##### 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 March 31, 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)


|                         |  |                                  
|------------------------ |  | ---------------------------------
|California               |  | 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  [ü] |  | No  [  ]

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

|          |  |        
|--------- |  | -------
|Yes  [  ] |  | No  [ü]

As of May 5, 2003, 12,120,793 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                     
|CERTIFICATION                 
|EXHIBIT 99.1                  
|EXHIBIT 99.2                  



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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                            |  |    | 22 | 
|                               | Item 4. Controls and Procedures                                                               |  |    | 22 | 
|PART II - OTHER INFORMATION    |                                                                                               |  | 24 |   
|                               | Item 1. Legal Proceedings                                                                     |  |    | 24 | 
|                               | Item 2. Changes in Securities and Use of Proceeds                                             |  |    | 24 | 
|                               | Item 3. Defaults Upon Senior Securites                                                        |  |    | 24 | 
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                   |  |    | 24 | 
|                               | Item 5. Other Information                                                                     |  |    | 25 | 
|                               | Item 6. Exhibits and Reports on Form 8-K                                                      |  |    | 25 | 
|SIGNATURE                      |                                                                                               |  | 26 |   
|CERTIFICATION                  |                                                                                               |  | 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, |       | March 31,
|                                                                          |                                                                                                                                                                           |                                            |       |         |        | 2002         |       | 2003     
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |          
|ASSETS                                                                    |                                                                                                                                                                           |                                            |       |         |        |              |       |          
|Current
Aseets:                                                           |                                                                                                                                                                           |                                            |       |         |        |              |       |           |        |  |  | 
|                                                                          | Cash and cash equivalents                                                                                                                                                 |                                            | $     | 19,382  |        |              | $     | 737       |       
|                                                                          | Accounts receivable, net of allowance for doubtful accounts                                                                                                               |                                            |       | 7,384   |        |              |       | 10,568    |       
|                                                                          | Inventories                                                                                                                                                               |                                            |       | 7,462   |        |              |       | 13,747    |       
|                                                                          | Refund receivable from the seller of Burdick, Inc.                                                                                                                        |                                            |       |        |        |              |       | 2,297     |       
|                                                                          | Prepaid expenses and other current assets                                                                                                                                 |                                            |       | 528     |        |              |       | 732       |       
|                                                                          | Income taxes receivable                                                                                                                                                   |                                            |       | 206     |        |              |       | 206       |       
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|                                                                          |                                                                                                                                                                           | Total current assets                       |       |         | 34,962 |              |       |           | 28,287 | 
|Machinery and equipment, net of accumulated depreciation
and amortization |                                                                                                                                                                           |                                            | 3,510 |         |        |              | 5,527 |          
|Intangible assets, net of accumulated amortization                        |                                                                                                                                                                           |                                            | 393   |         |        |              | 5,939 |          
|Goodwill                                                                  |                                                                                                                                                                           |                                            | 860   |         |        |              | 9,991 |          
|Investment in unconsolidated entity                                       |                                                                                                                                                                           |                                            | 1,000 |         |        |              | 1,000 |          
|Restricted cash deposit                                                   |                                                                                                                                                                           |                                            | 1,325 |         |        |              |      |          
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|                                                                          |                                                                                                                                                                           | Total assets                               |       | $       | 42,050 |              |       | $         | 50,744 | 
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|LIABILITIES AND SHAREHOLDERS EQUITY                                      |                                                                                                                                                                           |                                            |       |         |        |              |       |          
|Current Liabilities:                                                      |                                                                                                                                                                           |                                            |       |         |        |              |       |          
|                                                                          | Line of credit                                                                                                                                                            |                                            | $     |        |        |              | $     | 4,329     |       
|                                                                          | Current portion of long term debt                                                                                                                                         |                                            |       | 363     |        |              |       | 363       |       
|                                                                          | Accounts payable                                                                                                                                                          |                                            |       | 4,776   |        |              |       | 5,967     |       
|                                                                          | Accrued liabilities                                                                                                                                                       |                                            |       | 3,415   |        |              |       | 6,050     |       
|                                                                          | Warranty liability                                                                                                                                                        |                                            |       | 1,089   |        |              |       | 2,152     |       
|                                                                          | Deferred revenue                                                                                                                                                          |                                            |       | 4,407   |        |              |       | 4,508     |       
|                                                                          | Putable warrants                                                                                                                                                          |                                            |       | 328     |        |              |       | 233       |       
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|                                                                          |                                                                                                                                                                           | Total current liabilities                  |       |         | 14,378 |              |       |           | 23,602 | 
|Long term debt, net of current portion                                    |                                                                                                                                                                           |                                            | 363   |         |        |              | 272   |          
|Deferred tax liability                                                    |                                                                                                                                                                           |                                            |      |         |        |              | 1,156 |          
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|                                                                          |                                                                                                                                                                           | Total liabilities                          |       |         | 14,741 |              |       |           | 25,030 | 
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|Minority interest in consolidated entity                                  |                                                                                                                                                                           |                                            |      |         |        |              | 202   |          
|Shareholders Equity:                                                     |                                                                                                                                                                           |                                            |       |         |        |              |       |          
|                                                                          | Common stock (100,000,000 shares authorized), no par
value, 12,049,136 and 12,112,102 shares issued and
outstanding at December 31, 2002 and March 31, 2003,
respectively |                                            |       | 45,085  |        |              |       | 45,129    |       
|                                                                          | Deferred stock-based compensation                                                                                                                                         |                                            |       | (180    | )      |              |       | (162      | )     
|                                                                          | Accumulated deficit                                                                                                                                                       |                                            |       | (17,596 | )      |              |       | (19,455   | )     
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|                                                                          |                                                                                                                                                                           | Total shareholders equity                 |       |         | 27,309 |              |       |           | 25,512 | 
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       
|                                                                          |                                                                                                                                                                           | Total liabilities and shareholders equity |       | $       | 42,050 |              |       | $         | 50,744 | 
|                                                                          |                                                                                                                                                                           |                                            |       |         |        |              |       |           |       

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
|                                                                              |                                                                        |                              |         | March 31,         
|                                                                              |                                                                        |                              |         |                   
|                                                                              |                                                                        |                              |         | 2002               |        | 2003
|                                                                              |                                                                        |                              |         |                    |        |     
|Revenues:                                                                     |                                                                        |                              |         |                    |        |      |            |       
|                                                                              | Systems                                                                |                              | $       | 8,166              |        |      | $          | 16,957 |       
|                                                                              | Service                                                                |                              |         | 2,223              |        |      |            | 3,326  |       
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|                                                                              |                                                                        | Total revenues               |         |                    | 10,389 |      |            |        | 20,283 |  
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Cost of Revenues:                                                             |                                                                        |                              |         |                    |        |      |            |       
|                                                                              | Systems                                                                |                              |         | 5,045              |        |      |            | 10,652 |       
|                                                                              | Service                                                                |                              |         | 1,191              |        |      |            | 1,787  |       
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|                                                                              |                                                                        | Total cost of revenues       |         |                    | 6,236  |      |            |        | 12,439 |  
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|                                                                              |                                                                        | Gross profit                 |         |                    | 4,153  |      |            |        | 7,844  |  
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Operating Expenses:                                                           |                                                                        |                              |         |                    |        |      |            |       
|                                                                              | Research and development                                               |                              |         | 1,353              |        |      |            | 2,087  |       
|                                                                              | Write off of purchased in-process research and
development projects    |                              |         |                   |        |      |            | 1,290  |       
|                                                                              | Sales and marketing                                                    |                              |         | 2,453              |        |      |            | 4,326  |       
|                                                                              | General and administrative, excluding
stock-based compensation expense |                              |         | 1,483              |        |      |            | 2,027  |       
|                                                                              | Stock-based compensation                                               |                              |         | 35                 |        |      |            | 18     |       
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|                                                                              |                                                                        | Total operating expenses     |         |                    | 5,324  |      |            |        | 9,748  |  
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|                                                                              |                                                                        | Operating loss               |         |                    | (1,171 | )    |            |        | (1,904 | )
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Other Income (Expense):                                                       |                                                                        |                              |         |                    |        |      |            |       
|                                                                              | Interest income                                                        |                              |         |                   |        |      |            | 1      |       
|                                                                              | Interest expense                                                       |                              |         | (73                | )      |      |            | (76    | )     
|                                                                              | Interest income, putable warrants                                      |                              |         |                   |        |      |            | 95     |       
|                                                                              | Other income, net                                                      |                              |         | 3                  |        |      |            | 4      |       
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|                                                                              |                                                                        | Total other income (expense) |         |                    | (70    | )    |            |        | 24     |  
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Loss before income taxes and minority interest in loss of
consolidated entity |                                                                        |                              | (1,241  | )                  |        |      | (1,880     | )     
|                                                                              | Income tax provision                                                   |                              |         | (10                | )      |      |            |       |       
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Loss before minority interest in loss of consolidated entity                  |                                                                        |                              | (1,251  | )                  |        |      | (1,880     | )     
|                                                                              | Minority interest in loss of consolidated entity                       |                              |         |                   |        |      |            | 21     |       
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Net loss                                                                      |                                                                        | $                            | (1,251  | )                  |        | $    | (1,859     | )     
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Basic and diluted net loss per share                                          |                                                                        | $                            | (1.91   | )                  |        | $    | (0.15      | )     
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       
|Weighted average shares used to compute
basic and diluted
net loss per share  |                                                                        |                              | 656,609 |                    |        |      | 12,093,777 |       
|                                                                              |                                                                        |                              |         |                    |        |      |            |        |       

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

4



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QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |       |        |         |  
|------------------------------------------------- | ------------------------------------------------------------------------ | ---------------------------------------------------------------------- | ----------------------------------------- | ---------------------------------------- | --- | ------------------ | ------- | ------- | ----- | ------ | ------- | -
|                                                  |                                                                          |                                                                        |                                           |                                          |     | Three Months Ended
|                                                  |                                                                          |                                                                        |                                           |                                          |     | March 31,         
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                   
|                                                  |                                                                          |                                                                        |                                           |                                          |     | 2002               |         | 2003   
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |        
|Operating Activities:                             |                                                                          |                                                                        |                                           |                                          |     |                    |         |        
|                                                  | Net loss                                                                 |                                                                        | $                                         | (1,251                                   | )   |                    | $       | (1,859  | )    
|                                                  | Adjustments to reconcile net loss to net cash from operating activities |                                                                        |                                           |                                          |     |                    |         |         |      
|                                                  |                                                                          | Depreciation and amortization                                          |                                           |                                          | 291 |                    |         |         | 497   |       
|                                                  |                                                                          | Loss on sale of equipment                                              |                                           |                                          | 9   |                    |         |         |      |       
|                                                  |                                                                          | Stock-based compensation                                               |                                           |                                          | 35  |                    |         |         | 18    |       
|                                                  |                                                                          | Interest income, putable warrants                                      |                                           |                                          |    |                    |         |         | (95   | )     
|                                                  |                                                                          | Write off of purchased in-process research and development             |                                           |                                          |    |                    |         |         | 1,290 |       
|                                                  |                                                                          | Minority interest in loss of consolidated entity                       |                                           |                                          |    |                    |         |         | (21   | )     
|                                                  |                                                                          | Changes in operating assets and liabilities, net of business acquired: |                                           |                                          |     |                    |         |         |       |       
|                                                  |                                                                          |                                                                        | Accounts receivable                       |                                          |     | (39                | )       |         |       | 614    |        
|                                                  |                                                                          |                                                                        | Inventories                               |                                          |     | 404                |         |         |       | 486    |        
|                                                  |                                                                          |                                                                        | Prepaid expenses and other current assets |                                          |     | (28                | )       |         |       | (20    | )      
|                                                  |                                                                          |                                                                        | Accounts payable                          |                                          |     | 121                |         |         |       | (1,534 | )      
|                                                  |                                                                          |                                                                        | Accrued liabilities                       |                                          |     | 272                |         |         |       | (208   | )      
|                                                  |                                                                          |                                                                        | Warranty liability                        |                                          |     | (109               | )       |         |       | 47     |        
|                                                  |                                                                          |                                                                        | Deferred revenue                          |                                          |     | 274                |         |         |       | (193   | )      
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|                                                  |                                                                          |                                                                        |                                           | Net cash flows from operating activities |     |                    | (21     | )       |       |        | (978    | )
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|Investing Activities:                             |                                                                          |                                                                        |                                           |                                          |     |                    |         |        
|                                                  | Purchases of machinery and equipment                                     |                                                                        |                                           | (73                                      | )   |                    |         | (435    | )    
|                                                  | Proceeds from sale of machinery and equipment                            |                                                                        |                                           |                                         |     |                    |         | 35      |      
|                                                  | Purchase of Burdick, Inc., net of cash acquired                          |                                                                        |                                           |                                         |     |                    |         | (21,549 | )    
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|                                                  |                                                                          |                                                                        |                                           | Net cash flows from investing activities |     |                    | (73     | )       |       |        | (21,949 | )
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|Financing Activities:                             |                                                                          |                                                                        |                                           |                                          |     |                    |         |        
|                                                  | Borrowings on bank line of credit, net                                   |                                                                        |                                           | 306                                      |     |                    |         | 4,329   |      
|                                                  | Payments of long term debt                                               |                                                                        |                                           |                                         |     |                    |         | (91     | )    
|                                                  | Proceeds from exercise of stock options                                  |                                                                        |                                           |                                         |     |                    |         | 44      |      
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|                                                  |                                                                          |                                                                        |                                           | Net cash flows from financing activities |     |                    | 306     |         |       |        | 4,282   |  
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|Net change in cash and cash equivalents           |                                                                          |                                                                        | 212                                       |                                          |     |                    | (18,645 | )      
|Cash and cash equivalents, beginning of period    |                                                                          |                                                                        | 218                                       |                                          |     |                    | 19,382  |        
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|Cash and cash equivalents, end of period          |                                                                          | $                                                                      | 430                                       |                                          |     | $                  | 737     |        
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      
|Supplemental disclosure of cash flow information: |                                                                          |                                                                        |                                           |                                          |     |                    |         |        
|                                                  | Cash paid for interest                                                   |                                                                        | $                                         | 74                                       |     |                    | $       | 57      |      
|                                                  |                                                                          |                                                                        |                                           |                                          |     |                    |         |         |      

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 California 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 March
31, 2003, the condensed consolidated statements of operations for the
three-month periods ended March 31, 2002 and 2003 and the condensed
consolidated statements of cash flows for the three-month periods ended
March 31, 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

6



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##### Table of Contents





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



| |                            
| | ---------------------------
| | 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
common equivalent shares outstanding during the period. Common equivalent
shares consist of the shares of common stock issuable upon the conversion of
the convertible preferred stock (using the if-converted method) and shares
issuable upon the exercise of stock options, including outstanding shares
subject to repurchase, and warrants (using the treasury stock method);
common equivalent 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-month periods ended
March 31, 2002 and 2003:

|                                        |                                                     |  |                    |         |      |  |  |            | 
|--------------------------------------- | --------------------------------------------------- |  | ------------------ | ------- | ---- |  |  | ---------- | 
|                                        |                                                     |  | Three months ended
|                                        |                                                     |  | March 31,         
|                                        |                                                     |  |                   
|                                        |                                                     |  | 2002               |         | 2003
|                                        |                                                     |  |                    |         |     
|Shares (denominator basic and diluted): |                                                     |  |                    |         |      |  |  |           
|                                        | Weighted average common shares outstanding          |  |                    | 677,456 |      |  |  | 12,093,777 | 
|                                        | Less: weighted average shares subject to repurchase |  |                    | (20,847 | )    |  |  |           | 
|                                        |                                                     |  |                    |         |      |  |  |            | 
|                                        | Denominator for basic and diluted calculation       |  |                    | 656,609 |      |  |  | 12,093,777 | 
|                                        |                                                     |  |                    |         |      |  |  |            | 



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For the three months ended March 31, 2002 and 2003, 7,955,682, and
1,802,435 respectively, shares of common stock subject to repurchase, stock
options, warrants and common stock issuable upon conversion of outstanding
preferred stock 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 common stock equivalents 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



---



##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Had compensation cost been determined based on the fair value of the
options at the grant dates during the three month periods ended March 31,
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):

|                                                                                                                                            |  |           |        |           |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | ------ | --------- |  | - | ------ | -
|                                                                                                                                            |  | March 31, |        | March 31,
|                                                                                                                                            |  | 2002      |        | 2003     
|                                                                                                                                            |  |           |        |          
|Net loss  as reported                                                                                                                      |  | $         | (1,251 | )         |  | $ | (1,859 | )
|Add back: Total stock-based employee compensation
expense
included in reported loss, net of related tax effects                             |  |           | 35     |           |  |   | 18     |  
|Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects |  |           | (130   | )         |  |   | (207   | )
|                                                                                                                                            |  |           |        |           |  |   |        |  
|Net loss  pro forma                                                                                                                        |  | $         | (1,346 | )         |  | $ | (2,048 | )
|                                                                                                                                            |  |           |        |           |  |   |        |  
|Net loss per share  as reported                                                                                                            |  | $         | (1.91  | )         |  | $ | (0.15  | )
|Net loss per share  pro forma                                                                                                              |  | $         | (2.05  | )         |  | $ | (0.17  | )



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 $4.62, 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. The Company 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. The Company 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

8



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 $30,000 and $114,000 for the three-month periods ended March
31, 2002 and 2003, respectively.



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



| |                                                                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Most but not all of the information that the Company has arranged to
obtain in order to finalize the purchase price allocation has been obtained.
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 | )

9



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##### Table of Contents



|                      |  |                     |        |   |        |  |  |  |  | 
|--------------------- |  | ------------------- | ------ | - | ------ |  |  |  |  | 
|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 three-month period
ended March 31, 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.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 period ended March 31, 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 three month period ended March 31, 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.

10



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##### Table of Contents





| |                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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-month period ended March 31, 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,
expect per share amounts)

|                                     |  |                 |        |  
|------------------------------------ |  | --------------- | ------ | -
|                                     |  | Three Months   
|                                     |  | Ended March 31,
|                                     |  | 2002           
|                                     |  |                
|Revenues                             |  | $               | 20,206 |  
|Net loss                             |  | $               | (1,810 | )
|Basic and diluted net loss per share |  | $               | (2.76  | )



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



| |               
| | --------------
| | 4. 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, |       | March 31,
|                 |                   |   | 2002         |       | 2003     
|                 |                   |   |              |       |          
|Raw materials    |                   | $ | 3,433        |       |           | $ | 8,495 |       
|Work in progress |                   |   | 984          |       |           |   | 930   |       
|Finished goods   |                   |   | 3,045        |       |           |   | 4,322 |       
|                 |                   |   |              |       |           |   |       |       
|                 | Total inventories |   | $            | 7,462 |           |   | $     | 13,747 | 
|                 |                   |   |              |       |           |   |       |       



| |              
| | -------------
| | 5. 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

11



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| |                                                                                                                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 March 31, 2003).



| |                    
| | -------------------
| | 6. 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 market value of the shares was approximately
$158,000. As of March 31, 2003, the fair value of the remaining outstanding
putable warrants was approximately $233,000. Changes in the fair value of
this liability are recorded in the statements of operations as interest
income (expense), putable warrants. These warrants expire on June 30, 2003.



| |                      
| | ---------------------
| | 7. Warranty Liability



| |                                                                                  
| | ---------------------------------------------------------------------------------
| | The Companys warranty liability is summarized as follows (amounts in
thousands):

|                                               |  |   |       |   | 
|---------------------------------------------- |  | - | ----- | - | 
|Beginning of period, December 31, 2002         |  | $ | 1,089 |  
|Charged to cost of revenues                    |  |   | 281   |  
|Applied to liability                           |  |   | (234  | )
|Warranty liability acquired from Burdick, Inc. |  |   | 1,016 |  
|                                               |  |   |       |  
|End of period, March 31, 2003                  |  | $ | 2,152 |  
|                                               |  |   |       |  



| |                 
| | ----------------
| | 8. 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 other 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

12



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 is 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.



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

13



---



##### Table of Contents



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.



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

|                    |                                                                        |                                                  |       |                               |       |      |      |      |       |  
|------------------- | ---------------------------------------------------------------------- | ------------------------------------------------ | ----- | ----------------------------- | ----- | ---- | ---- | ---- | ----- | -
|                    |                                                                        |                                                  |       | Three Months Ended           
|                    |                                                                        |                                                  |       | March 31,                    
|                    |                                                                        |                                                  |       |                              
|                    |                                                                        |                                                  |       | 2002                          |       | 2003
|                    |                                                                        |                                                  |       |                               |       |     
|                    |                                                                        |                                                  |       | (as a percentage of revenues)
|Revenues:           |                                                                        |                                                  |       |                               |       |      |      |     
|                    | Systems                                                                |                                                  |       | 78.6                          | %     |      |      | 83.6 | %    
|                    | Service                                                                |                                                  |       | 21.4                          |       |      |      | 16.4 |      
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|                    |                                                                        | Total revenues                                   |       |                               | 100.0 |      |      |      | 100.0 |  
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|Gross Profit:       |                                                                        |                                                  |       |                               |       |      |      |     
|                    | Systems (as a percentage of systems revenue)                           |                                                  |       | 38.2                          |       |      |      | 37.2 |      
|                    | Service (as a percentage of service revenue)                           |                                                  |       | 46.4                          |       |      |      | 46.3 |      
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|                    |                                                                        | Gross profit                                     |       |                               | 40.0  |      |      |      | 38.7  |  
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|Operating Expenses: |                                                                        |                                                  |       |                               |       |      |      |     
|                    | Research and development                                               |                                                  |       | 13.0                          |       |      |      | 10.3 |      
|                    | Write off of purchased in-process research and development             |                                                  |       |                              |       |      |      | 6.4  |      
|                    | Sales and marketing                                                    |                                                  |       | 23.6                          |       |      |      | 21.3 |      
|                    | General and administrative, excluding
stock-based compensation expense |                                                  |       | 14.3                          |       |      |      | 10.0 |      
|                    | Stock-based compensation                                               |                                                  |       | 0.3                           |       |      |      | 0.1  |      
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|                    |                                                                        | Total operating expenses                         |       |                               | 51.2  |      |      |      | 48.1  |  
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|                    |                                                                        | Operating loss                                   |       |                               | (11.3 | )    |      |      | (9.4  | )
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|                    |                                                                        | Total other income (expense)                     |       |                               | (0.7  | )    |      |      | 0.1   |  
|                    |                                                                        | Minority interest in loss of consolidated entity |       |                               |      |      |      |      | 0.1   |  
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      
|Net loss            |                                                                        |                                                  | (12.0 | )%                            |       |      | (9.2 | )%  
|                    |                                                                        |                                                  |       |                               |       |      |      |      |      



| |                                                                                                
| | -----------------------------------------------------------------------------------------------
| | Three Month Period Ended March 31, 2003 Compared to the Three Month Period
Ended March 31, 2002



| |                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Consolidated operating results for the three-month period ended March
31, 2003 include the operating results of Burdick, which we acquired on
January 2, 2003.



| |         
| | --------
| | Revenues



| |                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Revenues for the three-month period ended March 31, 2003 increased by
$9,894,000, or 95.2%, to $20,283,000 from $10,389,000 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 period ended
March 31, 2002, had the acquisition been completed as of January 1, 2002,
would have been $20,206,000. 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

14



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | at the time of our
acquisition. During the three month period ending March 31, 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 $8,791,000, or 107.7%, to $16,957,000 for
the three-month period ended March 31, 2003 from $8,166,000 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
system, primarily due to a new rehabilitation telemetry product released in May 2002.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Service revenues increased by $1,103,000, or 49.6%, to $3,326,000 for
the three-month period ended March 31, 2003 from $2,223,000 as compared to
the same 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 three-month period ended March 31, 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 three-month period ended March 31, 2003 increased
by $3,691,000, or 88.9%, to $7,844,000 from $4,153,000 for the comparable
period in 2002. Gross profit, as a percentage of revenues, decreased to
38.7% for the three-month period ended March 31, 2003 from 40.0% for the
comparable period in 2002. The decrease in gross profit percentage is
primarily due to 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 three-month period ended March 31, 2003. This
nonrecurring charge to cost of sales represented an adverse impact to gross
profit of approximately 1.5 percentage points. Charges of this nature
relating to the Burdick acquisition are not expected to recur.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Gross profit from systems revenues decreased to 37.2% for the
three-month period ended March 31, 2003, from 38.2% for the comparable
period in 2002. This decrease was primarily the result of 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 profit from systems revenues of approximately 1.8 percentage points.
Other fluctuations in product mix, resulting in slightly higher
proportionate sales of higher margin products, partially offset this
decrease.



| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | Gross profit from service revenues for the three-month period ended
March 31, 2003 was comparable to that for the same period in 2002.



| |                   
| | ------------------
| | Operating Expenses



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Research and development expenses for the three-month period ended
March 31, 2003 increased by $734,000 to $2,087,000 from $1,353,000 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 10.3% for the three-month period ended March 31, 2003
from 13.0% for the comparable period in 2002. This decrease reflects lower
proportionate spending on research and development in the Burdick business
than Quinton.



| |                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During the three-month period ended March 31, 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

15



---



##### Table of Contents





| |                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 three-month period ended March 31,
2003 increased by $1,873,000 to $4,326,000 from $2,453,000 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 21.3% for the three-month period ended March 31, 2003 from
23.6% 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 March 31, 2003, increased by
$544,000 to $2,027,000 from $1,483,000 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 10.0% for the three-month period
ended March 31, 2003 from 14.3% 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 March
31, 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 second quarter of 2003 at a
level similar to the amount recorded in the first quarter of 2003.



| |               
| | --------------
| | Operating Loss



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Operating loss for the three-month period ended March 31, 2003
increased by $733,000, or 62.6%, to $1,904,000 from $1,171,000 for the
comparable period in 2002. The increase in operating loss was due primarily
to 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. This was partially offset by other factors noted above, primarily
lower research and development, sales and marketing and general and
administrative expenses as a percentage of revenues.



| |                         
| | ------------------------
| | Other Income and Expense



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Total other income for the three-month period ended March 31, 2003 was
$24,000, as compared to total other expense of $70,000 for the comparable
period in 2002. This change was primarily the result of recording interest
income related to putable warrants of $95,000 during the three-month period
ended March 31, 2003. These warrants, held by a former lender, are 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 warrants
expire on June 30, 2003. There was no interest income or expense related to
putable warrants in the comparable period in 2002.



| |             
| | ------------
| | Income Taxes



| |                                                                                                 
| | ------------------------------------------------------------------------------------------------
| | There was no income tax benefit or loss recorded for the three-month
period ended March 31, 2003



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



| |                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For the three-month period ended March 31, 2003, we used cash from
operating activities of $978,000. This cash flow resulted primarily from
working capital requirements of the newly acquired Burdick business.

16



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Net cash used in investing activities was $21,949,000 for the
three-month period ended March 31, 2003 compared to $73,000 for the
comparable period in 2002 primarily due to our investment in Burdick of
$21,549,000 net of cash acquired, payments of acquisition costs, and an
increase in expenditures for capital equipment, primarily for the purchase
and conversion of an enterprise resource planning system. We anticipate an
additional investment of approximately $50,000 to complete the purchase and
conversion of our enterprise resource planning system.                                                                                                                                                                                                                                
|
| | Net cash from financing activities for the three-month period ended
March 31, 2003 of $4,282,000 resulted primarily from net borrowings on our
credit line of $4,329,000 and proceeds from exercises of stock options of
$44,000, partially offset by a debt payment of $91,000 related to the note
payable issued in the treadmill manufacturing business acquisition. Net
borrowings on our credit line for the three-month period ended March 31,
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 $306,000 for the three-month period ended March 31,
2002 was the result of net borrowings on our bank line of credit.                                                         
|
| | Accounts receivable, inventories, and prepaid expenses and other
current assets at March 31, 2003 increased $3,184,000, $6,285,000, and
$204,000, 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 $737,000 at March 31, 2002, due
primarily to the use of cash to fund the Burdick acquisition. Accounts
payable, accrued liabilities and warranty liability increased $1,191,000,
$2,635,000 and $1,063,000, respectively, from balances at December 31, 2002
due primarily to the acquisition of Burdick. The balance on our line of
credit at March 31, 2002 was $4,329,000. This indebtedness was incurred to
pay part of the purchase price for our acquisition of Burdick.
|
| | At March 31, 2003, we had a $2.3 million refund receivable from the
seller of Burdick, relating to a post-closing purchase price adjustment. We
have since collected this receivable and have used the proceeds to reduce
our line of credit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | 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.                                                                                                                                                       



| |                                                                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17



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##### Table of Contents





| |  |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| | 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,                                                                                                                                                                                                                                                                                                                                                                                                        

18



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| |                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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;                                       
|
| |  |  | 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.

19



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we fail to successfully integrate acquired businesses, including Burdick
and the treadmill manufacturing business, product lines, assets or
technologies, our operating results may suffer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | As part of our growth strategy, we acquired the treadmill manufacturing
business in October 2002 and Burdick in January 2003. As a result of these
acquisitions, we increased our headcount significantly and added additional
products, technology and manufacturing operations. Integrating these
acquisitions with our business will require a substantial amount of time and
effort from our management team. This diversion of managements attention,
as well as any difficulties encountered in the integration process, could
have an adverse impact on our business and our future operating results.
Moreover, our failure to successfully integrate these acquisitions,
particularly Burdick, may result in the loss of sales and customers of
Burdick. We intend to selectively acquire other businesses, product lines,
assets, or technologies. Integration of future acquisitions will require
significant management attention and, if not accomplished successfully,
could harm our business, our acquired entitys business and our future
operating results.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | Our future financial results could be adversely impacted by asset
impairments or other charges.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | Effective January 1, 2003, 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 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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

20



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| |                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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;        
| | - |  | ---------------------------------------------
|
| |  |  | loss of customers, revenues and market share;
|
| |  |  | diversion of development resources;          

21



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| |  |  | 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 within 90 days prior to the
filing of this quarterly report of Form 10-Q and have determined that such
disclosure controls and procedures are effective.

22



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| |                                                                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There have been no significant changes in our internal controls or in
other factors that could significantly affect internal controls subsequent
to the date of their evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

23



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##### Table of Contents






PART II - OTHER INFORMATION




Item 1.   Legal Proceedings



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In November 2000, we disputed the notice of termination from a former
supplier, Zymed, Inc., and initiated a lawsuit in the federal district court
for the Western District of Washington against the supplier. We also named
Agilent Technologies, Inc. and The Hewlett Packard Company as defendants.
We sought monetary damages and other available remedies against the
defendants for harm to our business resulting from Zymeds termination of
our Holter monitoring systems distribution agreement in August 2000. We
incurred significant costs in prosecuting this lawsuit in 2001 and in 2002.
The case went to trial and concluded in January 2003. The jury found in
favor of the supplier and, consequently, we did not obtain any award for
damages. We do not expect to incur any significant additional expenses in
connection with this lawsuit.



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




Item 2.   Changes in Securities and Use of Proceeds



| |                                                       
| | ------------------------------------------------------
| | (d) Use of Proceeds from Sale of Registered Securities



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our registration statement on Form S-1 under the Securities Act of 1933
(File No. 333-83272), relating to our initial public offering of common
stock, without par value, was declared effective by the Securities and
Exchange Commission on May 6, 2002. The offering was co-managed by Adams,
Harkness & Hill, Inc., WR Hambrecht+Co and Delafield Hambrecht, Inc.
Pursuant to the registration statement, we registered and sold an aggregate
of 4,600,000 shares of common stock, including the underwriters exercise of
their over-allotment option to purchase 600,000 shares, at $7.00 per share,
for an aggregate offering price of $32.2 million. In connection with the
offering we incurred total expenses of approximately $4.0 million, including
underwriting discounts and commissions of approximately $2.3 million. WR
Hambrecht+Co received approximately $348,000 as compensation for its
underwriting services. At the time, WR Hambrecht+Co was a member of
W.R.Hambrecht/QIC, LLC, our largest shareholder until the latters
distribution of all of its shares of our common stock to its members in
November 2002. Our director, William R. Hambrecht, is a significant
shareholder, director and officer of WR Hambrecht+Co. Delafield Hambrecht,
Inc. received approximately $288,000 as compensation for its underwriting
services. John D. Delafield, who served as one of our directors from April
1998 until October 2002, is a significant shareholder, director and officer
of Delafield Hambrecht. The remaining expenses were all direct or indirect
payments to others and not payments to our directors, officers (or their
associates), affiliates or 10% shareholders. None of the net proceeds was
used as payments to our director, officers (or their associates), affiliates
or 10% shareholders. In May 2002, we used approximately $4.5 million of the
net proceeds from the offering to repay outstanding balances under our bank
line of credit. In October 2002, we used $1,000,000 of the net proceeds of
the offering to pay part of the purchase price for the acquisition of our
treadmill manufacturing business. We used the remaining net proceeds in
December 2002 and January 2003 to pay part of the purchase price to acquire
100% of the stock of Spacelabs Burdick, Inc.




Item 3.   Defaults Upon Senior Securities



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




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



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

24



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Item 5.   Other Information



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




Item 6.   Exhibits and Reports on Form 8-K

(a)   Exhibits

| |              |  |                                                                                                                        
| | ------------ |  | -----------------------------------------------------------------------------------------------------------------------
| | Exhibit 99.1 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| |              |  |                                                                                                                        
| | Exhibit 99.2 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)   Reports on Form 8-K



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On January 17, 2003, we filed a Form 8-K under Item 2 to report the
acquisition of all of the outstanding shares of capital stock of Spacelabs
Burdick, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | On March 18, 2003, we filed a Form 8-K/A under Item 2 to report the
acquisition of all of the outstanding shares of capital stock of Spacelabs
Burdick, Inc., and under Item 7 to report Spacelabs Burdick, Inc.
Consolidated Financial Statements as of December 31, 2001 and 2002, for the
years ended December 31, 2000 and 2001, for the period January 1, 2002
through July 2, 2002, and for the period July 3, 2002 through December 31,
2002 (With Independent Auditors Report Thereon) and to report Quinton
Cardiology Systems, Inc. Unaudited Pro Forma Condensed Consolidated
Financial Statements as of and for the year ended December 31, 2002.

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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: May 15, 2003 |  |                                  |                                                   |                       

26



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##### Table of Contents






CERTIFICATION



| |                                           
| | ------------------------------------------
| | I, Ruediger Naumann-Etienne, certify that:



| |                                                                                                   
| | --------------------------------------------------------------------------------------------------
| | 1.         I have reviewed this quarterly report on Form 10-Q of Quinton
Cardiology Systems, Inc.;



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



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



| |                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 4.         The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



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



| |                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b)         Evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and



| |                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | c)         Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;



| |                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5.         The registrants other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrants auditors and the
audit committee of registrants board of directors (or persons performing
the equivalent function):



| |                                                                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a)         All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and



| |                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b)         Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants internal
controls; and



| |                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6.         The registrants other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.

|                   |  |                                                  
|------------------ |  | -------------------------------------------------
|Date: May 15, 2003 |  |                                                  
|                   |  |                                                  
|                   |  | /s/ Ruediger Naumann-Etienne                     
|                   |  | Ruediger Naumann-Etienne                         
|                   |  | Chairman of the Board and Chief Executive Officer

27



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##### Table of Contents



CERTIFICATION



| |                                     
| | ------------------------------------
| | I, Michael K. Matysik, certify that:



| |                                                                                                   
| | --------------------------------------------------------------------------------------------------
| | 1.         I have reviewed this quarterly report on Form 10-Q of Quinton
Cardiology Systems, Inc.;



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



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



| |                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 4.         The registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:



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



| |                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b)         Evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and



| |                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | c)         Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;



| |                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5.         The registrants other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrants auditors and the
audit committee of registrants board of directors (or persons performing
the equivalent function):



| |                                                                                                                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a)         All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to record,
process, summarize and report financial data and have identified for the
registrants auditors any material weaknesses in internal controls; and



| |                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | b)         Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrants internal
controls; and



| |                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6.         The registrants other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.

|                   |  |                                                  
|------------------ |  | -------------------------------------------------
|Date: May 15, 2003 |  |                                                  
|                   |  |                                                  
|                   |  | /s/ Michael K. Matysik                           
|                   |  | Michael K. Matysik                               
|                   |  | Senior Vice President and Chief Financial Officer

28