10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly period ended May 31, 2005

¨ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             

Commission File No. 0-12240

BIO-LOGIC SYSTEMS CORP.

(Exact Name of Registrant as Specified in its Charter)

Delaware	36-3025678
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)
One Bio-logic Plaza, Mundelein, Illinois	60060
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s Telephone Number, Including Area Code (847-949-5200)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report): not applicable

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at June 24, 2005
Common Stock $.01 par value	6,641,746

TABLE OF CONTENTS

			Page
Part I.	Financial Information
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets at May 31, 2005 (Unaudited) and February 28, 2005	3
		Condensed Consolidated Statements of Operations and Retained Earnings for the three months ended May 31, 2005 and 2004 (Unaudited)	4
		Condensed Consolidated Statements of Cash Flows for the three months ended May 31, 2005 and 2004 (Unaudited)	5
		Notes to Unaudited Condensed Consolidated Financial Statements (Unaudited)	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16
	Item 4.	Controls and Procedures	16
Part II.	Other Information
	Item 1.	Legal Proceedings	16
	Item 6.	Exhibits	17
Signatures			18

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Part 1. Financial Information

Item 1. Financial Statements

Bio-logic Systems Corp.

Condensed Consolidated Balance Sheets

(In Thousands)

	May 31, 2005 (Unaudited)		February 28, 2005
ASSETS
Current Assets:
Cash and cash equivalents	$	14,286	$	14,866
Accounts receivable, net		5,961		6,361
Inventories, net		2,663		2,251
Prepaid expenses		474		244
Deferred income taxes		1,719		1,688
Total current assets		25,103		25,410
Property, Plant and Equipment, Net		2,408		2,432
Intangible Assets, Net		1,938		1,897
Other Assets		121		128
Other Receivables		108		340
Total Assets	$	29,678	$	30,207
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	1,127	$	1,949
Accrued salaries and payroll taxes		1,774		1,476
Accrued interest and other expenses		1,357		1,551
Accrued income taxes		133		318
Deferred revenue		1,165		1,242
Total current liabilities		5,556		6,536
Long-Term Liabilities:
Deferred income taxes		904		877
Long-term liabilities		33		33
Total liabilities		6,493		7,446
Commitments		—		—
Stockholders’ Equity:
Common stock, $.01 par value; authorized, 10,000,000 shares; 6,641,746 issued and outstanding at May 31, 2005; 6,573,625 issued outstanding at February 28, 2005;		66		66
Additional paid-in capital		5,531		5,369
Retained earnings		17,588		17,326
Total stockholders’ equity		23,185		22,761
Total Liabilities and Stockholders’ Equity	$	29,678	$	30,207

The accompanying notes are an integral part of these statements.

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Bio-logic Systems Corp.

Condensed Consolidated Statement of Operations and Retained Earnings

(Unaudited)

(In Thousands, Except Share and Per Share Data)

	Three Months Ended May 31,
	2005		2004
Net Sales	$	6,959	$	6,251
Cost of Sales		2,361		2,059
Gross Profit		4,598		4,192
Operating Expenses:
Selling, general & administrative		3,066		3,048
Research & development		1,267		1,008
Total operating expenses		4,333		4,056
Operating Income		265		136
Other Income		90		24
Income Before Income Taxes		355		160
Provision for Income Taxes		93		46
Net Income	$	262	$	114
Retained Earnings, Beginning of Period		17,326		15,444
Retained Earnings, End of Period	$	17,588	$	15,558
Earnings Per Share:
Basic	$	0.04	$	0.02
Diluted	$	0.04	$	0.02
Average Number of Shares Outstanding:
Basic		6,604,070		6,384,227
Diluted		7,278,669		6,828,465

The accompanying notes are an integral part of these statements.

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Bio-logic Systems Corp.

Condensed Consolidated Statement of Cash Flows

(Unaudited)

(In Thousands)

	Three Months Ended May 31,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	262		$	114
Adjustments to reconcile net income to net cash flows provided by operating activities:
Depreciation and amortization		202			169
Deferred income tax provision		(4	)
(Increases) decreases in assets:
Accounts receivable		400			1,453
Inventories		(412	)		(253	)
Prepaid expenses		(230	)		114
Increases (decreases) in liabilities:
Accounts payable and overdrafts		(822	)		(625	)
Accrued liabilities and deferred revenue		27			53
Accrued income taxes		(185	)		(5	)
Net cash flows provided by (used in) operating activities		(762	)		1,020
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures		(55	)		(73	)
Intangible assets		(164	)		(147	)
Other assets		7			23
Other receivables		232			—
Net cash flows provided by (used in) investing activities		20			(197	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options		162			45
Net cash flows provided by financing activities		162			45
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(580	)		868
CASH AND CASH EQUIVALENTS - Beginning of period		14,866			12,750
CASH AND CASH EQUIVALENTS - End of period	$	14,286		$	13,618
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS:
Cash paid during the period for:
Income taxes	$	283		$	51

The accompanying notes are an integral part of these statements.

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Bio-logic Systems Corp. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

(Unaudited)

These unaudited interim condensed consolidated financial statements of Bio-logic Systems Corp. (the “Company,” “we” or “us”) were prepared under the rules and regulations for reporting on Form 10-Q. Accordingly, we omitted some information and footnote disclosures normally accompanying the annual financial statements. You should read these interim financial statements and notes in conjunction with our audited consolidated financial statements and their notes included in our Annual Report on Form 10-K for the fiscal year ended February 28, 2005, as filed with the Securities and Exchange Commission on June 27, 2005 (the “Annual Report”). In our opinion, the unaudited condensed consolidated financial statements include all adjustments necessary for a fair statement of the results of operations, financial position and cash flows for the interim periods. All adjustments were of a normal recurring nature. Operating results for the three months ended May 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending February 28, 2006. For additional information, refer to the Annual Report.

Consolidation - The consolidated financial statements include the Company and its wholly owned domestic subsidiary, Bio-logic Holding Inc., and its wholly owned foreign subsidiary, Bio-logic Systems Corp., Ltd. All significant intercompany balances and transactions have been eliminated in consolidation.

Cash and Cash Equivalents - Cash equivalents include all highly liquid investments purchased with maturities of three months or less.

Concentration of Credit Risk - The Company maintains cash balances at several financial institutions located predominantly in the United States, as well as in Israel and Poland. The majority of the Company’s investments are in money market accounts in the United States, and are insured by the Federal Deposit Insurance Corporation up to $100,000. Cash in foreign bank accounts is not insured. Uninsured balances in the aggregate were approximately $14,722,000 and $12,895,000 at May 31, 2005 and February 28, 2005, respectively. The Company has not experienced any losses in such accounts and management believes it is not exposed to any significant credit risk on cash and cash equivalents.

Accounts Receivable - The majority of the Company’s accounts receivable are due from companies in the medical and health care industries. Credit is extended based on evaluation of a customer’s financial condition. New customers not affiliated with governments, hospitals or universities are generally subject to a deposit. Accounts receivable are stated at amounts due from customers net of an allowance for doubtful accounts, and are generally due within 30 days for domestic customers and 60 days for international customers. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due and the Company’s previous loss history. The Company writes off accounts receivable when the Company determines that they are uncollectable, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Charges for doubtful accounts are recorded in selling, general and administrative expenses.

Inventories - Inventories consist principally of components, parts and supplies, and are stated at the lower of cost, determined by the first-in, first-out method, or market. Inventories (in thousands) consist of the following:

	May 31, 2005		February 28, 2005
Raw Materials	$	1,870	$	1,587
Work In process		1,139		974
Finished Goods		407		414
Gross Inventory		3,416		2,975
Less Reserves		753		724
Net Inventory	$	2,663	$	2,251

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Property, Plant and Equipment - Property, plant and equipment are stated at cost. The cost of maintenance and repairs is charged to income as incurred, and significant renewals and betterments are capitalized. Depreciation is provided using the straight-line method over the estimated useful lives of the assets, ranging from three years to forty years.

Intangible Assets - Intangible assets consist primarily of capitalized software costs for research and development, as well as certain patent, trademark and license costs. Capitalized software development costs are recorded in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed,” with costs being amortized using the straight-line method over a five-year period. Patent, trademark and license costs are amortized using the straight-line method over their estimated useful lives of five years. On an ongoing basis, management reviews the valuation of intangible assets to determine if there has been impairment by comparing the related assets’ carrying value to the undiscounted estimated future cash flows and/or operating income from related operations.

The following table (in thousands) summarizes the components of gross and net intangible asset balances:

	May 31, 2005							February 28, 2005
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Capitalized Research and Development	$	2,610	$	(786	)	$	1,824	$	2,446	$	(678	)	$	1,768
Patents and Trademarks		182		(113	)		69		182		(106	)		76
Licenses		174		(129	)		45		174		(121	)		53
Total Amortizable Intangible Assets	$	2,966	$	(1,028	)	$	1,938	$	2,802	$	(905	)	$	1,897

Long-Lived Assets - The Company regularly reviews long-lived assets for impairment in accordance with SFAS No. 144, “Accounting for the Impairment of Long-Lived Assets.” No impairment was realized for the three-month periods ended May 31, 2005 and 2004.

Other Assets - Other assets consist mainly of long-term trade receivables. Any required reserves for long-term trade receivables are recorded as part of the allowance for doubtful accounts. There are currently no reserve requirements for long-term receivables.

Revenue Recognition - The Company derives revenue from the sales of electrodiagnostic systems, disposable supplies, extended warranty contracts, non-warranty repair, and governmental research and development contracts. With the exception of domestic customers associated with certain group purchasing contracts, the terms of sale for systems and related supplies are generally FOB shipping point.

Domestically, the Company sells its neurology and sleep systems through a direct sales force, and uses a dealer network to sell its hearing screening and diagnostic systems. Internationally, the entire line of electrodiagnostic systems and supplies is sold through distributors located in various countries. There is no general right for a customer, dealer or distributor to return product. All sales are final, regardless of the distribution channel; returns are rare and are usually allowed due to order error or quality concerns.

The Company recognizes revenue when it is realized or realizable and earned, in accordance with Statement of Position No. 97-2, Software Revenue Recognition; specifically, when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collectability is reasonably assured. Set-up and training revenue related to system sales is not recognized until the service is completed. Revenue from the performance of non-warranty repair activities is recognized in the period in which the work is performed. Revenue from extended warranty contracts is recognized over the life of the warranty. The Company carries a sales reserve that reduces revenue for potential future product returns as well as unperformed set-up and training, and reviews its adequacy quarterly. To date, this reserve has been insignificant.

Revenue from research and development contracts relate to governmental grants awarded by the National Institute of Health. The grants cover reimbursement of specific expenses related to the feasibility and development of projects for which the grants were given, and the Company recognizes revenue in the same period the qualifying

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costs are incurred. The Company’s obligation is to perform these feasibility and development activities in accordance with the terms of the grants, with no obligation for the work to result in a successful outcome such as a new product or successful discovery.

Advertising - Advertising costs are expensed as incurred.

Research and Development Costs - Research and development (R&D) costs are expensed as incurred. Capitalized research and development costs reflect internally generated software development costs associated with bringing new products to market, or significantly adding new features and functions to existing products. Accounting for software development costs is in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to Be Sold, Leased, Or Otherwise Marketed.” Specifically, (a) R&D costs incurred in determining technological feasibility are expensed; (b) all material costs from the point where technological feasibility is determined up to the point when the product is available for general release to customers are capitalized; and (c) capitalization ceases when the developed product is available for general release to customers.

Income Taxes - Deferred tax assets and liabilities are computed annually for differences between the financial statement bases and tax bases of assets and liabilities using enacted tax rates for the years in which the differences are expected to become recoverable. A valuation allowance is established where necessary to reduce deferred tax assets to the amount expected to be realized.

Deferred Federal income taxes are not provided for the undistributed earnings of the Company’s foreign subsidiary. Undistributed foreign earnings were $2,900,936 and $3,044,181 as of May 31, 2005 and February 28, 2005, respectively.

Use of Estimates - In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. Actual results could differ from those estimates.

Fair Value of Financial Instruments - The Company’s financial instruments include cash equivalents, accounts receivable and accounts payable. The carrying value of cash equivalents, accounts receivable and accounts payable approximate their fair value because of the short-term nature of these instruments.

Shipping and Handling Costs - In accordance with Emerging Issues Task Force 00-10, “Accounting for Shipping and Handling Fees and Costs,” the Company has reflected billings to customers for freight and handling as net sales and associated freight-out as cost of sales.

Stock-Based Compensation - The Company maintains a stock incentive plan under which it makes option grants to employees and non-employee directors. The Company accounts for the option grants under this plan under the recognition and measurement principles of Accounting Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. All options granted under the Company’s plan have an exercise price equal to or greater than the market value of the underlying common stock on the date of the grant. No compensation costs are recognized for these stock option grants.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Financial Accounting Standards Board (FASB) SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock-based compensation.

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	Three Months Ended May 31,
	2005			2004
Net income, as reported	$	262		$	114
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(157	)		(168	)
Pro-forma net income	$	105		$	(54	)
Earnings per share:
Basic - as reported	$	0.04		$	0.02
- pro forma	$	0.02		$	(0.01	)
Diluted - as reported	$	0.04		$	0.02
- pro forma	$	0.01		$	(0.01	)

See “Recent Accounting Pronouncements” below for a discussion of SFAS No. 123 (revised 2004), “Share-Based Payment,” which is a revision of SFAS No. 123.

Earnings per Share (EPS) - Basic EPS is based on the weighted average number of shares outstanding during the year. Diluted EPS is based on the combination of weighted average number of shares outstanding and dilutive potential shares.

Comprehensive Income - SFAS No. 130, “Reporting Comprehensive Income,” requires disclosure of the components of and total comprehensive income in the period in which they are recognized in the financial statements. Comprehensive income is defined as the change in equity (net assets) of a business enterprise arising from transactions and other events and circumstances from non-owner sources. It includes all changes in stockholders’ equity during the reporting period, except those resulting from investments by owners and distributions to owners. The Company does not have changes in stockholders’ equity other than those resulting from investments by and distributions to owners. The functional currency for the Company’s international operations is the U.S. dollar.

Product Line, Customer and Geographic Information

Revenue (in thousands) by product line is as follows:

	Three Months Ended May 31,
	2005		2004
Electrodiagnostic products and systems	$	4,592	$	4,405
Supplies, service, and repair		2,367		1,846
Total	$	6,959	$	6,251

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Revenue (in thousands) from customers by geographic area is as follows:

	Three Months Ended May 31,
	2005		2004
United States	$	5,739	$	5,087
Europe and Asia		580		686
All other		640		478
Total	$	6,959	$	6,251

For the fiscal quarters ended May 31, 2005 and 2004, there were no sales to a single customer that accounted for greater than 10% of revenue.

Long-lived assets include fixed assets (property, plant and equipment) and intangible assets. The Company has fixed assets in the United States and overseas. All intangible assets are domiciled in the United States. Long-lived assets in the United States and all foreign countries, in total (in thousands), are as follows:

	Three Months Ended May 31,
	2005		2004
United States	$	4,330	$	3,645
All other		16		40
Total	$	4,346	$	3,685

Contingencies

On April 22, 2004, two plaintiffs filed a product liability claim against us and certain other defendants seeking specific damages of $12,300,000, as well as unspecified damages for future loss of income earning capacity. A brief description of this lawsuit may be found in Part II, Item 1 to this Form 10-Q. The plaintiff’s attorney has informed the Company’s counsel that the Company will be dismissed from this lawsuit.

The Company has an employment agreement with its Chief Executive Officer that will provide salary and other benefits upon his termination, currently amounting to $1,102,000 after the initial term of the agreement, subject to his performing certain non-compete and non-solicitation activities. The initial term of this agreement ends February 29, 2008.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). SFAS 123R supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS 123R is similar to that described in SFAS 123. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure will no longer be allowed. Public companies, other than those filing as small business issuers, will be required to apply SFAS 123R as of the first reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. The Company expects to adopt SFAS 123R in fiscal 2007.

SFAS 123R permits public companies to adopt its requirement using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123R for all share-based payments granted after the effective date and (b) based on the

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requirements of SFAS 123R for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date; or (2) a “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using the intrinsic value method under APB Opinion No. 25, and as such, the Company generally recognizes no compensation cost for employee stock options. The Company intend to continue applying APB Opinion No. 25 to equity-based compensation awards until the first quarter of fiscal 2007. Upon the Company’s adoption of SFAS 123R, the Company expects to use the modified prospective application transition method without restatement of prior interim or annual periods. This will result in the recognition of compensation cost based on the requirements of SFAS 123R for all equity-based compensation awards issued after March 1, 2006. For all equity-based compensation awards that are unvested as of March 1, 2006, compensation cost will be recognized for the unamortized portion of compensation cost not previously included in the SFAS 123 pro forma footnote disclosure. The Company is currently evaluating the impact that adoption of SFAS 123R may have on the Company’s results of operations and financial position. The Company expects that the adoption could have a material effect on the Company’s results of operations, depending on the level and form of future equity-based compensation awards issued, but it should not have a material effect on the Company’s financial position.

Stock Split—On January 7, 2005, the Company’s Board of Directors declared a 3-for-2 stock split on the Company’s Common Stock, to be effected as a 50% stock dividend. The new shares and cash payments in lieu of fractional shares were distributed on February 11, 2005 to stockholders of record on January 26, 2005. The total number of authorized Common Stock shares and associated par value were unchanged by this action. As a result of the split, the Company’s stockholders received one additional share of the Company’s Common Stock for every two shares owned on January 26, 2005. Cash payments in lieu of fractional shares were based on the closing price of the Common Stock on the record date. All per-share amounts in the financial statements reflect the impact of the stock split for all periods presented.

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

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933, that reflect our current expectations about our future results, performance, prospects and opportunities. The forward-looking statements within this Form 10-Q may be identified by words such as “believes,” “anticipates,” “expects,” “intends,” “may,” “would,” “will” and other similar expressions. These words are not, however, the exclusive means of identifying these statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. These forward-looking statements are subject to significant risks, uncertainties, and other factors, including those identified in Exhibit 99.1, “Risk Factors” filed with this Quarterly Report on Form 10-Q, which may cause actual results to differ materially from those expressed in, or implied by, any such forward-looking statements. You should be aware that the risks and uncertainties described herein are not the only ones facing us. Additional risks and uncertainties that we do not yet know of, or that we currently think are immaterial, may also impair our business operations. Except as expressly required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances occurring subsequent to the filing of this Form 10-Q with the SEC or for any other reason. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the SEC that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business.

The following discussion and analysis should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and the Notes to the Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 to this Form 10-Q, and the audited consolidated financial statements and their notes included in our Annual Report on Form 10-K for the fiscal year ended February 28, 2005, as filed with the SEC on May 27, 2005 (the “Annual Report”).

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Overview

We are a medical technology company that designs, manufactures and markets computerized medical electrodiagnostic products and systems, and provides supplies and product services related to those systems. Our systems conduct tests that are typically used by medical practitioners to aid in the diagnosis of certain neurological disorders, brain disorders and tumors, sensory disorders, sleep disorders, and hearing loss, including audiological and hearing screening and diagnosis. Our customers are generally hospitals, clinics, universities and physicians.

Our electrodiagnostic products and systems accounted for approximately 66% of our total net sales in the fiscal quarter ended May 31, 2005, which is slightly lower than our historical contributions of these systems to our total net sales. System sales typically represent capital expenditures on the part of our customers. As the U.S. hearing screening market continues to decline and become a replacement market, with an estimated 95% of the estimated four million newborns now being screened, our product development focus in this area for the future will be on diagnostic products for babies referred for further testing after initial screening. Our M^.A^.S^.T^.E^.R^® diagnostic technology has gained strong acceptance among audiologists for aiding in the determination of appropriate therapies to benefit infants diagnosed with hearing loss. The EEG market for short-term EEG and long-term monitoring is essentially flat, and is marked by significant competition with respect to technology and product features. Our sleep diagnostic products and systems are in a growing market, fueled by the growth and expansion of private and institutional sleep centers. We have experienced some price erosion in our sleep and neurology diagnostic systems as a result of the strong competition in this area. The timing of system sales can be affected by many factors, including features, pricing, order size (especially for neurology system sales to hospitals), customers’ trial periods and approval processes, and the hospital or medical practitioner’s capital availability. These factors can materially impact revenues and earnings from one fiscal quarter or fiscal year to the next.

We are also a full-line supplier of hearing, neurology and sleep disposable and reusable products, with approximately 600 products being offered. Our disposable products are used on systems that are part of our installed customer base as well as on our competitors’ systems. Certain proprietary hearing products, such as the HALO Ear Muffin^™ (the “HALO”) ear coupler and our disposable infant TreeTip^®, continue to be the basis for much of our revenue and profit growth in this area. We experience intense competition related to our Ear Muffin products, which are designed for use on our systems, as well as for use as equivalent products to replace the Natus^® Flexicoupler^® disposables, a competitor’s disposable product.

In addition to the one-year warranty that we provide to our customers when they purchase our electrodiagnostic systems, we offer our customers extended warranties of up to five years. We also generate revenue by servicing and repairing customer systems that are out of warranty, and from governmental research grants.

Critical Accounting Policies and the Use of Estimates

Our “critical accounting policies” are those that require application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain and may change in future periods. They are not intended to be a comprehensive list of all of our significant accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas in which the selection of an available alternative policy would not produce a materially different result. We have identified the following as our critical accounting policies: revenue recognition, inventory valuation and the capitalization of software development costs.

Revenue Recognition

We recognize revenue when it is realized or realizable and earned, in accordance with Statement of Position No. 97-2, “Software Revenue Recognition.” Specifically, we recognize revenue when there is persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. Set-up and training revenue related to system sales is not recognized until the service is completed. With the exception of domestic customers associated with certain group purchasing contracts, the terms of sale for systems and related supplies are generally free-on-board (FOB) shipping point. Revenue from the performance of non-warranty repair activities is recognized in the period in which the work is performed. Revenue from extended warranty contracts is recognized over the life of the warranty. All sales are final; there is no general right for a customer, dealer or distributor to return our products. Any exception regarding product returns requires senior management approval. A small sales reserve exists to cover possible future product returns, as well as unperformed set-up and training.

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We also maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This estimate is based on historical experience, current economic and industry conditions, and the financial condition of our customers. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We review the adequacy of this allowance, and adjust it accordingly, on a quarterly basis. Historically, write-offs have generally been immaterial.

Inventory Valuation

Inventories consist principally of components, parts, supplies, and demonstration equipment, and are valued at the lower of cost or market, and include materials, labor and manufacturing overhead. We write down inventory for estimated obsolescence and for market value impairment equal to the difference between the cost of the inventory and its estimated market value, based on assumptions about future demand and market conditions. We also amortize the cost of demonstration and loaner equipment over three years. If future demands or market conditions were to be less favorable than what was projected, additional inventory write-downs may be required. Due to the proprietary nature of many of our raw materials and components, we generally do not sell excess or obsolete inventory to third parties. Demonstration inventory is sold at a discount, thus generating similar margins to new systems sold.

Capitalization of Software Development Costs

Capitalized software costs for research and development are amortized over a five-year period. On a quarterly basis, management reviews the valuation of these software costs to determine if there has been an impairment to the carrying value of these assets, and adjusts this value accordingly.

Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies relating to fair value of financial instruments, depreciation and income taxes require judgments on complex matters that are often subject to multiple external sources of authoritative guidance such as the Financial Accounting Standards Board and the Securities and Exchange Commission. See the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for a summary of our significant accounting policies.

Dollar amounts in the following discussion are in thousands except for per share amounts.

Results of Operations

Net Sales

Net sales for the three month period ended May 31, 2005 (the “Fiscal 2006 First Quarter”) were $6,959, an 11% increase from $6,251 in the three month period ended May 31, 2004 (the “Fiscal 2005 First Quarter”).

Domestic sales for the Fiscal 2006 First Quarter, which include sales to Canada, were $6,011, or 86% of net sales. This represents a 12% increase from the Fiscal 2005 First Quarter net sales of $5,353, which was also 86% of net sales. Domestic system sales increased 8% in the Fiscal 2006 First Quarter over the Fiscal 2005 First Quarter, led by our Sleepscan^® product line that experienced significant double-digit sales growth due to market acceptance of our VISION sleep monitoring product released in the second quarter of fiscal 2005. Our Ceegraph^® VISION EEG monitoring product line also experienced double-digit growth domestically, but at more moderate levels. Higher system sales of the Sleepscan and Ceegraph VISION EEG product lines were partially offset by declines in the sales of our hearing screening and diagnostic products due to a greater focus on hearing disposable products and a vacancy in the Vice President-Hearing position.

Non-system sales in the Fiscal 2006 First Quarter increased 22% domestically over the Fiscal 2005 First Quarter, primarily due to the acceptance of our HALO transducer introduced in June 2004, and to the increase in our customer base for the HALO product as a result of our customer conversion efforts. Domestic sales of our Ear Muffin^™ products more than doubled in the Fiscal 2006 First Quarter over the Fiscal 2005 First Quarter levels.

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Foreign sales for the Fiscal 2006 First Quarter, representing 14% of the Company’s net sales, increased 6% to $948, from $898 in the Fiscal 2005 First Quarter. Non-system sales provided the growth internationally, again led by higher Ear Muffin and HALO sales, but at a more moderate growth level than was experienced domestically. Foreign non-system sales growth was partially offset by declines in foreign system sales, primarily in the hearing screening and diagnostic areas.

Gross Margin

Gross margin for the Fiscal 2006 First Quarter was 66.1%, a 1.0% decrease from the 67.1% margin for the Fiscal 2005 First Quarter. The decline was primarily due to sales mix changes from our more profitable hearing system lines to our lower margin neurology and sleep product lines. We also experienced margin declines in our non-system areas due to price reductions on certain of our supplies products based on our growth initiatives, and to pricing discounts for certain national accounts. The absence of governmental grant revenue during the Fiscal 2006 First Quarter also contributed to the reduced margins.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses for the Fiscal 2006 First Quarter were $3,066, essentially unchanged from the $3,048 recorded for the Fiscal 2005 First Quarter. Reductions in legal and medical expenses were offset by increases in compensation and consulting expenses. As a percentage of net sales, however, SG&A expenses were 44% for the Fiscal 2006 First Quarter, as compared to 49% for the Fiscal 2005 First Quarter.

During the third quarter of fiscal 2005, our management initiated a review of our internal controls as required by Section 404 of the Sarbanes-Oxley Act of 2002. During the Fiscal 2006 First Quarter, we incurred approximately $35 in consulting services in connection with this review process. Through May 31, 2005 we have incurred approximately $170 in total consulting expenses related to this review.

Research and Development Expenses

Research and development (“R&D”) expenses for the Fiscal 2006 First Quarter were $1,267, compared to $1,008 recorded for the Fiscal 2005 First Quarter. As a percentage of net sales, R&D expense was 18% for the Fiscal 2006 First Quarter compared to 16% for the Fiscal 2005 First Quarter. The increase in R&D expenses reflects our continued commitment to product development domestically and overseas. Capitalized software development costs were approximately the same in both the Fiscal 2006 First Quarter and the Fiscal 2005 First Quarter.

Operating Income

We had operating income in the Fiscal 2006 First Quarter of $265, compared to $136 for the Fiscal 2005 First Quarter. The increase was due primarily to higher gross profit, partially offset by increased R&D expenses.

Other Income

Other income for the Fiscal 2006 First Quarter increased $66 to $90, compared to $24 reported for the Fiscal 2005 First Quarter, driven by increased cash levels and higher interest rates earned on cash deposits.

Income Tax

Income tax expense was $93 and $46 for the Fiscal 2006 First Quarter and the Fiscal 2005 First Quarter, respectively, or 26% and 29%, respectively, of pretax income. The Company’s income tax rate reflects the combination of federal and state effective tax rates, adjusted for the favorable impact of estimated tax credits.

Net Income

Net income for the Fiscal 2006 First Quarter was $262, compared to $114 for the Fiscal 2005 First Quarter. Diluted earnings per share (“EPS”) for the Fiscal 2006 First Quarter was $0.04, compared to $0.02 per diluted share for the Fiscal 2005 First Quarter. The increase in EPS was due to higher pretax income, partially offset by an increase in the number of outstanding shares as a result of stock option exercises. As of May 31, 2005 there were 7,278,669 weighted average diluted shares outstanding.

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Liquidity and Capital Resources

As of May 31, 2005, we had working capital of $19,547, a $673 increase from a working capital balance of $18,874 at February 28, 2005. Total cash and cash equivalents decreased $580, from $14,866 at February 28, 2005 to $14,286 at May 31, 2005.

Cash Flow Related to Operating Activities

Net cash used in operating activities for the three months ended May 31, 2005 was $762, compared to cash provided by operating activities of $1,020 for the three months ended May 31, 2004. The main use of operating cash was related to the payment in the Fiscal 2006 First Quarter of approximately $645 of expenses incurred in fiscal 2005 in connection with the negotiation and preparation for a proposed acquisition that ultimately was not completed, and with increased inventory levels primarily associated with new product releases. This use of cash was partially offset by the collection of receivables associated with our year-end sales effort.

Net inventory at May 31, 2005 was $2,663, a $412 increase from the February 28, 2005 level of $2,251. We have increased inventory in preparation for a new product launch, as well as replenishing inventory consumed during the fourth quarter of fiscal 2005. We manage inventory using a metric of days inventory on hand (DIOH), which relates the dollar amount of ending inventory levels to the amount of cost of sales that it generates. DIOH as of May 31, 2005 was 97 days, up from 86 days as of February 28, 2005.

Our net accounts receivable balance at May 31, 2005 was $5,961, a decrease of $400 from $6,361 at February 28, 2005. This reduction was principally driven by collections of receivables related to strong fiscal 2005 year-end sales. We manage receivables through two key measurements: (1) day sales outstanding (DSO) and (2) the dollar amount of customer account balances over 90 days past due. DSO allows us to analyze changes in our receivables balance as a function of the sales that generated that balance, rather than simply by looking at the dollar change in the account on a standalone basis. We use the exhaustion method to calculate DSO, which assumes that the receivables balance was generated from the most recent sales. Using this method, our DSO at May 31, 2005 was 75 days, a 14-day increase from our DSO of 61 days at February 28, 2005. This increase was associated with the increase in the backlog of pending system installations associated with our high year-end sales. We anticipate that our DSO will return to approximately our fiscal 2005 year end level during the second quarter of fiscal 2006. Our other receivables measurement of past due balances greater than 90 days is indicative of the potential risk to us of the existence of uncollectible accounts that could exist in our receivables balances. At May 31, 2005, our past due receivables balances greater than 90 days increased over 44% from the February 28, 2005 level, again primarily due to the timing of system installations. We feel that our current bad debt reserves are adequate to address any truly questionable receivable balances aged in excess of 90 days, and we expect to be at or below our fiscal 2005 year-end aged receivables levels by the end of the second quarter.

Cash Flow Related to Investing Activities

Net cash flow provided by investing activities for the Fiscal 2006 First Quarter was $20, compared to net cash flows used in investing activities of $197 for the Fiscal 2005 First Quarter. Our Fiscal 2006 First Quarter cash provided by investing activities was primarily due to the collection of a $250 receivable established at the end of fiscal 2005 that resulted from a proposed acquisition that ultimately was not completed in fiscal 2005, partially offset by increases in capitalized software development costs.

Cash Flow Related to Financing Activities

Net cash flow provided by financing activities for the Fiscal 2006 First Quarter were $162 compared to $45 for the Fiscal 2005 First Quarter. The provisions for both of these quarters were generated from stock option exercises.

We believe available cash balances and cash flows from operations will satisfy the liquidity and capital requirements of our current operations for the foreseeable future. As of May 31, 2005, our cash balances of $14,286 represent 49% of our total assets, and we have no interest bearing debt. To the extent our capital and liquidity requirements are not satisfied by available cash balances and cash flows from operations, we have available to us a $1 million unsecured bank line of credit, with an interest rate set at the bank’s prime rate.

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On April 15, 2005 we entered into an agreement to sell approximately 14 acres of vacant, unimproved land adjoining our corporate headquarters to a residential developer. Our sale price for the property is approximately $2,828,500, based on the developer’s receiving approval to build a minimum of 90 attached single-family residences on the property. Our sale price will increase if the developer receives permission to build more than 90 such residences. There are provisions that allow the developer to terminate the agreement if certain events occur. The sale of the land could be consummated as late as October 2006.

From time to time, we explore various corporate finance transactions such as business combinations or acquisitions, certain of which may include the issuance of our securities. However, we have no agreements or commitments with respect to any particular transaction and there can be no assurance that any such transactions would be completed. Given our strong financial position, our bank has indicated its willingness to finance acquisitions through the use of secured and unsecured debt arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our cash and variable-rate short-term cash equivalents are sensitive to changes in interest rates. Interest rate changes would result in a change in interest income. At current investment levels, our results of operations and statement of financial condition would vary by approximately $150,000 for every 100 basis point change in our short-term interest rate. Exchange rate risk is not material for us: the United States dollar is the functional currency for our Israeli operation, virtually all of our sales transactions are denominated in United States dollars, and less than US$25,000 resides in accounts denominated in foreign currency.

Item 4. Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Corporate Controller, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and Corporate Controller concluded that, as of May 31, 2005, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by us in the reports we file under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding disclosure.

Any control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that its objectives will be met. Furthermore, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.

There was not any change in our internal control over financial reporting during the fiscal quarter ended May 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

On April 22, 2004, Marcus L. Forsythe and Elizabeth Forsythe of Multnomah County, Oregon (the “Plaintiffs”) filed a Second Amended Complaint naming the Company as a defendant in a lawsuit against several parties that was filed in the Circuit Court of the State of Oregon for the County of Multnomah. The Plaintiffs allege they suffered damages as a result of auditory brain stem response and other related testing Mr. Forsythe underwent in April 2002 that was allegedly conducted, in part, using the Company’s Navigator Pro product. Plaintiffs seek to recover an aggregate of $12,300,000 in damages from the defendants for physical pain and suffering, emotional distress, the loss of past income and benefits, past and future medical, therapy, medication and household costs, and other foregone benefits, as well as unspecified damages for future loss of income earning capacity. The plaintiff’s attorney has informed the Company’s counsel that the Company will be dismissed from this lawsuit.

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Item 6. Exhibits

(a) Exhibits

31.1 Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) (under Section 302 of the Sarbanes-Oxley Act of 2002).

31.2 Certification of Principal Financial Officer pursuant to Exchange Act Rule 13-14(a) (under Section 302 of the Sarbanes-Oxley Act of 2002).

32.1 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.1 Risk Factors

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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.

Date: July 12, 2005	By:	/s/    Gabriel Raviv
		Gabriel Raviv,
		Chairman and Chief Executive Officer
		(principal executive officer)
Date: July 12, 2005	By:	/s/    Michael J. Hanley
		Michael J. Hanley
		Corporate Controller
		(principal financial and accounting officer)

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EX-31.1

EXHIBIT 31.1

CERTIFICATIONS

I, Gabriel Raviv, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Bio-logic Systems Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date: July 12, 2005

/s/    Gabriel Raviv

Gabriel Raviv

Chief Executive Officer

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EX-31.2

EXHIBIT 31.2

CERTIFICATIONS

I, Michael J. Hanley, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Bio-logic Systems Corp.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls over financial reporting.

Date: July 12, 2005

/s/    Michael J. Hanley

Michael J. Hanley

Corporate Controller

(principal financial and accounting officer)

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EX-32.1

EXHIBIT 32.1

CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q of Bio-logic Systems Corp. (the “Company”) for the quarterly period ended May 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gabriel Raviv, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date: July 12, 2005

/s/    Gabriel Raviv

Gabriel Raviv

Chief Executive Officer

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EX-32.2

EXHIBIT 32.2

CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q of Bio-logic Systems Corp. (the “Company”) for the quarterly period ended May 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael J. Hanley, Corporate Controller of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, that:

1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

Date: July 12, 2005

/s/    Michael J. Hanley

Michael J. Hanley

Corporate Controller

(principal financial and accounting officer)

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EX-99.1

EXHIBIT 99.1

RISK FACTORS

Risks Related to Our Business

We face aggressive competition in many areas of our business, and our business will be harmed if we fail to compete effectively.

We encounter aggressive competition from numerous companies in many areas of our business. Although we believe that our products currently compete favorably, we cannot give assurance that we can maintain our competitive position against our current and potential competitors. Many of our current and potential competitors have longer operating histories, greater name recognition and greater financial, technical and marketing resources than we have, and we may not be able to compete effectively with them. To remain competitive, we must develop new products and periodically enhance our existing products. We anticipate that we may have to adjust the prices of many of our products to stay competitive. In addition, new competitors may emerge and entire product lines may be threatened by new technologies or market trends that reduce the value of our product lines.

Demand for some of our products depends on the capital spending policies of our customers. Changes in these policies could negatively affect our business.

A majority of our customers are hospitals, physician offices and clinics. Many factors, including public policy spending provisions, available resources and economic cycles have a significant effect on the capital spending policies of these entities. These factors can have a significant effect on the demand for our products.

Our sales efforts through group purchasing organizations and sales to high volume purchasers may reduce our average selling prices, which could reduce our revenue and gross profit from these sales.

We have entered, and may in the future enter, into agreements with customers who purchase high volumes of our products. Our agreements with these customers may contain discounts off of our normal selling prices and other special pricing considerations, which could cause our revenue and profit margins to decline. In addition, we have entered into agreements to sell our products to members of group purchasing organizations, which negotiate volume purchase prices for medical devices and supplies for member hospitals, group practices and other clinics. While we make sales directly to group purchasing organization members, the members of these organizations now receive volume discounts off of our normal selling price and may receive other special pricing considerations from us from time to time. Our sales efforts through group purchasing organizations may conflict with our direct sales efforts to our existing customers. If we enter into agreements with new group purchasing organizations and some of our existing customers begin purchasing our products through those group purchasing organizations, our revenue and profit margins could decline.

The complexity presented by international operations could negatively affect our business.

International revenues account for a material portion of our revenues. International revenues (excluding Canada) from continuing operations, accounted for approximately 14% of our total revenues for the three month periods ended May 31, 2005 and 2004. While we plan to continue expanding our presence in international markets, our international operations present a number of risks, including the following:

• Foreign laws may limit our ability to properly maintain our distribution channels. For example, a number of foreign laws restrict our ability to terminate a distributor for taking actions that adversely affect our business, such as manufacturing and selling competing products.

• Fluctuations in currency exchange rates have, on occasion, forced us to lower our prices, thereby reducing margins for some of our products.

• If we fail to obtain and maintain necessary foreign regulatory approvals in order to market and sell our products outside of the U.S., we may not be able to sell our products in other countries.

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• Because we rely on distributors to sell our products outside of the U.S., our revenues could decline if our existing distributors reduce the volume of purchases from us, or if our relationship with any of these distributors is terminated.

Other risks that could affect our international business include:

• The impact of possible recessions in economies outside the U.S.

• Political and economic instability, including instability related to war and terrorist attacks in the U.S. and abroad.

• Decreased health care spending by foreign governments that would reduce international demand for our products.

• Greater difficulty in accounts receivable collection and longer collection periods.

• Reduced acceptance of our products and systems due to lack of appropriate language translations.

• Reduced protection for intellectual property rights in some countries and potentially conflicting intellectual property rights of third parties under the laws of various foreign jurisdictions.

• A strengthening of the dollar that could make our products less competitive in foreign markets, because our sales contracts call for payment in U.S. dollars.

Our operating results could suffer if future changes in technology or market conditions result in adjustments to our recorded asset balance for intangible assets.

We currently carry approximately $1.9 million of net intangible assets on our books, the most significant of which relates to internally developed software development costs. The determination of related estimated useful lives and whether these assets are impaired involves significant judgments. Due to the highly competitive nature of the medical device industry, new technologies could impair the value of our intangible assets if they create market conditions where our products are no longer competitive.

Our operating results may decline if we do not succeed in developing, acquiring and marketing additional products or improving our existing products.

The development and acquisition of additional products and technologies, and the improvement of our existing products requires significant investments in research and development. If we fail to successfully sell new products and update our existing products, our operating results may decline as our existing products reach the end of their commercial life cycles.

Our growth may be impaired and our operating results and financial condition could be adversely affected if the results of efforts related to business development activities do not achieve expected benefits.

Our growth may depend on our ability to acquire or make investments in complementary businesses, technologies, services or products. The process of integrating any acquired business, technology, service or product into our business and operations may result in unforeseen operating difficulties and expenditures. Integration of an acquired company also may consume much of our management’s time and attention that could otherwise be available for ongoing development of our business. We may not be able to obtain required regulatory approvals of an acquisition. Moreover, there also would be no assurance that such an acquisition will enhance our business, results of operation or financial condition. Furthermore, we may not be able to identify, negotiate or finance acquisitions successfully. Even if an acquisition is completed, we may have difficulties in meeting operating expectations for acquired businesses, services and technologies, possibly lose key employees and customers of the acquired business and may miss opportunities as a result of our inexperience in new business areas. We may incur significant legal and other professional service fees and other costs and expenses in connection with potential acquisitions that we must pay whether or not the acquisitions are completed. To the extent that we capitalize certain business development costs in connection with potential acquisitions, we will have to write off such costs if we fail to consummate those acquisitions. Future acquisitions could also result in our use of significant working capital resources, potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or amortization expenses related to intangible assets.

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Our business could be harmed if our competitors establish cooperative relationships with large medical device vendors or rapidly acquire market share through industry consolidation.

We expect that the medical device industry will continue to consolidate. Large medical device vendors may acquire or establish cooperative relationships with our current competitors, or new competitors or alliances among competitors may emerge and rapidly acquire significant market share, either of which would harm our business and financial prospects.

Our dependence on suppliers for materials could impair our ability to manufacture our products.

We contract with third parties for the supply of some of the components used in our products. The lead-time involved in the manufacturing of some of these components can be lengthy and unpredictable. Some of these suppliers are not obligated to continue to supply us. For certain of these materials and components, relatively few alternative sources of supply exist. We may not be able to find alternative sources of these components in a reasonable time period, or on commercially reasonable terms, if at all, which could impair our ability to produce and supply our products.

Additionally, replacement or alternative sources might not be readily obtainable due to regulatory requirements and other factors applicable to our manufacturing operations. Incorporation of components from a new supplier into our products may require a new or supplemental filing with applicable regulatory authorities and clearance or approval of the filing before we could resume product sales. This process may take a substantial period of time, and we cannot be assured that we would be able to obtain the necessary regulatory clearance or approval. This could create supply disruptions that would harm our product sales and operating results.

Finally, an uncorrected defect or supplier’s variation in a component or raw material, either unknown to us or incompatible with our manufacturing process, could harm our ability to manufacture the affected product.

Our ability to market and sell our products depends upon receipt of domestic and foreign regulatory approval of our products and manufacturing operations. Our failure to obtain or maintain regulatory approvals and compliance could negatively affect our business.

Our products and manufacturing operations are subject to extensive regulation in the United States by the FDA and by similar regulatory agencies in many other countries in which we do business. Unless an exemption applies, each medical device that we seek to market in the U.S. must first receive 510(k) premarket clearance pursuant to Section 510(k) of the Food, Drug, and Cosmetics Act of 1938, as amended. The principal risks that we face in obtaining and maintaining the regulatory approvals necessary to market our products include:

• The approval process for medical devices in the United States and abroad can be lengthy and expensive. The FDA’s 510(k) clearance process usually takes three to 12 months, but can take longer. The process of obtaining premarket approval is much more costly, lengthy and uncertain than the 510(k) premarket clearance process, where the new product is based on products already in the marketplace that have previously received FDA approval. Premarket approval generally takes one to three years, but can take even longer. We cannot assure you that the FDA will ever grant either 510(k) clearance or premarket approval for any product we propose to market. As a result, we may expend substantial resources in developing and testing a new product but fail to obtain the necessary approvals or clearances to market or manufacture the product on a timely basis, if at all. Furthermore, if the FDA concludes that these future products using our technology do not meet the requirements to obtain 510(k) clearance (the other intended use of the product is similar to existing products in the market, and the product is not based on new technological breakthroughs), we would have to seek premarket approval as a new product. We cannot assure you that the FDA will not impose the more burdensome premarket approval requirement on modifications to our existing products or future products, which in either case could be costly and cause us to divert our attention and resources from our business.

• When we modify a medical device for which we have received marketing approval, we must determine whether the modification requires us to seek new regulatory approvals. If the FDA or other regulatory

25

agency does not agree with our determination, we may be prohibited from marketing the modified device until we receive the requisite regulatory approval or clearance. In addition, the FDA actively enforces regulations prohibiting marketing of devices for uses that have not been cleared or approved by the FDA.

If we fail to comply with applicable regulations, we could be subject to a number of enforcement actions, including warning letters, fines, product seizures, recalls, injunctions, total or partial suspension of production, operating restrictions or limitations on marketing, refusal of the government to grant new clearances or approvals, withdrawal of marketing clearances or approvals and civil and criminal penalties.

Regulating legislation other than that which is administered by the FDA to which our business is subject includes the Environmental Protection Act, the Occupational Safety and Health Act, and state and local counterparts to these acts.

Product liability suits against us could result in expensive and time consuming litigation, payment of substantial damages and an increase in our insurance rates.

The sale and use of our products could lead to the filing of product liability claims by persons claiming to have been injured using one of our products or claiming that one of our products failed to perform properly. For information concerning an existing product liability action against the Company, see Part II, Item 1 “Legal Proceedings” to this Quarterly Report on Form 10-Q. A product liability claim brought against us, with or without merit, could result in substantial damages, judgments or settlement costs and be costly and time consuming to defend, which could materially harm our business or financial condition. Our product liability insurance may not be adequate to protect our assets from the full financial impact of defending a product liability claim. These claims could increase our product liability insurance rates or prevent us from securing any coverage in the future.

We may not be able to protect our intellectual property rights and, as a result, we could lose competitive advantages that could adversely affect our operating results.

Our success depends, in part, on our ability and the ability of our licensors to obtain, assert and defend patent rights, protect trade secrets and operate without infringing the proprietary rights of others. We currently own or have rights to eight U.S. patents. We may not, however, be able to obtain additional licenses to patents of others or be able to develop additional patentable technology of our own. Any patents issued to us may not provide us with competitive advantages, or the patents or proprietary rights of others may have an adverse effect on our ability to do business. Others may independently develop similar products or design around or infringe such patents or proprietary rights owned by or licensed to us. Any patent obtained or licensed by us may not be held to be valid and enforceable if challenged by another party.

Although we endeavor to protect our patent rights from infringement, we may not be aware, or become aware, of patents issued to our competitors or others that conflict with our own. Such conflicts could result in a rejection of important patent applications or the invalidation of important patents, which could have a materially adverse effect on our competitive position. In the event of such conflicts, or in the event we believe that competitive products infringe patents to which we hold rights, we may pursue patent infringement litigation or interference proceedings against, or may be required to defend against such litigation or proceedings involving, holders of such conflicting patents or competing products. Such litigation or proceedings may have a materially adverse effect on our competitive position, and there can be no assurance that we will be successful in any such litigation or proceeding. Litigation and other proceedings relating to patent matters, whether initiated by us or a third party, can be expensive and time consuming, regardless of whether the outcome is favorable to us, and can result in the diversion of substantial financial, managerial and other resources. An adverse outcome could subject us to significant liabilities to third parties or require us to cease any related development or commercialization activities. In addition, if patents that contain dominating or conflicting claims have been or are subsequently issued to others and such claims are ultimately determined to be valid, we may be required to obtain licenses under patents or other proprietary rights of others. Any licenses required under any such patents or proprietary rights may not be made available on terms acceptable to us, if at all. If we do not obtain such licenses, we could encounter delays or could find that the development, manufacture or sale of products requiring such licenses is foreclosed.

We rely on proprietary know-how and confidential information and employ various methods, such as entering into confidentiality and non-compete agreements with our current employees and with certain third parties to whom we have divulged proprietary information, to protect the processes, concepts, ideas and documentation associated with our technologies. Such methods may not afford significant protection to us, and may not be able to adequately protect our trade secrets or ensure that other companies would not acquire information that we consider proprietary.

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Our business is likely to be adversely affected if we are unable to retain our senior executive officers and key business and technical personnel.

We are dependent upon the services of our senior executives, in particular Gabriel Raviv, our Chief Executive Officer, and other key business and technical personnel. We do not maintain key-man life insurance on our senior executives. The loss of the services of Mr. Raviv or other senior executives or key employees could have a material adverse effect on us. Also, our continued commercialization will depend upon, among other things, the successful recruiting and retention of highly skilled managerial and marketing personnel with experience in business activities such as ours. Competition for the type of highly skilled individuals sought by us is intense. There can be no assurance that we will be able to retain existing key employees or that we will be able to find, attract and retain skilled personnel on acceptable terms.

If we breach any of the agreements under which we license commercialization rights to products or technology from others, we could lose licenses that are important to our business.

We license rights to products and technology that are important to our business and we expect to enter into additional licenses in the future. Under these licenses, we are subject to commercialization and development, sublicensing, royalty, insurance and other obligations. If we fail to comply with any of these requirements, or otherwise breach a license agreement, the licensor may have the right to terminate the license in whole or to terminate the exclusive nature of the license. In addition, upon the termination of the license, we may be required to license to the licensor any related intellectual property that we develop.

We may be unable to successfully develop and/or commercialize our new and existing products.

The successful development and commercialization of new products will depend upon our ability to obtain regulatory approvals. If we are unable to obtain these approvals, we will be unable to market and sell our products, which will negatively affect our business. Even if we are able to obtain regulatory approval for our products, we may have difficulty in bringing these products to market. In addition, once our products are brought to market, their shipment may be delayed or the products may have to be discontinued based on design, mechanical, software, regulatory or other issues. These matters may adversely affect our business and reputation.

Risks Related to Our Common Stock

The trading price of our common stock may fluctuate substantially in the future.

The trading price of our common stock may fluctuate widely as a result of a number of factors, some of which are not in our control, including:

• Our ability to meet or exceed our own forecasts or expectations of analysts or investors.

• Quarter to quarter variations in our operating results.

• Announcements regarding clinical activities or new products by our competitors or us.

• General conditions in the medical device industry.

• Changes in our own forecasts or earnings estimates by analysts.

• Price and volume fluctuations in the overall stock market, which have particularly affected the market prices of many medical device companies.

• General economic conditions.

In addition, the market for our stock may experience price and volume fluctuations unrelated or disproportionate to our operating performance. As a result, you may not be able to sell shares of our common stock at or above the price at which you purchased them. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against that company. If any securities litigation is initiated against us, with or without merit, we could incur substantial cost, and our management’s attention and resources could be diverted from our business.

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Our executive officers, directors, principal stockholders and their affiliates hold a substantial portion of our stock and could exercise significant influence over matters requiring stockholder approval, regardless of the wishes of other stockholders.

As of June 15, 2005, our executive officers, directors, and their affiliates beneficially owned in the aggregate approximately 23% of our outstanding common stock. If some or all of these stockholders act together, they could significantly influence all matters that our stockholders vote upon, including the election of directors and determination of significant corporate actions. This concentration of ownership could delay or prevent a change of control transaction that could otherwise be beneficial to our stockholders.

Provisions of our amended certificate of incorporation, by-laws and Delaware law, and an agreement among certain stockholders and the Company, may discourage a third party from acquiring us.

Provisions of our amended certificate of incorporation, by-laws and Delaware law, including provisions providing for a staggered board of directors, as well as an agreement among certain stockholders and the Company granting those stockholders rights of first refusal in the event that one or more of such stockholders either obtains a written bona fide offer from a third party to sell or transfer any of their shares of our common stock, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.

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