdaq Stock Market
indicating that the Nasdaq Listing Qualifications Panel determined to delist our common stock from
The Nasdaq SmallCap Market effective July 2, 2003. Our common stock became immediately eligible to
trade on the OTC Bulletin Board, an NASD-sponsored and operated inter-dealer automated quotation
system for equity securities not included on The Nasdaq Stock Market, under the symbol DMED.
Trading our common stock through the OTC Bulletin Board may be more difficult because of lower
trading volumes, transaction delays and reduced security analyst and news media coverage. These
factors could contribute to lower share prices and larger spreads in the bid and ask prices for our
common stock. Trading of our common stock in an over-the-counter market may also attract a
different type of investor in our common stock which may limit further our future equity funding
options. Failure on our part to maintain our eligibility for trading on the OTCBB, such as for
failure to timely file required reports under the Securities Exchange Act, may further reduce the
liquidity of our common stock as well as result in an event of default under the terms of our
outstanding convertible debt. Our stock price is volatile. As a result of the decline in our operations and the change in our business strategy, our
stock price is highly volatile. For example, in the fifty-two weeks prior to December 31, 2004,
the trading price of our common stock has ranged from a high of $0.54 per share to a low of $0.02
per share. Our stock price may be affected by a number of factors, such as:  
    our ability to develop a marketable product;
    our cash liquidity and ability to raise additional funding;
    adverse developments regarding the safety and efficacy of our products;
    changes in reimbursement policies or medical practices;
    clinical trial results;
    product development announcements by us or our competitors;
    regulatory matters;
    intellectual property and legal matters; and
    broader economic, industry and market trends unrelated to our performance. Our outstanding convertible debt, convertible preferred stock and warrants may have an adverse
effect on the market price of common stock and make it more difficult to effect a business
combination. We
currently have approximately 600,000,000 shares of common stock reserved for issuance upon
exercise or conversion of outstanding convertible notes, convertible preferred stock and warrants
that were issued in conjunction with previous rounds of financing. The sale, or even the
possibility of sale, of the shares underlying the convertible securities could have an adverse
effect on the market price for our common stock or on our ability to obtain future public
financing. Additionally, the potential for the issuance of substantial numbers of additional shares
upon exercise of these convertible securities could make us a less attractive acquisition vehicle
in the eyes of a target business as such securities, when exercised, will increase the number of
issued and outstanding shares of our common stock and reduce the value of the shares issued to complete the business combination. Accordingly, our convertible
securities may make it more difficult to effectuate a business combination or increase the cost of
the target business. Additionally, if and to the extent these warrants and options are exercised,
you may experience dilution to your holdings. We have not in the past and do not intend in the foreseeable future to pay cash dividends on
our common stock. We currently do not pay any cash dividends on our common stock and do not anticipate paying
any cash dividends on our common stock in the foreseeable future. We intend to retain future
earnings, if any, to finance our operations and for general corporate purposes. 8




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Item 2. Properties The Companys principal executive offices are located in Roseville, Minnesota, and
consists of approximately 3,500 square feet of office space leased through November 2008.
During the year ended December 31, 2004, the Companys other principal properties were as
follows: ApproximateSquareLocation of Property
    
    Use of Facility
    
    Footage
    
    Lease Expiration DateHigh Wycombe, United Kingdom
    
    Manufacturing, process
engineering and materials
management
    
    
    14,500
    
    
    June 2005 (2)High Wycombe, United Kingdom
    
    Sales support, marketing and
administration
    
    
    5,500
    
    
    May 2004 (1)High Wycombe, United Kingdom
    
    Research and development
    
    
    6,000
    
    
    April 2005 (2)Malvern, Pennsylvania
    
    Research and development
    
    
    2,700
    
    
    March 2007 (3)
   (1)
    
    Lease was terminated May 31, 2004 and a termination penalty of 30,000 British pounds sterling
was subsequently paid.(2)
    
    Lease was terminated November 22, 2004 as part of the liquidation of Diametrics Medical, Ltd.(3)
    
    Space was vacated in 2004 and efforts undertaken to sublease for remainder of term. In
addition, the Company is negotiating with the landlord for an early termination of the lease. The Company is evaluating facilities required for its projected future needs. 
 Item 3. Legal Proceedings The Company is currently not subject to any material pending or threatened legal proceedings. 
 Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2004. 
 PART II 
 Item 5. Market for Registrants Common Equity and Related Stockholder Matters On January 9, 2003, the Company received a NASDAQ Staff Determination indicating
that the Company did not comply with the minimum stockholders equity requirement for continued
listing on the NASDAQ National Market set forth in Marketplace Rule 4450(a)(3), and that its
securities were subject to delisting from that market. The Company subsequently applied and
received approval to transfer the listing of its securities to the NASDAQ SmallCap Market effective
February 26, 2003. On April 25, 2003, the Company received a NASDAQ Staff Determination indicating
that it failed to comply with the minimum common stock market value requirement for continued
listing on the NASDAQ SmallCap Market set forth in Marketplace Rule 4310(c)(2)(B)(ii), and that its
securities were subject to delisting. On July 1, 2003, the Company received a notice from the
NASDAQ Stock Market indicating that, following a review of an appeal the Company presented on 9




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June 5, 2003, the NASDAQ Listing Qualifications Panel determined to
delist the Companys common stock from the NASDAQ SmallCap Market effective with the open of
business on Wednesday, July 2, 2003. The Companys common stock became immediately eligible to
trade on the Over-the-Counter Bulletin Board effective with the open of business on July 2, 2003
under the symbol DMED. The following table sets forth, for the periods indicated, the high and
low quarterly closing prices for the Common Stock as quoted on The NASDAQ National Market, The
NASDAQ SmallCap Market or the Over-the-Counter Bulletin Board, as applicable. 2004
    
    High
    
    
    LowFirst Quarter
    
    $
    0.54
    
    
    $
    0.29Second Quarter
    
    
    0.31
    
    
    
    0.09Third Quarter
    
    
    0.29
    
    
    
    0.10Fourth Quarter
    
    
    0.17
    
    
    
    0.02
 2003
    
    High
    
    
    LowFirst Quarter
    
    $
    1.94
    
    
    $
    0.69Second Quarter
    
    
    1.40
    
    
    
    0.54Third Quarter
    
    
    1.23
    
    
    
    0.60Fourth Quarter
    
    
    0.86
    
    
    
    0.26
 There were approximately 340 common shareholders of record and an estimated 4,800 shareholders holding stock in street name accounts as of December 31, 2004. The Company has not paid any stock dividends on its common stock since its inception and management does not anticipate paying cash dividends in the foreseeable future. 
 Item 6. Selected Financial Data The table below provides selected historical consolidated financial data for the Company as of and for the periods indicated, as derived from our audited historical consolidated financial statements. The data should be read in conjunction with the Companys consolidated financial statements and related notes and Management Discussion and Analysis of Results of Operations and Financial Condition in this report. All amounts have been restated to reflect discontinued operations, as discussed in note 3 to the consolidated financial statements. 10




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SELECTED THREE-YEAR FINANCIAL DATA Years ended December 31,(in thousands, except share and per share amounts)
    
    2004
    
    
    2003
    
    
    2002Statement of Operations Data:Revenue from continuing operations
    
    $
    
    
    
    $
    
    
    
    $
    Operating loss
    
    
    (1,666
    )
    
    
    (2,387
    )
    
    
    (2,988
    )Loss from
continuing operations
    
    
    (4,971
    )
    
    
    (2,069
    )
    
    
    (3,299
    )Loss from discontinued operations
    
    
    (4,128
    )
    
    
    (8,242
    )
    
    
    (4,232
    )Loss on liquidation of discontinued operations
    
    
    (2,437
    )
    
    
    
    
    
    
    Gain on sale of discontinued operations
    
    
    557
    
    
    
    1,832
    
    
    
    Loss from discontinued operations
    
    
    (6,008
    )
    
    
    (6,410
    )
    
    
    (4,232
    )Net loss
    
    
    (10,979
    )
    
    
    (8,479
    )
    
    
    (7,531
    )Beneficial conversion feature
    
    
    (1,946
    )
    
    
    (959
    )
    
    
    Deemed dividend on preferred stock
    
    
    (1,211
    )
    
    
    
    
    
    
    Net loss available to common shareholders
    
    
    (14,136
    )
    
    
    (9,438
    )
    
    
    (7,531
    )Net loss per share from continuing operations
    
    
    (0.26
    )
    
    
    (0.11
    )
    
    
    (0.12
    )Loss from discontinued operations
    
    
    (0.13
    )
    
    
    (0.31
    )
    
    
    (0.16
    )Loss on liquidation of discontinued operations
    
    
    (0.08
    )
    
    
    
    
    
    
    Gain on sale of discontinued operation
    
    
    0.02
    
    
    
    0.07
    
    
    
    Loss from discontinued operations
    
    
    (0.19
    )
    
    
    (0.24
    )
    
    
    (0.16
    )Net loss available to common shareholders
    
    $
    (0.45
    )
    
    $
    (0.35
    )
    
    $
    (0.28
    )Weighted average shares outstanding
    
    
    31,396,653
    
    
    
    26,967,708
    
    
    
    26,816,130
 As of December 31,2004
    
    
    2003
    
    
    2002Balance Sheet Data:Working capital (deficit) from continuing operations
    
    $
    (331
    )
    
    $
    (417
    )
    
    $
    7,597Net assets (liabilities) of discontinued operations
    
    
    (69
    )
    
    
    185
    
    
    
    7,940Total assets
    
    
    1,256
    
    
    
    5,193
    
    
    
    13,451Long-term liabilities
    
    
    988
    
    
    
    5,632
    
    
    
    7,300Shareholders equity (deficit)
    
    $
    (1,209
    )
    
    $
    (5,871
    )
    
    $
    (671
    )
 11




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##### 



Item 7. Managements Discussion and Analysis of Results of Operations and Financial Condition FORWARD-LOOKING STATEMENTS This annual report on Form 10-K of Diametrics Medical, Inc. for the year ended December 31,
2004 contains forward-looking statements, principally in the sections entitled Managements
Discussion and Analysis of Results of Operations and Financial Condition and Business.
Generally, you can identify these statements because they use words like anticipates, believes,
expects, future, intends, plans, and similar terms. These statements reflect only our
current expectations. Although we do not make forward-looking statements unless we believe we have
a reasonable basis for doing so, we cannot guarantee their accuracy and actual results may differ
materially from those we anticipated due to a number of uncertainties, many of which are
unforeseen, including, among others, the risks we face as described in this filing. You should not
place undue reliance on these forward-looking statements which apply only as of the date of this
annual report. These forward-looking statements are within the meaning of Section 27A of the
Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as
amended, and are intended to be covered by the safe harbors created thereby. To the extent that
such statements are not recitations of historical fact, such statements constitute forward-looking
statements that, by definition, involve risks and uncertainties. In any forward-looking statement
where we express an expectation or belief as to future results or events, such expectation or
belief is expressed in good faith and believed to have a reasonable basis, but there can be no
assurance that the statement of expectation of belief will be accomplished. We believe it is important to communicate our expectations to our investors. There may be
events in the future, however, that we are unable to predict accurately or over which we have no
control. The risk factors listed in this filing, as well as any cautionary language in this annual
report, provide examples of risks, uncertainties and events that may cause our actual results to
differ materially from the expectations we describe in our forward-looking statements. Factors
that could cause actual results or events to differ materially from those anticipated, include, but
are not limited to: our ability to successfully develop new products; the ability to obtain
financing for product development; changes in product strategies; general economic, financial and
business conditions; changes in and compliance with governmental healthcare and other regulations;
changes in tax laws; and the availability of key management and other personnel. OVERVIEW The focus of the Company has changed significantly over the past 18 months. On November 1,
2004, we terminated all of our employees in the United Kingdom and all but four of our employees in
the United States. On November 22, 2004, a Meeting of Creditors was held in London, England for
the purposes of liquidating the assets of the Companys wholly-owned subsidiary in the United
Kingdom, Diametrics Medical Limited (DML). The Company subsequently created a new, wholly-owned
subsidiary in the United Kingdom, TGC Research Limited (TGC), which acquired certain equipment
and intellectual property from the liquidator of DML in early 2005. TGC will become a research and development organization which will focus initially on the
development of a line of new products aimed at continuous glucose monitoring and control in
critically ill patients in a hospital setting at the point-of-patient care. During the past three
years, clinical practice patterns in intensive care units around the world have changed
dramatically. Clinical evidence, we believe, has conclusively demonstrated that maintaining
patients within strict glycemic limits (a clinical practice known as tight glycemic control) can
dramatically reduce mortality, risk of infection and other complications. We believe that optimal
glycemic control can only be achieved by the continuous monitoring of glucose, a measurement
modality that is not currently available in intensive care units. We believe that clinically
accurate glucose measurements can only be achieved by in-vivo measurement. Our new focus will be
to develop a product system that will effectively and accurately measure, on a continuous basis,
glucose in the critically ill patient. We expect this product offering will allow clinicians
around the world to maintain tight glycemic control in this patient population, which we believe,
represents a significant business opportunity. From October 2003 to November 1, 2004, we developed, manufactured and distributed blood and
tissue monitoring systems that provided continuous diagnostic information at the point-of-patient
care. That business, known as Diametrics Medical, Ltd., was acquired in late 1996 and operated as
a wholly-owned subsidiary of the Company, with manufacturing, research and development and
marketing operations located in High Wycombe, England. Blood and tissue analysis is an integral
part of patient diagnosis and treatment and timely access to certain measurements is critical to
effective patient care. We believed that use of our systems would result in more timely decisions
by providing accurate and continuous test results at the patients bedside, thereby reducing the
time spent in critical care settings. Our monitoring systems had also recently been used in
several biotech applications to provide continuous measurement of environments surrounding cell
research and growth. Most of those utilizations had been on a trial basis, although others had
generated revenue from systems and sensor sales. 12




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We marketed and distributed our TrendCare products through a direct sales force in the United
States, the United Kingdom and Germany and through nonexclusive third-party distributors in various
other countries. We distributed our Neurotrend cerebral tissue monitoring system through Codman &
Shurtleff, Inc., a Johnson & Johnson Company (Codman), under an exclusive worldwide distribution
agreement. Our primary line of business from our inception in 1990 through September 2003 was the
development, manufacture and distribution of intermittent blood testing products. That line of
business, which comprised 66% and 57% of consolidated revenues for the years ended December 31,
2003 and 2002, respectively, was sold in late September 2003 to International Technidyne
Corporation (ITC), a wholly owned subsidiary of Thoratec Corporation, for approximately $5.2
million in cash and the assumption of certain liabilities, including $583,000 in trade payables.
Of the cash payment, $758,000 was placed in escrow by ITC for 180 days to cover any shortfall in
collected receivables or any indemnification claims. In late March 2004, sales proceeds of
$713,000 remaining in escrow were released to the Company. The results of operations for the intermittent testing business have been reported as
discontinued operations for all periods presented in this report. Revenues of the intermittent
testing business totaled $4.8 million for the year ended December 31, 2003, and $12.3 million for
the year ended December 31, 2002. Net losses attributable to the intermittent testing business
during the same periods totaled $2.1 million and $1.9 million, respectively. The carrying value of
assets sold to ITC approximated $3 million and ITC assumed liabilities of the intermittent testing
business totaling $669,000. The results of operation for the continuous monitoring business have also been reported as
discontinued operation for all periods presented in this report. Revenues of the continuous
monitoring business totaled $2.4 million, $3.1 million and $5.5 million, respectively for the three
years ended December 31, 2004. Net losses attributable to that business during those periods were
$4.1 million, $6.2 million and $2.4 million, respectively. APPLICATION OF CRITICAL ACCOUNTING POLICIES The Companys consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the U.S., which require the Company to make estimates and
assumptions in certain circumstances that affect amounts reported. In preparing these financial
statements, management has made its best estimates and judgments of certain amounts, giving due
consideration to materiality. The Company believes that of its significant accounting policies
(more fully described in notes to the consolidated financial statements), the following are
particularly important to the portrayal of the Companys results of operations and financial
position and may require the application of a higher level of judgment by the Companys management,
and as a result are subject to an inherent degree of uncertainty. Debt and Equity Instruments.On December 15, 2004, the Company borrowed $1,800,000 under
Convertible Senior Secured Notes due December 15, 2007 (the Convertible Senior Notes). Principal
and interest are payable in cash or registered shares over a 32-month period beginning 120 days
after closing. The subscribers also received warrants to purchase up to 45,000,000 shares of the
Companys common stock at an exercise price of $0.025. The warrants expire on December 15, 2009. The Company determined the relative fair value of the debt was $2,627,588 and $1,549,818 for
the warrants. The Company allocated $1,018,980 and $601,020 of the net proceeds totaling
$1,620,000 to the debt and warrants, respectively. The application of the provisions of EITF
98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, and EITF 00-27, Application of Issue 98-5 to Certain Convertible
Instruments resulted in the calculation of an embedded beneficial conversion feature in the
Convertible Senior Notes, which is required to be treated as an additional discount to the debt.
The value of the beneficial conversion feature of $1,018,980 was limited to the amount allocated to
the debt. $16,010 of the beneficial conversion feature was amortized into interest expense for
the year ended December 31, 2004. The relative fair value of the warrants issued were determined using the Black-Scholes
option-pricing model based on the following assumptions: volatility of 116%, expected life of 5
years, risk free interest rate of 3.53% and no dividends. The subscribers received a first lien on all of the assets of the Company. The holders of
the Companys previously issued convertible senior secured fixed rate notes due August 4, 2005 (the
Convertible Subordinated Notes), consented to the new financing and the subordination of their
secured position to a second lien on all of the assets of the Company in consideration for an
amendment of the conversion price of the Convertible Subordinated Notes to $0.02 per share and the
amendment of the exercise price of their outstanding
warrants to purchase up to 4,255,837 shares of the Companys common stock to $0.025 per share.
See below for the recording of the amendment to the Convertible Subordinated Notes. 13




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Stock warrants outstanding to purchase up to 17,555,589 shares of the Companys common stock,
issued in connection with the Companys Series E, F and G preferred stock financing, were also
amended to reduce the exercise price thereof to $0.025 per share, of which certain warrants
outstanding to purchase up to 12,000,000 shares of the Companys common stock were further amended
to reduce the exercise price thereof to $0.01 per share. See note 6 for discussion related to the
accounting for the modification of these warrants. The reductions in the exercise price or ceiling
exercise price, as applicable, of the warrants previously issued to these investors and the
issuance of new warrants to purchase 12,000,000 additional shares of common stock resulted in a
deemed dividend on the Series E, F and G preferred stock, requiring a charge to retained earnings
and an offsetting credit to additional paid-in capital aggregating $1,211,247. Similar to the
beneficial conversion features, this amount was charged to retained earnings, with an offsetting
credit to additional paid-in-capital, and was treated as a reconciling item on the statement of
operations to adjust the reported net loss to net loss available to common shareholders, which is
used in the numerator in the loss per share calculation for the year ended December 31, 2004. The Company classified the warrants issued in connection with the Series E, F and G preferred
stock financing as equity rather than debt based upon an assessment of the Companys contractual
obligations for registration of the related common shares issuable upon exercise of the warrants as
provided under EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Companys Own Stock. During the second quarter 2003, the Company completed the renegotiation of the terms of its
Convertible Subordinated Notes and completed a $1.5 million financing through the sale of 15,000
shares of Series E convertible preferred stock. Both transactions also included the issuance of
warrants for the purchase of the Companys common stock. The accounting for these debt and equity
related transactions was complex and required the Company to make certain judgements regarding
their accounting treatment. The Companys significant conclusions related to these transactions
included: 1) the accounting applicable to the modification of the convertible notes falls primarily
under the treatment prescribed by EITF 96-19, Debtors Accounting for a Modification or Exchange of
Debt Instruments, 2) the determination of the respective fair values to use as a basis for
recording the carrying values of the convertible notes, Series E preferred stock and warrants
issued in connection with each transaction and 3) the classification of the warrants as equity
versus debt based upon an assessment under EITF 00-19 of the Companys contractual obligations for
registration of the related common shares issuable upon exercise of the warrants. On January 16, 2004, the Company completed the sale of 15,000 shares of Series F convertible
preferred stock at a price of $100 per share, resulting in aggregate gross proceeds to the Company
of $1.5 million. Each share of preferred stock is convertible at any time into common stock at 75%
of the volume weighted average trading price of the lowest three inter-day trading prices of the
common stock for the five consecutive trading days preceding the conversion date, but at an
exercise price of no more than $.25 per share and no less than $.20 per share. In accordance with
the terms of the Series F preferred stock agreement, the floor conversion price was reduced to $.15
per share effective June 30, 2004, due to the Companys inability to achieve a six-month cash flow
projection through that date. Five-year warrants were also issued to purchase an aggregate of
6,000,000 shares of the Companys common stock at the lower of $.35 per share or the average of the
lowest ten inter-day closing prices of the Companys common stock on the Over-the-Counter Bulletin
Board during the 10 trading days immediately preceding the exercise date. The ceiling exercise
price on the Series F warrants was reduced from $.35 to $.11 per share in connection with the
Series G preferred stock financing transaction completed in May 2004. Accounting for this transaction falls primarily under EITF 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and
EITF 00-27, Application of Issue 98-5 to Certain Convertible Instruments. The Company allocated
the net investor proceeds of $1,350,000 from the issuance of the Series F convertible preferred
stock to the preferred stock and associated warrants based upon their estimated relative fair
values. The resulting fair value allocations of $665,994 and $684,006 for the preferred stock and
warrants, respectively, were recorded as equity in the first quarter 2004. The beneficial
conversion feature embedded in the preferred stock was calculated at $665,994 and was limited to
the fair value allocated to the preferred stock. The beneficial conversion feature of $665,994 was
treated as a deemed dividend to preferred shareholders, and was charged to retained earnings, with
the offsetting credit to additional paid-in-capital. Additionally, the Company treated the
beneficial conversion feature of $665,994 as a reconciling item on the statement of operations to
adjust its reported net loss to net loss available to common shareholders, which is used in the
calculation for the year ended December 31, 2004. On May 28, 2004, the Company completed a $1.5 million financing through the sale of 15,000
shares of Series G convertible preferred stock at $100 per share. Each share of the Series G
preferred stock is convertible at any time into common stock at 75% of the volume weighted average
trading price of the lowest three inter-day trading prices of the common stock during the five
consecutive trading days preceding the conversion date, with a maximum exercise price of $.14 per
share and a minimum price of $.06 per share. The minimum exercise price was decreased automatically
to $.03 per share after the shareholders of the Company authorized an increase in common stock from
100 million shares to 200 million shares on September 7, 2004. As part of this financing, the Company issued three-year warrants (Series G warrants) to the
purchasers of the Series G preferred stock. Those warrants entitle the holders to purchase an
aggregate of 1,250,000 shares of the Companys common stock at the lower of $.11 per share or the
average of the lowest ten inter-day closing prices of the Companys common stock during the ten
trading days preceding the 14




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##### 



exercise date. The Company also issued three-year warrants to investors
in the Companys Series E and Series F preferred stock to purchase an aggregate of 12,241,608
shares of common stock at $.05 per share. In connection with the Series G financing, the holders of the Companys Convertible
Subordinated Debt agreed to defer until December 31, 2004 the Companys obligation to make interest
payments previously due on June 30, 2004 (including interest payments originally due on December
31, 2003 and March 31, 2004, payment of which was deferred until June 30, 2004) and September 30,
2004. In exchange for the deferral of interest payments, the exercise price on the note holders
common stock warrants was reduced from $.34 per share to $.09 per share. Accounting for these
transactions required a review of several criteria, including assessment of the treatment of the
beneficial conversion feature associated with the Series G preferred stock, an assessment of the
classification as debt or equity of the warrants issued in connection with the Series G preferred
stock financing, an assessment of the impact of the changes in the exercise and ceiling exercise
prices, as applicable, of the common stock warrants previously issued to the note holders and the
Series E and Series F preferred stock investors and an assessment of the treatment of the fair
value associated with the new warrants issued to the Series E and Series F preferred stock
investors. Additionally, in connection with the Series G financing, the exercise price of the outstanding
common stock warrants issued as part of the Series E preferred stock financing was reduced from
$.35 per share to $.11 per share, and the ceiling price for the exercise of the common stock
warrants issued as part of the Series F preferred stock financing was reduced from $.35 per share
to $.11 per share. The application of the provisions of EITF 98-5, Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and EITF 00-27,
Application of Issue 98-5 to Certain Convertible Instruments resulted in the calculation of an
embedded beneficial conversion feature in the Series G preferred stock, which is required to be
treated as a deemed dividend to preferred shareholders. The Company allocated the net investor
proceeds of $1,445,000 from the issuance of the Series G convertible preferred stock to the
preferred stock and Series G warrants based upon their relative fair values. The fair value
allocated to the Series G warrants of $68,205 was recorded as equity. The fair value allocated to
the preferred stock of $1,376,795 and the original conversion terms were used to calculate the
value of the beneficial conversion feature of $1,067,650 at the date of issuance of the Series G
preferred stock. The $1,067,650 was charged to retained earnings with the offsetting credit to
additional paid-in-capital. The Company treated the beneficial conversion feature of $1,067,650 as
a reconciling item on the statement of operations to adjust its reported net loss to net loss
available to common shareholders. As a result of the decrease in the conversions rate to $.03 per
share, the Company increased the value of beneficial conversion feature to $1,280,216 which was
limited to the amount of proceeds allocated to the Series G preferred stock. Additionally, the
Company treated the beneficial conversion feature of $1,280,216 as a reconciling item on the
statement of operations to adjust its reported net loss to net loss available to common
shareholders, which is used in the numerator in the loss per share calculation for the year ended
December 31, 2004. Revenue Recognition and Accounts Receivable. Effective July 1, 2003, the Company adopted the
provisions of EITF Issue 00-21, Revenue Arrangements with Multiple Deliverables, which provides
guidance on the measurement and allocation of revenue from sales undertakings to deliver more than
one product or service. Sales of the Companys hardware and disposable sensors were priced and
sold separately and had readily determined fair market values based upon sales histories of these
products. As such, the hardware and disposable sensors have stand-alone value to the customer.
Sales to distributors and existing end-user customers were specifically priced for each product and
had no right of return, except for standard warranty provisions. Revenue was recognized upon
shipment of products to distributors and direct customers or, in the case of trial monitors placed
directly with end-user customers, upon the customers acceptance of the product. Sales to new
direct end-user customers requires training on the products during a product evaluation period
completed prior to the customer making the purchase. Revenue for these sales transactions was
recognized when the purchase was made at the end of the evaluation period. Many of the Companys distribution agreements governing the terms of sales transactions with
its European and Asian distributors provided for retention of title to products delivered to such
distributors until the distributor made payment to allow the Company to recover the products in the
event of distributor defaulted on payment. The agreements provided for this protection because the
laws of the countries in which the distributors conducted business did not provide for a sellers
retention of a security interest in goods in the same manner as established in the U.S. Uniform
Commercial Code. The Company recognized revenue on sales transactions governed by such distributor
agreements upon delivery of the products, which may occur prior to receipt of payment and the
transfer of title. This treatment is permitted under SEC Staff Accounting Bulletin (SAB) No. 104
 Revenue Recognition, as all other revenue recognition criteria outlined in SAB No. 104 had been
met and the only rights the Company retained with the title in such transactions were those
enabling recovery of the products in the event of distributor payment default. The Company did not
retain any other rights of ownership, such as the
ability to direct the disposition of the products sold, rescind the transaction or prohibit
the distributor from moving, selling or otherwise using the goods in the normal course of business. 15




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##### 



RESULTS OF OPERATIONS 2004 Compared to 2003 Revenue and Cost of Revenue. As a result of discontinued operations, the Company has no
revenue or cost of sales related to continuing operations. Operating Expenses. Total operating expenses for the year ended December 31, 2004 totaled
$1,665,794, a decrease of $721,288 or 30% relative to 2003. The decrease in expense reflects the
Companys reduction in expenditures as operations declined. All operating expenses were related to
corporate level activities as all selling and research and development expenditures were
reclassified to discontinued operations. Other Income (Expense).The significant changes between periods in net other income and
expense occurred primarily as a result of the accounting treatment for the issuance of additional
debt and the modification of debt. The expensing of the beneficial conversion feature related to
the Convertible Senior Secured Notes resulted in the recognition of $16,010 of interest expense
and the modification of the Convertible Subordinated Debt resulted in a loss $1,670,683 in 2004.
Total accretion on notes payable in 2004 was $1,206,884 compared to $632,143 in 2003. Modification
of the Companys Convertible Subordinated Debt in April 2003, resulted in recognition of a
$1,500,000 gain during the second quarter 2003. Discontinued Operations.On October 4, 2004, the Company concluded that it was no longer able
to fund the operations of DML. The Directors of DML then ceased all operations in the U.K. and,
effective November 1, 2004 terminated all of our employees there. On November 22, 2004, a Meeting
of Creditors was held in London, England for the purposes of liquidating the assets of DML. Based
upon a review of SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets,
the Company assessed the measurement date for the sale transaction as the date of Director
approval, which occurred on October 4, 2004. As prescribed by SFAS No. 144, the Company began
reporting the results of operations of DML as discontinued operations effective as of the year
ended December 31, 2004 for all periods presented. Upon DML entering liquidation in November, the
Company recorded a loss of $2.4 million. The operations of the Companys continuous monitoring business, reflected in discontinued
operations, reported a net loss of $4,127,982, $6,170,974, and $2,368,005 for the years ended
December 31, 2004, 2003 and 2002 respectively. The decrease in net loss from 2003 to 2004 is
primarily the result of restructuring that took place in 2003. The increase in net loss from 2002
to 2003 is primarily the result of a reduction in revenues and an increase in sales and marketing
expenses as the Company expended its distribution channels after the termination of the exclusive
agreement with Philips Medical Systems. Net Loss / Net Loss Available to Common Shareholders.The Companys reported consolidated net
loss in 2004 of $10,978,828 was further adjusted by a $1,946,210 charge for a beneficial conversion
feature and $1,211,247 for deemed dividend on preferred stock to arrive at net loss available to
common shareholders of $14,136,285, which is used in the numerator in the loss per share
calculation. This occurred as a result of the application of the provisions of EITF 98-5,
Accounting for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, and EITF 00-27, Application of Issue 98-5 to Certain Convertible
Instruments resulted in the calculation of an embedded beneficial conversion feature in the Series
F and G preferred stock. The beneficial conversion feature  preferred stock dividend for Series F
and G was $665,994 and $1,280,216, respectively. Subsequent to the preferred stock financings described above, the exercise price of the
warrants issued with the preferred stock were adjusted downward during 2004 as a result of
the issuance of the Series G financing and the new Convertible Senior Notes. In addition new warrants to purchase
12,241,608 shares of common stock were issued to the Series E and Series F investors as a result of
the Series G financing. The new Convertible Senior Note financing reduce the exercise price of warrants to
purchase 5,555,589 shares of common stock to $.025 per share and warrants to purchase 12,000,000
shares of common stock to $.01 per share. The reductions in the exercise price or ceiling exercise
price, as applicable, of the warrants previously issued to these investors and the issuance of new
warrants to purchase additional shares of common stock resulted in a deemed dividend on the Series
E, F and G preferred stock, requiring a charge to retained earnings and an offsetting credit to
additional paid-in capital aggregating $1,211,247. Similar to the beneficial conversion features
discussed above, this amount was charged to retained earnings, with an offsetting credit to
additional paid-in-capital, and was treated as a reconciling item on the statement of operations to
adjust the reported net loss to net loss available to common shareholders, which is used in the
numerator in the loss per share calculation for the year ended December 31, 2004. 16




---



##### 



2003 Compared to 2002 Revenue and Cost of Revenue. As a result of discontinued operations, the Company has no
revenue or cost of sales related to continuing operations. Operating Expenses.Total operating expenses from continuing operations decreased by $601,831
or 20% from 2002 to 2003. The decrease in expense reflects the Companys reduction in expenditures
as operations declined. All operating expenses were related to corporate level activities as all
selling and research and development expenditures were reclassified to discontinued operations. Interest and Other Income / Expense.The Company realized interest income of $15,878 in 2003
compared to $86,441 in 2002. The year-to-year declines reflect the impact of lower average cash
and investment balances and lower average interest rates. The gain on modification of convertible notes in 2003 occurred as a result of the accounting
treatment for the modification of the Companys Convertible Subordinated Notes, which resulted in
the recognition as other income in the second quarter 2003 of a $1,500,000 gain. The modified
notes and associated warrants were recorded at their individual estimated fair values of $5,000,000
and $800,000, respectively. The $7,300,000 carrying value of the original notes was retired, and
the residual amount of $1,500,000 was reflected as a gain on the transaction. Prior to the
additional modification to the Convertible Subordinated Notes, the Company was accreting the
initial $5,000,000 carrying value of the modified notes to their redemption value of $7,300,000
using the effective interest method over the remaining term of the modified notes, which would have
resulted in the recording of $2,300,000 of additional interest expense over this period.
Accordingly, the accretion of the convertible notes balance resulted in an additional charge to
interest expense of $632,143 in 2003, partially offsetting the gain. Interest expense totaled $1,262,307 in 2003, compared to $545,976 in 2002. The significant
increase in interest expense in 2003 primarily reflects the recognition of additional interest
expense of $632,143 for the accretion of the convertible notes discussed above, the amortization of
extension costs associated with the Companys convertible notes and the impact of higher average
interest rates on capital lease obligations entered into in late 2002 and early 2003. Discontinued Operations.On October 4, 2004 the Company concluded that it was no longer able
to fund the operations of DML. The Directors of DML then ceased all operations in the U.K. and,
effective November 1, 2004, terminated all of its employees there. On November 22, 2004, a Meeting
of Creditors was held in London, England for the purposes of liquidating the assets of DML. Based upon
a review of SFAS No. 144, Accounting for the Impairment of Disposal of Long-lived Assets, the
Company assessed the measurement date for the sale transaction as the date of Director approval,
October 4, 2004. As prescribed by SFAS No. 144, the Company began reporting the results of
operations of DML as discontinued operations effective as of the year ended December 31, 2004 for
all periods presented. Upon DML entering liquidation in November, the Company recorded a loss of $2.4
million. On September 29, 2003, the Company completed the sale of substantially all of the assets used
in the Companys intermittent testing business to ITC. Based upon a review of SFAS No. 144,
Accounting for the Impairment or Disposal of Long-lived Assets, the Company assessed the
measurement date for the sale transaction as the date of shareholder approval, which occurred on
September 19, 2003. As prescribed by SFAS No. 144, the Company began reporting the results of
operations of the intermittent testing business as discontinued operations effective with the
quarter ended September 30, 2003, for all periods presented. Upon completion of the sale
transaction in September, the Company recorded a gain on the sale of the intermittent testing
business of $1.8 million. The operations of the Companys intermittent testing business, reflected in discontinued
operations, reported a net loss of $2,071,036 and $1,864,469 for the years ended December 31, 2003
and 2002 respectively. The increase in net loss is primarily the result of a reduction in revenues
and an increase in sales and marketing expenses, both stemming from the termination of the
exclusive agreement with Philips and the resulting transition to expanded distribution channels. Net Loss / Net Loss Available to Common Shareholders.The Companys reported consolidated net
loss in 2003 of $8,479,145 was further adjusted by a $958,962 charge for a beneficial conversion
feature to arrive at net loss available to common shareholders of $9,438,107, which is used in
the numerator in the loss per share calculation. This occurred as a result of the required
accounting treatment of the Companys issuance of $1.5 million of Series E convertible preferred
stock and associated warrants in May 2003. As further discussed in note 6 to the consolidated
financial statements, the Company allocated the net investor proceeds of $1,350,000 from the
issuance of the Series E convertible preferred stock to the preferred stock and associated warrants
based upon their estimated relative fair values. The resulting fair value allocations of $958,962
and $391,038 for the preferred stock and warrants,
respectively, were recorded as equity. The beneficial conversion feature embedded in the
preferred stock was calculated at $958,962 and was limited to the fair value allocated to the
preferred stock. The beneficial conversion feature of $958,962 was treated as a deemed dividend to
preferred shareholders, and was charged to retained earnings, with the offsetting credit to
additional paid-in-capital. 17




---



##### 



LIQUIDITY AND CAPITAL RESOURCES The accompanying financial statements have been prepared on a going-concern basis, which
contemplates the realization of assets and satisfaction of liabilities and other commitments in the
normal course of business. The report of the Companys independent auditors contains an
explanatory paragraph expressing substantial doubt about the Companys ability to continue as a
going concern as a result of recurring losses and negative cash flows. The financial statements do
not include any adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts and classification of liabilities that may be necessary if the Company is
unable to continue as a going concern. At December 31, 2004, the Company had negative working capital of approximately $331,000,
compared with negative working capital of approximately $417,000 at December 31, 2003, after
restatement of the balance sheet for the impact of discontinued operations. Cash of $1,096,000
represented 87% of total current assets at December 31, 2004. Current liabilities of $1,477,000 at
that date consisted primarily of $1,355,000 in accounts payable and accrued expenses and $28,000
in current maturities of long-term debt. The Company used the net proceeds from $1,800,000 of
Convertible Senior Notes funded on December 15, 2004, after banking, legal and accounting fees related to that
financing, to pay certain critical liabilities. Others have been negotiated or are being paid over
several months. Net losses for the years ended December 31, 2004 and 2003 were $10,979,000 and $8,479,000
respectively, after losses related to discontinued operations of $6,008,000 and $6,410,000. In
addition, charges were recorded for a deemed preferred stock dividend related to beneficial
conversion features of $1,946,000 in 2004 and $959,000 in 2003 and a deemed dividend of $1,211,000
on preferred stock in 2004. During 2004, the Company received net proceeds of $1,620,000 from borrowings and $2,611,000
from sales of preferred stock. These proceeds were used primarily to fund net requirements for continuing operating
activities in the amount of $1,351,000 and requirements for discontinued operations in the amount
of $1,947,000. The net increase in cash compared with net decreases of $3,736,000 in 2003 and
$3,233,000 in 2002. The most significant sources of funds in 2003 were $4,153,000 net proceeds,
including gain from the sale of discontinued operations and $596,000 from sales of preferred and
common stock, less mandatory redemptions. Continuing operations used $3,648,000 in 2003 and
provided $618,000 in 2002. The Company is monitoring its cash position carefully and is evaluating its future operating
cash requirements in the context of its strategy, business objectives and expected business
performance. Cash on hand at December 31, 2004 was expected to provide five to six months of
funding as the Company developed plans for its new product development activities. An additional
$150,000 was borrowed on May 2, 2005 and additional amounts will likely be required to complete
that planning. After receipt of the $150,000 in May 2005, the Company had available funds of
$250,000. Operations used about $100,000 in April 2005 and it is expected that requirements will be
similar in future months, excluding incremental accounting, auditing and legal fees related to
filings with the Securities and Exchange Commission and any initial new product development costs. The Companys long-term capital requirements for the development of its new products will
depend upon numerous factors, including the rate of market acceptance of the Companys products and
the level of research and development activities. It is presently anticipated that such activities
will require from $10 to $15 million. While there can be no assurance that adequate funds
will be available when needed, or on acceptable terms, management believes that the Company will be
able to raise adequate funding to meet its operational requirements. If the Company is unable to
raise an adequate level of additional capital or generate sufficient cash flows from operations,
the Companys ability to execute its business plan and remain a going concern will be significantly
impaired. Net
cash provided by financing activities totaled $4,246,000 in 2004, an increase over the
$514,000 of net cash provided financing activities in 2003. Financing activities in 2004 related
to the issuance of $1,620,000 net of cash discounts for the Convertible Senior Notes in
December 2004 and two rounds of preferred stock offerings which totaled $2,611,000 after offering
costs which occurred in January 2004 and May 2004. Income Tax Carryforwards.At December 31, 2004, the Company had U.S. tax net operating loss
and research and development tax credit carryforwards for income tax purposes of approximately
$139,500,000 and $1,493,000, respectively. Pursuant to the Tax Reform Act of 1986, use of a
portion of the Companys net operating loss carryforwards are limited due to a change in
ownership. If not used, these net operating loss carryforwards begin to expire in 2005 ($500,000)
and at increasing amounts between 2006 and 2023 ($31.6 million between 2006 and 2009, and $100
million thereafter). 18




---



##### 



Disclosure of Contractual Obligations In late 1996 the Company entered into a long-term debt obligation consisting of a $7.3 million
senior secured fixed rate loan note issued to Pfizer Inc. in connection with the Companys
acquisition of DML. Proceeds from the issuance in August 1998 of $7.3 million of Convertible
Subordinated Notes, issued in conjunction with a private equity placement, were simultaneously used
to retire the $7.3 million Pfizer note. Payments on the Companys contractual obligations,
consisting of debt, capital leases and operating leases are summarized below: Year ending December 312005
    
    
    2006
    
    
    Thereafter
    
    
    TotalLong-term debt (1)
    
    $
    
    
    
    $
    
    
    
    $
    10,075,028
    
    
    $
    10,075,028Operating leases
    
    
    103,147
    
    
    
    104,014
    
    
    
    121,202
    
    
    
    328,363Long Term Notes
    
    
    582,737
    
    
    
    763,453
    
    
    
    706,078
    
    
    
    2,052,268Total contractual obligations
    
    $
    685,884
    
    
    $
    867,467
    
    
    $
    10,902,308
    
    
    $
    12,455,659
   (1)
    
    Amounts include principal and interest. NEW ACCOUNTING PRONOUNCEMENTS EITF Issue No. 03-01, Meaning of Other-Than Temporary Impairment and Its Application to
Certain Investments, addresses both qualitative and quantitative disclosures required for
marketable equity and debt securities accounted for under FASB Statement No. 115, Accounting for
Certain Investments in Debt and Equity Securities. The disclosure requirements are effective for
fiscal years ending after December 15, 2003. EITF Issue No. 03-01 did not have a material impact
on the Companys financial statements. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, which established standards for how an issuer
classifies and measures in its statement of financial position certain financial instruments with
characteristics of both debt and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. For example, the Statement requires
liability classification for a financial instrument issued in the form of shares that are
mandatorily redeemable, e.g., includes an unconditional obligation requiring the issuer to redeem
it by transferring at a specified or determinable date or dates or upon an event certain to occur.
SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period beginning after June 15,
2003. The Company has adopted SFAS No. 150 and applied its provisions to the classification at
September 30, 2003 of the $750,000 of Series E convertible preferred stock that was put back to the
Company effective with the sale of the Companys intermittent testing business. In December 2003, the FASB issued a revision to FASB Interpretation No. 46, Consolidation of
Variable Interest Entities, which replaces the original issuance of FASB Interpretation No. 46 in
January 2003 and clarifies the application of Accounting Research Bulletin No. 51, Consolidated
Financial Statements. This interpretation addresses consolidation by business enterprises of
variable interest entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support. The adoption of this standard did not have a significant impact on the consolidated financial statements. 
 Item 7.a. Quantitative and Qualitative Disclosures About Market Risk The Company is exposed to market risk from foreign exchange rate fluctuations of the British
pound sterling to the U.S. dollar as the financial position and operating results of the Companys
U.K. subsidiary, TGC, are translated into U.S. dollars for consolidation. The Company is presently
considering certain product development contracts with European based businesses. Such contracts
would likely be denominated in Euros which would also create market risk as funds were transferred
from the U.S. The Companys exposure to foreign exchange rate fluctuations also arises from
transferring funds to its U.K. subsidiary in British pounds sterling. As a result of fluctuations of the British pound sterling to the U.S. dollar in 2003, the
Companys reported consolidated net loss for 2003 increased in excess of $400,000 relative to 2002.
The effect of foreign exchange rate fluctuations on the Companys financial results for 2002 was not material. The Company does not currently use derivative financial instruments to
hedge against exchange rate risk or 19




---



##### 



interest rate risk. The Companys debt obligations as of
December 31, 2004 bear interest at fixed rates, and are therefore not subject to exposure from
fluctuating interest rates. 
 Item 8. Financial Statements and Supplementary Data Index to Consolidated Financial Statements
    
    PageFinancial Statements:Report of Independent Registered Public Accounting Firm
    
    
    21Consolidated Statements of Operations
    
    
    22Consolidated Balance Sheets
    
    
    23Consolidated Statements of Shareholders Equity (Deficit) and
Comprehensive Loss
    
    
    24Consolidated Statements of Cash Flows
    
    
    25Notes to Consolidated Financial Statements
    
    
    26Financial Statement Schedule:Schedule II  Valuation and Qualifying Accounts
    
    
    72
 All other schedules have been omitted because they are not applicable or not required, or
because the required information is included in the consolidated financial statements or the notes
thereto. 20




---



##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders, Audit Committee and Board of Directors
Diametrics Medical, Inc.
Roseville, Minnesota We have audited the accompanying consolidated balance sheet of Diametrics Medical, Inc. as of
December 31, 2004, and the related consolidated statements of operations, shareholders
deficit and comprehensive loss and cash flows for the year then ended. These consolidated financial statements are
the responsibility of the companys management. Our responsibility is to express an opinion
on these consolidated financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management as well
as evaluating the overall consolidated financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in
all material respects, the financial position of Diametrics Medical, Inc. as of December 31,
2004 and the results of their operations and their cash flows for the year then ended, in
conformity with U.S. generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to
the consolidated financial
statements, the Company has recurring operating losses, negative cash flows from operations,
a working capital deficit, and a shareholders deficit that raise substantial doubt about its
ability to continue as a going concern. Managements plans in regards to these matters are
also described in Note 2. The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. /s/ Virchow, Krause & Company, LLP Minneapolis, Minnesota
April 28, 2005 (except as to Note 17,
as to which the date is May 2, 2005) 21




---



##### 



Consolidated Statements of Operations Years ended December 31,Diametrics Medical, Inc. and Subsidiary
    
    2004
    
    
    2003
    
    
    2002Revenue:Product revenue
    
    $
    
    
    
    $
    
    
    
    $
    Other revenue
    
    
    
    
    
    
    
    
    
    
    Total revenue
    
    
    
    
    
    
    
    
    
    
    Cost of revenue
    
    
    
    
    
    
    
    
    
    
    Gross profit
    
    
    
    
    
    
    
    
    
    
    Operating expenses:Selling, general and administrative
    
    
    1,665,794
    
    
    
    2,387,082
    
    
    
    2,484,913Restructuring and other charges
    
    
    
    
    
    
    
    
    
    
    504,0001,665,794
    
    
    
    2,387,082
    
    
    
    2,988,913Operating loss
    
    
    (1,665,794
    )
    
    
    (2,387,082
    )
    
    
    (2,988,913
    )Interest income
    
    
    8,170
    
    
    
    15,878
    
    
    
    86,441Interest expense
    
    
    (1,615,371
    )
    
    
    (1,138,388
    )
    
    
    (370,643
    )Gain (loss) on modification of convertible notes
    
    
    (1,670,683
    )
    
    
    1,500,000
    
    
    
    Other expense, net
    
    
    (27,490
    )
    
    
    (59,602
    )
    
    
    (25,427
    )Loss before discontinued operations
    
    
    (4,971,168
    )
    
    
    (2,069,194
    )
    
    
    (3,298,542
    )Discontinued operations:Loss from discontinued operations
    
    
    (4,127,982
    )
    
    
    (8,242,010
    )
    
    
    (4,232,474
    )Loss on liquidation of discontinued operation
    
    
    (2,436,730
    )
    
    
    
    
    
    
    Gain on sale of discontinued operations
    
    
    557,052
    
    
    
    1,832,059
    
    
    
    Loss from discontinued operations
    
    
    (6,007,660
    )
    
    
    (6,409,951
    )
    
    
    (4,232,474
    )Net loss
    
    
    (10,978,828
    )
    
    
    (8,479,145
    )
    
    
    (7,531,016
    )Beneficial conversion featurepreferred
stock dividend
    
    
    (1,946,210
    )
    
    
    (958,962
    )
    
    
    Deemed dividend on preferred stock
    
    
    (1,211,247
    )
    
    
    
    
    
    
    Net loss available to common shareholders
    
    $
    (14,136,285
    )
    
    $
    (9,438,107
    )
    
    $
    (7,531,016
    )Basic and diluted net loss per common share available to common shareholders:Loss from continuing operations
    
    $
    (0.26
    )
    
    $
    (0.11
    )
    
    $
    (0.12
    )Discontinued operations:Loss from discontinued operations
    
    
    (0.13
    )
    
    
    (0.31
    )
    
    
    (0.16
    )Loss on liquidation of discontinued
operation
    
    
    (0.08
    )
    
    
    
    
    
    
    Gain on sale of discontinued operations
    
    
    0.02
    
    
    
    0.07
    
    
    
    Loss from discontinued operations
    
    
    (0.19
    )
    
    
    (0.24
    )
    
    
    (0.16
    )Net loss available to common shareholders
    
    $
    (0.45
    )
    
    $
    (0.35
    )
    
    $
    (0.28
    )Weighted average common shares outstanding
    
    
    31,396,653
    
    
    
    26,967,708
    
    
    
    26,816,130
 The accompanying notes are an integral part of these consolidated financial statements. 22




---



##### 



Consolidated Balance Sheets December 31,Diametrics Medical, Inc. and Subsidiary
    
    2004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    1,095,800
    
    
    $
    170,692Restricted cash
    
    
    
    
    
    
    720,169Prepaid expenses and other current assets
    
    
    24,815
    
    
    
    181,116Assets of discontinued operations
    
    
    25,017
    
    
    
    3,942,037Total current assets
    
    
    1,145,632
    
    
    
    5,014,014Property and equipment, net
    
    
    3,171
    
    
    
    93,751Other assets, net
    
    
    107,226
    
    
    
    85,234$
    1,256,029
    
    
    $
    5,192,999Liabilities and Shareholders Equity (Deficit)Current liabilities:Accounts payable
    
    $
    636,055
    
    
    $
    465,021Accrued expenses
    
    
    718,784
    
    
    
    483,092Deferred credits and revenue
    
    
    
    
    
    
    726,359Convertible senior secured fixed rate notes
    
    
    28,281
    
    
    
    Liabilities of discontinued operations
    
    
    93,677
    
    
    
    3,756,961Total current liabilities
    
    
    1,476,797
    
    
    
    5,431,433Long-term liabilities:Convertible subordinated debt
    
    
    988,106
    
    
    
    5,632,142Total liabilities
    
    
    2,464,903
    
    
    
    11,063,575Commitments and contingenciesShareholders equity (deficit):Preferred stock, $.01 par value: 5,000,000 shares
authorized, 25,000 shares issued and outstanding at December 31, 2004
and 7,500 shared issued and outstanding at December 31, 2003,
respectively (Liquidation preference of preferred shares is
$2,500,000 at December 31, 2004)
    
    
    250
    
    
    
    75Common
stock, $.01 par value: 200,000,000 shares authorized, 35,121,835
and 27,456,209 shares issued and outstanding at December 31, 2004
and 2003, respectively
    
    
    351,218
    
    
    
    274,562Additional paid-in capital
    
    
    165,432,535
    
    
    
    150,612,474Accumulated deficit
    
    
    (166,992,877
    )
    
    
    (152,856,593
    )Deferred compensation
    
    
    
    
    
    
    (93,699
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (3,807,395
    )Total shareholders equity (deficit)
    
    
    (1,208,874
    )
    
    
    (5,870,576
    )$
    1,256,029
    
    
    $
    5,192,999
 The accompanying notes are an integral part of these consolidated financial statements. 23




---



##### 



Consolidated Statements of Shareholders Equity (Deficit) and Comprehensive Loss Additional
    
    
    
    
    
    
    
    
    
    
    Accumulated other
    
    
    Total
    
    
    TotalPreferred
    
    
    Common
    
    
    Preferred
    
    
    Common
    
    
    paid-in
    
    
    Accumulated
    
    
    Deferred
    
    
    comprehensive
    
    
    shareholders
    
    
    comprehensiveDiametrics Medical, Inc. and Subsidiary
    
    Shares
    
    
    Shares
    
    
    stock
    
    
    stock
    
    
    capital
    
    
    deficit
    
    
    compensation
    
    
    income (loss)
    
    
    equity (deficit)
    
    
    lossBalance, December 31, 2002
    
    
    
    
    
    
    27,165,336
    
    
    $
    
    
    
    $
    271,653
    
    
    $
    148,479,677
    
    
    $
    (143,418,486
    )
    
    $
    (652,896
    )
    
    $
    (4,009,052
    )
    
    $
    670,896Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,479,145
    )
    
    
    
    
    
    
    
    
    
    
    (8,479,145
    )
    
    $
    (8,479,145
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    192,818
    
    
    
    192,818
    
    
    
    192,818Minimum pension liability
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,839
    
    
    
    8,839
    
    
    
    8,839Comprehensive loss for the year ended
December 31, 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,479,145
    )
    
    
    
    
    
    
    201,657
    
    
    
    
    
    
    $
    (8,277,488
    )Cancellation of restricted stock
    
    
    
    
    
    
    (87,480
    )
    
    
    
    
    
    
    (875
    )
    
    
    (217,826
    )
    
    
    
    
    
    
    218,701
    
    
    
    
    
    
    
    Amortization of deferred compensation
under restricted stock plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    340,496
    
    
    
    
    
    
    
    340,496Issuance of preferred stock
    
    
    15,000
    
    
    
    
    
    
    
    150
    
    
    
    
    
    
    
    1,205,120
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,205,270Beneficial conversion value of preferred stock
    
    
    
    
    
    
    
    
    
    
    0
    
    
    
    
    
    
    
    958,962
    
    
    
    (958,962
    )
    
    
    
    
    
    
    
    
    
    
    Redemption of preferred stock
    
    
    (7,500
    )
    
    
    
    
    
    
    (75
    )
    
    
    
    
    
    
    (749,925
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (750,000
    )Valuation of warrants issued in connection with
extension of convertible subordinated debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800,000Exercise of warrants to common stock
    
    
    
    
    
    
    330,751
    
    
    
    
    
    
    
    3,308
    
    
    
    112,455
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    115,763Issuance of common stock under
employee stock purchase plan
    
    
    
    
    
    
    47,602
    
    
    
    
    
    
    
    476
    
    
    
    24,011
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24,487Balance, December 31, 2003
    
    
    7,500
    
    
    
    27,456,209
    
    
    $
    75
    
    
    $
    274,562
    
    
    $
    150,612,474
    
    
    $
    (152,856,593
    )
    
    $
    (93,699
    )
    
    $
    (3,807,395
    )
    
    $
    (5,870,576
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,979,828
    )
    
    
    
    
    
    
    
    
    
    
    (10,979,828
    )
    
    $
    (10,979,828
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    904,015
    
    
    
    904,015
    
    
    
    904,015Minimum pension liability
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,903,380
    
    
    
    2,903,380
    
    
    
    2,903,380Comprehensive loss for the year ended
December 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,979,828
    )
    
    
    
    
    
    
    3,807,395
    
    
    
    
    
    
    $
    (7,171,433
    )Amortization of deferred compensation
under restricted stock plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93,699
    
    
    
    
    
    
    
    93,699Conversion of preferred stock
    
    
    (12,500
    )
    
    
    5,983,509
    
    
    
    (125
    )
    
    
    59,835
    
    
    
    (59,710
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of preferred stock
    
    
    30,000
    
    
    
    
    
    
    
    300
    
    
    
    
    
    
    
    2,610,813
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,611,113Beneficial conversion value of preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,946,210
    
    
    
    (1,946,210
    )
    
    
    
    
    
    
    
    
    
    
    Valuation of warrants issued in connection with
extension of convertible subordinated debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    193,322
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    193,322Valuation of warrants issued in connection with
issuance of convertible senior secured notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    601,020
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    601,020Beneficial conversion value related to convertible
senior secured notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,018,980
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,018,980Beneficial conversion value related to convertible
subordinated debt
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,300,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,300,000Deemed dividend related to the valuation of change in
warrant exercise price and issuance of
additional
to preferred stockholders
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,211,247
    
    
    
    (1,211,247
    )
    
    
    
    
    
    
    
    
    
    
    Exercise of warrants to common stock
    
    
    
    
    
    
    1,682,117
    
    
    
    
    
    
    
    16,821
    
    
    
    (1,821
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,000Balance, December 31, 2004
    
    
    25,000
    
    
    
    35,121,835
    
    
    $
    250
    
    
    $
    351,218
    
    
    $
    165,432,535
    
    
    $
    (166,992,877
    )
    
    $
    
    
    
    $
    
    
    
    $
    (1,208,874
    )
 The accompanying notes are an integral part of these consolidated financial statements. 24




---



##### 



Consolidated Statements of Cash Flows Years ended December 31,Diametrics Medical, Inc. and Subsidiary
    
    2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net loss
    
    $
    (10,978,828
    )
    
    $
    (8,479,145
    )
    
    $
    (7,531,016
    )Adjustments to reconcile net loss to net cash
used in continuing operating activities:Loss from discontinued operations
    
    
    4,127,982
    
    
    
    8,479,145
    
    
    
    4,232,474Gain on sale of discontinued operations
    
    
    (557,052
    )
    
    
    
    
    
    
    Loss on liquidation of discontinued operations
    
    
    2,436,730
    
    
    
    
    
    
    
    Depreciation and amortization
    
    
    45,386
    
    
    
    208,669
    
    
    
    999,305Loss (gain) on modification of convertible subordinated notes
    
    
    1,670,683
    
    
    
    (1,500,000
    )
    
    
    Accretion of convertible notes
    
    
    1,206,884
    
    
    
    632,142
    
    
    
    Stock-based compensation
    
    
    93,699
    
    
    
    340,496
    
    
    
    230,270Loss on disposal of property and equipment
    
    
    46,532
    
    
    
    145,156
    
    
    
    12,150Changes in operating assets and liabilities (net of operations sold):Prepaid expenses and other current assets
    
    
    156,301
    
    
    
    9,683
    
    
    
    (14,037
    )Accounts payable
    
    
    171,034
    
    
    
    (131,675
    )
    
    
    48,483Accrued expenses
    
    
    235,692
    
    
    
    (3,359,699
    )
    
    
    2,639,972Deferred credits and revenue
    
    
    (6,190
    )
    
    
    7,436
    
    
    
    Net cash provided by (used in) continuing operating
activities
    
    
    (1,351,147
    )
    
    
    (3,647,792
    )
    
    
    617,601Cash flows from investing activities:Purchases of property and equipment
    
    
    (1,337
    )
    
    
    (80,628
    )
    
    
    (168,896
    )Proceeds from maturities of marketable securities
    
    
    
    
    
    
    
    
    
    
    749,141Net proceeds from sale of discontinued operations
    
    
    
    
    
    
    4,153,938
    
    
    
    Proceeds from sale of discontinued operations placed in escrow
    
    
    
    
    
    
    (720,169
    )
    
    
    Deferred gain on sale of discontinued operations
    
    
    
    
    
    
    718,923
    
    
    
    Other
    
    
    (21,992
    )
    
    
    2,772
    
    
    
    Net cash provided by (used in) investing activities
    
    
    (23,329
    )
    
    
    4,074,836
    
    
    
    580,245Cash flows from financing activities:Redemption of preferred stock
    
    
    
    
    
    
    (750,000
    )
    
    
    Principal payments on borrowings
    
    
    
    
    
    
    
    
    
    
    (156,636
    )Convertible subordinated debt extension costs
    
    
    
    
    
    
    (81,306
    )
    
    
    Proceeds from borrowings
    
    
    1,620,000
    
    
    
    
    
    
    
    31,240Net proceeds from issuance of preferred stock
    
    
    2,611,113
    
    
    
    1,205,270
    
    
    
    Net proceeds from issuance of common stock
    
    
    15,000
    
    
    
    140,250
    
    
    
    83,059Net cash provided by (used in) financing activities
    
    
    4,246,113
    
    
    
    514,214
    
    
    
    (42,337
    )Net cash used in discontinued operations
    
    
    (1,946,529
    )
    
    
    (4,677,180
    )
    
    
    (4,388,216
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    
    
    
    
    
    
    
    
    Net increase (decrease) in cash and cash equivalents
    
    
    925,108
    
    
    
    (3,735,922
    )
    
    
    (3,232,707
    )Cash and cash equivalents at beginning of year
    
    
    170,692
    
    
    
    3,906,614
    
    
    
    7,139,321Cash and cash equivalents at end of year
    
    $
    1,095,800
    
    
    $
    170,692
    
    
    $
    3,906,614Supplemental disclosures of cash flow information:Cash paid during the year for interest
    
    $
    
    
    
    $
    479,089
    
    
    $
    545,976
 The accompanying notes are an integral part of these consolidated financial statements. 25




---



##### 



(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of the Business.Diametrics Medical, Inc., along with its subsidiary (the
Company), is a medical device company whose focus has changed significantly over the past 18
months. On November 1, 2004, the Company terminated all of its employees in the United Kingdom and
all but four of its employees in the United States. On November 22, 2004, a meeting of creditors
was held in London, England for the purposes of liquidating the assets of its wholly owned
subsidiary in the United Kingdom, Diametrics Medical Limited (DML). The Company has created a
new, wholly owned subsidiary called TGC Research Limited (TGC), which has acquired certain
assets, including equipment and intellectual property, from the liquidator of DML in January 2005.
TGC will become an R&D organization which will focus initially on the development of a line of new
products aimed at continuous glucose monitoring and control in critically ill patients in a
hospital setting at the point-of-patient care. On September 29, 2003, the Company completed the sale of substantially all of the assets used
in the Companys intermittent testing business to International Technidyne Corporation (ITC), a
wholly owned subsidiary of Thoratec Corporation, for approximately $5.2 million in cash and the
assumption of certain liabilities, including $583,000 in trade payables. The results of operations
for the intermittent testing business have been reported as discontinued operations for all periods
presented in this Annual Report on Form 10-K. With the termination effective November 1, 2002 of the Companys agreement with Philips
Medical Systems for exclusive worldwide distribution of the Companys TrendCare continuous blood
gas monitoring systems, the Company began reestablishing a direct sales force in the United States,
the United Kingdom and Germany, as well as nonexclusive third-party distributors in various other
countries. The Company continued to sell disposable sensors and related accessories to Philips for
Philips nonexclusive distribution to its customer base through October 31, 2003. Until November 1,
2004, the Company continued to distribute its Neurotrend cerebral tissue monitoring system through
Codman & Shurtleff, Inc. a Johnson & Johnson Company (Codman), under an exclusive distribution
agreement entered into October 1, 1998. Principles of Consolidation.The accompanying consolidated financial statements include the
accounts of Diametrics Medical, Inc. and its wholly owned subsidiaries TGC Research Medical
Limited, and Diametrics Medical, Ltd. All material intercompany accounts and transactions have
been eliminated. Foreign Currency Translation/Transactions.The financial statements of the Companys foreign
subsidiary are translated into U.S. dollars for consolidation. All assets and liabilities are
translated using period-end exchange rates and statements of operations items are translated using
average exchange rates for the period. The resulting translation adjustments are recorded as a
separate component of shareholders equity (deficit). Also recorded as translation adjustments in
shareholders equity (deficit) are transaction gains and losses on intercompany balances for which
settlement is not planned or anticipated in the foreseeable future. Other foreign currency
transaction gains and losses are included in determining net loss, but have not been material in
any of the years presented. Cash Equivalents.The Company considers highly liquid debt instruments purchased with an
original maturity of 90-days or less to be cash equivalents. The
Company maintains its cash in high quality financial institutions.
The balances, at times, may exceed the insured limits. 26




---



##### 



Inventories.Inventories were stated at the lower of cost or market using the first in, first
out method. Reserves for slow moving and obsolete inventories were provided based upon current and
expected future product sales, the expected impact of changes in production levels and product
transitions or modifications. Property and Equipment.Property and equipment are recorded at cost. Depreciation and
amortization are computed using the straight-line method over estimated useful lives of 2 to 10
years for equipment and furniture and the term of the underlying lease for leasehold improvements.
Maintenance and repairs are expensed as incurred. Impairment of Long-lived Assets.The Company reviews its long-lived asset groups for
impairment whenever events or changes in circumstances indicate that the carrying amount of an
asset group may not be recoverable. Recoverability of asset groups to be held and used is measured
by a comparison of the carrying amount of an asset group to future net cash flows expected to be
generated by the asset group. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the asset group exceeds the
fair value of the assets in the group. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell. Revenue Recognition.The Company recognizes revenue upon its shipment of product to
its distributors and direct customers or, in the case of trial monitors placed directly with
customers, upon the customers acceptance of the product. The Companys sales terms to its
distributors and direct customers provide no right of return outside of the Companys standard
warranty policy and payment terms consistent with industry standards apply. Sales terms and pricing
extended to the Companys distributors and direct customers are governed by the respective
distribution agreements and contracts, together with binding purchase orders for each transaction.
The transition to expanded distribution channels and the resulting increase in sales to direct
end-user customers is expected to increase the diversity of the Companys sales transactions and
customer base, which may result in some transactions with nonstandard terms and conditions, such as
acceptance criteria. In these cases, revenue will be recognized upon the fulfillment of the
obligation specific to the terms of the customers contract. In cases where an end-user customer
requires more than an insignificant amount of post-sales training, the Company will defer the
greater of the relative fair value of that training or any contingent payments until the training
is completed in accordance with EITF 00-21 Revenue Arrangements with Multiple Deliverables. Research and Development.Research and development costs relate to hardware and software
development and enhancements to existing products. All such costs are expensed as incurred.
Research and development funds earned by the Company under the Philips exclusive agreement (which
ceased with the termination of that agreement effective November 1, 2002), were recorded as a
reduction of the development costs incurred, and approximated $467,000 in 2002. Net Loss Per Common Share.Basic earnings per share (EPS) is calculated by dividing net
loss by the weighted average common shares outstanding during the period. Diluted EPS reflects the
potential dilution to basic EPS that could occur upon conversion or exercise of securities, options, or other such items,
to common shares using the treasury stock method based upon the weighted average fair value of the
Companys common shares during the period. For each period presented, basic and diluted loss per
share amounts are identical, as the effect of potential common shares is antidilutive. The following is a summary of outstanding securities which have been excluded from the
calculation of diluted EPS because the effect on net loss per common share would have been
antidilutive: 27




---



##### 



December 31,2004
    
    
    2003
    
    
    2002Common stock options
    
    
    1,422,600
    
    
    
    3,423,256
    
    
    
    3,802,255Common stock warrants
    
    
    66,811,426
    
    
    
    4,668,996
    
    
    
    1,201,667Convertible senior secured fixed rate notes
    
    
    2,013,430
    
    
    
    2,013,430
    
    
    
    869,047Convertible preferred stock-Series E
    
    
    
    
    
    
    2,650,177
    
    
    
    Convertible preferred stock-Series F
    
    
    6,666,667
    
    
    
    
    
    
    
    Convertible preferred stock-Series G
    
    
    25,000,000
    
    
    
    
    
    
    
    Restricted stock
    
    
    64,251
    
    
    
    64,251
    
    
    
    329,885
 Income Taxes.Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. Due to historical net losses of the Company, a valuation
allowance is established to offset the deferred tax asset. Use of Estimates.The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
and the reported amounts of revenues and expenses during the reporting period. The Companys
significant estimates primarily relate to the assessment of required accounts receivable and
inventory valuation allowances, the fair value of long-lived assets, accounting for debt and equity
transactions, accounting for foreign currency translation and transactions and defined benefit
retirement plan funding and accounting. Actual results could differ from those estimates. Fair
value of financial instruments. The Companys financial instruments are
recorded on its consolidated balance sheet. The carrying amount for cash and
cash equivalents, accounts receivable, accounts payable and accrued expenses
approximates fair value due to the immediate or short-term maturity of these
financial instruments. The fair value of long-term debt approximates the
carrying amounts based upon the Companys expected borrowing rate for debt with
similar remaining maturities and comparable risk. Stock
Based Compensation.As permitted by Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, the Company applies the intrinsic-value method prescribed in Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, to account for the
issuance of stock incentives to employees and directors. As a result, no compensation expense
related to employees and directors stock incentives has been recognized in the financial
statements as all options granted under stock incentive plans had an exercise price equal to the
market value of the underlying common stock on the date of grant. Had compensation costs for the
Companys stock incentive plans been determined based on the fair value of the awards on the date
of grant, consistent with the provisions of SFAS No. 123, the Companys net loss per share would
have increased to the pro forma amounts indicated below: 2004
    
    
    2003
    
    
    2002Net loss available to common stock shareholders, as reported
    
    $
    (14,136,285
    )
    
    $
    (9,438,107
    )
    
    $
    (7,531,016
    )Stock-based employee compensation expense included in
reported in net loss available to common stock shareholders
    
    
    93,699
    
    
    
    340,496
    
    
    
    230,270Total stock-based employee compensation expense determined
under fair value-based method for all awards
    
    
    (618,523
    )
    
    
    (1,955,578
    )
    
    
    (2,493,200
    )Pro forma net loss available to common stock shareholders
    
    $
    (14,661,109
    )
    
    $
    (11,053,189
    )
    
    $
    (9,793,946
    )Net loss
available to common shareholders:Basic and diluted, as reported
    
    $
    (0.45
    )
    
    $
    (0.35
    )
    
    $
    (0.28
    )Basic and diluted, proforma
    
    $
    (0.47
    )
    
    $
    (0.41
    )
    
    $
    (0.37
    )
 28




---



##### 



For each period presented, basic and diluted loss per share amounts are identical, as the effect of
potential common shares is antidilutive. An option to purchase 25,000 shares was granted to a new Director in 2004. The per share
weighted-average fair value of options granted under the Companys stock option plans was $.14,
$.75 and $2.41 for the years ended December 31, 2004, 2003 and 2002, respectively. These per share
values were determined using the Black Scholes option-pricing model with the following assumptions:
annualized volatility of 115.77%, 100.92% and 91.53% for 2003 and 2002, respectively; risk-free
interest rate of 3.5% in 2004, 3.25% in 2003 and 3.76%; and an expected life of five years and no
dividends for each year. Comprehensive Loss.Comprehensive loss is presented as a component of Shareholders Equity
(Deficit) and consists of net loss, foreign currency translation adjustments and changes in the
Companys minimum pension liability. The accumulated balances for each component of accumulated
other comprehensive loss are as follows: Foreign Currency
    
    
    Minimum
    
    
    Total AccumulatedTranslation
    
    
    Pension
    
    
    OtherAdjustment
    
    
    Liability
    
    
    Comprehensive LossBalances at December 31, 2001
    
    $
    (1,203,271
    )
    
    $
    (1,165,455
    )
    
    $
    (2,368,726
    )Foreign currency rate changes
    
    
    106,438
    
    
    
    
    
    
    
    106,438Change in minimum pension liability
    
    
    
    
    
    
    (1,746,764
    )
    
    
    (1,746,764
    )Balances at December 31, 2002
    
    
    (1,096,833
    )
    
    
    (2,912,219
    )
    
    
    (4,009,052
    )Foreign currency rate changes
    
    
    192,818
    
    
    
    
    
    
    
    192,818Change in minimum pension liability
    
    
    
    
    
    
    8,839
    
    
    
    8,839Balances at December 31, 2003
    
    
    (904,015
    )
    
    
    (2,903,380
    )
    
    
    (3,807,395
    )Change in minimum pension liability
    
    
    
    
    
    
    2,903,380
    
    
    
    2,903,380Foreign currency rate changes
    
    
    904,015
    
    
    
    
    
    
    
    904,015Balances at December 31, 2004
    
    $
    
    
    
    $
    
    
    
    $
    
 The foreign currency translation adjustment and minimum pension liability were related to the
Companys discontinued DML subsidiary. These amounts were realized in the statement of operations
as part of the loss on liquidation of the DML subsidiary. Defined Benefit Retirement Plan Funding.The Companys U.K. subsidiary sponsored a
contributory defined benefit retirement plan (Retirement Plan) covering all eligible employees.
The Companys funding policy was to contribute into a trust fund at an annual rate that was
intended to remain at a level percentage of total pensionable payroll. Annual contribution amounts
were determined by a qualified actuary and were intended to adequately fund the Companys projected
pension liability payable upon employees retirement, given actuarial assumed rates of average
market and trust fund investment performance. Reclassifications.Certain amounts included in the prior year consolidated financial
statements, including the impact of the Companys discontinued operations, have been reclassified
in prior years to conform to the current year presentation. Such reclassifications had no effect
on the Companys previously reported consolidated financial position, net loss or cash flows. New
Accounting Pronouncements.In December 2004, the Financial
Accounting Standards Board (FASB) issued SFAS No. 123(R),
Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation and supersedes APB 25 Accounting for Stock Issued to Employees. SFAS 123(R)
requires companies to recognize the cost of employee services received in exchange for awards of
equity instruments, based on the grant date fair value of those awards, in the financial
statements. The effective date of SFAS No. 123(R) for the Company is January 1, 2006. SFAS No.
123(R) permits companies to adopt its requirements using either a modified prospective method, or
a modified retrospective method. Under the modified prospective method, compensation cost is
recognized in the financial statements beginning with the effective date, based 29




---



##### 



on the requirements
of SFAS No. 123® for all share-based payments granted after that date, and based on the
requirements of SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS
123®. Under the modified retrospective method, the requirements are the same as under the
modified prospective method, but also permits entities to restate financial statements of
previous periods based on proforma disclosures made in accordance with SFAS No. 123. The Company
expects to adopt the modified prospective method under SFAS No. 123®. The Company is
currently determining the impact on the Companys financial statements. In December 2003, the FASB issued a revision to FASB Interpretation No. 46, Consolidation of
Variable Interest Entities, which replaces the original issuance of FASB Interpretation No. 46 in
January 2003 and clarifies the application of Accounting Research Bulletin No. 51, Consolidated
Financial Statements. This interpretation addresses consolidation by business enterprises of
variable interest entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support. The adoption of FIN 46 did not
have a material effect on our results of operations, cash flows or financial position. (2) GOING CONCERN Although the Company discontinued all its operations in October 2004, it did obtain additional
funding in December 2004 and again in May 2005 for a new product research project started in early
2005. The accompanying financial statements have therefore been prepared on a going-concern basis
after adjusting all assets and liabilities to amounts expected to be realized or paid,
respectively, in the normal course of business. The report of the Companys independent auditors
contains an explanatory paragraph expressing substantial doubt about the Companys ability to
continue as a going concern as a result of recurring losses, negative cash flows and uncertainties
regarding the Companys ability to successfully develop, produce and market a new product or
products. The financial statements would require additional adjustments relating to the
recoverability and classification of recorded asset amounts and the amounts and classification of
liabilities and would be necessary if the Company is unable to continue as a going concern. The Company is planning to use available funds to develop new products aimed at continuous
glucose monitoring in critically ill patients. It believes its experience with in-vivo measurement
systems positions it well to develop such products. Planning efforts are projected to continue
through summer 2005. We will be required to raise additional capital in order to sustain and fund our operations
over the long term. Our initial projections indicated a need for $10 million to $15 million, which
may be adjusted as we develop our business plan and evaluate further the need for costs of product
enhancements and sales and marketing programs. We do not currently have any available lines of
credit or other credit facilities and we are not certain that we can obtain financing or, if it is
available, whether it will be on acceptable terms. We may pursue the issuance of additional equity
or debt securities to the extent funding raised from other business alternatives is not sufficient
to meet our funding requirements. If we raise additional funds through the issuance of equity or
equity-related securities, our shareowners may experience dilution of their ownership interests and
the newly issued securities may have rights superior to those of common stock. If we raise
additional funds by issuing debt, we may be subject to restrictive covenants that could limit our
operating flexibility. While we believe that we will be able to raise adequate funding to meet our
operational requirements, there can be no assurance that adequate funds will be available when
needed and on acceptable terms. If we are unable to obtain additional financing when needed, we
would be required to significantly scale back development plans and, depending upon cash flow from
our business, reduce the scope of our operations or cease operations entirely. (3) DISCONTINUED OPERATIONS On October 4, 2004, the Company determined it would longer fund the operations of DML. On
that same day, DMLs board of directors decided to shut-down DML. On November 1, 2004, the Company
terminated all of our employees in the United Kingdom and all but three of our employees in the
United States. On November 22, 2004, a Meeting of Creditors was held in London, England for the
purposes of liquidating the assets of DML. Based upon a review of SFAS No. 144, Accounting for
the Impairment or Disposal of Long-lived Assets, the Company assessed the measurement date for the
sale transaction as the date of board of director approval, which occurred on October 4, 2004. As
prescribed by SFAS No. 144, the Company began reporting the results of operations of DML as
discontinued operations effective as of the year ended December 31, 2004 and for all periods
presented. Upon DML entering liquidation in November, the Company recorded a loss of $2.4 million. Following are summary operating results of the continuous monitoring business, included in
discontinued operations in the Companys Consolidated Statements of Operations for the respective
periods: 30




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##### 



2004
    
    
    2003
    
    
    2002Revenue
    
    $
    2,412,071
    
    
    $
    3,083,451
    
    
    $
    5,485,937Gross profit
    
    
    (551,944
    )
    
    
    51,274
    
    
    
    1,949,570Net loss
    
    
    (4,127,982
    )
    
    
    (6,170,974
    )
    
    
    (2,368,005
    )
 On September 29, 2003, the Company completed the sale of substantially all of the assets used
in the Companys intermittent testing business to ITC, for approximately $5.2 million in cash and
the assumption of certain liabilities, including trade payables of approximately $583,000, certain
capital lease obligations of $56,000 and product warranty obligations estimated at $30,000. Of the
cash payment, $758,000 was placed in escrow by ITC and was restricted from the Companys use for
180 days to cover any shortfall in collected receivables or any indemnification claims. Amounts
remaining in escrow at December 31, 2003, after deducting escrow account fees and $33,000 in trade
payables assumed by ITC in excess of an established $550,000 ceiling, approximated $720,000 and
were recorded as restricted cash and a deferred credit in current liabilities. Based upon a review
of SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, the Company
assessed the measurement date for the sale transaction as the date of shareholder approval, which
occurred on September 19, 2003. As prescribed by SFAS No. 144, the Company began reporting the
results of operations of the intermittent testing business as discontinued operations effective
with the quarter ended September 30, 2003, for all periods presented. Upon completion of the sale
transaction in September, the Company recorded a gain on the sale of the intermittent testing
business of $1.8 million. In late March 2004, sale proceeds remaining in escrow and deferred for
recognition were released to the Company, amounting to approximately $713,000. After deducting
transaction costs of $156,000, an additional gain on the sale of discontinued operations was
recognized in the first quarter 2004 of approximately $557,000. Following are summary operating results of the intermittent testing business, included in
discontinued operations in the Companys Consolidated Statements of Operations for the respective
periods: 2004
    
    
    2003
    
    
    2002Revenue
    
    $
    
    
    
    $
    4,821,996
    
    
    $
    12,328,108Gross profit
    
    
    
    
    
    
    1,008,126
    
    
    
    2,033,761Net loss
    
    
    
    
    
    
    (2,071,036
    )
    
    
    (1,864,469
    )
 The carrying value of assets sold to ITC, consisting primarily of accounts receivable,
inventory and property and equipment, approximated $3.0 million, and liabilities assumed by ITC
totaled approximately $669,000. The
assets and liabilities of the discontinued operations at
December 31, 2004 are as follows: Accounts
receivable, net
    
    
    
    
    
    
    
    
    
    $
    14,532Inventories,
net
    
    
    
    
    
    
    
    
    
    $
    10,485Accounts
payable
    
    
    
    
    
    
    
    
    
    $
    71,424Accrued rent
    
    
    
    
    
    
    
    
    
    $
    22,253
 31




---



##### 



(4) COMPONENTS OF SELECTED BALANCE SHEET ACCOUNTS December 31,2004
    
    
    2003Property and equipment:Computer hardware and software
    
    $
    176,044
    
    
    $
    211,843Furniture and fixtures
    
    
    49,199
    
    
    
    148,045225,243
    
    
    
    359,888Less accumulated depreciation
    
    
    222,072
    
    
    
    266,137$
    3,171
    
    
    $
    93,751Accrued expenses:Employee compensation
    
    $
    
    
    
    $
    218,998Interest payable
    
    
    675,843
    
    
    
    129,418Other
    
    
    42,941
    
    
    
    134,676$
    718,784
    
    
    $
    483,092Deferred credits and revenue:Deferred gain on sale of business
    
    $
    
    
    
    $
    718,923Other
    
    
    
    
    
    
    7,436$
    
    
    
    $
    726,359
 Approximately $720,000 of the proceeds from the sale of the Companys intermittent testing
business remained in escrow at December 31, 2003 and were restricted from the Companys use for 180
days after the closing date to fund indemnification obligations. In late March 2004, sale proceeds
remaining in escrow and deferred for recognition were released to the Company, amounting to
approximately $713,000. After deducting transaction costs of $156,000, an additional gain on the
sale of discontinued operations was recognized in the first quarter 2004 of approximately $557,000. (5) BORROWINGS Long-term debt at December 31, 2004 and 2003 consisted of the following: 2004
    
    
    2003Long-term debt:Convertible senior notes
    
    $
    28,281
    
    
    $
    Convertible subordinated notes
    
    
    988,106
    
    
    
    5,632,1421,016,387
    
    
    
    5,632,142Less current portion of long-term debt
    
    
    (28,281
    )
    
    
    $
    988,106
    
    
    $
    5,632,142
 The
following is a schedule of principal payments for long-term debt: Year ending December 31:2005
    
    $
    450,0002006
    
    
    675,0002007
    
    
    7,975,000$
    9,100,000Less:
Unamortized debt discounts
    
    
    (8,083,613)Net Carrying
Amount
    
    $
    1,016,387
 32




---



##### 



CONVERTIBLE SENIOR SECURED NOTES On December 14, 2004, the Company entered into a subscription agreement with certain
institutional investors (the Subscribers) for a new round of financing for the Company of up to
$3,000,000. On December 15, 2004, the Company received the first tranche of $1,800,000 in gross
proceeds. The notes, Convertible Senior Notes are due December 15, 2007, with
principal and interest payable in cash or registered shares over a 32-month period beginning 120
days after closing. The Subscribers also received a due diligence fee of $180,000. Interest on
the notes is at prime plus 4% with a floor of 8% (9.25% at
December 31, 2004). The conversion price of the notes is fixed at $0.02 per share, subject to
adjustment depending upon the market price of the Companys common stock. Of the total 90,000,000
shares that the debt is convertible into, 80,000,000 shares had been reserved at December 31, 2004,
with the remaining 10,000,000 being allocated when additional shares of stock are authorized by the
Company shareholders (see subsequent events note). The Subscribers also received warrants (the Warrants) to purchase up to 45,000,000 shares of
the Companys common stock at an exercise price of $0.025 per share in the first tranche, and will
receive additional warrants to purchase up to 30,000,000 shares if the second tranche is funded.
The Warrants expire on December 15, 2009. The Company determined the relative fair value of the debt was $2,627,588 and $1,549,318 for
the warrants. The Company allocated $1,018,980 and $601,020 of the net proceeds totaling
$1,620,000 to the debt and warrants, respectively. The application of the provisions of EITF
98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, and EITF 00-27, Application of Issue 98-5 to Certain Convertible
Instruments resulted in the calculation of an embedded beneficial conversion feature in the
Convertible Senior Notes, which is required to be treated as an additional discount to the
debt. The value of the beneficial conversion feature of $1,018,980 was limited to the amount
allocated to the debt. $16,010 of the beneficial conversion feature was amortized into interest
expense for the year ended December 31, 2004. The relative fair value of the warrants issued were determined using the Black-Scholes
option-pricing model based on the following assumptions: volatility of 116%, expected life of 5
years, risk free interest rate of 3.53% and no dividends. The effective interest rate on the
notes is approximately 193%. The Subscribers received a first lien on all of the assets of the Company. The holders of
the Companys previously issued convertible senior secured fixed rate notes due August 4, 2005 (the
Convertible Subordinated Notes), consented to the new financing and the subordination of their
secured position to a second lien on all of the assets of the Company in consideration for an
amendment of the conversion price of the Convertible Subordinated Notes to $0.02 per share and the
amendment of the exercise price of their outstanding warrants to purchase up to 4,255,837 shares of
the Companys common stock to $0.025 per share. See below for the recording of the amendment to the
Convertible Subordinated Notes. Preferred stock warrants outstanding to purchase up to 17,555,589
shares of the Companys common stock were also amended to reduce the exercise price thereof to
$0.025 per share, of which certain warrants outstanding to purchase up to 12,000,000 shares of the
Companys common stock were further amended to reduce the exercise price thereof to $0.01 per
share. See note 6 for discussion related to the accounting for the modification of these warrants. CONVERIBLE SUBORDINATED NOTES On August 4, 1998, the Company issued Convertible Subordinated Notes with proceeds aggregating
$7,300,000. Subsequent to the date of issuance the terms of the Convertible Subordinated Notes
have been renegotiated. With the issuance of the Convertible Senior Notes on 33




---



##### 



December 15, 2004,
the Convertible Subordinated Note holders agreed to subordination of their senior position. In
addition, they agreed to defer all principal and interest payments until after the Convertible
Senior Notes were repaid. For these concessions, the Convertible Subordinated Note holders
received a reduction in the conversion rate of their debt from $3.51 to $0.02 and a
reduction in the exercise price of previously issued warrants from $0.09 to $0.025. Of the
360,000,000 shares of common stock the Convertible Subordinated Notes are convertible into, only
2,013,431 shares were allocated for potential conversion at December 31, 2004. Additional shares
were to be allocated when additional shares of the Company stock was authorized by the Company (see
the subsequent events note). This transaction required accounting treatment prescribed under EITF
96-19, Debtors Accounting for a Modification or Exchange of Debt Instruments. As such, the
modified notes were recorded at its fair value of $8,295,112. The increase of $1,670,683 was
recorded in other income as a loss on modification of the notes. With the decrease in the conversion price of the debt, the Company applied the provisions of
EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios, and EITF 00-27, Application of Issue 98-5 to Certain
Convertible Instruments. This resulted in the calculation of an embedded beneficial conversion
feature in the Convertible Subordinated Notes, which is required to be treated as an additional
discount to the debt. The value of the beneficial conversion feature of $7,300,000 was recorded as
a discount to the debt. $40,269 of the beneficial conversion feature was amortized into interest
expense for the year ended December 31, 2004. The remaining balance will be amortized into
interest expense in the first quarter of 2005. The reduction in the exercise price increased the value of the warrant by $32,131. The
increased value in warrants was recorded as a discount to the debt with an offsetting amount
recorded to accumulated paid-in capital. The notes have a stated interest rate of 7% for principal balances that are not past due and
9% on the principal balances that have been deferred and accrued interest. Effective April 7, 2003, the Company completed the renegotiation of the terms of the
Convertible Subordinated Notes, to extend repayment of the notes to August 4, 2005. In exchange
for the extension of repayment, the Company agreed to reduce the conversion price for $6.9 million
principal value of the notes from $8.40 to $3.51 per share, and to use 50% of the net proceeds in excess of $10 million received
prior to August 4, 2005 from the issuance of any equity securities to pay down the principal value
of the notes. In addition, the Company issued the note holders five-year warrants for 4,255,837
shares of its common stock at an exercise price of $.94 per share. This transaction required
accounting treatment prescribed under EITF 96-19, Debtors Accounting for a Modification or
Exchange of Debt Instruments. As such, the modified notes and associated warrants were recorded
in debt and equity, respectively, at their respective fair values of $5 million and $800,000. The
$7.3 million carrying value of the original notes was retired, and the residual amount of $1.5
million was recorded in the second quarter 2003 in other income as a gain on modification of the
notes. The Company is accreting the initial $5 million carrying value of the modified notes to
their redemption value of $7.3 million over the remaining term of the notes using the effective
interest method at an effective interest rate of approximately 17%. This will result in the
recording of $2.3 million of additional interest expense over the remaining term of the notes, of
which $632,142 was recorded during 2003. In August 2003, the Convertible Subordinated Note holders agreed to further amend the Note
Purchase Agreement to defer the timing of interest payments on the notes for the first and second
quarters of 2003, amounting to approximately $254,000, as well as increase their security position
to include all unencumbered assets of the Company. The deferred interest was fully paid to the
note holders in September 2003. In January 2004, the note holders agreed to further amend the Note
Purchase Agreement effective December 30, 2003 to defer the timing of interest payments due for the
fourth quarter 2003 and the first quarter 2004, amounting to approximately $256,000, to June 30,
2004, and to reduce the exercise price on the warrants from $.94 per share to $.34 per share. In connection with the Series G preferred stock financing completed in May 2004, the
Convertible Subordinated Note holders agreed to again amend the Note Purchase Agreement to defer
until December 31, 2004 the Companys obligation to make interest payments previously 34




---



##### 



due on June
30, 2004 (including the deferred interest payments described above) and September 30, 2004,
amounting to approximately $640,000. In exchange for the deferral of interest payments, the
exercise price on the note holders common stock warrants was further reduced from $.34 per share
to $.09 per share. The first and second quarter reductions in the exercise price of the warrants
resulted in an increase in the fair value of the warrants of $90,674 and $70,517, respectively.
These amounts were recorded as a charge to interest expense with an offsetting credit to additional
paid-in capital in the respective quarter. The Company evaluated the appropriate accounting
treatment for the modification of the terms of the convertible notes and associated warrants and
determined that the provisions of SFAS No. 15, Accounting for Debtors and Creditors for Troubled
Debt Restructurings, and EITF 96-19, Debtors Accounting for a Modification or Exchange of Debt
Instruments, were not applicable. (6) CONVERTIBLE PREFERRED STOCK The following is a summary the status of the Companys preferred stock as of December 31, 2004
and 2003: Preferred Shares
    
    
    Par ValueSeries E
    
    
    Series F
    
    
    Series G
    
    
    Series E
    
    
    Series F
    
    
    Series GBalance at December 31, 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Issuance of preferred stock
    
    
    15,000
    
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    
    
    
    
    Redemption of preferred stock
    
    
    (7,500
    )
    
    
    
    
    
    
    
    
    
    
    (75
    )
    
    
    
    
    
    
    Balance at December 31, 2003
    
    
    7,500
    
    
    
    
    
    
    
    
    
    
    
    75
    
    
    
    
    
    
    
    Conversion of Series E
    
    
    (7,500
    )
    
    
    
    
    
    
    
    
    
    
    (75
    )
    
    
    
    
    
    
    Issuance of Series F
    
    
    
    
    
    
    15,000
    
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    Conversion of Series F
    
    
    
    
    
    
    (5,000
    )
    
    
    
    
    
    
    
    
    
    
    (50
    )
    
    
    Issuance of Series G
    
    
    
    
    
    
    
    
    
    
    15,000
    
    
    
    
    
    
    
    
    
    
    
    150Balance at December 31, 2004
    
    
    
    
    
    
    10,000
    
    
    
    15,000
    
    
    $
    
    
    
    $
    100
    
    
    $
    150
 SERIES G CONVERTIBLE PREFERRED STOCK On May 28, 2004, the Company completed a $1.5 million financing through the sale of 15,000
shares of Series G convertible preferred stock at $100 per share. The financing was completed in a
private placement with the Mercator Advisory Group and its related funds and BCC Acquisition II,
LLC. The Mercator Advisory Group and its related funds were also the investors in the Companys
Series E and Series F convertible preferred stock issued in May 2003 and January 2004,
respectively. Each share of the Series G preferred stock is convertible at any time into common
stock at 75% of the volume weighted average trading price of the lowest three inter-day trading
prices of the common stock during the five consecutive trading days preceding the conversion date,
with a maximum exercise price of $.14 per share and a minimum price of $.06 per share. The minimum
exercise price was decreased automatically to $.03 per share after the shareholders of the Company
authorized an increase in common stock from 100 million shares to 200 million shares on September
7, 2004. The Series G financing effectively replaced the unfunded second tranche of the Series F
preferred stock financing arranged in January 2004. As expected, the first $1.5 million tranche of
financing generated in January 2004 under the Series F preferred stock agreement and other
available funds had been substantially consumed by operations by the time the Series G financing
was completed. This additional financing was necessary to help meet near-term funding requirements
for support of the Companys operations as the Company continued to 35




---



##### 



pursue longer-term financing in
order to sustain the development of its continuous monitoring business and explore additional
applications of its technology. As part of this financing, the Company issued three-year warrants (Series G warrants) to the
purchasers of the Series G preferred stock. Those warrants entitle the holders to purchase an
aggregate of 1,250,000 shares of the Companys common stock at the lower of $.11 per share or the
average of the lowest ten inter-day closing prices of the Companys common stock during the ten
trading days preceding the exercise date. The Company also issued three-year warrants to the
Mercator Advisory Group and its related funds that invested in the Companys Series E and Series F
preferred stock to purchase an aggregate of 12,241,608 shares of common stock at $.05 per share. In connection with the Series G financing, the holders of the Companys Convertible
Subordinated Notes agreed to defer until December 31, 2004 the Companys obligation to make interest
payments previously due on June 30, 2004 (including interest payments originally due on December
31, 2003 and March 31, 2004, payment of which was deferred until June 30, 2004) and September 30,
2004. In exchange for the deferral of interest payments, the exercise price on the note holders
common stock warrants was reduced from $.34 per share to $.09 per share (see note 5). Additionally,
in connection with the Series G financing, the exercise price of the outstanding common stock
warrants issued as part of the Series E preferred stock financing was reduced from $.35 per share
to $.11 per share, and the ceiling price for the exercise of the common stock warrants issued as
part of the Series F preferred stock financing was reduced from $.35 per share to $.11 per share
(see below for additional discussion). Accounting for these transactions required a review of several criteria, including assessment
of the treatment of the beneficial conversion feature associated with the Series G preferred stock,
an assessment of the classification as debt or equity of the warrants issued in connection with the
Series G preferred stock financing, an assessment of the impact of the changes in the exercise and
ceiling exercise prices, as applicable, of the common stock warrants previously issued to the note
holders and the Series E and Series F preferred stock investors and an assessment of the treatment
of the fair value associated with the new warrants issued to the Series E and Series F preferred
stock investors. The application of the provisions of EITF 98-5, Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and EITF 00-27,
Application of Issue 98-5 to Certain Convertible Instruments resulted in the calculation of an
embedded beneficial conversion feature in the Series G preferred stock, which is required to be
treated as increase in the net loss available to common shareholders. The Company allocated the net
investor proceeds of $1,445,000 from the issuance of the Series G convertible preferred stock to
the preferred stock and Series G warrants based upon their relative fair values. The fair value
allocated to the Series G warrants of $68,205 was recorded as equity. The fair value allocated to
the preferred stock of $1,376,795 and the original conversion terms were used to calculate the
value of the beneficial conversion feature of $1,067,650 at the date of issuance of the Series G
preferred stock. The $1,067,650 was charged to retained earnings with the offsetting credit to
additional paid-in-capital. The Company treated the beneficial conversion feature of $1,067,650 as
a reconciling item on the statement of operations to adjust its reported net loss to net loss
available to common shareholders. As a result of the decrease in the conversions rate to $.03 per
share, the Company increased the value of beneficial conversion feature to $1,280,216 which was
limited to the amount of proceeds allocated to the Series G preferred stock. Additionally, the
Company treated the beneficial conversion feature of $1,280,216 as a reconciling item on the
statement of operations to adjust its reported net loss to net loss available to common
shareholders, which is used in the numerator in the loss per share calculation for the year ended
December 31, 2004. SERIES F CONVERTIBLE PREFERRED STOCK On January 16, 2004, the Company completed the sale in a private placement of 15,000 shares of
Series F convertible preferred stock at a price of $100 per share, resulting in aggregate gross
proceeds to the Company of $1.5 million. Each share of preferred stock is convertible at any time
into common stock at 75% of the volume weighted average trading price of the lowest three inter-day
trading prices of the common stock for the five consecutive trading days preceding the conversion
date, but at an exercise price of no more than $.25 per share and 36




---



##### 



no less than $.20 per share. In
accordance with the terms of the Series F preferred stock agreement, the floor conversion price was
reduced to $.15 per share effective June 30, 2004, due to the Companys inability to achieve a
six-month cash flow projection through that date. Five-year warrants were also issued to purchase
an aggregate of 6,000,000 shares of the Companys common stock at the lower of $.35 per share or
the average of the lowest ten inter-day closing prices of the Companys common stock on the
Over-the-Counter Bulletin Board during the 10 trading days immediately preceding the exercise date.
As discussed in note 2, the ceiling exercise price on the Series F warrants was reduced from $.35
to $.11 per share in connection with the Series G preferred stock financing transaction completed
in May 2004. Proceeds from the Series F interim financing were used to help meet the Companys
short-term funding requirements for support of its operations. Accounting for this transaction falls primarily under EITF 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and
EITF 00-27, Application of Issue 98-5 to Certain Convertible Instruments. The Company allocated
the net investor proceeds of $1,350,000 from the issuance of the Series F convertible preferred
stock to the preferred stock and associated warrants based upon their estimated relative fair
values. The resulting fair value allocations of $665,994 and $684,006 for the preferred stock and
warrants, respectively, were recorded as equity in the first quarter 2004. The beneficial
conversion feature embedded in the preferred stock was calculated at $665,994 and was limited to
the fair value allocated to the preferred stock. The beneficial conversion feature of $665,994 was
treated as a deemed dividend to preferred shareholders, and was charged to retained earnings, with
the offsetting credit to additional paid-in-capital. Additionally, the Company treated the beneficial conversion feature of
$665,994 as a reconciling item on the statement of operations to adjust its reported net loss to
net loss available to common shareholders, which is used in the numerator in the loss per share
calculation for the year ended December 31, 2004. SERIES E CONVERTIBLE PREFERRED STOCK On May 12, 2003, the Company completed a $1.5 million financing through the sale of 15,000
shares of Series E convertible preferred stock at a price of $100 per share. The preferred stock
is convertible at any time into the Companys common stock at 88% of the volume weighted average
trading price of the common stock for the five consecutive trading days before the conversion date,
subject to a maximum and minimum conversion price of $.75 per share and $.35 per share,
respectively. The preferred stock is callable by the Company during the first 12 months at the
original purchase price plus a return of 2% per month from the date of investment, and 50% could be
put back to the Company in the event of the Companys completion of the sale of its intermittent
testing business, at the original purchase price plus a return of 1% per month. Effective upon the
sale of the Companys intermittent testing business, the holders of the Series E preferred stock
elected to exercise their option to put back to the Company 50% of their original $1.5 million
investment plus a return of 1% per month. Five-year warrants to purchase 735,000 shares of the Companys common stock at $.35 per share
were also issued in conjunction with the financing. The warrants are exercisable after the
conversion of the preferred stock. Accounting for this transaction falls primarily under EITF
98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios, and EITF 00-27, Application of Issue 98-5 to Certain Convertible
Instruments. The Company allocated the net investor proceeds of $1,350,000 from the issuance of
the Series E convertible preferred stock to the preferred stock and associated warrants based upon
their estimated relative fair values. The resulting fair value allocations of $958,962 and
$391,038 for the preferred stock and warrants, respectively, were recorded as equity in the second
quarter 2003. The beneficial conversion feature embedded in the preferred stock was calculated at $958,962
and was limited to the fair value allocated to the preferred stock. The beneficial conversion
feature of $958,962 was treated as a deemed dividend to preferred shareholders, and was charged to
retained earnings, with the offsetting credit to additional paid-in-capital. Additionally, the
Company treated the beneficial conversion feature of $958,962 as a reconciling item on the
statement of operations to adjust its reported net loss to net loss available to common
shareholders, which is used in the numerator in the loss per share calculation for the year ended
December 31, 2003. 37




---



##### 



PREFERRED STOCK WARRANTS Subsequent to the preferred stock financings described above, the exercise price of the
warrants to purchase common stock issued with the preferred stock were adjusted downward during 2004 as a result of
the issuance of the Series G financing and the new Convertible Senior Notes. In addition new warrants to purchase
12,241,608 shares of common stock were issued to the Series E and Series F investors as a result of
the Series G financing. The new financing reduced the exercise price of warrants to
purchase 5,555,589 shares of common stock to $.025 per share and warrants to purchase 12,000,000
shares of common stock to $.01 per share The reductions in the exercise price or ceiling exercise
price, as applicable, of the warrants previously issued to these investors and the issuance of new
warrants to purchase additional shares of common stock resulted in a deemed dividend on the Series
E, F and G preferred stock, requiring a charge to retained earnings and an offsetting credit to
additional paid-in capital aggregating $1,211,247. Similar to the beneficial conversion features
discussed above, this amount was charged to retained earnings, with an offsetting credit to
additional paid-in-capital, and was treated as a reconciling item on the statement of operations to
adjust the reported net loss to net loss available to common shareholders, which is used in the
numerator in the loss per share calculation for the year ended December 31, 2004. The Company classified the warrants issued in connection with the Series E, F and G preferred
stock financing as equity rather than debt based upon an assessment of the Companys contractual
obligations for registration of the related common shares issuable upon exercise of the warrants as provided
under EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Companys Own Stock. (7) STOCK OPTIONS, WARRANTS AND RESTRICTED STOCK The Companys 1990 Stock Option Plan provides for the grant of incentive stock options,
non-qualified stock options, stock appreciation rights, restricted stock awards and performance
awards for the purchase or issuance of up to 5,200,000 shares of common stock to Company employees,
directors and consultants. In July 2002, the Compensation Committee of the Companys Board of Directors approved
retention agreements for certain of the Companys key employees. The agreements became effective
August 1, 2002 and provided for the grant under the 1990 Stock Option Plan of 329,885 restricted
shares of the Companys Common Stock as an incentive to the employees to remain in the employ of
the Company and put forth maximum efforts for the success of the Company. The agreements provide
for vesting of 50% of the shares on August 1, 2003, and vesting of the remaining 50% on August 1,
2004, provided the employee remains employed by the Company. The fair value of the restricted
shares on the date of grant, August 1, 2002, was $824,711, which was recognized as restricted stock
with a corresponding charge to deferred compensation, a contra equity account. The Company is
recognizing the deferred compensation as expense ratably over the two-year vesting period.
Compensation expense related to these shares was $340,496 in 2003 and $171,815 in 2002. Under the terms of the retention agreements, in the event of involuntary termination,
including transfer of employees to ITC, 50% of a participants restricted shares vest if
termination occurs prior to August 1, 2003 and a pro rata portion of shares vest for each full
month of employment if termination occurs on or after August 1, 2003. The retention agreements
require cancellation of remaining unvested shares. As a result of the sale of the Companys
intermittent testing business to ITC, and also due to involuntary employee terminations in the
Companys continuing operations, 87,483 restricted shares previously granted to participating
employees were cancelled as of September 30, 2003. This resulted in the retirement of
approximately $219,000 of common stock and additional paid-in capital and a corresponding reduction
in deferred compensation as of September 30, 2003. The Companys 1993 Directors Stock Option Plan, which provided for annual and discretionary
grants to non-employee directors of the Company of non-qualified stock options, expired during 2003
in accordance with its terms. The Companys shareholders approved an amendment to the 1990 Stock
Option Plan in May 2003 to modify the eligibility requirements for participation in that plan in
order to allow nonemployee directors to participate and become eligible to receive awards or
options under the 1990 Stock Option Plan. While no grants were 38




---



##### 



made from the 1993 Directors Plan
during 2004 and 2003, outstanding options under that plan remain exercisable under their original
terms. Under the plans, the option price is equal to the fair value on the date of grant. Under the
1990 Stock Option Plan, options become exercisable over varying periods and terminate up to ten
years from the date of grant. Under the 1993 Directors Stock Option Plan, initial grants of
options to new directors became exercisable over a three-year period and terminate ten years from
the date of grant. Annual grants to directors vested six months after the date of grant. At
December 31, 2004, 578,490 shares were available for grant under the 1990 Stock Option Plan. Summarized below is the status of the Companys stock option plans as of December 31, 2004,
2003 and 2002 and changes during those years: 2004
    
    
    2003
    
    
    
    
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    
    average
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    averageShares
    
    
    exercise price
    
    
    Shares
    
    
    exercise price
    
    
    
    
    
    
    Shares
    
    
    
    
    
    
    exercise price1990 Stock Option PlanOutstanding at beginning of year
    
    
    3,105,463
    
    
    $
    3.87
    
    
    
    3,469,962
    
    
    $
    5.02
    
    
    
    
    
    
    
    2,256,225
    
    
    
    
    
    
    $
    6.19Granted
    
    
    25,000
    
    
    
    0.17
    
    
    
    700,000
    
    
    
    0.98
    
    
    
    
    
    
    
    1,402,500
    
    
    
    
    
    
    
    3.32Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,350
    )
    
    
    
    
    
    
    3.45Expired
    
    
    (1,801,863
    )
    
    
    5.49
    
    
    
    (1,064,499
    )
    
    
    5.71
    
    
    
    
    
    
    
    (184,413
    )
    
    
    
    
    
    
    6.47Outstanding at end of year
    
    
    1,328,600
    
    
    
    1.60
    
    
    
    3,105,463
    
    
    
    3.87
    
    
    
    
    
    
    
    3,469,962
    
    
    
    
    
    
    
    5.02Options exercisable at year-end
    
    
    602,850
    
    
    
    1.69
    
    
    
    1,463,588
    
    
    
    5.55
    
    
    
    
    
    
    
    1,793,524
    
    
    
    
    
    
    
    6.061993 Directors Stock Option PlanOutstanding at beginning of year
    
    
    317,793
    
    
    $
    5.89
    
    
    
    332,293
    
    
    $
    5.84
    
    
    
    
    
    
    
    300,293
    
    
    
    
    
    
    $
    6.02Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,000
    
    
    
    
    
    
    
    4.14Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expired
    
    
    (223,793
    )
    
    
    5.47
    
    
    
    (14,500
    )
    
    
    (4.60
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at end of year
    
    
    94,000
    
    
    
    6.90
    
    
    
    317,793
    
    
    
    5.89
    
    
    
    
    
    
    
    332,293
    
    
    
    
    
    
    
    5.84Options exercisable at year-end
    
    
    94,000
    
    
    
    6.90
    
    
    
    292,793
    
    
    
    5.94
    
    
    
    
    
    
    
    277,793
    
    
    
    
    
    
    
    5.88
 39




---



##### 



The following table summarizes information concerning stock options at December 31, 2004 for the above plan: OPTIONS OUTSTANDINGWeighted
    
    
    Weighted
    
    
    
    
    
    
    WeightedRange of exercise
    
    Number
    
    
    average
    
    
    average
    
    
    Number
    
    
    averageprices
    
    Outstanding
    
    
    remaining life
    
    
    exercise price
    
    
    Exercisable
    
    
    exercise price$       -   1.00
    
    
    525,000
    
    
    
    8.5
    
    
    $
    0.93
    
    
    
    250,000
    
    
    $
    0.971.01
-   2.00
    
    
    600,000
    
    
    
    8.1
    
    
    
    1.61
    
    
    
    250,000
    
    
    
    1.722.01 -   3.00
    
    
    100,000
    
    
    
    7.8
    
    
    
    2.40
    
    
    
    50,000
    
    
    
    2.403.01 -   4.00
    
    
    8,000
    
    
    
    6.4
    
    
    
    3.01
    
    
    
    8,000
    
    
    
    3.014.01 -   5.00
    
    
    126,000
    
    
    
    6.8
    
    
    
    4.14
    
    
    
    75,250
    
    
    
    4.175.01 -   6.00
    
    
    600
    
    
    
    4.2
    
    
    
    5.88
    
    
    
    600
    
    
    
    5.886.01 -   7.00
    
    
    8,000
    
    
    
    4.4
    
    
    
    6.44
    
    
    
    8,000
    
    
    
    6.447.01 -   8.00
    
    
    5,500
    
    
    
    2.0
    
    
    
    7.47
    
    
    
    5,500
    
    
    
    7.478.01 -   9.00
    
    
    26,000
    
    
    
    5.1
    
    
    
    8.08
    
    
    
    26,000
    
    
    
    8.089.01 - 10.00
    
    
    22,500
    
    
    
    2.2
    
    
    
    9.71
    
    
    
    22,500
    
    
    
    9.7110.01 - 12.00
    
    
    1,000
    
    
    
    5.2
    
    
    
    12.00
    
    
    
    1,000
    
    
    
    12.001,422,600
    
    
    
    
    
    
    
    
    
    
    
    696,850


In connection with certain financing arrangements entered into since the Companys inception,
the Company has granted stock purchase warrants for the purchase of common stock, preferred stock
and issuance of debt. The stock purchase warrants become exercisable over varying periods and
expire up to ten years from the date of grant. Stock warrants outstanding as December 31, 2004 under these arrangements are
summarized as follows:

2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    
    average
    
    
    
    
    
    
    averageShares
    
    
    exercise price
    
    
    Shares
    
    
    exercise price
    
    
    Shares
    
    
    exercise priceOutstanding at beginning of year
    
    
    4,668,996
    
    
    $
    0.34 - 6.00
    
    
    
    1,201,667
    
    
    $
    6.00-8.40
    
    
    
    1,406,667
    
    
    $
    4.53-8.40Granted
    
    
    68,747,445
    
    
    
    0.025 - 0.35
    
    
    
    4,990,837
    
    
    
    0.34 - .35
    
    
    
    
    
    
    
    Exercised
    
    
    (2,340,268
    )
    
    
    0.025 - 0.11
    
    
    
    (330,751
    )
    
    
    0.35
    
    
    
    
    
    
    
    Expired
    
    
    (4,264,747
    )
    
    
    0.34 - 6.00
    
    
    
    (1,192,757
    )
    
    
    6.00 - 8.40
    
    
    
    (205,000
    )
    
    
    4.53 - 5.06Outstanding at end of year
    
    
    66,811,426
    
    
    
    0.02
    
    
    
    4,668,996
    
    
    
    .34 - 6.00
    
    
    
    1,201,667
    
    
    
    6.00 - 8.40Options exercisable at year-end
    
    
    66,811,426
    
    
    
    0.02
    
    
    
    1,464,129
    
    
    
    .34 - 6.00
    
    
    
    1,201,667
    
    
    
    6.00 - 8.40


40



---



##### 



(8) EMPLOYEE STOCK PURCHASE PLAN The Company adopted an employee stock purchase plan (the Plan) effective July 3, 1995, under
which 400,000 shares of common stock are available for sale to employees. The Plan enables all
employees, after an initial 90-day waiting period, to contribute up to 10 percent of their wages
toward the purchase of the Companys common stock at 85 percent of the lower of fair market value
for such shares on the first or last business day of each quarter. Participant elections resulted in the issuance of 47,602 shares at an average price per share
of $.51 in 2003 and 28,414 shares at an average price per share of $2.40 in 2002. No shares were
issued under the Plan during 2004. (9) EMPLOYEE BENEFIT PLANS The Company has a 401(k) savings plan for its U.S. employees. U.S. employees of the Company
who meet certain age and service requirements may contribute up to 20 percent of their salaries to
the plan on a pre-tax basis. The Company has the discretion to match employee contributions $.50
for each $1.00 contributed by an employee up to a maximum company contribution of $1,000 per year.
The matching contributions in 2003 and 2002 totaled $11,274 and $47,624, respectively. The Company
has not provided matching contributions to participating employees of the plan since the first
quarter of 2003. As part of its acquisition of DML in November 1996, the Company assumed sponsorship of the
subsidiarys contributory defined benefit retirement plan (the Retirement Plan), covering the
majority of the subsidiarys employees. The Retirement Plan provided benefits based upon final
pensionable salary and years of credited service. The Companys funding policy for the Retirement
Plan was to contribute into a trust fund at a rate that is intended to remain at a level percentage
of total pensionable payroll. The assets of the Retirement Plan are held separately from those of
the Company and invested in the London and Manchester Secure Growth Fund, High Equity Mixed Fund
and a small holding in the Deposit and Property Funds. A portion of the Retirement Plan assets are
also invested in the Scottish Equitable Funds. Contributions to the Retirement Plan were charged to expense so as to provide for the cost of
the pensions over the employees working lives with the Company. The contributions are determined
by a qualified actuary on the basis of a valuation using the attained age valuation method. The Retirement Plans projected benefit obligation exceeded the fair value of plan assets by
approximately $3 million at the plans previous valuation date of December 31, 2002, reflecting a
$1.6 million increase in the plans underfunded status relative to the prior year. As a result, the
Companys balance sheet at December 31, 2002 reflected significant increases in the accrued
retirement plan benefit liability and minimum pension liability (included as a charge to
accumulated other comprehensive loss in shareholders equity) relative to the prior year. This
occurred due to an environment of weaker investment performance in the global markets over the
prior two to three years (which negatively affected the value of Retirement Plan assets), and to a
lesser extent, lower prevailing interest rates (which drove the use of a lower discount rate to
calculate the projected benefit obligation, thereby increasing the amount of this obligation at
December 31, 2002). While the underfunded status of the Companys Retirement Plan has improved as
of the most recent valuation date of December 31, 2003 to approximately $2.5 million, and was
expected to continue to improve over time as a result of actuarial assumed improvements in future
average market (and trust fund) performance, the inability of the trust fund investments to perform
at or near these average projected rates of return over the employees remaining service lives
could result in a significant future funding obligation of the Company. To help manage this
exposure, the Company modified the Retirement Plan effective August 31, 2003 to close the plan to
future accrual of benefits. The Retirement Plan will continue to exist; however, the liabilities
of the Retirement Plan were frozen effective August 31, 2003. The Company continued to make
monthly contributions into the Retirement Plan, but these contributions will be fully allocated to
reduce the Retirement Plans liabilities for participant benefits earned through August 31, 2003.
This change helped secure the Retirement
Plan participants benefits earned through that date and
reduced the Companys exposure to a potential future significant funding
obligation. 41




---



##### 



The closing of the Retirement Plan to future accrual of benefits is considered a curtailment
under SFAS No. 88, Employers Accounting for Settlement and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits. The curtailment resulted in a reduction in the
projected benefit obligation under the Retirement Plan. This, combined with improvements in the
market value of the Retirement Plan fund investments, reduced the underfunded status of the
Retirement Plan to approximately $2.5 million as of December 31, 2003, an approximate $500,000
improvement from the underfunded status as of December 31, 2002. The Company has analyzed the
impact of the Retirement Plan curtailment under SFAS No. 88 and has concluded that no significant
financial statement adjustments or gain or loss recognition is required in 2003. The following provides a reconciliation of the projected benefit obligation, plan assets and
funded status of the Retirement Plan at December 31, 2003, along with the components of net
periodic pension cost for each year presented: 47




---



##### 



2003Change in Projected Benefit ObligationProjected benefit obligation at beginning of year
    
    $
    7,511,892Service cost
    
    
    296,660Interest cost
    
    
    422,170Plan participants contributions
    
    
    62,695Plan participants rollover contributions
    
    
    100,731Actuarial (gain) loss
    
    
    (361,358
    )Benefits paid
    
    
    (62,867
    )Foreign currency exchange rate changes
    
    
    931,747Projected benefit obligation at end of year
    
    $
    8,901,670Change in Plan AssetsFair value of plan assets at beginning of year
    
    $
    4,498,810Actual return (loss) on plan assets
    
    
    708,175Employer contribution
    
    
    444,737Plan participants contributions
    
    
    62,695Plan participants rollover contributions
    
    
    100,731Benefits paid
    
    
    (62,867
    )Foreign currency exchange rate changes
    
    
    654,129Fair value of plan assets at end of year
    
    $
    6,406,410Funded status
    
    $
    (2,495,260
    )Unrecognized actuarial loss
    
    
    2,903,380Net amount recognized
    
    $
    408,120Amounts recognized in the balance sheet consist of:Accrued benefit liability
    
    $
    (2,495,260
    )Minimum pension liability
    
    
    2,903,380Net amount recognized
    
    $
    408,120Rate assumptions:Discount rate
    
    
    5.50
    %Rate of salary progression
    
    
    3.75
    %Long-term rate of return on assets
    
    
    8.00
    %
 2003Components of Net Periodic Benefit CostService cost
    
    $
    296,660Interest cost
    
    
    422,170Expected return on plan assets
    
    
    (381,420
    )Recognized net actuarial loss
    
    
    190,710$
    528,120
 The liquidation and recording of DML as a discontinued operation in the fourth quarter of 2004
resulted in the elimination of the accrued retirement plan liability and the minimum pension
liability from the Companys financial statements. 43




---



##### 



(10) INCOME TAXES The Company has incurred net operating losses since inception. The Company has not reflected
any benefit of such net operating loss carryforwards in the accompanying financial statements. As of December 31, 2004 the Company had U.S. tax net operating loss and research and
development tax credit carryforwards of approximately $139,500,000 and $1,493,000, respectively.
These net operating loss and credit carryforwards may currently be
limited due to past changes in ownership of the Company or business
operations. Future changes in the ownership of the Company or
business operations may place additional limitations on the use of
these net operating loss and credit carryforwards. Before the Company
uses any of the carryforwards, the Company will undertake a change in
ownership study. If not used, net operating loss carryforwards
begin to expire in 2005 at the following amounts each year: Year ending December 31:2005
    
    $
    500,0002006
    
    
    1,900,0002007
    
    
    4,300,0002008
    
    
    13,600,0002009
    
    
    11,800,000Thereafter through 2023
    
    
    107,400,000Total net operating loss carryforwards
    
    $
    139,500,000
 The Companys foreign subsidiary previous net operating loss carryforward is no longer
available for use due to the liquidation of that subsidiary. The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities of continuing operations are as follows at
December 31: 2004
    
    
    2003Tax credits
    
    $
    1,493,000
    
    
    $
    1,493,000Federal net operating loss carryforward
    
    
    6,970,000
    
    
    
    5,870,000Foreign net operating loss carryforward
    
    
    
    
    
    
    18,331,000Deferred revenue
    
    
    
    
    
    
    266,000Fixed asset depreciation
    
    
    
    
    
    
    (21,000
    )Amortization of goodwill
    
    
    400,000
    
    
    
    459,000Accrued expenses
    
    
    252,000
    
    
    
    61,000Other differences
    
    
    
    
    
    
    25,000Valuation allowance
    
    
    (9,115,000
    )
    
    
    (26,484,000
    )Net deferred tax asset
    
    $
    
    
    
    $
    
 The provision for income taxes from continuing operations differs from the expected tax
expense, computed by applying the federal corporate rate of 34% to earnings before income taxes as
follows: 44




---



##### 



2003
    
    
    2002
    
    
    2001Expected federal benefit
    
    $
    (2,802,000
    )
    
    $
    (1,927,000
    )
    
    $
    (1,146,000
    )State tax, net of federal benefit
    
    
    (47,000
    )
    
    
    (36,000
    )
    
    
    (39,000
    )Other, net
    
    
    104,000
    
    
    
    (50,000
    )
    
    
    (168,000
    )Increase in valuation allowance
    
    
    2,745,000
    
    
    
    2,013,000
    
    
    
    1,353,000$
    
    
    
    $
    
    
    
    $
    
 45




---



##### 



(11) RESTRUCTURING AND OTHER CHARGES As a result of the Companys sale of its intermittent testing business and also as part of
changes made to reduce the cost structure of the Companys continuing operations, the Company
eliminated certain general and administrative and sales support positions, resulting in
restructuring and other nonrecurring charges of approximately $758,000 in the third quarter of
2003. These charges affected five employees in the Companys discontinued intermittent testing
business for which the Company incurred restructuring charges for severance costs of approximately
$107,000, included in discontinued operations in the Statements of Operations for the year ended
December 31, 2003. Additionally, two positions were eliminated and one officer level resignation
occurred in the Companys continuing operations, resulting in restructuring charges of
approximately $405,000 and other nonrecurring charges of approximately $246,000, respectively, all
for severance and related benefits costs. These charges are included in continuing operations as
restructuring and other nonrecurring charges in the Statements of Operations for the year ended
December 31, 2003. Of the total restructuring and other nonrecurring charges of $758,000, the
Company paid approximately $675,000 in 2003 and $83,000 in 2004 Operating results for the year ended December 31, 2002 included restructuring and other
nonrecurring charges of approximately $887,000. Approximately $194,000 of the restructuring
charges are included in discontinued operations for year ended December 31, 2002, consisting of
severance costs related to work force reductions in the Companys discontinued intermittent testing
business. These changes affected 18 positions, including eight in manufacturing, nine in research
and development and one in general and administration. Additionally, restructuring and other
nonrecurring charges of approximately $693,000 are included in continuing operations for the year
ended December 31, 2002. Charges during 2002 included approximately $504,000 of nonrecurring
charges for severance and related costs resulting from the resignation of the Companys Chief
Executive Officer and President effective June 1, 2002. Remaining amounts of approximately
$189,000 represent restructuring charges consisting of severance and related costs associated with
a work force reduction in the Companys continuing operations impacting 26 manufacturing and one
research and development position. Of the $887,000 of total restructuring and other nonrecurring
charges, $725,000 was paid during 2002 and $162,000 was paid during 2003. 46




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##### 



(12) RELATED PARTY TRANSACTIONS In August 1998, the Company issued Convertible Subordinated Notes, with proceeds aggregating
$7,300,000, which were used to retire other debt of the Company. The investor group was led by BCC
Acquisition II LLC. Effective April 7, 2003, the Company and the note holders completed a
modification of the terms of the notes, including a two-year extension of repayment of the notes to
August 4, 2005 and a reduction in the conversion price for $6,900,000 of the notes from $8.40 to
$3.51 per share. Additionally, the note holders received five-year warrants for 4,255,837 shares
of the Companys common stock, at an exercise price of $.94 per share, subsequently reduced to $.34
per share as part of an amendment to the Note Purchase Agreement completed in January 2004 with an
effective date of December 30, 2003. At the time, two of the directors of the Company were affiliated with BCC Acquisition II LLC,
and one of these directors participated in the issuance and subsequent modification in terms of the
Convertible Subordinated Notes, although the conversion price of the note held by the director was
not reduced from $8.40 per share. This director was also a director of DVI, Inc., a health care
finance company with which the Company had an outstanding capital lease with a balance of
approximately $155,000 as of December 31, 2003. See notes 5 and 6 for further detail on the
Convertible Subordinated Notes and capital lease. Codman and Philips, former distributors of the Company, respectively, are shareholders of the
Company. Codman distributed the Companys Neurotrend cerebral tissue monitoring system under an
exclusive global distribution agreement entered into effective October 1998. The Companys
exclusive global distribution agreement with Philips for sale of the Companys TrendCare continuous
blood gas monitoring systems ended effective November 1, 2002, and provided for minimum annual
purchase amounts, market development commitments and research and development funding through
October 31, 2002. As provided for under the terms of an amended agreement between the parties,
completed on April 10, 2003 and further amended effective November 1, 2003, Philips maintained a
nonexclusive right to sell the Companys disposable sensors and related accessories to its existing
customer base through October 31, 2003. Revenues from Philips and Codman, including payments in
lieu of product purchases, were approximately $676,000 and $5.7 million for the years ended
December 31, 2003 and 2002, respectively. Outstanding accounts receivable with these parties
represented less than 1% of total accounts receivable as of December 31, 2003, and 38% of total
outstanding accounts receivable relating to the Companys as of December 31, 2002, respectively.
Revenues and related accounts receivable balances with these parties in 2002 were primarily
concentrated with Philips. These amounts are now included as part of the Companys discontinued
operations presentation. (13) COMMITMENTS Leases The Company leases its facilities and some of its equipment under non-cancelable operating
lease arrangements. The rental payments under these leases are charged to expense as incurred.
Rent expense for continuing operations included in the accompanying Consolidated Statements of
Operations was $45,855, $28,466 and $14,986 for the years ended December 31, 2004, 2003 and 2002,
respectively. 47




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##### 



The
following is a schedule of future minimum
rental payments, excluding property taxes and
other operating expenses, required under all non-cancelable operating leases: Continued
    
    
    DiscontinuedYear ending December 31:
    
    Operations
    
    
    Operations
    
    
    Total2005
    
    $
    54,817
    
    
    $
    48,330
    
    
    $
    103,1472006
    
    
    55,684
    
    
    
    48,330
    
    
    
    104,0142007
    
    
    56,551
    
    
    
    12,083
    
    
    
    68,6332008
    
    
    52,569
    
    
    
    
    
    
    
    52,569Total minimum lease payments
    
    $
    219,620
    
    
    $
    108,743
    
    
    $
    328,363
 Employment Contracts and Change in Control Agreements None of the Companys executive officers or employees has a written employment agreement.
Severance arrangements for each of the companys other executive officers have been established
that provide, under certain circumstances following a change in control, for payment of full base
salary, bonus and benefits earned through date of termination, lump-sum cash severance payments
equal to two times full base salary in effect immediately prior to termination, plus the targeted
bonus such executive officers would have earned for the year in which termination is effective
(assuming for such purpose the achievement of targeted performance), subject to certain tax
adjustments. In addition severance arrangements have been established for the Companys executive
officers in the event of termination for reasons other than cause providing for the payment of
full base salary, bonus and benefits earned through date of termination and the continuation for
payment of full base salary then in effect for an additional twelve month period, plus the targeted
bonus such executive officer would have earned for the year in which termination is effective
(assuming for such purpose the achievement of targeted performance). Aggregate annual salaries for
the three officers are $772,500 at December 31, 2004. No bonuses have been earned as a result of
failure to achieve targeted Performance. 48




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##### 



(14) QUARTERLY RESULTS OF
OPERATIONS (unaudited) First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter2004Revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Gross profit (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating loss
    
    
    (521,616
    )
    
    
    (456,575
    )
    
    
    (338,044
    )
    
    
    (349,599
    )Loss before discontinued operations
    
    
    (1,021,901
    )
    
    
    (940,280
    )
    
    
    (729,278
    )
    
    
    (3,169,459
    )Discontinued operations:Loss from discontinued operations
    
    
    (1,134,050
    )
    
    
    (1,432,618
    )
    
    
    (3,134,811
    )
    
    
    1,573,497Loss on liquidation of discontinued
operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,436,730
    )Gain on sale of discontinued operations
    
    
    557,052
    
    
    
    
    
    
    
    
    
    
    
    Loss from discontinued
operations
    
    
    (576,998
    )
    
    
    (1,432,618
    )
    
    
    (3,134,811
    )
    
    
    (863,233
    )Net loss
    
    
    (1,598,899
    )
    
    
    (2,372,898
    )
    
    
    (3,864,089
    )
    
    
    (4,032,692
    )Beneficial conversion feature
    
    
    (665,994
    )
    
    
    (1,067,650
    )
    
    
    
    
    
    
    (212,566
    )Deemed dividend on preferred stock
    
    
    
    
    
    
    (1,050,690
    )
    
    
    
    
    
    
    (160,557
    )Net loss available to common shareholders
    
    $
    (2,264,893
    )
    
    $
    (4,491,238
    )
    
    $
    (3,864,089
    )
    
    $
    (4,405,815
    )Basic and diluted net loss per common share:Net loss from continuing operations
    
    $
    (0.03
    )
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.09
    )Discontinued operations:Loss from discontinued operations
    
    
    (0.03
    )
    
    
    (0.04
    )
    
    
    (0.09
    )
    
    
    0.04Loss on liquidation of discontinued
operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.07
    )Gain on sale of discontinued operations
    
    
    0.02
    
    
    
    
    
    
    
    
    
    
    
    Loss from discontinued
operations
    
    
    (0.02
    )
    
    
    (0.04
    )
    
    
    (0.09
    )
    
    
    (0.02
    )Net loss available to common shareholders
    
    $
    (0.06
    )
    
    $
    (0.13
    )
    
    $
    (0.11
    )
    
    $
    (0.13
    )
 First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter2003Revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Gross loss
    
    
    (767,454
    )
    
    
    (668,518
    )
    
    
    (536,747
    )
    
    
    (414,363
    )Income (loss) from continuing operations
    
    
    (866,017
    )
    
    
    512,506
    
    
    
    (933,961
    )
    
    
    (781,722
    )Discontinued operations:Loss from discontinued operations
    
    
    (2,024,604
    )
    
    
    (1,738,510
    )
    
    
    (2,647,646
    )
    
    
    (1,831,250
    )Gain on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    1,832,059
    
    
    
    Income (loss) from discontinued operations
    
    
    (2,024,604
    )
    
    
    (1,738,510
    )
    
    
    (815,587
    )
    
    
    (1,831,250
    )Net loss
    
    
    (2,890,621
    )
    
    
    (1,226,004
    )
    
    
    (1,749,548
    )
    
    
    (2,612,972
    )Beneficial conversion feature
    
    
    
    
    
    
    (958,962
    )
    
    
    
    
    
    
    Net loss available to common shareholders
    
    $
    (2,890,621
    )
    
    $
    (2,184,966
    )
    
    $
    (1,749,548
    )
    
    $
    (2,612,972
    )Basic and diluted net loss available to common shareholders per common share:Income (loss) from continuing operations
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.03
    )
    
    $
    (0.03
    )Discontinued operations:Loss from discontinued operations
    
    
    (0.08
    )
    
    
    (0.06
    )
    
    
    (0.10
    )
    
    
    (0.07
    )Gain on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    0.07
    
    
    
    Income (loss) from discontinued operations
    
    
    (0.08
    )
    
    
    (0.06
    )
    
    
    (0.03
    )
    
    
    (0.07
    )Net loss available to common shareholders
    
    $
    (0.11
    )
    
    $
    (0.08
    )
    
    $
    (0.06
    )
    
    $
    (0.10
    )
 49




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##### 



(15) LEGAL PROCEEDINGS There are no legal proceedings pending, threatened against or involving the Company, which, in
the opinion of management, will have a material adverse effect upon consolidated results of
operations or financial condition. (16) SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES As further described in note 5, in 2004 and 2003, the Company completed the renegotiation of
the terms of its $7,3000,000 million Convertible Subordinated Notes. The modified debt and
associated warrants to purchase 4.3 million shares of common stock were recorded in the second
quarter 2003 as debt and equity, respectively, at their respective fair values of $5,000,000
million and $800,000, and the $7,300,000 million carrying value of the original notes was retired.
The modified debt and associated warrants to purchase 4.3 million shares of common stock were
recorded in the fourth quarter 2004 as debt and equity, respectively, at their respective fair
values of $988,106 million and $193,322, and the $6,624,430 carrying value of the original notes
was retired. In addition a beneficial conversion feature was embedded in the debt resulting in a
non-cash adjustment to additional paid-in capital of $7,300,000. As further described in note 6, effective May 12, 2003, the Company completed a $1.5 million
interim financing through the sale of 15,000 shares of Series E convertible preferred stock. A
beneficial conversion feature embedded in the preferred stock was calculated at $958,962 and was
recorded as a non-cash charge to retained earnings and treated as a reconciling item on the
Statements of Operations to adjust the reported net loss to net loss available to common
shareholders. As further described in note 6, effective January 16, 2004, the Company completed a $1.5
million interim financing through the sale of 15,000 shares of Series F convertible preferred
stock. A beneficial conversion feature embedded in the preferred stock was calculated at $665,994
and was recorded as a non-cash charge to retained earnings and treated as a reconciling item on
the Statements of Operations to adjust the reported net loss to net loss available to common
shareholders. As further described in note 6, effective May 28, 2004, the Company completed a $1.5 million
interim financing through the sale of 15,000 shares of Series G convertible preferred stock. A
beneficial conversion feature embedded in the preferred stock was calculated at $1,280,216 and was
recorded as a non-cash charge to retained earnings and treated as a reconciling item on the
Statements of Operations to adjust the reported net loss to net loss available to common
shareholders. A further described in note 6, as part of the Series G convertible preferred stock financing
and the Convertible Subordinated Notes financing, the exercise price of warrants issued to
preferred stock holders were modified and additional warrants were issued to the preferred
shareholders. A deemed dividend was calculated at $1,211,247 and was recorded as a non-cash
charge to retained earnings and treated as a reconciling item on the Statements of Operations to
adjust the reported net loss to net loss available to common shareholders. During 2004, holders of warrants exercised their cashless exercise right and were issued
73,656 shares of common stock. During 2004, the restricted cash of
$720,169 was released from escrow and was also treated as a reduction
of deferred credits and revenue. 50




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##### 



(17) SUBSEQUENT EVENTS On January 14, 2005, the Company announced that its wholly-owned subsidiary in the United
Kingdom, TGC, had acquired certain assets out of liquidation from the liquidator of DML. DML was
formerly a wholly owned subsidiary of the Company that was placed into liquidation in November
2004. The assets purchased by TGC included certain equipment and intellectual property, including
certain trademarks, of DML. The purchased assets are expected to form the core of a new product
research and development program that TGC will begin implementing in 2005. This R&D program
initially will be focused on bringing to market a line of products aimed at monitoring and
controlling glucose on a continuous basis in critically ill patients in a hospital setting at the
point-of-patient care. The cost of purchasing the assets was approximately $333,000, which was
funded by proceeds from the sale of Convertible Senior Notes due December 15, 2007. On March 18, 2005, the Companys shareholders approved an increase in the number of authorized
shares of all classes of stock from 205,000,000 to 1,005,000,000 and in the number of authorized
shares of Common Stock from 200,000,000 to 1,000,000,000. On
May 2, 2005, the Company arranged an additional loan of $150,000
on the same terms as
borrowings under the Convertible Senior Note dated December 14, 2005 and expects to use the proceeds to
continue planning for its new product development. In addition, warrants to purchase an additional 3,750,000
shares of common stock were issued to the lenders. 
 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure On June 9, 2004, KPMG LLP provided written notice to the Company that they declined to stand
for reappointment and had resigned as auditors and principal accountants for the year ended
December 31, 2004. They informed the Company that the client-auditor relationship would cease upon
completion of the review by KPMG LLP of the Companys consolidated financial statements as of and
for the three and six-month periods ended June 30, 2004. The audit reports of KPMG LLP on the consolidated financial statements of Diametrics Medical,
Inc. as of and for the years ended December 31, 2003 and 2002, contained a separate paragraph
stating: The consolidated financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the
Company has recurring losses and negative cash flows that raise substantial doubt about its ability
to continue as a going concern. Managements plans in regard to these matters are also described in
Note 2. The consolidated financial statements do not include any adjustments that might result from
the outcome of this uncertainty. Other than such qualification as to uncertainty as a going
concern, the aforementioned audit reports of KPMG LLP did not contain any adverse opinion or
disclaimer of opinion, nor were they qualified or modified as to audit scope or accounting
principles. In connection with the audits of the consolidated financial statements of the Company for the
two years ended December 31, 2003, and the subsequent interim period through August 9, 2004 (the
date that KPMG LLP completed its review), there were no disagreements with KPMG LLP on any matter
of accounting principles or practices, financial statement disclosure, or auditing scope or
procedures, which disagreements if not resolved to their satisfaction would have caused them to
make reference in connection with their opinion to the subject matter of the disagreement. On August 16, 2004, the Audit Committee of the Board of Directors of the Company selected and
engaged Virchow, Krause & Company, LLP as its independent public accountants for the fiscal year
ending December 31, 2004. On September 3, 2004, Virchow, Krause & Company, LLP advised the Company
of its acceptance of the
engagement. During the two most recent fiscal years and through August 16, 2004, the Company has
not consulted with Virchow, Krause & Company, LLP regarding either (i) the application of
accounting principles to a specified transaction, either completed or proposed; or the type of
audit opinion that might be rendered in the Companys financial
statements, and 51




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##### 



neither a written
report was provided to the Company nor oral advice was provided by Virchow, Krause & Company, LLP
that was an important factor considered by the Company in reaching a decision as to any accounting,
auditing or financial reporting issue; or (ii) any matter that was the subject of a disagreement,
as that term is defined in Item 304 (a) (1) (iv) of Regulation S-K and the related instructions to
Item 304 of Regulation S-K, or a reportable event, as that term is defined in Item 304 (a) (1) (v)
of Regulation S-K. 
 Item 9a. Controls and Procedures (a) Disclosure controls and procedures. As of December 31, 2004, the Company carried out an evaluation, under the supervision and with
the participation of management, including the Companys Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of its disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange
Act)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Companys disclosure controls and procedures were effective as of December 31,
2004 to ensure that information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and reported within the
time periods specified in Securities and Exchange Commission rules and forms. (b) Internal controls over financial reporting. Although we currently qualify as a non-accelerated filer for purposes of filing required
reports under the Securities Exchange Act of 1934, prior to December 31, 2004 we were deemed to be
an accelerated filer. As a result, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,
beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2004 we are
required to furnish a report by our management on our internal control over financial reporting.
Such report will contain, among other matters, an assessment of the effectiveness of our internal
control over financial reporting as of the end of our fiscal year, including a statement as to
whether or not our internal control over financial reporting is effective. This assessment must
include disclosure of any material weaknesses in our internal control over financial reporting
identified by management. Such report will also contain a statement that our auditors have issued
an attestation report on managements assessment of such internal controls. Management of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act.
The internal control system is designed to provide reasonable assurance to the Companys management
and Board of Directors regarding the preparation and fair presentation of published financial
statements. All internal control systems, no matter how well designed, have inherent limitations.
Therefore, even those systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation. In late November 2004, the Securities and Exchange Commission issued an exemptive order
providing a 45 day extension for the filing of these reports and attestations by eligible
companies. We intended to utilize this 45 day extension. Because of the change in our independent
auditors and the significant change in our business operations during 2004 and the resulting delay
in the completion of our audit for the fiscal year ended December 31, 2004, we have not yet been
able to complete the process of documenting and testing our internal control procedures in order to
satisfy the requirements of Section 404 of the Sarbanes-Oxley Act and have not been able to meet
the deadline currently imposed on us. We intend to provide the required management and auditor
attestation reports in an amendment to our Form 10-K as soon as practicable. As discussed elsewhere in this report, we discontinued all operations of our continuous
monitoring business in November 2004. We had depleted all available funds and did not secure
additional funds until December 15, 2004. At that time we had three employees. The only activity
that proceeded from that date to year-end was planning for a possible new product development
effort. At December 31, 2004, our only significant asset was cash,
which we carefully controlled as reflected in internal reports to management and the Board of
Directors. As we began additional activities in 2005, we also began implementing internal controls
that we considered adequate. 52




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##### 



During the course of our testing we may identify deficiencies that
will require remediation. Currently we are not aware of any material weaknesses in our internal
control over financial reporting and related disclosures. 
 Item 9b. Other Information None. 
 PART III 
 Item 10. Directors and Executive Officers of the Registrant Certain biographical information furnished by the Companys current directors and executive
officers is presented below. Name
    
    Age
    
    PositionDavid B. Kaysen
    
    
    55
    
    
    President, Chief Executive Officer and DirectorW. Glen Winchell
    
    
    58
    
    
    Senior Vice President of Finance and Chief Financial OfficerSteven G. Emery
    
    
    59
    
    
    Senior Vice President of Worldwide
Marketing & Business DevelopmentCarl S. Goldfischer, M.D. (1)(2)
    
    
    45
    
    
    DirectorMark B. Knudson, Ph.D. (1)(2)
    
    
    55
    
    
    DirectorWilliam P. Moffitt (1)
    
    
    58
    
    
    Director, Chairman of the Board
   (1)
    
    Member of the Compensation Committee of the Board of Directors.(2)
    
    Member of the Audit Committee of the Board of Directors. Mr. Kaysenwas appointed President, Chief Executive Officer and a director of the Company in
December 2002. Mr. Kaysen has more than 25 years of executive management and sales and marketing
experience in the medical products and services industry, most recently serving 10 years as
President, Chief Executive Officer and a director of Rehabilicare Inc. (now Compex Technologies,
Inc.), a manufacturer and marketer of home electrotherapy equipment for the physical therapy,
rehabilitation, occupational and sports medicine markets. From 1988 to 1989 Mr. Kaysen served as
President, Chief Executive Officer and a director of Surgidyne, Inc. (now Sterion, Inc.). Mr.
Kaysen has also held senior management positions in sales and marketing at several medical product
and services companies including Redline Healthcare, American Hospital Supply Corporation, Emeritus
Corporation and Lectec/NDM Corporation. Mr. Kaysen currently serves as a director of Zevex
International, Inc., a publicly held company engaged in the business of designing, manufacturing
and distributing medical devices, and MedicalCV, Inc., a publicly held manufacturer of mechanical
heart valves. Mr. Winchelljoined the Company in August 2003 as Senior Vice President of Finance and Chief
Financial Officer. Mr. Winchell has over 20 years of experience in various senior financial and
operational management positions, most recently spending nine years as Vice President and Chief
Financial Officer of Rehabilicare, Inc. (now Compex Technologies, Inc). Mr. Emeryjoined the Company in October 2002, and is currently Senior Vice President of
Worldwide Marketing and Business Development. Prior to joining Diametrics, Mr. Emery was employed
by Philips Medical Systems (a division of Royal Philips Electronics) and a predecessor business,
the Healthcare Solutions Group of Agilent Technologies, Inc., formerly part of Hewlett-Packard
Company. During his 26-year career with these companies, Mr. Emery held a number of senior
management level marketing and business development positions, most recently as Director of
Marketing in the Cardiac and Monitoring Systems Point-of-Care Diagnostics group. Dr. Goldfischerhas been a director of the Company since November 2000. Dr. Goldfischer is a
private investor and a limited partner in Bay City Capital LLC of San Francisco, CA. Dr.
Goldfischer served as chief financial officer of ImClone Systems, Inc., a biopharmaceutical
company, from 1996 to 2000. Prior to that, he was a
healthcare analyst with the Reliance Insurance Company. From 1991 to 1994, he was director of
research for D. Blech & Co., an investment banking firm. Dr. Goldfischer currently serves as a
director for Immulogic 53




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##### 



Pharmaceutical Corp. and NeoRx Corp. Dr. Goldfischer serves on the Board of
Directors of the Company as a representative of BCC Acquisition II LLC. Pursuant to a Common Stock
Purchase Agreement dated June 30, 1998 among the Company, BCC Acquisition II LLC and certain other
persons, the Company agreed to appoint two representatives of BCC Acquisition II LLC to serve as
members of the Board of Directors, and to use its reasonable efforts to ensure that the two
representatives will be included as nominees of the Board of Directors and elected to serve on the
Board of Directors for so long as BCC Acquisition II LLC and the other investors (or their
assignees) collectively own at least 5% of the Companys outstanding voting securities or at least
75% of the number of shares issued under the Common Stock Purchase Agreement. BCC Acquisition II
LLC nominated Dr. Goldfischer and Mr. Cohn (who had already been a director of the Company since
1996) as their current representatives. Dr. Knudsonhas been a director of the Company since March 1990. Dr. Knudson is President and
Chief Executive Officer of EnteroMedics, Inc., a private company developing products for the
treatment of gastrointestinal tract disorders; Dr. Knudson is also Chairman and Chief Executive
Officer of Venturi Group, LLC, a medical device development incubator, and the Executive Chairman
of the Board of Restore Medical Inc., a private company developing products for the treatment of
sleep disordered breathing. William P. Moffitthas been a director of the Company since September, 2004, filling the
vacancy on the Board left by Gerald L. Cohn, who retired from the Board on August 1, 2004. Mr.
Moffitt is President and Chief Executive Officer of Nanosphere, Inc., and was formerly President
and Chief Executive Officer of i-STAT Corporation, which he joined in July 1989. i-STAT was
recently acquired by Abbott Laboratories. Mr. Moffitt has been appointed by the Board to the
position of Chairman of the Board, replacing Carl Goldfischer, MD, who has served as the Companys
Chairman since September 2003. The Board of Directors of the Company is divided into three classes. The members of each
class are elected to serve three-year terms with the term of office of each class ending in
successive years. Committees of the Board of Directors The Board of Directors has a Compensation Committee which consists of Dr. Knudson, Mr. Moffitt
and Dr. Goldfischer. The Compensation Committee of the Board of Directors makes recommendations
concerning executive salaries and incentive compensation for employees of the Company, subject to
ratification by the full Board, and administers the Companys 1990 Stock Option Plan (the Stock
Option Plan). The Board of Directors has an Audit Committee which consists of Dr. Goldfischer and Dr.
Knudson. All members of the committee have a basic understanding of finance and accounting, and
are able to read and understand fundamental financial statements. The Board of Directors has
determined that Dr. Goldfischer meets the definition of an Audit Committee Financial Expert as
established by the Securities and Exchange Commission, and is independent (as that term is used in
Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act). The Audit Committee has the sole
authority to appoint, review and discharge the Companys independent auditors. The Audit Committee
reviews the results and scope of the audit and other services provided by the Companys independent
certified public accountants, as well as the Companys accounting principles and its system of
internal controls, reports the results of their review to the full Board and to management and
recommends to the full Board that the Companys audited consolidated financial statements be
included in the Companys Annual Report on Form 10-K filed with the Securities and Exchange
Commission. The Board of Directors does not have a separate Nominating Committee, and has determined that
it is appropriate for the entire Board to serve that function for the time being. With respect to
Board of Director nominees, the Board of Directors will consider nominees recommended by
shareholders that are submitted in accordance with the Companys Bylaws. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Companys
directors and executive officers, and persons who own more than ten percent of a registered class
of the Companys equity securities, to file with the Securities and Exchange Commission initial
reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. Officers,
directors and greater-than ten
percent shareholders are also
required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file. 54




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##### 



To the Companys knowledge, based solely on review of the copies of such reports furnished to
the Company and written representations that no other reports were required, during the fiscal year
ended December 31, 2004, all Section 16(a) filing requirements applicable to its officers,
directors and greater than ten-percent beneficial owners were complied with except that an initial
statement of beneficial ownership on Form 3 and a statement of change of beneficial ownership on
Form 4 were not timely filed by Mr. Moffitt to reflect his appointment to the Board in September
2004 and the grant of an option to purchase 25,000 shares of the Companys common stock
concurrently therewith. Code of Ethics The Company has adopted a code of ethics that applies to the Companys principal executive
officer, principal financial officer, principal accounting officer, and all other company employees
performing similar functions. This code of ethics has been filed as an exhibit to the Companys
Annual Report on Form 10-K for the fiscal year ended December 31, 2003. 
 Item 11. Executive Compensation Compensation of Directors Members of the Board of Directors who are not employees of the Company are eligible to receive
an annual retainer of $8,000; $2,000 per Board meeting attended in person and $500 where the
meeting is attended by means of telephonic communication, with the proviso that each nonemployee
Director shall be compensated for not less than six Board meetings in any 12-month period. In
addition, each nonemployee member of the Board of Directors of the Company serving on a Committee
of the Board of Directors receives $500 per committee meeting attended. As a result of the
Companys implementation of cost-cutting measures, the Board of Directors agreed to temporarily
forgo receipt of fees payable for normal Board services. All Directors are reimbursed for expenses
actually incurred in attending meetings of the Board of Directors and its committees. Nonemployee Directors have also participated in the Companys 1993 Directors Stock Option
Plan (the Directors Plan), which expired in 2003. In May 2003, the Companys shareholders
approved an amendment to the 1990 Stock Option Plan to modify its eligibility requirements to allow
nonemployee directors to participate and become eligible to receive awards or options under the
Stock Option Plan. The Directors Plan provided for an automatic grant of nonqualified stock
options to purchase 18,000 shares of Common Stock to nonemployee Directors of the Company on the
date such individuals became directors of the Company (the Initial Grant), and an option to
purchase 8,000 shares of Common Stock on each subsequent annual shareholder meeting date, subject
to certain limitations (a Subsequent Grant). Options granted in connection with the Initial
Grant vest and become exercisable as to 50% of such shares on the twelve month anniversary of the
date of such Initial Grant and 25% at each such successive anniversary date thereafter if the
holder remains a director on such dates. Subsequent Grants become fully exercisable six months
subsequent to the date of grant. Stock options previously issued and outstanding under the
Directors Plan remain exercisable in accordance with their original terms. No stock options were
granted to nonemployee Directors under the Directors Plan or the Stock Option Plan in 2004, other
than an option to purchase 25,000 shares of common stock granted to Mr. Moffitt in conjunction with
his admittance to the Board, as further described below under Employment Contracts and Change in
Control Agreements. Compensation Committee Interlocks and Insider Participation Gerald L. Cohn, who retired from the Board on August 1, 2004, served as a member of the
Companys Compensation Committee during 2004. Effective January 2001, the Companys U.K.
subsidiary, Diametrics Medical, Ltd., entered into a capital lease agreement with DVI Financial
Services, Inc. in the amount of £319,500 (or approximately $466,800 based
upon the currency
exchange rate between the British pound sterling and the U.S. dollar on the
date of the
transaction). DVI Financial Services, Inc. was a business unit of DVI, Inc., of
which Mr. Cohn was
a director and consultant. 55




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##### 



Compensation of Executive Officers The following table sets forth the cash and noncash compensation for each of the last three
fiscal years awarded to or earned by the Chief Executive Officer and the other most highly
compensated executive officers of the Company whose salary and bonus earned in the fiscal year
ended December 31, 2004 exceeded $100,000 for services rendered: SUMMARY COMPENSATION TABLE Long-TermAnnual Compensation
    
    
    Compensation AwardsSecuritiesUnderlying
    
    
    Restricted
    
    
    All OtherName and Principal Position
    
    Year
    
    
    Salary
    
    
    Bonus
    
    
    Options (#)
    
    
    Stock ($)
    
    
    CompensationDavid B. Kaysen
    
    
    2004
    
    
    $
    385,636
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    President and Chief Executive Officer (1)
    
    
    2003
    
    
    
    347,091
    
    
    
    
    
    
    
    500,000
    
    
    
    
    
    
    
    2002
    
    
    
    21,635
    
    
    
    
    
    
    
    400,000
    
    
    
    
    
    
    
    Steven G. Emery
    
    
    2004
    
    
    $
    187,903
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    Senior Vice President of Worldwide Marketing
and Business Development (2)
    
    
    2003
    
    
    
    178,197
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2002
    
    
    
    38,942
    
    
    
    25,000
    
    
    
    100,000
    
    
    
    
    
    
    
    W. Glen Winchell
    
    
    2004
    
    
    $
    215,625
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    $
    Senior Vice President and Chief Financial Officer (3)
    
    
    2003
    
    
    
    80,769
    
    
    
    
    
    
    
    200,000
    
    
    
    
    
    
    
    
   (1)
    
    Mr. Kaysen joined the Company as President and Chief Executive Officer effective December
2, 2002.(2)
    
    Mr. Emery joined the Company in October 2002, as Senior Vice President of Worldwide Marketing
and Business Development.(3)
    
    Mr. Winchell joined the Company as Senior Vice President and Chief Financial Officer
effective August 4, 2003. Employment Contracts and Change in Control Agreements None of the Companys executive officers has a written employment agreement. Severance
arrangements for Mr. Kaysen and the Companys other executive officers have been established that
provide, under certain circumstances following a change in control, for payment of full base
salary, bonus and benefits earned through date of termination, lump-sum cash severance payments
equal to two times full base salary in effect immediately prior to termination, plus the targeted
bonus such executive officers would have earned for the year in which termination is effective
(assuming for such purpose the achievement of targeted performance), subject to certain tax
adjustments. In addition, severance arrangements have been established for the Companys executive
officers in the event of termination for reasons other than cause, providing for the payment of
full base salary, bonus and benefits earned through date of termination, and the continuation of
payment of the full base salary then in effect for an additional twelve month period, plus the
targeted bonus such executive officer would have earned for the year in which termination is
effective (assuming for such purpose the achievement of targeted performance). On September 8, 2004, the Company entered into an Employment Agreement with William P.
Moffitt, pursuant to which Mr. Moffitt has been employed by the Company as its Chairman of the
Board. The agreement provides that Mr. Moffitts compensation shall consist of a cash salary equal
to $100 for each day during which Mr. Moffitt provides service to the Company in his capacity as
Chairman, plus an initial stock option grant to purchase
25,000 shares of the Companys common stock at a per share price equal to $0.17, and a subsequent
option grant, upon the occurrence of a recapitalization of the Company, to purchase up to a number
of shares of common stock equal to 10% or more of the then outstanding common stock at a per share
exercise price equal to the fair market value of a share on the date of grant.
Upon a change of 56




---



##### 



control of the Company, Mr. Moffitt will be entitled to certain bonus payments and the vesting of
the options may accelerate, depending upon the total aggregate proceeds received by the Company or
the Companys shareholders. Either party may terminate the agreement upon 60 days prior written
notice. The parties acknowledge that the Company may undertake a recapitalization as part of the
implementation of a new strategic plan, the terms and conditions of which are not at this time
ascertainable, and have therefore agreed to negotiate in good faith such changes to Mr. Moffitts
compensation as may then be in their mutual best interests and consistent with the spirit and
intent of the agreement. As described below in footnote (1) to the table entitled Aggregate Value of Options Held At
December 31, 2004, the exercisability of options granted to named executive officers is
accelerated in the event of a change in control involving the Company. Stock Options There were no option grants during the year ended December 31, 2004 to the executive officers
named in the Summary Compensation Table above. The following table summarizes the value of all
options held at December 31, 2004 by the executive officers named in the Summary Compensation
Table above: Aggregate Value of Options Held At December 31, 2004 Number of Unexercised Options
    
    
    Value of Unexercised In-the-MoneyHeld at December 31, 2004 (1)
    
    
    Options Held at December 31, 2004 (2)Name
    
    Exercisable
    
    
    Unexercisable
    
    
    Exercisable
    
    
    UnexercisableDavid B. Kaysen
    
    
    325,000
    
    
    
    575,000
    
    
    $
    
    
    
    $
    Steven G. Emery
    
    
    50,000
    
    
    
    50,000
    
    
    
    
    
    
    
    W. Glen Winchell
    
    
    50,000
    
    
    
    150,000
    
    
    
    
    
    
    
    
   (1)
    
    Each option represents the right to purchase one share of common stock, and all grants to
Messrs. Kaysen, Emery and Winchell were made pursuant to the Stock Option Plan. To the extent
not already exercisable, the options granted to the named executive officers become
exercisable in the event of a change in control (as defined in the stock option agreements)
involving the Company.(2)
    
    Value based on the difference between the fair market value of the shares of common stock at
December 31, 2004 ($0.043) and the exercise price of the options. Limitation of Liability and Indemnification of Directors and Officers Section 302A.521 of the Minnesota Business Corporation Act provides that unless prohibited or
limited by a corporations articles of incorporation or bylaws, a corporation must indemnify its
current and former officers, directors, employees and agents against expenses (including attorneys
fees), judgments, penalties, fines and amounts paid in settlement which, in each case, were
incurred in connection with actions, suits or proceedings in which such person is a party by reason
of the fact that he or she was an officer, director, employee or agent of the corporation, if such
person (i) has not been indemnified by another organization or employee benefit plan for the same
judgments, penalties, fines, including without limitation, excise taxes assessed against the person
with respect to an employee benefit plan, settlements and reasonable expenses, including attorneys
fees and disbursements, incurred by the person in connection with the proceeding with respect to
the same acts or omissions, (ii) acted in good faith, (iii) received no improper personal benefit
and statutory procedure has been followed in the case of any conflict of interest by a director,
(iv) in the case of any criminal proceedings, had no reasonable cause to believe the conduct was
unlawful, and (v) in the case of acts or omissions occurring in the persons performance in the
official capacity of director or, for a person not a director, in the official capacity of officer,
committee member, employee or agent, reasonably believed that the conduct was in the best 57




---



##### 



interests of the corporation, or, in the case
of performance by a director, officers, employee or agent of the corporation as a director,
officer, partner, trustee, employee or agent of another organization or employee benefit plan,
reasonably believed that the conduct was not opposed to the best interests of the corporation.
Section 302A.521 required the corporation to advance, in certain circumstances and upon written
request, reasonable expenses prior to final disposition. Section 302A.521 also permits a
corporation to purchase and maintain insurance on behalf of its officers, directors, employees and
agents against any liability which may be asserted against, or incurred by, such persons in their
capacities as officers, directors, employees and agents of the corporation, whether or not the
corporation would have been required to indemnify the person against the liability under the
provisions of such section. The Companys Restated Articles of Incorporation limit personal liability for breach of the
fiduciary duty of our directors to the fullest extent provided by the Minnesota Business
Corporation Act. The Companys articles of incorporation eliminate the personal liability of
directors for damages occasioned by breach of fiduciary duty, except for liability based on (i) the
directors duty of loyalty to the Company, (ii) acts or omissions not made in good faith, (iii)
acts or omissions involving intentional misconduct, (iv) payments of improper dividends, (v)
violations of state securities laws and (vi) acts occurring prior to the date such provision was
added. Any amendment to or repeal of such provision shall not adversely affect any right or
protection of a director for or with respect to any acts or omissions of such director occurring
prior to such amendment or repeal. The Companys restated bylaws provide that each director and
officer, past or present, and each person who serves or may have served at the Companys request as
a director, officer, employee or agent of another corporation or employee benefit plan and their
respective heirs, administrators and executors, will be indemnified by us to such extent as
permitted by Minnesota Statutes, Section 302A.521, as now enacted or hereafter amended. Insofar as indemnification for liabilities arising under the Securities Act may be permitted
to directors, officers or persons controlling the Company pursuant to the foregoing provisions, the
Company has been informed that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act and is therefore
unenforceable. 
 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding beneficial ownership of the
Companys Common Stock, as of May 2, 2005 by: (i) each person who is known by the Company to
beneficially own more than 5% of the Common Stock, (ii) each of the Companys directors, (iii) each
of the Companys executive officers and (iv) all directors and executive officers of the Company as
a group: 58




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##### 



Number of SharesName of Beneficial Owner
    
    Beneficially Owned(1)
    
    
    Percent of ClassBCC Acquisition II LLC (2)
c/o Bay City Capital LLC
750 Battery Street, Suite 600
San Francisco, CA 94111
    
    
    373,970,797
    
    
    
    91.4
    %Monarch Pointe, Ltd. (3)
c/o Bank of Ireland Securities Services, Ltd.
New Century House 
International Financial Services Center 
Mayor Street Lower
Dublin 1, Republic of Ireland
    
    
    57,282,049
    
    
    
    62.0
    %Mercator Momentum Fund L.P. (4)
555 South Flower Street, Suite 4500 
Los Angeles, CA 90071
    
    
    37,580,772
    
    
    
    51.9
    %Longview Fund LP (5)
600 Montgomery Street, 44th Floor
San Francisco, CA 94111
    
    
    35,714,650
    
    
    
    55.4
    %Mercator Momentum Fund III L.P. (6)
555 South Flower Street, Suite 4500
Los Angeles, CA 90071
    
    
    35,614,176
    
    
    
    50.6
    %Camden International (7)
Charlotte House, Charlotte Street
Nassau, Bahamas
    
    
    20,972,400
    
    
    
    37.4
    %Longview Equity Fund, LP (8)
600 Montgomery Street, 44th Floor
San Francisco, CA 94111
    
    
    16,777,600
    
    
    
    32.3
    %Longview International Equity Fund, LP (9)
600 Montgomery Street, 44th Floor
San Francisco, CA 94111
    
    
    8,388,800
    
    
    
    19.3
    %Mercator Advisory Group LLC (10)
555 South Flower Street, Suite 4500
Los Angeles, CA 90071
    
    
    4,073,500
    
    
    
    10.4
    %Mark B. Knudson, Ph.D. (11)
    
    
    463,620
    
    
    
    1.6
    %David B. Kaysen (12)
    
    
    450,000
    
    
    
    1.3
    %W. Glen Winchell (13)
    
    
    50,000
    
    
    
    *Steven G. Emery (14)
    
    
    50,000
    
    
    
    *Carl S. Goldfischer, M.D. (15)
    
    
    26,000
    
    
    
    *William Moffitt (16)
    
    
    25,000
    
    
    
    *All directors and executive officers as a group (6 persons)(17)
    
    
    1,064,620
    
    
    
    2.9
    %
 59




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##### 



*
    
    Less than 1%.(1)
    
    Beneficial ownership is determined in accordance with rules
of the Securities and Exchange Commission, and includes
generally voting power and/or investment power with respect
to securities. Shares of Common Stock subject to options,
warrants or other securities currently exercisable or
convertible, or exercisable or convertible within 60 days
of May 2, 2005 are deemed outstanding for computing the
percentage of the person holding such convertible
securities but are not deemed outstanding for computing the
percentage of any other person. Shares of Common Stock
issuable upon conversion of Preferred Stock are calculated
assuming: (i) a market price equal to the closing price of
the Companys Common Stock on May 2, 2005, or $0.018 per
share; (ii) a floor price for Series F Shares equal to
$0.15 per share; and (iii) a floor price for Series G
Shares equal to $0.03 per share. Except as indicated by
footnote, the persons named in the table above have sole
voting and investment power with respect to all shares of
Common Stock shown as beneficially owned by them.(2)
    
    As reported in a Schedule 13D/A filed April 13, 2005,
includes 4,686,580 shares of Common Stock issuable upon the
exercise of outstanding warrants, 352,617,550 shares of
Common Stock issuable upon the conversion of 2005 Notes and
up to 16,666,667 shares of Common Stock issuable upon
conversion of Series G Shares.(3)
    
    Includes up to 11,113,333 shares of Common Stock issuable
upon conversion of Series G Shares, 29,750,000 shares of
Common Stock issuable upon the conversion of 2007 Notes and
16,418,716 shares of Common Stock to be issued upon
exercise of Common Stock warrants. The shareholder has
contractually agreed not to convert Series G Shares or 2007
Notes, as applicable, or to exercise warrants to the extent
such holders beneficial ownership of Common Stock will
exceed 9.99% of the Common Stock then outstanding and, as
described in a Schedule 13G/A filed February 14, 2005,
disclaims beneficial ownership in excess of 9.99%.(4)
    
    In addition to 311,024 shares of Common Stock owned,
includes up to 2,333,333 shares of Common Stock issuable
upon conversion of Series F Shares, 11,110,000 shares of
Common Stock issuable upon conversion of Series G Shares,
13,416,650 shares of Common Stock issuable upon the
conversion of 2007 Notes and 10,409,765 shares of Common
Stock to be issued upon exercise of Common Stock warrants.
Mercator Advisory Group LLC is the general partner of
Mercator Momentum Fund, L.P. David Firestone, as managing
member of Mercator Advisory Group LLC, and as a member of
Mercator Group LLC, has voting and investment control over
the shares held by Mercator Momentum Fund, L.P. The
shareholder has contractually agreed not to convert Series
F Shares, Series G Shares or 2007 Notes, as applicable, or
to exercise warrants to the extent such holders beneficial
ownership of Common Stock will exceed 9.99% of the Common
Stock then outstanding and, as described in a Schedule
13G/A filed February 14, 2005, disclaims beneficial
ownership in excess of 9.99%.(5)
    
    In addition to 6,353,450 shares of Common Stock owned,
includes up to 17,500,000 shares of Common Stock issuable
upon conversion of 2007 Notes and 11,861,200 shares of
Common Stock to be issued upon exercise of Common Stock
warrants. The shareholder has contractually agreed not to
convert 2007 Notes or to exercise warrants to the extent
such holders beneficial ownership of Common Stock will
exceed 9.99% of the Common Stock then outstanding.(6)
    
    In addition to 327,689 shares of Common Stock owned,
includes up to 4,333,334 shares of Common Stock issuable
upon conversion of Series F Shares, 11,110,000 shares of
Common Stock issuable upon conversion of Series G Shares,
9,333,350 shares of Common Stock issuable upon the
conversion of 2007 Notes and 10,509,803 shares of Common
Stock to be issued upon exercise of Common Stock warrants.
Mercator Advisory Group LLC is the general partner of
Mercator Momentum Fund III, L.P. David Firestone, as
managing member of Mercator Advisory Group LLC, and as a
member of Mercator Group LLC, has voting and investment
control over the shares held by Mercator Momentum Fund III,
L.P. The shareholder has contractually agreed not to
convert Series F Shares, Series G Shares or 2007 Notes, as
applicable, or to exercise warrants to the extent such
holders beneficial ownership of Common Stock will exceed
9.99% of the Common Stock then outstanding and, as
described in a Schedule 13G/A filed February 14, 2005,
disclaims beneficial ownership in excess of 9.99%.(7)
    
    Includes up to 12,500,000 shares of Common Stock issuable
upon conversion of 2007 Notes and 8,472,400 shares of
Common Stock to be issued upon exercise of Common Stock
warrants. The shareholder has contractually agreed not to
convert 2007 Notes or to exercise warrants to the extent
such holders beneficial ownership of Common Stock will
exceed 9.99% of the Common Stock then outstanding. 60




---



##### 



(8)
    
    Includes up to 10,000,000 shares of Common Stock issuable
upon conversion of 2007 Notes and 6,777,600 shares of
Common Stock to be issued upon exercise of Common Stock
warrants. The shareholder has contractually agreed not to
convert 2007 Notes or to exercise warrants to the extent
such holders beneficial ownership of Common Stock will
exceed 9.99% of the Common Stock then outstanding.(9)
    
    Includes up to 5,000,000 shares of Common Stock issuable
upon conversion of 2007 Notes and 3,388,800 shares of
Common Stock to be issued upon exercise of Common Stock
warrants. The shareholder has contractually agreed not to
convert 2007 Notes or to exercise warrants to the extent
such holders beneficial ownership of Common Stock will
exceed 9.99% of the Common Stock then outstanding.(10)
    
    Includes up to 4,073,500 shares of Common Stock to be
issued upon exercise of Common Stock warrants. Mercator
Advisory Group LLC is the general partner of Mercator
Momentum Fund III, L.P., Mercator Momentum Fund, L.P. and
Mercator Focus Fund, L.P. David Firestone, as managing
member of Mercator Advisory Group LLC, and as a member of
Mercator Group LLC, has voting and investment control over
the shares held by Mercator Momentum Fund III, L.P.,
Mercator Momentum Fund, L.P., Mercator Focus Fund, L.P.
and Mercator Advisory Group LLC. The shareholder has
contractually agreed not to exercise warrants to the
extent such holders beneficial ownership of Common Stock
will exceed 9.99% of the Common Stock then outstanding
and, as described in a Schedule 13G/A filed February 14,
2005, disclaims beneficial ownership in excess of 9.99%.(11)
    
    Includes 132,500 shares of Common Stock issuable upon the
exercise of outstanding options. Includes 156,250 shares
of Common Stock beneficially owned by Medical Innovation
Fund II (MIF II). Dr. Knudson is a general partner of
Medical Innovation Partners II, the general partner of MIF
II. Dr. Knudson disclaims beneficial ownership of these
securities except to the extent of his proportionate
pecuniary interest in the partnerships. Excludes 459,254
shares of Common Stock held by Medical Innovation Fund
(MIF). Medical Innovation Partners (MIP) is the
general partner of MIF. Dr. Knudson is a partner of MIP.
Dr. Knudson disclaims beneficial ownership of such shares
except to the extent of his proportionate pecuniary
interests in such partnerships.(12)
    
    Includes 450,000 shares of Common Stock issuable upon exercise of outstanding options.(13)
    
    Includes 50,000 shares of Common Stock issuable upon exercise of outstanding options.(14)
    
    Includes 50,000 shares of Common Stock issuable upon exercise of outstanding options.(15)
    
    Includes 26,000 shares of Common Stock issuable upon exercise of outstanding options.(16)
    
    Includes 25,000 shares of Common Stock issuable upon exercise of outstanding options.(17)
    
    See Notes (11)  (16) above. 61




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##### 



EQUITY COMPENSATION PLANS The following table summarizes share and exercise price information about the Companys equity
compensation plans as of December 31, 2004. Number ofsecuritiesremainingNumber of
    
    
    
    
    
    
    available forsecurities to be
    
    
    Weighted-
    
    
    future issuanceissued upon
    
    
    average
    
    
    under equityexercise of
    
    
    exercise price
    
    
    compensationoutstanding
    
    
    of outstanding
    
    
    plans (excludingoptions,
    
    
    options,
    
    
    securitieswarrants and
    
    
    warrants and
    
    
    reflected in thePlan Category
    
    rights
    
    
    rights
    
    
    first column)Equity compensation
plans approved by
security holders
(1)
    
    
    1,422,600
    (1)
    
    
    1.95
    
    
    
    2,382,208
    (2)Equity compensation
plans not approved by
security
holders
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    1,422,600
    (1)
    
    
    1.95
    
    
    
    2,382,208
    (2)
   (1)
    
    Includes 1,328,600 and 94,000 outstanding stock options issued under the Companys 1990
Stock Option Plan and 1993 Directors Plan (which expired in 2003), respectively.(2)
    
    Includes shares reserved and available for future issuance under the Companys equity
compensation plans as follows: 1990 Stock Option Plan  2,355,353 shares, Employee Stock
Purchase Plan  26,855 shares. 
 Item 13. Certain Relationships and Related Transactions Effective January 2001, the Companys U.K. subsidiary, Diametrics Medical, Ltd., entered into
a capital lease agreement with DVI Financial Services in the amount of £319,500 (or approximately
$466,800 based upon the currency exchange rate between the British pound sterling and the U.S.
dollar on the date of the transaction). The capital lease agreement required principal and
interest payments in monthly installments through January 2005, at an annual interest rate of 12%,
and was secured by equipment. DVI Financial Services is a business unit of
DVI, Inc., of which Mr. Cohn (who retired from the Companys Board of Directors on August 1, 2004)
was a director and consultant. 
 Item 14. Principal Accounting Fees and Services The Audit Committee appointed Virchow, Krause & Company, LLP as independent registered public
accountants for the Company for the fiscal year ending December 31, 2004. Virchow, Krause &
Company, LLP has served as the Companys independent registered public accountants since September,
2004 and has no relationship with the Company other than that arising from its engagement as
independent registered public accountants. KPMG LLP served as the Companys independent
registered public accountants from 1990 to August 9, 2004. Independent Registered Public Accountants Fees The following table summarizes the aggregate fees for services performed by the independent
registered public accountants engaged by Diametrics Medical, Inc. 62




---



##### 



Fee Category
    
    2004 Fees
    
    
    2003 FeesAudit Fees (a)
    
    $
    77,000
    
    
    $
    112,160Audit-Related Fees (b)
    
    
    38,400
    
    
    
    58,000Tax Fees (c)
    
    
    9,600
    
    
    
    21,514All Other Fees
    
    
    0
    
    
    
    0Total
    
    $
    125,000
    
    
    $
    191,674
   (a)     Includes audit
fees of $61,000 billed or to be billed to the Company by Virchow, Krause & Company, LLP for
review of the Companys consolidated financial statements for the fiscal year ended December 31,
2004, and audit fees of $128,160 billed to the Company by KPMG LLP for review of the Companys
consolidated financial statements for the fiscal year ended December 31, 2004 and the financial
statements included in the Companys quarterly reports on Form 10-Q for the such fiscal year and
the quarterly reports on Form 10-Q for the quarters ended March 31, 2004 and June 30, 2004.(b)     Includes fees $96,400 billed to the Company by KPMG LLP during 2004 and 2003 for audit
related services, consisting of the audit of financial statements of certain employee benefit
plans, review of registration and proxy statements, and review of selected accounting issues.(c)     Fees for all tax-related services rendered to the Company by KPMG LLP. Audit Committee Pre-Approval Policy In accordance with the Diametrics Medical, Inc. Audit Committee Charter, the Committee has
adopted the following policies and procedures for the approval of the engagement of an independent
auditor for audit, review or attest services and for pre-approval of certain permissible non-audit
services, all to ensure auditor independence. The Companys independent auditor will provide audit, review and attest services only at the
direction of, and pursuant to engagement fees and terms approved by, the Audit Committee. Such
engagement will be pursuant to a written proposal, submitted to the Audit Committee for review and
discussion. If acceptable, the Audit Committee will engage the independent auditor pursuant to a
written retention agreement, duly approved by the Audit Committee. As proscribed by Section 10A(g) of the Securities Exchange Act of 1934, certain non-audit
services may not be provided by the Companys auditor, including:  
    bookkeeping or other services related to the accounting records or financial
statements of the Company,
    financial information systems design and implementation,
    appraisal or valuation services, fairness opinions, or contribution-in-kind reports,
    actuarial services,
    internal audit outsourcing services,
    management functions or human resource functions,
    broker or dealer, investment adviser, or investment banking services, 63




---



##### 




    legal services and expert services unrelated to the audit; and
    any other service that the Public Company Accounting Oversight Board determines, by
regulation, is impermissible. With respect to permissible non-audit services, including tax services, the Companys Chief
Financial Officer or Principal Accounting Officer will submit a request to the Audit Committee to
retain the Companys auditor when the management of the Company believes it is in the best interest
of the Company to do so. The requesting Company officer will submit specific reasons supporting
this determination. In such event, the requesting officer of the Company shall submit a written
proposal from the audit firm for the non-audit services, which shall be specific as to the scope of
the services to be provided, and the compensation structure. The Audit Committee will review the
proposed retention for compliance with three basic principles, violations of which would impair the
auditors independence: (1) an auditor cannot function in the role of management, (2) an auditor
cannot audit his or her own work, and (3) an auditor cannot serve in an advocacy role for the
Company. If the Audit Committee determines that the proposed retention does not and will not
violate these principles, it may authorize, in writing, the retention of the auditor for the agreed
scope of non-audit services and compensation structure. From and after the effective date of the Securities and Exchange Commission Rule requiring
pre-approval of all audit and permissible non-audit services provided by independent registered
public accountants, the Audit Committee has pre-approved all audit and permissible non-audit
services by Virchow, Krause & Company, LLP and KPMG LLP. 
 PART IV 
 Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) 1. Financial Statements The following consolidated financial statements of Diametrics Medical, Inc. and Independent
Auditors Report as of and for the year ended December 31, 2004 are filed as part of this Report. Report of
Independent Registered Public Accounting FirmConsolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002Consolidated Balance Sheets at December 31, 2004 and 2003Consolidated Statements of Shareholders Equity (Deficit) and Comprehensive Loss for the years ended December 31, 2004, 2003 and 2002Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002Notes to Consolidated Financial Statements
 The consolidated financial statements as of December 31, 2003 and for the two years then ended
were examined by KMPG LLP. They declined to stand for reappointment and resigned as auditors and
principal accountants for the year ended December 31, 2004.
Their resignation was concluded after
they completed their review of the consolidated financial statements as of and for the three and
six-month periods ended June 30, 2004. The audit reports of KPMG LLP on the consolidated financial statements of Diametrics Medical,
Inc. as of and for the years ended December 31, 2003 and 2002, contained a separate paragraph
stating: 64




---



##### 



The
consolidated financial statements have been
prepared assuming that the Company will
continue as a going concern. As discussed in Note 2 to the consolidated
financial statements, the
Company has recurring losses and negative cash flows that
raise
substantial doubt about its ability
to continue as a going concern. Managements plans in regard to these matters are also described in
Note 2. The consolidated financial statements do not include any adjustments that might result from
the outcome of this uncertainty. Other than such qualification as to uncertainty as a going
concern, the aforementioned audit reports of KPMG LLP did not contain any adverse opinion or
disclaimer of opinion, nor were they qualified or modified as to audit scope or accounting
principles. In connection with the audits of the consolidated financial statements of the Company for the
two years ended December 31, 2003, and the subsequent interim period through August 9, 2004 (the
date that KPMG LLP completed its review), there were no disagreements with KPMG LLP on any matter
of accounting principles or practices, financial statement disclosure, or auditing scope or
procedures, which disagreements if not resolved to their satisfaction would have caused them to
make reference in connection with their opinion to the subject matter of the disagreement. Subsequent to the receipt of additional funding on December 15, 2004, the Company advised
KPMG LLP that it wanted to engage KPMG LLP to update previous reports in connection with
filing the annual report on Form 10-K and various registration statements and amendments thereto.
It is anticipated that KPMG LLP will consent to the use of such reports subsequent to completion
of the 2004 audit by Virchow Krause & Company, LLP. Such consent has not yet been received and
will therefore be filed by amendment to this Form10-K 2. Financial Statement Schedules The following consolidated financial statement schedule of Diametrics Medical, Inc. is filed
as part of this Report and should be read in conjunction with the consolidated financial statements
of Diametrics Medical, Inc. Schedule II  Valuation and Qualifying Accounts All other schedules have been omitted because they are not applicable or not required, or
because the required information is included in the consolidated financial statements or the notes
thereto. 3. Exhibits Exhibit
    
    
    
    Method ofNo.
    
    Description
    
    Filing2.1
    
    Asset Purchase Agreement dated July 17, 2003 between the
Company and International Technidyne Corporation
    
    
    (1
    )3.1
    
    Articles of Incorporation of the Company (as amended)
    
    Filed herewith3.2
    
    Bylaws of the Company (as amended)
    
    
    (3
    )4.1
    
    Certificate of Designations of Series E Convertible Preferred
Stock of the Company, dated May 12, 2003
    
    
    (2
    )4.2
    
    Certificate of Designations of Series F Convertible Preferred
Stock of the Company, dated January 14, 2004 (as amended)
    
    
    (15
    )4.3
    
    Certificate of Designations of Series G Convertible Preferred
Stock of the Company, dated May 28, 2004
    
    
    (11
    )10.1*
    
    1990 Stock Option Plan, as amended and restated
    
    
    (12
    )10.2*
    
    1993 Directors Stock Option Plan, as amended and restated
    
    
    (5
    )
 65




---



##### 



Exhibit
    
    
    
    Method ofNo.
    
    Description
    
    Filing10.3*
    
    1995 Equalizing Director Stock Option Plan
    
    
    (6
    )10.4
    
    1995 Employee Stock Purchase Plan (as revised and restated)
    
    
    (12
    )10.5
    
    Common Stock Purchase Agreement, dated June 30, 1998, between
the Company and the Purchasers named therein
    
    
    (7
    )10.6
    
    Note Purchase Agreement, dated August 4, 1998, between the
Company and the Purchasers named therein
    
    
    (7
    )10.7
    
    Form of Convertible Senior Secured Fixed Rate Note due August
4, 2003
    
    
    (7
    )10.8
    
    Form of Severance Pay Agreement (in the event of Change of
Control) dated July 31, 1998, between the Company and its
executive officers
    
    
    (8
    )10.9
    
    Form of Severance Pay Agreement (in the event of Termination
Without Cause) dated July 31, 1998, between the Company and
its executive officers
    
    
    (8
    )10.10
    
    First Amendment to Note Purchase Agreement, dated April 7,
2003, between the Company and the Purchasers named therein
    
    
    (2
    )10.11
    
    Form of First Amended and Restated Convertible Senior Secured
Fixed Rate Note due August 4, 2005
    
    
    (2
    )10.12
    
    Amendment to Manufacturing and Distribution Agreement, dated
April 10, 2003, between the Company and Philips Medical
Systems
    
    
    (2
    )10.13
    
    Subscription Agreement for shares of Series E Convertible
Preferred Stock and Common Stock Warrant, dated May 12, 2003,
between the Company and the Purchasers named therein
    
    
    (2
    )10.14
    
    Form of Stock Purchase Warrant, dated May 12, 2003
    
    
    (2
    )10.15
    
    Escrow Agreement, dated September 26, 2003, by and among
International Technidyne Corporation, the Company and
Deutsche Bank Trust Company Americas, as Escrow Agent
    
    
    (10
    )10.16
    
    Subscription Agreement for shares of Series F Convertible
Preferred Stock and Common Stock Warrant, dated January 14,
2004, between the Company and the Purchasers named therein
    
    
    (4
    )10.17
    
    Form of Stock Purchase Warrant, dated January 14, 2004
    
    
    (4
    )10.18
    
    Limited Waiver and Amendment, effective as of December 30,
2003, between the Company and the Noteholders named therein
    
    
    (4
    )10.19
    
    Subscription Agreement for shares of Series G Convertible
Preferred Stock and Common Stock Warrants, dated May 28,
2004, between the Company and the Purchasers named therein
    
    
    (11
    )10.20
    
    Form of Stock Purchase Warrant, dated May 28, 2004, issued to
the purchasers of Series G Convertible Preferred Stock
    
    
    (11
    )10.21
    
    Form of Stock Purchase Warrant, dated May 28, 2004, issued in
connection with Series G Convertible Preferred Stock
financing
    
    
    (11
    )
 66




---



##### 



Exhibit
    
    
    
    Method ofNo.
    
    Description
    
    Filing10.22*
    
    Employment Agreement, dated September 8, 2004, between the
Company and William P. Moffitt
    
    
    (13
    )10.23
    
    Subscription Agreement, dated December 14, 2004, between the
Company and the Subscribers named therein.
    
    
    (16
    )10.24
    
    Form of Fixed Price Convertible Notes due December 15, 2007.
    
    
    (16
    )10.25
    
    Form of Common Stock Purchase Warrant dated December 15, 2004.
    
    
    (16
    )10.26
    
    Security and Pledge Agreement, dated December 15, 2004,
between the Company and Barbara R. Mittman as Collateral
Agent.
    
    
    (16
    )10.27
    
    Trademark Security Agreement, dated December 15, 2004,
between the Company and Barbara R. Mittman as Collateral
Agent.
    
    
    (16
    )10.28
    
    Guaranty Agreement, dated December 15, 2004, between TGC
Research Limited and Barbara R. Mittman as Collateral Agent.
    
    
    (16
    )10.29
    
    Debenture, dated December 15, 2004, between TGC Research
Limited and Barbara R. Mittman as Agent.
    
    
    (16
    )10.30
    
    Charge Over Shares, dated December 15, 2004, between the
Company and Barbara R. Mittman as Agent.
    
    
    (16
    )10.31
    
    General Security Agreement, dated December 15, 2004, between
TGC Research Limited and BCC Acquisition II LLC as Agent.
    
    
    (16
    )10.32
    
    Trademark Security Agreement, dated December 15, 2004,
between TGC Research Limited and BCC Acquisition II LLC as
Agent.
    
    
    (16
    )10.33
    
    Patent Security Agreement, dated December 15, 2004, between
TGC Research Limited and BCC Acquisition II LLC as Agent.
    
    
    (16
    )10.34
    
    Debenture, dated December 15, 2004, between TGC Research
Limited and BCC Acquisition II LLC as Agent.
    
    
    (16
    )10.35
    
    Charge Over Shares, dated December 15, 2004, between the
Company and BCC Acquisition II LLC as Agent.
    
    
    (16
    )10.36
    
    Subordination Agreement, dated December 15, 2004, by and
between the Company, TGC Research Limited, and the Senior
Creditors and Junior Creditors named therein.
    
    
    (16
    )10.37
    
    Consent and Amendment, dated December 15, 2004, among the
Company and the Note Holders named therein.
    
    
    (16
    )10.38
    
    Amendment, dated December 15, 2004, among the Company and the
holders of the Series G Warrants named therein.
    
    
    (16
    )10.39
    
    Amendment, dated December 15, 2004, among the Company and the
holders of the Series F Warrants named therein.
    
    
    (16
    )10.40
    
    Amendment, dated December 15, 2004, among the Company and the
holders of the Series E Warrants named therein.
    
    
    (16
    )10.41
    
    Amendment, dated December 15, 2004, among the Company and the
holders of the Warrants issued May 28, 2004 named therein.
    
    
    (16
    )
 67




---



##### 



Exhibit
    
    
    
    Method ofNo.
    
    Description
    
    Filing10.42
    
    Amendment, dated December 15, 2004, among the Company and the
holders of the Warrants assigned December 15, 2004.
    
    
    (16
    )10.43
    
    Limited Waiver and Consent, dated May 2, 2005, among the
Company and the noteholders named therein
    
    Filed herewith14
    
    Code of Business Conduct and Ethics for Directors, Officers
and Employees
    
    
    (4
    )16
    
    Letter from KPMG LLP to Securities and Exchange Commission
    
    
    (14
    )21
    
    List of Subsidiaries
    
    Filed herewith23.1
    
    Consent of Independent Registered
Public Accounting FirmVirchow, Krause & Company, LLP
    
    Filed herewith23.2
    
    Report of Independent Registered Public Accounting Firm and
Consent of KPMG LLP
    
    [To be filed by
amendment]24.1
    
    Power of Attorney (included on signature page of this Report)
    
    Filed herewith31.1
    
    Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
    
    Filed herewith31.2
    
    Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
    
    Filed herewith32.1
    
    Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
    
    Filed herewith32.2
    
    Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
    
    Filed herewith
   *
    
    Management compensatory plan filed pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K.(1)
    
    Incorporated by reference to the Companys Current Report on Form 8-K, filed on July 22, 2003.(2)
    
    Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 2003.(3)
    
    Incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
December 31, 1999.(4)
    
    Incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
December 31, 2003.(5)
    
    Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 2001.(6)
    
    Incorporated by reference to the Companys Annual Report on Form 10-K for the year ended
December 31, 1995.(7)
    
    Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998. 68




---



##### 



(8)
    
    Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998.(9)
    
    Incorporated by reference to the Companys Current Report on Form 8-K, filed on July 23, 1999.(10)
    
    Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003.(11)
    
    Incorporated by reference to the Companys Current Report on Form 8-K, filed June 7, 2004.(12)
    
    Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 2004.(13)
    
    Incorporated by reference to the Companys Current Report on Form 8-K/A, filed September 17,
2004.(14)
    
    Incorporated by reference to the Companys Current Report on Form 8-K/A, filed September 21,
2004.(15)
    
    Incorporated by reference to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2004.(16)
    
    Incorporated by reference to the Companys Current Report on Form 8-K, filed December 20,
2004. (b) See Item 15(a)(3) above.
(c) See Item 15(a)(2) above. 69




---



##### 



SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Roseville, State of Minnesota, on May 5, 2005. DIAMETRICS MEDICAL, INC.By:
    
    /s/ David B. KaysenDavid B. KaysenChief Executive Officer and President
 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been
signed below by the following persons on behalf of the registrant and in the capacities indicated
on May 5, 2005. KNOW ALL MEN BY THESE PRESENTS, that the undersigned do hereby constitute and appoint David B.
Kaysen and W. Glen Winchell, and each of them, each with full power to act without the other, his
true and lawful attorneys-in-fact and agents, each with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any
and all amendments to the Annual Report on Form 10-K for the year ended December 31, 2004 of
Diametrics Medical, Inc., and to file the same, with any and all exhibits thereto, and all other
documents in connection therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, full power and authority to do and perform each and every act and
thing requisite and necessary to be done as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all of each of said attorneys-in-fact
and agents or any of them may lawfully do or cause to be done by virtue thereof. Signature
    
    Title/s/     David B. Kaysen
    
    President, Chief Executive Officer and Director (Principal Executive Officer)David B. Kaysen/s/     W. Glen Winchell
    
    Senior Vice President of Finance and Chief Financial Officer (Principal Financial and Accounting Officer)W. Glen Winchell/s/ William P. Moffitt
    
    Chairman of the BoardWilliam P. Moffitt/s/ Carl S. Goldfischer
    
    DirectorCarl S. Goldfischer, M.D./s/ Mark B. Knudson
    
    DirectorMark B. Knudson, Ph.D.
 70




---



##### 



Report of Independent Registered Public Accounting Firm on Financial Statement Schedule The Board of Directors and Shareholders
Diametrics Medical, Inc.: Under date of April 28, 2005 (except as to Note 17, as to which the date is May 2, 2005),
we reported on the consolidated balance sheet of Diametrics Medical, Inc. as of December 31, 2004,
and the related consolidated statements of operations, shareholders equity (deficit) and
comprehensive loss, and cash flows for the year ended December 31, 2004, which are included in the
Annual Report on Form 10-K. In connection with our audit of the aforementioned consolidated
financial statements, we also audited the related financial statement schedule as listed in the
accompanying index. The financial statement schedule is the responsibility of the Companys
management. Our responsibility is to express an opinion on the financial statement schedule based
on our audit. In our opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, present fairly, in all material respects,
the information set forth therein. The consolidated financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the
Company has recurring losses and negative cash flows that raise substantial doubt about its ability
to continue as a going concern. Managements plans in regard to these matters are also described in
Note 2. The consolidated financial statements do not include any adjustments that might result from
the outcome of this uncertainty. s/ Virchow, Krause & Company, LLP Minneapolis, Minnesota
April 28, 2005 71




---



##### 



Schedule II  Valuation and Qualifying Accounts ForeignBalance at
    
    
    Charged to
    
    
    currencybeginning of
    
    
    costs and
    
    
    exchange
    
    
    
    
    
    
    Balance atperiod
    
    
    expenses
    
    
    rate changes
    
    
    Deductions
    
    
    end of periodAllowance for
doubtful accounts:2004
    
    $
    89,495
    
    
    $
    
    
    
    $
    
    
    
    $
    (84,495)
    *
    
    $
    5,0002003
    
    
    
    
    
    
    85,661
    
    
    
    10,683
    
    
    
    (6,849)
    
    
    
    89,4952002
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
   *
    
    Trade accounts receivable written off against the allowance for doubtful accounts. 72




---



##### 



EXHIBIT INDEX ExhibitNo.
    
    Description3.1
    
    Articles of Incorporation of the Company (as amended)10.43
    
    Limited Waiver and Consent, dated May 2, 2005, among the Company
and the noteholders named therein21
    
    List of Subsidiaries23.1
    
    Report of Independent Registered Public Accounting Firm and
Consent of Virchow, Krause & Company, LLP24.1
    
    Power of Attorney (included on signature page of this Report)31.1
    
    Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002