FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2002

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1010397

PHYSIOMETRIX, INC.

(Exact name of registrant as specified in its charter)

Delaware		77-0248588
(State or other jurisdiction of incorporation or organization)		(IRS Employer identification No.)

Five Billerica Park, N. Billerica, MA		01862-1256
(Address of principal executive offices)		(Zip code)

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

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

The number of shares outstanding of each of the issuer’s classes of common stock as of

Class		Outstanding at July 31, 2002

Common Stock, $.001 par value		8,422,994

PHYSIOMETRIX, INC.

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION

	ITEM 1	Unaudited Condensed Financial Statements

		Unaudited Condensed Balance Sheets as of December 31, 2001 and June 30, 2002

		Unaudited Condensed Statements of Operations for the Three and Six Months ended June 30, 2001 and 2002

		Unaudited Condensed Statements of Cash Flows for the Six Months ended June 30, 2001 and 2002

		Notes to Unaudited Financial Statements

	ITEM 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations

	ITEM 3	Risk Factors

PART II	OTHER INFORMATION

SIGNATURES

PHYSIOMETRIX, INC.

UNAUDITED CONDENSED BALANCE SHEETS

	December 31 2001			June 30 2002
ASSETS
Current assets:
Cash and cash equivalents	$	2,730,460		$	4,294,465
Short-term investments	7,997,531			2,046,571
Accounts receivable, net	31,780			33,231
Inventories	1,338,674			1,321,721
Prepaid expenses	89,083			226,070
Total current assets	12,187,528			7,922,058

Property, plant and equipment	1,237,877			1,268,470
Less allowances for depreciation.	(715,071		)	(832,487		)
	522,806			435,983
Due from officer	84,000			84,000
Other assets	14,322			14,322

Total assets	$	12,808,656		$	8,456,363

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	325,378		$	73,675
Accrued expenses	1,585,348			870,982
Total current liabilities	1,910,726			944,657

Stockholders’ equity
Preferred stock: $.001 par value; 10,000,000 shares authorized: none issued and outstanding	—			—
Common stock: $.001 par value; 50,000,000 shares authorized: 8,421,952 shares in 2001 and 8,422,994 shares in 2002 issued and outstanding	8,422			8,423
Additional paid-in capital	56,997,319			56,953,809
Deferred compensation	(35,425		)	(9,994		)
Accumulated other comprehensive income	7,055			1,828
Accumulated deficit	(46,079,441		)	(49,442,360		)
Total stockholders’ equity	10,897,930			7,511,706

Total liabilities and stockholders’ equity	$	12,808,656		$	8,456,363

See accompanying notes

PHYSIOMETRIX, INC.

UNAUDITED CONDENSED STATEMENTS OF OPERATIONS

	Three Months Ended June 30						Six Months Ended June 30
	2001			2002			2001			2002

Revenues	$	474,852		$	91,293		$	2,557,941		$	183,600

Costs and expenses:
Cost of products sold	681,984			310,320			2,725,763			537,480
Research and development	997,741			682,998			1,833,751			1,502,215
Selling, general and administrative	1,614,999			791,178			2,605,981			1,582,881
	3,294,724			1,784,496			7,165,495			3,622,576

Operating loss	(2,819,872		)	(1,693,203		)	(4,607,554		)	(3,438,976		)

Interest income	213,987			31,072			535,895			76,057

Net loss	$	(2,605,885	)	$	(1,662,131	)	$	(4,071,659	)	$	(3,362,919	)

Basic and diluted net loss per common share	$	(0.31	)	$	(0.20	)	$	(0.48	)	$	(0.40	)

Shares used in computing basic and diluted net loss per common share	8,420,703			8,422,299			8,419,486			8,422,126

See accompanying notes.

PHYSIOMETRIX, INC.

UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

	Six Months Ended June 30
	2001			2002
Operating activities:
Net loss	$	(4,071,659	)	$	(3,362,919	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	102,288			117,416
Stock-based compensation in connection with issuance of stock options to consultants	17,012			(18,729		)
Changes in operating assets and liabilities:
Accounts receivable	1,304,399			(1,451		)
Inventories	(2,163,406		)	16,953
Prepaid expenses and other assets	94,119			(136,987		)
Accounts payable and accrued expenses	(575,769		)	(966,069		)
Net cash used in operating activities	(5,293,016		)	(4,351,786		)

Investing activities:
Purchase of equipment	(271,059		)	(30,593		)
Purchase of short-term investments	(13,160,052		)	(2,034,888		)
Proceeds from maturity of short-term investments	17,264,640			7,980,621
Net cash provided by investing activities	3,833,529			5,915,140

Financing activities:
Proceeds from issuance of common stock	25,022			651
Net cash provided by financing activities	25,022			651

Net (decrease) increase in cash and cash equivalents	(1,434,465		)	1,564,005
Cash and cash equivalents at beginning of period	3,399,310			2,730,460

Cash and cash equivalents at end of period	$	1,964,845		$	4,294,465

See accompanying notes.

PHYSIOMETRIX, INC.

Notes to Unaudited Condensed Financial Statements

Note A - Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and in accordance with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2002 or any other interim period. The accompanying financial statements should be read in conjunction with the audited financial statements for the period ended December 31, 2001 included in our form 10-K filed with the SEC on March 29, 2002.

Note B - Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment only approach. The adoption of this standard in 2002 did not have any impact on the Company’s financial statements since the Company has not acquired any businesses and, consequently, does not have any goodwill.

In August 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The adoption of this new accounting standard in 2002 did not have any impact on the Company’s financial statements.

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No.144), which the Company adopted in 2002. SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of”, however, retains the fundamental provision of that statement related to the recognition and measurement of the impairment of long-lived assets to be

held and used. In addition, SFAS No. 144 provides additional guidance on estimating cash flows when performing a recoverability test, requiring that a long-lived asset to be disposed of other than by sale be classified as an asset held for sale until it is disposed of, and establishes more restrictive criteria to classify an asset as held for sale. The adoption of this accounting standard did not have any impact on the Company’s financial statements.

Note C - Significant Accounting Policies

Inventories

Inventory is recorded at the lower of cost (first-in, first-out) or market, and consists of the following:

	December 31, 2001		June 30, 2002

Purchased components	$	985,904	$	931,030
Work in process	8,053		26,341
Finished units	344,717		364,350
	$	1,338,674	$	1,321,721

Net Loss Per Share

Basic net loss per share is based on the weighted average common shares outstanding for the three and six months ended June 30, 2001 and 2002. Diluted net loss per common share is the same as basic net loss per common share since the inclusion of common stock equivalents (the effect of stock options) would be anti-dilutive.

Comprehensive Income (Loss)

SFAS No. 130, “Reporting Comprehensive Income”, establishes standards for the reporting and display of comprehensive income (loss) and its components in financial statements. The Company’s accumulated other comprehensive income is comprised primarily of net unrealized gains or losses on available-for-sale securities. Comprehensive loss was as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2001			2002			2001			2002
Net loss	$	(2,605,885	)	$	(1,662,131	)	$	(4,071,659	)	$	(3,662,919	)
Changes in comprehensive loss:
Net unrealized holding gains (losses) on investments	—			1,455			—			(5,227		)
Total comprehensive loss	$	(2,605,885)		$	(1,660,676	)	$	(4,071,659	)	$	(3,668,146	)

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of operations of Physiometrix, Inc. (the “Company”) should be read in conjunction with the Financial Statements and related Notes thereto included elsewhere in this Form 10-Q. This Form 10-Q 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. Actual events or results may differ materially from those projected in the forward-looking statements as a result of the factors described herein and other risks detailed from time to time in the Company’s SEC reports, including its annual report on Form 10-K for the year ended December 31, 2001. Such forward-looking statements include, but are not limited to, statements concerning (i) business strategy; (ii) products under development; (iii) other products; (iv) marketing and distribution; (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 and (xi) clinical trials.

Overview

Since its inception in January 1990, Physiometrix has been engaged primarily in the design and development and more recently the manufacture and sale of noninvasive, advanced medical products. The Company’s products, which incorporate proprietary materials and electronics technology, are used in neurological monitoring applications. The Company’s initial products are its e-Net headpiece and disposable HydroDot biosensors and custom electronics, which are packaged as the HydroDot NeuroMonitoring System. The Company also has an additional neurological monitoring product, the Patient State Analyzer (“PSA 4000”) which received FDA 510(k) approval on June 30, 2000.

Physiometrix has a limited history of operations and has experienced significant operating losses since its inception. As of June 30, 2002, the Company had an accumulated deficit of approximately $49.4 million. The PSA 4000 and the HydroDot NeuroMonitoring System are currently the Company’s principal commercial products. The Company anticipates that its operating results will fluctuate on a quarterly basis for the foreseeable future due to several factors, including actions relating to regulatory and reimbursement matters, the extent to which the Company’s products gain market acceptance, introduction of alternative means for neurophysiological monitoring and competition. Results of operations will also be affected by the progress of clinical trials and in-house development activities, and the extent to which the Company establishes distribution channels for its products domestically and internationally. Since the third quarter of 2000, substantially all of the Company’s sales were to Baxter Healthcare Corporation (Baxter). There can be no assurance the Company will achieve significant commercial revenues or profitability.

In May 2000, the Company entered into a distribution arrangement with Baxter for the exclusive distribution of the Company’s PSA 4000 in the United States. Baxter is required to make quarterly minimum purchases under the contract. The penalty for purchases below minimum requirements is loss of exclusivity. The contract is for five years and is cancelable by

either party eighteen months after the effective date with a six-month notice. The Company began shipments of the PSA 4000 in the third quarter of 2000.

During the fourth quarter of 2000 and first quarter of 2001, shipments exceeded the minimum amounts required to permit Baxter to maintain its exclusive distributorship of the PSA 4000 in the U.S. Since the second quarter of 2001, orders by and, consequently, shipments to Baxter were not sufficient to meet the exclusivity provisions of the distribution agreement. The Company is currently in discussion with Baxter regarding purchase commitments for the future, as well as other amendments to the distribution agreement with Baxter, but no agreement has yet been reached.

During 2001, the Company began development of the PSArray2, which is a new frontal-only disposable array sensor which attaches to and is used with the Company’s PSA 4000 consciousness-monitoring system. The PSArray2 was developed in an effort to improve market acceptance of the PSA 4000. The Company submitted its 510(k) application for the commercial clearance of the PSArray2 on February 28, 2002. On May 31, 2002, Physiometrix received a request for additional information from the FDA related to its 510(k) application, and provided the additional information to the FDA on July 3, 2002. The Company anticipates that the FDA will respond to the additional information within the customary 90 day cycle. The introduction of this product is critical to the future success of the Company. The Company expects to be able to introduce this product in the third quarter of 2002; however, the Company cannot assure you as to when or whether FDA clearance for this product will be obtained. FDA clearance for the PSArray2 is critical to the Company, and the failure to obtain such clearance in a reasonable time frame will materially and adversely affect the Company’s business, financial condition and operating results.

Critical Accounting Policies

In December 2001, the Securities and Exchange Commission requested that all registrants discuss their most “critical accounting policies” in Management’s Discussion and Analysis of Financial Condition and Operations. The Commission indicated that a “critical accounting policy” is one which is both important to the portrayal of the Company’s financial condition and results, and requires management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Management believes the following accounting policies to be critical:

Use of Estimates

The Company prepares its financial statements in accordance with generally accepted accounting principles. These principles require that the Company make estimates and use assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates are made in connection with determining the market value of inventory, if lower than cost, establishing allowances for bad debts and warranty costs, and other accruals. Actual results could differ from those estimates.

Revenue Recognition

The Company recognizes revenue for product sales upon shipment, net of allowances for discounts and estimated returns which are also provided for at the time of shipment in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements.

Results of Operations

Three Months Ended June 30, 2002 and 2001

Revenues

Revenues decreased 81% to $91,000 for the three months ended June 30, 2002 from $475,000 for the three months ended June 30, 2001. This decrease is primarily due to lack of sales of the PSA 4000 during the quarter. The Company did not ship any PSA 4000 units during the period three months ended June 30, 2002 as compared to 90 units shipped during the same period in 2001. The lack of sales was due to Baxter’s decision not to purchase any PSA 4000 units in the second quarter of 2002 due to lower than expected market demand and in anticipation of the commercial release of the PSArray2, a new frontal-only disposable array sensor which attaches to and is used with the Company’s PSA 4000 system. The PSArray2 was developed in an effort to improve market acceptance of the PSA 4000.

The Company submitted its 510(k) application for the commercial clearance of the PSArray2 on February 28, 2002. On May 31, 2002, Physiometrix received a request for additional information from the FDA related to its 510(k) application, and provided the additional information to the FDA on July 3, 2002. The Company anticipates that the FDA will respond to the additional information within the customary 90 day cycle. The introduction of this product is critical to the future success of the Company. The Company expects to be able to introduce this product in the third quarter of 2002; however, the Company cannot assure you as to when or whether FDA clearance for this product will be obtained.

Sales of the Company’s HydroDot NeuroMonitoring products were relatively unchanged compared with the same quarter last year.

Cost of Products Sold

Cost of products sold decreased 54% to $310,000 for the three months ended June 30, 2002 from $682,000 for the three months ended June 30, 2001. This decrease was primarily due to the decrease in the shipments of the PSA 4000.

Gross Margin

The negative gross profit margin during the second quarter of 2002 and 2001 resulted from the fact that costs of the product together with headcount and overhead costs required in the Company’s manufacturing group exceeded the reported revenues. Staff reductions undertaken in April of 2002 will lower expenses in the second half of 2002 and improve gross margin.

Research and Development Expenses

Research and development expenses consisting principally of headcount related expenses, clinical study costs, and consulting fees, decreased 32% to $683,000 for the three months ended June 30, 2002 from $998,000 for the three months ended June 30, 2001. This decrease is primarily due to a decrease in outside consulting costs associated with development of the PSA 4000. Staff reductions and other discretionary expense reductions undertaken in the second quarter of 2002 will lower overall research and development expenses in the second half of 2002.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased 51% to $791,000 for the three months ended June 30, 2002 from $1,615,000 for the three months ended June 30, 2001. This decrease is due to decreased sales and marketing expenses, such as travel, headcount related expenses and outside market research consulting incurred related to the commercialization of the PSA 4000, as well as investment banking fees incurred in 2001.

Interest Income

Interest income decreased to $31,000 for the three months ended June 30, 2002 from $214,000 for the three months ended June 30, 2001. This decrease was due to lower average cash balances available for investment in 2002 along with lower interest rates.

Six Months Ended June 30, 2002 and 2001

Revenues

Revenues decreased 93% to $184,000 for the six months ended June 30, 2002 from $2,558,000 for the six months ended June 30, 2001. This decrease is primarily due to lack of sales of the PSA 4000 during the first half of 2002. The Company did not ship any PSA 4000 units during the six months ended June 30, 2002 as compared to 490 units shipped during the same period in 2001. The lack of sales was due to Baxter’s decision not to purchase any PSA 4000 units in the first half of 2002 due to lower than expected market demand and in anticipation of the commercial release of the PSArray2, a new frontal-only disposable array sensor which attaches to and is used with the Company’s PSA 4000 system. The PSArray2 was developed in an effort to improve market acceptance of the PSA 4000. The Company submitted its 510(k) application for the commercial clearance of the PSArray2 on February 28, 2002. On May 31, 2002, Physiometrix received a request for additional information from the FDA related to its

510(k) application, and provided the additional information to the FDA on July 3, 2002. The Company anticipates that the FDA will respond to the additional information within the customary 90 day cycle. The introduction of this product is critical to the future success of the Company. The Company expects to be able to introduce this product in the third quarter of 2002; however, the Company cannot assure you as to when or whether FDA clearance for this product will be obtained. Sales of the Company’s HydroDot NeuroMonitoring products were relatively unchanged compared with the same period last year.

Cost of Product Sold

Cost of products sold decreased 80% to $537,000 for the six months ended June 30, 2002 from $2,726,000 for the six months ended June 30, 2001. This decrease was primarily due to the decrease in the shipments of the PSA 4000.

Gross Margin

The negative gross profit margin incurred during the six months ended June 30, 2002 and 2001 resulted from the fact that costs of the product incurred together with headcount and overhead costs required in the Company’s manufacturing group exceeded the reported revenues. Staff reductions undertaken in April of 2002 will lower expenses in the second half of 2002 and improve gross margin.

Research and Development Expenses

Research and development expenses, consisting principally of headcount related expenses, clinical study costs and consulting fees, decreased 18% to $1,502,000 for the six months ended June 30, 2002 from $1,834,000 for the six months ended June 30, 2001. This decrease is primarily due to a decrease in outside consulting costs associated with development of the PSA 4000. Staff reductions and other discretionary expense reductions undertaken in the second quarter of 2002 will lower overall research and development expenses in the second half of 2002.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased 39% to $1,583,000 for the six months ended June 30, 2002 from $2,606,000 for the six months ended June 30, 2001. This decrease is due to decreased sales and marketing expenses incurred, such as travel, headcount related expenses and outside market research consulting related to the commercialization of the PSA 4000, as well as investment banking fees incurred in 2001.

Interest Income

Interest income decreased to $76,000 for the six months ended June 30, 2002 from $536,000 for the six months ended June 30, 2001. This decrease was due to lower average cash balances available for investment in 2002 along with lower interest rates.

Liquidity and Capital Resources

At June 30, 2002, the Company’s cash, cash equivalents and short-term investments were $6,341,000 as compared to $10,728,000 at December 31, 2001.

The Company’s operating activities used cash of $4,352,000 in the six months ended June 30, 2002 as compared to $5,293,000 in the six months ended June 30, 2001. The decrease in net cash used in 2002 compared to 2001 was due to the reduced net loss along with decreased inventory purchases, partially offset by a decrease in accounts receivable.

Net cash provided by investing activities in the six months ended June 30, 2002 was $5,915,000, as compared with $3,834,000 provided in the six months ended June 30, 2001. The increase was due to the net proceeds from the sale of short-term investments in the amount of $5,946,000 during the first half of 2002 compared to $4,105,000 during the same period of 2001, coupled with a decrease in equipment purchases in the amount of $240,000.

The Company’s financing activities provided cash of $651 in the six months ended June 30, 2002 as compared to $25,000 of cash provided in the six months ended June 30, 2001. This decrease was due to reduced stock option activity during the first half of 2002.

The Company’s principal source of liquidity at June 30, 2002 consists of cash, cash equivalents and short-term investments in the amount of $6.3 million. The Company believes it has the necessary cash, cash equivalents and short-term investments on hand to fund its operations through at least the next 15 months. The Company has already taken the necessary actions in the first half of 2002 to manage its cash consistent with its operating plan by eliminating staff and specifically identified incremental costs including outside consultants.

The Company has a $1.3 million investment in inventory related to the PSA 4000 system. The sale of this inventory will be subject to conditions that are generally outside the Company’s control. More specifically, the FDA approval of and commercial release of the PSArray2, a new frontal-only disposable array sensor that attaches to and is used with the Company’s PSA 4000 system, will be critical to the sale of the finished units that are currently in inventory. The Company submitted its 510(k) application for the commercial clearance of the PSArray2 on February 28, 2002. On May 31, 2002, the Company received a request for additional information from the FDA related to its 510(k) application, and provided the additional information to the FDA on July 3, 2002. The Company anticipates that the FDA will respond to the additional information within the customary 90-day cycle and expects to introduce the PSArray2 in the third quarter of 2002. The Company does not expect this delay to impact its ability to sell its existing inventory to Baxter at a price in excess of cost and pursue a distributor for rest of world rights. However, there can be no assurance that the Company will obtain FDA approval or when such approval will be obtained.

The Company believes that the success of the PSA 4000 is the most critical component to the Company’s ability to continue as a going concern. The costs to be incurred in 2002 through 510(k) approval are not expected to be in excess of $200,000. If the Company secures regulatory

approval, the Company intends to sell to its existing distributor, Baxter, in North America and pursue a distributor for rest of the world rights.

In the event the regulatory approval is denied, the Company would consider further refinement or development of the PSArray2. Should this event occur, the Company’s liquidity will be negatively impacted, and the Company would need to adjust its expenditures in the remainder of 2002 to conserve working capital.

Although management and the current investors of the Company do not have any intention of liquidating the business, the Company would consider a sale of its technology if, by the end of 2002 or early 2003, its cash constraints would not allow the Company to execute its plan.

The Company is aware of one other company with similar products to the PSA 4000. Such competitor has an FDA-cleared frontal array for its system. In the event the Company is able to obtain FDA clearance for the PSArray2 in a reasonable time frame, the Company believes that it would then not be at a significant disadvantage in marketing its products against this company.

At December 31, 2001, the Company had available net operating loss carryforwards (NOL’s) of approximately $29.7 million available to offset future federal taxable income, if any. These NOL’s expire in varying amounts through 2021. At December 31, 2001, the Company also had research and development tax credit carryforwards of approximately $1,278,000 available to offset future income taxes, if any, which expire in varying amounts through 2021. Since the Company has incurred only losses since its inception, and due to the degree of uncertainty related to the use of the loss and credit carryforwards, the Company has provided a full valuation allowance against these future tax benefits.

ITEM 3. RISK FACTORS

You should carefully consider the risks described below before making an investment decision. 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 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 able to introduce the PSA 4000, we will need to build market acceptance for the system. Because we will depend upon our PSA 4000 for substantially all of our future revenue and we have no other significant products, if we are unable to commence commercial sales of or 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.

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 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 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 they do not consider the PSA 4000 to be a clinically reliable measuring system for other reasons. If extensive or frequent malfunctions occur, these providers may also conclude that the PSA 4000 is unreliable. 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.

During the second, third and fourth quarters of 2001 and first and second quarters of 2002, we experienced a sharp downturn in orders and in end-user demand for the PSA 4000. We believe that this downturn is due in part to economic conditions generally and in the healthcare sector in particular. In addition, marketing programs instituted by one of our competitors have adversely affected our ability to sell PSA 4000 products. More specifically, however, as a result of market feedback, we have concluded that we need to introduce a simpler headpiece for use with the PSA 4000. This frontal-only disposable array sensor (“PSArray2”) has been developed, and we have filed a 510(k) clearance application with the FDA for this headpiece. We cannot assure you as to when or whether FDA clearance for this headpiece will be received. Even if FDA clearance for this headpiece is received, 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 currently 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.

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 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. We have had limited revenues from commercial sales of the PSA 4000. Accordingly, our historical results of operations may be of 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, we will need to develop in collaboration with third parties, 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. 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.

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. 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.

If we do not successfully adapt the PSA 4000 for new products and applications both within and outside the field of anesthesia monitoring, then we could lose revenue opportunities and customers.

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 June 30, 2002 had an accumulated deficit of approximately $49.2 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, including particularly if the PSA 4000 is able to garner market acceptance. In addition, competition, availability of third party reimbursement and other factors may affect our future results of operations.

We may need additional funds, and such funds may not be available on commercially reasonable terms when we need them.

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. Although we believe that our existing cash reserves will be sufficient to meet our operating and capital requirements during at least the next 15 months, we may require additional financing within this time frame. 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 gains 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 financings may require us to pledge assets and to comply with financial and operational covenants.

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 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.

Our ability to compete effectively will depend in part on our ability to develop and maintain proprietary aspects of our technology. We cannot assure you that our issued patents or any patents that may be issued as a result of our U.S. or international patent applications will offer any degree of protection. We cannot assure you that any patents that may be issued to us or any of our patent applications will not be challenged, invalidated or circumvented in the future. In addition, we cannot assure you that competitors, many of which have substantial resources and have made substantial investments in competing technologies, will not seek to apply for and obtain patents that will prevent, limit or interfere with the our ability to make, use or sell our products either in the U.S. or in international markets.

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.

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 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 to obtain adequate reimbursement from third party payors could limit market 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. Accordingly, potential users of the PSA 4000 would 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 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 to obtain adequate reimbursement from third-party payors, or any reduction in the reimbursement by third-party payors to hospitals and other users as a result of using the PSA 4000 could limit market

acceptance of the PSA 4000, 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 addition, 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, 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.

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.

PHYSIOMETRIX, INC.

June 30, 2002

PART II	Other Information

	ITEM 1	Legal Proceedings:
		Not applicable.

	ITEM 2	Changes in Securities:
		Not applicable.

	ITEM 3	Defaults upon Senior Securities:
		Not applicable.

	ITEM 4	Submission of matters to a vote of security holders:

		On May 30, 2002, the Company held its annual meeting of shareholders. The following items were submitted for a vote of the shareholders.

		Election of Thomas Baruch as a Class III director.
		For:	6,410,605
		Against:	0
		Abstain:	23,455

		Election of John A. Williams as a Class III director.
		For:	6,410,605
		Against:	0
		Abstain:	23,455

		Ratification of Ernst & Young as independent auditors for the year ending December 31, 2002.
		For:	6,428,240
		Against:	5,620
		Abstain:	200

	ITEM 5	Other information:
		None.

ITEM 6 Exhibits and reports on Form 8-K:

(a)		Exhibits

99.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. section 1350.

(b)		Reports on Form 8-K - None

June 30, 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		PHYSIOMETRIX, INC.


DATE:	August 12, 2002


		BY:	/s/John A. Williams
			John A. Williams
			President, Chief Executive Officer


		BY:	/s/Daniel W. Muehl
			Daniel W. Muehl
			Vice President and Chief
			Financial Officer
			(Principal Financial and
			Accounting Officer)

Note C - Significant Accounting Policies

Net Loss Per Share

Results of Operations

Three Months Ended June 30, 2002 and 2001

Six Months Ended June 30, 2002 and 2001

PART II

Other Information