##### Table of Contents



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 June 30, 2003

OR

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|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 000-49755

QUINTON CARDIOLOGY SYSTEMS, INC.

(Exact name of registrant as specified in its charter)


|                         |  |                                  
|------------------------ |  | ---------------------------------
|Delaware                 |  | 94-3300396                       
|(State of Incorporation) |  | (IRS Employer Identification No.)

3303 Monte Villa Parkway
Bothell, Washington 98021
(Address of principal executive offices)

(425) 402-2000
(Registrants telephone number)

Indicated by check ü whether the
registrant: (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes   
þ       No   o

Indicated by check
ü whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act.)

Yes   o
       No þ

As of August 8, 2003, 12,160,701 shares of the issuers common stock were
outstanding.

1



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TABLE OF CONTENTS



|                               |                                                                                               |  |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               | Item 1. Unaudited Financial Statements                                                       
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 2. Changes in Securities and Use of Proceeds                                            
|                               | Item 3. Defaults Upon Senior Securities                                                      
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                               | Item 5. Other Information                                                                    
|                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                     
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  
|EXHIBIT 32.2                  



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##### Table of Contents



TABLE OF CONTENTS

|                               |                                                                                               |  |    |    | 
|------------------------------ | --------------------------------------------------------------------------------------------- |  | -- | -- | 
|PART I - FINANCIAL INFORMATION |                                                                                               |  | 3  |   
|                               | Item 1. Unaudited Financial Statements                                                        |  |    | 3  | 
|                               | Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations |  |    | 12 | 
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  |    | 24 | 
|                               | Item 4. Controls and Procedures                                                               |  |    | 24 | 
|PART II - OTHER INFORMATION    |                                                                                               |  | 25 |   
|                               | Item 1. Legal Proceedings                                                                     |  |    | 25 | 
|                               | Item 2. Changes in Securities and Use of Proceeds                                             |  |    | 25 | 
|                               | Item 3. Defaults Upon Senior Securities                                                       |  |    | 25 | 
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                   |  |    | 25 | 
|                               | Item 5. Other Information                                                                     |  |    | 25 | 
|                               | Item 6. Exhibits and Reports on Form 8-K                                                      |  |    | 26 | 
|SIGNATURE                      |                                                                                               |  | 27 |   

2



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##### Table of Contents






PART I - FINANCIAL INFORMATION




Item 1. Unaudited Financial Statements

QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |        | 
|------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | ------------ | ------ | -------- | ------ | ------- | ------ | 
|                                                                          |                                                                                                                                                                             |                                            |       | December 31, |        | June 30,
|                                                                          |                                                                                                                                                                             |                                            |       | 2002         |        | 2003    
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |         
|ASSETS                                                                    |                                                                                                                                                                             |                                            |       |              |        |          |        |        
|Current Assets:                                                           |                                                                                                                                                                             |                                            |       |              |        |          |        |        
|                                                                          | Cash and cash equivalents                                                                                                                                                   |                                            | $     | 19,382       |        |          | $      | 903     |       
|                                                                          | Accounts receivable, net of allowance for doubtful accounts                                                                                                                 |                                            |       | 7,384        |        |          |        | 10,318  |       
|                                                                          | Inventories                                                                                                                                                                 |                                            |       | 7,462        |        |          |        | 12,076  |       
|                                                                          | Prepaid expenses and other current assets                                                                                                                                   |                                            |       | 528          |        |          |        | 813     |       
|                                                                          | Income taxes receivable                                                                                                                                                     |                                            |       | 206          |        |          |        |        |       
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|                                                                          |                                                                                                                                                                             | Total current assets                       |       |              | 34,962 |          |        |         | 24,110 | 
|Machinery and equipment, net of accumulated depreciation
and amortization |                                                                                                                                                                             |                                            | 3,510 |              |        |          | 5,367  |        
|Intangible assets, net of accumulated amortization                        |                                                                                                                                                                             |                                            | 393   |              |        |          | 5,835  |        
|Goodwill                                                                  |                                                                                                                                                                             |                                            | 860   |              |        |          | 10,057 |        
|Investment in unconsolidated entity                                       |                                                                                                                                                                             |                                            | 1,000 |              |        |          | 1,000  |        
|Restricted cash deposit                                                   |                                                                                                                                                                             |                                            | 1,325 |              |        |          |       |        
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|                                                                          |                                                                                                                                                                             | Total assets                               |       | $            | 42,050 |          |        | $       | 46,369 | 
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|LIABILITIES AND SHAREHOLDERS EQUITY                                      |                                                                                                                                                                             |                                            |       |              |        |          |        |        
|Current Liabilities:                                                      |                                                                                                                                                                             |                                            |       |              |        |          |        |        
|                                                                          | Line of credit                                                                                                                                                              |                                            | $     |             |        |          | $      | 2,474   |       
|                                                                          | Current portion of long term debt                                                                                                                                           |                                            |       | 363          |        |          |        | 363     |       
|                                                                          | Accounts payable                                                                                                                                                            |                                            |       | 4,776        |        |          |        | 4,848   |       
|                                                                          | Accrued liabilities                                                                                                                                                         |                                            |       | 3,415        |        |          |        | 5,003   |       
|                                                                          | Warranty liability                                                                                                                                                          |                                            |       | 1,089        |        |          |        | 2,096   |       
|                                                                          | Deferred revenue                                                                                                                                                            |                                            |       | 4,407        |        |          |        | 4,447   |       
|                                                                          | Putable warrants                                                                                                                                                            |                                            |       | 328          |        |          |        |        |       
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|                                                                          |                                                                                                                                                                             | Total current liabilities                  |       |              | 14,378 |          |        |         | 19,231 | 
|Long term debt, net of current portion                                    |                                                                                                                                                                             |                                            | 363   |              |        |          | 181    |        
|Deferred tax liability                                                    |                                                                                                                                                                             |                                            |      |              |        |          | 1,156  |        
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|                                                                          |                                                                                                                                                                             | Total liabilities                          |       |              | 14,741 |          |        |         | 20,568 | 
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|Minority interest in consolidated entity                                  |                                                                                                                                                                             |                                            |      |              |        |          | 203    |        
|Shareholders Equity:                                                     |                                                                                                                                                                             |                                            |       |              |        |          |        |        
|                                                                          | Preferred stock (10,000,000 shares authorized), $0.001 par
value, no shares outstanding in 2002 or 2003                                                                     |                                            |       |             |        |          |        |        |       
|                                                                          | Common stock (65,000,000 shares authorized), $0.001 par
value, 12,049,136 and 12,158,807 shares issued and
outstanding at December 31, 2002 and June 30, 2003,
respectively |                                            |       | 12           |        |          |        | 12      |       
|                                                                          | Additional paid-in capital                                                                                                                                                  |                                            |       | 45,073       |        |          |        | 45,342  |       
|                                                                          | Deferred stock-based compensation                                                                                                                                           |                                            |       | (180         | )      |          |        | (144    | )     
|                                                                          | Accumulated deficit                                                                                                                                                         |                                            |       | (17,596      | )      |          |        | (19,612 | )     
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|                                                                          |                                                                                                                                                                             | Total shareholders equity                 |       |              | 27,309 |          |        |         | 25,598 | 
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       
|                                                                          |                                                                                                                                                                             | Total liabilities and shareholders equity |       | $            | 42,050 |          |        | $       | 46,369 | 
|                                                                          |                                                                                                                                                                             |                                            |       |              |        |          |        |         |       

The accompanying notes are an integral part of these unaudited condensed
consolidated balance sheets.

3



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)

|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |        |  
|---------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ---------------------------- | --------- | ------------------ | ------ | ---------------- | ---------- | ------ | ------ | ---- | --------- | ------ | ------ | - | ---------- | ------ | ------ | -
|                                                                             |                                                                        |                              |           | Three months Ended |        | Six months ended
|                                                                             |                                                                        |                              |           | June 30,           |        | June 30,        
|                                                                             |                                                                        |                              |           |                    |        |                 
|                                                                             |                                                                        |                              |           | 2002               |        | 2003             |            | 2002   |        | 2003
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |     
|Revenues:                                                                    |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |       
|                                                                             | Systems                                                                |                              | $         | 9,063              |        |                  | $          | 17,604 |        |      | $         | 17,229 |        |   | $          | 34,561 |       
|                                                                             | Service                                                                |                              |           | 2,196              |        |                  |            | 3,102  |        |      |           | 4,419  |        |   |            | 6,428  |       
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|                                                                             |                                                                        | Total revenues               |           |                    | 11,259 |                  |            |        | 20,706 |      |           |        | 21,648 |   |            |        | 40,989 |  
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Cost of Revenues:                                                            |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |       
|                                                                             | Systems                                                                |                              |           | 5,697              |        |                  |            | 10,472 |        |      |           | 10,742 |        |   |            | 21,124 |       
|                                                                             | Service                                                                |                              |           | 1,185              |        |                  |            | 1,792  |        |      |           | 2,376  |        |   |            | 3,579  |       
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|                                                                             |                                                                        | Total cost of revenues       |           |                    | 6,882  |                  |            |        | 12,264 |      |           |        | 13,118 |   |            |        | 24,703 |  
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|                                                                             |                                                                        | Gross profit                 |           |                    | 4,377  |                  |            |        | 8,442  |      |           |        | 8,530  |   |            |        | 16,286 |  
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Operating Expenses:                                                          |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |       
|                                                                             | Research and development                                               |                              |           | 1,334              |        |                  |            | 1,989  |        |      |           | 2,687  |        |   |            | 4,076  |       
|                                                                             | Write off of purchased in-process research
and development projects    |                              |           |                   |        |                  |            |       |        |      |           |       |        |   |            | 1,290  |       
|                                                                             | Sales and marketing                                                    |                              |           | 2,466              |        |                  |            | 4,491  |        |      |           | 4,919  |        |   |            | 8,817  |       
|                                                                             | General and administrative, excluding
stock-based compensation expense |                              |           | 1,106              |        |                  |            | 1,942  |        |      |           | 2,589  |        |   |            | 3,969  |       
|                                                                             | Stock-based compensation                                               |                              |           | 35                 |        |                  |            | 18     |        |      |           | 70     |        |   |            | 36     |       
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|                                                                             |                                                                        | Total operating expenses     |           |                    | 4,941  |                  |            |        | 8,440  |      |           |        | 10,265 |   |            |        | 18,188 |  
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|                                                                             |                                                                        | Operating income (loss)      |           |                    | (564   | )                |            |        | 2      |      |           |        | (1,735 | ) |            |        | (1,902 | )
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Other Income (Expense):                                                      |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |       
|                                                                             | Interest income                                                        |                              |           | 46                 |        |                  |            | 9      |        |      |           | 46     |        |   |            | 10     |       
|                                                                             | Interest expense                                                       |                              |           | (29                | )      |                  |            | (82    | )      |      |           | (102   | )      |   |            | (158   | )     
|                                                                             | Interest income (expense), putable warrants                            |                              |           | 133                |        |                  |            | (63    | )      |      |           | 133    |        |   |            | 32     |       
|                                                                             | Other income (expense), net                                            |                              |           |                   |        |                  |            | (13    | )      |      |           | 3      |        |   |            | (9     | )     
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|                                                                             |                                                                        | Total other income (expense) |           |                    | 150    |                  |            |        | (149   | )    |           |        | 80     |   |            |        | (125   | )
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Loss before income taxes and minority interest in
consolidated entity        |                                                                        |                              | (414      | )                  |        |                  | (147       | )      |        |      | (1,655    | )      |        |   | (2,027     | )     
|                                                                             | Income tax provision                                                   |                              |           | (4                 | )      |                  |            | (9     | )      |      |           | (14    | )      |   |            | (9     | )     
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Loss before minority interest in consolidated entity                         |                                                                        |                              | (418      | )                  |        |                  | (156       | )      |        |      | (1,669    | )      |        |   | (2,036     | )     
|                                                                             | Minority interest in loss (income) of consolidated
entity              |                              |           |                   |        |                  |            | (1     | )      |      |           |       |        |   |            | 20     |       
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Net loss                                                                     |                                                                        | $                            | (418      | )                  |        | $                | (157       | )      |        | $    | (1,669    | )      |        | $ | (2,016     | )     
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Basic and diluted net loss per share                                         |                                                                        | $                            | (0.06     | )                  |        | $                | (0.01      | )      |        | $    | (0.44     | )      |        | $ | (0.17      | )     
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       
|Weighted average shares used to compute
basic and diluted net loss per share |                                                                        |                              | 6,812,713 |                    |        |                  | 12,130,211 |        |        |      | 3,751,667 |        |        |   | 12,112,095 |       
|                                                                             |                                                                        |                              |           |                    |        |                  |            |        |        |      |           |        |        |   |            |        |       

The accompanying notes are an integral part of these unaudited condensed
consolidated statements.

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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(in thousands)

|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |       |        |         |  
|------------------------------------------------- | ------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ----------------------------------------- | ---------------------------------------- | ---- | ------------------ | ------ | ---------------- | --- | ------ | ------ | ------ | ---- | ---- | ------- | ------- | ----- | ------ | ------- | -
|                                                  |                                                                           |                                                                        |                                           |                                          |      | Three Months Ended |        | Six Months Ended
|                                                  |                                                                           |                                                                        |                                           |                                          |      | June 30,           |        | June 30,        
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                 
|                                                  |                                                                           |                                                                        |                                           |                                          |      | 2002               |        | 2003             |     | 2002   |        | 2003  
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |       
|Operating Activities:                             |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |        
|                                                  | Net loss                                                                  |                                                                        | $                                         | (418                                     | )    |                    | $      | (157             | )   |        | $      | (1,669 | )    |      | $       | (2,016  | )    
|                                                  | Adjustments to reconcile net loss to net cash from operating
activities  |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|                                                  |                                                                           | Depreciation and amortization                                          |                                           |                                          | 292  |                    |        |                  | 476 |        |        |        | 583  |      |         |         | 973   |       
|                                                  |                                                                           | Loss on disposal of equipment                                          |                                           |                                          |     |                    |        |                  | 6   |        |        |        | 9    |      |         |         | 6     |       
|                                                  |                                                                           | Amortization of deferred stock-based compensation                      |                                           |                                          | 35   |                    |        |                  | 18  |        |        |        | 70   |      |         |         | 36    |       
|                                                  |                                                                           | Interest expense (income), putable warrants                            |                                           |                                          | (133 | )                  |        |                  | 63  |        |        |        | (133 | )    |         |         | (32   | )     
|                                                  |                                                                           | Write off of purchased in-process research and
development             |                                           |                                          |     |                    |        |                  |    |        |        |        |     |      |         |         | 1,290 |       
|                                                  |                                                                           | Minority interest in income (loss) of consolidated entity              |                                           |                                          |     |                    |        |                  | 1   |        |        |        |     |      |         |         | (20   | )     
|                                                  |                                                                           | Changes in operating assets and liabilities, net of
business acquired: |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |       |       
|                                                  |                                                                           |                                                                        | Accounts receivable                       |                                          |      | (9                 | )      |                  |     | 250    |        |        |      | (48  | )       |         |       | 864    |        
|                                                  |                                                                           |                                                                        | Inventories                               |                                          |      | 351                |        |                  |     | 1,671  |        |        |      | 755  |         |         |       | 2,157  |        
|                                                  |                                                                           |                                                                        | Prepaid expenses and other current assets |                                          |      | (61                | )      |                  |     | 125    |        |        |      | (89  | )       |         |       | 105    |        
|                                                  |                                                                           |                                                                        | Accounts payable                          |                                          |      | 16                 |        |                  |     | (1,119 | )      |        |      | 137  |         |         |       | (2,653 | )      
|                                                  |                                                                           |                                                                        | Accrued liabilities                       |                                          |      | (112               | )      |                  |     | (927   | )      |        |      | 160  |         |         |       | (1,135 | )      
|                                                  |                                                                           |                                                                        | Warranty liability                        |                                          |      | (63                | )      |                  |     | (56    | )      |        |      | (172 | )       |         |       | (9     | )      
|                                                  |                                                                           |                                                                        | Deferred revenue                          |                                          |      | 9                  |        |                  |     | (61    | )      |        |      | 283  |         |         |       | (254   | )      
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|                                                  |                                                                           |                                                                        |                                           | Net cash flows from operating activities |      |                    | (93    | )                |     |        | 290    |        |      |      | (114    | )       |       |        | (688    | )
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|Investing Activities:                             |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |        
|                                                  | Purchases of machinery and equipment                                      |                                                                        |                                           | (325                                     | )    |                    |        | (357             | )   |        |        | (398   | )    |      |         | (792    | )    
|                                                  | Proceeds from sale of machinery and equipment                             |                                                                        |                                           |                                         |      |                    |        | 73               |     |        |        |       |      |      |         | 108     |      
|                                                  | Purchase of Burdick, Inc., net of cash acquired                           |                                                                        |                                           |                                         |      |                    |        | 2,177            |     |        |        |       |      |      |         | (19,372 | )    
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|                                                  |                                                                           |                                                                        |                                           | Net cash flows from investing activities |      |                    | (325   | )                |     |        | 1,893  |        |      |      | (398    | )       |       |        | (20,056 | )
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|Financing Activities:                             |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |        
|                                                  | Borrowings (repayments) on bank line of credit, net                       |                                                                        |                                           | (4,777                                   | )    |                    |        | (1,855           | )   |        |        | (4,471 | )    |      |         | 2,474   |      
|                                                  | Payments of long term debt                                                |                                                                        |                                           |                                         |      |                    |        | (91              | )   |        |        |       |      |      |         | (182    | )    
|                                                  | Proceeds from exercise of stock options                                   |                                                                        |                                           | 39                                       |      |                    |        | 19               |     |        |        | 39     |      |      |         | 63      |      
|                                                  | Redemption of putable warrants                                            |                                                                        |                                           |                                         |      |                    |        | (296             | )   |        |        |       |      |      |         | (296    | )    
|                                                  | Proceeds from issuance of stock, net of issuance costs                    |                                                                        |                                           | 28,991                                   |      |                    |        | 206              |     |        |        | 28,991 |      |      |         | 206     |      
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|                                                  |                                                                           |                                                                        |                                           | Net cash flows from financing activities |      |                    | 24,253 |                  |     |        | (2,017 | )      |      |      | 24,559  |         |       |        | 2,265   |  
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|Net change in cash and cash equivalents           |                                                                           |                                                                        | 23,835                                    |                                          |      |                    | 166    |                  |     |        | 24,047 |        |      |      | (18,479 | )      
|Cash and cash equivalents, beginning of period    |                                                                           |                                                                        | 430                                       |                                          |      |                    | 737    |                  |     |        | 218    |        |      |      | 19,382  |        
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|Cash and cash equivalents, end of period          |                                                                           | $                                                                      | 24,265                                    |                                          |      | $                  | 903    |                  |     | $      | 24,265 |        |      | $    | 903     |        
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      
|Supplemental disclosure of cash flow information: |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |        
|                                                  | Cash paid for interest                                                    |                                                                        | $                                         | 57                                       |      |                    | $      | 83               |     |        | $      | 131    |      |      | $       | 140     |      
|                                                  |                                                                           |                                                                        |                                           |                                          |      |                    |        |                  |     |        |        |        |      |      |         |         |      

The accompanying notes are an integral part of these unaudited condensed
consolidated statements.

5



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC.

AND SUBSIDIARIES


NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.   Organization and Description of Business



| |                                                                                                                                                                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Quinton Cardiology Systems, Inc. (QCS) is a Delaware corporation. QCS
and its subsidiaries, Quinton Inc. (Quinton) and Burdick, Inc. (Burdick)
are referred to herein as the Company. The Company develops, manufactures,
markets and services a family of diagnostic cardiology systems used in the
diagnosis, treatment and rehabilitation of patients with heart disease.

2.   Summary of Significant Accounting Policies



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Basis of Presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | The condensed financial statements present the Company on a consolidated
basis. All significant intercompany accounts and transactions have been
eliminated. The condensed consolidated balance sheet dated June 30, 2003,
the condensed consolidated statements of operations for the three and
six-month periods ended June 30, 2002 and 2003 and the condensed consolidated
statements of cash flows for the three and six-month periods ended June 30,
2002 and 2003 have been prepared by the Company and are unaudited. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. The notes
to the audited consolidated financial statements included in the Companys
annual report on form 10-K for the fiscal year ended December 31, 2002
provide a summary of significant accounting policies and additional financial
information that should be read in conjunction with this report. In the
opinion of management, all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position of the
Company for the interim periods, have been made. The results of operations
for such interim periods are not necessarily indicative of the results for
the full year or any future period. All share information in these financial
statements gives effect to a 1 for 2.2 reverse stock split, which was
effected in April 2002.
|
| | Use of Estimates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
of America requires management 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 revenues
and expenses during the periods reported. These estimates include but are not
limited to estimates affecting revenues and estimates assessing the
collectability of accounts receivable, the salability and recoverability of
inventory, the adequacy of warranty liabilities, the realizability of
investments, the realization of deferred tax assets, the fair value of
putable warrants and the useful lives of tangible and intangible assets. The
market for the Companys products is characterized by intense competition,
rapid technological development and frequent new product introductions, all
of which could affect the future realizability of the Companys assets. The
Company reviews estimates and assumptions periodically, and the effects of
revisions are reflected in the consolidated financial statements in the
period they are determined to be necessary. Actual results could differ from
these estimates.                                                                                                                                                                                                                                                                                                
|
| | Recent Accounting Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus on EITF 00-21, Revenue Arrangements with Multiple Deliverables
with respect to determining when and how to allocate revenue from sales with
multiple deliverables. The EITF 00-21 consensus provides a framework for
determining when and how to allocate revenue from sales with multiple
deliverables based on a determination of whether the multiple deliverables
qualify to be
accounted for as separate units of accounting. The consensus is
effective prospectively for arrangements entered into in                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

6



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | fiscal periods
beginning after June 15, 2003. The Company does not expect that the adoption
of this consensus will have a material impact on the Companys consolidated
financial statements as a whole.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | In January 2003, the FASB issued Interpretation 46, Consolidation of
Variable Interest Entities. In general, Interpretation 46 requires a
variable interest entity (as defined) to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable
interest entitys activities or entitled to receive a majority of the
entitys residual returns or both. The Company does not expect that the
adoption of this interpretation will have a material impact on the Companys
consolidated financial statements as a whole.                                                                                                                                                                                                                                      
|
| | In April 2003, the FASB issued Statement of Financial Accounting
Standard No. 149, Amendment of Statement No. 133 on Derivative Instruments
and Hedging Activities. This standard amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, collectively referred to
as derivatives, and for hedging activities under statement No. 133,
Accounting for Derivative Instruments and Hedging Relationships. SFAS No.
149 is effective for contracts entered into or modified after June 30, 2003
and for hedging relationships after June 30, 2003. The Company does not
expect that the adoption of this standard will have a material impact on the
Companys consolidated financial statements as a whole.
|
| | Net Income (Loss) Per Share                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | In accordance with SFAS No. 128, Computation of Earnings Per Share,
basic loss per share is computed by dividing net loss by the weighted average
number of shares of common stock outstanding during the period. Common stock
that the Company has the right to repurchase is not included in the
calculation of outstanding shares. Diluted loss per share is computed by
dividing net loss by the weighted average number of common and dilutive
potential common shares outstanding during the period. Potential common shares
consist of shares issuable upon the exercise of stock options, including
outstanding shares subject to repurchase, and warrants (using the treasury
stock method); potential common shares are excluded from the calculation
if their effect is antidilutive.             
|
| | The following table sets forth the computation of basic and diluted
weighted average common shares outstanding for the three and six-month
periods ended June 30, 2002 and 2003:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

|                                        |                                                     |  |                    |           |                  |  |      |            |      |  |  |           |   |  |  |            | 
|--------------------------------------- | --------------------------------------------------- |  | ------------------ | --------- | ---------------- |  | ---- | ---------- | ---- |  |  | --------- | - |  |  | ---------- | 
|                                        |                                                     |  | Three months ended |           | Six months ended
|                                        |                                                     |  | June 30,           |           | June 30,        
|                                        |                                                     |  |                    |           |                 
|                                        |                                                     |  | 2002               |           | 2003             |  | 2002 |            | 2003
|                                        |                                                     |  |                    |           |                  |  |      |            |     
|Shares (denominator basic and diluted): |                                                     |  |                    |           |                  |  |      |            |      |  |  |           |   |  |  |           
|                                        | Weighted average common shares outstanding          |  |                    | 6,822,488 |                  |  |      | 12,130,211 |      |  |  | 3,766,948 |   |  |  | 12,112,095 | 
|                                        | Less: weighted average shares subject to
repurchase |  |                    | (9,775    | )                |  |      |           |      |  |  | (15,281   | ) |  |  |           | 
|                                        |                                                     |  |                    |           |                  |  |      |            |      |  |  |           |   |  |  |            | 
|                                        | Denominator for basic and diluted calculation       |  |                    | 6,812,713 |                  |  |      | 12,130,211 |      |  |  | 3,751,667 |   |  |  | 12,112,095 | 
|                                        |                                                     |  |                    |           |                  |  |      |            |      |  |  |           |   |  |  |            | 



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | As of June 30, 2002 and 2003, 1,566,414, and 1,732,499, respectively,
shares of common stock subject to repurchase, stock options and warrants were
excluded from the computation of diluted loss per share, as their impact was
antidilutive. If the Company had reported net income, the calculation of
earnings per share would have included the dilutive effect of these potential
common shares using the treasury stock and if converted methods.                                                                                                                                
|
| | Accounting for Stock-Based Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | The Company has elected to apply the disclosure-only provisions of SFAS
No. 123, Accounting for Stock-Based Compensation. In accordance with the
provisions of SFAS 123, the Company applies Accounting Principles Board
Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and
related interpretations in accounting for its stock option plans.
Accordingly, compensation expense is recognized for options awarded to
employees only to the extent that the exercise price of the option is less
than the fair value of the underlying stock on the date of grant.

7



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Had compensation cost been determined based on the fair value of the
options at the grant dates during the three and six-month periods ended June
30, 2002 and 2003, consistent with the provisions of SFAS 123, the Companys
reported net loss would have been the pro forma amounts indicated below
(amounts in thousands except per share amounts):

|                                                                                                                                            |  |                    |       |                  |  |      |       |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----- | ---------------- |  | ---- | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                            |  | Three months ended |       | Six months ended
|                                                                                                                                            |  | June 30,           |       | June 30,        
|                                                                                                                                            |  |                    |       |                 
|                                                                                                                                            |  | 2002               |       | 2003             |  | 2002 |       | 2003
|                                                                                                                                            |  |                    |       |                  |  |      |       |     
|Net loss  as reported                                                                                                                      |  | $                  | (418  | )                |  | $    | (157  | )    |  | $ | (1,669 | ) |  | $ | (2,016 | )
|Add back: Total stock-based employee compensation
expense
included in reported loss, net of related tax effects                             |  |                    | 35    |                  |  |      | 18    |      |  |   | 70     |   |  |   | 36     |  
|Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects |  |                    | (129  | )                |  |      | (282  | )    |  |   | (259   | ) |  |   | (489   | )
|                                                                                                                                            |  |                    |       |                  |  |      |       |      |  |   |        |   |  |   |        |  
|Net loss  pro forma                                                                                                                        |  | $                  | (512  | )                |  | $    | (421  | )    |  | $ | (1,858 | ) |  | $ | (2,469 | )
|                                                                                                                                            |  |                    |       |                  |  |      |       |      |  |   |        |   |  |   |        |  
|Net loss per share  as reported                                                                                                            |  | $                  | (0.06 | )                |  | $    | (0.01 | )    |  | $ | (0.44  | ) |  | $ | (0.17  | )
|Net loss per share  pro forma                                                                                                              |  | $                  | (0.08 | )                |  | $    | (0.03 | )    |  | $ | (0.50  | ) |  | $ | (0.20  | )



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The fair value of each employee option grant is established on the date
of grant using the Black-Scholes option-pricing model with the following
assumptions used for grants during 2002 and 2003: zero dividend yield;
risk-free interest rate of 4.2% and 3.5%, respectively; volatility of 90% and
85%, respectively; and expected lives of four years and seven years,
respectively. The weighted-average fair value of options granted in 2002 and
2003 was $5.49 and $4.64, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Goodwill                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| | Goodwill represents the excess of cost over the estimated fair value of
net assets acquired in connection with our acquisitions of the medical
treadmill manufacturing line and Spacelabs Burdick, Inc., which in accordance
with SFAS No. 142, Goodwill and Other Intangible Assets, is not being
amortized. Also in accordance with SFAS No. 142, the Company tests goodwill
for impairment at the reporting unit level on an annual basis and between
annual tests in certain circumstances. The Company determined that it has
three reporting units, consisting of the Burdick line of products, the
Quinton line of products and the Shanghai-Burdick joint venture, all of which
operate in the diagnostic cardiology market and have similar operating and
economic characteristics. SFAS No. 142 requires a two-step goodwill
impairment test whereby the first step, used to identify potential
impairment, compares the fair value of a reporting unit with its carrying
amount including goodwill. If the fair value of a reporting unit exceeds its
carrying amount, goodwill of the reporting unit is considered not impaired,
thus the second step of the goodwill impairment test used to quantify
impairment is unnecessary. Management has estimated that the fair values of
the Companys reporting units to which goodwill has been allocated exceed
their carrying amounts, and as a result, the second step of the impairment
test, which would compare the implied fair value of the reporting unit
goodwill with the carrying amount of that goodwill, was unnecessary for the
periods presented.                                                                                                                                                                                                                                                                                                     
|
| | Intangible Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | The Companys intangible assets are comprised primarily of a trade name,
developed technology and customer relationships, all of which were acquired
in our acquisition of Burdick. Company management uses judgment to estimate
the fair value of each of these intangible assets. The judgment about fair
value is based on expectations of future cash flows and an appropriate
discount rate. Company management also uses judgment to estimate the useful
lives of each intangible asset. The Company believes the Burdick trade name
has an indefinite life, and accordingly does not amortize the trade name.
The Company evaluates this conclusion annually and makes a judgment about
whether there are factors that would limit the ability to benefit from the
trade name in the future. If there were such factors, the Company would
start amortizing the trade name. With respect to developed technology and
customer relationship intangible assets, the Company also evaluates the
remaining useful lives annually to evaluate whether the intangible assets are
impaired. For the trade name, this evaluation is performed annually or if
events occur that suggest there may be an impairment loss, and involves
comparing the carrying amount to the Companys estimate of fair value. For
developed technology and customer relationship intangible assets, this
evaluation would be performed if events occur that suggest there may be an
impairment loss. If we conclude that any of our intangible assets are
impaired, we would record this as a loss on our statement of operations and
as a reduction to the intangible asset. The Company recorded amortization
expense for identifiable intangibles of $31,000 and $103,000 for the
three-month periods ended June 30, 2002 and 2003, respectively, and $61,000
and $217,000 for the six-month periods ended June 30, 2002 and 2003,
respectively.

8



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Purchase Accounting                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | SFAS No. 141, Business Combinations, requires that the purchase method
of accounting be used for all business combinations and establishes specific
criteria for the recognition of intangible assets separately from goodwill.
In connection with the Companys acquisitions of the medical treadmill
manufacturing line and Spacelabs Burdick, Inc., the Company allocated the
respective purchase prices plus transaction costs to estimated fair values of
assets acquired and liabilities assumed. These purchase price allocation
estimates were made based on our estimates of fair values.

3.   Acquisition of Burdick, Inc.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On January 2, 2003, the Company purchased 100% of the stock of Spacelabs
Burdick, Inc. (Burdick). Based in Deerfield, Wisconsin, Burdick has
approximately 140 employees. Burdicks historical strength in ECG
cardiographs, Holter monitors and cardiology information systems, combined
with its distribution network focused on U.S. physicians offices,
complements Quintons strength in cardiac stress testing and cardiac
rehabilitation monitoring and its hospital focused direct sales force. The
consolidated financial statements include Burdicks results since January 2,
2003.
|
| | The original purchase price of $24.0 million was funded with
approximately $20.2 million in cash, a holdback of $1.3 million for working
capital adjustments plus a partial draw down on our revolving bank credit
facility. Transaction related costs were approximately $700,000.                                                                                                                                                                                                                                                                                                              
|
| | On April 21, 2003, an agreement was reached with the seller to adjust
the purchase price to $20.4 million, based principally on the amount of
Burdicks net working capital at the date of acquisition. In accordance
with this agreement, the Company kept the $1.3 million that was held back at
closing and received a $2.3 million refund from the seller subsequent to the
April 21, 2003 agreement. The refund was used to reduce borrowings against
the Companys line of credit.                                                                                                         
|
| | The Company has obtained most, but not all, of the information the
Company has arranged to obtain in order to finalize the purchase price
allocation. The purchase price, including incremental costs directly
related to the transaction, was allocated, based on information currently
available, as follows (in thousands):                                                                                                                                                                                                                                                                   

|                                                            |                       |   |        |        | 
|----------------------------------------------------------- | --------------------- | - | ------ | ------ | 
|Cash and cash equivalents                                   |                       | $ | 386    |       
|Accounts receivable, net of allowance for doubtful accounts |                       |   | 3,798  |       
|Inventories                                                 |                       |   | 6,771  |       
|Prepaid expenses and other current assets                   |                       |   | 184    |       
|Machinery and equipment                                     |                       |   | 2,000  |       
|In-process research and development                         |                       |   | 1,290  |       
|Intangible assets                                           |                       |   | 5,660  |       
|Goodwill                                                    |                       |   | 9,131  |       
|                                                            |                       |   |        |       
|                                                            | Total assets acquired |   |        | 29,220 | 
|Current liabilities                                         |                       |   | (6,961 | )     
|Deferred income taxes                                       |                       |   | (1,156 | )     
|                                                            |                       |   |        |       
|                                                            | Net assets acquired   |   | $      | 21,103 | 
|                                                            |                       |   |        |       



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Inventories included an adjustment to Burdicks historical cost to
increase finished goods to fair market value less expected disposal costs and
selling margin. This adjustment resulted in valuation of inventory of
$300,000 in excess of Burdicks historical cost. This increase in the
inventory valuation was charged to cost of sales in the six-month period
ended June 30, 2003, as the associated inventories were sold in the normal
course of business.                                                                                                                                                                                                                                                                                                       
|
| | In-process research and development relates to two product development
projects underway at the time of the acquisition. Neither project had
received required regulatory approvals at the acquisition date, and each
project had risks associated with achieving desired functionality and market
acceptance. The value assigned to in-process research and development was
determined using a discounted cash flow method applied to expected cash flows
over a 15 year period commencing in 2003. In discounting expected future
cash flows, the company used an annual discount rate of 16%, which management
believes is an appropriate risk adjusted rate given the nature of the
projects, the remaining project risks and the uncertainty of the future cash
flows.

9



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The first of the two projects, representing 87% of the total value of
acquired in-process research and development, relates to a new resting ECG
monitor. This project was approximately 70% complete at the date of
acquisition and was completed and the related product (the Atria 3000) was
released, as expected, at the end of the first quarter of 2003. Margins on
this product are expected to be in line with the Companys historical
margins. A failure to achieve expected market results and margins relating
to this product could materially adversely affect the overall return on
investment relating to the Burdick acquisition. Costs to complete this
project were expensed in the six-month period ended June 30, 2003.                                                                                                                                                                                                 
|
| | The second of the two projects, representing 13% of the total value of
acquired in-process research and development relates to a product for the
detection and preprocessing of low-level electrical signals generated by the
heart. This project was approximately 50% complete at the date of
acquisition and is expected to be completed later in 2003. Margins on these
products are expected to be in line with the Companys historical margins.
In the opinion of management, a failure to achieve expected results relating
to this project would not materially adversely affect the overall return on
investment relating to the Burdick acquisition.                                                                                                                                                                                                                                                                               
|
| | All of the acquired in process research and development was written off
during the first quarter of 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | Intangible assets consist of the trade name of $3,400,000, developed
technology of $860,000 and distributor relationships of $1,400,000, which
were valued based on discounted cash flow methods applied to the estimated
future cash flows attributable to the respective assets. The trade name was
determined, by management, to have an indefinite useful life. Developed
technology was assigned a seven year useful life, based on the estimated
remaining economic life of the related products. Distributor relationships
relate to long-standing contractual relationships with an extensive network
of independent distributors, which represents the exclusive channel through
which Burdick sells its products. The economic life of the distributor
relationships has been determined to be 10 years, based on historical
turnover experience and in consideration of the long standing and stable
nature of these relationships.
|
| | Goodwill represents the excess of the net purchase price over the fair
value of the assets and liabilities acquired. Goodwill recorded in the
Burdick acquisition relates to the long-standing nature of Burdicks
business, its substantial market share, its complementary fit with Quintons
pre-existing business, and managements expectations relating to future
operating synergies and cost efficiencies that can be realized as a result of
operating the businesses on a combined basis.                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | A deferred income tax liability was recorded related to the trade name,
which has no tax basis. Because of the indefinite life of the trade name,
this liability has not been used to reduce the valuation allowance against
existing deferred income tax assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | The following pro forma data summarizes the results of operations for
the three and six-month periods ended June 30, 2002 as if the Burdick
acquisition had been completed on January 1, 2002. The pro forma data gives
effect to actual operating results prior to the acquisition, adjusted to
include the pro forma effect of depreciation of machinery and equipment,
amortization of identified intangible assets and interest on cash balances.
(in thousands, except per share amounts)                                                                                                                                                                                                                                                                                                                                                                                                                                                

|                                     |  |                |        |                |  |   |        |  
|------------------------------------ |  | -------------- | ------ | -------------- |  | - | ------ | -
|                                     |  | Three Months   |        | Six Months    
|                                     |  | Ended June 30, |        | Ended June 30,
|                                     |  | 2002           |        | 2002          
|                                     |  |                |        |               
|Revenues                             |  | $              | 21,316 |                |  | $ | 41,522 |  
|Net loss                             |  | $              | (1,193 | )              |  | $ | (3,003 | )
|Basic and diluted net loss per share |  | $              | (0.18  | )              |  | $ | (0.80  | )

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4.   Initial Public Offering



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In May 2002, the Company consummated a public offering of its common
stock as more fully described in its prospectus dated May 6, 2002 filed with
the Securities and Exchange Commission. In the offering, the Company sold
4,000,000 shares of common stock at a price of $7.00 per share. In June
2002, the underwriters of the offering exercised their over-allotment option
to purchase an additional 600,000 shares at $7.00 per share. Proceeds from
the offering, including the over-allotment shares, were approximately $28.2
million, net of underwriting discounts and offering expenses. As a result of
the consummation of the offering, all of the convertible preferred stock
outstanding prior to the closing was automatically converted into an
aggregate of 6,639,347 shares of common stock.

5.   Inventories



| |                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------
| | Inventories were valued at the lower of cost, on an average cost basis,
or market and were comprised of the following (amounts in thousands):



|                 |                   |   |              |       |          |   |       |        | 
|---------------- | ----------------- | - | ------------ | ----- | -------- | - | ----- | ------ | 
|                 |                   |   | December 31, |       | June 30,
|                 |                   |   | 2002         |       | 2003    
|                 |                   |   |              |       |         
|Raw materials    |                   | $ | 3,433        |       |          | $ | 6,727 |       
|Work in progress |                   |   | 984          |       |          |   | 482   |       
|Finished goods   |                   |   | 3,045        |       |          |   | 4,867 |       
|                 |                   |   |              |       |          |   |       |       
|                 | Total inventories |   | $            | 7,462 |          |   | $     | 12,076 | 
|                 |                   |   |              |       |          |   |       |       

6.   Borrowings



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In connection with the January 2003 acquisition of Burdick, the Company
established a line of credit on December 30, 2002. Borrowings under the
Companys bank line of credit are limited to the lesser of $12,000,000 or an
amount based on eligible accounts receivable and eligible inventories.
Substantially all of the Companys assets are pledged as collateral for the
line of credit. This credit line carries an interest rate at the banks prime
rate plus a minimum of 0.5% to a maximum of 1.5% based on a funded debt to
earnings before interest, taxes, depreciation, and amortization (EBITDA)
ratio (which amounted to 5.75% at June 30, 2003).

7.   Putable Warrants



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In connection with a loan in 1998, the Company issued warrants to
purchase 123,536 shares of Series A convertible preferred stock with an
exercise price of $0.01 per share that were immediately exercisable. Upon
completion of the initial public offering in 2002, the conversion rights
associated with the Companys Series A convertible preferred stock resulted
in the warrants being exercisable for 63,092 shares of common stock at an
exercise price equal to $0.02 per share. At the holders option, the Company
is required to make a cash payment to the holder equal to the fair market
value of the shares issuable upon conversion of the warrants. On July 22,
2002, a holder of 21,632 putable warrants exercised a put option for cash
when the fair value of the shares was approximately $158,000. On May
21, 2003, the holder of the remaining 41,460 putable warrants exercised a put
option for cash when the fair value of the shares was approximately
$296,000. Changes in the fair value of this liability are recorded in the
statements of operations as interest income (expense), putable warrants.
There were no warrants outstanding as of June 30, 2003.

8.   Warranty Liability



| |                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------
| | Changes in the warranty liability for the six months ended June 30, 2003
were as follows (amounts in thousands):

|                                               |  |   |       |  
|---------------------------------------------- |  | - | ----- | -
|Warranty liability as of December 31, 2002     |  | $ | 1,089 |  
|Charged to cost of revenues                    |  |   | 562   |  
|Warranty expenditures                          |  |   | (571  | )
|Warranty liability acquired from Burdick, Inc. |  |   | 1,016 |  
|                                               |  |   |       |  
|Warranty liability as of June 30, 2003         |  | $ | 2,096 |  
|                                               |  |   |       |  

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9.   Contingencies



| |                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Legal Matters                                                                                                                                                                                                                                                                
|
| | The Company is a defendant in various legal matters arising in the
normal course of business. In the opinion of management, the ultimate
resolution of these matters is not expected to have a material effect on the
Companys consolidated financial statements as a whole.




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



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | You should read the following discussion and analysis in conjunction
with our unaudited condensed consolidated financial statements and related
notes included elsewhere in this report. Except for historical information,
the following discussion contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All
statements other than statements of historical fact, including future results
of operations or financial position, made in this Quarterly Report on Form
10-Q, are forward looking. We use words such as anticipate, believe, expect,
future, intend and similar expressions to identify forward looking
statements. These forward-looking statements reflect managements current
expectations and involve risks and uncertainties. Our actual results could
differ materially from results that may be anticipated by such
forward-looking statements. The principal factors that could cause or
contribute to such differences include, but are not limited to, those
discussed in the section entitled Certain Factors That May Affect Future
Results below, those discussed elsewhere in this report and those discussed
in our Annual Report on Form 10-K filed on March 18, 2003. Readers are
cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date of this report. We undertake no obligation
to revise any forward-looking statements to reflect events or circumstances
that may subsequently arise. Readers are urged to review and consider
carefully the various disclosures made in this report and in our other
filings made with the SEC that attempt to advise interested parties of the
risks and factors that may affect our business, prospects and results of
operations.
|
| | Critical Accounting Estimates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | The discussion and analysis of our financial condition and results of
operations are based upon our unaudited condensed consolidated financial
statements which have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
statements. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our estimates
including those affecting revenues, the allowance for doubtful accounts, the
salability and recoverability of inventory, warranty liabilities, the
carrying value of our investments, the useful lives of intangible assets and
income taxes. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances,
the results of which form our basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions. A more complete description of our critical
accounting estimates established prior to the end of the fiscal year ending
December 31, 2002 is contained in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2002. In addition to those critical
accounting estimates, since December 31, 2002, we have established the
following critical accounting estimates:                                                                                                                                                                                  
|
| | Purchase Allocation Accounting                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | In connection with our acquisitions of the medical treadmill
manufacturing line and Spacelabs Burdick, Inc., we have allocated the
respective purchase prices plus transaction costs to estimated fair values of
assets acquired and liabilities assumed. These purchase price allocation
estimates were made based on our estimates of fair values. Had these
estimates been different, reported amounts allocated to assets and
liabilities and results of operations subsequent to the acquisitions could be
materially impacted.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Useful Lives of Intangible Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Our intangible assets are comprised primarily of a trade name, developed
technology and customer relationships, all of which were acquired in our
acquisition of Burdick. We use our judgment to estimate the fair value of
each of these intangible assets. Our judgment about fair value is based on
our expectation of future cash flows and an appropriate discount rate. We
also use our judgment to estimate the useful lives of each intangible asset.
We believe there are presently no factors which would limit our ability to
benefit from the Burdick trade name in the future, and accordingly do not
amortize the trade name. We evaluate this conclusion annually and make a
judgment about whether there are circumstances that would limit our ability
to benefit from the trade name in the future. If we determine that such
circumstances exist, we would amortize the trade name over the expected
remaining period in which we believe it would continue to provide benefit.
With respect to our developed technology and customer relationship intangible
assets, we also evaluate the remaining useful lives annually. We also
evaluate whether our intangible assets are impaired. For our trade name this
evaluation is performed annually, or more frequently if events occur that
suggest there may be an impairment loss, and involves comparing the carrying
amount to our estimate of fair value. For our developed technology and
customer relationship intangible assets, this evaluation would be performed
if events occur that suggest there may be an impairment loss. If we
concluded any of our intangible assets is impaired, we would record this as a
loss on our statement of operations and as a reduction to the intangible
asset.
|
| | Goodwill                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | Goodwill represents the excess of cost over the estimated fair value of
net assets acquired in connection with our acquisitions of the medical
treadmill manufacturing line and Spacelabs Burdick, Inc. noted above. We
test goodwill for impairment on an annual basis, and between annual tests in
certain circumstances, for each reporting unit identified for purposes of
accounting for goodwill. A reporting unit represents a portion of our
business for which we regularly review certain discrete financial information
and operational results. We have determined that we have three reporting
units, consisting of the Burdick line of products, the Quinton line of
products and the Shanghai-Burdick joint venture. All of our reporting units
operate in the diagnostic cardiology market and have similar economic and
operating characteristics. Application of the goodwill impairment test
requires judgment, including the identification of reporting units, assigning
assets and liabilities to reporting units, assigning goodwill to reporting
units, and determining the fair value of each reporting unit. Significant
judgments required to estimate the fair value of reporting units include
estimating future cash flows, determining appropriate discount rates and
other assumptions. Changes in these estimates and assumptions could
materially affect the determination of fair value for each reporting unit,
and potentially result in recognition of an impairment of goodwill, which
would be reflected as a loss on our statement of operations and as a
reduction in the carrying value of goodwill.                                                                                                                                

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| |                      
| | ---------------------
| | Results of Operations

|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |      |       |  
|------------------- | ---------------------------------------------------------------------- | ------------------------------------------------ | ---- | ----------------------------- | ----- | ----------------------------- | ---- | ---- | ----- | ---- | ---- | ---- | ----- | - | ---- | ---- | ----- | -
|                    |                                                                        |                                                  |      | Three Months Ended            |       | Six Months Ended             
|                    |                                                                        |                                                  |      | June 30,                      |       | June 30,                     
|                    |                                                                        |                                                  |      |                               |       |                              
|                    |                                                                        |                                                  |      | 2002                          |       | 2003                          |      | 2002 |       | 2003
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |     
|                    |                                                                        |                                                  |      | (as a percentage of revenues) |       | (as a percentage of revenues)
|Revenues:           |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    | Systems                                                                |                                                  |      | 80.5                          | %     |                               |      | 85.0 | %     |      |      | 79.6 | %     |   |      | 84.3 | %    
|                    | Service                                                                |                                                  |      | 19.5                          |       |                               |      | 15.0 |       |      |      | 20.4 |       |   |      | 15.7 |      
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Total revenues                                   |      |                               | 100.0 |                               |      |      | 100.0 |      |      |      | 100.0 |   |      |      | 100.0 |  
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|Gross Profit:       |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    | Systems (as a percentage of systems revenue)                           |                                                  |      | 37.1                          |       |                               |      | 40.5 |       |      |      | 37.6 |       |   |      | 38.9 |      
|                    | Service (as a percentage of service revenue)                           |                                                  |      | 46.0                          |       |                               |      | 42.2 |       |      |      | 46.2 |       |   |      | 44.3 |      
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Gross profit                                     |      |                               | 38.9  |                               |      |      | 40.8  |      |      |      | 39.4  |   |      |      | 39.7  |  
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|Operating Expenses: |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    | Research and development                                               |                                                  |      | 11.9                          |       |                               |      | 9.6  |       |      |      | 12.4 |       |   |      | 9.9  |      
|                    | Write off of purchased in-process research
and development             |                                                  |      |                              |       |                               |      |     |       |      |      |     |       |   |      | 3.2  |      
|                    | Sales and marketing                                                    |                                                  |      | 21.9                          |       |                               |      | 21.7 |       |      |      | 22.7 |       |   |      | 21.5 |      
|                    | General and administrative, excluding
stock-based compensation expense |                                                  |      | 9.8                           |       |                               |      | 9.4  |       |      |      | 12.0 |       |   |      | 9.7  |      
|                    | Stock-based compensation                                               |                                                  |      | 0.3                           |       |                               |      | 0.1  |       |      |      | 0.3  |       |   |      | 0.1  |      
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Total operating expenses                         |      |                               | 43.9  |                               |      |      | 40.8  |      |      |      | 47.4  |   |      |      | 44.4  |  
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Operating income (loss)                          |      |                               | (5.0  | )                             |      |      | 0.0   |      |      |      | (8.0  | ) |      |      | (4.7  | )
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Total other income (expense)                     |      |                               | 1.3   |                               |      |      | (0.7  | )    |      |      | 0.4   |   |      |      | (0.3  | )
|                    |                                                                        | Income tax provision                             |      |                               |      |                               |      |      | (0.1  | )    |      |      | (0.1  | ) |      |      |      |  
|                    |                                                                        | Minority interest in loss of
consolidated entity |      |                               |      |                               |      |      |      |      |      |      |      |   |      |      | 0.1   |  
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     
|Net loss            |                                                                        |                                                  | (3.7 | )%                            |       |                               | (0.8 | )%   |       |      | (7.7 | )%   |       |   | (4.9 | )%  
|                    |                                                                        |                                                  |      |                               |       |                               |      |      |       |      |      |      |       |   |      |     



| | Three Month Period Ended June 30, 2003 Compared to the Three Month Period
Ended June 30, 2002
| | ---------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Consolidated operating results for the three-month period ended June 30,
2003 include the operating results of Burdick, which we acquired on January
2, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | Revenues                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Revenues for the three-month period ended June 30, 2003 increased by
$9,447,000, or 83.9%, to $20,706,000 from $11,259,000 for the comparable
period in 2002. This increase was principally due to the addition of
Burdicks revenues, which have been integrated with those of Quinton in 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| | Pro forma combined revenues of Quinton and Burdick for the three-month
period ended June 30, 2002, had the acquisition been completed as of January
1, 2002, would have been $21,316,000. Because of significant uncertainty in
Burdicks distributor channels resulting from the pending sale of Burdick
during the fourth quarter of 2002 and the earlier sale of Burdicks parent on
July 2, 2002, Burdicks revenues were declining at the time of our
acquisition. During the three month period ending June 30, 2003, increases
in Quintons revenues over the comparable period in 2002 were offset by a
decline in Burdicks revenues over the comparable period in 2002. Management
believes that uncertainties in the market relating to Burdicks sale have
been substantially resolved, and management does not expect Burdicks
revenues to decline significantly further in future periods.

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Systems revenue increased by $8,541,000, or 94.2%, to $17,604,000 for
the three-month period ended June 30, 2003 from $9,063,000 for the comparable
period in 2002. This increase was primarily due to the impact of Burdicks
systems revenues. To a lesser extent, the growth in revenues was
attributable to increases in sales of Quintons telemetry systems, including
a new rehabilitation telemetry product released in May 2002.                                                                                                                                                                                                                                                                                                                                                          
|
| | Service revenues increased by $906,000, or 41.3%, to $3,102,000 for the
three-month period ended June 30, 2003 from $2,196,000 as compared to the
same period in 2002. This increase was primarily due to the impact of
Burdicks service revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | Gross Profit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | Gross profit for the three-month period ended June 30, 2003 increased by
$4,065,000, or 92.9%, to $8,442,000 from $4,377,000 for the comparable period
in 2002. Gross profit, as a percentage of revenues, increased to 40.8% for
the three-month period ended June 30, 2003 from 38.9% for the comparable
period in 2002. The increase in gross profit, as a percentage of revenues,
was primarily due to the results of product cost reduction initiatives,
including design cost reductions and other reductions in purchased components
of our products.                                                                                                                                                                                                                                       
|
| | Gross margin from systems revenues increased to 40.5% for the
three-month period ended June 30, 2003, from 37.1% for the comparable period
in 2002. This increase in gross margin, as a percentage of revenues, was
primarily due to the product cost reduction measures referred to above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| | Gross margin from service revenues decreased to 42.2% for the
three-month period ended June 30, 2003, from 46.0% for the comparable period
in 2002. This decrease in gross margin, as a percentage of revenues, was
primarily due to the impact of Burdicks lower gross margin on service
revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| | Operating Expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Research and development expenses for the three-month period ended June
30, 2003 increased by $655,000 to $1,989,000 from $1,334,000 for the
comparable period in 2002. This increase was primarily due to the impact of
additional research and development expenses relating to the acquired Burdick
business. As a percentage of revenues, research and development expenses
decreased to 9.6% for the three-month period ended June 30, 2003 from 11.9%
for the comparable period in 2002. This decrease reflects lower
proportionate spending on research and development in the Burdick business
than Quinton.                                                                                                                                                                               
|
| | Sales and marketing expenses for the three-month period ended June 30,
2003 increased by $2,025,000 to $4,491,000 from $2,466,000 for the comparable
period in 2002. This increase was primarily due to the impact of additional
sales and marketing expenses relating to the acquired Burdick business. As a
percentage of revenues, sales and marketing expenses decreased to 21.7% for
the three-month period ended June 30, 2003 from 21.9% for the comparable
period in 2002. This decrease primarily reflects lower proportionate
spending on sales and marketing in the Burdick business and cost efficiencies
of operating the Quinton and Burdick businesses on a combined basis.                                                                                                         
|
| | General and administrative expenses, excluding stock-based compensation,
for the three-month period ended June 30, 2003, increased by $836,000 to
$1,942,000 from $1,106,000 for the comparable period in 2002. This increase
was primarily due to the impact of additional general and administrative
expenses relating to the acquired Burdick business. As a percentage of
revenues, general and administrative expenses, excluding stock-based
compensation, decreased to 9.4% for the three-month period ended June 30,
2003 from 9.8% for the comparable period in 2002. This decrease primarily
reflects lower proportionate spending in general and administrative areas in
the Burdick business and cost efficiencies of operating the Quinton and
Burdick businesses on a combined basis.
|
| | Stock-based compensation expense for the three-month period ended June
30, 2003 decreased by $17,000 to $18,000, from $35,000 for the comparable
period in 2002. Stock-based compensation expense for both periods relates to
the intrinsic value of stock options granted in 2001. We expect to record
stock-based compensation expense in the third and fourth quarters of 2003 at
a level similar to the amount recorded in the second quarter of 2003.                                                                                                                                                                                                                                                                                                                                         

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Operating Loss                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Operating income for the three-month period ended June 30, 2003 was
$2,000 compared to an operating loss of $564,000 for the comparable period in
2002. The period-over-period improvement was due to factors noted above,
primarily higher gross profit percentage and lower research and development
expenses as a percentage of revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | Other Income and Expense                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | Total other expense for the three-month period ended June 30, 2003 was
$149,000, as compared to total other income of $150,000 for the comparable
period in 2002. Interest income decreased by $37,000 to $9,000 for the
three-month period ended June 30, 2003 from $46,000 for the comparable period
in 2002 primarily due to interest earned on average cash balances during the
three-month period ended 2002. Interest expense increased by $53,000 to
$82,000 for the three-month period ended June 30, 2003 from $29,000 for the
comparable period in 2002 primarily due to an increase in average borrowings
on our bank line of credit over the three-month period ended June 30, 2003 as
compared to average borrowings over the comparable period in 2002. In
addition, interest expense related to putable warrants was $63,000, as
compared to interest income of $133,000 for the comparable period in 2002.
These warrants, held by a former lender, were adjusted to their fair market
value at the end of each accounting period. Gains and losses reflected in the
income statement represent the adjustment of the warrants to their fair
market value during the related period. The holder of the remaining warrants
exercised their put option during the second quarter of 2003. There were no
warrants outstanding as of June 30, 2003.
|
| | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | The income tax provisions recorded in the three month periods ended June
30, 2003 and 2002 were due to state income tax provisions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            



| | Six Month Period Ended June 30, 2003 Compared to the Six Month Period Ended
June 30, 2002
| | -----------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Consolidated operating results for the six-month period ended June 30,
2003 include the operating results of Burdick, which we acquired on January
2, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Revenues                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | Revenues for the six-month period ended June 30, 2003 increased by
$19,341,000, or 89.3%, to $40,989,000 from $21,648,000 for the comparable
period in 2002. This increase was principally due to the addition of
Burdicks revenues, which have been integrated with those of Quinton in 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | Pro forma combined revenues of Quinton and Burdick for the six-month
period ended June 30, 2002, had the acquisition been completed as of January
1, 2002, would have been $41,522,000. Because of significant uncertainty in
Burdicks distributor channels resulting from the pending sale of Burdick
during the fourth quarter of 2002 and the earlier sale of Burdicks parent on
July 2, 2002, Burdicks revenues were declining at the time of our
acquisition. During the six-month period ending June 30, 2003, increases in
Quintons revenues over the comparable period in 2002 were offset by a
decline in Burdicks revenues over the comparable period in 2002. Management
believes that uncertainties in the market relating to Burdicks sale have
been substantially resolved, and management does not expect Burdicks
revenues to decline significantly further in future periods.
|
| | Systems revenue increased by $17,332,000, or 100.6%, to $34,561,000 for
the six-month period ended June 30, 2003 from $17,229,000 for the comparable
period in 2002. This increase was primarily due to the impact of Burdicks
systems revenues. To a lesser extent, the growth in revenues was
attributable to increases in sales of Quintons telemetry systems, including
a new rehabilitation telemetry product released in May 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                           

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Service revenues increased by $2,009,000, or 45.5%, to $6,428,000 for
the six-month period ended June 30, 2003 from $4,419,000 for the comparable
period in 2002. This increase was primarily due to the impact of Burdicks
service revenues and, to a lesser extent, an increase in Quintons service
revenues for the six-month period ended June 30, 2003 over the comparable
period in 2002. The increase in Quintons service revenues was related to
the growth of our customer installed base.                                                                                                                                                                                                                                                                                                                                                                             
|
| | Gross Profit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | Gross profit for the six-month period ended June 30, 2003 increased by
$7,756,000, or 90.9%, to $16,286,000 from $8,530,000 for the comparable
period in 2002. Gross profit, as a percentage of revenues, increased to
39.7% for the six-month period ended June 30, 2003 from 39.4% for the
comparable period in 2002. For the six-month period ended June 30, 2003,
gross profit included a nonrecurring acquisition related charge to cost of
sales of $300,000, reflecting an upward adjustment to Burdicks inventory
valuation from Burdicks historical cost at the acquisition date and its
subsequent expensing in the quarter ended March 31, 2003. This nonrecurring
charge to cost of sales represented an adverse impact to gross profit of
approximately 0.7 percentage points. Charges of this nature relating to the
Burdick acquisition are not expected to recur.
|
| | Gross margin from systems revenues increased to 38.9% for the six-month
period ended June 30, 2003, from 37.6% for the comparable period in 2002.
This increase is primarily due to reductions in material costs. For the
six-month period ended June 30, 2003, gross profit from systems revenues
included a nonrecurring acquisition related charge to cost of sales of
$300,000 discussed above. This nonrecurring charge to cost of sales
represented an adverse impact to gross margin from systems revenues of
approximately 0.9 percentage points.                                                                                                                                                                                                                                                                                                                          
|
| | Gross margin from service revenues of 44.3% for the six-month period
ended June 30, 2003 decreased from 46.2% for comparable period in 2002. This
decrease in gross margin, as a percentage of revenues, was primarily due to
the impact of Burdicks lower gross margin on service revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | Operating Expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Research and development expenses for the six-month period ended June
30, 2003 increased by $1,389,000 to $4,076,000 from $2,687,000 for the
comparable period in 2002. This increase was primarily due to the impact of
additional research and development expenses relating to the acquired Burdick
business. As a percentage of revenues, research and development expenses
decreased to 9.9% for the six-month period ended June 30, 2003 from 12.4% for
the comparable period in 2002. This decrease reflects lower proportionate
spending on research and development in the Burdick business than Quinton.                                                                                                                                                                                                                                                                 
|
| | During the six-month period ended June 30, 2003, we recorded a charge of
$1,290,000 to write off in-process research and development acquired in the
Burdick acquisition. See Note 3 to Unaudited Condensed Consolidated
Financial Statements. We do not expect to incur additional charges in future
periods related to the write off of in-process research and development
acquired in the Burdick acquisition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | Sales and marketing expenses for the six-month period ended June 30,
2003 increased by $3,898,000 to $8,817,000 from $4,919,000 for the comparable
period in 2002. This increase was primarily due to the impact of additional
sales and marketing expenses relating to the acquired Burdick business. As a
percentage of revenues, sales and marketing expenses decreased to 21.5% for
the six-month period ended June 30, 2003 from 22.7% for the comparable period
in 2002. This decrease primarily reflects lower proportionate spending on
sales and marketing in the Burdick business and cost efficiencies of
operating the Quinton and Burdick businesses on a combined basis.                                                                                                                                                                                             
|
| | General and administrative expenses, excluding stock-based compensation,
for the six-month period ended June 30, 2003, increased by $1,380,000 to
$3,969,000 from $2,589,000 for the comparable period in 2002. This increase
was primarily due to the impact of additional general and administrative
expenses relating to the acquired Burdick business. As a percentage of
revenues, general and administrative expenses, excluding stock-based
compensation, decreased to 9.7% for the six-month period ended June 30, 2003
from 12.0% for the comparable period in 2002. This decrease primarily
reflects lower proportionate spending in general and administrative areas in
the Burdick business and cost efficiencies of operating the Quinton and
Burdick businesses on a combined basis.                                                                                 

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| |                                                                                                                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Stock-based compensation expense for the six-month period ended June 30,
2003 decreased by $34,000 to $36,000, from $70,000 for the comparable period
in 2002. Stock-based compensation expense for both periods relates to the
intrinsic value of stock options granted in 2001.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Operating Loss                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Operating loss for the six-month period ended June 30, 2003 increased by
$167,000, or 9.6%, to $1,902,000 from $1,735,000 for the comparable period in
2002. As a percentage of revenues, operating loss for the six-month period
ended June 30, 2003 decreased to 4.7% from 8.0% for the comparable period in
2002. Operating loss for the six-month period ended June 30, 2003 included a
write off of purchased in-process research and development expenses of
$1,290,000 and an acquisition related charge included in cost of sales of
$300,000, both of which were recorded in the quarter ended March 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | Other Income and Expense                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | Total other expense for the six-month period ended June 30, 2003 was
$125,000, as compared to total other income of $80,000 for the comparable
period in 2002. Interest expense increased by $56,000 to $158,000 for the
six-month period ended June 30, 2003 from $102,000 for the comparable period
in 2002 primarily due to an increase in average borrowings on our bank line
of credit over the six-month period ended June 30, 2003 as compared to
average borrowings over the comparable period in 2002. In addition, interest
income related to putable warrants decreased by $101,000 to $32,000 for the
six-month period ended June 30, 2003 from $133,000 for the comparable period
in 2002. These warrants, held by a former lender, were adjusted to their
fair market value at the end of each accounting period. Gains and losses
reflected in the income statement represent the adjustment of the warrants to
their fair market value during the related period. The holder of the
remaining warrants exercised their put option during the second quarter of
2003. There were no warrants outstanding as of June 30, 2003.
|
| | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | Income tax provisions recorded in the six-month periods ended June 30,
2003 and 2002 were due to state income tax provisions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               



| | Consolidation of Manufacturing Operations
| | -----------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have announced plans to consolidate our Deerfield, Wisconsin
and Bothell, Washington manufacturing and production activities to the
Deerfield location. As a result of the related transition activities,
Quinton will incur certain one-time charges relating to severance and
retention of certain employees, moving costs, asset write-offs and
other related charges in the third and fourth quarters of 2003. We
currently estimate that these charges will be in the range of $500,000
to $700,000 in the third quarter of 2003 and between $1,400,000 and
$1,500,000 in the fourth quarter of 2003, which include non-cash
asset write-offs of approximately $400,000. We do not expect this
consolidation to adversely affect revenues in the third or fourth
quarter of 2003. We expect to complete this consolidation by the end
of 2003. We expect to realize cost savings of between $1,500,000 and
$2,000,000 annually thereafter. Substantially all of this cost savings
will be to cost of sales.



| | Liquidity and Capital Resources
| | -------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For the three-month period ended June, 2003, we provided cash from
operating activities of $290,000 primarily from income excluding non-cash
expenses of $407,000 and a reduction of inventories of $1,671,000, which were
partially offset by a reduction of accounts payable of $1,119,000 and accrued
liabilities of $927,000. Inventories and accounts payable at

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| |                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | June 30, 2003 decreased from balances at March 31, 2003 primarily due to
inventory reduction measures resulting in reduced inventory purchases.
Accrued liabilities decreased from the balance at March 31, 2003 primarily
due to lower period-ending payroll and payroll related accruals.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For the six-month period ended June 30, 2003, we used cash from
operating activities of $688,000. This cash flow resulted primarily from
working capital requirements of the newly acquired Burdick business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | Net cash provided from investing activities was $1,893,000 for the
three-month period ended June 30, 2003 primarily due to receiving a
$2,297,000 refund on the Burdick acquisition price. The purchase price
refund was principally used to pay down our credit line and to purchase
capital equipment related to our enterprise resource planning, or ERP, system
conversion. For the three-month period ended June 30, 2002, we used cash in
investing activities of $325,000 primarily for purchases of machinery and
equipment related to our ERP system conversion.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | Net cash used in investing activities was $20,056,000 for the six-month
period ended June 30, 2003 compared to $398,000 for the comparable period in
2002 primarily due to our investment in Burdick of $19,372,000 net of cash
acquired, payments of acquisition costs and a refund from the reduction in
the purchase price. For the six-month period ended June 30, 2003, capital
equipment expenditures increased by $394,000 over the comparable period in
2002. The increase was primarily due to the purchase and conversion of an
enterprise resource planning system.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | Net cash used for financing activities for the three-month period ended
June 30, 2003 of $2,017,000 resulted primarily from net repayments on our
credit line of $1,855,000, a debt payment of $91,000 related to the note
payable issued in the treadmill manufacturing business acquisition and a
payment of $296,000 for the redemption of putable warrants, which was
partially offset by proceeds from exercises of stock options of $19,000 and
proceeds from the issuance of common stock in accordance with our employee
stock purchase plan of $206,000. Net cash from financing activities of
$24,253,000 for the three-month period ended June 30, 2002 was primarily the
result of proceeds from our initial public offering, including the
over-allotment shares, of approximately $28,200,000, net of underwriting
discounts and offering expenses, offset by net repayments on our bank line of
credit of $4,477,000.                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | Net cash from financing activities for the six-month period ended June
30, 2003 of $2,265,000 resulted primarily from net borrowings on our credit
line of $2,474,000, proceeds from exercises of stock options of $63,000 and
proceeds from issuance of common stock of $206,000, partially offset by debt
payments of $182,000 related to the note payable issued in the treadmill
manufacturing business acquisition and a payment for the redemption of
putable warrants of $296,000. Net borrowings on our credit line for the
six-month period ended June 30, 2003 were partially used to fund part of the
purchase price of acquiring Burdick and partially for working capital
requirements. Net cash from financing activities of $24,559,000 for the
six-month period ended June 30, 2002 was the result of proceeds from our
initial public offering, including the over-allotment shares, of
approximately $28,991,000, net of underwriting discounts and offering
expenses, offset by net repayments on our bank line of credit of $4,471,000.
Additional offering expenses of approximately $800,000 related to the initial
public offering were accrued as of June 30, 2002 but were paid in later
periods. The net proceeds from our initial public offering, after payment of
all offering expenses and underwriting discounts was $28,200,000.
|
| | Accounts receivable, inventories, and prepaid expenses and other current
assets at June 30, 2003 increased $2,934,000, $4,614,000, and $285,000,
respectively, from balances at December 31, 2002 due primarily to the
acquisition of Burdick. Cash and cash equivalents declined from $19,382,000
at December 31, 2002 to $903,000 at June 30, 2003, due primarily to the use
of cash to fund the Burdick acquisition. Accounts payable, accrued
liabilities and warranty liability increased $72,000, $1,588,000 and
$1,007,000, respectively, from balances at December 31, 2002 due primarily to
the acquisition of Burdick. The balance on our line of credit at June 30,
2003 was $2,474,000. This indebtedness was incurred to pay part of the
purchase price for our acquisition of Burdick.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | We anticipate that our future operating cash flow and borrowings
available to us under credit facilities will be sufficient to meet our
operating expenses, working capital requirements, capital expenditures and
other obligations for at least 12 months. We periodically evaluate potential
acquisitions of technology or businesses that complement or expand our
existing business or that may enable us to expand into new markets. Future
acquisitions may require additional debt, equity financing or both. We may
not be able to obtain any additional financing, or may not be able to obtain
additional financing on acceptable terms.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

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| | Certain Factors that May Affect Future Results
| | ----------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In addition to the other information contained in this report, the
following risk factors could affect our actual results and could cause our
actual results to differ materially from those achieved in the past or
expressed in our forward-looking statements. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial
also may impair our business operations.



| | The unpredictability of our quarterly revenues and operating results may
cause the trading price of our stock to decrease.
| | --------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our quarterly revenues and operating results have varied in the past and
may continue to vary in the future due to a number of factors, many of which
are outside of our control. Factors contributing to these fluctuations
include:



| |  |  | changes in our ability to obtain products and product components that
are manufactured for us by third parties, such as Holter monitors, as
well as variations in prices of these products and product components;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | delays in the development or commercial introduction of new versions of products and systems;                                                                                                                     
|
| |  |  | our ability to attain and maintain production volumes and quality levels for our products and product components;                                                                                                 
|
| |  |  | the impact of acquisitions, divestitures and other significant corporate events;                                                                                                                                  
|
| |  |  | effects of domestic and foreign economic conditions on our industry and/or customers;                                                                                                                             
|
| |  |  | adoption of our system-oriented sales approach;                                                                                                                                                                   
|
| |  |  | changes in the demand for our products and systems;                                                                                                                                                               
|
| |  |  | varying sales cycles that can take up to a year or more;                                                                                                                                                          
|
| |  |  | changes in the mix of products and systems we sell;                                                                                                                                                               
|
| |  |  | unpredictable budgeting cycles of our customers;                                                                                                                                                                  
|
| |  |  | delays in obtaining regulatory clearance for new versions of our products and systems;                                                                                                                            
|
| |  |  | increased product and price competition;                                                                                                                                                                          
|
| |  |  | the impact of regulatory changes on the availability of third-party
reimbursement to customers of our products and systems;                                                                                       
|
| |  |  | the loss of key sales personnel or distributors; and                                                                                                                                                              
|
| |  |  | seasonality in the sales of our products and systems.                                                                                                                                                             



| |                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Due to the factors summarized above, we believe that period-to-period
comparisons of our operating results are not a good indication of our future
performance and should not be relied on to predict future operating results.
Also, it is possible that, in future periods, our operating results will not
meet the expectations of public market analysts or investors. In that event,
the price of our common stock may decrease.



| | Failure to keep pace with changes in the marketplace may cause us to lose
market share and our revenues may decrease.
| | ---------------------------------------------------------------------------------------------------------------------

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The marketplace for diagnostic cardiology systems is characterized by
rapid change and technological innovation, requiring suppliers in the market
to regularly update product features and incorporate new technologies in
order to remain competitive. In developing and enhancing our products we
have made, and will continue to make, assumptions about which features,
technology standards and performance criteria will be attractive to, or
demanded by, our customers. If we implement features, standards and
performance criteria that are different from those required by our customers
or if our competitors introduce products and systems that better address
these needs, market acceptance of our offerings may suffer or may become
obsolete. In that event, our market share and revenues would likely
decrease.



| | Failure to develop and commercialize new versions of our products would cause
our operating results to suffer.
| | --------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | To be successful, we must develop and commercialize new versions of our
products. Our products are technologically complex and must keep pace with
rapid and significant technological change, comply with rapidly evolving
industry standards and government regulations, and compete effectively with
new product introductions of our competitors. Accordingly, many of our
products require significant planning, design, development and testing at the
technological, product and manufacturing process levels. Our success in
developing and commercializing new versions of our products is affected by
our ability to:



| |  |  | accurately assess customer needs;                                                                          
| | - |  | -----------------------------------------------------------------------------------------------------------
|
| |  |  | develop products that are easy to use;                                                                     
|
| |  |  | minimize the time required to obtain, as well as the costs of, required regulatory clearance or approval;  
|
| |  |  | price competitively;                                                                                       
|
| |  |  | manufacture and deliver on time;                                                                           
|
| |  |  | accurately predict and control costs associated with manufacturing, installation, warranty and maintenance;
|
| |  |  | manage customer acceptance and payment;                                                                    
|
| |  |  | limit demands by our customers for retrofits; and                                                          
|
| |  |  | anticipate and compete effectively with our competitors efforts.                                          



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The rate of market acceptance of our current or future products and
systems using our recently introduced Microsoft Windows-based software
platform may impact our operating results. In addition, we may experience
design, manufacturing, marketing or other difficulties that could delay or
prevent our development, introduction or marketing of new versions of our
products. Such difficulties and delays could cause our development expenses
to increase and harm our operating results.



| | If market conditions cause us to reduce the selling price of our products and
systems, or our market share is negatively affected by the activities of our
competitors, our margins and operating results will decrease.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The selling price of our products and systems and the extent of our
market share are subject to market conditions. Market conditions that could
impact these aspects of our operations include:



| |  |  | delays in product launches;             
| | - |  | ----------------------------------------
|
| |  |  | lengthening of buying or selling cycles;
|
| |  |  | the introduction of competing products; 
|
| |  |  | price reductions by our competitors;    

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| |  |  | development of more effective products by our competitors;                 
| | - |  | ---------------------------------------------------------------------------
|
| |  |  | hospital budgetary constraints; and                                        
|
| |  |  | changes in the reimbursement policies of government and third-party payers.



| |                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If such conditions force us to sell our products and systems at lower
prices, or if we are unable to effectively develop and market competitive
products, our market share, margins and operating results will likely
decrease.



| | A number of factors could adversely affect our operating performance during
and after the transition period required to consolidate the Quinton
manufacturing operations into the Deerfield location.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have decided to consolidate the Bothell, Washington and Deerfield,
Wisconsin manufacturing operations into the Deerfield location and to
consolidate our corporate headquarters in Bothell into a smaller space. This
transition will take place during the third and fourth quarters of 2003. We
expect cost savings will come from a combination of a reduction in facilities
space and a reduction in staffing requirements due to consolidation of the
two previously separate manufacturing and production organizations. In
connection with the transition activities, Quinton expects to incur certain
one-time charges relating to severance and retention of certain employees,
moving costs, asset write-offs and other related charges in the third and
fourth quarters of 2003. Given the magnitude and complexity of these
changes, a number of factors could adversely affect our performance during
and after the transition process. These factors could increase the magnitude
of the one-time charges we expect to incur, could cause significant and
costly operating inefficiencies, could adversely impact our ability to
deliver products to our customers on a timely basis and could reduce the
level of overall cost savings that we ultimately achieve through the
consolidation. These factors include, but are not limited to, our possible
inability to retain key manufacturing and operations personnel in
Bothell through the transition period, possible delays in hiring key new
personnel in Deerfield, unexpected
costs in consolidating our manufacturing operations, unexpected delays in the
manufacturing process after the consolidation of the manufacturing
operations, our inability to achieve anticipated cost savings from our
consolidation of manufacturing operations and disruptions in supplies or
increases in prices of certain components used in our manufacturing
operations.



| | If we fail to successfully integrate acquired businesses, product lines,
assets or technologies, our operating results may suffer.
| | ----------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | As part of our growth strategy, we intend to selectively acquire other
businesses, product lines, assets, or technologies. Successful execution of
our acquisition strategy depends upon our ability to identify, negotiate,
complete and integrate suitable acquisitions and, if necessary, to obtain
satisfactory debt or equity financing. If we acquire complementary
businesses or assets but fail to successfully integrate them, our financial
condition or results of operations may suffer.



| | Our future financial results could be adversely impacted by asset impairments
or other charges.
| | -----------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We adopted Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets. As a result, we are required to test
both acquired goodwill and other indefinite-lived intangible assets,
consisting of a trade name for impairment on an annual basis based upon a
fair value approach, rather than amortizing them over time. We are also
required to test goodwill for impairment between annual tests if an event
occurs or circumstances change that would more likely than not reduce the
fair value of our reporting units below their book value. These events or
circumstances could include a significant change in the business climate,
legal factors, operating performance indicators, competition, sale or
disposition of a significant portion of the business, or other factors such
as a decline in our market value below our book value for an extended period
of time. Additionally, our other indefinite-lived intangible assets must be
tested between annual tests if events or changes in circumstances indicate
that the assets might be impaired. Additionally, we evaluate the estimated
lives of all intangible assets on an annual basis, including those with
indefinite lives, to determine if events and circumstances warrant a revision
in the remaining period of amortization. In the case of intangible assets
with indefinite lives, we evaluate whether events or circumstances continue
to support an indefinite useful life. The amount of any such annual or
interim impairment charge could be significant, and could have a material
adverse effect on our reported financial results for the period in which the
charge is taken.



| | If we fail to maintain our distributor relationships our sales and operating
results may suffer.
| | ------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Burdick sells its products, both domestically and internationally,
principally through third party distributors, and Quinton sells its products
internationally through third party distributors. While both Burdick and
Quinton have well

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| |                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | established relationships with these distributors, the underlying
agreements are generally for periods of one year or less. If these agreements
are cancelled or if we are unable to renew them as they expire, our sales and
operating results may suffer materially.



| | We may need additional capital to continue our acquisition growth strategy.
| | ---------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Successful continued execution of our acquisition strategy depends upon
our ability to identify, negotiate, complete and integrate suitable
acquisitions and, if necessary, to obtain satisfactory debt or equity
financing. We are likely to require additional debt or equity financing to
make any further significant acquisitions. Such financing may not be
available on terms that are acceptable to us or at all. If we are required to
incur additional indebtedness to fund acquisitions in the future, our cash
flow may be negatively affected by additional debt servicing requirements and
the terms of such indebtedness may impose covenants and restrictions that
provide us less flexibility in how we operate our business. Recent
performance of our stock price may make it difficult to make acquisitions
using our stock as consideration. Moreover, use of our stock to fund
acquisitions may have a significant dilutive effect on existing shareholders.



| | Our lack of customer purchase contracts and our limited order backlog make it
difficult to predict sales and plan manufacturing requirements, which can
lead to lower revenues, higher expenses and reduced margins.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We do not generally have long-term purchase contracts with customers who
order products on a purchase order basis. In limited circumstances, customer
orders may be cancelled, changed or delayed on short notice. Lack of
significant order backlog makes it difficult for us to forecast future sales
with certainty. Long and varying sales cycles with our customers make it
difficult to accurately forecast component and product requirements. These
factors expose us to a number of risks:



| |  |  | if we overestimate our requirements we may be obligated to purchase
more components or third-party products than is required;                                                                                                                       
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | if we underestimate our requirements, our third-party manufacturers
and suppliers may have an inadequate product or product component
inventory, which could interrupt manufacturing of our products and
result in delays in shipments and revenues;
|
| |  |  | we may also experience shortages of product components from time to
time, which also could delay the manufacturing of our products; and                                                                                                             
|
| |  |  | over or under production can lead to higher expense, lower than
anticipated revenues, and reduced margins.                                                                                                                                          



| | If we do not develop or maintain successful relationships with international
distributors, our growth may be limited, sales of our products and systems
may decrease and our operating results may suffer.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During 2000, 2001, and 2002, we generated, on average, approximately 8%
of our revenues from international sales and our growth strategy contemplates
expanded efforts to increase international sales. All of our international
sales in recent periods were attributable to third-party distributors, and
our success in expanding international sales in the future will depend on our
ability to develop and manage a network of international distributors and the
performance of our distributors. Because we do not generally have long-term
contracts with our distributors, our distribution relationships may be
terminated on little or no notice. If we lose any significant international
distributors, or if any of our distributors devote more effort to selling
competing products and systems, our international sales and operating results
may suffer and our growth may be limited. Consequently, our success in
expanding international sales may be limited if our distributors lack, or are
unable to develop, relationships with important target customers in
international markets.



| | Undetected product errors or defects could result in increased warranty
costs, loss of revenues, product recalls, delayed market acceptance and
claims against us.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | Any errors or defects in our products discovered after commercial release could result in:



| |  |  | failure to achieve market acceptance;
| | - |  | -------------------------------------

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| |  |  | loss of customers, revenues and market share;
| | - |  | ---------------------------------------------
|
| |  |  | diversion of development resources;          
|
| |  |  | increased service and warranty costs;        
|
| |  |  | legal actions by our customers; and          
|
| |  |  | increased insurance costs.                   



| | Inadequate levels of reimbursement from governmental or other third-party
payers for procedures using our products and systems may cause our revenues
to decrease.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Significant changes in the healthcare systems in the U.S. or elsewhere
could have a significant impact on the demand for our products and services
as well as the way we conduct business. Federal, state and local governments
have adopted a number of healthcare policies intended to curb rising
healthcare costs. In the U.S., healthcare providers that purchase our
products and systems generally rely on governmental and other third-party
payers, such as federal Medicare, state Medicaid, and private health
insurance plans, to pay for all or a portion of the cost of heart-monitoring
procedures and consumable products utilized in those procedures. The
availability of such reimbursement affects our customers decisions to
purchase capital equipment. Denial of coverage or reductions in levels of
reimbursement for procedures performed using our products and systems by
governmental or other third-party payers would cause our revenues to
decrease. We are unable to predict whether federal, state or local healthcare
reform legislation or regulation affecting our business may be proposed or
enacted in the future, or what effect any such legislation or regulation
would have on our business.



| | If we fail to obtain or maintain applicable regulatory clearances or
approvals for our products, or if clearances or approvals are delayed, we
will be unable to commercially distribute and market our products in the U.S.
and other jurisdictions.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our products are medical devices that are subject to significant
regulation in the U.S. and in foreign countries where we do business. The
processes for obtaining regulatory approval can be lengthy and expensive, and
the results are unpredictable. If we are unable to obtain clearances or
approvals needed to market existing or new products, or obtain such
clearances or approvals in a timely fashion, it could adversely affect our
revenues and profitability.




Item 3. Quantitative and Qualitative Disclosures About Market Risk



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We develop products in the U.S. and sell them worldwide. As a result,
our financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic conditions in foreign markets. Since
our products are currently priced in U.S. dollars and are translated to local
currency amounts, a strengthening of the dollar could make our products less
competitive in foreign markets. Interest income is sensitive to changes in
the general level of U.S. interest rates, particularly since our investments
are in short-term investments calculated at variable rates.




Item 4. Controls and Procedures



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We maintain disclosure controls and procedures designed to ensure that
information required to be disclosed in our filings under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commissions rules
and forms. Our chief executive officer and chief financial officer have
evaluated our disclosure controls and procedures as of the end of the period
covered by this quarterly report of Form 10-Q and have determined that such
disclosure controls and procedures are effective.
|
| | There has been no change in our internal control over financial
reporting in connection with this evaluation that has materially affected, or
is reasonably likely to materially affect, our internal control over
financial reporting.                                                                                                                                                                                                                                                                                                                                                    

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##### Table of Contents






PART II - OTHER INFORMATION




Item 1. Legal Proceedings



| |                                                                
| | ---------------------------------------------------------------
| | We are not currently a party to any material legal proceedings.




Item 2. Changes in Securities and Use of Proceeds



| |      
| | -----
| | None.




Item 3. Defaults Upon Senior Securities



| |      
| | -----
| | None.




Item 4. Submission of Matters to a Vote of Security Holders



| |                                                                                              
| | ---------------------------------------------------------------------------------------------
| | At our Annual Meeting of Stockholders held on May 16, 2003, the
following actions were taken:



| | 1. |  | Election of Directors
| | -- |  | ---------------------

|                         |  |     |           |          |  |  |        | 
|------------------------ |  | --- | --------- | -------- |  |  | ------ | 
|                         |  | For |           | Withheld
|                         |  |     |           |         
|Ruediger Naumann-Etienne |  |     | 8,119,682 |          |  |  | 1,006  | 
|Harvey N. Gillis         |  |     | 8,106,160 |          |  |  | 14,528 | 



| | 2. |  | To approve our reincorporation from California to Delaware by
means of a merger with and into a wholly-owned Delaware subsidiary.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------

|          |  |               |        |             |  |           |     |  |  |        |           | 
|--------- |  | ------------- | ------ | ----------- |  | --------- | --- |  |  | ------ | --------- | 
|          |  |               |        |             |  |           |     |  |  | Broker
|          |  |               |        |             |  |           |     |  |  |       
|Votes For |  | Votes Against |        | Abstentions |  | Non-Votes
|          |  |               |        |             |  |          
|6,857,551 |  |               | 14,798 |             |  |           | 976 |  |  |        | 1,247,363 | 




Item 5. Other Information



| |      
| | -----
| | None.

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Item 6. Exhibits and Reports on Form 8-K



| | (a) |  | Exhibits
| | --- |  | --------

| |              |  |                                                                                                                                             
| | ------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------
| | Exhibit 31.1 |  | Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934 of Item 601 of
Regulation S-K.
| |              |  |                                                                                                                                             
| | Exhibit 31.2 |  | Certification of Chief Financial Officer Pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934 of Item 601 of
Regulation S-K.
| |              |  |                                                                                                                                             
| | Exhibit 32.1 |  | Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350 (Section 906 of the
Sarbanes-Oxley Act of 2002).                
| |              |  |                                                                                                                                             
| | Exhibit 32.2 |  | Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350 (Section 906 of the
Sarbanes-Oxley Act of 2002).                



| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------



| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | On April 25, 2003, we filed a Form 8-K related to the press release
discussing the Companys results for the first quarter of 2003.



| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | On May 21, 2003, we filed a Form 8-K to report a reincorporation in the
state of Delaware.

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##### Table of Contents






SIGNATURE



| |                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

| |  |                                  |  |                                                                                                                  
| |  | -------------------------------- |  | -----------------------------------------------------------------------------------------------------------------
| |  | QUINTON CARDIOLOGY SYSTEMS, INC.
| |  |                                  |  |                                                                                                                  
| |  | By:                              |  | /s/ Michael K. Matysik                                                                                           
| |  |                                  |  |                                                                                                                  
| |  |                                  |  | Michael K. Matysik
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

Date: August 14, 2003

27