##### 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 September 30, 2003

OR

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________to__________

Commission File Number 000-49755

QUINTON CARDIOLOGY SYSTEMS, INC.

(Exact name of registrant as specified in its charter)


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

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

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

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

Yes
x                    
No o

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

Yes o                   No x

As of November 7, 2003, 12,187,873 shares of the issuers common stock were
outstanding.

1



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TABLE OF CONTENTS



|                               |                                                                                               |  |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I - FINANCIAL INFORMATION
|                               | Item 1. Unaudited Financial Statements                                                       
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|PART II  OTHER INFORMATION   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 2. Changes in Securities and Use of Proceeds                                            
|                               | Item 3. Defaults Upon Senior Securities                                                      
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                               | Item 5. Other Information                                                                    
|                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                     
|EXHIBIT 10.1                  
|EXHIBIT 10.2                  
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  
|EXHIBIT 32.2                  



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##### Table of Contents



TABLE OF CONTENTS

|                               |                                                                                               |  |    |    | 
|------------------------------ | --------------------------------------------------------------------------------------------- |  | -- | -- | 
|PART I - FINANCIAL INFORMATION |                                                                                               |  | 3  |   
|                               | Item 1. Unaudited Financial Statements                                                        |  |    | 3  | 
|                               | Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations |  |    | 13 | 
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  |    | 27 | 
|                               | Item 4. Controls and Procedures                                                               |  |    | 27 | 
|PART II - OTHER INFORMATION    |                                                                                               |  | 28 |   
|                               | Item 1. Legal Proceedings                                                                     |  |    | 28 | 
|                               | Item 2. Changes in Securities and Use of Proceeds                                             |  |    | 28 | 
|                               | Item 3. Defaults Upon Senior Securites                                                        |  |    | 28 | 
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                   |  |    | 28 | 
|                               | Item 5. Other Information                                                                     |  |    | 28 | 
|                               | Item 6. Exhibits and Reports on Form 8-K                                                      |  |    | 28 | 
|SIGNATURE                      |                                                                                               |  | 29 |   

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, |       | September 30,
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        | 2002         |       | 2003         
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|ASSETS                                                                    |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|Current Assets:                                                           |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|                                                                          | Cash and cash equivalents                                                                                                                                                        |                                            | $     | 19,382  |        |              | $     | 451           |       
|                                                                          | Accounts receivable, net of allowance for doubtful accounts                                                                                                                      |                                            |       | 7,384   |        |              |       | 11,101        |       
|                                                                          | Inventories                                                                                                                                                                      |                                            |       | 7,462   |        |              |       | 11,918        |       
|                                                                          | Prepaid expenses and other current assets                                                                                                                                        |                                            |       | 528     |        |              |       | 574           |       
|                                                                          | Income taxes receivable                                                                                                                                                          |                                            |       | 206     |        |              |       |              |       
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|                                                                          |                                                                                                                                                                                  | Total current assets                       |       |         | 34,962 |              |       |               | 24,044 | 
|Machinery and equipment, net of accumulated depreciation
and amortization |                                                                                                                                                                                  |                                            | 3,510 |         |        |              | 5,410 |              
|Intangible assets, net of accumulated amortization                        |                                                                                                                                                                                  |                                            | 393   |         |        |              | 5,751 |              
|Goodwill                                                                  |                                                                                                                                                                                  |                                            | 860   |         |        |              | 9,953 |              
|Investment in unconsolidated entity                                       |                                                                                                                                                                                  |                                            | 1,000 |         |        |              | 1,000 |              
|Restricted cash deposit                                                   |                                                                                                                                                                                  |                                            | 1,325 |         |        |              |      |              
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |               |       
|                                                                          |                                                                                                                                                                                  | Total assets                               |       | $       | 42,050 |              |       | $             | 46,158 | 
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |               |       
|LIABILITIES AND SHAREHOLDERS EQUITY                                      |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|Current Liabilities:                                                      |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|                                                                          | Line of credit                                                                                                                                                                   |                                            | $     |        |        |              | $     | 883           |       
|                                                                          | Current portion of long term debt                                                                                                                                                |                                            |       | 363     |        |              |       | 363           |       
|                                                                          | Accounts payable                                                                                                                                                                 |                                            |       | 4,776   |        |              |       | 5,184         |       
|                                                                          | Accrued liabilities                                                                                                                                                              |                                            |       | 3,415   |        |              |       | 5,617         |       
|                                                                          | Warranty liability                                                                                                                                                               |                                            |       | 1,089   |        |              |       | 2,101         |       
|                                                                          | Deferred revenue                                                                                                                                                                 |                                            |       | 4,407   |        |              |       | 4,630         |       
|                                                                          | Putable warrants                                                                                                                                                                 |                                            |       | 328     |        |              |       |              |       
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |               |       
|                                                                          |                                                                                                                                                                                  | Total current liabilities                  |       |         | 14,378 |              |       |               | 18,778 | 
|Long term debt, net of current portion                                    |                                                                                                                                                                                  |                                            | 363   |         |        |              | 91    |              
|Deferred tax liability                                                    |                                                                                                                                                                                  |                                            |      |         |        |              | 1,156 |              
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |               |       
|                                                                          |                                                                                                                                                                                  | Total liabilities                          |       |         | 14,741 |              |       |               | 20,025 | 
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |               |       
|Minority interest in consolidated entity                                  |                                                                                                                                                                                  |                                            |      |         |        |              | 199   |              
|Shareholders Equity:                                                     |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|                                                                          | Preferred stock (10,000,000 shares authorized), $0.001 par
value, no shares outstanding in 2002 or 2003                                                                          |                                            |       |        |        |              |       |              |       
|                                                                          | Common stock (65,000,000 shares authorized), $0.001 par
value, 12,049,136 and 12,187,207 shares issued and
outstanding at December 31, 2002 and September 30,
2003, respectively |                                            |       | 12      |        |              |       | 12            |       
|                                                                          | Additional paid-in capital                                                                                                                                                       |                                            |       | 45,073  |        |              |       | 45,477        |       
|                                                                          | Deferred stock-based compensation                                                                                                                                                |                                            |       | (180    | )      |              |       | (126          | )     
|                                                                          | Accumulated deficit                                                                                                                                                              |                                            |       | (17,596 | )      |              |       | (19,429       | )     
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|                                                                          |                                                                                                                                                                                  | Total shareholders equity                 |       |         | 27,309 |              |       |               | 25,934 | 
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |              
|                                                                          |                                                                                                                                                                                  | Total liabilities and shareholders equity |       | $       | 42,050 |              |       | $             | 46,158 | 
|                                                                          |                                                                                                                                                                                  |                                            |       |         |        |              |       |               |       

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 |        | Nine months ended
|                                                                               |                                                                        |                              |            | September 30,      |        | September 30,    
|                                                                               |                                                                        |                              |            |                    |        |                  
|                                                                               |                                                                        |                              |            | 2002               |        | 2003              |            | 2002   |        | 2003
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |     
|Revenues:                                                                      |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               | Systems                                                                |                              | $          | 9,380              |        |                   | $          | 17,747 |        |      | $         | 26,609 |        |   | $          | 52,308 |       
|                                                                               | Service                                                                |                              |            | 2,275              |        |                   |            | 3,287  |        |      |           | 6,694  |        |   |            | 9,715  |       
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               |                                                                        | Total revenues               |            |                    | 11,655 |                   |            |        | 21,034 |      |           |        | 33,303 |   |            |        | 62,023 |  
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Cost of Revenues:                                                              |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               | Systems                                                                |                              |            | 5,959              |        |                   |            | 10,669 |        |      |           | 16,701 |        |   |            | 31,793 |       
|                                                                               | Service                                                                |                              |            | 1,109              |        |                   |            | 1,777  |        |      |           | 3,485  |        |   |            | 5,356  |       
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               |                                                                        | Total cost of revenues       |            |                    | 7,068  |                   |            |        | 12,446 |      |           |        | 20,186 |   |            |        | 37,149 |  
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               |                                                                        | Gross profit                 |            |                    | 4,587  |                   |            |        | 8,588  |      |           |        | 13,117 |   |            |        | 24,874 |  
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Operating Expenses:                                                            |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               | Research and development                                               |                              |            | 1,205              |        |                   |            | 1,969  |        |      |           | 3,892  |        |   |            | 6,045  |       
|                                                                               | Write off of purchased in-process research
and development projects    |                              |            |                   |        |                   |            |       |        |      |           |       |        |   |            | 1,290  |       
|                                                                               | Sales and marketing                                                    |                              |            | 2,460              |        |                   |            | 4,519  |        |      |           | 7,379  |        |   |            | 13,336 |       
|                                                                               | General and administrative, excluding
stock-based compensation expense |                              |            | 1,434              |        |                   |            | 1,838  |        |      |           | 4,023  |        |   |            | 5,807  |       
|                                                                               | Stock-based compensation                                               |                              |            | 23                 |        |                   |            | 18     |        |      |           | 93     |        |   |            | 54     |       
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               |                                                                        | Total operating expenses     |            |                    | 5,122  |                   |            |        | 8,344  |      |           |        | 15,387 |   |            |        | 26,532 |  
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               |                                                                        | Operating income (loss)      |            |                    | (535   | )                 |            |        | 244    |      |           |        | (2,270 | ) |            |        | (1,658 | )
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Other Income (Expense):                                                        |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               | Interest income                                                        |                              |            | 97                 |        |                   |            |       |        |      |           | 143    |        |   |            | 10     |       
|                                                                               | Interest expense                                                       |                              |            |                   |        |                   |            | (63    | )      |      |           | (102   | )      |   |            | (221   | )     
|                                                                               | Interest income, putable warrants                                      |                              |            | 161                |        |                   |            |       |        |      |           | 294    |        |   |            | 32     |       
|                                                                               | Other income (expense), net                                            |                              |            | (2                 | )      |                   |            | 2      |        |      |           | 1      |        |   |            | (7     | )     
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|                                                                               |                                                                        | Total other income (expense) |            |                    | 256    |                   |            |        | (61    | )    |           |        | 336    |   |            |        | (186   | )
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Income (loss) before income taxes and minority interest
in consolidated entity |                                                                        |                              | (279       | )                  |        |                   | 183        |        |        |      | (1,934    | )      |        |   | (1,844     | )     
|                                                                               | Income tax provision                                                   |                              |            | (2                 | )      |                   |            | (4     | )      |      |           | (16    | )      |   |            | (13    | )     
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Income (loss) before minority interest in consolidated
entity                  |                                                                        |                              | (281       | )                  |        |                   | 179        |        |        |      | (1,950    | )      |        |   | (1,857     | )     
|                                                                               | Minority interest in loss of consolidated entity                       |                              |            |                   |        |                   |            | 4      |        |      |           |       |        |   |            | 24     |       
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Net income (loss)                                                              |                                                                        | $                            | (281       | )                  |        | $                 | 183        |        |        | $    | (1,950    | )      |        | $ | (1,833     | )     
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Net income (loss) per share  basic                                            |                                                                        | $                            | (0.02      | )                  |        | $                 | 0.02       |        |        | $    | (0.30     | )      |        | $ | (0.15      | )     
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Net income (loss) per share  diluted                                          |                                                                        | $                            | (0.02      | )                  |        | $                 | 0.01       |        |        | $    | (0.30     | )      |        | $ | (0.15      | )     
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Weighted average shares outstanding  basic                                    |                                                                        |                              | 11,951,569 |                    |        |                   | 12,168,390 |        |        |      | 6,512,247 |        |        |   | 12,131,066 |       
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       
|Weighted average shares outstanding  diluted                                  |                                                                        |                              | 11,951,569 |                    |        |                   | 13,052,236 |        |        |      | 6,512,247 |        |        |   | 12,131,066 |       
|                                                                               |                                                                        |                              |            |                    |        |                   |            |        |        |      |           |        |        |   |            |       

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

4



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(in thousands)

|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |         |       |        |         |  
|------------------------------------------------- | ---------------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ----------------------------------------- | ---------------------------------------- | ---- | ------------------ | ---- | ----------------- | --- | ---- | ------ | ------ | ---- | ---- | ------- | ------- | ----- | ------ | ------- | -
|                                                  |                                                                                    |                                                                        |                                           |                                          |      | Three Months Ended |      | Nine Months Ended
|                                                  |                                                                                    |                                                                        |                                           |                                          |      | September 30,      |      | September 30,    
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                  
|                                                  |                                                                                    |                                                                        |                                           |                                          |      | 2002               |      | 2003              |     | 2002 |        | 2003  
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |       
|Operating Activities:                             |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|                                                  | Net income (loss)                                                                  |                                                                        | $                                         | (281                                     | )    |                    | $    | 183               |     |      | $      | (1,950 | )    |      | $       | (1,833  | )    
|                                                  | Adjustments to reconcile net income (loss) to net cash from
operating activities  |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |         |      
|                                                  |                                                                                    | Depreciation and amortization                                          |                                           |                                          | 308  |                    |      |                   | 420 |      |        |        | 891  |      |         |         | 1,393 |       
|                                                  |                                                                                    | Loss on disposal of equipment                                          |                                           |                                          | 5    |                    |      |                   |    |      |        |        | 14   |      |         |         | 6     |       
|                                                  |                                                                                    | Amortization of deferred stock-based compensation                      |                                           |                                          | 23   |                    |      |                   | 18  |      |        |        | 93   |      |         |         | 54    |       
|                                                  |                                                                                    | Interest income, putable warrants                                      |                                           |                                          | (161 | )                  |      |                   |    |      |        |        | (294 | )    |         |         | (32   | )     
|                                                  |                                                                                    | Write off of purchased in-process research and development             |                                           |                                          |     |                    |      |                   |    |      |        |        |     |      |         |         | 1,290 |       
|                                                  |                                                                                    | Minority interest in loss of consolidated entity                       |                                           |                                          |     |                    |      |                   | (4  | )    |        |        |     |      |         |         | (24   | )     
|                                                  |                                                                                    | Changes in operating assets and liabilities, net of
business acquired: |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |         |       |       
|                                                  |                                                                                    |                                                                        | Accounts receivable                       |                                          |      | 608                |      |                   |     | (783 | )      |        |      | 560  |         |         |       | 81     |        
|                                                  |                                                                                    |                                                                        | Inventories                               |                                          |      | (752               | )    |                   |     | 158  |        |        |      | 3    |         |         |       | 2,315  |        
|                                                  |                                                                                    |                                                                        | Prepaid expenses and other current assets |                                          |      | 82                 |      |                   |     | 239  |        |        |      | (7   | )       |         |       | 344    |        
|                                                  |                                                                                    |                                                                        | Accounts payable                          |                                          |      | 91                 |      |                   |     | 336  |        |        |      | 228  |         |         |       | (2,317 | )      
|                                                  |                                                                                    |                                                                        | Accrued liabilities                       |                                          |      | 65                 |      |                   |     | 627  |        |        |      | 225  |         |         |       | (508   | )      
|                                                  |                                                                                    |                                                                        | Warranty liability                        |                                          |      | (57                | )    |                   |     | 5    |        |        |      | (229 | )       |         |       | (4     | )      
|                                                  |                                                                                    |                                                                        | Deferred revenue                          |                                          |      | 306                |      |                   |     | 183  |        |        |      | 589  |         |         |       | (71    | )      
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|                                                  |                                                                                    |                                                                        |                                           | Net cash flows from operating activities |      |                    | 237  |                   |     |      | 1,382  |        |      |      | 123     |         |       |        | 694     |  
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|Investing Activities:                             |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|                                                  | Purchases of machinery and equipment                                               |                                                                        |                                           | (286                                     | )    |                    |      | (275              | )   |      |        | (684   | )    |      |         | (1,067  | )    
|                                                  | Proceeds from sale of machinery and equipment                                      |                                                                        |                                           |                                         |      |                    |      |                  |     |      |        |       |      |      |         | 108     |      
|                                                  | Purchase of Burdick, Inc., net of cash acquired                                    |                                                                        |                                           |                                         |      |                    |      | (13               | )   |      |        |       |      |      |         | (19,385 | )    
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |         |      
|                                                  |                                                                                    |                                                                        |                                           | Net cash flows from investing activities |      |                    | (286 | )                 |     |      | (288   | )      |      |      | (684    | )       |       |        | (20,344 | )
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|Financing Activities:                             |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|                                                  | Borrowings (repayments) on bank line of credit, net                                |                                                                        |                                           |                                         |      |                    |      | (1,591            | )   |      |        | (4,471 | )    |      |         | 883     |      
|                                                  | Payments of long term debt                                                         |                                                                        |                                           |                                         |      |                    |      | (90               | )   |      |        |       |      |      |         | (272    | )    
|                                                  | Proceeds from exercise of stock options                                            |                                                                        |                                           | 3                                        |      |                    |      | 10                |     |      |        | 42     |      |      |         | 73      |      
|                                                  | Redemption of putable warrants                                                     |                                                                        |                                           | (158                                     | )    |                    |      |                  |     |      |        | (158   | )    |      |         | (296    | )    
|                                                  | Proceeds from (costs of) issuance of stock, net of issuance costs                  |                                                                        |                                           | (630                                     | )    |                    |      | 125               |     |      |        | 28,361 |      |      |         | 331     |      
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|                                                  |                                                                                    |                                                                        |                                           | Net cash flows from financing activities |      |                    | (785 | )                 |     |      | (1,546 | )      |      |      | 23,774  |         |       |        | 719     |  
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|Net change in cash and cash equivalents           |                                                                                    |                                                                        | (834                                      | )                                        |      |                    | (452 | )                 |     |      | 23,213 |        |      |      | (18,931 | )      
|Cash and cash equivalents, beginning of period    |                                                                                    |                                                                        | 24,265                                    |                                          |      |                    | 903  |                   |     |      | 218    |        |      |      | 19,382  |        
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|Cash and cash equivalents, end of period          |                                                                                    | $                                                                      | 23,431                                    |                                          |      | $                  | 451  |                   |     | $    | 23,431 |        |      | $    | 451     |        
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |         |      
|Supplemental disclosure of cash flow information: |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        
|                                                  | Cash paid for interest                                                             |                                                                        | $                                         |                                         |      |                    | $    | 84                |     |      | $      | 131    |      |      | $       | 224     |      
|                                                  |                                                                                    |                                                                        |                                           |                                          |      |                    |      |                   |     |      |        |        |      |      |         |        

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

5



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.     Organization and Description of Business



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

2.     Summary of Significant Accounting Policies



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Basis of Presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | The condensed financial statements present the Company on a consolidated
basis. All significant intercompany accounts and transactions have been
eliminated. The condensed consolidated balance sheet dated September 30,
2003, the condensed consolidated statements of operations for the three and
nine-month periods ended September 30, 2002 and 2003 and the condensed
consolidated statements of cash flows for the three and nine-month periods
ended September 30, 2002 and 2003 have been prepared by the Company and are
unaudited. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been omitted pursuant
to the rules and regulations of the Securities and Exchange Commission. The
notes to the audited consolidated financial statements included in the
Companys annual report on form 10-K for the fiscal year ended December 31,
2002 provide a summary of significant accounting policies and additional
financial information that should be read in conjunction with this report.
In the opinion of management, all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial position of
the Company for the interim periods, have been made. The results of
operations for such interim periods are not necessarily indicative of the
results for the full year or any future period. All share information in
these financial statements gives effect to a 1 for 2.2 reverse stock split,
which was effected in April 2002.
|
| | Use of Estimates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues
and expenses during the periods reported. These estimates include but are not
limited to estimates affecting revenues and estimates assessing the
collectability of accounts receivable, the salability and recoverability of
inventory, the adequacy of warranty liabilities, the realizability of
investments, the realization of deferred tax assets, the fair value of
putable warrants and the useful lives of tangible and intangible assets. The
market for the Companys products is characterized by intense competition,
rapid technological development and frequent new product introductions, all
of which could affect the future realizability of the Companys assets. The
Company reviews estimates and assumptions periodically, and the effects of
revisions are reflected in the consolidated financial statements in the
period they are determined to be necessary. Actual results could differ from
these estimates.                                                                                                                                                                                                                                                                                                                 
|
| | Recent Accounting Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| | In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus on EITF 00-21, Revenue Arrangements with Multiple Deliverables
with respect to determining when and how to allocate revenue from sales with
multiple deliverables. The EITF 00-21 consensus provides a framework for
determining when and how to allocate revenue from sales with multiple
deliverables based on a determination of whether the multiple deliverables
qualify to be accounted for as separate units of accounting. The consensus is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company adopted this consensus during the
three-month period
ended September 30, 2003. The adoption of this consensus resulted in
the Company deferring approximately $150,000 of                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

6



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | revenues during the
three-month period ending September 30, 2003, which represented the value of
installation obligations associated with the sales of our systems.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | In April 2003, the FASB issued Statement of Financial Accounting
Standard No. 149, Amendment of Statement No. 133 on Derivative Instruments
and Hedging Activities. This standard amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts, collectively referred to
as derivatives, and for hedging activities under statement No. 133,
Accounting for Derivative Instruments and Hedging Relationships. SFAS No.
149 is effective for contracts entered into or modified after June 30, 2003
and for hedging relationships after June 30, 2003. The adoption of this
standard did not have a material impact on the Companys consolidated
financial statements as a whole.                                                                                      
|
| | In May 2003, the FASB issued Statement of Financial Accounting Standard
No. 150, Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity. The Statement establishes standards for how
an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or
an asset in some circumstances). The Company adopted this statement at the
beginning of the three-month period ended September 30, 2003. While the
adoption of this standard did not have a material impact on the Companys
consolidated financial statements as a whole, footnote 3 contains additional
disclosures as required by the standard.                                                        
|
| | Net Income (Loss) Per Share                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | In accordance with Statement of Financial Accounting Standard No. 128,
Computation of Earnings Per Share, basic income (loss) per share is
computed by dividing net income (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 income per share is computed by dividing net
income by the weighted average number of common and dilutive potential common
shares outstanding during the period. Dilutive potential common shares
consist of shares issuable upon the exercise of stock options, including
outstanding shares subject to repurchase, and warrants (using the treasury
stock method). Potential common shares are excluded from the calculation if
their effect is antidilutive.
|
| | The following table sets forth the computation of basic and diluted
weighted average common shares outstanding for the three and nine-month
periods ended September 30, 2002 and 2003:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|                      |                                                     |  |                    |            |                   |  |      |            |      |  |  |           |   |  |  |            | 
|--------------------- | --------------------------------------------------- |  | ------------------ | ---------- | ----------------- |  | ---- | ---------- | ---- |  |  | --------- | - |  |  | ---------- | 
|                      |                                                     |  | Three months ended |            | Nine months ended
|                      |                                                     |  | September 30,      |            | September 30,    
|                      |                                                     |  |                    |            |                  
|                      |                                                     |  | 2002               |            | 2003              |  | 2002 |            | 2003
|                      |                                                     |  |                    |            |                   |  |      |            |     
|Shares (denominator): |                                                     |  |                    |            |                   |  |      |            |      |  |  |           |   |  |  |           
|                      | Weighted average common shares outstanding          |  |                    | 11,953,912 |                   |  |      | 12,168,390 |      |  |  | 6,523,151 |   |  |  | 12,131,066 | 
|                      | Less: weighted average shares subject to
repurchase |  |                    | (2,343     | )                 |  |      |           |      |  |  | (10,904   | ) |  |  |           | 
|                      |                                                     |  |                    |            |                   |  |      |            |      |  |  |           |   |  |  |           
|                      | Weighted average shares for basic calculation       |  |                    | 11,951,569 |                   |  |      | 12,168,390 |      |  |  | 6,512,247 |   |  |  | 12,131,066 | 
|                      | Incremental shares from employee stock options      |  |                    |           |                   |  |      | 883,846    |      |  |  |          |   |  |  |           | 
|                      |                                                     |  |                    |            |                   |  |      |            |      |  |  |           |   |  |  |           
|                      | Weighted average shares for diluted calculation     |  |                    | 11,951,569 |                   |  |      | 13,052,236 |      |  |  | 6,512,247 |   |  |  | 12,131,066 | 
|                      |                                                     |  |                    |            |                   |  |      |            |      |  |  |           |   |  |  |           



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For the three and nine-month periods ended September 30, 2002, 1,556,901
shares of common stock subject to repurchase, stock options and warrants were
excluded from the computation of diluted loss per share as their impact was
antidilutive. For the nine-month period ended September 30, 2003, 1,398,890
stock options were excluded from the computation of diluted loss per share as
their impact was antidilutive. If the Company had reported net income during
the three-month period ended September 30, 2002 and the nine-month periods
ended September 30, 2002 and 2003, the
calculation of earnings per share would have included the dilutive
effect of these potential common shares using the treasury stock method.

7



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##### Table of Contents





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

|                                                                                                                                            |  |                    |       |                   |  |      |       |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----- | ----------------- |  | ---- | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                            |  | Three months ended |       | Nine months ended
|                                                                                                                                            |  | September 30,      |       | September 30,    
|                                                                                                                                            |  |                    |       |                  
|                                                                                                                                            |  | 2002               |       | 2003              |  | 2002 |       | 2003
|                                                                                                                                            |  |                    |       |                   |  |      |       |     
|Net income (loss)  as reported                                                                                                             |  | $                  | (281  | )                 |  | $    | 183   |      |  | $ | (1,950 | ) |  | $ | (1,833 | )
|Add back: Total stock-based employee compensation expense
included in reported income (loss), net of related tax effects                    |  |                    | 23    |                   |  |      | 18    |      |  |   | 93     |   |  |   | 54     |  
|Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects |  |                    | (111  | )                 |  |      | (299  | )    |  |   | (370   | ) |  |   | (788   | )
|                                                                                                                                            |  |                    |       |                   |  |      |       |      |  |   |        |   |  |   |        |  
|Net loss  pro forma                                                                                                                        |  | $                  | (369  | )                 |  | $    | (98   | )    |  | $ | (2,227 | ) |  | $ | (2,567 | )
|                                                                                                                                            |  |                    |       |                   |  |      |       |      |  |   |        |   |  |   |        |  
|Net income (loss) per share  as reported  basic                                                                                           |  | $                  | (0.02 | )                 |  | $    | 0.02  |      |  | $ | (0.30  | ) |  | $ | (0.15  | )
|Net income (loss) per share  as reported  diluted                                                                                         |  | $                  | (0.02 | )                 |  | $    | 0.01  |      |  | $ | (0.30  | ) |  | $ | (0.15  | )
|Net loss per share  pro forma  basic and diluted                                                                                          |  | $                  | (0.03 | )                 |  | $    | (0.01 | )    |  | $ | (0.34  | ) |  | $ | (0.21  | )



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 $4.89, 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. On the date of the Spacelabs
Burdick acquisition, the Company determined that it had 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. As of the beginning of the fourth quarter of 2003, the
Company decided to reorganize its reporting units and consolidate the Quinton
and Burdick reporting units into one reporting unit. This was driven by the
Companys decision to consolidate its manufacturing operations into one
facility in Deerfield, Wisconsin. After the consolidation of the
manufacturing operations, the Company will manufacture its products under
both the Quinton and the Burdick brands in one facility. In conjunction with
this consolidation, the Company will modify its reporting structures and will
no longer review Quinton and Burdick operations separately. The
Shanghai-Burdick joint venture will remain as a separate reporting unit.
|
| | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

8



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Intangible Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| | The Companys intangible assets are comprised primarily of a trade name,
developed technology and customer relationships, all of which were acquired
in our acquisition of Burdick. Company management uses judgment to estimate
the fair value of each of these intangible assets. The judgment about fair
value is based on expectations of future cash flows and an appropriate
discount rate. Company management also uses judgment to estimate the useful
lives of each intangible asset. The Company believes the Burdick trade name
has an indefinite life, and accordingly does not amortize the trade name.
The Company evaluates this conclusion annually and makes a judgment about
whether there are factors that would limit the ability to benefit from the
trade name in the future. If there were such factors, the Company would
start amortizing the trade name. The Company also tests the indefinite life
trade name intangible asset for impairment on an annual basis or more
frequently if events or changes in circumstances indicate that the asset
might be impaired. With respect to developed technology and customer
relationship intangible assets, the Company also evaluates the remaining
useful lives annually to evaluate whether the intangible assets are impaired.
For the trade name, this evaluation is performed annually or if events occur
that suggest there may be an impairment loss, and involves comparing the
carrying amount to the Companys estimate of fair value. For developed
technology and customer relationship intangible assets, this evaluation would
be performed if events occur that suggest there may be an impairment loss. If
we conclude that any of our intangible assets are impaired, we would record
this as a loss on our statement of operations and as a reduction to the
intangible asset. The Company recorded amortization expense for identifiable
intangibles of $30,000 and $84,000 for the three-month periods ended
September 30, 2002 and 2003, respectively, and $91,000 and $301,000 for the
nine-month periods ended September 30, 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). 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.                                                                                             
|
| | Further information was obtained during the three-month period ended
September 30, 2003 regarding the value of Burdicks and Shanghai-Burdicks
machinery and equipment. This information required an adjustment to the
previously disclosed purchase price allocation which decreased goodwill by
$104,000. The Company has now obtained all of the information the Company
has arranged to obtain in order to finalize the purchase price allocation.
The purchase price, including incremental costs directly related to the
transaction, was allocated as follows (in thousands):

9



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##### Table of Contents



|                                                            |                       |   |        |        | 
|----------------------------------------------------------- | --------------------- | - | ------ | ------ | 
|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                                     |                       |   | 2,104  |       
|In-process research and development                         |                       |   | 1,290  |       
|Intangible assets                                           |                       |   | 5,660  |       
|Goodwill                                                    |                       |   | 9,027  |       
|                                                            |                       |   |        |       
|                                                            | Total assets acquired |   |        | 29,220 | 
|Current liabilities                                         |                       |   | (6,961 | )     
|Deferred income taxes                                       |                       |   | (1,156 | )     
|                                                            |                       |   |        |       
|                                                            | Net assets acquired   |   | $      | 21,103 | 
|                                                            |                       |   |        |       



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Inventories included an adjustment to Burdicks historical cost to
increase finished goods to fair market value less expected disposal costs and
selling margin. This adjustment resulted in valuation of inventory of
$300,000 in excess of Burdicks historical cost. This increase in the
inventory valuation was charged to cost of revenues in the nine-month period
ended September 30, 2003, as the associated inventories were sold in the
normal course of business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | In-process research and development relates to two product development
projects underway at the time of the acquisition. Neither project had
received required regulatory approvals at the acquisition date, and each
project had risks associated with achieving desired functionality and market
acceptance. The value assigned to in-process research and development was
determined using a discounted cash flow method applied to expected cash flows
over a 15 year period commencing in 2003. In discounting expected future
cash flows, the Company used an annual discount rate of 16%, which management
believes is an appropriate risk adjusted rate given the nature of the
projects, the remaining project risks and the uncertainty of the future cash
flows.                                                                                                                                                                   
|
| | 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. In the opinion of management, 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 nine-month period ended
September 30, 2003.                                                                                                                                                               
|
| | The second of the two projects, representing 13% of the total value of
acquired in-process research and development relates to a product for the
detection and preprocessing of low-level electrical signals generated by the
heart. This project was approximately 50% complete at the date of
acquisition. Management has assigned a low priority to this project and
decided to postpone further development indefinitely, although the underlying
technology may have application to other projects that the Company may pursue
in the future. In the opinion of management, the indefinite postponement of
further development of this project will not materially adversely affect the
overall return on investment relating to the Burdick acquisition.                                                                                                                                                                                
|
| | All of the acquired in process research and development was written off
during the first quarter of 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | Intangible assets consist of the trade name of $3,400,000, developed
technology of $860,000 and distributor relationships of $1,400,000, which
were valued based on discounted cash flow methods applied to the estimated
future cash flows attributable to the respective assets. The trade name was
determined, by management, to have an indefinite useful life. Developed
technology was assigned a seven year useful life, based on the estimated
remaining economic
life of the related products. Distributor relationships relate to
long-standing contractual relationships with an extensive network of
independent distributors, which represents the exclusive channel through
which Burdick sells its products. The economic life of the distributor
relationships has been determined to be 10 years, based on historical
turnover experience and in consideration of the long standing and stable
nature of these relationships.
|
| | Goodwill represents the excess of the net purchase price over the fair
value of the assets and liabilities acquired. Goodwill recorded in the
Burdick acquisition relates to the long-standing nature of Burdicks
business, its substantial market share, its complementary fit with Quintons
pre-existing business, and managements expectations relating to future
operating synergies and cost efficiencies that can be realized as a result of
operating the businesses on a combined basis.                                                                                                                                                                                                                                                                                                                                                                                                                                           

10



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| |                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A deferred income tax liability was recorded related to the trade name,
which has no tax basis. Because of the indefinite life of the trade name,
this liability has not been used to reduce the valuation allowance against
existing deferred income tax assets.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The following pro forma data summarizes the results of operations for
the three and nine-month periods ended September 30, 2002 as if the Burdick
acquisition had been completed on January 1, 2002. The pro forma data gives
effect to actual operating results prior to the acquisition, adjusted to
include the pro forma effect of depreciation of machinery and equipment,
amortization of identified intangible assets and interest on cash balances.
(in thousands, except per share amounts)

|                                     |  |                    |        |                   |  |   |        |  
|------------------------------------ |  | ------------------ | ------ | ----------------- |  | - | ------ | -
|                                     |  | Three Months Ended |        | Nine Months Ended
|                                     |  | September 30,      |        | September 30,    
|                                     |  |                    |        |                  
|                                     |  | 2002               |        | 2002             
|                                     |  |                    |        |                  
|Revenues                             |  | $                  | 20,798 |                   |  | $ | 62,320 |  
|Net loss                             |  | $                  | (2,734 | )                 |  | $ | (5,737 | )
|Basic and diluted net loss per share |  | $                  | (0.23  | )                 |  | $ | (0.88  | )



| |                  
| | -----------------
| | Minority Interest



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | As part of the purchase acquisition of Burdick, the Company acquired 56%
ownership of Shanghai Burdick Medical Instrument Co., LTD.
(Shanghai-Burdick). The Shanghai-Burdick joint venture has a limited life
of thirty years, terminating in 2030. If the joint venture is terminated,
the Company would be required to liquidate the net assets of the joint
venture and distribute proceeds to the partners. Assuming the joint venture
were to have been terminated effective September 30, 2003, the Company
estimates that such net proceeds would approximate the carrying value of the
minority interest recorded in the accompanying consolidated balance sheet,
which was $199,000 at September 30, 2003.

4.     Consolidation of Manufacturing Operations



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During the third quarter, the Company announced plans to consolidate its
Deerfield, Wisconsin and Bothell, Washington manufacturing and production
activities to its Deerfield location. As a result of the related transition
activities, the Company recognized certain charges relating to severance and
other consolidation related activities of approximately $271,000 during the
three-month period ended September 30, 2003. The Company expects to
recognize similar costs, plus moving costs and other related charges in the
fourth quarter of 2003 of between $1,100,000 and $1,500,000, including
possible non-cash write-offs of up to $400,000 relating to certain assets for
which management is currently evaluating the future usefulness. The Company
does not expect this consolidation to adversely affect revenues in the fourth
quarter of 2003. The Company expects to complete this consolidation by the
end of 2003.



| |                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Changes in the Companys accrued liabilities for the three-month period
ended September 30, 2003 related to the consolidation of manufacturing
operations were as follows (amounts in thousands):

|                                                                 |  |                                                                                              |     |  |     |  
|---------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------- | --- |  | --- | -
|Manufacturing consolidation liabilities as of June 30, 2003      |  | $                                                                                            |    | 
|                                                                 |  | Severance and other employee transition costs charged to
systems cost of revenues            |     |  | 240 |  
|                                                                 |  | Severance and other employee transition costs charged to
service cost of revenues            |     |  | 22  |  
|                                                                 |  | Severance and other employee transition costs charged to
general and administrative expenses |     |  | 5   |  
|                                                                 |  | Professional services charged to general and administrative
expenses                         |     |  | 4   |  
|                                                                 |  | Costs paid during the period                                                                 |     |  | (43 | )
|                                                                 |  |                                                                                              |     | 
|Manufacturing consolidation liabilities as of September 30, 2003 |  | $                                                                                            | 228 | 
|                                                                 |  |                                                                                              |     | 

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5.     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.

6.     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, |       | September 30,
|                 |                   |   | 2002         |       | 2003         
|                 |                   |   |              |       |              
|Raw materials    |                   | $ | 3,433        |       |               | $ | 5,955 |       
|Work in progress |                   |   | 984          |       |               |   | 756   |       
|Finished goods   |                   |   | 3,045        |       |               |   | 5,207 |       
|                 |                   |   |              |       |               |   |       |       
|                 | Total inventories |   | $            | 7,462 |               |   | $     | 11,918 | 
|                 |                   |   |              |       |               |   |       |       

7.     Borrowings



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

8.     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 value of
the shares issuable upon conversion of the warrants. On July 22, 2002, a
holder of 21,632 putable warrants exercised a put option for cash when the
fair value of the shares was approximately $158,000. On May 21, 2003, the
holder of the remaining 41,460 putable warrants exercised a put option for
cash when the fair value of the shares was approximately $296,000. Changes
in the fair value of this liability are recorded in the statements of
operations as interest income (expense), putable warrants. There were no
warrants outstanding as of September 30, 2003.

9.     Warranty Liability



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

|                                               |  |   |        |   | 
|---------------------------------------------- |  | - | ------ | - | 
|Warranty liability as of December 31, 2002     |  | $ | 1,089  |  
|Charged to cost of revenues                    |  |   | 1,017  |  
|Warranty expenditures                          |  |   | (1,021 | )
|Warranty liability acquired from Burdick, Inc. |  |   | 1,016  |  
|                                               |  |   |        |  
|Warranty liability as of September 30, 2003    |  | $ | 2,101  |  
|                                               |  |   |        |  

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10.     Contingencies



| |              
| | -------------
| | Legal Matters



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

11.     Subsequent Event



| |                                            
| | -------------------------------------------
| | Sale of Hemodynamic Monitoring Product Line



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On October 21, 2003, the Company announced the sale of its hemodynamic
monitoring product line. As consideration, the Company received $1,000,000
in cash on October 21, 2003 and a note receivable of $750,000, due October
21, 2004. The buyer may pay additional contingent consideration of up to
$1,500,000 based on future sales of the buyers products to the Companys
previous hemodynamic products customers. Based on the Companys post-closing
transitional responsibilities, which extend into the second quarter of 2004,
the Company will defer the recognition of any gain on the transaction. The
Company expects to recognize a gain in the second quarter of 2004 of between
$600,000 and $700,000 on the transaction, excluding the effect of any
contingent consideration. Contingent consideration received during the
period in which the Company is filling its post-closing transitional
obligations will be deferred until these obligations are fulfilled.
Contingent consideration received after this period will be recognized as
income in the period in which it is received.




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



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | You should read the following discussion and analysis in conjunction
with our unaudited condensed consolidated financial statements and related
notes included elsewhere in this report. Except for historical information,
the following discussion contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. All
statements other than statements of historical fact, including future results
of operations or financial position, made in this Quarterly Report on Form
10-Q, are forward looking. We use words such as anticipate, believe, expect,
future, intend and similar expressions to identify forward looking
statements. These forward-looking statements reflect managements current
expectations and involve risks and uncertainties. Our actual results could
differ materially from results that may be anticipated by such
forward-looking statements. The principal factors that could cause or
contribute to such differences include, but are not limited to, those
discussed in the section entitled Certain Factors That May Affect Future
Results below, those discussed elsewhere in this report and those discussed
in our Annual Report on Form 10-K filed on March 18, 2003. Readers are
cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date of this report. We undertake no obligation
to revise any forward-looking statements to reflect events or circumstances
that may subsequently arise. Readers are urged to review and consider
carefully the various disclosures made in this report and in our other
filings made with the SEC that attempt to advise interested parties of the
risks and factors that may affect our business, prospects and results of
operations.
|
| | Critical Accounting Estimates                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The discussion and analysis of our financial condition and results of
operations are based upon our unaudited condensed consolidated financial
statements which have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
statements. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses,

13



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 asset.
We believe there are presently no factors which would limit our ability to
benefit from the Burdick trade name in the future, and accordingly do not
amortize the trade name. We evaluate this conclusion annually and make a
judgment about whether there are circumstances that would limit our ability
to benefit from the trade name in the future. If we determine that such
circumstances exist, we would amortize the trade name over the expected
remaining period in which we believe it would continue to provide benefit.
With respect to our developed technology and customer relationship intangible
assets, we also evaluate the remaining useful lives annually. We also
evaluate whether our intangible assets are impaired. For our trade name,
this evaluation is performed annually, or more frequently if events occur
that suggest there may be an impairment loss, and involves comparing the
carrying amount to our estimate of fair value. For our developed technology
and customer relationship intangible assets, this evaluation would be
performed if events occur that suggest there may be an impairment loss. If
we concluded any of our intangible assets is impaired, we would record this
as a loss on our statement of operations and as a reduction to the intangible
asset.
|
| | Goodwill                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Goodwill represents the excess of cost over the estimated fair value of
net assets acquired in connection with our acquisitions of the medical
treadmill manufacturing line and Spacelabs Burdick, Inc. noted above. We
test goodwill for impairment on an annual basis, and between annual tests in
certain circumstances, for each reporting unit identified for purposes of
accounting for goodwill. 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.

14



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

|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |      |       |  
|------------------- | ---------------------------------------------------------------------- | ------------------------------------------------ | ---- | ----------------------------- | ----- | ----------------------------- | --- | ---- | ----- | ---- | ---- | ---- | ----- | - | ---- | ---- | ----- | -
|                    |                                                                        |                                                  |      | Three Months Ended            |       | Nine Months Ended            
|                    |                                                                        |                                                  |      | September 30,                 |       | September 30,                
|                    |                                                                        |                                                  |      |                               |       |                              
|                    |                                                                        |                                                  |      | 2002                          |       | 2003                          |     | 2002 |       | 2003
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |     
|                    |                                                                        |                                                  |      | (as a percentage of revenues) |       | (as a percentage of revenues)
|Revenues:           |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    | Systems                                                                |                                                  |      | 80.5                          | %     |                               |     | 84.4 | %     |      |      | 79.9 | %     |   |      | 84.3 | %    
|                    | Service                                                                |                                                  |      | 19.5                          |       |                               |     | 15.6 |       |      |      | 20.1 |       |   |      | 15.7 |      
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Total revenues                                   |      |                               | 100.0 |                               |     |      | 100.0 |      |      |      | 100.0 |   |      |      | 100.0 |  
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|Gross Profit:       |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    | Systems (as a percentage of systems revenue)                           |                                                  |      | 36.5                          |       |                               |     | 39.9 |       |      |      | 37.2 |       |   |      | 39.2 |      
|                    | Service (as a percentage of service revenue)                           |                                                  |      | 51.3                          |       |                               |     | 45.9 |       |      |      | 47.9 |       |   |      | 44.9 |      
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Gross profit                                     |      |                               | 39.4  |                               |     |      | 40.8  |      |      |      | 39.4  |   |      |      | 40.1  |  
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|Operating Expenses: |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    | Research and development                                               |                                                  |      | 10.3                          |       |                               |     | 9.4  |       |      |      | 11.7 |       |   |      | 9.8  |      
|                    | Write off of purchased in-process research
and development             |                                                  |      | 0.0                           |       |                               |     | 0.0  |       |      |      | 0.0  |       |   |      | 2.1  |      
|                    | Sales and marketing                                                    |                                                  |      | 21.1                          |       |                               |     | 21.5 |       |      |      | 22.2 |       |   |      | 21.5 |      
|                    | General and administrative, excluding
stock-based compensation expense |                                                  |      | 12.3                          |       |                               |     | 8.7  |       |      |      | 12.1 |       |   |      | 9.4  |      
|                    | Stock-based compensation                                               |                                                  |      | 0.2                           |       |                               |     | 0.0  |       |      |      | 0.3  |       |   |      | 0.0  |      
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Total operating expenses                         |      |                               | 44.0  |                               |     |      | 39.6  |      |      |      | 46.2  |   |      |      | 42.8  |  
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Operating income (loss)                          |      |                               | (4.6  | )                             |     |      | 1.2   |      |      |      | (6.8  | ) |      |      | (2.7  | )
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|                    |                                                                        | Total other income (expense)                     |      |                               | 2.2   |                               |     |      | (0.3  | )    |      |      | 1.0   |   |      |      | (0.3  | )
|                    |                                                                        | Income tax provision                             |      |                               | (0.0  | )                             |     |      | (0.0  | )    |      |      | (0.1  | ) |      |      | (0.0  | )
|                    |                                                                        | Minority interest in loss of
consolidated entity |      |                               | 0.0   |                               |     |      | 0.0   |      |      |      | 0.0   |   |      |      | 0.0   |  
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     
|Net income (loss)   |                                                                        |                                                  | (2.4 | )%                            |       |                               | 0.9 | %    |       |      | (5.9 | )%   |       |   | (3.0 | )%  
|                    |                                                                        |                                                  |      |                               |       |                               |     |      |       |      |      |      |       |   |      |     



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



| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Consolidated operating results for the three-month period ended
September 30, 2003 include the operating results of Burdick, which we
acquired on January 2, 2003.
|
| | Revenues                                                                                                                                                          



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Revenues for the three-month period ended September 30, 2003 increased
by $9,379,000, or 80.5%, to $21,034,000 from $11,655,000 for the comparable
period in 2002. This increase was principally due to the addition of
revenues from the Burdick business, which we acquired in January 2003. Pro
forma combined revenues of Quinton and Burdick for the three-month period
ended September 30, 2002, had the acquisition been completed as of January 1,
2002, would have been $20,798,000.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because of significant uncertainty in Burdicks distributor channels
resulting from the pending sale of Burdick during the fourth quarter of 2002
and the earlier sale of Burdicks parent on July 2, 2002, Burdicks revenues
were declining at the time of our acquisition. Management believes that
uncertainties in the market relating to Burdicks sale have been
substantially resolved. Burdicks revenues have stabilized, and management
does not expect Burdicks revenues to decline significantly in future
periods.

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| |                                                                                                                                                                                                                                             
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The modest increase in revenues for the three-month period ended
September 30, 2003 over the pro forma combined revenues for the three-month
period ended September 30, 2002 is due to the success of the Companys
overall selling efforts.



| |                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Systems revenue increased by $8,367,000, or 89.2%, to $17,747,000 for
the three-month period ended September 30, 2003 from $9,380,000 for the
comparable period in 2002. This increase was primarily due to the addition
of Burdicks systems revenues.



| |                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Service revenues increased by $1,012,000, or 44.5%, to $3,287,000 for
the three-month period ended September 30, 2003 from $2,275,000 for the
comparable period in 2002. This increase was primarily due to the
addition of
Burdicks service revenues.
|
| | Gross Profit                                                                                                                                                                                                                                           



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Gross profit for the three-month period ended September 30, 2003
increased by $4,001,000, or 87.2%, to $8,588,000 from $4,587,000 for the
comparable period in 2002, primarily reflecting the addition of Burdicks
operating results. Gross profit, as a percentage of revenues, increased to
40.8% for the three-month period ended September 30, 2003 from 39.4% for the
comparable period in 2002. The increase in gross profit, as a percentage of
revenues, was primarily due to the results of product cost reduction
initiatives, including design cost reductions and other reductions in
purchased components of our products. For the three-month period ended
September 30, 2003, we recognized a charge to cost of revenues of $262,000,
reflecting charges related to the consolidation of our manufacturing
operations. This charge to cost of revenues represented an adverse impact to
gross profit of approximately 1.2 percentage points. We expect to incur
similar charges in the fourth quarter of 2003 of between $1,100,000 and
$1,500,000. Charges of this nature are not expected beyond the fourth
quarter of 2003, as management expects the manufacturing consolidation to be
completed during this period. We expect to realize cost savings of between
$1,500,000 and $2,000,000 annually thereafter. Substantially all of the cost
savings will be to cost of revenues.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Gross margin from systems revenues increased to 41.2% for the
three-month period ended September 30, 2003, from 36.5% for the comparable
period in 2002. This increase in gross margin, as a percentage of revenues,
was primarily due to the product cost reduction measures referred to above.
For the three-month period ended September 30, 2003, we recognized a charge
to cost of revenues related to the consolidation of our manufacturing
operations of $240,000, which was discussed above. This charge to cost of
revenues represented an adverse impact to gross margin from systems revenues
of approximately 1.4 percentage points.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Gross margin from service revenues decreased to 46.6% for the
three-month period ended September 30, 2003, from 51.3% for the comparable
period in 2002. This decrease in gross margin, as a percentage of revenues,
was primarily due to the impact of Burdicks lower gross margin on service
revenues. For the three-month period ended September 30, 2003, we recognized
a charge to cost of revenues related to the consolidation of our
manufacturing operations of $22,000, which was discussed above. This charge
to cost of revenues represented an adverse impact to gross margin from
service revenues of approximately 0.7 percentage point.
|
| | Operating Expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Research and development expenses for the three-month period ended
September 30, 2003 increased by $764,000 to $1,969,000 from $1,205,000 for
the comparable period in 2002. This increase was primarily due to the
impact of additional research and development expenses relating to the
acquired Burdick business. As a percentage of revenues, research and
development expenses decreased to 9.4% for the three-month period ended
September 30, 2003 from 10.3% for the comparable period in 2002. This
decrease principally reflects lower proportionate spending on research and
development in the Burdick business and cost efficiencies of operating the
Quinton and Burdick businesses on a combined basis.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Sales and marketing expenses for the three-month period ended September
30, 2003 increased by $2,059,000 to $4,519,000 from $2,460,000 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
increased to 21.5% for the three-month period ended September 30, 2003 from
21.1% for the comparable period in 2002. This primarily reflects an increase
in marketing expenses for the three-month period ended September 30, 2003
over the comparable period in 2002.

16



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | General and administrative expenses, excluding stock-based compensation,
for the three-month period ended September 30, 2003, increased by $404,000 to
$1,838,000 from $1,434,000 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 8.7% for the three-month period ended September
30, 2003 from 12.3% 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. For the three-month period ended
September 30, 2003, general and administrative expenses, excluding
stock-based compensation, included a charge related to the consolidation of
our manufacturing operations of $9,000.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Stock-based compensation expense for the three-month period ended
September 30, 2003 decreased by $5,000 to $18,000, from $23,000 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 fourth quarter of 2003 at a
level similar to the amount recorded in the third quarter of 2003.
|
| | Operating Income (Loss)                                                                                                                                                                                                                                                                                                                                                                                                                           



| |                                                                                                                                                                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Operating income for the three-month period ended September 30, 2003 was
$244,000, compared to an operating loss of $535,000 for the comparable period
in 2002. The period-over-period improvement was due to factors noted above,
primarily higher gross profit percentage and lower general and administrative
expenses as a percentage of revenues.
|
| | Other Income and Expense                                                                                                                                                                                                                                                                                                                              



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Total other expense for the three-month period ended September 30, 2003
was $61,000, as compared to total other income of $256,000 for the comparable
period in 2002. Interest income decreased by $97,000 for the three-month
period ended September 30, 2003 primarily due to a decline in
interest-earning assets over the comparable period in 2002. Interest expense
increased by $63,000 for the three-month period ended September 30, 2003 from
the comparable period in 2002, primarily due to an increase in average
borrowings on our bank line of credit over the three-month period ended
September 30, 2003, as compared to average borrowings over the comparable
period in 2002. In addition, interest income related to putable warrants for
the three-month period ended September 30, 2003 decreased by $161,000 from
the comparable period in 2002. These warrants, held by a former lender, were
adjusted to their fair market value at the end of each accounting period.
Gains and losses reflected in the income statement represent the adjustment
of the warrants to their fair market value during the related period. There
were no warrants outstanding during the third quarter of 2003.
|
| | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          



| |                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------
| | Income tax provisions recorded in the three month periods ended
September 30, 2003 and 2002 related to state income taxes.



| |                                                                                                      
| | -----------------------------------------------------------------------------------------------------
| | Nine-Month Period Ended September 30, 2003 Compared to the Nine-Month Period
Ended September 30, 2002



| |                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Consolidated operating results for the nine-month period ended September
30, 2003 include the operating results of Burdick, which we acquired on
January 2, 2003.
|
| | Revenues                                                                                                                                                         



| |                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Revenues for the nine-month period ended September 30, 2003 increased by
$28,720,000, or 86.2%, to $62,023,000 from $33,303,000 for the comparable
period in 2002. This increase was principally due to the addition of
revenues from the Burdick business, which we acquired in January 2003.



| |                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Pro forma combined revenues of Quinton and Burdick for the nine-month
period ended September 30, 2002, had the acquisition been completed as of
January 1, 2002, would have been $62,320,000. Because of significant
uncertainty in

17



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Burdicks distributor channels resulting from the pending sale of
Burdick during the fourth quarter of 2002 and the earlier sale of Burdicks
parent on July 2, 2002, Burdicks revenues were declining at the time of our
acquisition. During the nine-month period ended September 30, 2003,
increases in Quintons revenues over the comparable period in 2002 were
offset by a decline in Burdicks revenues over the comparable period in 2002.
Management believes that uncertainties in the market relating to Burdicks
sale have been substantially resolved. Burdicks revenues have stabilized,
and management does not expect Burdicks revenues to decline significantly in
future periods.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Systems revenue increased by $25,699,000, or 96.6%, to $52,308,000 for
the nine-month period ended September 30, 2003 from $26,609,000 for the
comparable period in 2002. This increase was primarily due to the addition
of Burdicks systems revenues. To a lesser extent, the growth in revenues
was attributable to increases in sales of Quintons telemetry systems,
including a new rehabilitation telemetry product released in May 2002, and
various other products.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Service revenues increased by $3,021,000, or 45.1%, to $9,715,000 for
the nine-month period ended September 30, 2003 from $6,694,000 for the
comparable period in 2002. This increase was primarily due to the addition
of Burdicks service revenues and, to a lesser extent, an increase in
Quintons service revenues for the nine-month period ended September 30, 2003
over the comparable period in 2002. The increase in Quintons service
revenues was related to the growth of our installed customer base.
|
| | Gross Profit                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Gross profit for the nine-month period ended September 30, 2003
increased by $11,757,000, or 89.6%, to $24,874,000 from $13,117,000 for the
comparable period in 2002. This increase was primarily due to the addition
of gross profit from the Burdick business. Gross profit, as a percentage of
revenues, increased to 40.1% for the nine-month period ended September 30,
2003 from 39.4% for the comparable period in 2002. During the nine-month
period ended September 30, 2003, we recognized an acquisition-related charge
to cost of revenues of $300,000, reflecting an upward adjustment to Burdicks
inventory valuation from Burdicks historical cost at the acquisition date
that was expensed in the quarter ended March 31, 2003. In addition, for the
nine-month period ended September 30, 2003, we recognized a charge to cost of
revenues of $262,000, reflecting charges related to the consolidation of our
manufacturing operations. These charges to cost of revenues represented an
adverse impact to gross profit of approximately 0.9 percentage point.
Charges relating to the Burdick acquisition are not expected to recur. We
expect to incur additional charges relating to the consolidation of the
manufacturing operations in the fourth quarter of 2003 of between $1,100,000
and $1,500,000. Charges of this nature are not expected to recur beyond the
fourth quarter of 2003, as management expects the manufacturing consolidation
to be completed during this period. We expect to realize cost savings of
between $1,500,000 and $2,000,000 annually thereafter. Substantially all of
the cost savings will be to cost of revenues.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Gross margin from systems revenues increased to 39.2% for the nine-month
period ended September 30, 2003, from 37.2% for the comparable period in
2002. The increase in gross profit, as a percentage of revenues, was
primarily due to the results of product cost reduction initiatives, including
design cost reductions and other reductions in purchased components of our
products. For the nine-month period ended September 30, 2003, we recognized
an acquisition related charge to cost of revenues of $300,000 which was
discussed above. In addition, for the nine-month period ended September 30,
2003, we recognized a charge to cost of revenues related to the consolidation
of our manufacturing operations of $240,000 which was discussed above. These
charges to cost of revenues represented an adverse impact to gross margin
from systems revenues of approximately 1.0 percentage point.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Gross margin from service revenues of 44.9% for the nine-month period
ended September 30, 2003 decreased from 47.9% for the comparable period in 2002.
This decrease in gross margin, as a percentage of revenues, was primarily due
to the impact of Burdicks lower gross margin on service revenues. For the
nine-month period ended September 30, 2003, we recognized a charge to cost of
revenues related to the consolidation of our manufacturing operations of
$22,000, which was discussed above. This charge to cost of revenues
represented an adverse impact to gross margin from service revenues of
approximately 0.2 percentage point.
|
| | Operating Expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   



| |                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Research and development expenses for the nine-month period ended
September 30, 2003 increased by $2,153,000 to $6,045,000 from $3,892,000 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,

18



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| |                                                                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | research and development expenses decreased to 9.8% for the nine-month
period ended September 30, 2003 from 11.7% for the comparable period in 2002.
This decrease principally reflects lower proportionate spending on research
and development in the Burdick business and cost efficiencies of operating
the Quinton and Burdick businesses on a combined basis.



| |                                                                                                                                                                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During the nine-month period ended September 30, 2003, we recorded a
charge of $1,290,000 to write off in-process research and development
acquired in the Burdick acquisition. See Note 3 to Unaudited Condensed
Consolidated Financial Statements. In future periods, we do not expect to
incur additional in-process research and development write-offs relating to
the Burdick acquisition.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Sales and marketing expenses for the nine-month period ended September
30, 2003 increased by $5,957,000 to $13,336,000 from $7,379,000 for the
comparable period in 2002. This increase was primarily due to the impact of
additional sales and marketing expenses relating to the acquired Burdick
business. As a percentage of revenues, sales and marketing expenses
decreased to 21.5% for the nine-month period ended September 30, 2003 from
22.2% 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 nine-month period ended September 30, 2003, increased by $1,784,000
to $5,807,000 from $4,023,000 for the comparable period in 2002. This
increase was primarily due to the impact of additional general and
administrative expenses relating to the acquired Burdick business. As a
percentage of revenues, general and administrative expenses, excluding
stock-based compensation, decreased to 9.4% for the nine-month period ended
September 30, 2003 from 12.1% 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. For the
nine-month period ended September 30, 2003, general and administrative
expenses, excluding stock-based compensation, included a charge related to
the consolidation of our manufacturing operations of $9,000.



| |                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Stock-based compensation expense for the nine-month period ended
September 30, 2003 decreased by $39,000 to $54,000, from $93,000 for the
comparable period in 2002. Stock-based compensation expense for both periods
relates to the intrinsic value of stock options granted in 2001.
|
| | Operating Loss                                                                                                                                                                                                                                                                         



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Operating loss for the nine-month period ended September 30, 2003
decreased by $612,000, or 27.0%, to $1,658,000 from $2,270,000 for the
comparable period in 2002. As a percentage of revenues, operating loss for
the nine-month period ended September 30, 2003 decreased to 2.7% from 6.8%
for the comparable period in 2002. Operating loss for the nine-month period
ended September 30, 2003 included a $1,290,000 write off of purchased
in-process research and development and an acquisition related charge
included in cost of revenues of $300,000, both of which were recognized in
the quarter ended March 31, 2003. In addition, operating loss for the
nine-month period ended September 30, 2003 included a charge to cost of
revenues of $262,000 and a charge to general and administrative expenses of
$9,000, reflecting charges related to the consolidation of our manufacturing
operations
|
| | Other Income and Expense                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Total other expense for the nine-month period ended September 30, 2003
was $186,000, as compared to total other income of $336,000 for the
comparable period in 2002. Interest income decreased by $133,000 to $10,000
for the nine-month period ended September 30, 2003 from $143,000 for the
comparable period in 2002 primarily due to a decline in interest-earning
assets over the comparable period in 2002. Interest expense increased by
$119,000 to $221,000 for the nine-month period ended September 30, 2003 from
$102,000 for the comparable period in 2002 primarily due to an increase in
average borrowings on our bank line of credit over the nine-month period
ended September 30, 2003 as compared to average borrowings over the
comparable period in 2002. In addition, interest income related to putable
warrants decreased by $262,000 to $32,000 for the nine-month period ended
September 30, 2003 from $294,000 for the comparable period in 2002. These
warrants, held by a former lender, were adjusted to their fair market value
at the end of each accounting period. Gains and losses reflected in the
income statement represent the adjustment of the warrants to their fair
market value during the related period. There were no warrants outstanding
as of September 30, 2003.

19



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



| |                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------
| | Income tax provisions recorded in the nine-month periods ended September
30, 2003 and 2002 relate to state income taxes.
|
| | Liquidity and Capital Resources                                                                                         



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For the three-month period ended September, 2003, we generated cash from
operating activities of $1,382,000, primarily from income, excluding non-cash
expenses of $618,000, a reduction of inventories of $158,000, a reduction in
prepaid and other assets of $239,000, an increase to accounts payable of
$336,000 and an increase in accrued liabilities of $627,000, which were
partially offset by an increase in accounts receivable of $783,000.
Inventories at September 30, 2003 decreased from balances at June 30, 2003
primarily due to inventory reduction measures. Accrued liabilities at
September 30, 2003 increased from the balance at June 30, 2003 due to higher
period-ending payroll and payroll related accruals and accrued severance
costs related to our consolidation of our manufacturing facilities. Accounts
receivable at September 30, 2003 increased from the balance at June 30, 2003
primarily due to an increase in revenues compared to the three month-period
ended June 30, 2003.



| |                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For the nine-month period ended September 30, 2003, we generated cash
from operating activities of $694,000. This cash flow resulted primarily
from working capital reductions of the newly acquired Burdick business.



| |                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Net cash used for investing activities was $288,000 for the three-month
period ended September 30, 2003. This related primarily to purchases of a
telephone system and other machinery and equipment.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Net cash used in investing activities was $20,344,000 for the nine-month
period ended September 30, 2003 compared to $684,000 for the comparable
period in 2002 primarily due to our investment in Burdick of $19,385,000, net
of cash acquired, payments of acquisition costs and a refund from the
reduction in the purchase price. For the nine-month period ended September
30, 2003, capital equipment expenditures increased by $383,000 over the
comparable period in 2002. The increase was primarily due to the purchase
and conversion of an enterprise resource planning system and the purchase of
a telephone system.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Net cash used for financing activities for the three-month period ended
September 30, 2003 of $1,546,000 related primarily to net repayments on our
credit line of $1,591,000 and a debt payment of $90,000 related to the note
payable issued in the treadmill manufacturing business acquisition, which was
partially offset by proceeds from exercises of stock options of $10,000 and
proceeds from the issuance of common stock in accordance with our employee
stock purchase plan of $125,000. Net cash used for financing activities of
$785,000 for the three-month period ended September 30, 2002 was primarily
the result of payments of offering expenses related to our initial public
offering.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Net cash from financing activities for the nine-month period ended
September 30, 2003 of $719,000 resulted primarily from net borrowings on our
credit line of $883,000, proceeds from exercises of stock options of $73,000
and proceeds from issuance of common stock in accordance with our employee
stock purchase plan of $331,000, partially offset by debt payments of
$272,000 related to the note payable issued in the treadmill manufacturing
business acquisition and a payment for the redemption of putable warrants of
$296,000. Net borrowings on our credit line for the nine-month period ended
September 30, 2003 were partially used to fund part of the purchase price of
acquiring Burdick and partially for working capital requirements. Net cash
from financing activities of $23,774,000 for the nine-month period ended
September 30, 2002 was the result of proceeds from our initial public
offering, including the over-allotment shares, of approximately $28,361,000,
net of underwriting discounts and offering expenses, offset by net repayments
on our bank line of credit of $4,471,000 and a payment of $158,000 for the
redemption of putable warrants. Additional offering expenses of
approximately $160,000 related to the initial public offering were accrued as
of September 30, 2002 but were paid in later periods. The net proceeds from
our initial public offering, after payment of all offering expenses and
underwriting discounts was $28,200,000.



| |                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Accounts receivable, inventories, and prepaid expenses and other current
assets at September 30, 2003 increased $3,717,000, $4,456,000, and $46,000,
respectively, from balances at December 31, 2002 due primarily to the
acquisition

20



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | of Burdick. Cash and cash equivalents declined from $19,382,000 at
December 31, 2002 to $451,000 at September 30, 2003, due primarily to the use
of cash to fund the Burdick acquisition. Accounts payable, accrued
liabilities and warranty liability increased $408,000, $2,202,000 and
$1,012,000, respectively, from balances at December 31, 2002 due primarily to
the acquisition of Burdick. The balance on our line of credit at September
30, 2003 was $883,000. This indebtedness was incurred to pay part of the
purchase price for our acquisition of Burdick.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We anticipate that our future operating cash flow and borrowings
available to us under credit facilities will be sufficient to meet our
operating expenses, working capital requirements, capital expenditures and
other obligations for at least 12 months. We periodically evaluate potential
acquisitions of technology or businesses that complement or expand our
existing business or that may enable us to expand into new markets. Future
acquisitions may require additional debt, equity financing or both. We may
not be able to obtain any additional financing, or may not be able to obtain
additional financing on acceptable terms.
|
| | Consolidation of Manufacturing Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | During the third quarter, we announced plans to consolidate our
Deerfield, Wisconsin and Bothell, Washington manufacturing and production
activities to the Deerfield location. As a result of the related transition
activities, we incurred certain charges relating to severance and other
consolidation related activities of approximately $271,000 during the
three-month period ended September 30, 2003. We expect to incur similar
costs, plus moving costs and other related charges in the fourth quarter of
2003 of between $1,100,000 and $1,500,000, including possible non-cash
write-offs of up to $400,000 relating to certain assets for which management
is currently evaluating the future usefulness. We do not expect this
consolidation to adversely affect revenues in the fourth quarter of 2003. We
expect to complete this consolidation by the end of 2003. We expect to
realize cost savings of between $1,500,000 and $2,000,000 annually
thereafter. Substantially all of this cost savings will be to cost of
revenues.
|
| | Sale of Hemodynamic Monitoring Product Line                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On October 21, 2003, we announced the sale of our hemodynamic monitoring
product line. As consideration, we received $1,000,000 in cash on October
21, 2003 and a note receivable of $750,000, due October 21, 2004. The buyer
may pay additional contingent consideration of up to $1,500,000 based on
future sales of the buyers products to our previous hemodynamic products
customers. Based on our post-closing transitional responsibilities, which
extend into the second quarter of 2004, we will defer the recognition of any
gain on the transaction. We expect to recognize a gain in the second quarter
of 2004 of between $600,000 and $700,000 on the transaction, excluding the
effect of any contingent consideration. Contingent consideration received
during the period in which we are filling our post-closing transitional
obligations will be deferred until these obligations are fulfilled.
Contingent consideration received after this period will be recognized as
income in the period in which it is received.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The hemodynamic monitoring product line represented approximately $3
million of the Companys revenues for the nine-month period ended September
30, 2003. The loss of revenues associated with the hemodynamic product line
may have a material adverse affect on operating income in the fourth quarter
of 2003. During the fourth quarter of 2003, however, the Company expects to
make cost adjustments, principally in the form of staffing reductions, and
accordingly, management does not expect the loss of these revenues to have a
materially adverse impact on operating income in 2004 and beyond.

21



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



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



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



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



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



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



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



| |                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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

22



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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, both domestically and internationally.



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



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



| |                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The rate of market acceptance of our current or future products and
systems 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;

23



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| |  |  | hospital budgetary constraints; and                                        
| | - |  | ---------------------------------------------------------------------------
|
| |  |  | changes in the reimbursement policies of government and third-party payers.



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



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



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



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



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



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



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have 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

24



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| |                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------
| | these agreements are cancelled or if we are unable to renew them as they
expire, our sales and operating results may suffer materially.
|
| | We may need additional capital to continue our acquisition growth strategy.                                                            



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



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



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



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



| |                                                                                                                                                                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If suppliers discontinue production of purchased components of our products
and we are unable to secure alternative sources for these components on a
timely basis, our ability to ship products to our customers may be adversely
affected, our revenues may decline and our costs may increase as a result.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | For a variety of reasons, including but not limited to relatively low
volumes, our supplies may discontinue production of component parts for our
products. Alternative sources of these components may result in higher
costs. In addition, if we are unable to secure alternative sources for these
components, significant delays in product shipments may result while we
re-engineer our products to utilize available components. This could result
in reduced revenues, higher costs or both.



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

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

26



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##### Table of Contents






Item 3. Quantitative and Qualitative Disclosures About Market Risk



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




Item 4. Controls and Procedures



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We maintain disclosure controls and procedures designed to ensure that
information required to be disclosed in our filings under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commissions rules
and forms. Our chief executive officer and chief financial officer have
evaluated our disclosure controls and procedures as of the end of the period
covered by this quarterly report of Form 10-Q and have determined that such
disclosure controls and procedures are effective.



| |                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There has been no change in our internal control over financial
reporting in connection with this evaluation that has materially affected, or
is reasonably likely to materially affect, our internal control over
financial reporting.

27



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##### Table of Contents






PART II - OTHER INFORMATION




Item 1. Legal Proceedings

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




Item 2. Changes in Securities and Use of Proceeds

None.




Item 3. Defaults Upon Senior Securities

None.




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

None.




Item 5. Other Information

None.




Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits

|             |  |                                                                                                                                                                    
|------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit 10.1 |  | Form of Indemnification Agreement between Quinton
Cardiology Systems, Inc. and each of its directors and executive
officers.                                       
|             |  |                                                                                                                                                                    
|Exhibit 10.2 |  | Lease Agreement between Quinton Cardiology Systems, Inc.
and Hibbs/Woodinville Associates, L.L.C. regarding premises at
Bothell, Washington, dated August 29, 2003.
|             |  |                                                                                                                                                                    
|Exhibit 31.1 |  | Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934 of Item 601 of
Regulation S-K.                       
|             |  |                                                                                                                                                                    
|Exhibit 31.2 |  | Certification of Chief Financial Officer Pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934 of Item 601 of
Regulation S-K.                       
|             |  |                                                                                                                                                                    
|Exhibit 32.1 |  | Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).                                       
|             |  |                                                                                                                                                                    
|Exhibit 32.2 |  | Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).                                       

(b)  Reports on Form 8-K



| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | On July 24, 2003, we filed a Form 8-K related to the press release
discussing the Companys results for the second quarter of 2003.

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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: November 14, 2003

29