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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC, 20549

FORM 10-K

Commission File Number 0-19632

4-D NEUROIMAGING
(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, No Par Value Per Share

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

        The aggregate market value of the voting stock (which consists solely of shares of common stock) held by non-affiliates of the registrant as of March 28, 2002 was $4,987,731 based on the closing price on that date on the Nasdaq Over the Counter Bulletin Board. Shares of common stock held by each officer, director and holder of 10% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

        The number of shares outstanding of the registrant's common stock, no par value, as of January 3, 2003 was 220,338,589 shares.

DOCUMENTS INCORPORATED BY REFERENCE

1.

Certain portions of Registrant's Definitive Proxy Statement, to be filed not later than 120 days after September 30, 2002 pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, in connection with the 2003 Annual Meeting of Shareholders are incorporated by reference into Part III of this report where indicated.

2.

Certain Exhibits filed with the Registrant's prior registration statements and reports are incorporated herein by reference into Part IV of this report.

4-D NEUROIMAGING

FORM 10-K

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2002
INDEX

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PART I

        This annual report on Form 10-K may contain forward-looking statements that involve risks and uncertainties. Actual results could differ materially from any forward-looking statements and from past performance as a result of such risks and uncertainties. See the "Factors That May Affect Future Results" section of this report.

ITEM 1.    BUSINESS.

Company Overview

        4-D Neuroimaging, or 4-D, (formerly Biomagnetic Technologies, Inc.), a California corporation originally founded in 1970 to produce equipment for physics labs, currently develops, produces, markets and sells medical instrumentation that allows physicians to monitor how the body is functioning, and provides an important tool to neuroscientists, helping them to unravel how the brain functions. The basic technology is referred to as Magnetoencephalography, or MEG (sometimes Magnetic Source Imaging or MSI). MEG systems measure and locate magnetic fields generated by the human body, and assist in the noninvasive diagnosis of a potentially broad range of medical disorders. These measurements provide useful information about the normal and abnormal functioning of the brain, heart, spine and other organs. Currently, we are focusing our efforts on MEG applications for the brain.

        MEG systems use advanced superconducting technology to noninvasively detect and characterize naturally occurring magnetic fields that are one billion times smaller than the earth's magnetic field. This capability is used to measure the magnetic fields, from the brain or body thousands of times a second. Physician are employing this ability to aid in the evaluation and planning for surgical treatment of epilepsy, or Epilepsy, and the identification of important functional areas of the brain (e.g. motor and language-related cortex) that can be at risk during neurological surgery for tumors and other brain lesions, also referred to as pre-surgical functional mapping, or PSFM. The neuroscience research community is employing MEG to help them unravel the functional complexity of the brain.

        A major step was taken in 2001 in the commercialization of MEG. The American Medical Association, or AMA, issued Current Procedural Terminology, or CPT, codes for both Epilepsy and PSFM using MEG. While Epilepsy and PSFM be may relatively small markets in and of themselves, the issuance of CPT codes for these uses of MEG represent a major step forward in the market development of MEG. They form the foundation for other applications currently in development. A further step was taken in November 2002 when the Center for Medicare and Medicaid Services, or CMS, issued their recommended reimbursement levels for the use of MEG in Epilepsy and PSFM. The level of reimbursement established can provide an economic basis for the purchase and use of MEG systems. These reimbursement levels became effective January 1, 2003.

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

        MEG differs significantly from other anatomical and functional imaging methods. Traditional medical imaging technologies such as X-ray, magnetic resonance imaging, or MRI, and computed tomography, or CT, provide valuable anatomical detail but no direct functional information. Functional imaging methods such as electroencephalography or EEG, positron emission tomography or PET, single photon emission tomography or SPECT, and functional MRI or fMRI, have limited spatial or temporal resolution, or require invasive procedures, such as the injection of radioactive isotopes or surgical placement of electrodes into the brain, to locate normally or abnormally functioning areas of the brain. We believe that MEG is currently the only method that can noninvasively characterize the normal and

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abnormal function of the brain with the high temporal and spatial resolution necessary to be clinically useful in a potentially wide range of applications. A MEG system, when used in conjunction with CT and MRI images, provides the clinician with information that links anatomy with function to provide a more complete picture of the patient's condition without the use of radioactive isotopes or invasive procedures, the majority of which are inherently costly.

Product and Market Development

        After developing our core technology for the scientific research market for physics we looked to expand our markets with other applications. We determined that the market for the use of MEG systems in the diagnosis of neurological and neuropsychiatric disorders might be very large. Since focusing on this market, we have pursued both technical and market development strategies intended to create a commercial clinical market for MEG. We have developed and released a series of products leading up to the product line we are currently offering. The current main product line consists of two whole-head systems—the Magnes® 2500 WH, the Magnes 3600 WH—and the Magnes 1300C, a system designed for non-brain measurements including fetal, cardiac, spinal and gastrointestinal studies. All of the products, are available through common distribution channels throughout the world. As part of our ongoing commitment to the research market, any of these systems can be customized for the specific needs of a given research project. We market the Magnes 2500WH as our principle clinical system, while the Magnes 3600 WH is primarily marketed to the research market.

        As part of our market development strategy, we have targeted the evaluation of patients with Epilepsy, and the pre-surgical functional mapping of patients who are candidates for surgery that would endanger important functional areas of the brain, as near-term clinical applications for MEG. With the issuance by the AMA of CPT codes for these indications in 2001, and the issuance by CMS of reimbursement levels for these applications in 2002, MEG has taken significant steps forward in its commercialization.

        In the U.S. alone there are over 100 tertiary care epilepsy centers that we have identified and believe could benefit from the use of MEG technology. We are currently directing our marketing and sales efforts towards these centers as potential customers for MEG systems in the U.S. These centers are typically affiliated with academic medical institutions with large neurosurgical programs that would also benefit from the PSFM application. In addition, we believe there are an equivalent number of Epilepsy/PSFM centers with similar needs throughout the rest of the world. In addition to direct sales channels we are pursuing possible alliances or other distribution relationships that could expand the Company's access to the commercial market, which is expected to emerge following the issuance of CPT codes and the establishment of reimbursement levels.

        Currently, there are at least 5 centers in the U.S. using and receiving reimbursement for MEG on a routine basis for these indications: University of California, San Francisco, the University of Texas, Houston, Texas, Henry Ford Hospital in Detroit, Michigan, Scripps Research Institute in San Diego, California, and University of Alabama, Birmingham. All of these institutions currently operate MEG systems provided by 4-D Neuroimaging

MEG Technology

        MEG is based on fundamental properties of electromagnetism. Electrical currents produce magnetic fields that are perpendicular to the flow of current; these fields can be detected by our technology. A MEG instrument detects the magnetic fields produced by intracellular electrical activity that are associated with many of the body's most critical functions. Unlike electrical potentials generated by the body, upon which EEG and the electrocardiogram, or ECG, are based, the corresponding magnetic fields pass through surrounding body tissue undistorted, without obscuring the location of the source. MEG can non-invasively provide information about the timing and the location

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of the origin of normal and abnormal functional activity, by measuring and analyzing these magnetic fields. MEG can do this with a combination of millimeter spatial resolution and millisecond time resolution that has not been previously available without the use of surgically implanted electrodes, introducing radioactive or other tracer substances into the body, or the use of other costly, invasive procedures.

Current Medical Imaging Technology

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

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

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

        PET, SPECT and fMRI provide the physician with some functional information based on measurements of secondary effect of the body's activity. For PET and SPECT this is the uptake of certain radioactively labeled substances by the active tissue of the body, and for fMRI it is the change in blood flow due to the activity. All three techniques have relatively long physiological response times of one to five seconds, severely limiting their ability to follow function at the milli-second time scale, where MEG excels, and which is often required for functional disorder such a epilepsy. In addition, the use of radioactively labeled substances limits the ability of PET and SPECT to be used in longitudinal measurements. MEG, which provides a totally non-invasive functional measure with milli-second time resolution, is able to capture the brain's activity as it occurs, thereby allowing the physician to know precisely both when and, unlike EEG, where the activity occurred.

The 4-D MEG Systems

        The Company's MEG systems—the Magnes 2500 WH and 3600 WH whole-head systems, and the Magnes 1300 C that is designed for the rest of the body—are systems employing superconducting detection coils and amplifiers called Superconducting Quantum Interference Devices or SQUIDs. Integrated with each system are a patient support chair/bed, patient monitoring systems, and stimulus delivery systems, all isolated from environmental magnetic fields within a Magnetically Shielded Room, or MSR. Also integrated in the system are a control console, electronic components, stimulus generating devices and analysis workstations in a surrounding suite. These systems, as well as the Magnes I and Magnes II, have been used in both neurological and cardiac applications and incorporate a number of unique technologies, which are discussed below in more detail under the caption "Patents, Know How and Proprietary Rights".

Medical Applications

        We believe our Magnes systems have commercial potential in the diagnosis and treatment of a variety of neurological and other disorders. In developing MEG technology as a diagnostic technology we must create the appropriate economic incentives to enable a commercial success. Among these incentives, we continue to pursue the creation of sufficient numbers of diagnostic applications capable of generating cost savings or improved patient care so that large numbers of hospitals and clinics would consider purchasing MEG systems. This has facilitated the implementation of routine reimbursement

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for MEG procedures from third party payors and provided an increasing volume of evidence of routine approvals of reimbursements for clinical MEG procedures by third party payors.

        There are currently two clinically accepted applications for our MEG systems as evidenced by the issuance of CPT codes and reimbursement levels: planning of surgical treatment for epilepsy and presurgical functional mapping of the brain. Our next step is to establish that there exists sufficient numbers of treatment centers with the appropriate populations to support the operation of an MEG system, and provide the desired sales.

        To continue to develop the potential market for MEG, we will continue to work with our customers and other physicians and researchers to encourage and sponsor the clinical research needed to establish that the MEG applications described below, other than surgical planning for epilepsy and pre-surgical functional mapping, are medically useful and reimbursable.

        We are pursing a sales and marketing strategy to fully exploit the newly established CPT codes and reimbursement levels for MEG. While the commercial acceptance of MEG may still be uncertain, we are developing a strategy which is expected to include both our current direct-sales approach and the formation of strategic alliances to help accelerate the penetration of our MEG technology into our target markets of neurosurgeons, neurologists, and epileptologists.

Epilepsy Surgery

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

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

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

Presurgical Functional Mapping

        Approximately 110,000 brain surgeries are performed annually in the U.S. These procedures include tumor resection, surgical correction of epilepsy and removal of vascular malformations. The precise locations of important functional regions of the brain vary among healthy individuals and even more widely among patients with large brain lesions, therefore the locations of these regions often cannot be reliably determined solely from anatomical imaging, such as MRI. However, by relating information about the primary sensory function areas provided by our MEG systems to MRI-generated anatomical images, a functional map of the brain can be obtained and presented on a screen or

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recorded on film. Images thus produced with our MEG systems allow the surgeon to reliably estimate the risk of damage to the identified functional areas that might arise from the surgery itself. These images also help the surgeon to select an appropriate surgical approach, such as where to open the skull, and from which direction to access the targeted area, to minimize the surgical risk.

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

Neuropsychiatric Applications

        Potential neuropsychiatric applications of MEG include the diagnosis of schizophrenia and depression. It is currently estimated that approximately 3,000,000 people (1 percent of the U.S. population) will develop schizophrenia during the course of their lives, and at any given time approximately 100,000 people are hospitalized in public institutions in the U.S. for this disease. A number of studies indicate that MEG can detect differences in the brain activity in schizophrenic subjects compared to normal subjects. The variety and robustness of the differences suggest that MEG may eventually provide an objective indicator of the disease and be useful for monitoring treatment. Likewise, depressive illness affects more than 19,000,000 adults within the U.S. each year. Preliminary studies suggest that MEG may provide an objective indicator of the disease and lead to more effective treatment.

Applications to Learning Disorders

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

Other Neurological Applications

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

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

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

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        Alzheimer's disease affects an estimated 4,000,000 million people in the U.S. Current diagnostic technologies, PET, SPECT and EEG are not widely accepted as being valid diagnostic or prognostic indicators of the disease. Preliminary indications suggest that MEG may show altered responses to sensory stimuli in Alzheimer's patients, thus providing a tool for diagnosis and treatment.

Applications in other areas of the body

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

Sales to Date; Clinical Collaborations

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

        As of December 2002, we have 33 systems installed throughout the world. Installations are distributed among the U.S., Germany, Austria, Spain, France, Finland, Japan, Taiwan and China. Fifteen (15) sites operate Magnes 2500 WH systems. Two (2) sites operate Magnes 3600 WH systems. Twelve (12) sites operate Magnes I and Magnes II systems. Two (2) sites operate Magnes 1300 C systems and two (2) sites operate custom equipment made by us. The reduction of sites from previous years is a result of the sale of our Finnish subsidiary. See Note 2 to our consolidated financial statements for additional detail regarding the disposition of our Finnish subsidiary.

Marketing, Sales and Distribution

Market Description

        The overall market for our MEG systems can be divided into three overlapping markets: the basic research market, the clinical research market and the commercial clinical market. Customers in each of these markets are identified by the focus of their work, the source of purchase funds, and other characteristics, as described below.

        The basic research market consists of scientists working in university and government laboratories to discover new information about organ function and to make fundamental advances in their scientific fields. Patient treatment is not their principal concern. Equipment used by these scientists is generally purchased with funds provided by government and private research grants. The basic research market has been to date, and continues to represent, the majority of the Company's sales.

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

        With the issuance of the first CPT codes for MEG and the establishment of reimbursement levels, it becomes feasible for clinical users of MEG systems to create an MEG installation that is

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economically self-supporting. With our MEG systems, users with the appropriate neurosurgical patient populations can now begin to operate MEG systems with the potential for an economic return. While this model continues to need more demonstrated applications, we believe that the issuance of new CPT codes and reimbursement levels opens new sales opportunities in the commercial clinical market. We believe that we are uniquely positioned with our broad base of clinical users and clinical knowledge to take advantage of the issuance of CPT codes and work with both current and new users to create a commercial MEG market.

        The National Institute of Health, or NIH, has estimated that there are approximately 90 million cases annually of neurological and mental illness disorders in the U.S. Each case represents a separate incident of such disorders, but not necessarily separate patients. In most cases, diagnostic methods for these disorders remain inadequate. According to NIH estimates, the annual cost associated with these neurological and mental illness disorders in the U.S. is more than $285 billion. This amount includes the direct cost of health care and, in the case of neurological disorders, the indirect cost of income lost due to illness. The majority of these disorders are functional in nature and are a major cause of disability and death. In most cases, no noninvasive test exists to help physicians diagnose or effectively monitor the functional activity associated with these neurological and mental disorders. Our MEG systems are designed to address this need.

        There is substantial medical evidence supporting the view that a significant percentage of mental disorders have a physiological origin that can be treated by pharmaceuticals or other methods. Currently there are few objective measures of these physiological problems, making diagnosis and treatment, including measuring the effectiveness of the treatment, problematic. MEG has demonstrated the ability to provide accurate spatio-temporal maps of neurophysiological function that might serve as an objective measure, thereby improving the clinical process. We believe the MEG systems could fulfill a major need of physicians dealing with mental disorders. Researchers are in the early stages of investigating MEG applications for mental disorders such as schizophrenia and depression. Other researchers are investigating learning and behavioral disorders, such as dyslexia and autism. As yet, no reliable estimates can be made of the number of patients in these categories who might be aided by information provided by our MEG systems.

Marketing Programs

        The currently active market for MEG systems is approximately equally divided into a basic research market and a clinical research market. We promote our products to both markets by attendance and exhibits at medical and scientific meetings. Because of our historically dominant position among MEG researchers, we maintain close contacts with potential customers in the basic research market. In order to promote sales in the clinical research market and to develop the commercial clinical market, our fundamental marketing strategy is to accelerate clinical applications development for our systems by collaborating with and promoting the work of a core group of influential medical centers engaged in medical applications development. We plan to continue implementation of this strategy by (i) encouraging physicians developing applications for our MEG systems to publish their results in professional journals, (ii) participating in key medical meetings to generate interest among targeted medical specialists, (iii) encouraging communication and collaborative projects between research groups working with the MEG systems, (iv) initiating site visits by key customers and (v) co-sponsoring education programs with our customers. We are also actively involved with professional medical societies, such as the American Academy of Neurology, or AAN, in efforts to obtain and extend reimbursement for clinical MEG studies, and involved with patient advocacy groups, such as the Epilepsy Foundation of America and its local affiliates, to increase awareness of the technology and encourage its use.

        We will continue our efforts to seek out new clinical applications for MEG. Scientific publications by our customers in Europe, Japan and the U.S. have reported positive findings suggesting that MEG

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may be useful in the diagnosis and management of a number of neurological, neuropsychiatric and learning disorders. We will devote a significant portion of our available resources in the next year to verify and support such efforts. In addition, we will be expanding our marketing efforts into the neuropsychiatric and learning disorders fields by attending and exhibiting at appropriate medical and scientific meetings.

Distribution

        We have a small direct-sales organization with the specialized skills needed to sell our MEG systems in the U.S. The European and Asian markets are served, respectively, by the our branch office in Aachen, Germany and by the biomedical division of Elekta K.K. in Japan and the Far East excluding the Peoples Republic of China, or PRC. In the PRC, we are represented by Beijing Medi-Therm Instruments, Inc., or BMTI. We entered into the distribution agreement granting Elekta the exclusive rights to market, sell, distribute and service our MEG products in certain regions of Asia and in Australia and New Zealand for an initial period of three years in January 2000. We entered into a distribution agreement granting BMTI exclusive rights to market, sell, distribute and service our MEG products in the PRC in April 2000, valid through September 30, 2002. This agreement automatically renewed for one year and is currently valid until September 30, 2003. In February 2002 we entered into a distribution agreement granting Elekta Instruments, Inc. exclusive distribution rights for our Magnes systems for the neurosurgery market in the U.S. for a period of five years. We continue to explore other possible relationships that would enhance our ability to distribute and sell MEG systems throughout the world. Our revenues from sales in our North American, European and Asian markets are discussed in Note 6 to our financial statements.

Long-Lived Assets

        We have long-lived assets in Europe, as well as North America. Our long-lived assets consist primarily of various fixed assets and patents. Of our $781,000 of long-lived assets $584,000 is related to our former Finnish subsidiary. Additional detail regarding our long-lived assets is provided in Note 6 to our financial statements.

Reimbursement

        Our long-term commercial success in the U.S. is dependent upon obtaining routine approval of reimbursement for clinical MEG procedures by third-party payors. The Centers for Medicare and Medicaid Services, or CMS, formerly known as the Health Care Financing Administration which is responsible for the administration of Medicare, and the AMA that administers the use of CPT codes by most third-party payors, follow similar guidelines for determining whether a specific procedure or health care technology is "reasonable" and "necessary", and therefore reimbursable under Medicare or private insurance coverage. These guidelines generally include consideration of whether (i) the procedure or technology is more or less costly than an alternative already covered by insurance, (ii) the added benefit of the procedure or technology is significant enough to justify the expense, and (iii) the procedure or technology provides significant medical benefits not otherwise available from other procedures or technologies.

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

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

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

        95967 Magnetoencephalography ("MEG"), recording and analysis: for evoked magnetic fields, each additional modality (e.g., sensory, motor, language, or visual cortex localization) (List separately in addition to code for primary procedure).

        These codes were established in the neurology section of the CPT code listing. The reimbursement levels recommended provide for payments to the physician who interprets the study data are currently among the highest in the neurology section. Reimbursement levels are stated in relative value units or RVUs. These units are then assigned a dollar value depending on the specific hospital and location. For an Epilepsy study (95965) the recommended RVU level is 11.39. This RVU level is currently among the highest assigned reimbursement levels in the neurology section. For PSFM two levels were assigned, 5.78 units for the first exam on a patient and 5.07 for subsequent exams for the same patient on the same visit. We believe that these levels will enable an increasing number of referring physicians to utilize MEG.

        In the publication of the CPT codes on November 1, 2001, the reimbursement level to be paid for the use of the equipment, also known as the Technical Component fee, was designated to be carrier based. This means that each insurance carrier will independently assign a payment level. We work with each of our customers and prospects to establish appropriate reimbursement levels with the carriers used by their patients. This has been the method of reimbursement that our customers have been using for up to 8 years and, with our help, have been able to obtain satisfactory levels of reimbursement. We will continue to work with our customers, with the added advantage of have the CPT code available.

        In November 2002, the CMS published the Ambulatory Patient Cost, or APC, codes. APC codes are cost-based codes that set the technical fee that Medicare will pay for ambulatory patients being treated within the hospital. This publication provided for reimbursement levels from $850 to $2,250 for the three different CPT codes that have been established for MEG. This rule went into effect January 1, 2003.

        The CPT codes became available for use starting in January 2002 and the reimbursement levels established by the CMS became available January 1, 2003. They provide the potential basis for the economic operation of MEG installations. Our sales strategies in the U.S. will be continue to focus more on the development of commercially viable sales to clinical users. It is always difficult to predict the adoption rate of a new modality, but with the assignment of CPT codes and higher reimbursement rates we believe that we have a new and powerful sales tool.

        A parallel effort is underway to obtain approval for reimbursement of MEG clinical procedures in Japan, but the timeline for completion of this process is uncertain at this time.

        In Europe, the current MEG customers have concentrated primarily on basic research, and have not actively pursued governmental or private approval for reimbursement of MEG procedures. However, several European institutions are currently investigating mechanisms for obtaining reimbursement for MEG examinations. We are actively cooperating in these initiatives. There is no assurance at this time that these efforts will be successful, nor do we have an accurate estimate of the time frame.

Product Prices and Terms of Sale

        The current prices for our MEG systems range from approximately $1.0-$2.5 million, depending upon system configuration. Standard terms of sale provide for payments of 30-40% of the purchase price upon placement of the order, 40-50% upon shipment and the remaining 20% when installation is completed and final acceptance is obtained from the customer. For European customers who receive their funding from governmental agencies, we are generally required to provide a bank guarantee for

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the amount of the deposit. That guarantee is usually released upon shipment and/or acceptance by the customer. The time between placement of an order and installation typically ranges between six and twelve months. We also enter into special collaboration and sale arrangements with certain medical centers to promote clinical applications development. These standard terms of sale may change to accommodate customer requirements.

Installation, Service and Training

        In the medical device market the ability to provide comprehensive and timely service is a key competitive advantage and is important for establishing customer confidence. Installation and service for the our products in the U.S. and Europe is provided from our San Diego, California headquarters and from our branch office in Aachen, Germany, both of which maintain customer service departments capable of performing sophisticated systems installation and equipment maintenance. Elekta has its own service capabilities in Japan to service MEG systems sold in their distribution areas, and BMTI has its own service capabilities in China to service MEG systems sold in its distribution areas.

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

        Initial customer training in the operation of our MEG systems is provided by our personnel at the customer's site and is included in the selling price of the system. Physician training in interpreting the clinical significance of MEG information is currently provided at our cooperating U.S. clinical sites.

Competition

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

        Additionally, there continues to be significant price competition from our main competitors for the limited number of purchases of whole head systems worldwide. This aggressive competition has and may continue to affect profit margins on sales of our whole head system, the extent of which is not presently determinable.

        Companies we know that currently manufacture an integrated large-array MEG system are CTF Systems Inc., a Canadian company, Yokagawa Electric working in conjunction with Eagle Technologies, both Japanese companies, Shimadzu, a Japanese company, Daikin, a Japanese company and Neuromag, our former Finnish subsidiary.

        Many of our current or potential future competitors have significantly greater financial, manufacturing, distribution and technical resources than our company. Our success will depend upon various factors, including our ability to continue its technological and market development leadership role, and the ability to raise necessary capital for further development and commercialization.

Backlog

        As of September 30, 2002, the aggregate amount of revenue backlog from firm orders for Company products and services was approximately $5,100,000, compared to approximately $9,800,000 as of September 30, 2001, of which we expect to fill approximately $2,900,000 before September 30, 2003. The revenue backlog is composed primarily of orders for two Magnes 3600 WH systems and deferred service revenues on systems accepted before September 30, 2002. The amount of cash yet to be

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generated from backlog at September 30, 2002 is approximately $2,300,000 compared to approximately $2,500,000 as of September 30, 2001. As sales of our systems typically involve transactions of $1 million or more, backlog is expected to fluctuate significantly from year to year depending upon timing of orders received, installations completed and customer acceptances received during the reporting period.

Research and Development

        We have recently funded our product research and development primarily through private sales of stock, and revenues from product sales. We spent $1,370,000, $1,877,000 and $3,052,000, in fiscal years 2002, 2001 and 2000 respectively. The continued reduction in expenditures represents the maturity of the current product offered combined with the delay of the emergence of a clinical, commercial market for MEG. We have been able to shift our research and development focus from system development to support of applications development through incremental improvements in our hardware systems and improvements in our software systems to support both new research activities of our customers and increasing the efficiency of our software for clinical applications.

Manufacturing and Materials

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

        Of the major components of the MEG systems not manufactured by the Company, the host computer and peripherals are widely available standard items. Other major purchased components are constructed in accordance with Company specifications that ensure compatibility with its MEG systems. Three European manufacturers currently supply the MSRs for MEG systems sold in the U.S., Europe and China. A separate Japanese supplier provides MSRs for the Japanese market. We believe we have adequate alternate sources of supply for this major system component from these sources.

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

        We believe our current manufacturing and testing capacity in the U.S. is sufficient to satisfy present demand. In order to achieve our long-term objectives, however, the Company will be required to expand production capabilities, mainly through additional manufacturing personnel and by potentially subcontracting assembly of additional system components. We believe that our control over the development and manufacture of its MEG systems will enable us to modify our devices to address specific needs of anticipated clinical applications without significant dependence upon outside suppliers, manufacturers or providers of technology.

Governmental Regulation; Regulatory Approvals

        We are subject to various regulations of the FDA and California Health Services. In particular, the FDA and California Health Services have promulgated regulations to which we must adhere, including, but not limited to, minimum manufacturing standards, product operating effectiveness and functional safety of our diagnostic products. The FDA regulates marketing of medical devices, requiring pre-market clearance or pre-market approval based upon review of information submitted by us relating to intended product use, labeling, safety and efficacy. The pre-market clearance or approval

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processes are based upon risk class and degree of equivalence to devices already marketed that are proven to be safe and effective.

        Our continued compliance with applicable governmental regulations are assessed by internal audits and by audits of manufacturing operations and procedures conducted by the FDA and California Health Services. These agencies have the authority, among other rights, to limit or stop product shipments and require product recall should a failure to comply with regulations be observed. We have registered with the FDA and California Health Services as a medical device manufacturer. California Health Services has completed an inspection of our facilities and manufacturing processes and has issued us a license that permits it to manufacture, sell and ship the Magnes systems as medical devices for diagnostic purposes. The FDA conducted an audit of us for compliance with federal current Good Manufacturing Practices, or cGMP, regulation requirements in July 1996. We have updated our internal quality systems to be compliant with the current Quality System Regulations, or QSRs, of the FDA. Based on internal audits we believe we are in full compliance with the FDA QSRs. In addition, hawse have been certified as compliant with ISO 9001, an internationally recognized quality system that is compatible with the FDA QSR's and will aid in our ability to ship systems worldwide, especially to the European Union.

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

        Medical devices are placed in one of three classes, depending upon their use or the degree to which they provide functions critical to sustaining life. Class I devices, such as tongue depressors, are subject to general controls, including Quality System Regulations or QSR. Class II devices, to which MEG systems belong, are subject to general performance standards not yet established by regulation. General controls of Class I devices presently apply to Class II devices, because no performance standards have been developed or promulgated by the FDA for Class II devices. Other examples of Class II devices are the ECG and EEG instruments. Class III devices consist of "critical devices," those represented to be life sustaining or life supporting, implanted in the body or presenting potential unreasonable risk of illness or injury. Examples are kidney dialysis systems and cardiac pacemakers. Class I and II devices may be marketed by demonstration of "substantial equivalence" to existing devices via a Section 510(k) pre-market notification, and subsequent FDA clearance to market. Under this process the Magnes I and Magnes II systems have been determined to be substantially equivalent to our prior Model 607 Neuromagnetometer and to EEG. The Magnes 2500 WH system has been found to be substantially equivalent to the Magnes II system. The Magnes 3600 WH system has been found to be substantially equivalent to the Magnes 2500 WH.

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

Patents, Know How and Proprietary Rights

        We rely on proprietary technology and seek to maintain confidentiality of our trade secrets, un-patented proprietary know how and other proprietary information, and seek to obtain patent protection when appropriate. As of September 30, 2002, we held 44 patents in the U.S. of which 26

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pertain to our current whole head system product line. 16 of the 44 patents had counterpart patents issued in certain member countries of the European Patent Organization, in Canada and in Japan. These patents will expire at the earlier of 17 years after the issue date or twenty years after the priority date of record; these dates of expiration vary over the range from 2007 to 2019. As of September 30, 2002 we had filed 2 U.S. patent applications. We have also filed 4 applications with the European Patent Organization for patent protection in Western Europe, 5 applications in Japan and 4 applications in Canada. We anticipate that patents, if issued, will be issued (i) within 2 to 20 months, with respect to the pending patent applications in the U.S. and (ii) within 3 years, with respect to the pending patent applications in Western Europe. We have reserved our priority with respect to receiving patents on our applications in Japan, and are either currently pursuing or may pursue those applications in the future.

        Our patents protect several fundamental aspects of the technology used in our products. Patents have been issued with respect to superconducting devices, ultra-low-noise electronics circuits, biomagnetometer design, biomagnetic signal processing, magnetic shielding techniques, noise suppression methodologies, cryogenic apparatus construction techniques, and system design concepts. Patent applications have been filed with respect to a new process for fabrication of electronic devices using high-temperature superconducting materials, superconducting device designs, magnetic shielding technology, cryogenic refrigeration, ultra-low-noise electronic circuits, patient handling equipment and biomagnetic signal processing and data analysis. We are currently considering additional patent applications covering inventions already made in these and related fields of technology. Rights to certain of our patents associated with the application of so-called high temperature superconductors have been assigned to Magnesensors, Inc., partially owned by us, Quantum Magnetics and certain of our officers. Our President and Chief Executive Officer, D. Scott Buchanan, is also a member of the board of directors of Magnesensors.

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

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

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

Human Resources

        As of December 2, 2002, we employed a total of 30 permanent full-time and part-time employees, 8 of whom hold Ph.D. degrees. There are 21 employees based at our facilities in San Diego, California and 9 in Aachen, Germany. None of our employees are covered by a collective bargaining agreement and we have experienced no work stoppages. We believe our relationships with our employees have been good. The reduction from previous levels is primarily due to the sale of our Finnish subsidiary, which is discussed in Note 2 of our consolidated financial statements.

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Factors That May Affect Future Results

        This annual report on Form 10-K may contain forward-looking statements that involve risks and uncertainties. Such statements include, but are not limited to, statements containing the words "believes", "anticipates", "expects", "estimates", and words of similar import. Our results could differ materially from any forward-looking statements, which reflect management's opinions only as of the date hereof, as a result of factors, such as those more fully described under "Risks and Uncertainties" as well as described in this annual report. We undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements. Readers should carefully review the risk factors set forth below as well as other factors addressed in this report and other documents we file from time to time with the SEC. This caution is made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Risks and Uncertainties

        We face the following risks associated with our business operations:

        If we continue to incur operating losses and negative cash flows from operations, we may be unable to continue our operations.

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

•

$10,038,000 of losses in fiscal 2002,



•

$4,501,000 of losses in fiscal 2001, and



•

$8,127,000 of losses in fiscal 2000

        In the last three years our negative cash flows from operations have been as follows:

•

$2,757,000 in fiscal 2002



•

$4,153,000 in fiscal 2001, and



•

$5,217,000 in fiscal 2000

        Our total assets have also decreased in the last three fiscal years to $8,831,000 in 2002 compared to $21,824,000 and $22,184,000 in 2001 and 2000 respectively. At September 30, 2002, our accumulated deficit was $120,952,000, our shareholders' deficit was $3,281,000 and we had negative working capital of $3,867,000.

Our management and controlling shareholders, which together control a majority of our common stock, may control our operations and make decisions that you do not consider in your best interest.

        Our present directors, executive officers and principal shareholders and their affiliates beneficially own a majority of our outstanding common stock. As a result, if all or some of these shareholders were to act together, they would be able to exercise significant influence over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. Such concentration of ownership may also have the effect of delaying or preventing a change in our control that may be favored by other shareholders.

Our vendors may not continue providing favorable credit terms.

        Due to our liquidity issues, we have extended vendor payments beyond normal credit terms. If our major vendors were to decline further credit or require cash on delivery payments, our financial position, results of operations and cash flows would be adversely impacted.

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Our success is dependent upon our ability to attract and retain qualified scientific and management personnel.

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

        In addition, the loss of the services of Dr. Buchanan, who currently serves as our President, Chief Executive Officer and Principal Financial Officer would have a material adverse effect on our prospects. Currently none of the executive officers of the Company have an employment agreement or contract with us; all are "at-will" and under no specified term arrangements.

If we are unable to satisfy customer performance and service requirements, we may be unable to compete effectively.

        Our success may be limited by our ability to satisfy customer performance requirements for our systems; as well as by our ability to complete, in a timely fashion, product developments and enhancements to satisfy customer requirements. In addition, if we or our distributors are not able to respond in a timely manner to service requirements, our competitiveness may be adversely impacted.

If we are unable to identify additional clinical applications for our MEG systems, there will be no commercially viable markets for our products.

        Currently, there are only a few established diagnostic uses for MEG systems known by the medical industry. A commercial market may never develop for multiple uses of our products. A continued lack of clinical applications and commercial market for our MEG systems will have a material adverse impact on our financial position, results of operations and cash flows.

If discoveries or developments of new technologies occur, our products and technology may become obsolete.

        Our industry is characterized by rapid technological change, which may also impact our commercial success. Competitors may develop products using other technologies or may improve existing products. This competition may reduce the size of the potential market for our products or make them obsolete or non-competitive. Competitors may also develop new or different products using technology or imaging modalities that provide, or are perceived as providing, greater value than the Company's products. Our financial position and results of operations will be materially adversely affected if such competitive developments occur.

If we fail to compete successfully, our revenues and operating results will be adversely affected.

        Historically, our industry has been characterized by ongoing price competition. Our competitors compete with us for the currently limited number of whole head systems being purchased worldwide. The future profitability of our systems may be negatively impacted by this competition.

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

        Our success may be limited by our dependence on our current line of MEG systems. We are currently dependent on sales of our MEG systems to basic research institutions that represent a market of limited size. Our current product line may not fully meet the needs of a commercial clinical market and we may be required to develop additional products directly suited to an emerging set of needs from this market. Our financial results may be materially adversely affected if our current line of MEG

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products does not fully meet the commercial applications that emerge, or we are not able to offer new products in a timely and cost effective manner.

If new government legislation is enacted or unfavorable medical industry trends arise, we may be unable to sell our products and our revenues will suffer.

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

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

        Significant portions of our sales to date have been in foreign markets. Revenues from international sales represented 60% of our revenues of MEG systems for fiscal year ended September 30, 2002 compared to 48% in the same period of 2001. We expect that revenues from international sales will continue to represent a significant portion of our annual revenues. Because we sell in foreign markets, we are exposed to potential risks of increases and decreases in foreign currency exchange rates. Although at September 30, 2002 and 2001 we did not have any open forward exchange contracts, upon occasion, we may enter into forward exchange contracts to partially hedge (or protect) against such foreign currency exchange risks. Fluctuations may reduce the return in U.S. dollars that we actually receive on our sales. Foreign currency risks are discussed in more detail in this report under Part II, Item 7A Quantitative and Qualitative Disclosure About Market Risk.

If our products produce unreliable diagnostic information, it may result in a liability, which would adversely impact our financial condition.

        Although our products are noninvasive and diagnostic in nature, treatment courses based on the information generated by our instruments may be unreliable or result in adverse effects. This possibility exposes us to the risk of product liability claims. While we carry product liability insurance, there is no assurance that such insurance will be adequate, will be available in the future at a level and cost that is appropriate, or available at all, or that a product liability claim would not adversely affect our business prospects, financial position, results of operations and cash flows.

Our stock price is highly volatile and subject to swings based on sales and other market conditions.

        The market prices for securities of companies with newly emerging markets have historically been highly volatile, and their stock price from time to time has experienced significant price and volume fluctuations that are unrelated to the operating performance of such companies. Moreover, our relatively low trading volume increases the likelihood and severity of volume fluctuations, which likely will result in a corresponding increase in the volatility of our common stock price. Factors such as announcements of complex technological innovations or new sales, governmental regulations, developments in patent or other proprietary rights, developments in our relationships with collaborative partners, general market conditions and the timing of decisions by our existing shareholders to sell large positions of our common stock may have a significant effect on the market price of our common stock. Fluctuations in financial performance from period to period, or acceleration of any of our debt by our lenders, also may have a significant impact on the market price of the common stock.

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ITEM 2.    PROPERTIES.

        Our executive offices and manufacturing facilities are located in a 55,000 square foot facility at 9727 Pacific Heights Boulevard, San Diego, California. All U.S. operations are conducted from this facility, which was first occupied in December 1989. We lease this facility pursuant to a five-year lease agreement, which expires in February 2003. The average monthly lease payment over the term of the lease is approximately $62,000. We sublease approximately 4,950 square feet of this facility to two companies, for a net monthly rent of approximately $4,800. We have signed a term sheet with the owners of the property for an additional 5-year term in which the leased space will be reduced to approximately 44,000 square feet and the average monthly lease payment for the first year and over the term of the lease will be approximately $35,200 and $49,500 respectively. We will no long maintain the $4,000 per month sublease as the space occupied is no longer a part of our lease.

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

ITEM 3.    LEGAL PROCEEDINGS.

        We are not involved in any pending litigation which is expected to have a material adverse effect on our business, consolidated financial position and results of operations.

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

        None.

PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.

        Our stock is currently trading on the Nasdaq Over the Counter Bulletin Board, or OTCBB, under the symbol "FDNX.OB". The following table sets forth the range of high and low closing sales prices by quarter for our stock as reported by the OTCBB. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.

        As of December 2, 2002, there were approximately 303 holders of record of our common stock. The reported closing price for our common stock on the OTCBB on December 2, 2002 was $0.06 per share.

        We have never declared or paid dividends on our common stock. We do not anticipate declaring any dividends on our common stock in the foreseeable future and intends to retain future earnings, if

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any, for the development of its business. There are no contractual obligations, preferences or restrictions related to the declaration or distribution of dividends.

        The following table sets forth information as of September 30, 2002 regarding compensation plans under which equity securities of our company are authorized for issuance.

Equity Compensation Plan Information

        See Note 12 to our financial statements for more information regarding our equity compensation plans.

ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA.

        The selected financial data set forth below with respect to our consolidated statements of operations for each of the three years in the period ended September 30, 2002 and with respect to the consolidated balance sheets at September 30, 2002 and 2001, are derived from the audited consolidated financial statements which are included in Part II, Item 8 of this report. The consolidated statement of operations data for the years ended September 30, 1999 and 1998 and the consolidated balance sheet data at September 30, 2000, 1999 and 1998 are derived from audited consolidated financial statements not included in this document. The data set forth below should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this document including, without limitation, Note 2 which discusses our disposition of Neuromag Oy, a wholly-owned subsidiary, subsequent to our fiscal year ended September 30, 2002. Dollars are stated in thousands, except per-share amounts.

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Consolidated Statement of Operations Data:

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

        The following discussion should be read in conjunction with the consolidated financial statements and notes contained in Part II, Item 8 of this report. See "Risks and Uncertainties" regarding factors known to us that could cause reported financial information not to be necessarily indicative of future results.

Overview

        4-D Neuroimaging is engaged primarily in the business of developing, manufacturing and selling innovative medical imaging systems to medical institutions. The MEG systems developed by the Company measure magnetic fields created by the human body for the noninvasive diagnosis of certain medical disorders, primarily in the brain. We are focusing on the use of our technology for potential commercial market applications such as the diagnosis and planning for surgical treatment of epilepsy, and the functional mapping of areas of the brain at risk during surgery. We continue to investigate the potential applications of our technology for neuro-psychiatric disorders of the brain such as schizophrenia, as well as for problems of the heart, spine, and other organs,

        As of December 2002, thirty-three (33) of our MEG systems are installed in medical and research institutions worldwide. Related findings by us, and our collaborators, have been published in more than 200 scientific and medical papers. More than 200 insurance companies have approved reimbursement on a case-by-case basis. The reduction of installed systems from previous years is a result of the sale of our Finnish subsidiary (see Note 2 of the consolidated financial statements).

        Our current Magnes product line consists of the Magnes 2500 WH, the Magnes 3600 WH, and the Magnes 1300 C, pricing for which ranges from approximately $1.0 to $2.5 million, depending on the configuration. Major portions of our sales have been in foreign markets. We have previously priced certain of our European sales in the currency of the country in which the product was sold and the prices of such products in dollars varied as the value of the dollar fluctuated against the quoted foreign currency price. There can be no assurances that currency fluctuations will not reduce the dollar return to us on such sales if made in the future. Although at September 30, 2002, 2001 and 2000, we did not have any open forward exchange contracts we may in the future enter into forward exchange contracts to partially hedge such foreign currency exposure, if appropriate.

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        In October 2002, we sold 100% of our shares in Neuromag Oy to Vaandramolen Holding BV, or VHBV, for $4,000,000. We used $3,694,000 of the proceeds from the sale to fully pay the remaining debt outstanding under a loan from AIG Bank, which had been used to fund our acquisition of Neuromag in December 1999. We had acquired all of the issued and outstanding capital stock, or Shares, of Neuromag Oy pursuant to the terms of a share purchase agreement by and between us and Marconi Medical Systems, Inc., or Marconi. Under the terms of the share purchase agreement, we paid a total of $10 million in cash to Marconi for the purchase of the Shares and agreed to pay between a minimum of $2,500,000 and a maximum of $5,000,000 in royalties to Marconi under an ancillary royalty agreement over the next 8 years and additional consideration dependent upon the occurrence of certain future events. 4-D retains responsibility for the royalty agreement after the sale of Neuromag.

        Similar to us, Neuromag Oy, located in Helsinki, Finland, is engaged in the research, development and manufacturing of MEG systems. We operated Neuromag Oy as a subsidiary. Neuromag Oy developed and sold the Neuromag 122 and the Vectorview. Both whole head systems are designed to evaluate brain function. We sold Neuromag Oy on or about October 21, 2002 (see Note 2 of the consolidated financial statements).

        Since concentrating on the development of its MEG systems, our corporate strategy and commitment of resources have focused on long-term product applications and continued product development. We substantially completed the development of our Magnes 2500 WH system in fiscal 1996 and decreased expenditures in fiscal 1998 and 1999 as part of our restructuring and focus on developing a market for sale of our Magnes 2500 WH system. In fiscal 1999, research and development expenditures increased due to development efforts to enhance the Magnes 2500 WH and efforts to substantially complete the development of the Magnes 3600 WH system, which were successful. In fiscal 2002, 2001 and 2000, we again decreased our expenditures in research and development due to both an increased focus on marketing and sales and our liquidity position.

        We believe that to date the relatively small number of proven medical applications for MEG systems, the lack of routine reimbursement for MEG procedures, and the uncertainty of product acceptance in the U.S. market have limited system sales through fiscal 2002. With the issuance of CPT codes for MEG the clinically acceptance of MEG system should begin to increase. It is not possible to reliably predict the timing and extent of future product sales due to the long sales cycles and the uncertainties in the rate of impact the CPT codes will have on the market. We do not anticipate multiple sales to the same end-user at current sales volumes, and the sale of one MEG system may still have a significant impact on our financial position and results of operations during any reporting period. As a result, quarterly and annual operating performance will continue to fluctuate significantly.

Results of Operations

        The consolidated financial statements and notes thereto which appear in Part II, Item 8 should be read in conjunction with the following review:

Fiscal Years Ended September 30, 2002 and 2001

        Product revenues for fiscal 2002 totaled $9,607,000 as compared to $9,245,000 in fiscal 2001. This increase in product revenues was due primarily to the recognition of revenue for six new systems and one refurbished system in fiscal 2002 compared to six new systems recognized in fiscal 2001. Of the seven systems accepted, six were MEG systems attributable to Neuromag Oy in fiscal 2002.

        Product costs totaled $7,471,000 in fiscal 2002 as compared to $5,919,000 in fiscal 2001, an increase of approximately $1,552,000 from the prior year. Product costs as a percentage of product revenues amounted to 78% in fiscal 2002 as compared to 64% in fiscal 2001. This increase was primarily due to the greater overhead absorption over a greater number of accepted systems in fiscal 2002 as compared to fiscal 2001.

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        Service revenues for fiscal 2002 totaled $1,032,000 as compared to $1,019,000 in fiscal 2001. The increase of 1% is attributable to sale of additional service contracts to our customers. Service costs for fiscal 2002 totaled $1,146,000 as compared to $592,000 in fiscal 2001. This increase in cost was primarily related to the increase in our service expenses and warranty obligations in fiscal 2002 as compared to fiscal 2001 due to costs incurred servicing one system after flood damage as part of the replacement process.

        Research and development expenses totaled $1,370,000 in fiscal 2002 compared to $1,876,000 in fiscal 2001, a decrease of 27%. The decrease in research and development expenses in fiscal 2002 was due to the reduction of research and development personnel and expense associated with certain research programs due to both our increased focus on marketing and sales and our liquidity position. We believe our current hardware product lines fulfill current marketing and sales requirements and do not require significant additional research and development expenditures at this time.

        Marketing and sales expenses amounted to $1,990,000 in fiscal 2002 as compared to $1,988,000 in fiscal 2001. Expenditures remained relatively flat; however, we had begun to shift the focus from the research market to the clinical market, taking advantage of the issuance of CPT codes for MEG during 2002.

        General and administration expenses totaled $2,440,000 in fiscal 2002 as compared to $2,835,000 in fiscal 2001, a decrease of 14%. This decrease was primarily due to a reduction in