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INDEX
PART III

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

Commission File Number: 000-27956

Physiometrix, Inc.
(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code: (978) 670-2422

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

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

Common Stock, $0.001 par value
(Title of class)

        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. Item 1—Yes ý    No o    Item 2—Yes ý    No o

        Indicate by check mark if disclosures 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 value of voting stock held by non-affiliates of the Registrant was approximately $12,349,965 as of February 28, 2005, based upon the average of the high and low prices of the Registrant's Common Stock reported for such date on the NASDAQ SmallCap Market. Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. The determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 28, 2005, the Registrant had outstanding 13,701,366 shares of Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

        Certain information is incorporated into Part III of this report by reference to the Proxy Statement for the Registrant's 2005 annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K.

Physiometrix, Inc.

INDEX

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PART I

Item 1. BUSINESS

Forward Looking Statements

        This Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that involve certain risks and uncertainties. Actual events or results may differ materially from those projected in the forward-looking statements as a result of the factors described herein in the "Risk Factors" and in the documents incorporated herein by reference. These statements typically may be identified by the use of forward-looking words or phrases such as "believe," "expect," "intend," "anticipate," "should," "planned," "estimated," and "potential," among others. All forward-looking statements included in this document are based on our current expectations, and we assume no obligation to update any such forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for such forward-looking statements. In order to comply with the terms of the safe harbor, we note that a variety of factors could cause actual results and experience to differ materially from the anticipated results or other expectations expressed in such forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, and results of our businesses include, but are not limited to, statements concerning (i) business strategy; (ii) products under development; (iii) other products; (iv) marketing and distribution, including statements related to distribution plans and arrangements and future marketing, sales and distribution strategies; (v) research and development; (vi) manufacturing; (vii) competition; (viii) government regulation especially as it relates to Food and Drug Administration ("FDA") approvals; (ix) third-party reimbursement (x) operating and capital requirements: (xi) clinical trials; and (xii) other factors that might be described from time to time in periodic filings with the Securities and Exchange Commission and include those set forth in this Annual Report on Form 10-K as "Risk Factors".

Introduction

        Physiometrix, Inc. (also referred to herein as "Physiometrix," "Company," "we," "us," and "our") designs, develops, manufactures and markets noninvasive, advanced medical products incorporating proprietary materials, electronics technology and software for use in neurological monitoring applications during surgical and diagnostic procedures. We sell our products for use in hospitals, clinics and physicians' offices domestically and internationally. Our current principal product focus is our Patient State Analyzer ("PSA 4000"), an innovative system for monitoring brain activity during anesthesia. The PSA 4000 and disposable PSArray2 and, when introduced, the PSA 5000, are our primary products and most important to our success. We believe that the success of generating revenues as well as raising additional working capital, are the most critical components to our ability to continue as a going concern. Our cash, cash equivalents, and short-term investments, which aggregated $2.6 million as of December 31, 2004, will be sufficient to conduct operations only until the beginning of the third quarter of 2005, at which time, we will be unable to meet our working capital requirements. Our plan for the remainder of 2005 is to raise additional working capital, support the activities of our partner, Baxter Healthcare Corporation ("Baxter"), in the commercialization of the PSA 4000 with the PSArray2, and to launch the PSA 5000. We are aware of one other company with similar products to the PSA 4000. We do not believe we will be at a significant disadvantage in marketing our products against this company.

        Our initial products, which were commercially introduced in 1994, are our e-Net headpiece and disposable HydroDot biosensors, which are based upon our proprietary HydroGel technology, and its custom electronics. These products are packaged as the HydroDot NeuroMonitoring System, which was developed and is sold for brain monitoring applications, such as clinical electroencephalograph ("EEG") procedures. The system is marketed and sold as a safer, lower cost alternative to current

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EEG data collection technology. The system connects and interfaces to the standard input on all conventional EEG instruments currently in use worldwide, yet offers reduced patient setup time, more reliable data readings, and enhanced patient comfort and safety. The sale of these products are not a significant component of our operating plan and we do not consider the expected revenues from the HydroDot NeuroMonitoring System business to be significant to our financial success and liquidity.

        Patient State Analyzer.    The PSA 4000, which received initial 510(k) clearance from the Food and Drug Administration in June 2000, provides a simplified, user-friendly analysis of patient brain activity during surgical procedures involving general anesthesia. Currently, such monitoring conducted by EEG instruments is used only in a small percentage of all such procedures on a worldwide basis. Traditional EEG devices require a neurologist to interpret their data output. As a result, anesthesiologists are reluctant to use EEG monitoring during other surgical procedures, despite the potential benefits offered by brain monitoring, such as improved patient safety, shorter patient recovery times, and lower overall costs per procedure. On February 10, 2004, we received clearance from the FDA for commercial distribution of our PSA 5000 next generation monitor. The PSA 5000 is a new state of the art monitor that is more powerful, cost effective and offers improved ergonomics as compared to the PSA 4000. We anticipate launch of the product in mid 2005 and we will continue our effort to sell the remaining PSA 4000's.

        We have shown in clinical studies that monitoring patients' brain activity during surgery with the PSA 4000 will improve patient safety and lower costs per surgical procedure by better controlling the amount of anesthesia administered during surgeries. This will reduce the amount of post-operative recovery time required, and eliminate the requirement of a neurologist or specialized technologist to interpret EEG results during surgery. We believe that these benefits create the opportunity for the PSA 4000 to become the standard of care during surgical interventions using general anesthesia. We market the PSA 4000 in the United States and Canada through Baxter, our exclusive distributor.

        Since the third quarter of 2000, substantially all of our sales were to Baxter under a distribution agreement, which provides Baxter with exclusive distribution rights to our PSA 4000 in the United States and Canada. The agreement extends through termination and is cancelable by either party upon six months notice. Under the terms of the agreement, as amended in February 2003, if Baxter fails to meet minimum purchase commitments, we have the option to convert their distribution agreement into a non-exclusive relationship for the operating room ("OR") market segment. In 2003 and 2004, Baxter failed to meet minimum purchase requirements, however, we have not enforced our right to change the terms of the agreement, including Baxter's exclusivity rights. We may enter into additional distribution arrangements with other parties, enter into negotiations with Baxter to amend or modify our agreement or elect to enforce this right to change the terms of the existing agreement with Baxter.

        In October 2002, we received 510(k) clearance from the FDA for the PSArray2, a new frontal-only disposable array sensor for use with the PSA 4000 system, and are currently shipping this new sensor to Baxter, our exclusive distributor in the United States and Canada. This new frontal array headpiece is designed to be easier to affix to the head during surgical procedures than our previous headpiece. We believe, based on our market research and feedback, that the availability of this new frontal headpiece has enhanced the attractiveness of the PSA 4000.

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        The table below summarizes the principal products currently offered by us, the markets served by these products and their present development and/or commercialization status:

Industry Overview

        There are more than 40 million surgical interventions performed annually worldwide under general anesthesia according to Frost and Sullivan. This represents a large market opportunity for the PSA 4000. We have developed the PSA 4000 to address this market. Currently, anesthesiologists measure heart, breathing rates, as well as other physiological changes, to monitor the effect of anesthesia on patients. However, the brain, the organ which anesthetic drugs affect the earliest, is generally not directly monitored. Nevertheless, in several types of surgical procedures, including high-risk cardiology and vascular surgical procedures, brain monitoring is recognized by clinicians as particularly important. Routine monitoring of brain functions during surgery can result in earlier detection of abnormalities that, if left undetected, could result in serious surgical and post surgical complications. Such monitoring can also potentially reduce costs and postoperative recovery times by enabling a reduction in the amount of anesthesia used during the surgical procedure, which would enable patients to emerge from the effects of the anesthesia and be ambulatory more quickly following the procedure. In addition, anesthesiologists are typically not familiar with conventionally produced EEG test results, and a neurologist must therefore be on hand to interpret EEG test information. We believe that the availability of a low cost, easy to use monitoring device such as the PSA 4000 could substantially increase brain monitoring during surgical procedures involving general anesthesia.

EEG Market

        An EEG procedure measures neurophysiological activity by measuring the intensity and pattern of electrical signals generated by the brain. Undulations in the recorded electrical signals are called brain waves, and the entire record of electrical rhythms and other electrical activity (ongoing background signals and event related transients) of the brain is an EEG. EEGs are widely used to assist in the diagnosis of epilepsy, brain tumors, physiological disorders and other brain abnormalities. Because the electrical waves produced by an injured or abnormal brain will differ in predictable ways from waves produced by a normal brain, an EEG exam should disclose and help diagnose brain abnormalities and injuries.

        Although EEG based brain monitoring has been performed for over 70 years, it is only recently that medical professionals have begun to recognize the benefits of EEGs as a broad based diagnostic tool. This should be contrasted with the field of cardiac monitoring in which medical professionals have long been aware of the benefits of such monitoring, and have integrated electrocardiogram ("ECG") procedures into both preventive and diagnostic health care. As a result, medical device and instrument companies have concentrated on, and provided improved technology for, the cardiac monitoring market. However, EEG technology has remained virtually unchanged since its inception.

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The Physiometrix Solution

        We believe that the availability of a low-cost, easy to use monitoring device such as the PSA 4000 could substantially increase brain monitoring during surgery and has the potential to become the standard of care in brain monitoring during the administration of general anesthesia. The PSA 4000 was developed to provide patient brain activity during surgical procedures involving general anesthesia. The PSArray2, which attaches to and is used with the PSA 4000, is a disposable frontal headpiece that attaches to a patient's forehead to collect EEG data for analysis by the PSA 4000. During surgical procedures involving general anesthesia, the PSA 4000 will constantly monitor data and alert the anesthesiologists as to a patient's state of consciousness and provide the anesthesiologist with a readout regarding a patient's ideal anesthetized state. We believe that monitoring a patient's brain activity during surgery will improve patient safety and lower costs per surgical procedure by better controlling the amount of anesthesia administered during surgeries.

        On February 10, 2004, we received clearance from the FDA for commercial distribution of our PSA 5000 next generation monitor. The PSA 5000 is a new state of the art monitor that is more powerful, cost effective and offers improved ergonomics as compared to the PSA 4000. We anticipate launch of this product in mid 2005 and we will continue our effort to sell the remaining PSA 4000's.

Current Financial Condition

        Since inception, we have incurred cumulative net losses of approximately $66.0 million, including losses of approximately $6.3 million during 2004. For the year ended December 31, 2004, we used $5.0 million in cash flows from operating activities, and at December 31, 2004 had cash, cash equivalents and short-term investments of approximately $2.6 million.

        Our principal source of liquidity at December 31, 2004 consisted of cash, cash equivalents and short-term investments, which aggregated $2.6 million. We anticipate that our existing cash, cash equivalents, and short-term investments will be sufficient to conduct operations only until the beginning of the third quarter of 2005, at which time we will be unable to meet our working capital requirements. As a result, there is substantial doubt about our ability to continue as a going concern. We plan to raise capital through equity and/or debt issuance when, and if, such capital is available to us. We are engaged in negotiations and discussions with potential sources of new capital, and at this stage, we cannot assure you that we will be able to raise additional capital on acceptable terms, or at all. If additional amounts cannot be raised and we are unable to substantially reduce our expenses, we would suffer material adverse consequences to our business, financial condition and results of operations and would likely be required to seek other alternatives up to and including the sale of our technology, filing for protection under the United States bankruptcy laws or cessation of operations.

Business Strategy

        Our objective is to become the leader in the design, development and commercialization of anesthesia monitoring technology. Key elements of our strategy include the following:

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Design and Develop Innovative, Proprietary Products for the Neurology, Intensive Care Unit and Surgical Markets.  Physiometrix plans to capitalize on the growing recognition among medical professionals of easy to use and reliable methods of brain monitoring. We intend to remain focused on the development and marketing of products for surgery and the intensive care unit including products that are designed to expand the use of neurological monitoring. We have substantial design and development expertise in the neurological monitoring field and will seek to position ourselves at the forefront of innovation in this industry.



•

Diversify Product Offerings to Increase Market Penetration.  We seek to offer a range of products, including hardware and disposable products designed to encourage broader use of EEG

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monitoring. Toward this end, we developed and received FDA 510(k) clearance for the PSArray2, a frontal headpiece for use with the PSA 4000 system in October 2002 and for the PSA 5000 next generation monitor in February 2004. We plan to commercially introduce the PSA 5000 during 2005.

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Broaden Marketing Channels.  We have established a strategic relationship with Baxter for distribution of our PSA 4000 in the United States and Canada. We will seek to secure additional partners for distribution in major markets, principally the U.S., Europe and Japan. We intend to commercially introduce the PSA 5000 through either a direct sales force, which we would build following raising additional capital, or through new distribution partners or both.



•

Outsource Manufacturing to Control Costs.  We outsource many manufacturing processes to qualified contract manufacturers to control costs, maintain quality and reduce capital investment, while retaining control over key proprietary processes for certain components of our products.

Products and Technology

        PSA 4000.    We developed the PSA 4000 for brain monitoring in the operating room and in the intensive care unit. The PSA 4000 uses a single use disposable appliance to record EEG for continuous analysis. The PSA 4000 was designed to extract data known to be sensitive to the functional level of each region of the brain, the adequacy of blood supply and the interaction of each region with neighboring regions on the opposite side of the brain. Based on such measurements, statistical procedures will be used to deliver an analysis of the data into a measurement for monitoring the effects of anesthesia. During intraoperative procedures, the PSA 4000 will constantly monitor data and alert the anesthesiologist as to changes in the patient's state of consciousness. The PSA 4000 will provide the anesthesiologist with a readout regarding the patient's ideal anesthetized state.

        Traditionally, the anesthesiologist has had three objectives:

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put the patient to sleep



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prevent patient response to pain



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ensure that the patient does not move during surgery

        Typically, a combination of drugs is used to accomplish this, including analgesics to block pain, drugs to induce unconsciousness and muscle relaxants to immobilize the patient. However, current anesthesia practice is not always successful. Cases of surgical awareness are reported each year and, while fewer in number, deaths during general anesthesia also occur. Other known issues related to overmedication include nausea and exceptionally long recovery times.

        Brain monitoring with traditional EEG techniques involves lengthy setups, the use of flammable materials, and cumbersome equipment. Traditional EEG devices also require a neurologist to interpret their data output. As a result, anesthesiologists are generally reluctant to use EEG monitoring, despite the potential benefits offered by brain monitoring such as improved patient safety and shorter patient recovery times. Our PSA 4000 provides a simple automated resolution of the difficulties of EEG use and interpretation in the operating room.

        We believe that monitoring a patient's brain activity during surgery will improve patient safety and lower costs per surgical procedure by better controlling the amount of anesthesia administered during surgeries. This will reduce the amount of postoperative recovery time required.

        There is also a market opportunity for the use of awareness monitoring during the administration of sedation to patients in recovery rooms and during certain diagnostic and therapeutic procedures which are performed outside the operating room. We are ready to adapt our technology to any modular monitoring system now in use in operating rooms around the world.

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        The PSA 4000 consists of EEG hardware with a single use disposable sensor and an 8-channel preamplifier input. The PSA 4000 functions include testing electrode impedance, amplifier calibration, EEG collection, quantitative analysis after artifact removal (brain wave abnormalities resulting from external stimulation, eye blinking or muscle movement), display and storage.

        The PSA 4000 represents a revised approach for brain monitoring during surgery. Market acceptance of this product will be dependent upon, among other things, the willingness of physicians, EEG technicians and others to adopt these products. Market acceptance will also be dependent upon our ability to convince potential users of the cost and efficacy advantages of this product. Since commercial introduction of the PSA 4000 in 2000, we have ascertained that the lack of a frontal headpiece for use in capturing signals from the brain has affected market acceptance. Accordingly, we developed and received regulatory approval for such a headpiece. The PSArray2 frontal headpiece, which received FDA 510(k) approval in October 2002, is attached only to the patient's forehead and is therefore easier to attach than our original headpiece. We believe, based on our market research and feedback, that the availability of the PSArray2 frontal headpiece has enhanced the attractiveness of the PSA 4000.

        PSA 5000.    On February 10, 2004, we received clearance from the FDA for commercial distribution of our PSA 5000 next generation monitor. The PSA 5000 is a new state of the art monitor that is more powerful, cost effective and offers improved ergonomics as compared to the PSA 4000. We anticipate launch of the product in mid 2005 and we will continue our effort to sell the remaining PSA 4000's.

Other Products:

        We have several products that we sell including the e-Net and disposable biosensors and related accessories, which provide a small revenue stream to us. We maintain our current customer base and do not actively promote these products. The following is a brief description of these products.

        e-Net.    The e-Net is a headpiece designed to position and hold the HydroDot disposable biosensors symmetrically against the scalp during an EEG study. The e-Net is manufactured from a proprietary elastic material and positions 20 biosensors according to the internationally recognized 10-20 System (defined below) on head sizes varying from 48 to 62 centimeters in circumference. The 10-20 System is a standard, universal methodology for marking and measuring the patient's scalp for electrode placement in EEG procedures.

        HydroDot Disposable Biosensors.    The HydroDot biosensors are disposable and are used in lieu of conventional cup electrodes to acquire EEG signals from a patient. The biosensors are packaged in ready-to-use sealed trays of 24 sensors. Minimal skin preparation and no collodion are required when the sensors are inserted into the sockets on the e-Net.

        HydroSpot.    We developed the HydroSpot biosensor for those technicians who want the benefits of the HydroDot biosensors, but do not wish to use the e-Net because they prefer a procedure setup similar to that used with conventional cup electrodes. The HydroSpot is a hydrogelled disposable biosensor attached to a reusable lead wire and will be offered as an alternative to the conventional cup electrodes typically employed in EEG procedures.

Marketing and Distribution

        We selected Baxter, a major medical products company with substantial experience and capabilities in sales of capital equipment to hospitals, anesthesiologists and other potential users of brain monitoring systems, as our exclusive distribution partner in the United States and Canada for the PSA 4000. We currently intend to increase our sales, marketing and clinical support force to market the PSA 4000 and PSA 5000 in conjunction with Baxter and to secure additional partners for distribution in

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major markets, principally the U.S., Europe and Japan. We may sell and market the PSA 5000, through Baxter, with a direct sales force which we would develop in conjunction with a new financing or through other partners.

        In May 2000, we entered into a distribution arrangement with Baxter for the exclusive distribution of our PSA 4000 in the United States and Canada. The agreement was amended on February 12, 2003. Under the terms of the amended agreement, and in order to maintain exclusivity, Baxter is required to make quarterly minimum purchases under the contract. The contract is cancelable by either party with six months notice.

Research and Development

        Research and development activities are performed by our internal research and development staff, whose activities are augmented by the use of outside consultants for particular projects and areas of specialization. We have retained consultants for hardware and software design and clinical evaluation and development of the PSA 4000 and PSA 5000. Our future research and development efforts are expected to be focused on continued development of the PSA 4000 and PSA 5000 technology and related product enhancements and extensions.

        Research and development expenses for the years ended December 31, 2002, 2003 and 2004 were $2,229,736, $1,567,155 and $1,812,893 respectively, none of which was customer funded.

Manufacturing

        We manufacture our products at our facilities in North Billerica, Massachusetts. Production occurs in approximately 5,000 square feet of space utilizing standard production equipment for most processes and proprietary equipment for several specialized operations. Our production area includes a segregated area where temperature can be controlled and maintained for the production of the HydroDot biosensors. We intend to increase outsourcing of manufacturing to contract manufacturers for certain components in order to reduce cost and capital requirements and improve quality, while retaining control over certain proprietary manufacturing processes.

        We manufacture our products in conformance with FDA's Good Manufacturing Practices (GMPs). We are ISO 13485 certified and Certified Europe (CE)-marked both of which are required for the sale of our products in Europe. Any failure by us to remain in compliance with the GMPs or comply with ISO/European Norm ("EN") standards could have a material adverse effect on our business, financial condition and results of operation.

        We purchase components from various suppliers and rely on single source suppliers for several parts. To date, we have not experienced any significant adverse effects resulting from shortages of components. Delays associated with any future component shortages, particularly as we scale up our manufacturing activities, would have a material adverse effect on our business, financial condition and results of operations. We actively monitor inventory positions of all critical parts and purchase required materials in order to prevent productions delays. This, however, is not a guarantee that shortages will not occur.

        We currently manufacture our PSA 4000 products as well as our HydroDot NeuroMonitoring Systems, and beginning in mid 2005, our PSA 5000 products, in limited quantities. We do not have experience in manufacturing our products in commercial quantities. Manufacturers often encounter difficulties in scaling up production of products, including problems involving production yields, quality control and assurance, component supply and lack of qualified personnel. Difficulties encountered by us in scaling up manufacturing could have a material adverse effect on our business, financial condition and results of operations.

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Competition

        We believe that the primary competitive factors in the market for neurological monitoring devices are the ability to provide products that can improve clinical efficacy, reduce patient setup time, and contribute to improvement of laboratory operating efficiencies. We believe that the innovations we have developed in the field of neurology monitoring can potentially afford us a competitive advantage. There is currently one other company, Aspect Medical, that has a commercial product for brain monitoring during anesthesia similar to the PSA 4000. The PSA 5000, which received FDA 510(k) clearance in February 2004, was developed to be more powerful, cost effective and ergonomic than the PSA 4000.

Patents and Proprietary Rights

        Our policy is to protect our proprietary position by, among other methods, filing United States and foreign patent applications to protect technology, inventions and improvements that are important to our business. The patent positions of medical device companies, including ours, are uncertain and involve complex and evolving legal and factual questions. The coverage sought in a patent application either can be denied or significantly reduced before or after the patent is issued. Consequently, there can be no assurance that any patent applications will result in the issuance of patents, or that our issued or any future patents will provide significant protection or commercial advantage or will not be circumvented by others. Since patent applications are secret for 18 months after filing, or longer if permitted under applicable regulation, in the United States or corresponding applications are published in international countries, and since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain that we were the first to make the inventions covered by each of our pending patent applications or that we were the first to file patent applications for such inventions. There can be no assurance that patents held by or licensed to us or any patents that may be issued as a result of our pending or future patent applications will be of commercial benefit, afford us adequate protection from competing products or technologies or will not be challenged by competitors or others or declared invalid. Also, there can be no assurance that we will have the financial resources to defend our patents from infringement or claims of invalidity.

        In the event a third party has also filed a patent application relating to an invention claimed in one of our patent applications, we may be required to participate in an interference proceeding declared by the United States Patent and Trademark Office ("US PTO") to determine priority of invention, which could result in substantial uncertainties and costs to us, even if the eventual outcome is favorable to us. There can be no assurance that any patents issued to us would be held valid by a court of competent jurisdiction.

        We rely upon trade secret protection for certain unpatented aspects of other proprietary technology. There is no assurance that others will not independently develop or otherwise acquire substantially equivalent proprietary information or techniques, others will not otherwise gain access to our proprietary technology or disclose such technology, or we can meaningfully protect our trade secrets.

        We typically require our employees and consultants to execute appropriate confidentiality and proprietary information agreements upon the commencement of employment or consulting relationship with us. These agreements generally provide that all confidential information developed or made known to the individual by us during the course of the individual's relationship with us, is to be kept confidential and not disclosed to third parties, except in specific circumstances. The agreements generally provide that all inventions conceived by the individual in the course of rendering services to us shall be the exclusive property of ours, however, certain of our agreements with consultants, who typically are employed on a full time basis by academic institutions or hospitals, do not contain assignment of invention provisions. There can be no assurance, however, that these agreements will

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provide meaningful protection or adequate remedies for us in the event of unauthorized use, transfer or disclosure of such information or inventions.

Government Regulation

United States

        Our PSA 4000, PSA 5000, PSArray2, HydroDot NeuroMonitoring System, including its family of e-Nets, and HydroDot biosensors, HydroSpot, and other potential products are and will be regulated in the United States as medical devices by the FDA under the Federal Food, Drug, and Cosmetic Act ("FDC Act") and require premarket clearance or approval by the FDA prior to commercialization. In addition, certain material changes or modifications to medical devices also are subject to FDA review and clearance or approval. Pursuant to the FDC Act, the FDA regulates the research, testing, manufacture, safety, labeling, storage, record keeping, advertising, distribution and production of medical devices in the United States. Noncompliance with applicable requirements can result in warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance or premarket approval for devices, and criminal prosecution. Medical devices are classified into one of three classes, Class I, II or III, on the basis of the controls deemed by FDA to be necessary to reasonably ensure their safety and effectiveness. Class I devices are subject to general controls (e.g., labeling, premarket notification and adherence to Good Manufacturing Practices ("GMP"). Class II devices are subject to general controls and to special controls (e.g., performance standards, postmarket surveillance, patient registries, and FDA guidelines). Generally, Class III devices are those which must receive premarket approval by the FDA to ensure their safety and effectiveness (e.g., life sustaining, life supporting and implantable devices, or new devices which have not been found substantially equivalent to legally marketed devices), and require clinical testing to ensure safety and effectiveness and FDA approval prior to marketing and distribution. The FDA also has the authority to require clinical testing of Class I and Class II devices. A premarket approval ("PMA") application must be filed if the proposed device is not substantially equivalent to a legally marketed predicate device or if it is a Class II device for which the FDA has called for such applications.

        If human clinical trials of a device are required and if the device presents a "significant risk," the manufacturer or the distributor of the device is required to file an investigational device exemption ("IDE") application prior to commencing human clinical trials. The IDE application must be supported by data, typically including the results of animal and, possibly, mechanical testing. If the IDE application is approved by the FDA, human clinical trials may begin at a specific number of investigational sites with a maximum number of patients, as approved by the agency. Sponsors of clinical trials are permitted to sell those devices distributed in the course of the study provided such costs do not exceed recovery of the costs of manufacture, research, development and handling. The clinical trials must be conducted under the auspices of an independent institutional review board ("IRB") established pursuant to FDA regulations.

        Generally, before a new device can be introduced into the market in the United States, the manufacturer or distributor must obtain FDA clearance of a 510(k) notification or approval of a PMA application. If a medical device manufacturer or distributor can establish that a device is "substantially equivalent" to a legally marketed Class I or Class II device, or to a Class II device for which the FDA has not called for a PMA, the manufacturer or distributor may seek clearance from the FDA to market the device by filing a 510(K) notification. The 510(k) notification may need to be supported by appropriate data establishing the claim of substantial equivalence to the satisfaction of the FDA. The FDA recently has been requiring a more rigorous demonstration of substantial equivalence.

        Following submission of the 510(k) notification, the manufacturer or distributor may not place the device into commercial distribution until an order is issued by the FDA. No law or regulation specifies

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the time limit by which the FDA must respond to a 510(k) notification. At this time, the FDA typically responds to the submission of a 510(k) notification within 90 days. An FDA order may declare that the device is substantially equivalent to another legally marketed device and allow the proposed device to be marketed in the United States. The FDA, however, may determine that the proposed device is not substantially equivalent or require further information, including clinical data, to make a determination regarding substantial equivalence. Such determination or request for additional information could delay market introduction of the products that are the subject of the 510(k) notification.

        If a manufacturer or distributor of medical devices cannot establish that a proposed device is substantially equivalent to a legally marketed device, the manufacturer or distributor must seek premarket approval of the proposed device through submission of a PMA application. A PMA application must be supported by extensive data, including preclinical and clinical trial data, as well as extensive literature to prove the safety and effectiveness of the device. Following receipt of a PMA application, if the FDA determines that the application is sufficiently complete to permit a substantive review, the FDA will "file" the application. Under the FDC Act, the FDA has 180 days to review a PMA application, although the review of such an application more often occurs over a protracted time period, and generally takes approximately two years or more from the date of filing to complete.

        The PMA application approval process can be expensive, uncertain and lengthy. A number of devices for which premarket approval has been sought have never been approved for marketing. The review time is often significantly extended by the FDA, which may require more information or clarification of information already provided in the submission. During the review period, an advisory committee likely will be convened to review and evaluate the application and provide recommendations to the FDA as to whether the device should be approved. In addition, the FDA will inspect the manufacturing facility to ensure compliance with the FDA's GMP requirements prior to approval of an application. If granted, the approval of the PMA application may include significant limitations on the indicated uses for which a product may be marketed.

        We received clearance of 510(k) premarket notification from the FDA to market the PSA 4000, PSA 5000, PSArray2, HydroDot NeuroMonitoring System, HydroSpot and Equinox EEG System for EEG monitoring and the EP System for certain external defibrillation applications and Radio Frequency ("RF") return during electrosurgical procedures where a combination of defibrillation and RF return indications is required.

        We are also required to register as a medical device manufacturer with the FDA and state agencies and to list our products with the FDA. As such, we will be inspected by both FDA and state agencies for compliance with the FDA's GMP and other applicable regulations. These regulations require that we manufacture our products and maintain our documents in a prescribed manner with respect to manufacturing, testing and control activities. Further, we are required to comply with various FDA requirements for design, safety, advertising and labeling.

        We are required to provide information to the FDA on death or serious injuries alleged to have been associated with the use of our medical devices, as well as product malfunctions that would likely cause or contribute to death or serious injury if the malfunction were to recur. In addition, the FDA prohibits an approved device from being marketed for unapproved applications. If the FDA believes that a company is not in compliance with the law, it can institute proceedings to detain or seize products, issue a recall, enjoin future violations and assess civil and criminal penalties against the company, its officers and its employees. Failure to comply with the regulatory requirements could have a material adverse effect on our business, financial condition and results of operations.

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        The advertising of most FDA regulated products is subject to both FDA and Federal Trade Commission jurisdiction. We also are subject to regulation by the Occupational Safety and Health Administration and by other governmental entities.

        Regulations regarding the manufacture and sale of our products are subject to change. We cannot predict what impact, if any, such changes might have on our business, financial condition or results of operations.

International

        International sales of our products are subject to the regulatory agency product registration requirements of each country. The regulatory review process varies from country to country. We have obtained necessary regulatory approvals in certain European countries and Canada and will continue to seek approval in Japan in connection with future marketing and sales efforts.

        In connection with future sales in the European market, we implemented policies and procedures which allowed our manufacturing and quality assurance processes to receive ISO13485:1996 certification. These standards for quality operations have been developed to ensure that companies know, on a worldwide basis, the standards of quality to which they will be held. The European Union has promulgated rules which require that medical products receive the CE mark, an international symbol of quality and compliance with applicable European medical device directives. We received our EC certificate for electroencephalograph products to market the PSA 4000 and PSA 5000 in the European community.

Third Party Reimbursement

        In the United States, health care providers, such as hospitals and physicians, that purchase medical devices such as our products, generally rely on third party payors, principally federal Medicare, state Medicaid and private health insurance plans, to reimburse all or part of the cost of therapeutic and diagnostic catheterization procedures. Reimbursement for neurophysiological monitoring procedures performed using devices that have received FDA clearance or approval has generally been available in the United States. We anticipate that in a capitated payment system, such as the Diagnostically Related Group ("DRG") system utilized by Medicare and many managed care systems used by private health care payors, the cost of our products will be incorporated into the overall cost of the procedure and that there will be no separate, additional reimbursement for our products.

        Internationally, future market acceptance of our products may be dependent in part upon the availability of reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country. The main types of health care payment systems in international markets are government sponsored health care and private insurance. There can, however, be no assurance that reimbursement for procedures performed using our products will be available in international markets under either governmental or private reimbursement systems.

        We could be adversely affected by changes in reimbursement policies of governmental or private health care payors, particularly to the extent any such changes affect reimbursement for procedures in which our products are used. Failure by physicians, hospitals and other users of our products to obtain sufficient reimbursement from health care payors for procedures in which our products are used, or adverse changes in governmental and private third party payors' policies toward reimbursement for such procedures, would have a material adverse effect on our business, financial condition and results of operations.

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Product Liability and Insurance

        Our business involves the risk of product liability claims. We have not experienced any product liability claims to date. Although we maintain product liability insurance with coverage limits of $2 million per occurrence and an annual aggregate maximum of $3 million, there can be no assurance that product liability claims will not exceed such insurance coverage limits, which could have a material adverse effect on us, or that such insurance will be available on commercially reasonable terms or at all.

Employees

        As of December 31, 2004, we had 45 full time employees. Of these employees, 10 were engaged in research and development activities, 15 in manufacturing and manufacturing engineering, 7 in quality assurance and regulatory affairs, 7 in sales and marketing, and 6 in general and administrative functions. No employees are covered by collective bargaining agreements, and we believe we maintain good relations with our employees.

General Information

        Physiometrix was incorporated in Delaware in 1996. Our headquarters location and mailing address is 101 Billerica Ave. Bldg 5, N. Billerica, Massachusetts 01862, and the telephone number at that location is (978) 670-2422. Our Common Stock trades on the Nasdaq SmallCap Market under the symbol "PHYX." Our website is located at http://www.physiometrix.com. We make our periodic and current reports that are filed with the Securities and Exchange Commission ("SEC"), including reports on Form 10-K, Form 10-Q and Form 8-K, available, free of charge, on our website as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the SEC. In addition, the public may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington DC 20549. Information about the SEC's Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. All reports and information electronically filed by us with the SEC may also be obtained on the SEC's website located at http://www.sec.gov.

Risk Factors

        You should carefully consider the risks described below before making an investment decision. We believe that the risks and uncertainties described below are the principal material risks facing us as of the date of this Form 10-K. In the future, we may become subject to additional risks that are not currently known to us. If any of the following risks actually occur, our business, financial condition and operating results could be seriously harmed. As a result, the trading price of our common stock could decline, and you could lose all or part of the value of your investment.

        We will need additional funds, and such funds may not be available on commercially reasonable terms when we need them, and as a result, there is substantial doubt about our ability to continue as a going concern.

        We anticipate that our current cash, cash equivalents and short-term investments are adequate to maintain our current and planned operations only until the beginning of the third quarter of 2005, at which time, we will be unable to meet our working capital requirements. As a result, there is substantial doubt about our ability to continue as a going concern. We plan to raise capital through equity and/or debt issuance when, and if, such capital is available to us. There is no assurance, however, that we will be able to raise additional capital on acceptable terms, or at all. If we cannot raise additional capital, we would suffer material adverse consequences to our business, financial condition and results of operations and would likely be required to seek other strategic alternatives up

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to and including the sale of our technology, filing for protection under the United States bankruptcy laws or ceasing operations.

        We plan to continue to expend substantial funds for obtaining regulatory approvals, continuing sales and marketing activities and research and development. We may be required to expend greater than anticipated funds if unforeseen difficulties arise in the course of obtaining necessary regulatory approvals or in other aspects of our business. Our future liquidity and capital requirements will depend upon numerous factors, including actions relating to regulatory matters, and the extent to which the PSA 4000 and PSA 5000 gain market acceptance. Any additional financing, if required, may not be available on satisfactory terms or at all. Future equity financings may result in dilution to the holders of our common stock. Future debt financing may require us to pledge assets and to comply with financial and operational covenants.

        We are dependent upon the PSA 4000, and if we are unable to introduce and successfully commercialize this product, our business will be seriously harmed.

        Our business is completely dependent upon the PSA 4000. If we are unable to achieve widespread market acceptance for the PSA 4000, we will not be able to sustain or grow our business. In this event, our business and operating results would be seriously harmed and our stock price would likely decline.

        During 2001, we began development of the PSArray2, which is a frontal-only disposable array sensor that attaches to and is used with our PSA 4000 consciousness-monitoring system. The PSArray2 was developed in an effort to improve market acceptance of the PSA 4000. We received FDA 510(k) clearance for the PSArray2 in October 2002. The introduction and successful commercialization of this product is critical to our future success. We began shipments of this product to Baxter, our exclusive distribution partner in the U.S. and Canada, during the fourth quarter of 2002. Initial commercialization efforts for this product have only recently begun, and we are not currently able to predict as to when or whether this product will achieve commercial acceptance.

        We are significantly dependent on our distributor, Baxter, for sale of inventories of our principle product, the PSA 4000.

        Our current agreement with Baxter provides Baxter with exclusive distribution rights for the PSA 4000 in the U.S. and Canada, making us significantly dependent upon Baxter for successful commercialization of this product. There is no assurance that this will occur. The agreement extends through termination and is cancelable by either party upon six months notice. Under the terms of the agreement, as amended in February 2003, if Baxter fails to meet minimum purchase commitments, we have the option to convert their distribution agreement into a non-exclusive relationship for the operating room market segment. In 2003 and 2004, Baxter failed to meet minimum purchase requirements, however, we have not enforced our right to change the terms of the agreement, including Baxter's exclusivity rights. We may enter into additional distribution arrangements with other parties, enter into negotiations with Baxter to amend or modify our agreement or elect to enforce this right to change the terms of the existing agreement with Baxter. There can be no assurance that we will obtain a new distribution partner for the PSA 4000 on terms that are mutually acceptable or that Baxter will continue to support the PSA 4000 at current levels, which would cause our business and results of operations to be materially and adversely affected.

        We will not be able to achieve revenue growth or profitability if hospitals and anesthesia service providers do not buy and use the PSA 4000, our current principal product, in sufficient quantities.

        Our revenue growth and prospects will depend on customer acceptance and usage of the PSA 4000. Customers may determine that the cost of the PSA 4000 exceeds cost savings in drugs, personnel and post-anesthesia care recovery resulting from use of the PSA 4000. In addition, hospitals and

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anesthesia providers may not accept the PSA 4000 as an accurate means of assessing a patient's level of consciousness during surgery if patients regain consciousness during surgery while being monitored with the PSA 4000, or if the PSA 4000 is determined not to be a clinically reliable measuring system for other reasons. If hospitals and anesthesia providers do not accept the PSA 4000 as cost-effective, accurate or reliable, they will not buy and use the PSA 4000 in sufficient quantities to enable us to be profitable. In this event, our business, operating results and long-term prospects would be seriously harmed. Our stock price would also likely decline.

        As a result of market feedback, we concluded that we needed to introduce a simpler headpiece for use with the PSA 4000. Therefore, the PSArray2 was developed, and we received FDA 510(k) clearance for the PSArray2 in October 2002. Even with FDA clearance for this headpiece, we cannot assure that introduction of the PSArray2 will improve market acceptance of the PSA 4000 or our results of operations. At this point, we are unable to accurately predict future demand for the PSA 4000, and we cannot assure you that the current economic environment and current product market environment will not continue.

        Our ability to achieve future revenue growth or profitability will be dependent on the successful introduction of our newly developed product, the PSA 5000, and if we are unable to introduce and successfully commercialize this product, our business will be seriously harmed.

        In February 2004, we received clearance from the FDA for commercial distribution of our PSA 5000 next generation monitor. The PSA 5000 is a new state of the art monitor that is more powerful, cost effective and offers improved ergonomics as compared to the PSA 4000. We are currently developing our marketing, sales and distribution strategy for the PSA 5000, and anticipate launch of the product in the middle of 2005. Should we determine that the PSA 5000 can best be marketed through a distribution partner, there can be no assurance that we will be able to obtain a suitable distribution partner for the PSA 5000 on terms that are mutually acceptable. Further, we cannot assure that the introduction of the PSA 5000 will be accepted by customers, perform as anticipated or improve our results of operations or competitive position. As the PSA 5000 has not been released for commercial sale, there is no way to predict commercial viability or future demand of this product.

        We expect to continue to incur losses in the future, and we cannot assure you that we will ever become profitable.

        We have incurred net losses in each year since inception. We expect to continue to incur substantial research and development, sales and marketing and general and administrative expenses in future periods. We will spend these amounts before we receive any incremental revenue from these efforts. Therefore, our losses will be greater than the losses we would incur if we developed our business more slowly. In addition, we may find that these efforts are more expensive than we currently anticipate, which would further increase our losses. Failure to become and remain profitable may depress the market price of our common stock and our ability to raise capital and continue our operations.

        We have a limited operating history that you may use to assess our prospects, and we have no operating experience or history related to the PSA 4000, our current principal product.

        We have a limited history of operations. Since our inception in January 1990, we have been primarily engaged in research and development of neurophysiological monitoring products. To date, we have sold only a relatively small number of units of our HydroDot NeuroMonitoring System and these sales have generated only limited revenues. Furthermore, these products are not central to our core business, which relates to the development and commercialization of the PSA 4000, and in the future, the PSA 5000. We have had limited revenues from commercial sales of the PSA 4000 and have not yet released the PSA 5000 for commercial sale. Accordingly, our historical results of operations may be of

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limited utility in evaluating our future prospects. In addition, we do not have experience in manufacturing, marketing or selling our products in quantities necessary for achieving profitability. Whether we can successfully manage the transition to a larger scale commercial enterprise will depend upon the successful development of our manufacturing capability, the development of our marketing and distribution network, obtaining U.S. FDA and foreign regulatory approvals for future products and other potential products and strengthening our financial and management systems, procedures and controls. With respect to our PSA 4000, and in the future with respect to the PSA 5000, we will need to develop a sales and marketing effort targeted towards anesthesiologists, rather than neurologists to whom we have previously marketed our products. Accordingly, due to the significant change in our business associated with the PSA 4000, our historical financial information is of limited utility in evaluating our future prospects, and we cannot assure that we will be able to achieve or sustain revenue growth or profitability.

        We face intense competition and may not be able to compete effectively, which could harm the market for our products and our operating results.

        We expect to face substantial competition from larger medical device companies that have greater financial, technical, marketing and other resources than we do. As our resources in these areas are extremely limited, any current or potential competitor of ours is likely to have greater resources in these areas. In particular, Aspect Medical markets an anesthesia monitoring system that competes with the PSA 4000. Aspect has received FDA clearance for this system and is marketing it in the U.S and internationally. We may not be able to compete effectively with Aspect or other potential competitors. Other companies may develop anesthesia-monitoring systems that perform better than the PSA 4000 and/or sell for less. Competition in the sale of anesthesia-monitoring systems could result in the inability of the PSA 4000 to achieve market acceptance, price reductions, fewer orders, reduced gross margins and inability to establish or erosion of market share. In addition, the PSA 5000 has not been released for commercial sale and by the time it is released, competition and new or enhanced technologies could result in the inability of the PSA 5000 to achieve market acceptance. Any of these events would harm our business and operating results and cause our stock price to decline.

        We may not be able to keep up with new products or alternative techniques developed by competitors, which could impair our future growth and our ability to compete.

        The medical industry in which we market our products is characterized by rapid product development and technological advances. Our current or planned products are at risk of obsolescence from:

•

new monitoring products, based on new or improved technologies,



•

new products or technologies used on patients or in the operating room during surgery in lieu of monitoring devices,



•

electrical or mechanical interference from new or existing products or technologies,



•

alternative techniques for evaluating the effects of anesthesia,



•

significant changes in the methods of delivering anesthesia, and



•

the development of new anesthetic agents.

        We may not be able to improve our products or develop new products or technologies quickly enough to maintain a competitive position in our markets and continue to grow our business.

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        If we do not successfully develop and introduce new or enhanced products, we could lose revenue opportunities and customers.

        As the market for anesthesia monitoring equipment matures, we need to develop and introduce new products for anesthesia monitoring or other applications. In particular, we are developing versions of the PSA 4000 for use in areas outside the traditional hospital operating room setting and the success of these efforts and acceptance of our products and technology in these additional settings will be critical to our future success. We face at least the following risks:

•

we may not successfully adapt the PSA 4000 to function properly in the intensive care unit, for procedural sedation, when used with anesthetics we have not tested or with patient populations we have not studied, such as infants and young children, and



•

our technology is complex, and we may not be able to develop it further for applications outside anesthesia monitoring.

        In addition, we recently received FDA clearance for our new product, the PSA 5000. The PSA 5000 has not yet been released for commercial sale. Prior to its release, new or enhanced technologies could emerge, resulting in the inability of the PSA 5000 to achieve market acceptance. In addition, there is no assurance the PSA 5000 will perform as anticipated or that customers will accept or demand this technology. Further, we may not be able to successfully adapt the PSA 5000 to other applications.

        If we do not successfully adapt the PSA 4000 and PSA 5000 for new products and applications both within and outside the field of anesthesia monitoring, then we could lose revenue opportunities and customers. In this event, our business and results of operations would be harmed.

        We have experienced significant operating losses to date, and our future operating results could fluctuate significantly.

        We have experienced significant operating losses since inception and as of December 30, 2004, had an accumulated deficit of approximately $66.0 million. The development and commercialization of the PSA 4000 and other new products, if any, will require substantial development, clinical, regulatory and other expenditures. We expect our operating losses to continue for at least the next two years as we continue to expend substantial resources to maintain marketing and sales activities, scale up manufacturing capabilities, continue research and development and support regulatory and reimbursement approvals. Results of operations may fluctuate significantly from quarter to quarter and will depend upon numerous factors, including actions relating to regulatory and reimbursement matters, market acceptance of the PSA 4000, and the future market acceptance of the PSA 5000. In addition, competition, availability of third party reimbursement, implementing a distribution strategy for the PSA 5000 and other factors may affect our future results of operations.

        Our reliance on sole and limited source suppliers could harm our ability to meet customer requirements in a timely manner or within budget.

        Some of the components that are necessary for the assembly of our PSA 4000 are currently provided to us by separate sole suppliers or a limited group of suppliers. We purchase components through purchase orders rather than long-term supply agreements and generally do not maintain large volumes of inventory. We have experienced shortages and delays in obtaining some of the components of our PSA 4000 in the past, and we may experience similar delays or shortages in the future. The disruption or termination of the supply of components could cause a significant increase in the costs of these components, which could affect our profitability. A disruption or termination in the supply of components could also result in our inability to meet demand for our products, which could lead to customer dissatisfaction and damage our reputation. Furthermore, if we are required to change the manufacturer of a key component of the PSA 4000, we may be required to verify that the new

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manufacturer maintains facilities and procedures that comply with quality standards and with all applicable regulations and guidelines. The delays associated with the verification of a new manufacturer could delay our ability to manufacture the PSA 4000 in a timely manner or within budget.

        Our business depends on our intellectual property rights, and measures we take to protect those rights may not be sufficient.

        The success of our business depends, in part, on our ability to obtain patents and maintain adequate protection of our intellectual property for our technologies and products in the U.S. and other countries. The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the U.S., and many companies have encountered significant problems in protecting their proprietary rights in these foreign countries. These problems can be caused by, for example, a lack of rules and processes allowing for a meaningful defense of intellectual property rights. If we do not adequately protect our intellectual property, competitors may be able to practice our technologies and erode our competitive advantage, and our business and operating results could be harmed.

        The patent positions of technology companies, including our patent positions, are often uncertain and involve complex legal and factual questions. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets. We apply for patents covering our technologies and products as we deem appropriate. However, we may not obtain patents on all inventions for which we seek patents, and any patents we obtain may be challenged and may be narrowed in scope or extinguished as a result of such challenges. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. Others may independently develop similar or alternative technologies or design around our patented technologies or products. These companies would then be able to offer research services and develop, manufacture and sell products, which compete directly with our research services and products. In that case, our revenues and operating results would decline.

        In addition to patents, we rely on trade secrets and proprietary know how, which we seek to protect, in part, through appropriate confidentiality and proprietary information agreements. These agreements generally provide that all confidential information developed or made known to the individual by us during the course of the individual's relationship with us, is to be kept confidential and not disclosed to third parties, except in specific circumstances. The agreements generally provide that all inventions conceived by the individual in the course of rendering services to us are our exclusive property. However, some of our agreements with consultants, who typically are employed on a full time basis by academic institutions or hospitals, do not contain assignment of invention provisions. We cannot assure you that proprietary information or confidentiality agreements with employees, consultants and others will not be breached, that we would have adequate remedies for any breach, or that our trade secrets will not otherwise become known to or independently developed by competitors. Disclosure or misuse of our confidential information would harm our competitive position and could cause our revenues and operating results to decline.

        We could become involved in litigation relating to intellectual property rights, and any such litigation, even if resolved favorably to us, will result in significant cost and diversion of management's time and effort.

        The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. We cannot assure you that we will not in the future become subject to patent infringement claims and litigation or interference proceedings declared by the United States Patent and Trademark Office ("US PTO") to determine the priority of inventions. The defense and prosecution of intellectual property suits, US PTO interference

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proceedings and related legal and administrative proceedings are both costly and time consuming. Litigation may be necessary to enforce patents issued to us, to protect trade secrets or know how owned by us or to determine the enforceability, scope and validity of the proprietary rights of others.

        Any litigation or interference proceedings will result in substantial expense to us and significant diversion of effort by our technical and management personnel. An adverse determination in litigation or interference proceedings to which we may become a party could subject us to significant liabilities to third parties or require us to seek licenses from third parties. Costs associated with licensing or similar arrangements that may be involved in statement of intellectual property disputes, including patent disputes, may be substantial and could include ongoing royalties. Furthermore, there can be no assurance that necessary licenses would be available to us on satisfactory terms if at all. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing, marketing and selling our products, which would seriously harm our business and operating results and would likely cause our stock price to decline.

        Our business entails the risk of product liability claims, and these claims could harm our financial condition and our ability to maintain insurance coverage.

        The manufacture and sale of our products expose us to product liability claims and product recalls, including those which may arise from misuse or malfunction of, or design flaws in, our products or use of our products with components or systems not manufactured or sold by us. Product liability claims or product recalls, regardless of their ultimate outcome, could require us to spend significant time and money in litigation or to pay significant damages. We currently maintain insurance; however, it might not cover the costs of any product liability claims made against us. Furthermore, we may not be able to obtain insurance in the future at satisfactory rates or in adequate amounts.

        If we do not attract and retain skilled personnel, we will not be able to expand our business.

        Our products are based on complex technology. Accordingly, we require skilled personnel to develop, manufacture, sell and support our products. In addition, as we move to continue commercialization of our products, we may require additional personnel skilled in the sales and marketing of medical device products. Our future success will depend largely on our ability to continue to hire, train, retain and motivate additional skilled personnel, particularly sales representatives and clinical specialists who are responsible for customer education and training and post-installation customer support. We continue to experience difficulty in recruiting and retaining skilled personnel because the pool of experienced persons is small and we compete for personnel with other companies, many of which have greater resources than we do. Consequently, if we are not able to attract and retain skilled personnel, we will not be able to expand our business.

        Failure of users of the PSA 4000 and PSA 5000 to obtain adequate reimbursement from third party payers could limit market acceptance of the system, which could prevent us from growing our business.

        Anesthesia providers are generally not reimbursed separately for patient monitoring activities, including any such activities that would involve use of the PSA 4000 and PSA 5000. Accordingly, potential users of the PSA 4000 and PSA 5000 may have to justify its use based on the clinical and cost benefits they believe use of the system provides. For hospitals and outpatient surgical centers, when reimbursement is based on charges or costs, patient monitoring with the PSA 4000 and PSA 5000 may reduce reimbursements for surgical procedures, because charges or costs may decline as a result of monitoring with the PSA 4000. Failure by hospitals and other users of the PSA 4000 and PSA 5000 to obtain adequate reimbursement from third-party payers, or any reduction in the reimbursement by third-party payers to hospitals and other users as a result of using the PSA 4000 and PSA 5000 could

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limit market acceptance of the PSA 4000 and PSA 5000, which could prevent us from growing our revenues and our business.

        Our stock price may fluctuate, which may cause your investment in our stock to suffer a decline in value.

        The market price of our common stock has fluctuated significantly in the past and may fluctuate significantly in the future in response to factors which are beyond our control. In addition, the stock market in general has recently experienced extreme price and volume fluctuations. In particular, the market prices of securities of technology and medical device companies have been extremely volatile, and have experienced fluctuations that often have been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations could result in extreme fluctuations in the price of our common stock, which could cause a decline in the value of your shares.

        We may incur significant costs from securities class litigation due to our stock price volatility.

        Our stock price may fluctuate for many reasons, including timing of regulatory actions relating to the PSA 4000 and PSA 5000, variations in our quarterly operating results and changes in market valuations of medical device companies. Recently, when the market price of a stock has been volatile as our stock price may be, holders of that stock have occasionally instituted securities class action litigation against the company that issued the stock. If any of our stockholders were to bring a lawsuit of this type against us, even if the lawsuit is without merit, we could incur substantial costs defending the lawsuit. The lawsuit could also divert the time and attention of our management.

        Our investments could lose market value and consequently harm our ability to fund continuing operations.

        The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including government and corporate obligations and money market funds. These securities are generally classified as available for sale and consequently are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss). The market values of these investments may fluctuate due to market conditions and other conditions over which we have no control. Fluctuations in the market price and valuations of these securities may require us to record losses due to an impairment in the value of the securities underlying our investment. This could result in future charges on our earnings. All securities are held in U.S. currency.

        Investments in both fixed rate and floating rate interest earning instruments carry varying degrees of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates. In general, securities with longer maturities are subject to greater interest rate risk than those with shorter maturities. While floating rate securities generally are subject to less interest rate risk than fixed rate securities, floating rate securities may produce less income than expected if interest rates decrease. Due in part to these factors, our investment income may fall short of expectations or we may suffer losses in principal if securities are sold that have declined in market value due to changes in interest rates.

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        Anti-takeover provisions in our charter documents and under Delaware law could prevent or delay transactions that stockholders may favor.

        Provisions of our restated certificate of incorporation and amended and restated by-laws may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. These provisions include:

•

authorizing the issuance of "blank check" preferred stock without any need for action by stockholders,



•

requiring supermajority stockholder voting to effect certain amendments to our restated certificate of incorporation and amended and restated by-laws,



•

eliminating the ability of stockholders to call special meetings of stockholders,



•

prohibiting stockholder action by written consent, and



•

establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

Item 2. PROPERTIES

        We lease an approximately 16,810 square foot facility in North Billerica, Massachusetts. This facility includes manufacturing, laboratory and office space. The facility is leased through November 14, 2005, at which time we intend to renew our lease, if funds are available to us. We believe these facilities will be adequate to meet our current and reasonably anticipated future requirements.

Item 3. LEGAL PROCEEDINGS

        We are not party to any legal proceedings.

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

        Not applicable.

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PART II

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        Our Common Stock has been traded on the Nasdaq SmallCap Market under the symbol PHYX. During 2001 and through October 29, 2002, our Common Stock was traded on the Nasdaq National Market under the same symbol. The number of record holders of our Common Stock at February 28, 2005 was 70. The number of record owners was determined from our stockholder records maintained by our transfer agent and does not include beneficial owners or our common stock whose shares are held in the names of various security holders, dealers and clearing agencies. We believe that the number of beneficial owners of our common stock held by others as or in nominee names exceeds 2,100 in number. We have not paid any dividends since our inception and do not intend to pay any dividends in the foreseeable future.

        We completed an initial public offering of 2,000,000 shares of Common Stock in April 1996. Prior to the initial public offering, our Common Stock was not publicly traded.

        On February 29, 2000, we closed a private placement of 2,080,340 shares of Common Stock.

        On December 5, 2003, we completed a private placement of 4,957,487 shares of Common Stock for gross proceeds of approximately $8.2 million, and $7.5 million net of cash offering costs. The shares were sold at a price of $1.65 per share, based on the average closing bid prices for the five days ended December 1, 2003. The shares were purchased by a select group of investors. In conjunction with the placement of the shares of Common Stock, we issued to the investors warrants to purchase up to an aggregate of 4,957,488 shares of our Common Stock, fifty percent (50%) of which have an exercise price of $1.82 per share, and fifty percent (50%) of which have an exercise price of $2.48 per share. The net proceeds of this private placement are intended for general corporate purposes, including sales and marketing activities and research and development programs in the areas of neurological monitoring.

        The sale of the shares of Common Stock and the warrants were exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof. A registration statement covering the shares of Common Stock issued, and the shares of Common Stock issuable upon exercise of the warrants, as part of the private placement completed in December 2003 was filed with the Securities Exchange Commission on Form S-3 on December 11, 2003, and declared effective on February 5, 2004. Roth Capital Partners, LLC and Musket Research Associates acted as placement agents for Physiometrix for this private placement. As placement agents for the transaction, Roth Capital Partners, LLC and Musket Research Associates each received warrants to purchase 247,874 shares of our Common Stock, for an aggregate of 495,748 shares, at an exercise price of $1.98 per share.

        Quarterly high and low stock prices are as follows:

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EQUITY COMPENSATION PLAN INFORMATION

        The following table gives information about our common stock that may be issued upon the exercise of options, warrants and rights under all of our existing equity compensation plans as of December 31, 2004, including the 1991 Incentive Stock Plan, the 1996 Director Option Plan, the 2000 Supplemental Stock Plan, and the 2001 Incentive Stock Plan.