##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For
the quarterly period ended June 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Number 000-49755
 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4 3⁄4
 QUINTON CARDIOLOGY SYSTEMS, INC.
  Delaware
    
    94-3300396(State of Incorporation)
    
    (IRS Employer Identification No.)
 3303 Monte Villa Parkway
Bothell, Washington 98021
 (425) 402-2000
 þ o
 þ o




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TABLE OF CONTENTS
 PART I  FINANCIAL INFORMATION
    
    
    3Item 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    29PART II  OTHER INFORMATION
    
    
    30Item 1. Legal Proceedings
    
    
    30Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    30Item 3. Defaults Upon Senior Securites
    
    
    30Item 4. Submission of Matters to a Vote of Security Holders
    
    
    30Item 5. Other Information
    
    
    30Item 6. Exhibits
    
    
    30SIGNATURE
    
    
    31EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 December 31,
    
    June 30,2004
    
    2005(in thousands, except share and pershare amounts)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    21,902
    
    
    $
    23,830Marketable equity securities
    
    
    646
    
    
    
    Accounts receivable, net of allowance for doubtful accounts
    
    
    13,649
    
    
    
    13,008Inventories
    
    
    11,047
    
    
    
    11,432Deferred income taxes
    
    
    5,542
    
    
    
    4,890Prepaid expenses and other current assets
    
    
    790
    
    
    
    925Total current assets
    
    
    53,576
    
    
    
    54,085Machinery and equipment, net of accumulated depreciation
    
    
    4,314
    
    
    
    3,988Deferred income taxes
    
    
    3,594
    
    
    
    3,428Intangible assets, net of accumulated amortization
    
    
    5,619
    
    
    
    5,458Investment in unconsolidated entity
    
    
    1,000
    
    
    
    1,000Goodwill
    
    
    9,072
    
    
    
    9,072Deferred acquisition related costs
    
    
    
    
    
    
    1,357Total assets
    
    $
    77,175
    
    
    $
    78,388LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    5,615
    
    
    $
    5,772Accrued liabilities
    

    
    6,220
    
    
    
    4,803Warranty liability
    
    
    2,093
    
    
    
    2,059Deferred revenue
    
    
    4,754
    
    
    
    5,062Total current liabilities
    
    
    18,682
    
    
    
    17,696Minority interest in consolidated entity
    
    
    159
    
    
    
    133Shareholders Equity:Preferred stock (10,000,000 shares authorized), $0.001 par
value, no shares outstanding in 2004 or 2005
    
    
    
    
    
    
    Common stock (65,000,000 shares authorized), $0.001 par
value, 14,057,195 and 14,108,121 shares issued and
outstanding at December 31, 2004 and June 30, 2005,
respectively
    
    
    14
    
    
    
    14Additional paid-in capital
    
    
    62,642
    
    
    
    62,998Deferred stock-based compensation
    
    
    (33
    )
    
    
    Accumulated other comprehensive income
    
    
    22
    
    
    
    Accumulated deficit
    
    
    (4,311
    )
    
    
    (2,453
    )Total shareholders equity
    
    
    58,334
    
    
    
    60,559Total liabilities and shareholders equity
    
    $
    77,175
    
    
    $
    78,388
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 3




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QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005(in thousands, except share and per share amounts)Revenues:Systems
    
    $
    18,542
    
    
    $
    19,073
    
    
    $
    37,068
    
    
    $
    37,417Service
    
    
    3,106
    
    
    
    2,895
    
    
    
    6,232
    
    
    
    5,881Total revenues
    
    
    21,648
    
    
    
    21,968
    
    
    
    43,300
    
    
    
    43,298Cost of Revenues:Systems
    
    
    10,591
    
    
    
    10,198
    
    
    
    20,866
    
    
    
    19,880Service
    
    
    1,833
    
    
    
    1,895
    
    
    
    3,758
    
    
    
    3,777Total cost of revenues
    
    
    12,424
    
    
    
    12,093
    
    
    
    24,624
    
    
    
    23,657Gross profit
    
    
    9,224
    
    
    
    9,875
    
    
    
    18,676
    
    
    
    19,641Operating Expenses:Research and development
    
    
    1,796
    
    
    
    1,908
    
    
    
    3,627
    
    
    
    3,717Sales and marketing
    
    
    4,367
    
    
    
    4,592
    
    
    
    8,738
    
    
    
    9,249General and administrative
    
    
    1,967
    
    
    
    2,266
    
    
    
    4,073
    
    
    
    4,311Total operating expenses
    
    
    8,130
    
    
    
    8,766
    
    
    
    16,438
    
    
    
    17,277Operating income
    
    
    1,094
    
    
    
    1,109
    
    
    
    2,238
    
    
    
    2,364Other income (expense):Interest income (expense), net
    
    
    (19
    )
    
    
    145
    
    
    
    (60
    )
    
    
    258Other income, net
    
    
    633
    
    
    
    53
    
    
    
    633
    
    
    
    114Total other income
    
    
    614
    
    
    
    198
    
    
    
    573
    
    
    
    372Income before income taxes and minority interest in
consolidated entity
    
    
    1,708
    
    
    
    1,307
    
    
    
    2,811
    
    
    
    2,736Income taxes
    
    
    (35
    )
    
    
    (434
    )
    
    
    (70
    )
    
    
    (904
    )Income before minority interest in consolidated entity
    
    
    1,673
    
    
    
    873
    
    
    
    2,741
    
    
    
    1,832Minority interest in loss of consolidated entity
    
    
    10
    
    
    
    6
    
    
    
    30
    
    
    
    26Net income
    
    $
    1,683
    
    
    $
    879
    
    
    $
    2,771
    
    
    $
    1,858Net income per share  basic
    
    $
    0.13
    
    
    $
    0.06
    
    
    $
    0.22
    
    
    $
    0.13Net income per share  diluted
    
    $
    0.12
    
    
    $
    0.06
    
    
    $
    0.20
    
    
    $
    0.13Weighted average shares outstanding  basic
    
    
    12,806,759
    
    
    
    14,091,232
    
    
    
    12,526,004
    
    
    
    14,079,368Weighted average shares outstanding  diluted
    
    
    13,957,926
    
    
    
    14,665,430
    
    
    
    13,572,874
    
    
    
    14,721,730
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 4




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QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005(in thousands)Operating Activities:Net income
    
    $
    1,683
    
    
    $
    879
    
    
    $
    2,771
    
    
    $
    1,858Adjustments to reconcile net income to net cash flows from
operating activities -Depreciation and amortization
    
    
    402
    
    
    
    410
    
    
    
    788
    
    
    
    814Deferred income taxes
    
    
    5
    
    
    
    398
    
    
    
    10
    
    
    
    832Stock-based compensation
    
    
    18
    
    
    
    15
    
    
    
    36
    
    
    
    39Minority interest in loss of consolidated entity
    
    
    (10
    )
    
    
    (6
    )
    
    
    (30
    )
    
    
    (26
    )Gain on sale of marketable equity securities
    
    
    
    
    
    
    (15
    )
    
    
    
    
    
    
    (15
    )Gain on sale of hemodynamic monitoring business
    
    
    (633
    )
    
    
    
    
    
    
    (633
    )
    
    
    Loss on disposal of equipment
    
    
    4
    
    
    
    
    
    
    
    4
    
    
    
    Changes in operating assets and liabilities, net of
businesses acquired and divested:Accounts receivable
    
    
    (1,126
    )
    
    
    (786
    )
    
    
    (1,058
    )
    
    
    641Inventories
    
    
    551
    
    
    
    307
    
    
    
    457
    
    
    
    (385
    )Prepaid expenses and other current assets
    
    
    (120
    )
    
    
    (148
    )
    
    
    (110
    )
    
    
    (135
    )Accounts payable
    
    
    150
    
    
    
    (500
    )
    
    
    (215
    )
    
    
    (103
    )Accrued liabilities
    
    
    (325
    )
    
    
    447
    
    
    
    (1,854
    )
    
    
    (1,417
    )Warranty liability
    
    
    (10
    )
    
    
    43
    
    
    
    (34
    )
    
    
    (34
    )Deferred revenue
    
    
    99
    
    
    
    333
    
    
    
    (9
    )
    
    
    308Net cash flows from operating activities
    
    
    688
    
    
    
    1,377
    
    
    
    123
    
    
    
    2,377Investing Activities:Purchases of machinery and equipment
    
    
    (79
    )
    
    
    (140
    )
    
    
    (115
    )
    
    
    (327
    )Payments of deferred acquisition related costs
    
    
    
    
    
    
    (1,018
    )
    
    
    
    
    
    
    (1,097
    )Proceeds from sale of marketable equity securities
    
    
    
    
    
    
    625
    
    
    
    
    
    
    
    625Purchase of technology
    
    
    
    
    
    
    
    
    
    
    (125
    )
    
    
    Net cash flows used in investing activities
    
    
    (79
    )
    
    
    (533
    )
    
    
    (240
    )
    
    
    (799
    )Financing Activities:Proceeds from exercise of stock options and issuance of
shares under employee stock purchase plan
    
    
    181
    
    
    
    165
    
    
    
    407
    
    
    
    350Proceeds from issuance of stock, net of issuance costs
    
    
    15,791
    
    
    
    
    
    
    
    15,791
    
    
    
    Repayments on bank line of credit, net
    
    
    (923
    )
    
    
    
    
    
    
    (354
    )
    
    
    Payments of long term debt
    
    
    (91
    )
    
    
    
    
    
    
    (182
    )
    
    
    Net cash flows from financing activities
    
    
    14,958
    
    
    
    165
    
    
    
    15,662
    
    
    
    350Net change in cash and cash equivalents
    
    
    15,567
    
    
    
    1,009
    
    
    
    15,545
    
    
    
    1,928Cash and cash equivalents, beginning of period
    
    
    163
    
    
    
    22,821
    
    
    
    185
    
    
    
    21,902Cash and cash equivalents, end of period
    
    $
    15,730
    
    
    $
    23,830
    
    
    $
    15,730
    
    
    $
    23,830Supplemental disclosure of cash flow information:Cash paid for interest
    
    $
    36
    
    
    $
    7
    
    
    $
    83
    
    
    $
    135Cash paid for income taxes
    
    
    71
    
    
    
    120
    
    
    
    78
    
    
    
    129Supplemental disclosure of non-cash investing and financing
activities:Accounts payable recorded for deferred acquisition related
costs
    
    $
    
    
    
    $
    260
    
    
    $
    
    
    
    $
    260Note issued in connection with purchase of technology
    
    
    
    
    
    
    
    
    
    
    125
    
    
    
    
 The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 5




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QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
    Basis of Presentation
   Use of Estimates
  Recent Accounting Pronouncements
  6




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Net Income Per Share
   Three months ended
    
    Six months endedJune 30,
    

    June 30,2004
    
    2005
    
    2004
    
    2005(in thousands, except share amounts)Numerator:Net income
    
    $
    1,683
    
    
    $
    879
    
    
    $
    2,771
    
    
    $
    1,858Denominator:Weighted average
shares for basic
calculation
    
    
    12,806,759
    
    
    
    14,091,232
    
    
    
    12,526,004
    
    
    
    14,079,368Incremental
shares from
employee stock
options
    
    
    1,151,167
    
    
    
    574,198
    
    
    
    1,046,870
    
    
    
    642,362Weighted average
shares for
diluted
calculation
    
    
    13,957,926
    
    
    
    14,665,430
    
    
    
    13,572,874
    
    
    
    14,721,730
  Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005Antidilutive shares
    
    
    
    
    
    
    984,718
    
    
    
    12,500
    
    
    
    529,859
 Accounting for Stock-Based Compensation
   7




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Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005(in thousands, except per share amounts)Net income  as reported
    
    $
    1,683
    
    
    $
    879
    
    
    $
    2,771
    
    
    $
    1,858Add back: Stock-based employee compensation expense
included in reported income, net of related tax effects
    
    
    18
    
    
    
    15
    
    
    
    36
    
    
    
    39Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects of $0, $54, $0 and $111
    
    
    (554
    )
    
    
    (552
    )
    
    
    (976
    )
    
    
    (1,095
    )Net income  pro forma
    
    $
    1,147
    
    
    $
    342
    
    
    $
    1,831
    
    
    $
    802Net income per share  as reported  basic
    
    $
    0.13
    
    
    $
    0.06
    
    
    $
    0.22
    
    
    $
    0.13Net income per share  as reported  diluted
    
    $
    0.12
    
    
    $
    0.06
    
    
    $
    0.20
    
    
    $
    0.13Net income per share  pro forma  basic
    
    $
    0.09
    
    
    $
    0.02
    
    
    $
    0.15
    
    
    $
    0.06Net income per share  pro forma  diluted
    
    $
    0.09
    
    
    $
    0.02
    
    
    $
    0.14
    
    
    $
    0.06
  Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005Denominator:Pro forma weighted average shares for basic calculation
    
    
    12,806,759
    
    
    
    14,091,232
    
    
    
    12,526,004
    
    
    
    14,079,368Pro forma incremental shares from employee stock options
    
    
    618,564
    
    
    
    521
    
    
    
    432,153
    
    
    
    107,681Pro forma weighted average shares for diluted calculation
    
    
    13,425,323
    
    
    
    14,091,753
    
    
    
    12,958,157
    
    
    
    14,187,049
   Goodwill
   8




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Intangible Assets and Other Long-Lived Assets
       December 31,
    
    June 30,2004
    
    2005(in thousands)Raw materials
    
    $
    7,879
    
    
    $
    8,334Finished goods
    
    
    3,168
    
    
    
    3,098Total inventories
    
    $
    11,047
    
    
    $
    11,432
   9




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Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005(in thousands)
    
    (in thousands)Warranty liability, beginning of the period
    
    $
    2,035
    
    
    $
    2,016
    
    
    $
    2,059
    
    
    $
    2,093Charged to cost of revenues
    
    
    326
    
    
    
    333
    
    
    
    779
    
    
    
    763Warranty expenditures
    
    
    (351
    )
    
    
    (290
    )
    
    
    (828
    )
    
    
    (797
    )Warranty liability at the end of the period
    
    $
    2,010
    
    
    $
    2,059
    
    
    $
    2,010
    
    
    $
    2,059
   Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005(in thousands)
    
    (in thousands)Net income
    
    $
    1,683
    
    
    $
    879
    
    
    $
    2,771
    
    
    $
    1,858Other comprehensive
income (loss), net of
related tax effects of
$0, $1, $0 and $13
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    (22
    )Total comprehensive income
    
    $
    1,683
    
    
    $
    883
    
    
    $
    2,771
    
    
    $
    1,836
    10




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11




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
  Critical Accounting Estimates
  Business Combinations.
 12




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Results of Operations
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2005
    
    2004
    
    2005(as a percentage of revenues)Revenues:Systems
    
    
    85.7
    %
    
    
    86.8
    %
    
    
    85.6
    %
    
    
    86.4
    %Service
    
    
    14.3
    
    
    
    13.2
    
    
    
    14.4
    
    
    
    13.6Total revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Gross Profit:Systems (as a percentage of systems revenues)
    
    
    42.9
    
    
    
    46.5
    
    
    
    43.7
    
    
    
    46.9Service (as a percentage of service revenues)
    
    
    41.0
    
    
    
    34.5
    
    
    
    39.7
    
    
    
    35.8Gross profit
    
    
    42.6
    
    
    
    45.0
    
    
    
    43.1
    
    
    
    45.4Operating Expenses:Research and development
    
    
    8.3
    
    
    
    8.7
    
    
    
    8.4
    
    
    
    8.6Sales and marketing
    
    
    20.1
    
    
    
    20.9
    
    
    
    20.2
    
    
    
    21.3General and administrative
    
    
    9.1
    
    
    
    10.3
    
    
    
    9.4
    
    
    
    10.0Total operating expenses
    
    
    37.5
    
    
    
    39.9
    
    
    
    38.0
    
    
    
    39.9Operating income
    
    
    5.1
    
    
    
    5.1
    
    
    
    5.1
    
    
    
    5.5Total other income
    
    
    2.8
    
    
    
    0.9
    
    
    
    1.4
    
    
    
    0.8Income taxes
    
    
    (0.2
    )
    
    
    (2.0
    )
    
    
    (0.2
    )
    
    
    (2.1
    )Minority interest in loss of consolidated entity
    
    
    0.1
    
    
    
    0.0
    
    
    
    0.1
    
    
    
    0.1Net income
    
    
    7.8
    %
    
    
    4.0
    %
    
    
    6.4
    %
    
    
    4.3
    %
 Three-Month Period Ended June 30, 2005 Compared to the Three-Month Period Ended June 30,
2004
 Revenues
    Gross Profit
  13




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Operating Expenses
    Other Income and Expense
  Income Taxes
  14




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Six-Month Period Ended June 30, 2005 Compared to the Six-Month Period Ended June 30, 2004
 Revenues
    Gross Profit
    15




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Operating Expenses
    Other Income and Expense
  Income Taxes
   Liquidity and Capital Resources
  16




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Contractual Obligations
  17




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Less than
    
    1  3
    
    3  5
    
    AfterTotal
    
    1 year
    
    years
    
    years
    
    5 years(in thousands)Contractual ObligationsOperating leases
    
    $
    3,909
    
    
    $
    1,112
    
    
    $
    2,155
    
    
    $
    642
    
    
    $
    Purchase obligations
    
    
    9,077
    
    
    
    9,077
    
    
    
    
    
    
    
    
    
    
    
    Total contractual cash obligations
    
    $
    12,986
    
    
    $
    10,189
    
    
    $
    2,155
    
    
    $
    642
    
    
    $
    
  Less than
    
    1  3
    
    3  5
    
    AfterTotal
    
    1 year
    
    years
    
    years
    
    5 years(in thousands)Other commercial commitmentsLine of credit
    
    $
    45
    
    
    $
    45
    
    
    $
    
    
    
    $
    
    
    
    $
    Guarantees
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total commercial commitments
    
    $
    45
    
    
    $
    45
    
    
    $
    
    
    
    $
    
    
    
    $
    
   Merger Agreement with Cardiac Science, Inc.
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Certain Factors that May Affect Future Results
 In addition to the other information contained in this report, the following risk
factors could affect our actual results and could cause our actual results to differ materially
from those achieved in the past or expressed in our forward-looking statements or could cause
the trading price of our common stock to decline. Additional risks and uncertainties not
presently known to us or that we currently deem immaterial also may impair our business
operations or negatively impact the trading price of our common stock.
 The unpredictability of our quarterly revenues and operating results may cause the
trading price of our stock to decrease.
  
    
    the impact of acquisitions, divestitures, strategic alliances, and other significant
corporate events;
    
    changes in our ability to obtain products and product components that are
manufactured for us by third parties, such as Holter monitors, as well as variations in
prices of these products and product components;
    
    delays in the development or commercial introduction of new versions of products and
systems;
    
    the ability to attain and maintain production volumes and quality levels for our
products and product components;
    
    effects of domestic and foreign economic conditions on our industry and/or customers;
    
    the successful implementation 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, which could affect our revenue
levels as well as our gross margins;
    
    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 personnel;
    
    the loss of key distributors or distribution companies; and
    
    seasonality in the sales of our products and systems.
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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.
  
    
    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 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.
  
    
    lengthening of buying or selling cycles;
    
    the introduction of competing products;
    
    price reductions by our competitors;
    
    development of more effective products by our competitors;
    
    hospital budgetary constraints; and
    
    changes in the reimbursement policies of government and third-party payers.
  Our business and results of operations may be affected by our announced merger with
Cardiac Science, Inc.
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We may suffer additional adverse consequences if the proposed transaction with Cardiac
Science is not completed.
  
    
    we would not realize the benefits we expect from becoming part of a combined company
with Cardiac Science, such as the potentially enhanced financial position, enhanced
product diversity and sales, marketing and distribution capabilities;
    
    activities relating to the merger and related uncertainties may divert our
managements attention from our day-to-day business and other potential acquisition
opportunities, cause disruptions among our employees and negatively impact our
relationships with customers and business partners, thus detracting from our ability to
increase revenue and minimize costs and possibly leading to a loss of revenue and
market position that we may not be able to regain if the transaction does not occur;
    
    the market price of our common stock could decline following an announcement that
the merger has been abandoned, to the extent that the current market price reflects a
market assumption that the merger will be completed;
    
    we could be required to pay Cardiac Science a $4.0 million termination fee if the
merger agreement is terminated under certain specified conditions;
    
    we would be required to expense approximately $1.4 million or more in transaction
related costs that would otherwise be treated as part of the purchase price;
    
    we would remain liable for certain costs related to the transaction, such as legal,
accounting, financial advisor and financial printing fees; and
    
    we may not be able to take advantage of alternative business opportunities or
effectively respond to competitive pressures.
 Even if we consummate our pending transaction with Cardiac Science, the combined company
may experience difficulties in integrating the two companies and may not achieve the
anticipated benefits of the combination.
  
    
    the impairment of relationships with employees, customers, distributors, strategic
partners and suppliers as a result of integration of management and other key
personnel;
    
    the potential disruption of the combined companys ongoing business and distraction
of its management;
    
    the difficulty of incorporating acquired technology and rights into the product
offerings of the combined company;
    
    not achieving expected synergies; and
    
    unanticipated expenses related to integration of the two companies.
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Either independently or in connection with our proposed merger with Cardiac Science, we, or our
independent registered public accounting firm, may determine that we have material weaknesses in
our internal controls over financial reporting. As a result, current and potential stockholders
could lose confidence in our financial reporting, which would harm our business and the trading
price of our stock.
   We may make future acquisitions, which involve numerous risks that could impact our
business and results of operations.
  
    
    difficulties in integrating the operations, technologies, and products of the acquired companies;
    
    the risk of diverting managements attention from normal daily operations of the business;
    
    potential difficulties in completing projects associated with in-process research and development;
    
    risks of entering markets in which we have no or limited direct prior experience and
where competitors in such markets have stronger market positions;
    
    initial dependence on unfamiliar supply chains or relatively small supply partners;
    
    insufficient revenues to offset increased expenses associated with acquisitions;
    
    the risk that acquired lines of business may reduce or replace the sales of existing products; and
    
    the potential loss of key employees of the acquired companies.
  We may need additional capital to continue our acquisition growth strategy.
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If we fail to successfully enter into strategic alliances to generate growth, our
operating results may be negatively affected.
  Future changes in the accounting treatment for employee stock options may cause adverse
fluctuations and affect our reported results of operations.
  Compliance with changing regulation of corporate governance, public disclosure and accounting
matters may result in additional expenses.
  Failure to keep pace with changes in the marketplace may cause us to lose market share and our
revenues may decrease.
  If we fail to maintain our relationships with distribution organizations, our sales and
operating results may suffer.
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Failure to develop and commercialize new versions of our products would cause our
operating results to suffer, both domestically and internationally.
  
    
    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;
    
    access new interface standards needed for product connectivity;
    
    anticipate and meet demands of our international customers for products featuring
local language capabilities; and
    
    anticipate and compete effectively with our competitors efforts.
  We depend on the expertise of key personnel to manage our businesses effectively in a
changing market, and if we lose one or more members of our senior management team or if
our management team does not work together effectively, our business could be harmed.
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If we do not maintain or grow revenues from our support services or consumables, our
operating and financial results may be negatively impacted.
  Competition may decrease our market share and cause our revenues to decrease.
  
    
    greater financial and other resources;
    
    greater variety of products;
    
    greater pricing flexibility;
    
    more extensive technical capabilities;
    
    patent portfolios that may present an obstacle to our conduct of business;
    
    stronger name recognition; and
    
    larger distribution networks.
  If suppliers discontinue production of purchased components of our products and we are
unable to secure alternative sources for these components on a timely basis, our ability
to ship products to our customers may be adversely affected, our revenues may decline
and our costs may increase as a result.
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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.
  
    
    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.
 Our future financial results could be adversely impacted by asset impairments or other
charges.
   Inadequate levels of reimbursement from governmental or other third-party payers for
procedures using our products and systems may cause our revenues to decrease.
  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.
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Failure to adequately protect our intellectual property rights will cause our business
to suffer.
   If third parties claim that our products infringe their intellectual property rights, we
may be forced to expend significant financial resources and management time and our
operating results would suffer.
  We are dependent upon licensed and purchased technology for some of our products, and we may not
be able to renew these licenses or purchase agreements in the future.
  Our reliance on a principal manufacturing facility may impair our ability to respond to natural
disasters or other unforeseen catastrophic events.
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Recent and future Federal and state regulations in the U.S. relating to patient privacy
could impose burdens on us.
  Delaware law and provisions in our charter could make the acquisition of our company by another
company more difficult.
  The market price of our stock may be highly volatile.
  
    
    uncertainties created by our pending transaction with Cardiac Science;
    
    quarterly fluctuations in results of our operations;
    
    our ability to successfully commercialize our products;
    
    changes in coverage or earnings estimates by analysts;
    
    impact of other acquisitions, divestitures, strategic alliances, and other significant corporate events;
    
    changes in the mix of products and systems we sell, which could affect our gross margins;
    
    the loss of key distributors or distribution companies; and
    
    seasonality in the sales of our products and systems.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 4. Controls and Procedures
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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
 Exhibits31.1
    
    Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURE
  QUINTON CARDIOLOGY SYSTEMS, INC.By:
    /s/ Michael K. MatysikMichael K. MatysikSenior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)  31