##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



---



FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2002

OR

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

For the transition period from __________to__________

Commission File Number 000-49755

QUINTON CARDIOLOGY SYSTEMS, INC.

(Exact name of registrant as
specified in its charter)


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

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

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

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

|       |  |     
|------ |  | ----
|Yes  o |  | No þ

As of June 18, 2002, 11,919,718 shares of the issuers common stock were
outstanding.





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TABLE OF CONTENTS



|                               |                                                                                               |  |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               | Item 1. 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                           
|PART II  OTHER INFORMATION   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 2. Changes in Securities and Use of Proceeds                                            
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                     



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##### Table of Contents



TABLE OF CONTENTS

|                               |                                                                                               |  |    |    | 
|------------------------------ | --------------------------------------------------------------------------------------------- |  | -- | -- | 
|PART I  FINANCIAL INFORMATION |                                                                                               |  | 3  |   
|                              
|                               | Item 1. Financial Statements                                                                  |  |    | 3  | 
|                              
|                               | Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations |  |    | 10 | 
|                              
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  |    | 18 | 
|                              
|PART II  OTHER INFORMATION    |                                                                                               |  | 19 |   
|                              
|                               | Item 1. Legal Proceedings                                                                     |  |    | 19 | 
|                              
|                               | Item 2. Changes in Securities and Use of Proceeds                                             |  |    | 19 | 
|                              
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                   |  |    | 20 | 
|                              
|                               | Item 6. Exhibits and Reports on Form 8-K                                                      |  |    | 20 | 
|                              
|SIGNATURE                      |                                                                                               |  | 21 |   

2



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##### Table of Contents






PART I  FINANCIAL INFORMATION




Item 1. Financial Statements

QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |           |   |        |        |  
|-------------------------------------------------------- | ----------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------- | - | ------------------------------------ | ------ | --------- | - | ------ | ------ | -
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   | December 31,                         |        | March 31,
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   | 2001                                 |        | 2002     
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   | (in thousands, except share amounts)
|ASSETS                                                   |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|Current Assets:                                          |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         | Cash and cash equivalents                                   |  | $                                                                                                                                                                                                                                                        | 218                                                  |   |                                      | $      | 430       |  
|                                                         | Accounts receivable, net of allowance for doubtful accounts |  |                                                                                                                                                                                                                                                          | 6,123                                                |   |                                      |        | 6,162     |  
|                                                         | Inventories                                                 |  |                                                                                                                                                                                                                                                          | 6,161                                                |   |                                      |        | 5,757     |  
|                                                         | Prepaid expenses and other current assets                   |  |                                                                                                                                                                                                                                                          | 626                                                  |   |                                      |        | 632       |  
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          | Total current assets                                 |   |                                      | 13,128 |           |   |        | 12,981 |  
|Machinery and equipment, net of accumulated depreciation |                                                             |  | 3,165                                                                                                                                                                                                                                                    |                                                      |   |                                      | 2,969  |          
|Patents, net of accumulated amortization                 |                                                             |  | 173                                                                                                                                                                                                                                                      |                                                      |   |                                      | 142    |          
|Investment in unconsolidated entity                      |                                                             |  | 1,000                                                                                                                                                                                                                                                    |                                                      |   |                                      | 1,000  |          
|Other non-current assets                                 |                                                             |  |                                                                                                                                                                                                                                                         |                                                      |   |                                      | 388    |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          | Total assets                                         |   | $                                    | 17,466 |           |   | $      | 17,480 |  
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)           |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|Current Liabilities:                                     |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         | Line of credit                                              |  | $                                                                                                                                                                                                                                                        | 4,471                                                |   |                                      | $      | 4,777     |  
|                                                         | Accounts payable                                            |  |                                                                                                                                                                                                                                                          | 4,029                                                |   |                                      |        | 4,516     |  
|                                                         | Accrued liabilities                                         |  |                                                                                                                                                                                                                                                          | 2,548                                                |   |                                      |        | 3,028     |  
|                                                         | Warranty reserve                                            |  |                                                                                                                                                                                                                                                          | 1,269                                                |   |                                      |        | 1,160     |  
|                                                         | Deferred revenue                                            |  |                                                                                                                                                                                                                                                          | 3,556                                                |   |                                      |        | 3,830     |  
|                                                         | Putable warrants                                            |  |                                                                                                                                                                                                                                                          | 705                                                  |   |                                      |        | 705       |  
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          | Total current liabilities                            |   |                                      | 16,578 |           |   |        | 18,016 |  
|Sublease liability                                       |                                                             |  | 831                                                                                                                                                                                                                                                      |                                                      |   |                                      | 623    |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          | Total liabilities                                    |   |                                      | 17,409 |           |   |        | 18,639 |  
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|Shareholders Equity (Deficit):                          |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         | Preferred stock (50,000,000 shares authorized):             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |           |  
|                                                         |                                                             |  | Series A convertible preferred stock, no par value, aggregate
liquidation preferences of $12,230 at December 31, 2001 and March
31, 2002, 12,454,545 shares designated, 12,230,000 shares issued and
outstanding at December 31, 2001 and March 31, 2002 |                                                      |   | 12,230                               |        |           |   | 12,230 |       
|                                                         |                                                             |  | Series B convertible preferred stock, no par value, aggregate
liquidation preferences of $865 at December 31, 2001 and March 31,
2002, 6,000,000 shares designated, 865,000 shares issued and
outstanding at December 31, 2001 and March 31, 2002        |                                                      |   | 865                                  |        |           |   | 865    |       
|                                                         | Common stock (100,000,000 shares authorized):               |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |           |  
|                                                         |                                                             |  | No par value, 677,275 and 678,073 shares issued and outstanding at
December 31, 2001 and March 31, 2002, respectively                                                                                                                                    |                                                      |   | 3,490                                |        |           |   | 3,490  |       
|                                                         | Deferred stock compensation                                 |  |                                                                                                                                                                                                                                                          | (287                                                 | ) |                                      |        | (252      | )
|                                                         | Accumulated deficit                                         |  |                                                                                                                                                                                                                                                          | (16,241                                              | ) |                                      |        | (17,492   | )
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          | Total shareholders equity (deficit)                 |   |                                      | 57     |           |   |        | (1,159 | )
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          | Total liabilities and shareholders equity (deficit) |   | $                                    | 17,466 |           |   | $      | 17,480 |  
|                                                         |                                                             |  |                                                                                                                                                                                                                                                          |                                                      |   |                                      |        |          

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

|                                                                                       |                                |                                                                |           |                          |        |                              |           |      |        |   |        |  
|-------------------------------------------------------------------------------------- | ------------------------------ | -------------------------------------------------------------- | --------- | ------------------------ | ------ | ---------------------------- | --------- | ---- | ------ | - | ------ | -
|                                                                                       |                                |                                                                |           |                          |        | Three Months Ended March 31,
|                                                                                       |                                |                                                                |           |                          |        |                             
|                                                                                       |                                |                                                                |           |                          |        | 2001                         |           | 2002
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                |                                                                |           |                          |        | (in thousands, except share 
|                                                                                       |                                |                                                                |           |                          |        | and per share amounts)      
|Revenues:                                                                              |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                | Systems                                                        |           | $                        | 7,703  |                              |           | $    | 8,166  |  
|                                                                                       |                                | Service                                                        |           |                          | 2,375  |                              |           |      | 2,223  |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                |                                                                |           | Total revenues           |        |                              | 10,078    |      |        |   | 10,389 |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Cost of Revenues:                                                                      |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                | Systems                                                        |           |                          | 4,941  |                              |           |      | 5,045  |  
|                                                                                       |                                | Service                                                        |           |                          | 1,311  |                              |           |      | 1,191  |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                |                                                                |           | Total cost of revenues   |        |                              | 6,252     |      |        |   | 6,236  |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                |                                                                |           | Gross profit             |        |                              | 3,826     |      |        |   | 4,153  |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Operating Expenses:                                                                    |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                | Research and development                                       |           |                          | 1,494  |                              |           |      | 1,353  |  
|                                                                                       |                                | Sales and marketing                                            |           |                          | 2,246  |                              |           |      | 2,453  |  
|                                                                                       |                                | General and administrative, excluding stock-based compensation |           |                          | 1,284  |                              |           |      | 1,483  |  
|                                                                                       |                                | Stock-based compensation                                       |           |                          | 139    |                              |           |      | 35     |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                |                                                                |           | Total operating expenses |        |                              | 5,163     |      |        |   | 5,324  |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                |                                                                |           | Operating loss           |        |                              | (1,337    | )    |        |   | (1,171 | )
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Other Income (Expense):                                                                |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                | Interest expense, net                                          |           |                          | (88    | )                            |           |      | (73    | )
|                                                                                       |                                | Other income (expense), net                                    |           |                          | (6     | )                            |           |      | 3      |  
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                |                                                                |           | Total other expense      |        |                              | (94       | )    |        |   | (70    | )
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Loss before income taxes                                                               |                                |                                                                | (1,431    | )                        |        |                              | (1,241    | )   
|                                                                                       | Income tax benefit (provision) |                                                                |           | 211                      |        |                              |           | (10  | )     
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|                                                                                       |                                | Net loss                                                       |           | $                        | (1,220 | )                            |           | $    | (1,251 | )
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Basic and diluted net loss per share                                                   |                                | $                                                              | (2.01     | )                        |        | $                            | (1.91     | )   
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Pro forma basic and diluted net loss per share                                         |                                | $                                                              | (0.17     | )                        |        | $                            | (0.17     | )   
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Weighted average shares used to compute basic and diluted net loss per share           |                                |                                                                | 605,460   |                          |        |                              | 656,609   |     
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     
|Weighted average shares used to compute pro forma basic and diluted net loss per share |                                |                                                                | 7,244,807 |                          |        |                              | 7,295,956 |     
|                                                                                       |                                |                                                                |           |                          |        |                              |           |     

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

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QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |        |     |      |     |  
|------------------------------------------------- | ------------------------------------------------------------------------ | -------------------------------------------- | ------------------------------------------ | ---------------------------------------- | --- | ---------------------------- | ------ | ------ | --- | ---- | --- | -
|                                                  |                                                                          |                                              |                                            |                                          |     | Three months ended March 31,
|                                                  |                                                                          |                                              |                                            |                                          |     |                             
|                                                  |                                                                          |                                              |                                            |                                          |     | 2001                         |        | 2002  
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  |                                                                          |                                              |                                            |                                          |     | (in thousands)              
|Operating Activities:                             |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  | Net loss                                                                 |                                              | $                                          | (1,220                                   | )   |                              | $      | (1,251 | )  
|                                                  | Adjustments to reconcile net loss to net cash from operating activities |                                              |                                            |                                          |     |                              |        |        |    
|                                                  |                                                                          | Depreciation and amortization                |                                            |                                          | 290 |                              |        |        | 291 |     
|                                                  |                                                                          | Loss on sale of equipment                    |                                            |                                          | 36  |                              |        |        | 9   |     
|                                                  |                                                                          | Non-cash other income                        |                                            |                                          | (30 | )                            |        |        |    |     
|                                                  |                                                                          | Amortization of deferred stock compensation  |                                            |                                          | 139 |                              |        |        | 35  |     
|                                                  |                                                                          | Changes in operating assets and liabilities: |                                            |                                          |     |                              |        |        |     |     
|                                                  |                                                                          |                                              | Accounts receivable                        |                                          |     | 1,250                        |        |        |     | (39  | )  
|                                                  |                                                                          |                                              | Inventories                                |                                          |     | (126                         | )      |        |     | 404  |    
|                                                  |                                                                          |                                              | Prepaid expenses and other assets          |                                          |     | (327                         | )      |        |     | (28  | )  
|                                                  |                                                                          |                                              | Income taxes receivable                    |                                          |     | 1,209                        |        |        |     |     |    
|                                                  |                                                                          |                                              | Accounts payable                           |                                          |     | 633                          |        |        |     | 121  |    
|                                                  |                                                                          |                                              | Accrued liabilities and sublease liability |                                          |     | 31                           |        |        |     | 272  |    
|                                                  |                                                                          |                                              | Warranty reserve                           |                                          |     | (44                          | )      |        |     | (109 | )  
|                                                  |                                                                          |                                              | Deferred revenue                           |                                          |     | (125                         | )      |        |     | 274  |    
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  |                                                                          |                                              |                                            | Net cash flows from operating activities |     |                              | 1,716  |        |     |      | (21 | )
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|Investing Activities:                             |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  | Purchases of machinery and equipment                                     |                                              |                                            | (105                                     | )   |                              |        | (73    | )  
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  |                                                                          |                                              |                                            | Net cash flows from investing activities |     |                              | (105   | )      |     |      | (73 | )
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|Financing Activities:                             |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  | Proceeds from (repayments of) line of credit, net                        |                                              |                                            | (1,587                                   | )   |                              |        | 306    |    
|                                                  | Repurchase of shares in connection with termination                      |                                              |                                            | (94                                      | )   |                              |        |       |    
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  |                                                                          |                                              |                                            | Net cash flows from financing activities |     |                              | (1,681 | )      |     |      | 306 |  
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|Net change in cash and cash equivalents           |                                                                          |                                              | (70                                        | )                                        |     |                              | 212    |       
|Cash and cash equivalents, beginning of period    |                                                                          |                                              | 423                                        |                                          |     |                              | 218    |       
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|Cash and cash equivalents, end of period          |                                                                          | $                                            | 353                                        |                                          |     | $                            | 430    |       
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       
|Supplemental disclosure of cash flow information: |                                                                          |                                              |                                            |                                          |     |                              |        |       
|                                                  | Cash paid for interest                                                   |                                              | $                                          | 115                                      |     |                              | $      | 74     |    
|                                                  |                                                                          |                                              |                                            |                                          |     |                              |        |       

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

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QUINTON CARDIOLOGY SYSTEMS, INC.
AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Description of Business

QIC Holding Corp., a California corporation, changed its name to
Quinton Cardiology Systems, Inc. (Quinton) in February 2002. Quinton and
its subsidiaries 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 balance sheet dated March 31, 2002, the
condensed statements of operations for the three months ended March 31, 2001
and 2002 and the condensed statements of cash flows for the three months
ended March 31, 2001 and 2002 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 registration statement dated February 22, 2002, as
amended, on Form S-1 under the Securities Act of 1933 (Registration No.
333-83272) for the fiscal year ended December 31, 2001 provide a summary of
significant accounting policies and additional financial information that
should be read in conjunction with this report. These condensed financial
statements should be read in conjunction with the audited financial
statements dated December 31, 2001 and the notes thereto. 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.

Initial Public Offering and Pro Forma Amounts

In May 2002, the Company consummated a public offering of its common
stock as more fully described in its registration statement 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 $29.5 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. The weighted average shares used to compute pro forma basic and
diluted net loss per share for the three months ended March 31, 2002 is
presented in the accompanying condensed consolidated statement of operations
as if the outstanding preferred stock had been converted to common stock at
the original date of issuance (reflecting the impact of the 1 for 2.2
reverse stock split, which was effected in April 2002).

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Weighted Average Common Shares

The following table sets forth the computation of basic and diluted
weighted average common shares outstanding for the periods ended March 31,
2001 and 2002:

|                                                               |                                                     |                                                            |  |           |           |      |  |           |           | 
|-------------------------------------------------------------- | --------------------------------------------------- | ---------------------------------------------------------- |  | --------- | --------- | ---- |  | --------- | --------- | 
|                                                               |                                                     |                                                            |  | March 31,
|                                                               |                                                     |                                                            |  |          
|                                                               |                                                     |                                                            |  | 2001      |           | 2002
|                                                               |                                                     |                                                            |  |           |           |     
|Shares (denominator basic and diluted):                        |                                                     |                                                            |  |           |           |      |  |          
|                                                               | Weighted average common shares outstanding          |                                                            |  | 847,849   |           |      |  | 677,456   |          
|                                                               | Less: weighted average shares subject to repurchase |                                                            |  | (242,389  | )         |      |  | (20,847   | )        
|                                                               |                                                     |                                                            |  |           |           |      |  |          
|                                                               | Denominator for basic and diluted calculation       |                                                            |  | 605,460   |           |      |  | 656,609   |          
|                                                               |                                                     |                                                            |  |           |           |      |  |          
|Weighted average effect of pro forma conversion of securities: |                                                     |                                                            |  |           |           |      |  |          
|                                                               | Denominator for basic and diluted calculation       |                                                            |  | 605,460   |           |      |  | 656,609   |          
|                                                               | Series A convertible preferred stock                |                                                            |  | 6,246,168 |           |      |  | 6,246,168 |          
|                                                               | Series B convertible preferred stock                |                                                            |  | 393,179   |           |      |  | 393,179   |          
|                                                               |                                                     |                                                            |  |           |           |      |  |          
|                                                               |                                                     | Denominator for pro forma basic and diluted loss per share |  |           | 7,244,807 |      |  |           | 7,295,956 | 
|                                                               |                                                     |                                                            |  |           |           |      |  |          

For the three months ended March 31, 2001 and 2002, 8,091,588 and
7,955,682, respectively, shares of common stock subject to repurchase, stock
options, warrants, and common stock issuable upon conversion of outstanding
preferred stock were excluded from the computation of diluted loss per
share, as their impact was antidilutive. The pro forma diluted loss per
share for the three months ended March 31, 2002 excluded 1,316,335 potential
common shares.

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 assessing the collectability of accounts receivable, the saleability
and recoverability of inventory, the adequacy of warranty reserves, the
realizability of investments, the realization of deferred tax assets and
useful lives of tangible and intangible assets, among others. 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.
Estimates and assumptions are reviewed 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 June 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 141, Business Combinations (effective July 1, 2001) and SFAS No.
142, Goodwill and Other Intangible Assets (effective for the Company on
January 1, 2002). SFAS 141 did not have a material impact on the Companys
consolidated results of operations, financial position or cash flows. Since
the Companys intangible assets are limited to patents with a net book value
of $142,000 as of March 31, 2002, and are amortized over 5 years, SFAS 142
did not have a material impact on the Companys consolidated results of
operations, financial position or cash flows.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which provides the accounting requirements for
retirement obligations associated with tangible long-lived

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assets. SFAS 143 requires entities to record the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred. SFAS 143 is effective for the Companys 2003 fiscal year, and
early adoption is permitted. The adoption of SFAS 143 is not expected to
have a material impact on the Companys consolidated results of operations,
financial position or cash flows.

In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 requires that
long-lived assets to be disposed of by sale be measured at the lower of
carrying amount or fair value less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS 144 also expands
the reporting of discontinued operations to include components of an entity
that have been or will be disposed of rather than limiting such
discontinuance to a segment of a business. SFAS 144 is effective for the
Companys 2002 fiscal year. The adoption of SFAS 144 did not have a
material impact on the Companys consolidated results of operations,
financial position or cash flows.

3. Inventories

Inventories are stated at the lower of weighted-average cost or market
and are comprised of the following as of December 31, 2001 and March 31,
2002 (amounts in thousands):

|                 |                   |   |              |       |           |   |       |       | 
|---------------- | ----------------- | - | ------------ | ----- | --------- | - | ----- | ----- | 
|                 |                   |   | December 31, |       | March 31,
|                 |                   |   | 2001         |       | 2002     
|                 |                   |   |              |       |          
|Raw materials    |                   | $ | 2,037        |       |           | $ | 2,026 |      
|Work in progress |                   |   | 574          |       |           |   | 614   |      
|Finished goods   |                   |   | 3,550        |       |           |   | 3,117 |      
|                 |                   |   |              |       |           |   |       |      
|                 | Total Inventories |   | $            | 6,161 |           |   | $     | 5,757 | 
|                 |                   |   |              |       |           |   |       |      

4. Borrowings

Borrowings under the Companys bank line of credit were limited at both
December 31, 2001 and March 31, 2002 to the lesser of $7,500,000 or an
amount based on eligible accounts receivable and eligible inventories.
Substantially all of the Companys assets were collateral for the line of
credit. This line of credit carried an interest rate of the banks prime
rate plus 2.0% (which was 6.75% at March 31, 2002). As of March 31, 2002,
the Company had borrowed $4,777,000 and had capacity to borrow an additional
$530,000 based on eligible accounts receivable and eligible inventory. On
May 10, 2002, the balance of the credit line was repaid with proceeds from
the initial public offering. The current line of credit expired on June 5,
2002.

5. 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 which were immediately exercisable. Upon
completion of our initial public offering, the conversion rights associated
with our 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 (taking into account the 1 for 2.2 reverse stock split
effected in April 2002). At the holders option, the Company is required to
make a cash payment to the holder equal to the fair market value of the
shares issuable upon conversion of the warrants. At the initial public
offering price of $7.00 per common share, the fair value of this liability
was approximately $440,000.

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6. Income Taxes

The benefit from (provision for) income taxes is as follows (amounts in
thousands):

|        |         |                           |   |                            |     |      |   |     |     |  
|------- | ------- | ------------------------- | - | -------------------------- | --- | ---- | - | --- | --- | -
|        |         |                           |   | For the three months ended
|        |         |                           |   | March 31,                 
|        |         |                           |   |                           
|        |         |                           |   | 2001                       |     | 2002
|        |         |                           |   |                            |     |     
|Current |         |                           |   |                            |     |      |   |    
|        | Federal |                           | $ | 211                        |     |      | $ |    |    
|        | State   |                           |   |                           |     |      |   | (10 | )  
|        |         |                           |   |                            |     |      |   |    
|        |         | Total benefit (provision) |   | $                          | 211 |      |   | $   | (10 | )
|        |         |                           |   |                            |     |      |   |    

During the three months ended March 31, 2001 the Company recognized a
tax benefit for additional amounts refunded from the payment of taxes on the
sale of the Companys fitness business in 1999 through the ability to carry
back tax losses generated subsequent to the sale. During 2000, the Company
recorded an estimated income tax receivable of $1,209,000 related to the
refund of tax payments made on the sale of the fitness business. During the
three months ended March 31, 2001, the Company received a tax refund of
$1,420,000 and recorded a corresponding tax benefit of $211,000. A
valuation allowance has been recorded for the net balance of the deferred
tax assets as a result of uncertainties regarding realization of the asset.
The tax benefit recorded in the three months ended March 31, 2001 resulted
from reduction of the valuation allowance as a result of the refund.

7. Contingencies

Legal Matters

In July 1998, the Company signed an Original Equipment Manufacturer and
Distributor Agreement with Zymed, Incorporated (Zymed), a related party.
This agreement provided for the purchase of certain Holter monitoring
systems, and appointed the Company exclusive distributor of such products in
the United States and Canada for a period of five years. In the third
quarter of 2000 the Company received a notice of termination of this
agreement from Zymed based on the alleged inability of the parties to agree
on pricing and volume requirements as set forth in the agreement. This
notice of termination provided for a 180 day notice period that expired in
February 2001.

The Company has disputed this notice of termination, and has filed suit
in the State of Washington principally citing a claim for breach of
contract. The Company is seeking monetary damages and other remedies
available under the law. The products supplied under this agreement
represented a significant portion of the Companys revenues, approximately
12.0% in 2000 and 3.0% in 2001. The Company has made a significant effort to
mitigate the impact of this termination by entering into contracts with
other suppliers. The Company has incurred, and may continue to incur,
significant legal expenses related to the litigation of this dispute, which
may or may not be recoverable. A trial date for this matter has been set
for September 18, 2002.

The Company is a defendant in various other legal matters arising in
the normal course of business. In the opinion of management, the ultimate
resolution of these other matters is not expected to have a material effect
on the Companys financial position, results of operations or cash flows.

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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 below and those discussed elsewhere in this report
and those discussed in our registration statement on Form S-1 (Registration
No. 333-83272) filed on February 22, 2002, as amended. 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 in order to reflect events or
circumstances that may subsequently arise. Readers are urged to carefully
review and consider the various disclosures made in this report and in our
other filings made with the SEC that attempt to advise interested parties of
the risks and factors that may affect our business, prospects and results of
operations.

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of
operations is based upon our unaudited condensed consolidated financial
statements which have been prepared in accordance with accounting principles
generally accepted in the United States 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,
revenue and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates including those
affecting revenues, the allowance for doubtful accounts, the salability and
recoverability of inventory, warranty reserves, the carrying value of our
investments, income taxes, putable warrants and contingencies. 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.

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Results of Operations

Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001

Revenues

Revenues for the three months ended March 31, 2002 increased
approximately $311,000, or 3.1%, to $10,389,000 from $10,078,000 for the
comparable period in 2001. Systems revenue increased by $463,000, or 6.0%,
to $8,166,000 in 2002 from $7,703,000 in 2001. The increase in systems
revenues resulted primarily from an increase in stress test systems revenues
of $1,523,000, which was attributable to the release in April 2001 of our
new version of this product. The increase in stress test systems revenues
was offset by decreases in Holter monitoring system sales, consumables sales
and telemetry system sales of approximately $647,000, $225,000 and $148,000,
respectively. The decrease in Holter monitor systems sales was due to the
interruption in Holter component supplies when we transitioned to a new
supplier. The decrease in consumables sales was attributable to reduced
volume of electrodes sales. Telemetry system sales decreased as customers
were waiting for the release of our new telemetry product due for release in
the second quarter of 2002. Service revenues decreased by $152,000, or
6.4%, to $2,223,000 in 2002 from $2,375,000 in 2001. This decrease was
primarily the result of reduced volume of spare parts sales driven, in part,
by the replacement by some of our customers of aging equipment with newer
models.

Gross Profit

Gross profit for the three months ended March 31, 2002 increased
approximately $327,000, or 8.5%, to $4,153,000 from $3,826,000 for the
comparable period in 2001. Gross profit from systems increased
approximately $359,000, or 13.0%, to $3,121,000 in 2002 from $2,762,000 in
2001 and gross profit from service decreased approximately $32,000, or 3.0%,
to $1,032,000 in 2002 from $1,064,000 in 2001. Systems gross margin
increased to 38.2% in 2002 compared with 35.9% in 2001 primarily due to an
increase in stress test systems sales volume spread over a partially fixed
overhead cost base. Service gross margin increased, despite a decrease in
revenues, to 46.4% in 2002 compared with 44.8% in 2001. This was due
primarily to lower average material costs of spare parts.

Operating Expenses

Research and development expenses for the three months ended March 31,
2002 decreased approximately $141,000, or 9.4%, to $1,353,000 from
$1,494,000 for the comparable period in 2001. As a percentage of revenues,
research and development expenses decreased to 13.0% in 2002 from 14.8% in
2001. The decrease, in terms of both dollars and as a percentage of
revenue, resulted primarily from a decrease in the use of outside
engineering services, partially offset by an increase in internal research
and development staffing.

Sales and marketing expenses for the three months ended March 31, 2002
increased approximately $207,000, or 9.2%, to $2,453,000 from $2,246,000 for
the comparable period in 2001. As a percentage of revenues, sales and
marketing expenses increased to 23.6% in 2002 from 22.3% in 2001. The
increase, in terms of both dollars and as a percentage of revenues, resulted
primarily from an increase in staffing related to the recent introduction of
new products into the market.

General and administrative expenses, excluding stock-based
compensation, for the three months ended March 31, 2002 increased
approximately $199,000, or 15.5%, to $1,483,000 from $1,284,000 for the
comparable period in 2001. As a percentage of revenues, general and
administrative expenses, excluding stock-based compensation, for the three
months ended March 31, 2002 increased to 14.2% from 12.7% for the comparable
period in 2001. The increase in general and administrative expenses,
excluding stock based compensation, in terms of both dollars and as a
percentage of revenues was caused primarily by an increase of $280,000 in
legal expenses associated with litigation against a former supplier,
partially offset by reductions in other areas.

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Stock-based compensation expense for the three months ended March 31,
2002 decreased approximately $104,000 to $35,000 from $139,000 for the
comparable period in 2001. The charges in 2001 relate primarily to variable
compensation expense recorded on issued stock options. We expect to record
stock-based compensation expense in the remaining quarters of 2002 at levels
similar to the amount recorded in the first quarter of 2002.

Operating Loss

Operating loss for the three months ended March 31, 2002 decreased by
approximately $166,000, or 12.4%, to $1,171,000 from $1,337,000 for the
comparable period in 2001. The decrease in operating loss was attributable
primarily to an increase in gross profit of $327,000, offset by increases in
operating expenses of $161,000, both due to factors noted above.

Other Expense

Total other expense for the three months ended March 31, 2002 decreased
$24,000, or 25.5%, to $70,000 from $94,000 for the comparable period in
2001. This decrease was primarily the result of a decrease in net interest
expense of approximately $15,000 caused by a lower average interest rate on
outstanding borrowings under our bank line of credit.

Income Tax Benefit

For the three months ended March 31, 2001, we recorded an income tax
benefit of $211,000 for additional amounts refunded from the payment of
taxes on the sale of our fitness business in 1999 as a result of our ability
to carry back tax losses generated subsequent to the sale. For the three
months ended March 31, 2002, we had no such income tax benefit.

Liquidity and Capital Resources

We have required cash to fund our operations and for working capital
purposes. Historically, our primary sources of financing have been
borrowings from a commercial bank and proceeds from the sale of convertible
preferred stock. In May and June of 2002, we received proceeds from our
recent initial public offering.

We maintained a $7,500,000 credit facility originally entered into in
June 1998 with Silicon Valley Bank subject to certain accounts receivable
and inventory provisions. This facility had a one year term which expired
June 5, 2002, and all borrowings under this facility were classified as
current liabilities. As of March 31, 2002, $5,307,000 was available under
this credit facility, of which $4,777,000 was outstanding. Outstanding
balances under this facility bore interest at the banks prime lending rate
plus 2.0%. The outstanding balance of this facility was repaid in May 2002
with the proceeds of our initial public offering. We decided not to renew
this facility due to the successful completion of our initial public
offering.

For the three months ended March 31, 2002, we used cash of $21,000 in
operating activities. This cash flow resulted from a $916,000 loss
excluding non-cash expenses, offset by a reduction of our working capital of
$895,000. The reduction in our working capital was primarily caused by an
increase in our accounts payable and accrued liabilities, net of increases
in prepaid expenses and other assets, and a decrease in inventory. For the
three months ended March 31, 2001, we generated cash from operating
activities of $1,716,000, resulting primarily from a $1,420,000 tax refund.

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We incurred $1,494,000 and $1,353,000 of research and development
expenses during the three months ended March 31, 2001 and 2002,
respectively. We expect to continue incurring research and development
expenses based on the continued availability of capital resources, including
the proceeds of our initial public offering. We prioritize our research and
development spending to continue development of new product versions and to
meet the changing requirements of our customers. As a result, we expect our
research and development expenses to continue to be significant in the
future.

Net cash used in investing activities was $105,000 and $73,000 for the
three months ended March 31, 2001 and 2002, respectively. The amounts in
both years were used for capital expenditures. We anticipate our capital
expenditures will increase somewhat during 2002 primarily to fund the
purchase and conversion of an enterprise resource planning system.

Net cash from financing activities for the three months ended March 31,
2002 of $306,000 resulted from borrowings on our line of credit. Net cash
used for financing activities for the three months ended March 31, 2001
resulted from repayment of bank debt of $1,587,000 and the repurchase of
$94,000 of shares issued upon early exercise of options under our stock
option plan in connection with an employee termination.

Ongoing working capital requirements have historically required bank
borrowings that utilize a significant portion of our borrowing availability
under the bank line of credit. Although there is no certainty, we
anticipate that proceeds from our initial public offering, together with our
operating cash flow, will be sufficient to meet operating expenses, working
capital requirements, capital expenditures and other obligations for at
least 12 months. We may be affected by economic, financial, competitive,
legislative, regulatory, business and other factors beyond our control. In
addition, 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.

Subsequent Events

Initial Public Offering

In May 2002, we consummated an initial public offering of our common
stock. In the offering, we sold 4,000,000 shares of our common stock at a
price of $7.00 per share. In addition, 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 $29.5 million, net of
underwriting discounts and offering expenses. The principal purposes of the
offering were to obtain additional working capital and to establish a public
market for our common stock. In May 2002, we used approximately $4,500,000
of the offering proceeds to repay the outstanding balance under our line of
credit. Although we currently have no specific plans for the application of
a significant portion of the remaining net proceeds, we expect to use the
remaining net proceeds from this offering:



| |  |  | To acquire complementary businesses, product lines, assets or technologies;
| | - |  | ---------------------------------------------------------------------------
|
| |  |  | To fund product research and development;                                  
|
| |  |  | To expand international sales efforts; and                                 
|
| |  |  | For working capital and other general corporate purposes.                  

We will have significant discretion in the use of the net proceeds of
the offering, including with respect to net proceeds used to acquire
complementary businesses, product lines, assets or technologies.

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Certain Factors that May Affect Future Results

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

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

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

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

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

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



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

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

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

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



| |  |  | delays in product launches;                                                
| | - |  | ---------------------------------------------------------------------------
|
| |  |  | lengthening of buying or selling cycles;                                   
|
| |  |  | the introduction of competing products;                                    
|
| |  |  | price reductions by our competitors;                                       
|
| |  |  | development of more effective products by our competitors;                 
|
| |  |  | hospital budgetary constraints; and                                        
|
| |  |  | changes in the reimbursement policies of government and third-party payors.

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.

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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 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 our
customers, who order products on a purchase order basis. In limited
circumstances, customer orders may be cancelled, changed or delayed on short
notice. Lack of significant order backlog makes it difficult for us to
forecast future sales with certainty. Long and varying sales cycles with
our customers make it difficult to accurately forecast component and product
requirements. These factors expose us to a number of risks:



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

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

We have historically generated approximately 10% 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 generally do not 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
payors 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 payors, 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 payors 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.

Our operating results may be subject to seasonal fluctuations during the
first and third fiscal quarters of each year, which can lead to
unpredictable variations in our quarterly results and cause the stock price
of our common stock to decrease.

Companies in the medical device industry have historically experienced
sales decreases in the first calendar quarter due to patterns in the capital
budgeting and purchasing cycles of medical device customers. We may
experience similar seasonality. We may also experience declining revenues
in the third fiscal quarter due to summer holiday and vacation schedules.
These seasonal factors may lead to unpredictable variations in our quarterly
operating results and cause the stock price of our common stock to decrease.

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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 revenues 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.

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PART II  OTHER INFORMATION




Item 1. Legal Proceedings

In July 1998, we signed an Original Equipment Manufacturer and
Distributor Agreement with Zymed, Incorporated, a subsidiary of Koninklijke
Philips Electronics N.V. and an affiliate of Philips Electronics North
America Corporation. This agreement provides for the purchase of certain
Holter monitoring systems, and appointed us the exclusive distributor of
such products in the United States and Canada for a period of five years. In
the third quarter of 2000, we received a notice of termination of this
agreement from Zymed based on the alleged inability of the parties to agree
on pricing and volume requirements as set forth in the agreement. This
notice of termination provided for a 180 day notice period that expired in
February 2001.

We disputed this notice of termination and in November 2000 initiated a
lawsuit in the federal district court for the Western District of Washington
against Zymed. We also named Agilent Technologies, Inc. and The
Hewlett-Packard Company as defendants. We are seeking damages against the
defendants for harm to our business resulting from Zymeds termination of
our Holter monitoring systems distribution agreement in November 2000. We
are seeking monetary damages and other remedies available under the law. We
incurred significant costs in prosecuting this lawsuit in 2001 and in the
three months ended March 31, 2002. Expenses we incur in connection with this
lawsuit may increase in the future, particularly if it goes to trial or if
the trial is delayed or continued or any judgment rendered in the trial is
appealed. On April 8, 2002, the court entered an order denying defendants
motion to dismiss our breach of contract claim. The trial date, originally
scheduled for late April 2002, has been set for September 18, 2002.

Other than the lawsuit described above, we are not currently a party to
any material legal proceeding.




Item 2. Changes in Securities and Use of Proceeds

In the quarter ended March 31, 2002, we issued 798 shares of
unregistered common stock to employees pursuant to the exercise of stock
options under our 1998 Stock Option Plan. These options were exercised at a
weighted average exercise price of $0.29 per share. The issuance of these
securities was deemed to be exempt from registration under the Securities
Act in reliance on Rule 701 and Section 4(2) of the Securities Act.

Pursuant to our registration statement on Form S-1 under the Securities
Act of 1933 (Registration No. 333-83272), we consummated our initial public
offering in May 2002, selling 4,000,000 shares of our common stock at $7.00
per share. In June 2002, the underwriters exercised their over-allotment
option to purchase an additional 600,000 shares at $7.00 per share. The
offering yielded net proceeds of approximately $29.5 million. We used
approximately $4,500,000 of the net proceeds of our initial public offering
to repay existing balances under our line of credit at the time our offering
closed. Since the closing of the offering, we have invested the remaining
net proceeds in a variety of investment grade, fixed income securities,
including corporate bonds, commercial paper and money market instruments.

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

On February 21, 2002 the following resolutions were adopted by written
consent of our shareholders:

Approval of Name Change from QIC Holding Corp. to Quinton Cardiology Systems, Inc.

Approval of 2002 Stock Incentive Plan

Approval of 2002 Employee Stock Purchase Plan

All resolutions were approved by the holders of a total of 5,056,179 shares.
Because the resolutions were adopted by written consent, the holders of the
remaining outstanding shares did not vote.




Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits

None.

(b)  Reports on Form 8-K

We filed no reports on Form 8-K during the first quarter of 2002.

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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: June 20, 2002

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