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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO

SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


|                                                |  |                                                                                             
|----------------------------------------------- |  | --------------------------------------------------------------------------------------------
|þ                                               |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|                                               
|For the fiscal year ended December 31,
    2002
|                                               
|or                                             
|                                               
|o                                               |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                               
|Commission File Number: 000-49755              

Quinton Cardiology Systems, Inc.

(Exact Name of Registrant as Specified in its
Charter)


|                                                                                  |  |                                         
|--------------------------------------------------------------------------------- |  | ----------------------------------------
|California                                                                        |  | 94-3300396                              
|(State or Other Jurisdiction of
    Incorporation or Organization)                |  | (I.R.S. Employer
    Identification No.)
|                                                                                 
|3303 Monte Villa Parkway, Bothell, WA(Address of Principal Executive
    Offices) |  | 98021(Zip Code)                         
|(425) 402-2000(Registrants Telephone
    Number, Including Area Code)           

Securities Registered Pursuant to
Section 12(b) of the Act: None.

Securities Registered Pursuant to
Section 12(g) of the Act: Common Stock, no par
value.

Indicate by check mark 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.     þ     Yes          o No

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of the registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to
this Form 10-K. þ

Indicate by check mark whether the Registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Act).     o     Yes          þ No

The aggregate market value of the voting and
non-voting common stock held by non-affiliates of the
registrant, based on the closing price of the registrants
Common Stock on June 28, 2002 as reported on the Nasdaq
National market, was approximately $45,041,056. Shares of Common
Stock held by each executive officer and director and by each
shareholder whose beneficial ownership exceeded 5% of the
outstanding Common Stock at June 28, 2002 have been
excluded in that such persons may be deemed to be affiliates.
This determination of status is not necessarily conclusive for
determination for other purposes.

The number of shares of the registrants
Common Stock outstanding at March 11, 2003 was 12,111,603.



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TABLE OF CONTENTS



|                                                |                                                                                              |  |  |  |  |  |  | 
|----------------------------------------------- | -------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART 1                                         
|                                                | Item 1. Business                                                                            
|                                                | Item 2. Properties                                                                          
|                                                | Item 3. Legal Proceedings                                                                   
|                                                | Item 4. Submission of Matters to a Vote of Shareholders                                     
|PART II                                        
|                                                | Item 5. Market for Companys Common Stock and Related Shareholder Matters                   
|                                                | Item 6. Selected Financial Data                                                             
|                                                | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                         
|                                                | Item 8. Financial Statements and Supplementary Data                                         
|                                                | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
|PART III                                       
|                                                | Item 10. Executive Officers and Directors of the Company                                    
|                                                | Item 11. Executive Compensation                                                             
|                                                | Item 12. Security Ownership of Certain Beneficial Owners and Management                     
|                                                | Item 13. Certain Relationships and Related Transactions                                     
|PART IV                                        
|                                                | Item 14. Controls and Procedures                                                            
|                                                | Item 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K                  
|SIGNATURES                                     
|CONSOLIDATED BALANCE SHEETS                    
|CONSOLIDATED STATEMENTS OF OPERATIONS          
|CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS     
|EXHIBIT 10.13                                  
|EXHIBIT 10.14                                  
|EXHIBIT 10.15                                  
|EXHIBIT 10.16                                  
|EXHIBIT 10.17                                  
|EXHIBIT 10.18                                  
|EXHIBIT 10.19                                  
|EXHIBIT 10.20                                  
|EXHIBIT 10.21                                  
|EXHIBIT 21.1                                   
|EXHIBIT 23.1                                   
|EXHIBIT 23.2                                   
|EXHIBIT 99.1                                   
|EXHIBIT 99.2                                   



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QUINTON CARDIOLOGY SYSTEMS, INC.

2002 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS

|                                                                                                       |  |      |    | 
|------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                       |  | Page
|                                                                                                       |  |     
|PART I                                                                                                 |  |      |    | 
|Item 1.  Business                                                                                      |  |      | 1  | 
|Item 2.  Properties                                                                                    |  |      | 17 | 
|Item 3.  Legal Proceedings                                                                             |  |      | 17 | 
|Item 4.  Submission of Matters to
    a Vote of Shareholders                                           |  |      | 17 | 
|                                                                                                      
|PART II                                                                                                |  |      |    | 
|Item 5.  Market for Companys
    Common Stock and Related Shareholder Matters                         |  |      | 18 | 
|Item 6.  Selected Financial Data                                                                       |  |      | 18 | 
|Item 7.  Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations |  |      | 20 | 
|Item 7A.  Quantitative and
    Qualitative Disclosures About Market Risk                               |  |      | 34 | 
|Item 8.  Financial Statements and
    Supplementary Data                                               |  |      | 34 | 
|Item 9.  Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure  |  |      | 34 | 
|                                                                                                      
|PART III                                                                                               |  |      |    | 
|Item 10.  Executive Officers and
    Directors of the Company                                          |  |      | 35 | 
|Item 11.  Executive Compensation                                                                       |  |      | 35 | 
|Item 12.  Security Ownership of
    Certain Beneficial Owners and Management                           |  |      | 35 | 
|Item 13.  Certain Relationships
    and Related Transactions                                           |  |      | 36 | 
|                                                                                                      
|PART IV                                                                                                |  |      |    | 
|Item 14.  Controls and Procedures                                                                      |  |      | 37 | 
|Item 15.  Exhibits, Financial
    Statements, Schedules and Reports on Form 8-K                        |  |      | 37 | 

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this
Report, to the extent not set forth herein, is incorporated
herein by reference to the Registrants definitive Proxy
Statement relating to the annual meeting of shareholders to be
held on May 16, 2003, which definitive Proxy Statement
shall be filed with the Securities and Exchange Commission
within 120 days after the end of the fiscal year to which
this Report relates.

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PART 1

This annual report contains forward-looking
statements relating to Quinton Cardiology Systems, Inc. These
are forward-looking statements for purposes of the safe harbor
provisions under the Private Securities Litigation Reform Act of
1995. The words believe, expect,
intend, anticipate, variations of such
words, and similar expressions identify forward-looking
statements, but their absence does not mean that the statement
is not forward-looking. Actual results may vary significantly
from the results expressed or implied in these statements.
Forward-looking statements reflect managements current
expectations, plans or projections and are inherently uncertain.
These forward-looking statements reflect managements
current expectations and involve risks and uncertainties. Our
actual results could differ materially from results that may be
anticipated by such forward-looking statements. The principal
factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the section
entitled Certain Factors That May Affect Future
Results, 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 to reflect events or
circumstances that may subsequently arise. Readers are urged to
review and consider carefully the various disclosures made in
this report and in our other filings made with the SEC that
attempt to advise interested parties of the risks and factors
that may affect our business, prospects and results of
operations. The terms us, we and
our refer to Quinton Cardiology Systems, Inc. and
our wholly owned subsidiaries Quinton Inc. and Burdick,
Inc.




Item 1.     Business

Overview

We develop, manufacture, market and service a
family of diagnostic cardiology systems used in the diagnosis,
treatment, and rehabilitation of patients with heart disease.
Our products include electrocardiographs (ECGs), stress test
systems, Holter monitoring systems, cardiac catheterization
management systems, cardiac rehabilitation telemetry systems,
ECG management systems, medical treadmills and patented
electrodes. We also sell other consumables related to our
products.

Quinton Cardiology Systems, Inc. is a California
corporation formed in April 1998 to acquire Quinton Inc., a
leading supplier of ECGs, stress test systems, medical
treadmills and other cardiology diagnostic products. Quinton
Inc. was originally incorporated in 1966. At December 31,
2002, Quinton Inc. was our principal operating subsidiary. In
January 2003, we acquired Spacelabs Burdick, Inc, at which time
we changed its name to Burdick, Inc. Burdick, which was founded
in 1913, is a leading supplier of ECGs, Holter monitors and
cardiology information systems to U.S. physicians offices.

Industry
Background

The American Heart Association reports there are
over 60 million patients in the U.S. with active or
developing heart disease. Heart disease is the leading cause of
death in the U.S. The American Heart Association also estimates
the direct cost of treating heart disease and stroke at nearly
$200 billion annually, representing 13% of all domestic
healthcare spending. Our products compete in three medical
equipment market sectors: cardiovascular monitoring equipment,
ambulatory telemetry equipment, and cardiac catheterization
monitoring equipment. Based upon reports of Frost &
Sullivan, a leading independent research firm, we estimate
combined 2002 sales in these market sectors in excess of
$770 million.

Cardiovascular care facilities provide patients
with a variety of diagnostic and treatment techniques ranging
from risk assessment and stress testing to complex surgeries and
rehabilitation services. Diagnostic cardiology systems are
crucial to cardiovascular care. The core of diagnostic
cardiology is the electrocardiogram, or ECG waveform, a
representation of the electrical activity of the heart.
Clinicians use ECG waveform recordings and analyses to assess
the presence and severity of cardiac disease, and to monitor the
efficacy of treatments such as drugs, interventions, operations,
and device implants. Effective use of the ECG waveform in
patient management and the delivery of cardiovascular care
requires that the entire process of recording, storing,
analyzing, retrieving and distributing ECG waveform data be as
rapid and cost effective as possible.

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Despite the technological and clinical advances
in cardiology, healthcare providers face significant challenges
in delivering consistent and high quality cardiovascular care.
Healthcare reform continues to place increasing pressure on
providers of cardiovascular care to see and treat more patients
faster. In addition, the need to control costs, increase
efficiencies and manage data has introduced new layers into the
decision making process for technology utilization. This
changing healthcare environment has resulted in the following
critical needs:



| |   |                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | systems and services tailored to the workflow
    needs of clinicians, to improve efficiencies and reduce training
    times;                                                                                     
|
| |  | technologies that can effectively manage data
    from a variety of sources and be scaled from single offices to
    wide area networks;                                                                          
|
| |  | products that are implemented using standards
    such as DICOM and HL-7 for connectivity, to minimize the effort
    and expense required to integrate data across multiple sources;                             
|
| |  | tools to improve the management of resources by
    tracking and trending cost efficiencies in healthcare delivery
    systems, thus providing data to payors which differentiate among
    competitive providers;
|
| |  | methods for preserving and propagating healthcare
    data from legacy systems; and                                                                                                                               
|
| |  | progressive migration to network and Internet
    technologies within a security structure that meets HIPAA
    requirements.                                                                                     

Diagnostic cardiology systems that meet these
needs and challenges will have a significant opportunity and
advantage in the marketplace.

Quinton
Solution

We provide a family of diagnostic cardiology
systems that deliver reliable, cost effective solutions for
cardiologists and other healthcare providers. Our systems are
easy to use, with simple, intuitive user interfaces. Most of our
diagnostic cardiology systems are based on a Microsoft
Windows-based software architecture designed to integrate
critical data capture, provide enterprise level access to data,
and scale to meet the requirements of a variety of
cardiovascular care facility environments. We believe our
diagnostic cardiology systems provide our customers solutions
for overcoming many of the challenges they face, including the
following key benefits:

Ease of use.Our
systems feature intuitive user interfaces that are designed with
significant input from clinicians and technologists to address
the needs of providers and patients. Our systems automate many
of the data collection functions by uploading patient
information to a database for easy retrieval. Our systems use
standard computer components and require minimal configuration.
Our user interface has been designed to conform to the
particular clinical procedure rather than adapting the procedure
to the device. Additionally, users can customize the interface
to meet their unique requirements. We believe this functionality
enhances clinical success by allowing the user to concentrate on
the patient and procedure. Conversely, some products offered by
our competitors require significantly more interaction with the
device. In addition, we believe the ease of use features of our
products enable our customers to use our systems with
significantly lower training requirements and higher
productivity than competing systems that do not offer
customizable user interfaces.

Network compatibility.Many of our systems are designed to
support a clinical network environment, enabling cardiologists
to assimilate, collate and interpret data and disseminate
results of diagnosis, treatment and rehabilitation. These
systems collect data that may be stored in a local or network
server database. Many of our systems connect to larger
enterprise networks that allow data to be shared with other
users, both within the facility and remotely via secure
networks. To facilitate these connections, we have chosen to
implement commonly used formats and protocols. These formats,
such as portable document format and extensible markup language,
facilitate the storage and dissemination of clinical
information. In contrast, some of our competitors use
proprietary formats to store and disseminate clinical
information. We believe that standardized and efficient data
handling are key to addressing the user requirements.

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Effective data capture.Many of our systems automate and
assist in the collection, interpretation and retrieval of data
and can effectively display, for side-by-side comparison, the
results of tests performed over an extended period. These
systems improve clinical productivity and throughput, which is
the number of reimbursable procedures completed per hour of
system use. For our customers, greater throughput translates
into greater return on investment from our systems. Unlike many
competing systems, which require more intensive manual work, our
systems automate the capture of clinical data and provide
computer assisted interpretation where appropriate.

Improved diagnostic speed and accuracy.As a result of easy to use controls,
effective data capture, and computer assisted diagnosis, we
believe our systems allow for improved diagnostic accuracy. The
availability of historical results for comparison allows for a
greater understanding of changes in the patients physical
condition. In addition, by enabling the review and assessment of
test results remotely our systems can greatly speed the time of
diagnosis, which allows more rapid institution of appropriate
therapy for the patient.

Open technology architecture.Our Microsoft Windows-based technology
adheres to established standards for image, waveform, data and
report generation and dissemination, enabling healthcare
providers to share data across a private network or via the
Internet. This Windows-based technology platform was designed to
support data integration activities with other third-party
clinical systems. Unlike certain competitors that utilize
proprietary architecture or protocols, we believe this
technology will permit our customers to easily integrate our
products and systems with their existing infrastructure, and
scale to meet the needs of larger healthcare organizations.

Our
Advantages

We believe our business has several advantages:

Industry leading brands.Quintons founder, Wayne Quinton,
developed the first treadmill designed for cardiac stress
testing in 1953. Since 1966, Quinton has manufactured and sold
high quality, reliable diagnostic cardiology systems. Burdick
has been an innovator in medical devices since 1913 and in
diagnostic cardiology since 1949. We believe Quinton and Burdick
are among the most respected names in the field of cardiology.
We believe we have enjoyed recognition in ECG, stress test
systems, Holter monitors, cardiac catheterization management
systems, and rehabilitation telemetry systems and are known for
a high level of service, which drives customer loyalty and
strong relationships with healthcare providers.

Large installed base.We believe we have the leading U.S.
installed base of stress test systems and rehabilitation
telemetry systems. In addition, we have a large installed base
of Holter monitors and cardiac catheterization management
systems. Through the acquisition of Burdick, we have added a
substantial installed base of electrocardiographs and ECG
management systems and we have increased our stress systems and
Holter systems installed base. Our combined installed base
presents a substantial target market for future sales of
products, systems, and software upgrades, as well as related
service and consumables.

National sales and service organizations.Our national sales organization,
consisting of both Quintons direct sales force and
Burdicks independent distributor network, which is
supported by a team of internal sales representatives, possesses
extensive experience and expertise in diagnostic cardiology
systems. In addition, we have a national service organization
whose work enhances customer satisfaction and retention and
supports our sales force with cross-selling capabilities. We
believe we can rely on our national sales and service
organizations to support the sale of our products, whether
developed internally or acquired.

Commitment to research and development.We have invested on average 12.9% of
our revenues over the last three years in product development
efforts (excluding Burdick, which was acquired in January 2003).
Our research and development efforts contributed to the release
of new versions of products in most of our major product
categories in 2002.

Growth
Strategy

Our growth strategy is to expand our domestic
installed base through sales of new versions of our products and
systems, increase our penetration of international markets
through partnerships and acquisitions, develop

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industry-leading connectivity solutions for
diagnostic cardiology systems, and acquire businesses, assets,
product lines or technologies that complement our business or
offer other strategic advantages.


Domestic sales.We
target our installed base for future sales of products, systems
and software upgrades, as well as service and consumables to
support new and existing products. We plan to continue to
utilize Quintons direct sales force to focus on the acute
care market. We plan to complement this sales effort through
Burdicks well established distributor network, which is
focused on the primary care market. We plan to expand domestic
sales by offering products and systems that address customer
needs, from office practices through larger hospitals. We
believe these customer segments will be increasingly receptive
to our new technologies.

International sales.We have generated approximately 8.3%
of our revenues from international sales over the last three
years (excluding Burdick, which was acquired in January 2003).
We believe that international markets, particularly in Europe
and Asia, represent a significant opportunity to increase our
sales. We have developed products and systems to be compatible
with regulatory and compliance standards in international
markets. We plan to address this opportunity further through
partnerships with, and acquisitions of, diagnostic cardiology
system providers. For example, we have recently formed a
strategic alliance with one of the leading diagnostic cardiology
system providers in Japan to distribute our Q-Stress system in
that country. We believe that we will be able to expand our
international business further through Burdicks
international distributor network.

Connectivity.We
offer and continue to develop systems that enable customers to
extract electrocardiographic and other data from stand-alone
devices, link together disparate diagnostic and monitoring
devices, and automate the storage, retrieval and processing of
electrocardiographic data. These connectivity features address
significant unmet needs in the diagnostic cardiology systems
market, which should increase demand for, and lead to
incremental sales of our other products and services.

Acquisitions.We
plan to pursue acquisitions of businesses, product lines,
assets, or technologies that are complementary to our business
or offer us other strategic benefits, such as enhanced clinical
or technological value, expanded geographical reach, and
additional sales or research and development capabilities. The
fragmentation of the cardiology industry offers us a unique
opportunity for growth and consolidation through selective
acquisitions. We believe our brand and history in the cardiology
industry, and the acquisition and integration experience of our
management team, puts us in a position to take advantage of this
opportunity. Funding for potential acquisitions could be in the
form of our stock or, alternatively, from outside financing
sources. Because of the uncertainties related to either of these
funding alternatives, there can be no assurance that we will be
successful in making future acquisitions.

Our
Products

Revenues from sales of our systems and related
consumable products were $41.3 million, $33.8 million
and $37.4 million for each of the fiscal years ended
December 31, 2000, 2001 and 2002, respectively. Revenues
from sales of systems and related consumable products for these
fiscal years do not include historical revenues of Burdick,
which was acquired in January 2003. A description of the various
systems and consumable products we offer include:

Electrocardiographs.We offer a variety of
electrocardiographs at various price points and in various
configurations. These products cover the spectrum of market
needs, ranging from low-cost units targeted for physicians
offices to fully featured units that are designed for the most
rigorous clinical and hospital settings.

Stress test systems.Our integrated stress test systems
allow cardiologists and other healthcare providers to monitor
and analyze the performance of the heart under stress. Our
stress systems record a patients heart rate, heart rhythm,
blood pressure, and other vital signs during induced stress.
Quinton treadmills, specifically designed for cardiac monitoring
procedures, provide precise and replicable levels of exertion.
Our system provides real time analysis, charting, and reporting,
enabling cardiologists and other healthcare providers to
diagnose patients heart disease more accurately and
efficiently.

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Holter monitoring systems.Our integrated Holter monitoring
products and systems record and assess the performance of a
patients heart during various activities over extended
periods of time. The Holter recorder, which is typically worn
for a period of 24 hours, records the patients heart
rate, heart rhythm, and ECG waveform data. Our Holter offering
includes both 3 lead and true 12 lead ECG waveform
diagnostic capabilities.

Cardiac catheterization management systems.Our Q-Cath monitors and systems allow
cardiologists and other healthcare providers to monitor and
analyze cardiovascular performance, vital signs, and coronary
artery blockage during cardiac catheterization procedures.
Cardiac catheterization is a minimally invasive diagnostic or
therapeutic procedure involving the insertion of a small,
sterile tube through a large blood vessel and into a
patients heart. Q-Cath can be deployed as a standalone or
networked system. In the network configuration, patient data
from multiple labs can be reviewed and edited from a separate
network workstation.

Rehabilitation telemetry systems.Our integrated Q-Tel telemetry
devices, database products and treadmills monitor the
patients heart rate, heart rhythm, and ECG waveform data
during rehabilitation exercises. Our Outcomes rehabilitation
database provides real time clinical data and trend analysis to
enable cardiologists and other healthcare providers to track and
assess improvements in cardiovascular function.

ECG management systems.We provide an ECG management system
that automates the processing, storage, retrieval and editing of
electrocardiographic data. Our Pyramis system extracts the ECG
waveforms and arrhythmia data from ECGs via diskette, direct
serial interface, telephone modem, or network connections.

Consumable products and accessories.Diagnostic cardiology systems require
lead wires and electrodes to be attached to the patient to
retrieve and process cardiac electrical activity and chart paper
to generate reports. We sell all of these items, including our
patented Quik-Prep electrodes.

In 2002, we introduced new versions of products
in most of our product lines, and we are currently developing
additional new versions of products in each of these product
lines.

Product
Support and Maintenance Services

Revenues from our support and maintenance
services were $9.4 million, $9.0 million and
$9.1 million for each of the fiscal years ended
December 31, 2000, 2001 and 2002, respectively. Revenues
from support and maintenance services do not include historical
revenues of Burdick, which was acquired in January 2003. Our
product support and maintenance organization supports our
installed base. We provide product installation, repair and
scheduled maintenance services, as well as software and hardware
upgrades.

Sales and
Marketing

Within the U.S. we market and sell our products,
systems and services to hospitals and cardiology clinics through
a dedicated national sales force that has broad experience in
selling diagnostic cardiology systems. Each of our sales
representatives sells our entire product line and is responsible
for a region and a personal sales quota. At December 31,
2002, Quintons domestic sales force consisted of
30 sales representatives, including 28 direct sales
representatives and two independent manufacturers
representatives, managed by three regional managers. To
complement our domestic sales force and increase our sales to
existing customers, we encourage our service personnel to
actively seek cross-selling opportunities. With the acquisition
of Burdick, we have expanded our sales reach to include sales to
primary care physicians through a well established independent
distributor network, supported by a team of internal sales
representatives. At December 31, 2002, Burdick had
23 sales representatives managed by 3 regional
managers.

Outside the U.S. we rely on indirect sales
channels, using distributors to offer our products. Our
arrangements with distributors are typically territory specific
and cover several of our products. We provide our distributors
with discounts based on a variety of factors including the
annual volume of its orders.

Our sales efforts increasingly target system
sales opportunities. Our sales efforts historically promoted
stand alone product sales, and were most successful in small and
midsize hospitals, rehabilitation clinics and

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group cardiology practices. We believe
improvements in our technology and changes in customer needs
make our products attractive to larger hospitals and physician
practices, as well. Our new system-oriented sales approach will
allow us to adjust to the complex selling environment of larger
facilities as a result of the growing connectivity of devices
and systems within healthcare organizations, which increases the
technical knowledge required of our sales representatives. In
addition, while previous sales efforts have focused on the
individual clinician as the customer, our selling process
increasingly involves multiple customers with differing
expectations, including personnel responsible for information
technology and administration.


Our marketing activity consists primarily of
product marketing through product demonstrations, major
cardiology meetings, publications in professional journals,
telemarketing and website marketing. Our marketing efforts
emphasize our products ease of use, connectivity, quality,
and reliability. We organize our marketing function on a product
line basis and we have product managers for each of our major
product lines. In addition, we support the sales efforts of
Burdicks distributors by providing funding and other
support for certain promotional activities.

Quintons domestic and international sales
and marketing staff consisted of 60 persons as of
December 31, 2002, which includes our team of experienced
sales support and application specialists who are responsible
for providing pre-sale technical support and technical training
for the sales team and for our distributors. Burdicks
total domestic and international sales and marketing staff
consisted of approximately 34 persons as of
December 31, 2002.

We do not generally have significant sales order
backlog. At both December 31, 2002 and 2001, total sales
order backlog represented less than 30 days of anticipated
sales volume.

Customer
Service and Support

We believe that a broad range of support services
is essential to the successful installation and utilization of
our diagnostic cardiology systems. We offer a combination of
online, telephone and on-site technical assistance services,
including the ability to have assistance 24 hours a day,
seven days a week. We also provide professional services for
network analysis, design and implementation, and training and
education. Our multiple support programs include basic and
extended systems maintenance and parts replacement.

At December 31, 2002, Quintons
domestic service organization included 50 employees, 32 in
domestic field service locations and the remainder in
call-center operations and factory-based repair. Our large
installed base facilitates the sale of service contracts and
warranties, and presents a cross-selling opportunity for
products that are complementary to our customers existing
installations. In international markets our distributors provide
support and other services. At December 31, 2002,
Burdicks service organization consisted of approximately
16 persons.

Research and
Development

We believe that strong product development
capabilities are essential to our strategy of enhancing,
developing and incorporating improved functionality, and
maintaining the competitiveness of our products in our core
markets. We have assembled a team of engineers with experience
in user interface design, SQL database management, COM and C++
tools, network computing, clinical algorithms, electrical
engineering, and product verification and validation in clinical
settings. Our research and development process is dependent on
assessment of customer needs, identification and evaluation of
new technologies, and monitoring market acceptance and demand.
We have a structured process for undertaking product development
projects that involves all functional groups at all levels
within our company. This process is designed to provide a
framework for defining and addressing the steps, tasks, and
activities required to bring product concepts and development
projects to market.

Our research and development expenses were
$7.5 million in 2000, $5.5 million in 2001, and
$5.1 million in 2002. This represents approximately 12.9%
of our revenues over that three-year period. Research and
development expenses in total dollars and as a percentage of
revenues for these fiscal years do not reflect research and
development expenses nor revenues of Burdick. During this
period, our research and develop-

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ment efforts focused on enhancing and expanding
the proven capabilities of our existing product lines, as well
as introducing new versions of our products. As of
December 31, 2002, Quinton had 43 people engaged in
research and development activities, including 29 in product
development, seven in validation and verification, and seven in
sustaining engineering and management. At December 31,
2002, Burdick had 33 people engaged in research and
development activities.


Technology

We use object-oriented design based on Microsoft
technologies to create the software for many of our systems. We
develop our systems user interfaces for many of our
products using Microsoft Visual Basic and C++ tools. In
addition, in many cases, the data storage layer has been
developed on Microsoft SQL Server. Many of our systems have been
designed for network operation and deployment using industry
standard TCP/ IP network protocol. Many of our software modules
have been developed as objects that can be reused in our other
products as needed.

We are designing many of our systems to meet
emerging industry standards for data sharing. Final clinical
reports from certain of our products can now be rendered in
Adobe PDF format for easy transmission and viewing in standard
browsers. Extensible markup language, or XML, is also used in
certain of our products to communicate complex information with
third-party systems, and the HL7 messaging standard will be
supported to enable communications with leading hospital
information systems. ECG waveform data can be transmitted in
medical industry standard Serial Communication Protocol format
through many of our products.

Most of our systems include hardware components
that connect to the patient and digitize ECG waveform signals,
blood pressure, and other vital signs. These hardware components
connect to the computer operating system via special software
drivers. The digitized patient information is a continuous
stream of data that is analyzed in real-time and communicated to
the user interface components for display. Real-time analysis is
a critical function that typically runs at a high priority
within Microsoft Windows. Applications that require the storage
of all real-time patient data collect this information as a part
of the processing subsystem. Patient data and clinical results
are stored and managed via Microsofts SQL Server.

Manufacturing
and Supply

At Quintons Bothell, Washington facilities,
we primarily manufacture, assemble, and test stress test
systems, Holter monitoring systems, cardiac catheterization
management systems, rehabilitation telemetry systems, medical
treadmills and electrodes. As of December 31, 2002, Quinton
had 49 employees in manufacturing and supply functions. At
Burdicks Deerfield, Wisconsin facilities, we manufacture
and assemble ECG cardiographs, stress systems, Holter monitoring
systems, and a variety of other products. As of
December 31, 2002, Burdick had 53 employees in
manufacturing and supply functions. In addition, limited
manufacturing activities are performed at the facilities of our
majority owned joint venture operation in Shanghai, China.

We also rely upon other third-party suppliers to
provide us with various materials used in the production and
assembly of our devices and systems. We have long-standing
supply relationships for essentially all our outsourced product
components. We maintain a comprehensive quality assurance and
quality control program that includes documentation of all
material specifications, operating procedures, equipment
maintenance and quality control methods. Our quality systems are
based on and in compliance with the requirements of ISO 9001/ EN
46001 and the applicable regulations imposed by the FDA on
medical device manufacturers.

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Targeted
Acquisition Opportunities

We plan to pursue acquisition of businesses,
product lines, assets or technologies that are complementary to
our business or offer us other strategic benefits. We plan to
actively evaluate potential acquisition opportunities in the
following areas:



| |   |                                                            
| | - | -----------------------------------------------------------
| |  | arrhythmia and ischemia diagnostics;                       
|
| |  | cardiac monitoring and telemetry;                          
|
| |  | non-invasive cardiovascular imaging and stress
    testing;
|
| |  | ECG management; and                                        
|
| |  | cardiology information management.                         

Many single-product diagnostic cardiology system
companies in these categories either address markets that are
too small to justify national sales and service organizations or
lack the capital to build such a distribution and service
network. Without a strong distribution channel, industry-leading
products can fail to successfully penetrate existing markets. We
plan to expand our product lines, leverage the capabilities of
our existing sales force and increase sales of our existing and
new product lines by selectively acquiring those companies, or
assets of companies, with strong differentiated technologies or
product lines that complement ours. We believe that our national
sales force, our large installed customer base, our technology
and experienced management provide us with a suitable platform
for acquisitions. Funding for potential acquisitions could be in
the form of our stock or, alternatively, from outside financing
sources. Because of the uncertainties related to either of these
funding alternatives, there can be no assurance that we will be
successful in making future acquisitions.

Our
Competition

The following chart indicates the most
significant competitors for each of our product lines:

|                                           |  |                                           
|------------------------------------------ |  | ------------------------------------------
|Product                                    |  | Competitors                               
|                                           |  |                                           
|Electrocardiographs                        |  | General Electric, Philips, Welch Allyn    
|Stress test systems                        |  | General Electric, Philips                 
|Holter monitoring systems                  |  | Del Mar, General Electric, Philips        
|Cardiac catheterization management systems |  | General Electric, Siemens, Witt Biomedical
|Rehabilitation telemetry systems           |  | Life Sensing Instruments, Scott Care      
|ECG management systems                     |  | General Electric, Philips                 

We believe that cardiologists and other
healthcare providers consider the following factors in
determining which products to purchase:



| |   |                                           
| | - | ------------------------------------------
| |  | quality, accuracy, and reliability;       
|
| |  | reputation of the provider;               
|
| |  | relative ease of use;                     
|
| |  | depth and breadth of features;            
|
| |  | quality of customer support;              
|
| |  | frequency of updates;                     
|
| |  | availability of third-party reimbursement;
|
| |  | conformity to standards of care; and      
|
| |  | price.                                    

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We believe our products compete favorably on
these factors. However, products offered by some of our
competitors offer features that may compete favorably on these
factors as well. The market for diagnostic cardiology systems is
highly competitive and we expect competition to intensify. Many
of our competitors enjoy substantial advantages, including
greater resources that can be devoted to the development,
promotion and sale of their products. In addition, many of our
competitors may have more established sales channels, greater
product development experience or greater name recognition.

Third-Party
Reimbursement

In the U.S., as well as in foreign countries,
government-funded or private insurance programs, commonly known
as third-party payors, pay a significant portion of the cost of
a patients medical expenses. A uniform policy of
reimbursement does not exist among all these payors. We believe
that reimbursement is an important factor in the success of any
medical device.

All U.S. and foreign third-party reimbursement
programs, whether government funded or commercially insured, are
developing increasingly sophisticated methods of controlling
healthcare costs through prospective reimbursement and
capitation programs, group purchasing, redesign of benefits,
second opinions required prior to major surgery, careful review
of bills, encouraging healthier lifestyles and exploring more
cost-effective methods of delivering healthcare. These types of
programs can potentially limit the amount which healthcare
providers may be willing to pay for medical devices.

The federal Centers for Medicare & Medicaid
Services issued a Final Rule on its Prospective Payment System
For Outpatient Services on April 7, 2000. This rule
provides for a new system to reimburse Medicare outpatient
surgical services provided in a hospital, and currently
authorizes reimbursement for procedures performed using our
current products.

Government
Regulation

Our products are medical devices subject to
extensive regulation by the U.S. Food and Drug Administration,
or FDA, and other regulatory agencies. FDA regulations govern,
among other things, the following activities that we perform and
will continue to perform in connection with medical devices:



| |   |                                             
| | - | --------------------------------------------
| |  | product design and development;             
|
| |  | product testing;                            
|
| |  | product manufacturing;                      
|
| |  | product labeling and packaging;             
|
| |  | product handling, storage, and installation;
|
| |  | premarket clearance or approval;            
|
| |  | advertising and promotion; and              
|
| |  | product sales, distribution, and servicing. 

FDAs premarket clearance and approval
requirements.Unless an exemption
applies, each medical device we wish to commercially distribute
in the U.S. must first receive 510(k) clearance or premarket
approval from the FDA. The FDA classifies all medical devices
into one of three classes. Devices deemed to pose lower risk are
placed in either class I or II, which requires the
manufacturer to submit to the FDA a 510(k) premarket
notification, requesting clearance of the device for commercial
distribution in the U.S. Some low risk devices are exempted from
this requirement. Devices deemed by the FDA to pose the greatest
risk, such as life sustaining, life-supporting or implantable
devices, or devices deemed not substantially equivalent to a
previously 510(k) cleared device are placed in class III
requiring premarket approval.

510(k) clearance process.The 510(k) clearance process is the
process applicable to our current products. To obtain 510(k)
clearance, we must submit a premarket notification to the FDA
demonstrating that the proposed device is substantially
equivalent to a previously cleared 510(k) device, a device
that was in

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commercial distribution before May 28, 1976
for which the FDA has not yet called for the submission of
premarket approval applications, or is a device that has been
reclassified from class III to either class II or I.
The FDAs 510(k) clearance process usually takes three
months from the date the application is submitted and filed by
the FDA, but it can take significantly longer.


After a device receives 510(k) clearance, any
modification that could significantly affect its safety or
effectiveness, or that would constitute a major change in its
intended use, will require a new 510(k) clearance or could
require premarket approval. The FDA requires each manufacturer
to make this determination initially, but the FDA can review any
such decision and can disagree with a manufacturers
determination. If the FDA disagrees with a manufacturers
determination, the FDA can require the manufacturer to cease
marketing and/or recall the modified device until 510(k)
clearance or premarket approval is obtained. We have modified
aspects of some of our devices since receiving regulatory
clearance. Some of those modifications we believe are not
significant, and therefore, new 510(k) clearances or premarket
approvals are not required. Other modifications we believe are
significant and we have obtained new 510(k) clearances from the
FDA for these modifications. In the future, we may make
additional modifications to our products after they have
received FDA clearance or approval, and in appropriate
circumstances, determine that new clearance or approval is
unnecessary. However, the FDA may disagree with our
determination and if the FDA requires us to seek 510(k)
clearance or premarket approval for any modifications to a
previously cleared product, we may be required to cease
marketing or recall the modified device until we obtain the
required clearance or approval. Under these circumstances, we
may also be subject to significant regulatory fines or other
penalties.

Premarket approval process.A premarket approval application must
be submitted if the medical device is in class III
(although the FDA has the discretion to continue to allow
certain pre-amendment class III devices to use the 510(k)
process) or cannot be cleared through the 510(k) process. A
premarket approval application must be supported by, among other
things, extensive technical, preclinical, clinical trials,
manufacturing and labeling data to demonstrate to the FDAs
satisfaction the safety and effectiveness of the device.

After a premarket approval application is
submitted and filed, the FDA begins an in-depth review of the
submitted information, which typically takes between one and
three years, but may take significantly longer. During this
review period, the FDA may request additional information or
clarification of information already provided. Also during the
review period, an advisory panel of experts from outside the FDA
will be convened to review and evaluate the application and
provide recommendations to the FDA as to the approvability of
the device. In addition, the FDA will conduct a preapproval
inspection of the manufacturing facility to ensure compliance
with Quality System regulations. New premarket approval
applications or premarket approval application supplements are
required for significant modifications to the manufacturing
process, labeling and design of a device that is approved
through the premarket approval process. Premarket approval
supplements often require submission of the same type of
information as a premarket approval application, except that the
supplement is limited to information needed to support any
changes from the device covered by the original premarket
approval application, and may not require as extensive clinical
data or the convening of an advisory panel.

Certain of our devices have been classified as
class III pre-amendment devices. Although we currently have
510(k) clearance for these devices, the FDA has the discretion
at any time to request premarket approval applications from us
and all manufacturers of similar devices. If the FDA calls for
premarket approval applications, we will be required to submit
and obtain approvals for such devices within a specified period
of time. If we fail to do so, we will not be allowed to continue
marketing these products.

Clinical trials.A
clinical trial is almost always required to support a premarket
approval application and is sometimes required for a 510(k)
premarket notification. Clinical trials generally require
submission of an application for an investigational device
exemption to the FDA. The investigational device exemption
application must be supported by appropriate data, such as
animal and laboratory testing results, showing that it is safe
to test the device in humans and that the investigational
protocol is scientifically sound. The investigational device
exemption application must be approved in advance by the FDA for
a specified number of patients, unless the product is deemed a
non-significant risk device and eligible for more abbreviated

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investigational device exemption requirements.
Clinical trials for a significant risk device may begin once the
investigational device exemption application is approved by the
FDA as well as the appropriate institutional review boards at
the clinical trial sites, and the informed consent of the
patients participating in the clinical trial is obtained.


Pervasive and continuing FDA regulation.After a medical device is placed on
the market, numerous FDA regulatory requirements apply,
including, but not limited to the following:



| |   |                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Quality System regulation which requires
    manufacturers to follow design, testing, control, documentation
    and other quality assurance procedures during the manufacturing
    process;                                                                                                         
|
| |  | Establishment Registration, which requires
    establishments involved in the production and distribution of
    medical devices, intended for commercial distribution in the
    U.S. to register with the FDA;                                                                                      
|
| |  | Medical Device Listing which requires
    manufacturers to list the devices they have in commercial
    distribution with the FDA;                                                                                                                                                                    
|
| |  | Labeling regulations, which prohibit
    misbranded devices from entering the market, as well
    as prohibit the promotion of products for unapproved or
    off-label uses and impose other restrictions on
    labeling; and                                                                   
|
| |  | Medical Device Reporting regulations, which
    require that manufacturers report to the FDA if their device may
    have caused or contributed to a death or serious injury or
    malfunctioned in a way that would likely cause or contribute to
    a death or serious injury if it were to recur.

Failure to comply with applicable regulatory
requirements can result in enforcement action by the FDA, which
may include one or more of the following sanctions:



| |   |                                                                                             
| | - | --------------------------------------------------------------------------------------------
| |  | fines, injunctions, and civil penalties;                                                    
|
| |  | mandatory recall or seizure of our products;                                                
|
| |  | administrative detention or banning of our
    products;                                    
|
| |  | operating restrictions, partial suspension or
    total shutdown of production;             
|
| |  | refusing our request for 510(k) clearance or
    premarket approval of new product versions;
|
| |  | revocation of 510(k) clearance or premarket
    approvals previously granted; and           
|
| |  | criminal penalties.                                                                         

International Regulation.International sales of medical devices
are subject to foreign government regulations, which vary
substantially from country to country. The time required to
obtain approval by a foreign country may be longer or shorter
than that required for FDA approval, and the requirements may
differ significantly.

The European Union (currently consisting of the
following 15 countries or member states: Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Italy, Ireland,
Luxembourg, the Netherlands, Portugal, Spain, Sweden, the United
Kingdom) has adopted legislation, in the form of directives to
be implemented in each member state, concerning the regulation
of medical devices within the European Union. The directives
include, among others, the Medical Device Directive that
establishes standards for regulating the design, manufacture,
clinical trials, labeling, and vigilance reporting for medical
devices. Under the European Union Medical Device Directive,
medical devices are classified into four classes, I, IIa, IIb,
and III, with class I being the lowest risk and
class III being the highest risk. Under the Medical Device
Directive, a competent authority is nominated by the government
of each member state to monitor and ensure compliance with the
Directive. The competent authority of each member state then
designates a notified body to oversee the conformity assessment
procedures set forth in the Directive, whereby manufacturers
demonstrate that their devices comply with the requirements of
the Directive and are entitled to bear the CE marking. CE is an
abbreviation for Conformité Européene (or European
Conformity) and the CE marking, when placed on a product,
indicates compliance with the requirements of the applicable
directive. Medical devices properly

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bearing the CE marking may be commercially
distributed throughout the European Union. We have received CE
certification from the British Standards Institution for
conformity with ISO 9001 allowing us to CE mark our product
lines. The ISO quality system has been developed by the
International Organization for Standardization to ensure that
companies are aware of the standards of quality to which their
products will be held worldwide. While no additional premarket
approvals in individual European Union countries are required
prior to marketing of a device bearing the CE marking, practical
complications with respect to marketing introduction may occur.
For example, differences among countries have arisen with regard
to labeling requirements. Failure to maintain the CE marking
will preclude us from selling our products in the European
Union. We may not be successful in maintaining certification
requirements necessary for distribution of our products in the
European Union.


Under the Medical Devices Regulations of Canada,
all medical devices are classified into four classes,
class I being the lowest risk class and class IV
being the highest risk. Class I devices include among
others, devices that make only non-invasive contact with the
patient. Classes II, III and IV include devices of
increasingly higher risk as determined by such factors as degree
of invasiveness and the potential consequences to the patient if
the device fails or malfunctions. Our current products sold in
Canada generally fall into classes II and III. All
class II, III and IV medical devices must have a valid
Medical Device License issued by the Therapeutic Products
Directorate of Health Canada before they may be sold in Canada
(class I devices do not require such a license). We have
obtained applicable Medical Device Licenses for many of our
products. Failure to maintain required Medical Device Licenses
in Canada or to meet other requirements of the Canadian Medical
Devices Regulations (such as quality system standards and
labeling requirements) for our products will preclude us from
selling our products in Canada. We may not be successful in
continuing to meet the medical device licensing requirements
necessary for distribution of our products in Canada.

Intellectual
Property

The success of our products depends in part on
our internally developed intellectual property and other
proprietary rights. We rely on a combination of patent,
copyright, trademark and trade secret laws, confidentiality
procedures and contractual provisions to protect our
intellectual property and other proprietary rights. We also
generally enter into confidentiality agreements with our
employees and technical consultants.

As of December 31, 2002, Quinton holds
various U.S. and foreign patents, which expire at various times
between 2004 and 2018. Quinton also has certain patent
applications pending before foreign governmental bodies. Our
patents and patent applications protect various aspects of our
business including: filters for filtering ECG signals,
monitoring electrodes and methods of interfacing the monitoring
electrodes to a patient, and devices and methods for obtaining,
analyzing, and presenting physiological data, such as various
cardiology information. We also have perpetual rights to certain
patented technology relating to Quintons medical
treadmills. In addition, we have registered or applied to
register certain trademarks with domestic and certain foreign
trademark authorities.

Our business also depends in part on licenses to
use third parties software in our product offerings. We
believe that the agreements we have in place with these third
parties generally provide for such software at fair market value
and that, if any such agreements expire or terminate, we would
be able to obtain alternative software at comparable prices.

Employees

As of December 31, 2002, we had 228 full
time employees, including 43 in research and development, 60 in
sales and marketing, 50 in technical support services, 49 in
manufacturing and supplies operations, and 26 in finance and
administration. None of our employees are represented by a labor
union. We have not experienced any work stoppages and consider
our relations with our employees to be good. With the Burdick
acquisition in January 2003, we added an additional
150 employees, including 33 in research and development, 34
in sales and marketing, 16 in service, 53 in manufacturing
operations and 14 in finance and administration.

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Foreign
Operations

Prior to the acquisition of Burdick, we conducted
no manufacturing operations nor did we operate any facilities
outside of the United States. Sales to customers located outside
the United States were approximately $5.6 million,
$3.3 million, and $2.8 million in the years ended
December 31, 2000, 2001 and 2002, respectively. These sales
amounts do not include historical international sales of
Burdick. Burdick performs certain limited sales and
manufacturing activities through a majority owned joint venture
operation located in Shanghai, China.

Certain
Factors That May Affect Future Results

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

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

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



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

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

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

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

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

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



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

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

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

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



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

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

If we fail to successfully integrate acquired
businesses, including Burdick and the treadmill manufacturing
business, product lines, assets or technologies, our operating
results may suffer.

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

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

Burdick sells its products, both domestically and
internationally, principally through third party distributors,
and Quinton sells its products internationally through third
party distributors. While both Burdick and Quinton have well
established relationships with these distributors, the
underlying agreements are generally for periods of one year or
less. If these agreements are cancelled or if we are unable to
renew them as they expire, our sales and operating results may
suffer materially.

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

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

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

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



| |   |                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------
| |  | if we overestimate our requirements we may be
    obligated to purchase more components or third-party products
    than is required;

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

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

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

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

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



| |   |                                              
| | - | ---------------------------------------------
| |  | failure to achieve market acceptance;        
|
| |  | loss of customers, revenues and market share;
|
| |  | diversion of development resources;          
|
| |  | 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.

16



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##### Table of Contents



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.

Where You Can
Get Information We File With the SEC

We file annual, quarterly and special reports,
proxy statements and other information with the Securities and
Exchange Commission (SEC). You can read and copy any
materials we file with the SEC at the SECs Public
Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549. You may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
also maintains an Internet site that contains reports, proxy and
information statements and other information regarding issuers,
such as us, that file electronically with the SEC. The address
of the SECs Internet site is http://www.sec.gov.

We also maintain an Internet site at
http://www.quinton.com. We make available free of charge on or
through our Internet site, our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on
Form 8-K and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act as
soon as reasonably practicable after we electronically file such
material with, or furnish it to, the SEC. We will voluntarily
provide electronic or paper copies of our filings free of charge
upon request.




Item 2.     Properties

We have facilities located in a building complex
in Bothell, Washington which house our corporate offices and
certain of our manufacturing, research and development and
related customer support services operations, as well as the
marketing, administration and finance and administration
departments. We occupy approximately 147,000 square feet in this
complex. Our lease of the Bothell facility expires in December
2003. We are currently negotiating for a possible renewal of
this lease beyond 2003 and also exploring other alternatives.

We also have a facility in Deerfield, Wisconsin,
which houses additional manufacturing, research and development,
customer support services, marketing and finance and
administrative functions. This is a 100,000 square foot leased
facility. The lease expires in 2008.




Item 3. Legal
Proceedings

In November 2000, we disputed the notice of
termination from a former supplier, Zymed, Inc., and initiated a
lawsuit in the federal district court for the Western District
of Washington against the supplier. We incurred significant
costs in prosecuting this lawsuit in 2001 and in 2002. The case
went to trial and concluded in January 2003. The jury found in
favor of the supplier and, consequently, we did not obtain any
award for damages. The Company does not expect to incur any
significant additional expenses in connection with this lawsuit.

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




Item 4.     Submission
of Matters to a Vote of Shareholders

No matters were submitted to a vote of the
shareholders during the fourth quarter of the fiscal year ended
December 31, 2002.

17



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##### Table of Contents






PART II






|        |                                                                      
|------- | ---------------------------------------------------------------------
|Item 5. | Market for Companys Common Stock and
    Related Shareholder Matters

Our Common Stock is traded on the Nasdaq National
Market (symbol QUIN). The number of shareholders of
record of our Common Stock at March 11, 2003, was 152.

High and low bid quotations for our Common Stock
as quoted on the Nasdaq National Market for the periods
indicated, since May 6, 2002, the date our common stock
began trading, are as follows.

|                                          |                                   |             |   |      |  |  |   |      | 
|----------------------------------------- | --------------------------------- | ----------- | - | ---- |  |  | - | ---- | 
|                                          |                                   |            
|                                          |                                   | Stock Price
|                                          |                                   |            
|Year                                      |                                   | High        |   | Low 
|                                          |                                   |             |   |     
|Fiscal 2002 (ended December 31,
    2002) |                                   |             |   |      |  |  |   |     
|                                          | Second Quarter (from May 6, 2002) |             | $ | 9.06 |  |  | $ | 7.19 | 
|                                          | Third Quarter                     |             |   | 8.85 |  |  |   | 5.41 | 
|                                          | Fourth Quarter                    |             |   | 7.90 |  |  |   | 4.54 | 

We have never declared or paid any cash dividends
on our Common Stock. We currently anticipate that we will retain
any future earnings for use in the expansion and operations of
our business and do not anticipate paying cash dividends in the
foreseeable future.

Our registration statement on Form S-1 under
the Securities Act of 1933 (File No. 333-83272), relating
to our initial public offering of common stock, without par
value, was declared effective by the Securities and Exchange
Commission on May 6, 2002. Pursuant to the registration
statement, we registered and sold an aggregate of 4,600,000
shares of common stock, including the underwriters
exercise of their over-allotment option to purchase 600,000
shares, at $7.00 per share, for an aggregate offering price of
$32.2 million. In connection with the offering we incurred
total expenses of approximately $4.0 million, including
underwriting discounts and commissions of approximately
$2.3 million. In May 2002, we used approximately
$4.5 million of the net proceeds from the offering to repay
outstanding balances under our bank line of credit. In October
2002, we used $1.0 million of the proceeds to pay part of
the purchase price for the acquisition of our treadmill
manufacturing business. To pay part of the purchase price to
acquire 100% of the stock of Spacelabs Burdick, Inc., we used
$1.3 million of the proceeds in December 2002 and
$18.9 million of the proceeds in January 2003.




Item 6.     Selected
Financial Data

The following selected consolidated financial
data should be read in conjunction with the consolidated
financial statements and the notes thereto and the information
contained herein in Item 7, Managements
Discussion and Analysis of Financial Condition and Results of
Operations. The following selected consolidated financial
data as of and for the years ended December 31, 2000, 2001,
and 2002 are derived from our audited consolidated financial
statements included elsewhere in this annual report on
form 10-K. Historical results are not necessarily
indicative of future results.

|                                               |              |                |        |                                       |  |                                 |        |        |  |      |        |        |  |   |        |        |  |   |        |        |  |   |        |        | 
|---------------------------------------------- | ------------ | -------------- | ------ | ------------------------------------- |  | ------------------------------- | ------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                               |              | Predecessor    |        |                                       |  |                                 |        |        |  |      |        |       
|                                               |              | Company        |        |                                       |  |                                 |        |        |  |      |        |       
|                                               |              |                |        |                                       |  |                                 |        |        |  |      |        |       
|                                               |              | Period from    |        | Period from                           |  |                                
|                                               |              | January 1 to   |        | June 5 to                             |  | Fiscal Year Ending December 31,
|                                               |              | June 4,        |        | December 31,                          |  |                                
|                                               |              | 1998(1)        |        | 1998(2)(3)                            |  | 1999(4)                         |        | 2000   |  | 2001 |        | 2002  
|                                               |              |                |        |                                       |  |                                 |        |        |  |      |        |       
|                                               |              | (unaudited)    |        |                                      
|                                               |              | (in thousands) |        | (in thousands, except for share data)
|Consolidated Statement of Operations
    Data: |              |                |        |                                       |  |                                 |        |        |  |      |        |        |  |   |        |        |  |   |        |        |  |   |        |       
|Revenues                                       |              | $              | 25,701 |                                       |  | $                               | 35,660 |        |  | $    | 69,918 |        |  | $ | 50,734 |        |  | $ | 42,874 |        |  | $ | 46,496 |       
|Cost of revenues                               |              |                | 17,594 |                                       |  |                                 | 25,033 |        |  |      | 42,438 |        |  |   | 33,719 |        |  |   | 26,020 |        |  |   | 27,883 |       
|                                               |              |                |        |                                       |  |                                 |        |        |  |      |        |        |  |   |        |        |  |   |        |        |  |   |        |       
|                                               | Gross profit |                |        | 8,107                                 |  |                                 |        | 10,627 |  |      |        | 27,480 |  |   |        | 17,015 |  |   |        | 16,854 |  |   |        | 18,613 | 
|                                               |              |                |        |                                       |  |                                 |        |        |  |      |        |        |  |   |        |        |  |   |        |        |  |   |        |       

18



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|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |        |        |        |  
|-------------------------------------------------------------------------------------------- | ------------------------------------------------------------------- | ------------------------ | ---------------------------- | ------------------------------------- | ------ | ------------------------------- | ------ | ------ | ------ | ------ | ------- | ------- | ------ | ------ | ------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | --------- | ------ | ------ | ------ | -
|                                                                                             |                                                                     | Predecessor              |                              |                                       |        |                                 |        |        |        |        |         |        
|                                                                                             |                                                                     | Company                  |                              |                                       |        |                                 |        |        |        |        |         |        
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |        
|                                                                                             |                                                                     | Period from              |                              | Period from                           |        |                                
|                                                                                             |                                                                     | January 1 to             |                              | June 5 to                             |        | Fiscal Year Ending December 31,
|                                                                                             |                                                                     | June 4,                  |                              | December 31,                          |        |                                
|                                                                                             |                                                                     | 1998(1)                  |                              | 1998(2)(3)                            |        | 1999(4)                         |        | 2000   |        | 2001   |         | 2002   
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |        
|                                                                                             |                                                                     | (unaudited)              |                              |                                      
|                                                                                             |                                                                     | (in thousands)           |                              | (in thousands, except for share data)
|Operating Expenses:                                                                          |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             | Research and development                                            |                          |                              | 3,561                                 |        |                                 |        | 2,336  |        |        |         | 7,078   |        |        |         | 7,479  |        |        |         | 5,459  |        |        |           | 5,126  |       
|                                                                                             | Sales and marketing                                                 |                          |                              | 9,096                                 |        |                                 |        | 8,429  |        |        |         | 15,872  |        |        |         | 13,306 |        |        |         | 9,210  |        |        |           | 9,974  |       
|                                                                                             | General and administrative (excluding stock-based
    compensation) |                          |                              | 3,678                                 |        |                                 |        | 3,581  |        |        |         | 5,179   |        |        |         | 4,525  |        |        |         | 4,913  |        |        |           | 5,273  |       
|                                                                                             | Restructuring costs                                                 |                          |                              |                                      |        |                                 |        |       |        |        |         |        |        |        |         | 645    |        |        |         |       |        |        |           |       |       
|                                                                                             | Stock-based compensation (5)                                        |                          |                              |                                      |        |                                 |        |       |        |        |         | 67      |        |        |         | 215    |        |        |         | 2,664  |        |        |           | 111    |       
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             |                                                                     | Total operating expenses |                              |                                       | 16,335 |                                 |        |        | 14,346 |        |         |         | 28,196 |        |         |        | 26,170 |        |         |        | 22,246 |        |           |        | 20,484 |       
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             |                                                                     |                          | Operating loss               |                                       |        | (8,228                          | )      |        |        | (3,719 | )       |         |        | (716   | )       |        |        | (9,155 | )       |        |        | (5,392 | )         |        |        | (1,871 | )
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|Other Income (Expense):                                                                      |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             | Interest income (expense), net                                      |                          |                              |                                      |        |                                 |        | (1,024 | )      |        |         | (1,517  | )      |        |         | (302   | )      |        |         | (939   | )      |        |           | 330    |       
|                                                                                             | Write-off note receivable and accrued interest                      |                          |                              |                                      |        |                                 |        |       |        |        |         |        |        |        |         |       |        |        |         | (1,106 | )      |        |           |       |       
|                                                                                             | Other income (expense), net                                         |                          |                              |                                      |        |                                 |        | (24    | )      |        |         | 182     |        |        |         | 369    |        |        |         | 74     |        |        |           | (6     | )     
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             |                                                                     |                          | Total other income (expense) |                                       |        | (8,228                          | )      |        |        | (1,048 | )       |         |        | (1,335 | )       |        |        | 67     |         |        |        | (1,971 | )         |        |        | 324    |  
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|Loss from continuing operations before income
    taxes                                      |                                                                     |                          |                             |                                       |        |                                 | (4,767 | )      |        |        | (2,051  | )       |        |        | (9,088  | )      |        |        | (7,363  | )      |        |        | (1,547    | )     
|                                                                                             | Income tax benefit (provision)                                      |                          |                              |                                      |        |                                 |        | (6     | )      |        |         | (27     | )      |        |         | 2,088  |        |        |         | 205    |        |        |           | 192    |       
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|Loss from continuing operations                                                              |                                                                     |                          | (8,228                       | )                                     |        |                                 | (4,773 | )      |        |        | (2,078  | )       |        |        | (7,000  | )      |        |        | (7,158  | )      |        |        | (1,355    | )     
|Discontinued operations:                                                                     |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             | Income from operations, net                                         |                          |                              |                                       |        |                                 |        |        |        |        |         | 448     |        |        |         |       |        |        |         |       |        |        |           |       |       
|                                                                                             | Gain (loss) on sale, net                                            |                          |                              |                                      |        |                                 |        |       |        |        |         | 4,732   |        |        |         |       |        |        |         | (831   | )      |        |           |       |       
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             | Net income (loss)                                                   |                          | $                            | (8,228                                | )      |                                 | $      | (4,773 | )      |        | $       | 3,102   |        |        | $       | (7,000 | )      |        | $       | (7,989 | )      |        | $         | (1,355 | )     
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|Basic and diluted loss from continuing operations
    per share (6)                          |                                                                     |                          |                              |                                       |        |                                 |        |        |        | $      | (7.16   | )       |        | $      | (13.94  | )      |        | $      | (11.37  | )      |        | $      | (0.17     | )     
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|Shares used in computing basic and diluted loss
    from continuing operations per share (6) |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        | 290,264 |         |        |        | 502,065 |        |        |        | 629,647 |        |        |        | 7,887,659 |       
|Consolidated Statement of Cash Flows
    Data:                                               |                                                                     |                          |                              |                                       |        |                                 |        |        |        | $      | (1,738  | )       |        | $      | (2,115  | )      |        | $      | 719     |        |        | $      | (1,369    | )     
|                                                                                             | Cash flows from operations                                          |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |        |       
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             | Cash flows from investing activities                                |                          |                              |                                       |        |                                 |        |        |        |        | $       | 13,722  |        |        | $       | (672   | )      |        | $       | (280   | )      |        | $         | (3,369 | )     
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       
|                                                                                             | Cash flows from financing activities                                |                          |                              |                                       |        |                                 |        |        |        |        | $       | (13,123 | )      |        | $       | 2,409  |        |        | $       | (644   | )      |        | $         | 23,902 |       
|                                                                                             |                                                                     |                          |                              |                                       |        |                                 |        |        |        |        |         |         |        |        |         |        |        |        |         |        |        |        |           |       

19



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|                                 |                            |                |   |        |  |      |   |        |  |      |   |        |  |  |   |        |  |  |   |        | 
|-------------------------------- | -------------------------- | -------------- | - | ------ |  | ---- | - | ------ |  | ---- | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|                                 |                            |               
|                                 |                            | December 31,  
|                                 |                            |               
|                                 |                            | 1998           |   | 1999   |  | 2000 |   | 2001   |  | 2002
|                                 |                            |                |   |        |  |      |   |        |  |     
|                                 |                            |               
|                                 |                            | (in thousands)
|Consolidated Balance Sheet Data: |                            |                |   |        |  |      |   |        |  |      |   |        |  |  |   |        |  |  |   |       
|                                 | Cash and cash equivalents  |                | $ | 1,940  |  |      | $ | 801    |  |      | $ | 423    |  |  | $ | 218    |  |  | $ | 19,382 | 
|                                 | Total assets               |                |   | 44,099 |  |      |   | 32,682 |  |      |   | 23,654 |  |  |   | 17,466 |  |  |   | 42,050 | 
|                                 | Current liabilities        |                |   | 36,116 |  |      |   | 21,530 |  |      |   | 18,183 |  |  |   | 16,578 |  |  |   | 14,378 | 
|                                 | Long-term liabilities      |                |   |       |  |      |   |       |  |      |   |       |  |  |   | 831    |  |  |   | 363    | 
|                                 | Total shareholders equity |                | $ | 7,983  |  |      | $ | 11,152 |  |      | $ | 5,471  |  |  | $ | 57     |  |  | $ | 27,309 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | This period represents the historical financial
    information of Quinton Inc., as our predecessor.                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(2) | We were originally incorporated on April 22,
    1998. We had no significant operations from April 22, 1998
    until June 5, 1998. On that date, we acquired all of the
    stock of Quinton Inc. from American Home Products Corporation.
    The results of operations and the purchase costs of the acquired
    assets and liabilities are included in our audited consolidated
    financial statements for the period from the acquisition to
    December 31, 1998, which are not included in this report.
|   
|(3) | The application of purchase accounting resulted
    in our recording of inventory at its estimated fair value, which
    was approximately $3.9 million more than our
    predecessors book value of the inventory. We expensed this
    increase as the inventory was sold.                                                                                                                                                                                                                                     
|   
|(4) | The consolidated financial data as of and for the
    year ended December 31, 1999 are derived from our audited
    consolidated financial statements, which are not included in
    this report.                                                                                                                                                                                                                                                                                                                 
|   
|(5) | Stock-based compensation charges, though reported
    separately in the statement of operations, are attributed to
    general and administrative expenses.                                                                                                                                                                                                                                                                                                                                                       
|   
|(6) | See Note 2 to the consolidated financial
    statements for a reconciliation of the denominators used in
    computing basic and diluted loss per share from continuing
    operations for 2000, 2001, and 2002.                                                                                                                                                                                                                                                                                                  

Item 7.     Managements
Discussion and Analysis of Financial Condition and Results of
Operations

You should read the following discussion and
analysis in conjunction with our 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 Annual
Report on Form 10-K are forward looking. The words
believe, expect, intend,
anticipate, variations of such words, and similar
expressions identify forward-looking statements, but their
absence does not mean that the statement is not forward-looking.
These forward-looking statements reflect managements
current expectations and involve risks and uncertainties. Our
actual results could differ materially from results that may be
anticipated by such forward-looking statements. The principal
factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the section
entitled Certain Factors That May Affect Future
Results, 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 to reflect events or
circumstances that may subsequently arise. Readers are urged to
review and consider carefully the various disclosures made in
this report and in our other filings made with the SEC that
attempt to advise interested parties of the risks and factors
that may affect our business, prospects and results of
operations.

Critical
Accounting Estimates and Policies

The discussion and analysis of our financial
condition and results of operations is based upon our
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

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statements requires us to make estimates and
judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. On an on-going basis, we
evaluate our estimates including those affecting revenues, the
allowance for doubtful accounts, the salability and
recoverability of inventory, warranty liabilities, the carrying
value of our investments, the useful lives of tangible and
intangible assets, 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.


We use our judgment to determine whether
installation we offer in connection with system sales is an
inconsequential or perfunctory obligation of the overall sale.
Current revenue recognition is appropriate when the obligation
is viewed as inconsequential or perfunctory while revenue
deferral is required when the obligations are not. We also use
judgment to determine whether vendor specific objective evidence
of fair value exists for undelivered software elements. If
vendor specific objective evidence of fair value does not exist
for an undelivered software element, all revenue associated with
the original sale will be deferred until such vendor specific
objective evidence exists or all elements of the arrangement
have been delivered. Our judgment about whether vendor specific
evidence of fair value exists is based on whether the
undelivered element is sold separately at prices that are within
a narrow range, or if the undelivered element is not sold
separately, at established list prices which, in our judgment,
will be the probable price when the undelivered element is
introduced into the market. Differences could result in the
amount and timing of the recorded revenues if we make different
judgments or use different estimates.

We must make estimates of the collectability of
accounts receivable. We analyze historical write-offs, changes
in our internal credit policies and customer concentrations when
evaluating the adequacy of our allowance for doubtful accounts.
Differences may result in the amount and timing of expenses for
any period if we make different judgments or use different
estimates.

We value inventory at the lower of cost, on an
average cost basis, or market. We regularly review inventory
detail to determine whether a write-down is necessary. We
consider various factors in making this determination, including
recent sales history and predicted trends, industry market
conditions and general economic conditions. Differences could
result in the amount and timing of write-downs for any period if
we make different judgments or use different estimates.

We provide warranty service covering the systems
we sell. We estimate and accrue for future costs of providing
warranty service which relate principally to the hardware
components of the systems, when the systems are sold. Our
estimates are based in part on our warranty claims history and
other relevant information. Differences could result in the
amount and timing of the recorded warranty accruals if we make
different judgments or use different estimates.

We assess the carrying value of our investment in
ScImage, Inc. to determine whether the market value of the
investment has fallen below its carrying amount. Any difference
between the carrying amount and market value would be treated as
an unrealized loss and charged to operations. The basis of the
security would be reduced by the amount of the unrealized loss
and the resulting amount would be considered the new basis of
the investment. The information to evaluate the fair value of
the investment in ScImage is limited since ScImage is a
privately held company. We believe that the carrying amount of
the investment is appropriate, though our belief is necessarily
based on limited information and subjective judgments that could
change in the future.

As part of the process of preparing our
consolidated financial statements, we are required to determine
our income taxes. This process involves calculating our current
tax obligation or refund together with assessing temporary
differences resulting from differing treatment of items for tax
and accounting purposes. These differences result in deferred
tax assets and liabilities. We must then assess the likelihood
that our deferred tax assets will be recovered from existing
deferred tax liabilities or future taxable income, and, to the
extent we believe that recovery is not likely, we must establish
a valuation allowance. To the extent that we establish a
valuation allowance or increase this allowance in a period, we
must include a tax provision or reduce our tax

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benefit in the statements of operations. We use
our judgment to determine our provision or benefit for income
taxes, deferred tax assets and liabilities and any valuation
allowance recorded against our net deferred tax assets. We
believe, based on a number of factors including historical
operating losses, that we will not realize the future benefits
of a significant portion of our net deferred tax assets and we
have accordingly provided a valuation allowance against our
deferred tax assets except to the extent of existing deferred
tax liabilities and expected refunds. However, various factors
may cause those assumptions to change in the near term.


We cannot predict what future laws and
regulations might be passed that could have a material effect on
our results of operations. We assess the impact of significant
changes in laws and regulations on a regular basis and update
the assumptions and estimates used to prepare our financial
statements when we deem it necessary.

We have determined the critical principles by
considering accounting policies that involve the most complex or
subjective decisions or assessments. Our most critical
accounting policies are those related to revenue recognition,
accounting for stock-based compensation, and segment reporting.

Revenue Recognition.Our revenue recognition policies are based on the requirements
of SEC Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements,and to the extent
revenues are allocated to software elements, AICPA Statement of
Position 97-2, Software Revenue Recognition, as
amended by AICPA Statement of Position 98-9, Software
Revenue Recognition with Respect to Certain Arrangements.

Revenue from sales of systems is generally
recognized when title transfers to the customer, typically upon
shipment. We recognize revenue on sales of systems made to our
distributors when the product is shipped to our distributors and
all of our significant obligations have been satisfied. Our
distributors do not have price protection or product return
rights, except that our Canadian distributor has the right to
return unsold products to us upon termination of our distributor
agreement.

We occasionally sell software and hardware
upgrades.With respect to software
revenue, the fair value of undelivered software is deferred and
the residual fair value of delivered software is recognized.
With respect to hardware upgrades, we recognize revenue when the
hardware is shipped.

We offer optional extended service contracts to
our customers. Service revenues are recognized over the term of
the extended service contracts, which generally begin after the
expiration of the original warranty period. For service
performed, other than pursuant to warranty and extended service
contract obligations, revenue is recognized when the service is
performed and collection of the resulting receivable is probable.

Accounting for Stock-Based Compensation.We have elected to apply the
disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. In accordance
with the provisions of SFAS 123, we apply Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for our
stock option plans. Generally, under APB 25, if the option
exercise price for a fixed award to an employee is equal to the
fair value of the common stock at the date of grant of the stock
option, no compensation expense is recorded. Had we chosen to
account for our employee stock-based compensation under
SFAS 123, our recorded net loss would have been increased
by approximately $0.1 million, $0.1 million and
$0.4 million for the years ended December 31, 2000,
2001 and 2002, respectively.

We account for stock issued to non-employees in
accordance with the provisions of SFAS 123 and the Emerging
Issues Task Force consensus in Issue No. 96-18,
Accounting for Equity Instruments That are Issued to Other
Than Employees for Acquiring or in Conjunction with Selling,
Goods or Services.Under SFAS 123 and EITF 96-18,
the amount of compensation expense that is recorded is based on
an option pricing model which incorporates such factors as the
expected volatility of future movements in the price of the
underlying stock, risk-free interest rates, the term of the
options and any dividends expected to be paid. As a result,
under SFAS 123 and EITF 96-18, we would generally
expect to record a greater amount of compensation expense than
under APB 25.

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Segment Reporting.We have adopted
SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information.SFAS 131
requires companies to disclose certain information about
reportable segments. Based on the criteria within SFAS 131,
we have determined that we currently have one reportable
segment, diagnostic cardiology systems and related services.

Overview

We develop, manufacture, market and service a
family of diagnostic cardiology systems used in the diagnosis,
treatment, and rehabilitation of patients with heart disease.
Our product portfolio includes electrocardiographs (ECGs),
stress test systems, Holter monitoring systems, cardiac
rehabilitation telemetry systems, cardiac catheterization
management systems, ECG management systems, medical treadmills,
electrodes and other consumables related to our products.

On January 2, 2003, we concluded the
purchase of 100% of the stock of Spacelabs Burdick, Inc.
(Burdick). Based in Deerfield, Wisconsin, Burdick has
approximately 150 employees. Burdicks historical
strength in ECG cardiographs, Holter monitors and cardiology
information systems, combined with its distribution network
focused on U.S. physicians offices, complements
Quintons strength in cardiac stress testing and cardiac
rehabilitation monitoring and its hospital focused direct sales
force. We anticipate that the acquisition of Burdick will
materially affect our results of operations beginning in 2003.

We categorize our revenues as either systems
revenue, which includes capital equipment and related items, or
service revenue, which includes service contracts, equipment
repair and replacement part sales. We derive our revenues
primarily from the sale of our diagnostic cardiology systems and
related consumables, and to a lesser extent, from services. Our
revenues and operating results have depended, and will continue
to depend, upon the continued adoption of our products by
cardiologists and other healthcare providers. The rate of
adoption is influenced significantly over the longer term by
government laws and mandates, physician group guidelines,
performance and pricing of our products, relationships with key
physicians and hospitals and other factors.

Our quarterly revenues also may be impacted by
other factors including the length of our sales cycle, the
timing of sales orders, budget cycles of our customers,
competition, the timing and introduction of new versions of our
products, the loss of, or difficulties affecting, key personnel
and distributors, the timing of the implementation of screening
mandates, changes in market dynamics or the timing of product
developments or market introductions. These factors have
impacted our historical results to a greater extent than has
seasonality. Combinations of these factors have historically
influenced our growth rate and profitability significantly in
one period compared to another, and are expected to continue to
influence future periods, which may compromise our ability to
make accurate forecasts.

We also derive a portion of our service revenue
from sales of separate extended maintenance arrangements. We
defer a portion of these revenues based on the time period of
the maintenance arrangements and recognize these revenues over
the applicable maintenance period. No single customer accounted
for more than 10% of our revenues during any of the last three
years. Domestic sales accounted for an average of approximately
92% of our revenues over the last three years.

Cost of revenues consists primarily of the costs
associated with manufacturing, assembling and testing our
products, related overhead costs, and compensation and other
costs related to manufacturing support and logistics. We rely on
third parties to manufacture certain of our product components.
Accordingly, a significant portion of our cost of revenues
consists of payments to these manufacturers. Cost of service
revenue consists of customer support costs, training and
professional service expenses, parts and compensation. In
addition, our hardware products carry a one-year warranty that
includes factory repair services or replacement parts as needed.
We accrue estimated expenses for warranty obligations at the
time products are shipped.

Our gross profit has been and will continue to be
affected by a variety of factors, including competition, the mix
and average selling prices of products, maintenance and
services, new versions of products, the cost of components and
manufacturing labor, fluctuations in manufacturing volumes,
component shortages, and the mix of distribution channels
through which our products are sold. Our gross profit will be
adversely affected by

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price declines if we are unable to reduce costs
on existing products or to introduce new versions of products
with higher margins.


Research and development expenses consist
primarily of salaries and related expenses for development and
engineering personnel, fees paid to consultants, and prototype
costs related to the design, development, testing and
enhancement of our diagnostic cardiology systems. We expense our
research and development costs as they are incurred. Several
components of our research and development effort require
significant funding, the timing of which can cause significant
quarterly variability in our expenses. We are devoting
substantial resources to the continued development of new
versions of products to meet the changing requirements of our
customers. As a result, our research and development expenses
may increase in the future.

Sales and marketing expenses consist primarily of
salaries, commissions and related expenses for personnel engaged
in sales, marketing and sales support functions as well as costs
associated with promotional and other marketing activities. We
intend to expand our sales and marketing operations
substantially, both domestically and internationally, in order
to increase sales of our products. In addition, we believe part
of our future success will be dependent upon establishing
successful relationships with a variety of additional resellers
in other countries. We expect that sales and marketing expenses
will increase in absolute dollars as we expand our sales efforts
in both domestic and international locations, hire additional
sales and marketing personnel and initiate additional marketing
programs.

General and administrative expenses consist
primarily of salaries and related expenses for executive,
finance, accounting, legal and human resources personnel,
professional fees and corporate expenses. We expect general and
administrative expenses to increase in absolute dollars as we
employ additional personnel and incur additional costs related
to the growth of our business and our operation as a public
company. Expenses we incurred in connection with litigation
against a former supplier, which went to trial in January 2003,
caused general and administrative expenses to grow in 2001 and
2002. We do not expect to incur any further significant expenses
in connection with this litigation in 2003. Although stock-based
compensation is a general and administrative expense, we present
stock-based compensation separately from general and
administrative expenses.

Stock-based compensation charges are recorded
when the exercise price of an option or the sales price of
restricted stock is less than the fair value of the underlying
common stock for awards to employees. We also record stock-based
compensation charges when options are granted to non-employees.
Compensation charges for non-employees are based on estimates of
the underlying stock fair values and are determined using option
pricing models.

Results of
Operations

The following discussion of our results of
operations should be read in conjunction with Selected
Financial Data, the consolidated financial statements and
accompanying notes and other financial data included elsewhere
in this report. Our fiscal year ends on December 31.

|                              |         |                     |       |      |   |      |       |      |   |  |       |      |  
|----------------------------- | ------- | ------------------- | ----- | ---- | - | ---- | ----- | ---- | - |  | ----- | ---- | -
|                              |         |                    
|                              |         | Fiscal Year        
|                              |         |                    
|                              |         | 2000                |       | 2001 |   | 2002
|                              |         |                     |       |      |   |     
|                              |         |                    
|                              |         | (as a percentage of
|                              |         | revenues)          
|Statement of Operations Data: |         |                     |       |      |   |      |       |      |   |  |       |     
|Revenues:                     |         |                     |       |      |   |      |       |      |   |  |       |     
|                              | Systems |                     |       | 81.4 | % |      |       | 78.9 | % |  |       | 80.4 | %
|                              | Service |                     |       | 18.6 |   |      |       | 21.1 |   |  |       | 19.6 |  
|                              |         |                     |       |      |   |      |       |      |   |  |       |     
|Total revenues                |         |                     | 100.0 |      |   |      | 100.0 |      |   |  | 100.0 |     
|                              |         |                     |       |      |   |      |       |      |   |  |       |     
|Cost of Revenues:             |         |                     |       |      |   |      |       |      |   |  |       |     
|                              | Systems |                     |       | 56.1 |   |      |       | 49.4 |   |  |       | 50.0 |  
|                              | Service |                     |       | 10.4 |   |      |       | 11.3 |   |  |       | 10.0 |  
|                              |         |                     |       |      |   |      |       |      |   |  |       |     

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|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |      |      | 
|------------------------------------------------------- | -------------------------------------------------------------------------- | ------------------------ | ----- | ---- | ---- | ---- | ----- | ---- | ---- |  | ---- | ---- | ---- | 
|                                                        |                                                                            |                         
|                                                        |                                                                            | Fiscal Year             
|                                                        |                                                                            |                         
|                                                        |                                                                            | 2000                     |       | 2001 |      | 2002
|                                                        |                                                                            |                          |       |      |      |     
|                                                        |                                                                            |                         
|                                                        |                                                                            | (as a percentage of     
|                                                        |                                                                            | revenues)               
|Total cost of revenues                                  |                                                                            |                          | 66.5  |      |      |      | 60.7  |      |      |  | 60.0 |     
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|                                                        | Gross margin                                                               |                          |       | 33.5 |      |      |       | 39.3 |      |  |      | 40.0 |     
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|Operating Expenses:                                     |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|                                                        | Research and development                                                   |                          |       | 14.7 |      |      |       | 12.7 |      |  |      | 11.0 |     
|                                                        | Sales and marketing                                                        |                          |       | 26.2 |      |      |       | 21.5 |      |  |      | 21.5 |     
|                                                        | General and administrative, excluding stock-based
    compensation expense |                          |       | 8.9  |      |      |       | 11.5 |      |  |      | 11.3 |     
|                                                        | Restructuring costs                                                        |                          |       | 1.3  |      |      |       | 0.0  |      |  |      | 0.0  |     
|                                                        | Stock-based compensation                                                   |                          |       | 0.4  |      |      |       | 6.2  |      |  |      | 0.2  |     
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|                                                        |                                                                            | Total operating expenses |       |      | 51.5 |      |       |      | 51.9 |  |      |      | 44.0 | 
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|Operating loss                                          |                                                                            |                          | (18.0 | )    |      |      | (12.6 | )    |      |  | (4.0 | )   
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|Other Income (Expense):                                 |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|                                                        | Interest income (expense), net                                             |                          |       | (0.6 | )    |      |       | (0.8 | )    |  |      | 0.2  |     
|                                                        | Write-off note receivable and accrued interest                             |                          |       | 0.0  |      |      |       | (2.6 | )    |  |      | 0.0  |     
|                                                        | Interest income (expense), putable warrants                                |                          |       | 0.0  |      |      |       | (1.4 | )    |  |      | 0.5  |     
|                                                        | Gain on sale of net imaging assets                                         |                          |       | 0.6  |      |      |       | 0.0  |      |  |      | 0.0  |     
|                                                        | Other income, net                                                          |                          |       | 0.1  |      |      |       | 0.2  |      |  |      | 0.0  |     
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|                                                        | Total other income (expense)                                               |                          |       | 0.1  |      |      |       | (4.6 | )    |  |      | 0.7  |     
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|Loss from continuing operations before income
    taxes |                                                                            |                          | (17.9 | )    |      |      | (17.2 | )    |      |  | (3.3 | )   
|                                                        | Income tax benefit                                                         |                          |       | 4.1  |      |      |       | 0.5  |      |  |      | 0.4  |     
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|Loss from continuing operations                         |                                                                            |                          | (13.8 | )    |      |      | (16.7 | )    |      |  | (2.9 | )   
|Discontinued Operations:                                |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|                                                        | Loss on sale, net                                                          |                          |       | 0.0  |      |      |       | (1.9 | )    |  |      | 0.0  |     
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     
|Net loss                                                |                                                                            |                          | (13.8 | )%   |      |      | (18.6 | )%   |      |  | (2.9 | )%  
|                                                        |                                                                            |                          |       |      |      |      |       |      |      |  |      |     

Comparison of Years Ended December 31,
2002 and December 31, 2001



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

Revenues increased by $3.6 million, or 8.4%,
to $46.5 million in 2002 from $42.9 million in 2001.
Systems revenue increased by $3.6 million, or 10.5%, to
$37.4 million in 2002 from $33.8 million in 2001.
Stress system revenues increased by $1.5 million in 2002 as
compared to 2001, due primarily to continued market acceptance
of our new stress product following its introduction in
April 2001. In addition, we introduced the Q-Tel RMS system
in May 2002, which resulted in an increase in our
rehabilitation telemetry revenues of $3.8 million in 2002
as compared to 2001. The increase in stress and rehabilitation
telemetry revenues was offset partially by decreases in sales of
our cardiac catheterization management systems and Holter
monitoring systems of $1.4 million and $0.5 million,
respectively. We believe the decrease in cardiac catheterization
management systems sales was principally due to the anticipated
release of our next generation cardiac catheterization
management product, which is scheduled for release in early
2003. Our Holter systems sales decrease was caused by an
interruption in Holter component supplies when we transitioned
to a new supplier in mid-2001. Service revenues increased by
$0.1 million, or 0.7%, to $9.1 million in 2002 from
$9.0 million in 2001.

Systems revenues as a percentage of total
revenues increased to 80.4% in 2002 from 78.9% in 2001. This
increase has been primarily attributable to a larger percentage
increase in our systems revenues than in our

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services revenues. Because we derive service
revenues from our installed base, service revenue increases did
not directly correlate to system revenue increases. System
revenues as a percentage of total revenues increased in 2002
primarily due to the introduction of new versions of products
into the market in 2002.


The acquisition of Burdick in January 2003 will
significantly increase our consolidated revenues beginning in
2003. Burdicks revenues in 2002 were $39.0 million. Due to
uncertainty created in the market during the process of the sale
of Burdick and due to some overlap of Quintons and
Burdicks products and markets, as well as a variety of
other factors, we expect that the incremental effect of the
Burdick acquisition on our 2003 revenues will be less than
Burdicks actual revenues for 2002. Management has
estimated that the acquisition of Burdick will add between $32
and $35 million to our consolidated revenues during 2003.
There can be no assurance, however, that actual results will be
in this range.



| |             
| | ------------
| | Gross Profit

Gross profit increased by $1.7 million, or
10.4%, to $18.6 million in 2002 from $16.9 million in
2001. Overall gross margin percentage increased to 40.0% in 2002
from 39.3% in 2001. Gross profit from systems increased by $1.5
million or 11.7%, to $14.1 million in 2002 from
$12.7 million in 2001. Systems gross margin improved to
37.8% in 2002 compared to 37.4% in 2001. Gross profit from
service increased by $0.3 million, or 6.7%, to
$4.5 million in 2002 from $4.2 million in 2001.
Service gross margin improved to 49.1% in 2002 compared to 46.4%
in 2001. Our overall improvement in gross margin has been driven
primarily by our continued emphasis on cost reductions.

Burdicks gross profit margins have
historically been lower than Quintons, averaging 32.1%
from 2000 to 2002. In addition, in connection with our
accounting for the purchase of Burdick, we expect to value
inventories acquired in the acquisition at net realizable value.
This will have the effect of reducing gross profit margins as
that inventory is sold and charged to cost of revenues. Based on
the foregoing, while the acquisition of Burdick is expected to
increase our overall gross profit, in dollars, it may have the
effect of reducing our gross profit margin as a percentage of
revenues beginning in 2003.



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

Research and development expenses decreased by
$0.3 million, or 6.1%, to $5.1 million in 2002 from
$5.5 million in 2001. As a percentage of revenues, research
and development expenses decreased to 11.0% in 2002 from 12.7%
in 2001. The decrease resulted primarily from reductions in
staffing and outside engineering services.

With the acquisition of Burdick, our research and
development expenses are expected to increase beginning in 2003.
Burdick incurred research and development expenses of
$3.7 million, or 9.4% of its revenues in 2002. In
connection with the acquisition of Burdick, management expects
to incur a non-cash charge of approximately $2.0 million in
the first quarter of 2003, associated with the write-off of
acquired in-process research and development.

Sales and marketing expenses increased by
$0.8 million, or 8.3%, to $10.0 million in 2002 from
$9.2 million in 2001. Sales and marketing expenses was
approximately 21.5% of revenues for both 2002 and 2001. The
increase, in terms of dollars, was caused partially by a
$0.4 million increase in our marketing staffing in 2002,
and a $0.4 million increase in commission expenses
resulting from higher revenues. The increases in staffing were
related to our recent introduction of new products into the
market.

With the acquisition of Burdick, we expect to
increase our sales and marketing expenses beginning in 2003.
Burdick incurred sales and marketing expenses of
$7.8 million, or 19.9% of its revenues in 2002.

General and administrative expenses, excluding
stock-based compensation, increased by $0.4 million, or
7.3%, to $5.3 million in 2002 from $4.9 million in
2001. As a percentage of revenues, general and administrative
expenses, excluding stock-based compensation, decreased to 11.3%
in 2002 from 11.5% in 2001. The increase in general and
administrative expenses, excluding stock-based compensation, in
terms of dollars, was caused primarily by increased professional
fees, insurance and other costs relating to our public

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company status. Expenses associated with
litigation against a former supplier were approximately
$0.8 million in each of 2002 and 2001. The decrease in
general and administrative expenses, excluding stock-based
compensation, as a percentage of revenues was attributable to
higher revenues in 2002 compared to 2001.


With the acquisition of Burdick, our general and
administrative expenses are expected to increase beginning in
2003. Burdick incurred general and administrative expenses of
$4.7 million, or 12.1% of its revenues in 2002.

Stock-based compensation expense decreased by
$2.6 million to $0.1 million in 2002 from
$2.7 million in 2001. Stock-based compensation expense in
2002 relates to the intrinsic value of stock options granted in
2001. The expense in 2001 relates primarily to compensation
expense recorded for stock options issued to an officer of the
Company who was not an employee prior to December 31, 2001.

The acquisition of Burdick is not expected to
have a material effect on our stock-based compensation expenses.



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

Operating loss decreased by $3.5 million, or
65.3%, to $1.9 million in 2002 from $5.4 million in
2001. The decrease in operating loss was due primarily to an
increase in gross profit of $1.8 million and by a decrease
in operating expenses of $1.8 million. The factors that
affected gross profit and operating expenses are explained above.

The acquisition of Burdick may have a material
effect on our consolidated operating income or losses beginning
in 2003. The net effect of the acquisition on our consolidated
operating income or loss will be dependent upon actual sales,
gross profit and operating expenses that are actually realized
in 2003.



| |                       
| | ----------------------
| | Other Income (Expense)

Other income was $0.3 million in 2002, as
compared to other expense of $2.0 million in 2001. This
change was partially due to $0.2 million reduction of
interest expense on outstanding borrowings under our bank line
of credit that we repaid in May 2002 and interest income of
$0.2 million on our short-term investments. The increase in
other income was also partially the result of recording interest
income on putable warrants of $0.2 million in 2002 as
compared to recording interest expense on putable warrants of
$0.6 million in 2001. In addition, a write-off of a note
receivable and related accrued interest created a non-cash
expense of $1.1 million in 2001. This note receivable was
partial consideration for the sale of our fitness business net
assets in 1999. The company that purchased our fitness business
filed for bankruptcy in August 2001. In February 2002 the assets
of this bankrupt company were sold through an auction, and the
proceeds were insufficient to repay the amount owed to us.

In connection with the acquisition of Burdick, we
used substantially all of our cash, plus borrowings under our
line of credit, to fund the purchase price. As a result, we will
incur interest expense in 2003 and do not expect to realize a
material amount of interest income on invested cash.



| |                   
| | ------------------
| | Income Tax Benefit

In 2002, we recognized a tax benefit of
$0.2 million related principally to a refund of alternative
minimum taxes paid in prior periods that we expect to receive in
2003. During 2001, we recognized a tax benefit of
$0.2 million related to a carry back of tax losses to prior
years.

Our gross deferred tax assets of approximately
$8.9 million have been adjusted by a valuation allowance
for the net balance due to the uncertainty regarding
realization. At the end of 2002 we had approximately
$8.5 million of net operating loss carryforwards for
federal income tax purposes that expire in 2022.

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| |                                                                      
| | ---------------------------------------------------------------------
| | Comparison of Years Ended December 31,
    2001 and December 31, 2000



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

Revenues decreased approximately
$7.9 million, or 15.5%, to $42.9 million in 2001 from
$50.7 million in 2000. Systems revenue decreased by 18.1%,
to $33.8 million in 2001 from $41.3 million in 2000,
and service revenue decreased by 4.0%, to $9.0 million in
2001 from $9.4 million in 2000. The decrease in systems
revenue was caused primarily by a $4.1 million decrease in
rehabilitation telemetry systems sales resulting from the
delayed introduction of a new version of this product, a
$4.0 million decline in Holter monitor systems sales due to
the interruption in Holter component supplies when we
transitioned to a new supplier, and a $2.7 million impact
from the divestiture of our imaging business in 2000, partially
offset by a $4.1 million increase in sales of stress test
systems. The decrease in service revenues resulted primarily
from a decrease in the sales of spare parts due to lower sales
volumes.



| |             
| | ------------
| | Gross Profit

Gross profit decreased approximately
$0.2 million, or 0.9%, to $16.9 million in 2001 from
$17.0 million in 2000. Gross profit from systems decreased
approximately $0.2 million, or 1.6%, to $12.7 million
in 2001 from $12.9 million in 2000, while gross profit from
service increased slightly to $4.2 million in 2001 from
$4.1 million in 2000. Systems gross margin improved to
37.4% in 2001 compared with 31.2% in 2000, and service gross
margin improved to 46.4% compared with 44.0% in the prior year.
The increase in both systems and service gross margin resulted
primarily from successful personnel cost reduction efforts in
our manufacturing and service operations which reduced our costs
of systems and service by $0.3 million and
$1.3 million, respectively, partially offset by the
termination of our supply contract for our Holter systems, which
adversely impacted our gross profit by approximately $1.2
million. Our restructuring in the fourth quarter of 2000
resulted in severance of 16 employees whose personnel costs were
included in our systems and service cost of revenues, and
resulted in $0.6 million of annual cost savings.



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

Total operating expenses decreased by
approximately $3.9 million, or 15.0%, to $22.2 million
in 2001 from $26.2 million in 2000. As a percentage of
revenues, total operating expenses increased slightly to 51.9%
from 51.5% in the prior year. This dollar decrease resulted
primarily from a significant reduction in overall staffing
during 2000, largely through reorganization of sales and
research activities, which reduced our personnel related
operating expenses by $2.3 million, offset by a
$2.4 million increase in stock-based compensation expense.
The increase in operating expenses as a percentage of revenues
was attributable to lower revenues in 2001 compared to 2000.

Research and development expenses decreased
approximately $2.0 million, or 27.0%, to $5.5 million
in 2001 from $7.5 million in 2000. As a percentage of
revenues, research and development expenses decreased to 12.7%
from 14.7% in the prior year. The decrease in terms of both
dollars and as a percentage of revenues was due primarily to a
$0.4 million decline in personnel costs resulting from
research and development headcount reductions and a
$1.7 million decline in contract research and development
costs resulting from reduced use of external development
resources.

Sales and marketing expenses decreased
approximately $4.1 million, or 30.8%, to $9.2 million
in 2001 from $13.3 million in 2000. As a percentage of
revenues, sales and marketing expenses decreased to 21.5% from
26.2% in the prior year. The reduction in sales and marketing
expenses in terms of both dollars and as a percentage of
revenues was caused primarily by a $1.1 million decline in
personnel costs resulting from the elimination of several sales
and sales management positions in connection with the
combination of our previously separate invasive and diagnostic
sales organizations during 2000, and a $0.5 million reduction in
commission expenses resulting from lower revenues.

General and administrative expenses, excluding
stock-based compensation, increased approximately
$0.4 million, or 8.6%, to $4.9 million in 2001 from
$4.5 million in 2000. As a percentage of revenues, general
and administrative expenses, excluding stock-based compensation,
increased to 11.5% from 8.9% in the prior

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year. The increase in general and administrative
expenses, excluding stock-based compensation, in terms of both
dollars and as a percentage of sales was caused primarily by
$0.8 million in legal expenses associated with litigation
against a former supplier partially offset by a
$0.3 million decline in general and administrative
personnel costs resulting from general and administrative
headcount reductions.


General and administrative expenses, including
stock-based compensation, increased approximately
$2.8 million, or 59.9%, to $7.6 million in 2001 from
$4.7 million in 2000. As a percentage of revenues, general
and administrative expenses, including stock-based compensation,
increased to 17.7% from 9.3% in the prior year. The increase in
general and administrative expense, including stock-based
compensation, principally resulted from $2.6 million of
stock-based compensation expense recognized when we accelerated
vesting of options held by our non-employee chief executive
officer when he became an employee effective December 31,
2001.

Restructuring costs of $0.6 million in 2000
consist entirely of severance costs for 36 employees at our
Bothell, Washington facilities and three foreign employees. Our
restructuring was announced in October 2000, and severance
payments were due through 2002. The reductions in our workforce
included employees in our manufacturing, engineering, sales and
marketing, finance and administration, technical service and
procurement departments.

Stock-based compensation expense increased
approximately $2.5 million to $2.7 million in 2001
from $0.2 million in 2000. The charges relate primarily to
variable compensation expense recorded on issued options.



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

Operating loss decreased $3.8 million, or
41.1%, to $5.4 million in 2001 from $9.2 million in
2000. Although we experienced a decline in revenues of
approximately $7.9 million, we reduced our operating loss
by significantly decreasing our overall cost structure.
Excluding stock-based compensation expense, our operating losses
decreased $6.2 million, or 69.5%, to $2.7 million in
2001 from $8.9 million in 2000.



| |                       
| | ----------------------
| | Other Income (Expense)

Other expense increased $2.0 million in 2001
from other income of $0.1 million in 2000.

Net interest expense increased approximately
$0.6 million to $0.9 million in 2001 from
$0.3 million in 2000. Interest expense includes
$0.6 million of non-cash expense related to a required
adjustment to the carrying value of putable warrants in 2001.

Write-off of a note receivable and related
accrued interest created a non-cash expense of $1.1 million
in 2001. This note receivable was partial consideration for the
sale of our fitness business net assets in 1999; the company
that purchased our fitness business filed for bankruptcy in
August 2001. In February 2002 the assets of this bankrupt
company were sold through an auction, and the proceeds were
insufficient to repay the amount owed to us.

Other income recorded in 2000 was a gain of
$0.3 million associated with the sale of our imaging net
assets to ScImage, Inc. In return for our imaging inventory with
a net book value of $0.8 million and the assumption of our
warranty and installation obligations of $0.1 million, we
received shares of ScImage valued at $1.0 million.



| |                   
| | ------------------
| | Income Tax Benefit

During 2001 we recognized a tax benefit of
$0.2 million for additional amounts recaptured from the
payment of taxes on the sale of our fitness business in 1999
through our ability to carry back tax losses generated
subsequent to the sale. During 2000 we recorded an income tax
benefit of $2.1 million based on the application of our net
operating loss in 2000 to prior years. Our 2001 gross deferred
tax assets of approximately $7.7 million have been adjusted
by a valuation allowance for the net balance due to the
uncertainty regarding

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realization. At the end of 2001 we had
approximately $7.5 million of net operating loss
carryforwards for federal income tax purposes that expire in
2022.




| |                        
| | -----------------------
| | Discontinued Operations

The loss related to discontinued operations was
$0.8 million in 2001. There was no comparable loss in 2000.
In December 1999 we sold our discontinued fitness business net
assets to StairMaster and in connection with the sale we entered
into a sub-lease with StairMaster for the portion of our leased
facilities associated with that business. StairMaster filed for
bankruptcy in August 2001. We recognized the loss related to
discontinued operations as a result of the acquirer of the net
assets of this bankrupt company not assuming the full remaining
lease term.



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

During 2002, we used cash of $1.4 million in
operating activities. This cash flow resulted primarily from a
$0.5 million loss, excluding non-cash income and expenses,
and an increase in working capital of $0.9 million
associated with the overall growth of our business. The increase
in working capital was primarily due to an increase in accounts
receivable of approximately $1.3 million, an increase in
inventory of approximately $0.9 million, increases in accounts
payable and accrued liabilities of approximately
$0.6 million, a decrease in warranty liabilities of
$0.2 million, and an increase in deferred revenues of
$0.9 million. During 2001, we generated cash from operating
activities of $0.7 million, which was primarily due to an
income tax refund of approximately $1.4 million and a
reduction of our working capital of approximately
$0.9 million, offset by a $1.6 million loss, excluding
non-cash expenses. Excluding the impact of the tax refund, we
used cash in operating activities of $0.7 million during
2001.

During 2002, we incurred $5.1 million of
research and development expenses. We expect to continue
incurring research and development expenses. 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, our research and development expenses
will continue in the future.

Net cash used in investing activities was
$3.4 million in 2002 and $0.3 million in 2001. During 2002,
we made purchases of capital equipment of $1.0 million,
deposited cash of $1.3 million to an escrow fund for the
purchase of Spacelabs Burdick, Inc., and we used
$1.0 million of cash and issued $0.9 million of notes to
purchase the medical treadmill business. Our capital
expenditures in 2002 related primarily to the purchase of an
enterprise resource planning system and a telephone system. In
2001, our capital expenditures related to various smaller
purchases.

Net cash from financing activities of
$23.9 million during 2002 was due primarily to proceeds of
$28.2 million, net of offering expenses, received from our
initial public offering and from proceeds of $0.3 million
received from the purchase of common stock under our employee
stock purchase plan. The proceeds were offset by net repayments
of borrowings on our bank line of credit of $4.5 million and by
a cash payment of $0.2 million to a holder of putable
warrants that exercised their put option. Net cash used for
financing activities of $0.6 million in 2001 was due
primarily to net repayments on our bank borrowings.

In December 2002, in order to provide additional
funding for the acquisition of Burdick, we established a
$12.0 million revolving credit facility with Silicon Valley
Bank subject to certain accounts receivable and inventory
provisions relating to both Quinton and Burdick. This facility
has a term of two years. All borrowings under this facility will
be classified as current liabilities. As of December 31,
2002, no borrowings were outstanding. Outstanding balances under
this facility bear interest at a variable rate ranging from a
minimum of the prime lending rate plus 0.5% to a maximum of the
prime lending rate plus 1.5%, based on a ratio of funded debt to
earnings before interest, taxes, depreciation and amortization
(EBITDA). We have maintained the same commercial
banking relationship since June 1998.

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The tables below summarize our contractual
obligations and other commercial commitments as of
December 31, 2002:

|                        |                                    |       |       |           |  |       |       |       |  |         |     |     |  |   |   |   |  |   |   |   | 
|----------------------- | ---------------------------------- | ----- | ----- | --------- |  | ----- | ----- | ----- |  | ------- | --- | --- |  | - | - | - |  | - | - | - | 
|                        |                                    |       |       | Less than |  | 1  3 |       | 4  5 |  | After  
|                        |                                    | Total |       | 1 year    |  | years |       | years |  | 5 years
|                        |                                    |       |       |           |  |       |       |       |  |        
|Contractual Obligations |                                    |       |       |           |  |       |       |       |  |         |     |     |  |   |   |   |  |   |   |  
|Long-term debt          |                                    | $     | 726   |           |  | $     | 363   |       |  | $       | 363 |     |  | $ |  |   |  | $ |  |  
|Operating leases        |                                    |       | 1,556 |           |  |       | 1,501 |       |  |         | 55  |     |  |   |  |   |  |   |  |  
|Holter licenses         |                                    |       | 340   |           |  |       | 340   |       |  |         |    |     |  |   |  |   |  |   |  |  
|                        |                                    |       |       |           |  |       |       |       |  |         |     |     |  |   |   |   |  |   |   |  
|                        | Total contractual cash obligations |       | $     | 2,622     |  |       | $     | 2,204 |  |         | $   | 418 |  |   | $ |  |  |   | $ |  | 
|                        |                                    |       |       |           |  |       |       |       |  |         |     |     |  |   |   |   |  |   |   |  

|                             |                              |       |   |           |  |       |   |       |  |         |   |   |  |   |   |   |  |   |   |   | 
|---------------------------- | ---------------------------- | ----- | - | --------- |  | ----- | - | ----- |  | ------- | - | - |  | - | - | - |  | - | - | - | 
|                             |                              |       |   | Less than |  | 1  3 |   | 4  5 |  | After  
|                             |                              | Total |   | 1 year    |  | years |   | years |  | 5 years
|                             |                              |       |   |           |  |       |   |       |  |        
|Other Commercial Commitments |                              |       |   |           |  |       |   |       |  |         |   |   |  |   |   |   |  |   |   |  
|Line of credit               |                              | $     |  |           |  | $     |  |       |  | $       |  |   |  | $ |  |   |  | $ |  |  
|Guarantees                   |                              |       |  |           |  |       |  |       |  |         |  |   |  |   |  |   |  |   |  |  
|                             |                              |       |   |           |  |       |   |       |  |         |   |   |  |   |   |   |  |   |   |  
|                             | Total commercial commitments |       | $ |          |  |       | $ |      |  |         | $ |  |  |   | $ |  |  |   | $ |  | 
|                             |                              |       |   |           |  |       |   |       |  |         |   |   |  |   |   |   |  |   |   |  

The acquisition of Burdick will have the effect
of increasing our contractual obligations beginning in 2003.
Burdick has operating lease obligations totaling
$3.8 million, of which $0.6 million is due in less
than one year, $2.0 million is due in one to three years,
and $1.2 million is due in four to five years. The
acquisition of Burdick will not have an impact on our other
commercial commitments.

We anticipate that, for 2003, proceeds from our
initial public offering in May 2002, together with our future
expected operating cash flow and borrowings available to us
under credit facilities, will be sufficient to meet operating
expenses, working capital requirements, capital expenditures and
other obligations for at least 12 months. Our ability to
repay borrowings under the bank line of credit and to satisfy
other liabilities may depend on future operating performance. We
may be affected by economic, financial, competitive,
legislative, regulatory, business and other factors beyond our
control. In addition, we are continually considering
intellectual property and other acquisitions that complement or
expand our existing business or that may enable it 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.

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
$28.2 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
$4.5 million of the offering proceeds to repay the
outstanding balance under our line of credit. In October 2002,
we used $1.0 million of the offering proceeds to pay part
of the purchase price for the treadmill business acquisition
described below. During the months of December 2002 and January
2003, we used $20.2 million of the offering proceeds to pay
part of the purchase price to acquire 100% of the stock of
Spacelabs Burdick, Inc.

Medical
Treadmill Manufacturing Line Acquisition

On October 1, 2002, we acquired the medical
treadmill manufacturing line and related assets and technology
rights from our previous supplier of these treadmills.
Consideration for the purchase included $1,000,000 in cash and
approximately $900,000 in notes payable over two years. Medical
treadmills are an integral component of cardiac stress testing
systems and cardiac rehabilitation systems. This acquisition will

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permit us to continue to develop the underlying
technology of the treadmills in concert with advances in its
cardiac monitoring systems. We also expect to pursue design
changes that will provide updated features, drive a reduction in
per-unit costs and possibly result in an array of medical
treadmills at different price points. In connection with the
transaction, we will manufacture certain treadmills under an OEM
contract for two years, subject to certain terms and conditions.
We expect annual revenue from the OEM contract sales of these
treadmills to be approximately $1.5 million over the term
of the contract.


Spacelabs
Burdick, Inc. Acquisition

On January 2, 2003, we concluded the
purchase of 100% of the stock of Spacelabs Burdick, Inc.
(Burdick) for $24.0 million in cash, plus transaction
related costs of $700,000. The purchase price is subject to
certain post-closing adjustments. Based in Deerfield, Wisconsin,
Burdick has approximately 150 employees. Burdicks
historical strength in ECG cardiographs, Holter monitors and
cardiology information systems, combined with its distribution
network focused on U.S. physicians offices, complements
Quintons strength in cardiac stress testing and cardiac
rehabilitation monitoring and its hospital focused direct sales
force. The purchase was funded with approximately
$20.2 million in cash plus a partial draw down on our
revolving bank credit facility.

At the time of the purchase, $1,300,000 of the
purchase price was held back as an offset against the estimated
value of certain of Burdicks accounts receivable which are
to be retained and collected by Burdicks former owner and
treated, effectively, as a reduction in the purchase price. The
actual amount of such accounts receivable was subsequently
determined to be $1,473,000. By the terms of the agreement, the
difference of $173,000 will be paid to us by the former owner.

In addition, by the terms of the agreement, the
purchase price is subject to adjustment based on net working
capital (as defined in the agreement) as of the date of the
purchase. Based on the sellers determination of the
working capital as of the date of the purchase, the purchase
price would be reduced by $1,119,000 and this amount would be
refunded to us in addition to the $173,000 discussed above. We
are currently in the process of determining the appropriate
purchase price adjustment with the seller. This matter will be
resolved either through negotiation or through a third party
arbitration process, as outlined in the purchase agreement.

Quarterly
Financial Results

The following table sets forth selected unaudited
quarterly financial information and operating data for the last
eight quarters. This information has been prepared on the same
basis as our audited consolidated financial statements and
includes, in the opinion of management, all normal and recurring
adjustments that management considers necessary for a fair
statement of the quarterly results for the periods. The
operating results and data for any quarter are not necessarily
indicative of the results for future periods.

|                                               |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |              |        |   |        |       |        |   |        |       |       |   |        |       |       |   |        |       |       | 
|---------------------------------------------- | ------------------------------------------------------------------- | ------------------------------------- | ------ | -------- | ------ | ------------- | ------ | ------------ | ------ | --------- | ------ | -------- | ----- | ------------- | ------ | ------------ | ------ | - | ------ | ----- | ------ | - | ------ | ----- | ----- | - | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                               |                                                                     | March 31,                             |        | June 30, |        | September 30, |        | December 31, |        | March 31, |        | June 30, |       | September 30, |        | December 31,
|                                               |                                                                     | 2001                                  |        | 2001     |        | 2001          |        | 2001         |        | 2002      |        | 2002     |       | 2002          |        | 2002        
|                                               |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |             
|                                               |                                                                     |                                      
|                                               |                                                                     | (In thousands, except for share data)
|Consolidated Statement of Operations
    Data: |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |              |        |   |        |       |        |   |        |       |       |   |        |       |       |   |        |      
|Revenues                                       |                                                                     | $                                     | 10,078 |          |        | $             | 11,483 |              |        | $         | 10,830 |          |       | $             | 10,483 |              |        | $ | 10,389 |       |        | $ | 11,259 |       |       | $ | 11,655 |       |       | $ | 13,193 |      
|Cost of revenues                               |                                                                     |                                       | 6,252  |          |        |               | 7,283  |              |        |           | 6,349  |          |       |               | 6,136  |              |        |   | 6,236  |       |        |   | 6,882  |       |       |   | 7,068  |       |       |   | 7,697  |      
|                                               |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |              |        |   |        |       |        |   |        |       |       |   |        |       |       |   |        |      
|                                               |                                                                     | Gross profit                          |        |          | 3,826  |               |        |              | 4,200  |           |        |          | 4,481 |               |        |              | 4,347  |   |        |       | 4,153  |   |        |       | 4,377 |   |        |       | 4,587 |   |        |       | 5,496 | 
|Operating Expenses:                            |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |              |        |   |        |       |        |   |        |       |       |   |        |       |       |   |        |      
|                                               | Research and development                                            |                                       |        | 1,494    |        |               |        | 1,512        |        |           |        | 1,206    |       |               |        | 1,247        |        |   |        | 1,353 |        |   |        | 1,334 |       |   |        | 1,205 |       |   |        | 1,234 |      
|                                               | Sales and marketing                                                 |                                       |        | 2,246    |        |               |        | 2,518        |        |           |        | 2,381    |       |               |        | 2,065        |        |   |        | 2,453 |        |   |        | 2,466 |       |   |        | 2,460 |       |   |        | 2,595 |      
|                                               | General and administrative (excluding stock-based
    compensation) |                                       |        | 1,284    |        |               |        | 1,213        |        |           |        | 1,151    |       |               |        | 1,265        |        |   |        | 1,483 |        |   |        | 1,106 |       |   |        | 1,434 |       |   |        | 1,250 |      
|                                               | Stock-based compensation                                            |                                       |        | 139      |        |               |        | 312          |        |           |        | 577      |       |               |        | 1,636        |        |   |        | 35    |        |   |        | 35    |       |   |        | 23    |       |   |        | 18    |      
|                                               |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |              |        |   |        |       |        |   |        |       |       |   |        |       |       |   |        |      
|                                               |                                                                     | Total operating expenses              |        |          | 5,163  |               |        |              | 5,555  |           |        |          | 5,315 |               |        |              | 6,213  |   |        |       | 5,324  |   |        |       | 4,941 |   |        |       | 5,122 |   |        |       | 5,097 | 
|                                               |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |              |        |   |        |       |        |   |        |       |       |   |        |       |       |   |        |      
|                                               |                                                                     | Operating income (loss)               |        |          | (1,337 | )             |        |              | (1,355 | )         |        |          | (834  | )             |        |              | (1,866 | ) |        |       | (1,171 | ) |        |       | (564  | ) |        |       | (535  | ) |        |       | 399   | 
|Other Income (Expense):                        |                                                                     |                                       |        |          |        |               |        |              |        |           |        |          |       |               |        |              |        |   |        |       |        |   |        |       |       |   |        |       |       |   |        |      
|                                               | Interest income (expense), net                                      |                                       |        | (88      | )      |               |        | (95          | )      |           |        | (93      | )     |               |        | (82          | )      |   |        | (73   | )      |   |        | 17    |       |   |        | 97    |       |   |        | 70    |      

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|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |     |     |  
|------------------------------------------------------------------------ | -------------------------------------------------------- | ------------------------------------- | ------ | -------- | --- | ------------- | ------ | ------------ | ---- | --------- | ------ | -------- | ---- | ------------- | ------ | ------------ | ------ | - | ------ | ------ | --- | - | ----- | ---- | --- | - | ----- | ---- | --- | - | ---- | --- | --- | -
|                                                                         |                                                          | March 31,                             |        | June 30, |     | September 30, |        | December 31, |      | March 31, |        | June 30, |      | September 30, |        | December 31,
|                                                                         |                                                          | 2001                                  |        | 2001     |     | 2001          |        | 2001         |      | 2002      |        | 2002     |      | 2002          |        | 2002        
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |             
|                                                                         |                                                          |                                      
|                                                                         |                                                          | (In thousands, except for share data)
|                                                                         | Non-cash interest income (expense), putable
    warrants |                                       |        |         |     |               |        | (62          | )    |           |        | (186     | )    |               |        | (333         | )      |   |        |       |     |   |       | 133  |     |   |       | 161  |     |   |      | (75 | )  
|                                                                         | Write-off note receivable and accrued interest           |                                       |        |         |     |               |        |             |      |           |        |         |      |               |        | (1,106       | )      |   |        |       |     |   |       |     |     |   |       |     |     |   |      |    |    
|                                                                         | Other income (expense), net                              |                                       |        | (6       | )   |               |        | 30           |      |           |        | 23       |      |               |        | 27           |        |   |        | 3      |     |   |       |     |     |   |       | (2   | )   |   |      | (7  | )  
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |    
|                                                                         |                                                          | Total other income (expense)          |        |          | (94 | )             |        |              | (127 | )         |        |          | (256 | )             |        |              | (1,494 | ) |        |        | (70 | ) |       |      | 150 |   |       |      | 256 |   |      |     | (12 | )
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |    
|Income (loss) from continuing operations
    before income taxes         |                                                          |                                       | (1,431 | )        |     |               | (1,482 | )            |      |           | (1,090 | )        |      |               | (3,360 | )            |        |   | (1,241 | )      |     |   | (414  | )    |     |   | (279  | )    |     |   | 387  |    
|                                                                         | Income tax benefit (provision)                           |                                       |        | 211      |     |               |        | (14          | )    |           |        |         |      |               |        | 8            |        |   |        | (10    | )   |   |       | (4   | )   |   |       | (2   | )   |   |      | 208 |    
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |    
|Income (loss) from continuing operations                                 |                                                          |                                       | (1,220 | )        |     |               | (1,496 | )            |      |           | (1,090 | )        |      |               | (3,352 | )            |        |   | (1,251 | )      |     |   | (418  | )    |     |   | (281  | )    |     |   | 595  |    
|Loss from discontinued segment                                           |                                                          |                                       |       |          |     |               |       |              |      |           |       |          |      |               | (831   | )            |        |   |       |        |     |   |      |      |     |   |      |      |     |   |     |    
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |    
|                                                                         | Net income (loss)                                        |                                       | $      | (1,220   | )   |               | $      | (1,496       | )    |           | $      | (1,090   | )    |               | $      | (4,183       | )      |   | $      | (1,251 | )   |   | $     | (418 | )   |   | $     | (281 | )   |   | $    | 595 |    
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |    
|Basic and diluted income (loss) from
    continuing operations per share |                                                          | $                                     | (2.01  | )        |     | $             | (2.41  | )            |      | $         | (1.72  | )        |      | $             | (5.20  | )            |        | $ | (1.91  | )      |     | $ | (0.06 | )    |     | $ | (0.02 | )    |     | $ | 0.05 |    
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |    
|Net income (loss) per share                                              |                                                          | $                                     | (2.01  | )        |     | $             | (2.41  | )            |      | $         | (1.72  | )        |      | $             | (6.49  | )            |        | $ | (1.91  | )      |     | $ | (0.06 | )    |     | $ | (0.02 | )    |     | $ | 0.05 |    
|                                                                         |                                                          |                                       |        |          |     |               |        |              |      |           |        |          |      |               |        |              |        |   |        |        |     |   |       |      |     |   |       |      |     |   |      |    



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

In August 2001, the Financial Accounting
Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 143,
Accounting for Asset Retirement Obligations, which
provides the accounting requirements for retirement obligations
associated with tangible long-lived 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.
The adoption of SFAS 143 is not expected to have a material
impact on the Companys consolidated financial position or
results of operations.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. This statement addresses financial accounting
and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force
(EITF) Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring). This statement requires that a liability
for a cost associated with an exit or disposal activity should
be recognized at fair value when the liability is incurred. SFAS
146 is effective for the Companys 2003 fiscal year. The
adoption of SFAS 146 is not expected to have a material impact
on the Companys consolidated financial position or results
of operations.

In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This standard
establishes disclosure requirements for December 31, 2002
financial statements for companies that make certain types of
guarantees. Beginning in 2003, the standard requires that
companies record the fair value of certain types of guarantees
as a liability in the financial statements. The Company does not
expect the interpretation to have a material impact on the
Companys consolidated financial position or results of
operations.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an Amendment
of FASB Statement 123 (SFAS 148). SFAS 148 provides new
transition alternatives for companies adopting the fair value
method of accounting for stock-based compensation prescribed by
SFAS 123 and changes certain disclosure requirements for
companies electing to continue applying the APB 25 intrinsic
value method. The Company has no current plans to adopt the fair
value method of accounting but has revised its disclosures
accordingly.

In November 2002, the Emerging Issues Task Force
(EITF) reached a consensus on EITF 00-21, Revenue
Arrangements with Multiple Deliverables with respect to
determining when and how to allocate revenue from sales with
multiple deliverables. The EITF 00-21 consensus provides a
framework for

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determining when and how to allocate revenue from
sales with multiple deliverables based on a determination of
whether the multiple deliverables qualify to be accounted for as
separate units of accounting. The consensus is effective
prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company does not expect
that the adoption of this consensus will have a material impact
on the Companys consolidated financial position or results
of operations.







|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | 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
and expense 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.

We own preferred equity securities of a privately
held company, ScImage, Inc., which we account for using the cost
method. The fair value of our investment is not readily
determinable from published market data, so we use our judgment
to estimate the fair value. If the estimated fair value of this
investment were to decline to an amount below its carrying
amount, and we considered the decline other than temporary, we
would record a loss. We believe that our $1 million
carrying amount of this investment is appropriate, though our
belief is necessarily based on our estimate of fair value.






|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

The consolidated financial statements and
supplementary data are included beginning on page F-1 of this
Report.






|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

As of May 10, 2002, we dismissed Arthur
Andersen LLP (Arthur Andersen) as our independent
accountant. Arthur Andersen had served as our independent
accountant since May 1999. The decision to change our
independent accountant was recommended by our Audit Committee
and approved by our Board of Directors. Arthur Andersens
reports on the financial statements for each of the past two
years have not contained an adverse opinion or disclaimer of
opinion, nor were they qualified or modified as to uncertainty,
audit scope, or accounting principles. We have had no
disagreements with Arthur Andersen on any matter of accounting
principles or practices, financial statement disclosure, or
auditing scope or procedures, which, if not resolved to the
satisfaction of Arthur Andersen, would have caused it to make a
reference to the subject matter of the disagreement in
connection with its reports.

During the period that Arthur Andersen served as
our independent accountant and through May 10, 2002, there
have been no reportable events as defined in
Item 304(a)(1)(v) of Regulation S-K.

On May 10, 2002, we engaged KPMG LLP
(KPMG) as our independent accountant to audit our
financial statements for the fiscal year ending
December 31, 2002. The decision to engage KPMG was
recommended by our Audit Committee and approved by our Board of
Directors.

Since May 1999 and through May 10, 2002, we
had not consulted with KPMG regarding (i) the application
of accounting principles to a specified transaction, either
completed or proposed, that was an important factor we
considered in reaching a decision on an accounting, auditing, or
financial reporting issue, or the type of audit opinion that
might be rendered on our financial statements, or (ii) any
matter that was the subject of either a disagreement or a
reportable event.

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##### Table of Contents






PART III






|         |                                                    
|-------- | ---------------------------------------------------
|Item 10. | Executive Officers and Directors of the
    Company

Information called for by Part III, Item 10,
is included in our Proxy Statement relating to our annual
meeting of shareholders to be held on May 16, 2003, and is
incorporated herein by reference. Such Proxy Statement will be
filed within 120 days of December 31, 2002, our fiscal
year end.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

Information called for by Part III, Item 11,
is included in our Proxy Statement relating to our annual
meeting of shareholders to be held on May 16, 2003, and is
incorporated herein by reference.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

Information called for by Part III, Item 12,
is included in our Proxy Statement relating to our annual
meeting of shareholders to be held on May 16, 2003 and is
incorporated herein by reference.



| |                                         
| | ----------------------------------------
| | Equity Compensation Plan
    Information

The following table provides information as of
December 31, 2002 about Quintons common stock that
may be issued upon the exercise of outstanding stock options and
other rights granted to employees, consultants or directors
under our currently existing equity compensation plans.

|                                                               |       |                         |           |                      |  |                             |      |      |  |  |         |         | 
|-------------------------------------------------------------- | ----- | ----------------------- | --------- | -------------------- |  | --------------------------- | ---- | ---- |  |  | ------- | ------- | 
|                                                               |       |                         |           |                      |  | Number of securities       
|                                                               |       |                         |           |                      |  | remaining available for    
|                                                               |       | Number of               |           |                      |  | future issuance under      
|                                                               |       | securities to be issued |           | Weighted-average     |  | equity compensation        
|                                                               |       | upon exercise of        |           | exercise price of    |  | plans (excluding           
|                                                               |       | outstanding options,    |           | outstanding options, |  | securities reflected in the
|Plan category                                                  |       | warrants and rights     |           | warrants and rights  |  | first column)(1)(2)(3)     
|                                                               |       |                         |           |                      |  |                            
|Equity compensation plans approved by security
    holders     |       |                         | 1,449,324 |                      |  | $                           | 3.37 |      |  |  | 225,867 |        
|Equity compensation plans not approved by
    security holders |       |                         |          |                      |  |                             |     |      |  |  |        |        
|                                                               |       |                         |           |                      |  |                             |      |      |  |  |         |        
|                                                               | Total |                         |           | 1,449,324            |  |                             | $    | 3.37 |  |  |         | 225,867 | 
|                                                               |       |                         |           |                      |  |                             |      |      |  |  |         |        



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes 185,949 shares remaining available for
    purchase under Quintons 2002 Employee Stock Purchase Plan.
    The 2002 Employee Stock Purchase Plan includes an evergreen
    formula pursuant to which the number of shares authorized for
    grant will be increased annually by the least of
    (1) 227,272 shares, (2) an amount equal to
    2 percent of the outstanding shares of the common stock of
    the Company as of the end of the immediately preceding fiscal
    year on a fully diluted basis, and (3) a lesser amount
    determined by our Board of Directors. Excludes 227,272
    additional shares of common stock that became available for
    purchase under the 2002 Employee Stock Purchase Plan on
    January 1, 2003 pursuant to the evergreen formula.                                                                                                                                                                                                                                                                                                                                     
|   
|(2) | Includes 39,918 shares remaining available for
    issuance under Quintons 2002 Stock Incentive Plan. The
    2002 Stock Incentive Plan includes an evergreen formula pursuant
    to which the number of shares authorized for grant will be
    increased annually by the least of (1) 681,818 shares,
    (2) an amount equal to 3 percent of the number of
    shares of common stock outstanding on a fully diluted basis as
    of the end of our immediately preceding fiscal year, and
    (3) a lesser amount determined by our Board of Directors.
    Excludes 406,198 additional shares of common stock that became
    available for issuance under the 2002 Stock Incentive Plan on
    January 1, 2003 pursuant to the evergreen formula. Also
    excludes shares that will become issuable under the 2002 Stock
    Incentive Plan if and when they cease to be subject to
    outstanding awards (other than by reason of exercise or
    settlement of the awards) under our 1998 Amended and Restated
    Equity Incentive Plan (which was suspended on the effective date
    of our initial public offering).

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##### Table of Contents



(3) Our stock option grant program for
nonemployee directors is administered under the 2002 Stock
Incentive Plan and provides for the following automatic grants
of stock to each of our nonemployee directors: (1) an
initial grant to purchase 10,000 shares of our Common Stock
as of the date of the directors initial election or
appointment to the Board and (2) an annual grant to
purchase 5,000 shares of our common stock immediately
following each years annual shareholders meeting, except
that any nonemployee director who received an initial grant
within three months before an annual meeting of shareholders
will not receive an annual grant until immediately following the
second annual meeting after the date of the initial grant. Stock
options granted under this program will vest and become
exercisable in equal monthly installments over the 12-month
period following the grant date (assuming continued Board
service).




Item 13.     Certain
Relationships and Related Transactions

Information called for by Part III,
Item 13, is included in our Proxy Statement relating to our
annual meeting of shareholders to be held on May 16, 2003,
and is incorporated herein by reference.

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##### Table of Contents






PART IV




Item 14.     Controls
and Procedures

We maintain disclosure controls and procedures
designed to ensure that information required to be disclosed in
our filings under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange
Commissions rules and forms. Our chief executive officer
and chief financial officer have evaluated our disclosure
controls and procedures within 90 days prior to the filing
of this annual report of Form 10-K and have determined that
such disclosure controls and procedures are effective.

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




Item 15.     Exhibits,
Financial Statements, Schedules and Reports on
Form 8-K

(a) Documents filed as part of this Report:

(1) Index to Financial Statements:

|                                                               |  |  |     | 
|-------------------------------------------------------------- |  |  | --- | 
|Reports of Independent Auditors                                |  |  | F-2 | 
|Consolidated Balance Sheets                                    |  |  | F-4 | 
|Consolidated Statements of Operations                          |  |  | F-5 | 
|Consolidated Statements of Changes in
    Shareholders Equity |  |  | F-6 | 
|Consolidated Statements of Cash Flows                          |  |  | F-7 | 
|Notes to Consolidated Financial Statements                     |  |  | F-8 | 

(2) Index to Financial Statement
Schedules:



| |                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | All schedules are omitted because they are
    inapplicable or the requested information is shown in the
    consolidated financial statements or the related notes thereto.

(3) Index to Exhibits:

The Exhibit Index is included on pages 38 to
39.

(b) Reports on Form 8-K:

On November 12, 2002, we filed a
Form 8-K under Item 9 to report the termination of a
shareholders agreement among certain of our shareholders
and the expiration of the 180-day lock-up period pursuant to a
lock-up agreement entered into among the managing underwriter of
our IPO and our directors, officers and significant shareholders.

On December 23, 2002, we filed a
Form 8-K under Item 5 to report that we had entered
into an agreement to purchase all of the outstanding shares of
capital stock of Burdick, Inc.

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##### Table of Contents



EXHIBIT INDEX

|        |    |             |  |                                                                                                                                                                                
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1(1)       |  | Stock Purchase Agreement dated December 23,
    2002 by and among Spacelabs Medical, Inc., Spacelabs Burdick,
    Inc., Quinton Cardiology Systems, Inc. and Datex-Ohmeda, Inc.
|        | 2  | .2(1)       |  | Technology Cross-License Agreement by and between
    Spacelabs Medical, Inc. and Spacelabs Burdick, Inc.                                                                      
|        | 2  | .3(1)       |  | ABPM Private Label Distribution Agreement by and
    between Spacelabs Medical, Inc. and Spacelabs Burdick, Inc.                                                               
|        | 2  | .4(1)       |  | Sales and Marketing Cooperation Agreement by and
    among Spacelabs Medical, Inc., Spacelabs Burdick, Inc. and
    Quinton Cardiology Systems, Inc.                           
|        | 3  | .1(2)       |  | Amended and Restated Articles of Incorporation of
    the registrant.                                                                                                          
|        | 3  | .2(2)       |  | Amended and Restated Bylaws of the registrant.                                                                                                                                 
|        | 4  | .1(2)       |  | Specimen Company Stock Certificate.                                                                                                                                            
|        | 4  | .2(2)       |  | Investors Rights Agreement.                                                                                                                                                   
|        | 10 | .1(2)       |  | 1998 Amended and Restated Equity Incentive Plan.                                                                                                                               
|        | 10 | .2(2)       |  | 2002 Stock Incentive Plan.                                                                                                                                                     
|        | 10 | .3(2)       |  | 2002 Employee Stock Purchase Plan.                                                                                                                                             
|        | 10 | .4(2)       |  | Stock Option Grant Program for Nonemployee
    Directors.                                                                                                                      
|        | 10 | .5(2)       |  | 2002 Management Incentive Plan.                                                                                                                                                
|        | 10 | .6(2)       |  | Form of Indemnification Agreement.                                                                                                                                             
|        | 10 | .7(2)       |  | Lease Agreement between Quinton Inc. and AHP
    Subsidiary Holding Corporation regarding premises at Bothell,
    Washington, dated August 31, 1998.                          
|        | 10 | .8(2)       |  | First Amendment to Lease between Quinton Inc. and
    AHP Subsidiary Holding Corporation, dated August 31, 1998.                                                               
|        | 10 | .9(2)       |  | OEM Agreement between Quinton Inc. and Mortara
    Instrument, Inc. dated August 1, 2000.                                                                                      
|        | 10 | .10(2)      |  | OEM Agreement between Quinton Inc. and Mortara
    Instrument, Inc. dated October 17, 2000.                                                                                    
|        | 10 | .11(2)      |  | OEM Agreement between Quinton Inc. and Mortara
    Instrument, Inc. dated October 1, 2001.                                                                                     
|        | 10 | .12(2)      |  | Addendum No. 1 to the OEM Agreement between
    Mortara Instrument, Inc. and Quinton Inc. dated August 1,
    2001.                                                            
|        | 10 | .13         |  | Loan and Security Agreement between Quinton
    Cardiology Systems, Inc. and Quinton Inc. and Silicon Valley
    Bank dated December 30, 2002.                                 
|        | 10 | .14         |  | Amendment to Loan Documents between Quinton
    Cardiology Systems, Inc., Quinton Inc. and Burdick, Inc. and
    Silicon Valley Bank dated January 9, 2003.                    
|        | 10 | .15         |  | Streamline Facility Agreement between Quinton
    Cardiology Systems, Inc. and Quinton Inc. and Silicon Valley
    Bank dated as of December 30, 2002.                         
|        | 10 | .16         |  | Cross-Corporate Continuing Guaranty between
    Quinton Cardiology Systems, Inc. and Quinton Inc. and Silicon
    Valley Bank dated December 30, 2002.                         
|        | 10 | .17         |  | Intellectual Property Security Agreement between
    Quinton Cardiology Systems, Inc. and Quinton Inc. and Silicon
    Valley Bank dated December 30, 2002.                    
|        | 10 | .18         |  | Assumption Agreement between Quinton Cardiology
    Systems, Inc., Quinton Inc. and Burdick, Inc. and Silicon Valley
    Bank dated January 9, 2003.                           
|        | 10 | .19         |  | Cross-Corporate Continuing Guaranty between
    Burdick Inc. and Silicon Valley Bank dated January 9, 2003.                                                                    
|        | 10 | .20         |  | Intellectual Property Security Agreement between
    Burdick, Inc. and Silicon Valley Bank dated January 9, 2003.                                                              
|        | 10 | .21         |  | Lease Agreement between Carl Ruedebusch LLC and
    Burdick, Inc. regarding premises at Deerfield Industrial Park in
    Deerfield, Wisconsin dated as of April 6, 1998.       
|        | 21 | .1          |  | Subsidiaries.                                                                                                                                                                  
|        | 23 | .1          |  | Independent Auditors Consent.                                                                                                                                                 
|        | 23 | .2          |  | Notice Regarding Lack of Consent of Arthur
    Andersen LLP.                                                                                                                   

38



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##### Table of Contents



|        |    |             |  |                                                                                                                                
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 99 | .1          |  | Certification Pursuant to 18 U.S.C.
    Section 1350, as Adopted Pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.
|        | 99 | .2          |  | Certification 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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|    |                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to the
    Registrants Current Report on Form 8-K (File
    No. 000-49755) filed on January 17, 2003.
|   
|(2) | Incorporated by reference to the
    Registrants Registration Statement on Form S-1 (File
    No. 333-83272).                  

39



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) 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

| |                                
| | -------------------------------
| |                                
| | Name: Michael K. Matysik       
| | Title:  Chief Financial Officer

Date: March 18, 2003

Pursuant to the requirements of the Securities
Exchange Act of 1934, this Report has been signed below by the
following persons on behalf of the registrant and in the
capacities indicated below on the 18th day of March, 2003.

|                                                     |  |                                                                                                    |  |                |  | 
|---------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                                     |  |                                                                                                    |  |               
|Signature                                            |  | Title                                                                                              |  | Date          
|                                                     |  |                                                                                                    |  |               
|/s/ RUEDIGER NAUMANN-ETIENNERuediger Naumann-Etienne |  | Chairman and Chief Executive Officer
    (Principal Executive Officer)                             |  | March 18, 2003
|                                                    
|/s/ MICHAEL K. MATYSIKMichael K. Matysik             |  | Senior Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer) |  | March 18, 2003
|                                                    
|/s/ JOHN R. HINSONJohn R. Hinson                     |  | President, Chief Operating Officer
    and Director                                                |  | March 18, 2003
|                                                    
|/s/ W. ROBERT BERGW. Robert Berg                     |  | Director                                                                                           |  | March 18, 2003
|                                                    
|/s/ HARVEY N. GILLISHarvey N. Gillis                 |  | Director                                                                                           |  | March 18, 2003
|                                                    
|/s/ WILLIAM R. HAMBRECHTWilliam R. Hambrecht         |  | Director                                                                                           |  | March 18, 2003

40



---



##### Table of Contents



I, Ruediger Naumann-Etienne, certify that:

1.     I have reviewed
this annual report on Form 10-K of Quinton Cardiology
Systems, Inc.;

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

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

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



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

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



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the design or
    operation of internal controls which could adversely affect the
    registrants ability to record, process, summarize and
    report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6.     The
registrants other certifying officer and I have indicated
in this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.



| |                               
| | ------------------------------
| | /s/ RUEDIGER NAUMANN-ETIENNE  
| |                               
| | Name: Ruediger Naumann-Etienne

| |        |                                                  
| | ------ | -------------------------------------------------
| | Title: | Chairman of the Board and Chief Executive Officer

Date: March 18, 2003

41



---



##### Table of Contents



I, Michael K. Matysik, certify that:

1.     I have reviewed
this annual report on Form 10-K of Quinton Cardiology
Systems, Inc.;

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

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

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



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

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



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6.     The
registrants other certifying officer and I have indicated
in this annual report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.



| |                         
| | ------------------------
| | /s/ MICHAEL K. MATYSIK  
| |                         
| | Name: Michael K. Matysik

| |        |                                                  
| | ------ | -------------------------------------------------
| | Title: | Senior Vice President and Chief Financial Officer

Date: March 18, 2003

42



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC.

AND SUBSIDIARIES


INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                               |  |  |     | 
|-------------------------------------------------------------- |  |  | --- | 
|Reports of Independent Auditors                                |  |  | F-2 | 
|Consolidated Balance Sheets                                    |  |  | F-4 | 
|Consolidated Statements of Operations                          |  |  | F-5 | 
|Consolidated Statements of Changes in
    Shareholders Equity |  |  | F-6 | 
|Consolidated Statements of Cash Flows                          |  |  | F-7 | 
|Notes to Consolidated Financial Statements                     |  |  | F-8 | 

F-1



---



##### Table of Contents



INDEPENDENT AUDITORS REPORT

The Quinton Cardiology Systems, Inc. Board of
Directors and Shareholders:

We have audited the accompanying consolidated
balance sheet of Quinton Cardiology Systems, Inc.
(a California corporation) and subsidiaries as of
December 31, 2002, and the related consolidated statements
of operations, shareholders equity and cash flows for the
year then ended. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits. The consolidated financial
statements of Quinton Cardiology Systems, Inc. and subsidiaries
as of December 31, 2001, and for each of the two years in
the period ended December 31, 2001, were audited by other
auditors who have ceased operations. Those auditors expressed an
unqualified opinion on those financial statements in their
report dated February 8, 2002, except for the matter
discussed in Note 19 to those financial statements, for
which their report date was March 29, 2002.

We conducted our audit in accordance with
auditing standards generally accepted in the United States of
America. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the financial
position of Quinton Cardiology Systems, Inc. and subsidiaries as
of December 31, 2002, and the results of their operations
and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of
America.



| |             
| | ------------
| | /s/ KPMG LLP

Seattle, Washington

February 7, 2003


F-2



---



##### Table of Contents



REPORT OF INDEPENDENT PUBLIC
ACCOUNTANTS

To the Board of Directors and Shareholders of QIC
Holding Corp.:

We have audited the accompanying consolidated
balance sheets of QIC Holding Corp. (a California corporation,
since renamed as Quinton Cardiology Systems, Inc.) and
subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of operations,
shareholders equity and cash flows for each of the three
years in the period ended December 31, 2001. These
financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the financial
position of QIC Holding Corp. and subsidiaries as of
December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in
the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States.



| |                        
| | -----------------------
| | /s/ ARTHUR ANDERSEN LLP
| |                        

Seattle, Washington

February 8, 2002, (except for Note 17,


for which the date is March 29, 2002)


This audit report of Arthur Andersen LLP, our
former independent public accountants, is a copy of the original
report dated February 8, 2002 rendered by Arthur Andersen
LLP on our consolidated financial statements included in our
Form S-1 (Registration No. 333-83272) filed on
February 22, 2002, as amended. This audit report has not
been reissued by Arthur Andersen LLP since February 22,
2002 nor has Arthur Andersen LLP provided a consent to the
inclusion of its report in this Form 10-K. We are including
this copy of the Arthur Andersen LLP audit report pursuant to
Rule 2-02(e) of Regulation S-X under the Securities Act of
1933. For further discussion, see Exhibit 23.2 to the
Form 10-K for the fiscal year ended December 31, 2002,
of which this report forms a part.

F-3



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES






CONSOLIDATED BALANCE SHEETS


|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |         |   |        | 
|---------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------- | ------ | ------ | ----- | ------- | - | ------ | 
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                               
|                                                                                                                 |                                                                                                                                                                          | December 31,                                                                                                                                                                                                                  
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                               
|                                                                                                                 |                                                                                                                                                                          | 2001                                                                                                                                                                                                                           |                                            | 2002   
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                               
|                                                                                                                 |                                                                                                                                                                          | (in thousands, except                                                                                                                                                                                                         
|                                                                                                                 |                                                                                                                                                                          | share amounts)                                                                                                                                                                                                                
|ASSETS                                                                                                          
|Current Assets:                                                                                                  |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 | Cash and cash equivalents                                                                                                                                                |                                                                                                                                                                                                                                | $                                          | 218     |        |        | $     | 19,382  |  
|                                                                                                                 | Accounts receivable, net of allowance for
    doubtful accounts of $385 and $398, respectively                                                                           |                                                                                                                                                                                                                                |                                            | 6,123   |        |        |       | 7,384   |  
|                                                                                                                 | Inventories                                                                                                                                                              |                                                                                                                                                                                                                                |                                            | 6,161   |        |        |       | 7,462   |  
|                                                                                                                 | Prepaid expenses and other current assets                                                                                                                                |                                                                                                                                                                                                                                |                                            | 626     |        |        |       | 528     |  
|                                                                                                                 | Income taxes receivable                                                                                                                                                  |                                                                                                                                                                                                                                |                                            |        |        |        |       | 206     |  
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                | Total current assets                       |         |        | 13,128 |       |         |   | 34,962 | 
|Machinery and equipment, net of accumulated
    depreciation and amortization of $3,392 and $4,382, respectively |                                                                                                                                                                          |                                                                                                                                                                                                                                | 3,165                                      |         |        |        | 3,510 |        
|Patents, net of accumulated amortization of $437
    and $567, respectively                                      |                                                                                                                                                                          |                                                                                                                                                                                                                                | 173                                        |         |        |        | 393   |        
|Goodwill                                                                                                         |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                           |         |        |        | 860   |        
|Investment in unconsolidated entity                                                                              |                                                                                                                                                                          |                                                                                                                                                                                                                                | 1,000                                      |         |        |        | 1,000 |        
|Restricted cash deposit                                                                                          |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                           |         |        |        | 1,325 |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                | Total assets                               |         | $      | 17,466 |       |         | $ | 42,050 | 
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|LIABILITIES AND SHAREHOLDERS
    EQUITY                                                                        
|Current Liabilities:                                                                                             |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 | Line of credit                                                                                                                                                           |                                                                                                                                                                                                                                | $                                          | 4,471   |        |        | $     |        |  
|                                                                                                                 | Current portion of long term debt                                                                                                                                        |                                                                                                                                                                                                                                |                                            |        |        |        |       | 363     |  
|                                                                                                                 | Accounts payable                                                                                                                                                         |                                                                                                                                                                                                                                |                                            | 4,029   |        |        |       | 4,776   |  
|                                                                                                                 | Accrued liabilities                                                                                                                                                      |                                                                                                                                                                                                                                |                                            | 2,548   |        |        |       | 3,415   |  
|                                                                                                                 | Warranty liability                                                                                                                                                       |                                                                                                                                                                                                                                |                                            | 1,269   |        |        |       | 1,089   |  
|                                                                                                                 | Deferred revenue                                                                                                                                                         |                                                                                                                                                                                                                                |                                            | 3,556   |        |        |       | 4,407   |  
|                                                                                                                 | Putable warrants                                                                                                                                                         |                                                                                                                                                                                                                                |                                            | 705     |        |        |       | 328     |  
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                | Total current liabilities                  |         |        | 16,578 |       |         |   | 14,378 | 
|Long term debt, net of current portion                                                                           |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                           |         |        |        | 363   |        
|Sublease liability, net of current portion                                                                       |                                                                                                                                                                          |                                                                                                                                                                                                                                | 831                                        |         |        |        |      |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                | Total liabilities                          |         |        | 17,409 |       |         |   | 14,741 | 
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|Shareholders Equity:                                                                                            |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 | 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, 12,454,545 shares designated, 12,230,000
    shares issued and outstanding at December 31, 2001 |                                            |         | 12,230 |        |       |         |  |       
|                                                                                                                 |                                                                                                                                                                          | Series B convertible preferred stock, no par
    value, aggregate liquidation preferences of $865 at
    December 31, 2001, 6,000,000 shares designated, 865,000
    shares issued and outstanding at December 31, 2001        |                                            |         | 865    |        |       |         |  |       
|                                                                                                                 | Common stock (100,000,000 shares
    authorized), no par value, 677,275 and 12,049,136 shares
    issued and outstanding at December 31, 2001 and 2002,
    respectively |                                                                                                                                                                                                                                |                                            | 3,490   |        |        |       | 45,085  |  
|                                                                                                                 | Deferred stock-based compensation                                                                                                                                        |                                                                                                                                                                                                                                |                                            | (287    | )      |        |       | (180    | )
|                                                                                                                 | Accumulated deficit                                                                                                                                                      |                                                                                                                                                                                                                                |                                            | (16,241 | )      |        |       | (17,596 | )
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                | Total shareholders equity                 |         |        | 57     |       |         |   | 27,309 | 
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                | Total liabilities and shareholders equity |         | $      | 17,466 |       |         | $ | 42,050 | 
|                                                                                                                 |                                                                                                                                                                          |                                                                                                                                                                                                                                |                                            |         |        |        |       |        

The accompanying notes are an integral part of
these financial statements.

F-4



---



##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES






CONSOLIDATED STATEMENTS OF
OPERATIONS


|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |        |        |  
|-------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------- | ---------------------------- | ------- | ------ | ------ | ---- | ------- | ------ | ------ | - | --------- | ------ | ------ | -
|                                                                                 |                                                                                                             |                             
|                                                                                 |                                                                                                             | Year Ended December 31,     
|                                                                                 |                                                                                                             |                             
|                                                                                 |                                                                                                             | 2000                         |         | 2001   |        | 2002
|                                                                                 |                                                                                                             |                              |         |        |        |     
|                                                                                 |                                                                                                             |                             
|                                                                                 |                                                                                                             | (in thousands, except share 
|                                                                                 |                                                                                                             | and per share amounts)      
|Revenues:                                                                        |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Systems                                                                                                     |                              | $       | 41,318 |        |      | $       | 33,833 |        |   | $         | 37,389 |       
|                                                                                 | Service                                                                                                     |                              |         | 9,416  |        |      |         | 9,041  |        |   |           | 9,107  |       
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 |                                                                                                             | Total revenues               |         |        | 50,734 |      |         |        | 42,874 |   |           |        | 46,496 |  
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|Cost of Revenues:                                                                |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Systems                                                                                                     |                              |         | 28,447 |        |      |         | 21,170 |        |   |           | 23,247 |       
|                                                                                 | Service                                                                                                     |                              |         | 5,272  |        |      |         | 4,850  |        |   |           | 4,636  |       
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 |                                                                                                             | Total cost of revenues       |         |        | 33,719 |      |         |        | 26,020 |   |           |        | 27,883 |  
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 |                                                                                                             | Gross profit                 |         |        | 17,015 |      |         |        | 16,854 |   |           |        | 18,613 |  
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|Operating Expenses:                                                              |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Research and development                                                                                    |                              |         | 7,479  |        |      |         | 5,459  |        |   |           | 5,126  |       
|                                                                                 | Sales and marketing                                                                                         |                              |         | 13,306 |        |      |         | 9,210  |        |   |           | 9,974  |       
|                                                                                 | General and administrative (excluding $215,
    $2,664, and $111 of stock-based compensation, respectively) |                              |         | 4,525  |        |      |         | 4,913  |        |   |           | 5,273  |       
|                                                                                 | Restructuring costs                                                                                         |                              |         | 645    |        |      |         |       |        |   |           |       |       
|                                                                                 | Stock-based compensation                                                                                    |                              |         | 215    |        |      |         | 2,664  |        |   |           | 111    |       
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 |                                                                                                             | Total operating expenses     |         |        | 26,170 |      |         |        | 22,246 |   |           |        | 20,484 |  
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 |                                                                                                             | Operating loss               |         |        | (9,155 | )    |         |        | (5,392 | ) |           |        | (1,871 | )
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|Other Income (Expense):                                                          |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Interest income                                                                                             |                              |         |       |        |      |         |       |        |   |           | 225    |       
|                                                                                 | Interest expense                                                                                            |                              |         | (302   | )      |      |         | (358   | )      |   |           | (114   | )     
|                                                                                 | Interest income (expense), putable warrants                                                                 |                              |         |       |        |      |         | (581   | )      |   |           | 219    |       
|                                                                                 | Write-off of note receivable and accrued interest                                                           |                              |         |       |        |      |         | (1,106 | )      |   |           |       |       
|                                                                                 | Gain on sale of net imaging assets                                                                          |                              |         | 341    |        |      |         |       |        |   |           |       |       
|                                                                                 | Other income (expense), net                                                                                 |                              |         | 28     |        |      |         | 74     |        |   |           | (6     | )     
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 |                                                                                                             | Total other income (expense) |         |        | 67     |      |         |        | (1,971 | ) |           |        | 324    |  
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|Loss from continuing operations before income
    taxes                          |                                                                                                             |                              | (9,088  | )      |        |      | (7,363  | )      |        |   | (1,547    | )     
|                                                                                 | Income tax benefit                                                                                          |                              |         | 2,088  |        |      |         | 205    |        |   |           | 192    |       
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|Loss from continuing operations                                                  |                                                                                                             |                              | (7,000  | )      |        |      | (7,158  | )      |        |   | (1,355    | )     
|Discontinued operations:                                                         |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Loss on sale of discontinued segment, net of
    applicable income taxes of $0                              |                              |         |       |        |      |         | (831   | )      |   |           |       |       
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Net loss                                                                                                    |                              | $       | (7,000 | )      |      | $       | (7,989 | )      |   | $         | (1,355 | )     
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|Basic and diluted net loss per share:                                            |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Continuing operations                                                                                       |                              | $       | (13.94 | )      |      | $       | (11.37 | )      |   | $         | (0.17  | )     
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Discontinued operations                                                                                     |                              | $       |       |        |      | $       | (1.32  | )      |   | $         |       |       
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|                                                                                 | Net loss                                                                                                    |                              | $       | (13.94 | )      |      | $       | (12.69 | )      |   | $         | (0.17  | )     
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       
|Weighted average shares used to compute basic and
    diluted net loss per share |                                                                                                             |                              | 502,065 |        |        |      | 629,647 |        |        |   | 7,887,659 |       
|                                                                                 |                                                                                                             |                              |         |        |        |      |         |        |        |   |           |       

The accompanying notes are an integral part of
these financial statements.

F-5



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES






CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY


|                           |                                                                                |                                              |        |                 |   |              |            |             |   |             |     |        |   |              |         |          |   |       |        |        |   |  |            |           |   |   |      |        |   |   |         |        |   |   |        |        |  
|-------------------------- | ------------------------------------------------------------------------------ | -------------------------------------------- | ------ | --------------- | - | ------------ | ---------- | ----------- | - | ----------- | --- | ------ | - | ------------ | ------- | -------- | - | ----- | ------ | ------ | - |  | ---------- | --------- | - | - | ---- | ------ | - | - | ------- | ------ | - | - | ------ | ------ | -
|                           |                                                                                |                                              |        |                 |   |              |            |             |   |             |     |        |   |             
|                           |                                                                                | Series A                                     |        | Series B        |   |              |            |             |   |             |     |       
|                           |                                                                                | Preferred Stock                              |        | Preferred Stock |   | Common Stock |            | Deferred    |   |             |     |       
|                           |                                                                                |                                              |        |                 |   |              |            | Stock       |   | Accumulated |     |       
|                           |                                                                                | Amount                                       |        | Shares          |   | Amount       |            | Shares      |   | Amount      |     | Shares |   | Compensation |         | Deficit  |   | Total
|                           |                                                                                |                                              |        |                 |   |              |            |             |   |             |     |        |   |              |         |          |   |      
|                           |                                                                                |                                             
|                           |                                                                                | (dollars in thousands, except share amounts)
|Balance, December 31, 1999 |                                                                                | $                                            | 12,230 |                 |   |              | 12,230,000 |             |   | $           |    |        |   |              |        |          |   | $     | 597    |        |   |  | 1,066,405  |           |   | $ | (191 | )      |   | $ | (1,252  | )      |   | $ | 11,384 |       
|                           | Issuance of common stock upon exercise of stock
    options                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 7      |   |  |            | 26,667    |   |   |      |       |   |   |         |       |   |   |        | 7      |  
|                           | Deferred stock compensation                                                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 482    |   |  |            |          |   |   |      | (482   | ) |   |         |       |   |   |        |       |  
|                           | Issuance of Series B Preferred Stock                                           |                                              |        |                |   |              |            |            |   |             |     | 865    |   |              |         | 865,000  |   |       |        |       |   |  |            |          |   |   |      |       |   |   |         |       |   |   |        | 865    |  
|                           | Cancellation of deferred stock compensation in
    connection with termination |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | (80    | ) |  |            |          |   |   |      | 80     |   |   |         |       |   |   |        |       |  
|                           | Amortization of deferred stock compensation                                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        |       |   |  |            |          |   |   |      | 215    |   |   |         |       |   |   |        | 215    |  
|                           | Net loss                                                                       |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        |       |   |  |            |          |   |   |      |       |   |   |         | (7,000 | ) |   |        | (7,000 | )
|                           |                                                                                |                                              |        |                 |   |              |            |             |   |             |     |        |   |              |         |          |   |       |        |        |   |  |            |           |   |   |      |        |   |   |         |        |   |   |        |       
|Balance, December 31, 2000 |                                                                                |                                              | 12,230 |                 |   |              | 12,230,000 |             |   |             | 865 |        |   |              | 865,000 |          |   |       | 1,006  |        |   |  | 1,093,072  |           |   |   | (378 | )      |   |   | (8,252  | )      |   |   | 5,471  |       
|                           | Issuance of common stock upon exercise of stock
    options                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 5      |   |  |            | 10,403    |   |   |      |       |   |   |         |       |   |   |        | 5      |  
|                           | Repurchase of shares in connection with
    termination                        |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | (94    | ) |  |            | (426,200  | ) |   |      |       |   |   |         |       |   |   |        | (94    | )
|                           | Deferred stock compensation                                                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 2,573  |   |  |            |          |   |   |      | (2,573 | ) |   |         |       |   |   |        |       |  
|                           | Amortization of deferred stock compensation                                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        |       |   |  |            |          |   |   |      | 2,664  |   |   |         |       |   |   |        | 2,664  |  
|                           | Net loss                                                                       |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        |       |   |  |            |          |   |   |      |       |   |   |         | (7,989 | ) |   |        | (7,989 | )
|                           |                                                                                |                                              |        |                 |   |              |            |             |   |             |     |        |   |              |         |          |   |       |        |        |   |  |            |           |   |   |      |        |   |   |         |        |   |   |        |       
|Balance, December 31, 2001 |                                                                                |                                              | 12,230 |                 |   |              | 12,230,000 |             |   |             | 865 |        |   |              | 865,000 |          |   |       | 3,490  |        |   |  | 677,275    |           |   |   | (287 | )      |   |   | (16,241 | )      |   |   | 57     |       
|                           | Issuance of common stock upon exercise of stock
    options                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 60     |   |  |            | 91,191    |   |   |      |       |   |   |         |       |   |   |        | 60     |  
|                           | Deferred stock compensation                                                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 4      |   |  |            |          |   |   |      | (4     | ) |   |         |       |   |   |        |       |  
|                           | Amortization of deferred stock compensation                                    |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        |       |   |  |            |          |   |   |      | 111    |   |   |         |       |   |   |        | 111    |  
|                           | Proceeds from issuance of common stock, net of
    issuance costs              |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 28,184 |   |  |            | 4,600,000 |   |   |      |       |   |   |         |       |   |   |        | 28,184 |  
|                           | Conversion of preferred stock to common stock                                  |                                              |        | (12,230         | ) |              |            | (12,230,000 | ) |             |     | (865   | ) |              |         | (865,000 | ) |       |        | 13,095 |   |  |            | 6,639,347 |   |   |      |       |   |   |         |       |   |   |        |       |  
|                           | Proceeds from issuance of stock under employee
    stock purchase plan         |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        | 252    |   |  |            | 41,323    |   |   |      |       |   |   |         |       |   |   |        | 252    |  
|                           | Net loss                                                                       |                                              |        |                |   |              |            |            |   |             |     |       |   |              |         |         |   |       |        |       |   |  |            |          |   |   |      |       |   |   |         | (1,355 | ) |   |        | (1,355 | )
|                           |                                                                                |                                              |        |                 |   |              |            |             |   |             |     |        |   |              |         |          |   |       |        |        |   |  |            |           |   |   |      |        |   |   |         |        |   |   |        |       
|Balance, December 31, 2002 |                                                                                | $                                            |       |                 |   |              |           |             |   | $           |    |        |   |              |        |          |   | $     | 45,085 |        |   |  | 12,049,136 |           |   | $ | (180 | )      |   | $ | (17,596 | )      |   | $ | 27,309 |       
|                           |                                                                                |                                              |        |                 |   |              |            |             |   |             |     |        |   |              |         |          |   |       |        |        |   |  |            |           |   |   |      |        |   |   |         |        |   |   |        |       

The accompanying notes are an integral part of
these financial statements.

F-6



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |        |       |        |        |  
|------------------------------------------------- | ------------------------------------------------------------------------------------ | -------------------------------------------------------------------------- | ----------------------------------- | ---------------------------------------- | ----- | ------ | ------ | ------ | ----- | ------ | ------ | ------ | ----- | ------ | ------ | -
|                                                  |                                                                                      |                                                                           
|                                                  |                                                                                      | Year Ended December 31,                                                   
|                                                  |                                                                                      |                                                                           
|                                                  |                                                                                      | 2000                                                                       |                                     | 2001                                     |       | 2002  
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |       
|                                                  |                                                                                      |                                                                           
|                                                  |                                                                                      | (in thousands)                                                            
|Operating Activities:                             |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  | Net loss                                                                             |                                                                            | $                                   | (7,000                                   | )     |        | $      | (7,989 | )     |        | $      | (1,355 | )    
|                                                  | Adjustments to reconcile net loss to net cash
    from operating activities         |                                                                            |                                     |                                          |       |        |        |        |       |        |        |        |      
|                                                  |                                                                                      | Depreciation and amortization                                              |                                     |                                          | 1,196 |        |        |        | 1,148 |        |        |        | 1,197 |       
|                                                  |                                                                                      | Loss on sale of equipment                                                  |                                     |                                          | 24    |        |        |        | 58    |        |        |        | 21    |       
|                                                  |                                                                                      | Amortization of deferred stock-based compensation                          |                                     |                                          | 215   |        |        |        | 2,664 |        |        |        | 111   |       
|                                                  |                                                                                      | Gain on sale of net imaging assets                                         |                                     |                                          | (341  | )      |        |        |      |        |        |        |      |       
|                                                  |                                                                                      | Non-cash interest income                                                   |                                     |                                          | (46   | )      |        |        |      |        |        |        |      |       
|                                                  |                                                                                      | Interest expense (income), putable warrants                                |                                     |                                          |      |        |        |        | 581   |        |        |        | (219  | )     
|                                                  |                                                                                      | Write-off of note receivable and accrued interest                          |                                     |                                          |      |        |        |        | 1,106 |        |        |        |      |       
|                                                  |                                                                                      | Loss on sale of discontinued segment                                       |                                     |                                          |      |        |        |        | 831   |        |        |        |      |       
|                                                  |                                                                                      | Changes in operating assets and liabilities, net
    of business acquired: |                                     |                                          |       |        |        |        |       |        |        |        |       |       
|                                                  |                                                                                      |                                                                            | Accounts receivable                 |                                          |       | 6,690  |        |        |       | 2,055  |        |        |       | (1,261 | )     
|                                                  |                                                                                      |                                                                            | Inventories                         |                                          |       | 2,864  |        |        |       | 270    |        |        |       | (876   | )     
|                                                  |                                                                                      |                                                                            | Prepaid expenses and other assets   |                                          |       | 41     |        |        |       | 18     |        |        |       | 55     |       
|                                                  |                                                                                      |                                                                            | Income taxes receivable and payable |                                          |       | (3,605 | )      |        |       | 1,209  |        |        |       | (206   | )     
|                                                  |                                                                                      |                                                                            | Accounts payable                    |                                          |       | (2,013 | )      |        |       | 340    |        |        |       | 712    |       
|                                                  |                                                                                      |                                                                            | Accrued liabilities                 |                                          |       | (524   | )      |        |       | (1,042 | )      |        |       | (164   | )     
|                                                  |                                                                                      |                                                                            | Warranty liability                  |                                          |       | (405   | )      |        |       | (531   | )      |        |       | (235   | )     
|                                                  |                                                                                      |                                                                            | Deferred revenue                    |                                          |       | 789    |        |        |       | 1      |        |        |       | 851    |       
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  |                                                                                      |                                                                            |                                     | Net cash flows from operating activities |       |        | (2,115 | )      |       |        | 719    |        |       |        | (1,369 | )
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|Investing Activities:                             |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  | Restricted cash deposit for acquisition                                              |                                                                            |                                     |                                         |       |        |        |       |       |        |        | (1,325 | )    
|                                                  | Acquisition of treadmill manufacturing business                                      |                                                                            |                                     |                                         |       |        |        |       |       |        |        | (1,000 | )    
|                                                  | Purchases of machinery and equipment                                                 |                                                                            |                                     | (672                                     | )     |        |        | (280   | )     |        |        | (1,044 | )    
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  |                                                                                      |                                                                            |                                     | Net cash flows from investing activities |       |        | (672   | )      |       |        | (280   | )      |       |        | (3,369 | )
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|Financing Activities:                             |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  | Borrowings (repayments) on bank line of
    credit, net                              |                                                                            |                                     | 1,537                                    |       |        |        | (555   | )     |        |        | (4,471 | )    
|                                                  | Proceeds from issuance of common stock, net of
    issuance costs of $3,981          |                                                                            |                                     |                                         |       |        |        |       |       |        |        | 28,471 |      
|                                                  | Proceeds from issuance of preferred stock                                            |                                                                            |                                     | 865                                      |       |        |        |       |       |        |        |       |      
|                                                  | Redemption of putable warrants                                                       |                                                                            |                                     |                                         |       |        |        |       |       |        |        | (158   | )    
|                                                  | Proceeds from exercise of stock options                                              |                                                                            |                                     | 7                                        |       |        |        | 5      |       |        |        | 60     |      
|                                                  | Repurchase of shares in connection with
    termination                              |                                                                            |                                     |                                         |       |        |        | (94    | )     |        |        |       |      
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  |                                                                                      |                                                                            |                                     | Net cash flows from financing activities |       |        | 2,409  |        |       |        | (644   | )      |       |        | 23,902 |  
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|Net change in cash and cash equivalents           |                                                                                      |                                                                            | (378                                | )                                        |       |        | (205   | )      |       |        | 19,164 |       
|Cash and cash equivalents, beginning of year      |                                                                                      |                                                                            | 801                                 |                                          |       |        | 423    |        |       |        | 218    |       
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|Cash and cash equivalents, end of year            |                                                                                      | $                                                                          | 423                                 |                                          |       | $      | 218    |        |       | $      | 19,382 |       
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|Supplemental disclosure of cash flow information: |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  | Cash paid for interest                                                               |                                                                            | $                                   | 450                                      |       |        | $      | 389    |       |        | $      | 131    |      
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  | Notes issued in connection with acquisition of
    treadmill manufacturing business  |                                                                            | $                                   |                                         |       |        | $      |       |       |        | $      | 925    |      
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  | Non-marketable securities received in connection
    with sale of net imaging assets |                                                                            | $                                   | 1,000                                    |       |        | $      |       |       |        | $      |       |      
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       
|                                                  | Cash paid (refunds received) for income taxes                                        |                                                                            | $                                   | 1,563                                    |       |        | $      | (1,410 | )     |        | $      |       |      
|                                                  |                                                                                      |                                                                            |                                     |                                          |       |        |        |        |       |        |        |       

The accompanying notes are an integral part of
these financial statements.

F-7



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES




NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


1.     Organization
and Description of Business

Quinton Cardiology Systems, Inc.
(Quinton), a California corporation, changed its
name from QIC Holding Corp. 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.

On June 5, 1998, an investor group led by WR
Hambrecht+Co acquired the Company from American Home Products in
a leveraged buyout (the Acquisition). The results of
operations and the purchased costs of the acquired assets and
liabilities are included in the Companys consolidated
financial statements since the Acquisition.

Certain
Significant Risks and Uncertainties

The Company is subject to a number of risks and
can be affected by a variety of factors. For example, management
of the Company believes that any of the following factors could
have a significant negative effect on the Companys future
financial position, results of operations and cash flows:
failure to keep pace with changes in the marketplace; failure to
develop and commercialize new versions of products or product
lines; reduced demand for the Companys stress test
systems; lack of growth in demand or future acceptance for the
Companys products and services; risks associated with
product liability and product defects or errors; intense
competition with other companies with greater financial,
technical and marketing resources; inadequate levels of
reimbursement from governmental or other third-party payors for
procedures using the Companys products and systems;
failure of the Company or its suppliers to obtain or maintain
necessary FDA clearances or approvals for products; inability to
secure additional adequate financing; failure to attract and
retain key personnel; failure to protect intellectual property;
risks associated with expanding international operations;
failure to successfully integrate other businesses, products
lines, assets or technologies acquired by the Company; inability
to manage growth; and litigation or other claims against the
Company. Further, the Company may require additional funds that
may not be readily available or on terms that are acceptable to
the Company.

Concentrations

The Companys largest vendor accounted for
18%, 17% and 17% of the Companys purchases for the years
ended December 31, 2000, 2001 and 2002, respectively.
Although products are available from other sources, this
vendors inability or unwillingness to supply products in a
timely manner or on terms acceptable to the Company could
adversely affect the Companys ability to meet
customers demands.

2.     Summary of
Significant Accounting Policies

Basis of
Presentation

The financial statements present the Company on a
consolidated basis. All significant intercompany accounts and
transactions have been eliminated.

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 period reported.
These estimates include the collectability of accounts
receivable, the saleability and recoverability of inventory, the
adequacy of warranty liabilities, the realizability of
investments, the realizability of deferred tax assets and useful
lives of tangible and intangible assets, among others. The
market for the Companys products is characterized by

F-8



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

For purposes of the statement of cash flows,
highly liquid investments with a maturity at the date of
purchase of three months or less are considered cash equivalents.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost,
determined on a weighted-average basis, or market. Costs include
materials, labor and overhead. The Company records inventory
write-downs based on its estimate of excess and/or obsolete
inventory.



| |                        
| | -----------------------
| | Machinery and Equipment

Machinery and equipment are stated at cost.
Machinery and equipment is depreciated using the straight-line
method over the estimated useful lives of the assets of two to
14 years. Leasehold improvements are amortized over the
shorter of the estimated useful lives or the remaining lease
term. The costs for improvements are capitalized. Expenditures
for maintenance and repairs are expensed as incurred. Upon
retirement or disposal, the cost and accumulated depreciation of
machinery and equipment are reduced and any gain or loss is
recorded.



| |                                     
| | ------------------------------------
| | Long-Lived and Intangible
    Assets

The Companys intangible asset balance is
comprised of acquired patents, which are being amortized over
five to 10 years. Long-lived assets and patents are
reviewed for impairment whenever events such as product
discontinuance, product dispositions or other changes in
circumstances indicate that the carrying amount may not be
recoverable. In reviewing for impairment, the Company compares
the carrying value of assets subject to depreciation or
amortization to the estimated undiscounted future cash flows
expected from the use of the assets and their eventual
disposition. An impairment loss, equal to the difference between
the assets fair value and the carrying amount, would be
recognized if the estimated future undiscounted cash flows were
less than the carrying amount.



| |         
| | --------
| | Goodwill

Goodwill represents the excess of cost over the
estimated fair value of the assets of the treadmill
manufacturing business acquired, which in accordance with
Statement of Financial Accounting Standards (SFAS)
No. 142, is not being amortized. Goodwill is tested for
impairment at the reporting unit level. The first step of the
goodwill impairment test, used to identify potential impairment,
compares managements estimate of the fair value of each
reporting unit with its carrying amount, including goodwill. As
management has estimated that the fair values of the
Companys reporting units to which goodwill has been
allocated exceed their carrying amounts, goodwill is considered
not impaired. The second step of the impairment test, which
would compare the implied fair value of the reporting unit
goodwill with the carrying amount of that goodwill, was
unnecessary for the periods presented.



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

Income taxes are accounted for under the asset
and liability method. Under this method, deferred tax assets and
liabilities are recognized for the estimated future tax
consequences attributable to differences

F-9



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

between the financial statement carrying amounts
of existing assets and liabilities and their respective tax
bases, as well as net operating loss and tax credit
carryforwards. A valuation allowance is recorded to reduce the
carrying amounts of deferred tax assets if it is more likely
than not that such assets will not be realized.



| |                    
| | -------------------
| | Revenue Recognition

The Companys revenue recognition policies
are based on the requirements of SEC Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial
Statements, and to the extent revenues are allocated to
software elements, AICPA Statement of Position 97-2,
Software Revenue Recognition as amended by AICPA
Statement of Position 98-9, Software Revenue Recognition
with Respect to Certain Arrangements.

Revenue from sales of systems is generally
recognized when title transfers to the customer, typically upon
shipment. The Company recognizes revenue on sales of systems
made to distributors when the product is shipped to its
distributors and all significant obligations of the Company have
been satisfied. In making a determination of whether significant
obligations have been met, the Company evaluates any
installation or integration obligations to determine whether
those obligations are inconsequential or perfunctory. In cases
where the remaining installation or integration obligation is
not determined to be inconsequential or perfunctory, the Company
defers revenue until the installation and integration has been
completed. Distributors do not have price protection or product
return rights, except that the Companys Canadian
distributor has the right to return unsold product upon
cancellation of the agreement. With respect to software revenue,
the fair value of undelivered software is deferred and the
residual fair value of delivered software is recognized. Revenue
from software implementation services is recognized as the
services are provided. The Company occasionally sells software
and hardware upgrades. With respect to software upgrades, the
fair value of undelivered software upgrades is deferred and
recognized upon delivery of the specified upgrades. With respect
to hardware upgrades, the Company recognizes revenue when the
hardware is shipped.

The Company offers optional extended service
contracts to customers. Service revenues are recognized on a
straight-line basis over the term of the extended service
contracts, which generally begin after the expiration of the
original warranty period. For services performed, other than
pursuant to warranty and extended service contract obligations,
revenue is recognized when the service is performed and
collection of the resulting receivable is reasonably assured.

Freight charges billed to customers and included
in revenue were $935,000, $1,236,000 and $1,585,000 in 2000,
2001 and 2002, respectively. The associated expense is
classified within cost of revenues in the accompanying
consolidated statements of operations.



| |                           
| | --------------------------
| | Software Development Costs

Under the criteria set forth in SFAS No. 86,
Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed, capitalization of software
development costs begins upon the establishment of technological
feasibility of the product, which the Company has defined as the
completion of beta testing of a working product. The
establishment of technological feasibility requires considerable
judgment by management with respect to certain external factors,
including, but not limited to, the estimated economic life of
changes in software and hardware technology. Amounts
capitalizable under this statement, after consideration of the
above factors, were immaterial and, therefore, no software
development costs have been capitalized.



| |             
| | ------------
| | Export Sales

For the years ended December 31, 2000, 2001
and 2002, export sales were 11%, 8% and 6%, respectively, of
total revenues. Export sales are denominated in U.S. dollars.
Accordingly, the Company has not incurred any foreign currency
transaction or translation gains or losses.

F-10



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                  
| | -----------------
| | Advertising Costs

The cost of advertising is expensed as incurred.
During the years ended December 31, 2000, 2001 and 2002,
the Company incurred advertising expenses of $208,000, $110,000
and $114,000, respectively.



| |         
| | --------
| | Warranty

The Company provides warranty service covering
the systems it sells. Estimated future costs of providing
warranty service, which relate principally to the hardware
components of the systems, are provided when the systems are
sold. Estimated future costs are based in part on warranty
claims history and other relevant information.



| |                                   
| | ----------------------------------
| | Research and Development
    Costs

Research and development costs are expensed as
incurred.



| |                                                            
| | -----------------------------------------------------------
| | Financial Instruments And Concentrations Of
    Credit Risk

Financial instruments that potentially subject
the Company to concentrations of credit risk consist of cash and
cash equivalents, accounts receivable, accounts payable, accrued
liabilities and debt. Financial instruments that are short-term
and/or that have little or no market risk are estimated to have
a fair value equal to book value. The assets and liabilities
listed above fall under this category.

The Company owns preferred equity securities of a
privately held company, ScImage, Inc. which is accounted for
using the cost method. The fair value of the investment is not
readily determinable from published market data, so judgment is
used to estimate the fair value. If the estimated fair value of
this investment was to decline to an amount below its carrying
amount, and the decline was considered other than temporary, a
loss would be recorded. The Company believes that the carrying
amount of the investment is appropriate, but is necessarily
based on the Companys estimate of fair value.

The Company performs initial and ongoing
evaluations of its customers financial position, and
generally extends credit on open account. The Company maintains
an allowance for doubtful accounts which is reflective of
managements best estimate of probable accounts receivable
losses. Management determines the allowance based on known
troubled accounts, historical experience, and other currently
available evidence. Trade receivable balances are charged
against the allowance at the time management determines such
balances to be uncollectible.



| |                                            
| | -------------------------------------------
| | Accounting for Stock-Based
    Compensation

The Company has elected to apply the
disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation. In
accordance with the provisions of SFAS 123, the Company applies
Accounting Principles Board Opinion (APB)
No. 25, Accounting for Stock Issued to
Employees, and related interpretations in accounting for
its stock option plans. The Company accounts for stock options
issued to non-employees in accordance with the provisions of
SFAS 123 and Emerging Issues Task Force consensus in Issue
No. 96-18, Accounting for Equity Instruments That are
Issued to Other Than Employees for Acquiring, or in Conjunction
with Selling, Goods or Services (EITF 96-18).

F-11



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Had compensation cost been determined based on
the fair value of the options at the grant dates during 2000,
2001 and 2002, consistent with the provisions of SFAS 123, the
Companys reported net loss would have been the pro forma
amounts indicated below (amounts in thousands except per share
amounts):

|                                                                                                                                                    |  |      |        |      |  |      |        |   |  |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                                                                                                                                    |  | 2000 |        | 2001 |  | 2002
|                                                                                                                                                    |  |      |        |      |  |     
|Net loss  as reported                                                                                                                              |  | $    | (7,000 | )    |  | $    | (7,989 | ) |  | $ | (1,355 | )
|Add back: Stock-based employee compensation
    expense included in reported loss, net of related tax effects                                       |  |      | 75     |      |  |      | 42     |   |  |   | 111    |  
|Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards,
    net of related tax effects |  |      | (160   | )    |  |      | (153   | ) |  |   | (476   | )
|                                                                                                                                                    |  |      |        |      |  |      |        |   |  |   |        |  
|Net loss  pro forma                                                                                                                                |  | $    | (7,085 | )    |  | $    | (8,100 | ) |  | $ | (1,720 | )
|                                                                                                                                                    |  |      |        |      |  |      |        |   |  |   |        |  
|Net loss per share  as reported                                                                                                                    |  | $    | (13.94 | )    |  | $    | (12.69 | ) |  | $ | (0.17  | )
|Net loss per share  pro forma                                                                                                                      |  | $    | (14.11 | )    |  | $    | (12.86 | ) |  | $ | (0.22  | )

Net Income
(Loss) Per Share

In accordance with SFAS No. 128,
Computation of Earnings Per Share, basic loss per
share is computed by dividing net loss by the weighted average
number of shares of common stock outstanding during the period.
Common stock that the Company has the right to repurchase is not
included in the calculation of outstanding shares. Diluted loss
per share is computed by dividing net loss by the weighted
average number of common and dilutive common equivalent shares
outstanding during the period. Common equivalent shares consist
of the shares of common stock issuable upon the conversion of
the convertible preferred stock (using the if-converted method)
and shares issuable upon the exercise of stock options and
warrants (using the treasury stock method); common equivalent
shares are excluded from the calculation if their effect is
antidilutive.

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

|                                                                      |  |      |           |      |  |      |         |   |  |  |           |  
|--------------------------------------------------------------------- |  | ---- | --------- | ---- |  | ---- | ------- | - |  |  | --------- | -
|                                                                      |  | 2000 |           | 2001 |  | 2002
|                                                                      |  |      |           |      |  |     
|Weighted average common shares outstanding                            |  |      | 1,081,053 |      |  |      | 718,817 |   |  |  | 7,895,814 |  
|Less: weighted average shares subject to
    repurchase               |  |      | (578,988  | )    |  |      | (89,170 | ) |  |  | (8,155    | )
|                                                                      |  |      |           |      |  |      |         |   |  |  |           |  
|Denominator for basic and diluted earnings per
    share calculations |  |      | 502,065   |      |  |      | 629,647 |   |  |  | 7,887,659 |  
|                                                                      |  |      |           |      |  |      |         |   |  |  |           |  

For the years ended December 31, 2000, 2001
and 2002, 8,370,147, 7,965,245 and 1,490,784, respectively,
shares of common stock subject to repurchase, stock options,
warrants and common stock issuable upon conversion of
outstanding preferred stock were excluded from the computation
of diluted loss per share, as their impact was antidilutive. If
the Company had reported net income, the calculation of earnings
per share would have included the dilutive effect of these
common stock equivalents using the treasury stock and if
converted methods.

Segment
Reporting

The Company has adopted SFAS No. 131,
Disclosures About Segments of an Enterprise and Related
Information. SFAS 131 requires companies to disclose
certain information about reportable segments. Based on the
criteria within SFAS 131, the Company has determined that it
currently has one reportable segment, diagnostic cardiology
systems and related services.

F-12



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes revenues, which
are attributed based on the geographic location of the
customers, for the years ended December 31 (amounts in
thousands),

|                    |  |      |        |      |  |      |        |  |  |   |        | 
|------------------- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|                    |  | 2000 |        | 2001 |  | 2002
|                    |  |      |        |      |  |     
|Domestic            |  | $    | 45,133 |      |  | $    | 39,624 |  |  | $ | 43,702 | 
|Canada              |  |      | 1,500  |      |  |      | 851    |  |  |   | 707    | 
|Other International |  |      | 4,101  |      |  |      | 2,399  |  |  |   | 2,087  | 
|                    |  |      |        |      |  |      |        |  |  |   |        | 
|Total               |  | $    | 50,734 |      |  | $    | 42,874 |  |  | $ | 46,496 | 
|                    |  |      |        |      |  |      |        |  |  |   |        | 

Recent
Accounting Pronouncements

In August 2001, the Financial Accounting
Standards Board (FASB) issued SFAS No. 143,
Accounting for Asset Retirement Obligations, which
provides the accounting requirements for retirement obligations
associated with tangible long-lived 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.
The adoption of SFAS 143 is not expected to have a material
impact on the Companys consolidated financial position or
results of operations.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. This statement addresses financial accounting
and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force
(EITF) Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring). This statement requires that a liability
for a cost associated with an exit or disposal activity should
be recognized at fair value when the liability is incurred. SFAS
146 is effective for the Companys 2003 fiscal year. The
adoption of SFAS 146 is not expected to have a material impact
on the Companys consolidated financial position or results
of operations.

In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This standard
establishes disclosure requirements for December 31, 2002
financial statements for companies that make certain types of
guarantees. Beginning in 2003, the standard requires that
companies record the fair value of certain types of guarantees
as a liability in the financial statements. The Company does not
expect the interpretation to have a material impact on the
Companys consolidated financial position or results of
operations, but has revised its disclosures accordingly.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, an Amendment
of FASB Statement 123 (SFAS 148). SFAS 148
provides new transition alternatives for companies adopting the
fair value method of accounting for stock-based compensation
prescribed by SFAS 123 and changes certain disclosure
requirements for companies electing to continue applying the APB
25 intrinsic value method. The Company has no current plans to
adopt the fair value method of accounting but has revised its
disclosures accordingly.

In November 2002, the Emerging Issues Task Force
(EITF) reached a consensus on EITF 00-21, Revenue
Arrangements with Multiple Deliverables with respect to
determining when and how to allocate revenue from sales with
multiple deliverables. The EITF 00-21 consensus provides a
framework for determining when and how to allocate revenue from
sales with multiple deliverables based on a determination of
whether the multiple deliverables qualify to be accounted for as
separate units of accounting. The consensus is effective
prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company does not expect
that the adoption of this consensus will have a material impact
on the Companys consolidated financial position or results
of operations.

F-13



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

3. Discontinued Operations

In December 1999, the Company completed the sale
of the net assets of Quinton Fitness, Inc. (the Fitness
subsidiary) to StairMaster Sports/ Medical Products, Inc.
(StairMaster). The Company received cash proceeds of
approximately $11,287,000, $3,000,000 of equity representing a
10.5% interest in StairMaster, and a $1,000,000 promissory note
(the StairMaster Note). The Company sold its equity
in StairMaster to W.R. Hambrecht/ StairMaster, LLC on
December 17, 1999.

In 2001, in connection with a bankruptcy
declaration, the assets of StairMaster were acquired by an
unrelated third party. As a result of StairMasters
bankruptcy and the subsequent acquisition of its assets, the
Company recognized a loss related to the StairMaster Note and
$106,000 of related accrued interest. Also, in 2001 the Company
recognized a $831,000 loss, resulting from a contingency that
existed at the date of the sale to StairMaster, related to a
sublease agreement between the Company and StairMaster. The
sublease agreement originally extended through 2003, but was
amended to expire at December 31, 2002 as a result of the
bankruptcy proceedings. This amount was recorded within
discontinued operations for the year ended December 31,
2001.

4. Sale of Net Imaging Assets

In September 2000, the Company completed the sale
of substantially all of its imaging assets and liabilities to
ScImage, Inc. (ScImage). The Company received shares
of ScImage, a private company, with an estimated value of
$1,000,000. ScImage received imaging inventory with a net
recorded cost of $659,000 from the Company and assumed certain
of the Companys warranty and installation obligations.
Additionally, the Companys obligation to pay ScImage fees
of $250,000 per quarter to manufacture products under a
licensing agreement terminated concurrently with the completion
of this transaction. The Company retains the right to sell
certain ScImage products, and receives commissions from ScImage
on such sales. The Company recognized a gain of approximately
$341,000 in connection with this transaction for the year ended
December 31, 2000.

5. Restructuring Charges

The Company recorded restructuring costs of
$645,000 for severance costs associated with a reduction of
workforce that occurred in October 2000. Management approved the
plan, communicated the plan to employees, specifically
identified employees to be terminated and completed the plan of
termination in 2000. The restructuring resulted in termination
of 37 domestic employees in the manufacturing, engineering,
sales and marketing, finance and administration, technical
service and procurement departments and three foreign employees
in the sales department.

Restructuring costs are summarized as follows
(amounts in thousands):

|     |  |         |     |          |  |                |     |  |  |   |     | 
|---- |  | ------- | --- | -------- |  | -------------- | --- |  |  | - | --- | 
|     |  | Total   |     | Cash     |  | Liabilities at
|     |  | Charges |     | Payments |  | Year-End      
|     |  |         |     |          |  |               
|2000 |  | $       | 645 |          |  | $              | 216 |  |  | $ | 429 | 
|2001 |  | $       |    |          |  | $              | 315 |  |  | $ | 114 | 
|2002 |  | $       |    |          |  | $              | 114 |  |  | $ |    | 

Although the Companys restructuring plan
was executed by the end of 2000, payments of severance costs to
foreign employees continued into 2002.

F-14



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

6. Inventories

Inventories are comprised of the following as of
December 31 (amounts in thousands):

|                  |  |      |       |      |  |   |       | 
|----------------- |  | ---- | ----- | ---- |  | - | ----- | 
|                  |  | 2001 |       | 2002
|                  |  |      |       |     
|Raw materials     |  | $    | 2,037 |      |  | $ | 3,433 | 
|Work in progress  |  |      | 574   |      |  |   | 984   | 
|Finished goods    |  |      | 3,550 |      |  |   | 3,045 | 
|                  |  |      |       |      |  |   |       | 
|Total inventories |  | $    | 6,161 |      |  | $ | 7,462 | 
|                  |  |      |       |      |  |   |       | 



|   |                        
|-- | -----------------------
|7. | Machinery and Equipment

Machinery and equipment includes the following as
of December 31 (amounts in thousands):

|                                                |          |             |             |      |  |      |        |       |  |   |        |       | 
|----------------------------------------------- | -------- | ----------- | ----------- | ---- |  | ---- | ------ | ----- |  | - | ------ | ----- | 
|                                                |          | Depreciable |             |      |  |     
|                                                |          | Lives       |             | 2001 |  | 2002
|                                                |          |             |             |      |  |     
|Equipment                                       |          |             | (2-14 years | )    |  | $    | 5,141  |       |  | $ | 6,475  |      
|Furniture and fixtures                          |          |             | (3-13 years | )    |  |      | 612    |       |  |   | 613    |      
|Leasehold improvements                          |          |             | (2-6 years  | )    |  |      | 804    |       |  |   | 804    |      
|                                                |          |             |             |      |  |      |        |       |  |   |        |      
|                                                | Subtotal |             |             |      |  |      |        | 6,557 |  |   |        | 7,892 | 
|Less: Accumulated depreciation and amortization |          |             |             |      |  |      | (3,392 | )     |  |   | (4,382 | )    
|                                                |          |             |             |      |  |      |        |       |  |   |        |      
|Net machinery and equipment                     |          |             |             |      |  | $    | 3,165  |       |  | $ | 3,510  |      
|                                                |          |             |             |      |  |      |        |       |  |   |        |      

During the years ended December 31, 2000,
2001 and 2002, the Company recorded depreciation and
amortization expense of $1,074,000, $1,026,000 and $1,067,000,
respectively, relating to machinery and equipment.



|   |                  
|-- | -----------------
|8. | Intangible Assets

The gross carrying amount and accumulated
amortization of the Companys amortized patents was
$960,000 and $567,000, respectively, at December 31, 2002.
The patents have a weighted-average amortization period of
5.5 years. The Company recorded amortization expense of
$130,000 for the year ended December 31, 2002 relating to
patents.

The Companys estimated amortization expense
for the next five years is summarized as follows (in thousands):

|     |  |   |     | 
|---- |  | - | --- | 
|2003 |  | $ | 111 | 
|2004 |  | $ | 60  | 
|2005 |  | $ | 60  | 
|2006 |  | $ | 60  | 
|2007 |  | $ | 54  | 



|   |         
|-- | --------
|9. | Goodwill

On October 1, 2002, the Company acquired the
medical treadmill manufacturing business and related assets and
technology rights from its previous supplier of these
treadmills. The aggregate purchase price was $1,925,000,
including $1,000,000 in cash and $925,000 in notes payable over
two years. The Company recorded goodwill of $860,000 in
connection with this purchase.

F-15



---



##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                 
|--- | --------------------------------
|10. | Accrued Liabilities and Warranty

Accrued liabilities are comprised of the
following as of December 31 (amounts in thousands):

|                                  |  |      |       |      |  |   |       | 
|--------------------------------- |  | ---- | ----- | ---- |  | - | ----- | 
|                                  |  | 2001 |       | 2002
|                                  |  |      |       |     
|Accrued compensation and benefits |  | $    | 1,124 |      |  | $ | 1,336 | 
|Accrued sales tax                 |  |      | 237   |      |  |   | 196   | 
|Sublease liability                |  |      |      |      |  |   | 831   | 
|Restructuring liability           |  |      | 114   |      |  |   |      | 
|Other accrued liabilities         |  |      | 1,073 |      |  |   | 1,052 | 
|                                  |  |      |       |      |  |   |       | 
|Total accrued liabilities         |  | $    | 2,548 |      |  | $ | 3,415 | 
|                                  |  |      |       |      |  |   |       | 

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

|                             |  |           |       |            |  |            |     |           |  |   |      |   |  |   |       | 
|---------------------------- |  | --------- | ----- | ---------- |  | ---------- | --- | --------- |  | - | ---- | - |  | - | ----- | 
|                             |  |           |       | Charged to |  |            |     | Balance 
|                             |  | Beginning |       | cost of    |  | Applied to |     | End of   
|                             |  | of Period |       | revenues   |  | liability  |     | Period   
|                             |  |           |       |            |  |            |     |          
|Year Ended December 31, 2002 |  | $         | 1,269 |            |  | $          | 762 |           |  | $ | (942 | ) |  | $ | 1,089 | 



|    |           
|--- | ----------
|11. | Borrowings

In connection with the Acquisition, the Company
borrowed $20,000,000 under a term loan agreement. On
December 22, 1998, the Company converted $11,000,000 of the
term loan to a line of credit. The line of credit and the term
loan (collectively the Loan) were subject to the
terms and conditions of the original loan agreement. The term
loan was repaid in connection with the sale of the discontinued
segment. Borrowings under the line of credit were repaid in May
2002 with proceeds from the initial public offering. The line of
credit expired on June 5, 2002.

In connection with the 2003 acquisition of
Spacelabs Burdick, Inc., the Company established a line of
credit on December 30, 2002. Borrowings under the line of
credit are currently limited to the lesser of $12,000,000 or an
amount based on eligible accounts receivable and eligible
inventories. Substantially all of the Companys assets are
collateral for the line of credit. This line of credit carries
an interest rate of the banks prime rate plus a minimum of
0.5% to a maximum of 1.5% based on a funded debt to Earnings
Before Interest, Taxes, Depreciation, and Amortization
(EBITDA) ratio (which amounted to 4.75% at
December 31, 2002). The current line of credit expires on
December 30, 2004. At December 31, 2002, the Company
had no outstanding borrowings under this line of credit.



| |                 
| | ----------------
| | Putable Warrants

In connection with the 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. 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. Pursuant to
EITF 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a
Companys Own Stock, the Company has recorded this
obligation at its fair value in the accompanying balance sheet
as a liability. The liability is marked to fair value at each
reporting date with the fair value representing the amount of
cash payments the Company would be required to make to the
holder. The cash payment would be equal to the then current fair
value of the Companys securities issuable on exercise of
the warrants, net of the exercise price that the holder would
have been required to pay. The fair value of the Companys
securities issuable upon exercise of the warrants, for periods
prior to the initial public offering is based on
managements

F-16



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

estimate, which considers available evidence
including amounts received upon cash sales of the Companys
securities and other subjective measures including the
Companys operating performance, important Company
achievements and milestones, the availability of capital and,
for periods where available, a preliminary valuation provided by
the Companys investment bankers related to the
Companys pending initial public offering. The change in
fair value is recorded in the consolidated statements of
operations as interest income or expense, putable warrants.



|    |             
|--- | ------------
|12. | Income Taxes

The Company accounts for income taxes pursuant to
the provisions of SFAS No. 109, Accounting for
Income Taxes. 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 including the
lack of operating profitability to date and the uncertainty over
future operating profitability. The valuation allowance
increased in 2000, 2001, and 2002 by $2,023,000, $3,136,000 and
$1,501,000, respectively.

Deferred tax assets (liabilities) are
comprised of the following as of December 31 (amounts in
thousands):

|                          |                                      |      |        |       |   |   |        |       | 
|------------------------- | ------------------------------------ | ---- | ------ | ----- | - | - | ------ | ----- | 
|                          |                                      | 2001 |        | 2002 
|                          |                                      |      |        |      
|Deferred tax assets:      |                                      |      |        |       |   |   |        |      
|                          | Net operating loss carryforward      |      | $      | 2,541 |   |   | $      | 2,891 | 
|                          | Stock-based compensation             |      |        | 1,002 |   |   |        | 1,040 | 
|                          | Sublease liability                   |      |        | 283   |   |   |        | 283   | 
|                          | Putable warrants                     |      |        | 240   |   |   |        | 111   | 
|                          | Research and experimentation credits |      |        | 1,738 |   |   |        | 1,958 | 
|                          | Inventory basis difference           |      |        | 1,304 |   |   |        | 1,406 | 
|                          | Warranty liability                   |      |        | 431   |   |   |        | 370   | 
|                          | Depreciation                         |      |        |      |   |   |        | 167   | 
|                          | Other                                |      |        | 123   |   |   |        | 703   | 
|                          |                                      |      |        |       |   |   |        |      
|Gross deferred tax assets |                                      |      | 7,662  |       |   |   | 8,929  |      
|Valuation Allowance       |                                      |      | (7,428 | )     |   |   | (8,929 | )    
|Deferred tax liabilities: |                                      |      |        |       |   |   |        |      
|                          | Depreciation                         |      |        | (234  | ) |   |        |      | 
|                          |                                      |      |        |       |   |   |        |      
|Net deferred tax asset    |                                      | $    |       |       |   | $ |       |      
|                          |                                      |      |        |       |   |   |        |      

At December 31, 2002, the Company had net
operating loss carryforwards of approximately $8,500,000 related
to U.S. federal and state jurisdictions and credit carryforwards
totaling $1,958,000. Utilization of net operating loss and
research and experimentation credit carryforwards are subject to
certain limitations under Sections 382 and 383 of the
Internal Revenue Code of 1986, as amended. These carryforwards
expire between 2018 and 2022.

A tax law change effected in 2002 entitles the
Company to a refund of alternative minimum taxes paid in prior
periods. Due to this tax law change, the Company recognized a
tax benefit of $206,000 in 2002.

F-17



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The benefit from (provision for) income taxes
attributable to continuing operations are as follows (amounts in
thousands):

|        |               |                         |   |       |   |      |   |     |   |  |   |     |  
|------- | ------------- | ----------------------- | - | ----- | - | ---- | - | --- | - |  | - | --- | -
|        |               |                        
|        |               | Year Ended December 31,
|        |               |                        
|        |               | 2000                    |   | 2001  |   | 2002
|        |               |                         |   |       |   |     
|Current |               |                         |   |       |   |      |   |     |   |  |   |    
|        | Federal       |                         | $ | 2,136 |   |      | $ | 228 |   |  | $ | 206 |  
|        | State         |                         |   | (48   | ) |      |   | (23 | ) |  |   | (14 | )
|        |               |                         |   |       |   |      |   |     |   |  |   |    
|        | Total benefit |                         | $ | 2,088 |   |      | $ | 205 |   |  | $ | 192 |  
|        |               |                         |   |       |   |      |   |     |   |  |   |    

Reconciliation of the United States statutory
rate to the effective tax rates attributable to continuing
operations follows:

|                                                   |  |                         |       |      |  |      |       |   |  |  |       |  
|-------------------------------------------------- |  | ----------------------- | ----- | ---- |  | ---- | ----- | - |  |  | ----- | -
|                                                   |  |                        
|                                                   |  | Year Ended December 31,
|                                                   |  |                        
|                                                   |  | 2000                    |       | 2001 |  | 2002
|                                                   |  |                         |       |      |  |     
|Federal income tax benefit at U.S. statutory rates |  |                         | 34.0  | %    |  |      | 34.0  | % |  |  | 34.0  | %
|Alternative minimum tax                            |  |                         | 13.0  |      |  |      |      |   |  |  | 13.3  |  
|Non-deductible expenses                            |  |                         | (1.3  | )    |  |      | 11.6  |   |  |  | (2.5  | )
|State income taxes, net of federal benefit         |  |                         | (0.4  | )    |  |      | (0.2  | ) |  |  | (1.1  | )
|Increase in deferred tax valuation allowance       |  |                         | (22.3 | )    |  |      | (42.6 | ) |  |  | (31.5 | )
|                                                   |  |                         |       |      |  |      |       |   |  |  |       |  
|Benefit for income taxes                           |  |                         | 23.0  | %    |  |      | 2.8   | % |  |  | 12.2  | %
|                                                   |  |                         |       |      |  |      |       |   |  |  |       |  

13. Commitments and
Contingencies

Lease
Commitments

The Company leases its office, production and
warehouse facilities under an operating lease. This
non-cancelable facility lease agreement expires on
December 31, 2003, but the Company is able to enter into
two successive renewal terms of two years each. Future minimum
lease payments, including this facility lease, under
non-cancelable leases totaled $1,556,000 at December 31,
2002, payable as follows (amounts in thousands):

|     |  |   |       | 
|---- |  | - | ----- | 
|2003 |  | $ | 1,501 | 
|2004 |  |   | 37    | 
|2005 |  |   | 18    | 

Net rental expense, including common area
maintenance costs, during 2000, 2001 and 2002 was approximately
$1,727,000, $1,628,000 and $1,643,000, respectively. For the
years ended December 31, 2000, 2001 and 2002, the Company
received rent of approximately $742,000, $805,000 and $609,000,
respectively, including common area maintenance costs, from the
first, second and third year of what was to be a four-year,
non-cancelable facility sublease to StairMaster (see Note 3).
The sublease payments were recorded as reductions of monthly
rent expense.

The Company is committed under a licensing
agreement with a vendor to pay a license fee for each copy of
the vendors software incorporated into the Companys
products, and to purchase a minimum number of licenses each
year. The agreement term is five years, with an automatic annual
renewal. Minimum billings are calculated on an annual basis each
June and vary from year to year. At December 31, 2002, the
balance of the annual commitment is $104,000. Certain penalty
provisions exist if the Company chooses to cancel this agreement
prematurely. Early cancellation would require the Company to
purchase 140 additional licenses from the vendor at the price of
$4,000 each, payable over 12 months from notice of
cancellation. If the

F-18



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Company cancels the agreement prematurely for the
purpose of exiting participation in Holter monitoring in the
U.S. marketplace, this penalty clause would be reduced to a
purchase of 12 additional months of minimums from that point
forward, but no less than 85 additional licenses, which under
this penalty provision totals $340,000 as of December 31,
2002.

Legal
Matters

In July 1998, the Company signed an Original
Equipment Manufacturer and Distributor Agreement with Zymed,
Incorporated (Zymed), a related party (see Note 17).
This agreement provided for the purchase of certain Holter
monitoring items, 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 disputed this notice of termination,
and filed suit in the State of Washington principally citing a
claim for breach of contract. The Company was 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 made a significant effort to mitigate
the impact of this termination. The Company incurred significant
legal expenses related to the litigation of this dispute. The
case went to trial and concluded in January 2003. The jury found
in favor of the defendant.

The two members of the Companys Board of
Directors appointed by Zymed and Agilent Technologies, Inc.
(Agilent), Zymeds former parent (see Note 17),
resigned before the notice of termination was received.

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
consolidated financial position or results of operations.

14. Shareholders Equity

Convertible
Preferred Stock

The Company had 12,230,000 and 865,000 shares of
preferred stock as Series A convertible preferred stock and
Series B convertible preferred stock, respectively,
outstanding as of December 31, 2001. During 2002, all
preferred stock outstanding was converted according to the
original conversion terms to 6,639,347 shares of common stock.

During the year ended December 31, 2000, the
Company issued 865,000 shares of Series B convertible
preferred stock in connection with a limited offering of shares
to executive officers of the Company. Total proceeds in
connection with the issuance of these shares were $865,000.

The Company is authorized to issue a total of
50,000,000 shares of preferred stock, which includes the
Series A and B convertible preferred stock that was
converted to common stock during 2002. The Board of Directors is
authorized to determine or alter the rights, preferences,
privileges and restrictions granted to or imposed upon any
wholly unissued series of preferred stock.

F-19



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Common
Stock

The Company is authorized to issue a total of
100,000,000 shares of common stock.

During 2000, 2001 and 2002, the Company issued
26,667, 10,403 and 91,191 shares of common stock, respectively,
in connection with stock option exercises and stock grants for
total proceeds of $7,000, $5,000 and $60,000, respectively.

In May 2002, the Company consummated an initial
public offering of its common stock. In the offering, the
Company sold 4,000,000 shares of 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
$28,219,000, net of underwriting discounts and offering expenses
of $3,981,000. All of the outstanding shares of convertible
preferred stock automatically converted into 6,639,347 shares of
common stock upon completion of the offering.

During 2002, the Company issued 41,323 shares of
common stock in connection with the Employee Stock Purchase Plan
for total proceeds of $252,000.

In February 2001, the Company exercised its
option to repurchase 426,200 of unvested common shares from its
former President and Chief Executive Officer for $93,764, the
total purchase price paid by the former employee for the
unvested shares.

The following shares of common stock have been
reserved for issuance as of December 31, 2002:

|                                                 |  |  |           | 
|------------------------------------------------ |  |  | --------- | 
|Outstanding stock options                        |  |  | 1,449,324 | 
|Stock options available for future grant         |  |  | 225,867   | 
|Warrants to purchase common stock                |  |  | 41,460    | 
|                                                 |  |  |           | 
|Total common shares reserved for future issuance |  |  | 1,716,651 | 
|                                                 |  |  |           | 

15. Stock Option Plan

In February 2002, the Companys board of
directors adopted and the Companys shareholders approved
the 2002 Stock Incentive Plan (the 2002 Plan). The
2002 Plan became effective upon completion of the initial public
offering and replaced the 1998 Equity Incentive Plan (the
1998 Plan) for purposes of all future incentive stock
awards. The 2002 Plan allows the Company to issue awards of
incentive or nonqualified stock options, shares of common stock
or units denominated in common stock, all of which may be
subject to restrictions. The Company initially reserved
376,804 shares for issuance under the 2002 Plan, including
263,168 shares which were transferred from the 1998 Plan.
In addition, the 2002 Plan authorizes annual increases in shares
for issuance equal to the lesser of (i) 681,818 shares,
(ii) 3% of the number of shares of common stock outstanding
on a fully diluted basis as of the end of the Companys
immediately preceding fiscal year, (iii) and the lesser
amount established by the Companys board of directors. Any
shares from increases in previous years that are not actually
issued will continue to be included in the aggregate number of
shares available for future issuance.

Options generally vest ratably over a three and a
half year period. The term of the options is for a period of ten
years or less. Options generally expire 90 days after
termination of employment. If participants exercise unvested
options, the Company has the right to repurchase the unvested
shares at the original option exercise price in the event of
termination of employment. At December 31, 2001 and 2002,
20,076 and 0 shares, respectively, of unvested common stock
were subject to repurchase by the Company according to these
repurchase rights.

F-20



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Company has also adopted a stock option grant
program for nonemployee directors, administered under the terms
and conditions of the 2002 Plan, which became effective upon
completion of the Companys public stock offering.

In addition, the Company adopted a 2002 Employee
Stock Purchase Plan (ESPP) in February 2002. The
ESPP was implemented upon the effectiveness of the
Companys public stock offering. The ESPP permits eligible
employees to purchase common stock through payroll deductions.
The Company initially reserved 227,272 shares for issuance
under the ESPP Plan. In addition, the ESPP Plan authorizes
annual increases in shares for issuance equal to the lesser of
(i) 227,272 shares, (ii) 2% of the number of shares of
common stock outstanding on a fully diluted basis as of the end
of the Companys immediately preceding fiscal year, and
(iii) and the lesser amount established by the
Companys board of directors. Any shares from increases in
previous years that are not actually issued will continue to be
included in the aggregate number of shares available for future
issuance.

The following table summarizes information about
option transactions:

|                           |           |         |           |           |   |   |      |      | 
|-------------------------- | --------- | ------- | --------- | --------- | - | - | ---- | ---- | 
|                           |           |         |           | Weighted-
|                           |           |         |           | Average  
|                           |           |         |           | Exercise 
|                           |           | Options |           | Price    
|                           |           |         |           |          
|Balance, December 31, 1999 |           |         | 398,565   |           |   | $ | 0.31 |     
|                           | Granted   |         |           | 846,619   |   |   |      | 2.20 | 
|                           | Exercised |         |           | (26,667   | ) |   |      | 0.26 | 
|                           | Canceled  |         |           | (48,043   | ) |   |      | 0.66 | 
|                           |           |         |           |           |   |   |      |     
|Balance, December 31, 2000 |           |         | 1,170,474 |           |   |   | 1.67 |     
|                           | Granted   |         |           | 121,438   |   |   |      | 2.53 | 
|                           | Exercised |         |           | (10,403   | ) |   |      | 0.53 | 
|                           | Canceled  |         |           | (38,779   | ) |   |      | 1.08 | 
|                           |           |         |           |           |   |   |      |     
|Balance, December 31, 2001 |           |         | 1,242,730 |           |   |   | 1.78 |     
|                           | Granted   |         |           | 336,886   |   |   |      | 8.30 | 
|                           | Exercised |         |           | (91,191   | ) |   |      | 0.67 | 
|                           | Canceled  |         |           | (39,101   | ) |   |      | 1.69 | 
|                           |           |         |           |           |   |   |      |     
|Balance, December 31, 2002 |           |         | 1,449,324 |           |   | $ | 3.37 |     
|                           |           |         |           |           |   |   |      |     

The following information is provided for options
outstanding and exercisable at December 31, 2002:

|                |  |             |           |             |  |             |      |           |  |           |           |  |  |  |           |  |  |   |      | 
|--------------- |  | ----------- | --------- | ----------- |  | ----------- | ---- | --------- |  | --------- | --------- |  |  |  | --------- |  |  | - | ---- | 
|                |  |             |           |             |  |            
|                |  | Outstanding |           |            
|                |  |             |           | Exercisable
|                |  |             |           | Weighted-   |  |            
|                |  |             |           | Weighted-   |  | Average     |      |           |  | Weighted-
|                |  |             |           | Average     |  | Remaining   |      |           |  | Average  
|Range of        |  | Number of   |           | Exercise    |  | Contractual |      | Number of |  | Exercise 
|Exercise Prices |  | Options     |           | Price       |  | Life        |      | Options   |  | Price    
|                |  |             |           |             |  |             |      |           |  |          
|$0.22           |  |             | 191,338   |             |  | $           | 0.22 |           |  |           | 5.8 years |  |  |  | 191,338   |  |  | $ | 0.22 | 
|$0.88 - $1.87   |  |             | 19,313    |             |  | $           | 1.28 |           |  |           | 6.6 years |  |  |  | 18,596    |  |  | $ | 1.26 | 
|$2.20           |  |             | 870,003   |             |  | $           | 2.20 |           |  |           | 7.7 years |  |  |  | 759,489   |  |  | $ | 2.20 | 
|$3.30           |  |             | 32,394    |             |  | $           | 3.30 |           |  |           | 8.9 years |  |  |  | 12,048    |  |  | $ | 3.30 | 
|$6.28 - $8.37   |  |             | 336,276   |             |  | $           | 8.30 |           |  |           | 9.5 years |  |  |  | 86,171    |  |  | $ | 8.28 | 
|                |  |             |           |             |  |             |      |           |  |           |           |  |  |  |           |  |  |   |      | 
|$0.22 - $8.37   |  |             | 1,449,324 |             |  | $           | 3.37 |           |  |           | 7.9 years |  |  |  | 1,067,642 |  |  | $ | 2.33 | 
|                |  |             |           |             |  |             |      |           |  |           |           |  |  |  |           |  |  |   |      | 

F-21



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Under APB 25, no compensation expense is
recognized for options awarded to employees if the exercise
price of the option equals the fair value of the underlying
stock on the grant date. Deferred stock-based compensation is
recorded when the exercise price of an option or the sales price
of the restricted stock is lower than the fair value of the
underlying common stock on the date of grant. The Company is
amortizing the deferred stock-based compensation over the
vesting period of the underlying options, which is typically
three and a half years. Amortization of deferred stock-based
compensation to employees was approximately $75,000, $42,000 and
$111,000 for the years ended December 31, 2000, 2001 and
2002, respectively. Compensation expense is decreased in the
period of forfeiture by any recognized but unvested compensation
upon the early termination of an option holders services.
For the year ended December 31, 2000, deferred compensation
has been reduced by approximately $80,000, related to the
forfeiture of certain rights under unvested stock options.

The fair value of each employee option grant is
established on the date of grant using the Black-Scholes
option-pricing model with the following assumptions used for
grants during 2000, 2001 and 2002: zero dividend yield;
risk-free interest rate of 6.0%, 5.0% and 4.2%, respectively;
volatility of zero in 2000 and 2001 and 90% in 2002; and
expected lives of five years in all periods. The
weighted-average fair value of options granted in 2000, 2001 and
2002 was $0.57, $3.30 and $5.49, respectively.

During the year ended December 31, 2000, the
Company granted 391,363 stock options to the Companys
non-employee Chief Executive Officer. The options were scheduled
to vest over a three and a half year period. The original terms
required that the individual continue his consulting
relationship with the Company in order to continue vesting.
These options were accounted for in accordance with the
provisions of SFAS 123 and EITF 96-18. Accordingly,
using the Black-Scholes option pricing model and assuming a term
of 10 years, a risk-free interest rate of 5.2% and expected
volatility of 70.0%, the options were marked to fair value at
each reporting period through charges to stock-based
compensation in the statements of operations. Effective
December 31, 2001, the individual became an employee of the
Company. Additionally, on that date the individuals
remaining unvested options were accelerated and became fully
vested. Approximately, $140,000 and $2,622,000, respectively was
recognized in stock-based compensation expense related to these
options for the years ended December 31, 2000 and 2001.



|    |                      
|--- | ---------------------
|16. | Employee Benefit Plan

The Company is the sponsor of the Quinton Inc
401(k) Plan and Trust (the 401(k) Plan), which was
established in August 1998. The 401(k) Plan covers all employees
of the Company who are at least 21 years of age. The 401(k)
Plan includes a provision for an employee deferral of up to 16%
of compensation and a discretionary employer match determined by
the Board. The Company made matching contributions of
approximately $458,000, $288,000 and $306,000 for the years
ended December 31, 2000, 2001 and 2002, respectively. At
December 31, 2001 and 2002, the Company had accrued $57,000
and $64,000 for matching plan contributions, respectively.



|    |                           
|--- | --------------------------
|17. | Related Party Transactions

The Companys transactions with related
parties included in the consolidated financial statements are as
follows:



| |                
| | ---------------
| | WR Hambrecht+Co

WR Hambrecht+Co is a member of W.R. Hambrecht/
QIC, LLC, which owned 81% of the Series A convertible
preferred stock prior to conversion to common stock in 2002. One
of the Companys directors, William R. Hambrecht, is an
executive of WR Hambrecht+Co.

F-22



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

WR Hambrecht+Co beneficially held more than five
percent of the outstanding shares of StairMaster. During the
years ended December 31, 2000, 2001, and 2002, the Company
paid StairMaster $2,551,000, $2,610,000, and $2,338,000,
respectively, for treadmills and related components that
StairMaster supplied to the Company.



| |        
| | -------
| | Agilent

The Company has a royalty agreement with Agilent,
a former owner of 19.0% of the Series A convertible
preferred stock prior to conversion to common stock in 2002.
Agilent sold these shares to Philips Electronics North America
Corporation in August 2001. For the years ended
December 31, 2000, 2001 and 2002, the Company paid
approximately $8,000, $5,000 and $5,000, respectively, in
royalties related to this agreement.



| |      
| | -----
| | Zymed

Zymed, Incorporated is a member of W.R.
Hambrecht/ QIC, LLC. During the year ended December 31,
2000, Agilent acquired Zymed. The Company has a software
development and license agreement with Zymed. The agreement
requires the Company to pay royalties to Zymed related to a
non-exclusive software package license. For the year ended
December 31, 2002, the Company paid royalties of $13,000
related to this agreement. At December 31, 2001, the
Company had a prepaid royalty balance of $11,000, and at
December 31, 2002, the Company had a royalty liability of
$9,000 related to this agreement.

For the years ended December 31, 2000, 2001
and 2002, the Company purchased approximately $4,390,000,
$1,079,000 and $94,000, respectively, of inventory from Zymed.



| |        
| | -------
| | ScImage

The Company owns an investment in ScImage,
representing a 3% preferred ownership interest, a privately held
company, which is accounted for using the cost method. The
Company earns commissions from the sale of ScImages
products. For the years ended December 31, 2001 and 2002,
the Company recorded commissions from ScImage of $77,000 and $0,
respectively.



|    |                                  
|--- | ---------------------------------
|18. | Valuation and Qualifying Accounts

A summary of the activity in the allowance for
doubtful accounts follows (amounts in thousands):

|                             |  |           |     |             |  |            |     |           |  |   |     |  |  |   |     | 
|---------------------------- |  | --------- | --- | ----------- |  | ---------- | --- | --------- |  | - | --- |  |  | - | --- | 
|                             |  |           |     | Expenses    |  |            |     | Balance 
|                             |  | Beginning |     | and         |  |            |     | End of   
|                             |  | of Period |     | Adjustments |  | Write-offs |     | Period   
|                             |  |           |     |             |  |            |     |          
|Year Ended December 31, 2000 |  | $         | 839 |             |  | $          | (40 | )         |  | $ | 125 |  |  | $ | 674 | 
|Year Ended December 31, 2001 |  | $         | 674 |             |  | $          | 120 |           |  | $ | 409 |  |  | $ | 385 | 
|Year Ended December 31, 2002 |  | $         | 385 |             |  | $          | 160 |           |  | $ | 147 |  |  | $ | 398 | 

A summary of the activity in the sublease
liability follows (amounts in thousands):

|                             |  |           |     |             |  |            |     |           |  |   |   |  |  |   |     | 
|---------------------------- |  | --------- | --- | ----------- |  | ---------- | --- | --------- |  | - | - |  |  | - | --- | 
|                             |  |           |     | Expenses    |  |            |     | Balance 
|                             |  | Beginning |     | and         |  |            |     | End of   
|                             |  | of Period |     | Adjustments |  | Write-offs |     | Period   
|                             |  |           |     |             |  |            |     |          
|Year Ended December 31, 2001 |  | $         |    |             |  | $          | 831 |           |  | $ |  |  |  | $ | 831 | 
|Year Ended December 31, 2002 |  | $         | 831 |             |  | $          |    |           |  | $ |  |  |  | $ | 831 | 

F-23



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##### Table of Contents



QUINTON CARDIOLOGY SYSTEMS, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

19. Reverse Stock Split

Effective March 29, 2002, the Companys
Board of Directors approved a 1 to 2.2 reverse stock split of
the Companys common stock. All common shares and per share
amounts in the accompanying consolidated financial statements
have been adjusted to reflect the reverse stock split.

20. Subsequent Event

On January 2, 2003, the Company acquired
100% of the common stock of Spacelabs Burdick, Inc.
(Burdick). Burdick is a leading supplier of
diagnostic cardiology products, including electrocardiographs,
cardiology information systems, stress and Holter systems and
related products. The acquisition of Burdick will provide
complementary products to our diagnostic cardiology line, extend
our sales reach into U.S. physicians offices and increase
the Companys sales internationally. The accompanying
financial statements do not include the historical results of
operations of Burdick.

The purchase price for Burdick was
$24.0 million in cash, plus transaction related costs of
approximately $700,000. The purchase price is subject to certain
post closing adjustments. At the time of the purchase,
$1,300,000 of the purchase price was held back as an offset
against the estimated value of certain of Burdicks
accounts receivable, which will be retained and collected by
Burdicks former owner. The actual amount of such accounts
receivable was subsequently determined to be $1,473,000. By the
terms of the purchase agreement, the $1,473,000 will be treated,
effectively, as a reduction in the purchase price.

In addition, the purchase price is subject to
adjustment based on net working capital, as defined, as of the
date of the purchase. Based on the sellers determination
of net working capital as of the date of the purchase, the
purchase price would be reduced by another $1,119,000 and this
amount would be refunded to the Company, in addition to the
$173,000, discussed above. The Company is in the process of
determining the appropriate purchase price adjustment with the
seller. This matter will be resolved either through negotiation
or through a third party arbitration process, as outlined in the
purchase agreement.

The following table summarizes the estimated fair
values of the assets acquired and liabilities assumed at the
date of acquisition (in thousands).

|                            |  |   |        |  
|--------------------------- |  | - | ------ | -
|Current assets              |  | $ | 13,213 |  
|Property and equipment, net |  |   | 2,000  |  
|Intangible assets           |  |   | 7,700  |  
|Goodwill                    |  |   | 8,114  |  
|                            |  |   |        |  
|Total assets acquired       |  |   | 31,027 |  
|Current liabilities         |  |   | (7,388 | )
|                            |  |   |        |  
|Net assets acquired         |  | $ | 23,639 |  
|                            |  |   |        |  

Approximately $1,520,000 of the amount included
in intangible assets relates to in-process research and
development, which will be written off at the time of
acquisition. Approximately $2,700,000 of the amount included in
intangible assets relates to the Burdick trade name, which the
Company believes has an indefinite life and therefore will not
be subject to amortization. The estimated remaining $3,480,000
of acquired intangible assets is expected to include distributor
relationships of $2,200,000 (10 year life) and developed
technology of $1,280,000 (7 year life). The aggregate
amount of amortizable intangible assets is $3,480,000 and the
weighted average life is approximately 8.9 years.

Management has estimated that goodwill of
approximately $8 million will be recorded in connection with the
purchase of Burdick. The actual amount of goodwill that will
ultimately be recorded, however, will be dependent upon the
resolution of uncertainties relating to the difference in
working capital, as discussed above. Amortization of goodwill is
not expected to be deductible for income tax purposes.

F-24