UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 31, 2005

OR

Commission File Number 000-49755

QUINTON CARDIOLOGY SYSTEMS, INC.

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

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

     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. YES þ    NO o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES þ    NO o

     The number of shares outstanding of the registrant’s common stock as of May 3, 2005 was 14,083,730.

TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

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

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QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

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QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

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

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QUINTON CARDIOLOGY SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Description of Business

     Quinton Cardiology Systems, Inc. (“QCS”) is a Delaware corporation. QCS and its subsidiary, Quinton Cardiology, Inc. (“Quinton”) and its majority owned subsidiary Shanghai Quinton Medical Device Co., Ltd. (“Shanghai-Quinton”) are referred to herein as the Company. The Company develops, manufactures, markets and services a family of advanced cardiology products used in the diagnosis, monitoring and management of patients with heart disease.

2. Summary of Significant Accounting Policies

     Basis of Presentation

     The condensed financial statements present the Company on a consolidated basis. All significant intercompany accounts and transactions have been eliminated. The condensed consolidated balance sheet dated March 31, 2005, the condensed consolidated statements of operations for the three-month periods ended March 31, 2004 and 2005 and the condensed consolidated statements of cash flows for the three-month periods ended March 31, 2004 and 2005 have been prepared by the Company and are unaudited. The condensed consolidated balance sheet dated December 31, 2004 was derived from audited financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The notes to the audited consolidated financial statements included in the Company’s annual report on form 10-K for the fiscal year ended December 31, 2004 provide a summary of significant accounting policies and additional financial information that should be read in conjunction with this report. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company for the interim periods, have been made. The results of operations for such interim periods are not necessarily indicative of the results for the full year or any future period.

     Certain prior year amounts have been reclassified to conform to current period presentation.

     Use of Estimates

     The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the periods reported. These estimates include but are not limited to estimates assessing the collectability of accounts receivable, the salability and recoverability of inventory, the adequacy of warranty liabilities, the realizability of investments, the calculation of our effective tax rate, the impairment of long-lived assets, the likelihood of closing on a potential business combination and the useful lives of tangible and intangible assets. The market for the Company’s products is characterized by intense competition, rapid technological development and frequent new product introductions, all of which could affect the future realizability of the Company’s assets. The Company reviews estimates and assumptions periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results could differ from these estimates.

     Recent Accounting Pronouncements

     In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R requires the Company to measure the cost of employee services received in exchange for an award of an equity instrument, such as stock options, based on the grant-date fair-value of the award. The associated cost must be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). In April 2005, the U.S. Securities and Exchange Commission adopted a new rule amending the compliance dates for SFAS No. 123R. In accordance with the new rule, the accounting provisions of SFAS No. 123R will be effective for the Company in the first

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quarter of 2006. SFAS No. 123R provides for a variety of implementation alternatives, including accounting for the change prospectively or restating previously reported amounts to reflect the compensation expense that would have been recorded under SFAS No. 123R. The Company is in the process of evaluating the impact of adopting SFAS No. 123R and of determining the impact on its results of operations and statements of cash flows.

     Net Income Per Share

     In accordance with SFAS No. 128, “Computation of Earnings Per Share,” basic income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted income per share is computed by dividing net income by the weighted average number of common and dilutive potential common shares outstanding during the period. Potential common shares consist of shares issuable upon the exercise of stock options using the treasury stock method. Potential common shares are excluded from the calculation if their effect is antidilutive.

     The following table sets forth the computation of basic and diluted net income per share:

     For the three-month periods ended March 31, 2004 and 2005, 25,000 and 75,000, respectively, of shares issuable upon exercise of stock options were excluded from the computation of diluted income per share as their impact was antidilutive.

     Accounting for Stock-Based Compensation

     The Company has elected to apply the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). In accordance with the provisions of SFAS No. 123, the Company applies Accounting Principles Board Opinion 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 No. 123 and Emerging Issues Task Force consensus on 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.”

     Had compensation cost been determined based on the fair value of the option awards at the grant dates during the three-month periods ended March 31, 2004 and 2005, consistent with the provisions of SFAS No. 123, the Company’s reported net income would have been the pro forma amounts indicated below:

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     The following table sets forth, consistent with the provisions of SFAS No. 123, the denominator for calculating pro forma diluted net income per share for each respective period:

     The Company calculated the fair value of each option grant on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for each respective period:

          Goodwill

     Goodwill represents the excess of costs over the estimated fair values of net assets acquired in connection with our acquisitions of a medical treadmill manufacturing line in 2002 and Spacelabs Burdick, Inc. (“Burdick”) in 2003, which, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” (“SFAS No. 142”) are not being amortized. Also in accordance with SFAS No. 142, the Company tests goodwill for impairment at the reporting unit level on an annual basis and between annual tests in certain circumstances. The Company has determined that it has two reporting units, consisting of general cardiology products, which includes the service business, and the Shanghai-Quinton joint venture, both of which operate in the cardiology market and have similar economic and operating characteristics.

     SFAS No. 142 requires a two-step goodwill impairment test whereby the first step, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, thus the second step of the goodwill impairment test used to quantify impairment is unnecessary. Management has estimated that the fair

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values of the Company’s reporting units to which goodwill has been allocated exceed their carrying amounts, and as a result, the second step of the impairment test, which would compare the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill, was unnecessary for the periods presented.

     Intangible Assets and Other Long-Lived Assets

     The Company’s intangible assets are comprised primarily of a trade name, developed technology and customer relationships, all of which were acquired in our acquisition of Burdick in 2003. Company management uses judgment to estimate the useful lives of each intangible asset. The Company believes the Burdick trade name has an indefinite life, and accordingly does not amortize the trade name. Developed technology was assigned a seven year useful life, based on the estimated remaining economic life of the related products. The useful life of the distributor relationships has been determined to be 10 years, based on historical turnover experience and in consideration of the long standing and stable nature of these relationships.

     The Company annually re-evaluates its conclusion that the Burdick trade name has an indefinite live and makes a judgment about whether there are factors that would limit the ability to benefit from the trade name in the future. If there were such factors, the Company would amortize the trade name. Company management annually reviews the trade name intangible asset for impairment by comparing the fair value of the asset to its carrying value. The Company uses judgment to estimate the fair value of the trade name. The judgment about fair value is based on expectations of future cash flows and an appropriate discount rate.

     In accordance with Statement 144, long-lived assets, such as property, plant, and equipment, and intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized on our statement of operations and as a reduction to the asset by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

     The Company recorded amortization expense for identifiable intangibles of $81,000 in each of the three-month periods ended March 31, 2004 and 2005.

3. Inventories

     Inventories were valued at the lower of cost, on an average cost basis, or market and were comprised of the following:

4. Credit Facility

     The Company established a line of credit in December 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 pledged as collateral for the line of credit. This line of credit bears interest based on a variable rate ranging from the bank’s prime rate plus a minimum of 0.0% to a maximum of 0.5% based on a funded debt to Earnings Before Interest, Taxes, Depreciation, and Amortization (“EBITDA”) ratio, which amounted to 5.25% and 5.75% at December 31, 2004 and March 31, 2005, respectively. In addition, unused balances under this facility bear monthly

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fees equal to 0.25% per annum on the difference between the maximum credit limit and the sum of (i) the average daily principal balance during the month and (ii) the face amount of any letters of credit. The current line of credit expires on December 30, 2005. At December 31, 2004 and March 31, 2005, the Company did not have any borrowings under this line of credit. As of March 31, 2005, the Company had capacity to borrow $9,049,000 based on eligible accounts receivable and eligible inventory. The credit facility contains standard negative covenants and restrictions on actions by the Company, including but not limited to, activity related to common stock repurchases, liens, investments, capital expenditures, indebtedness, restricted payments including cash payments of dividends, and fundamental changes in, or disposition of assets. Certain of these actions may be taken with the consent of the lender. In addition, the credit agreement requires that the Company meet certain financial covenants, namely a minimum tangible net worth measure. As of December 31, 2004 and March 31, 2005, the Company was in compliance with all covenants under the credit facility.

5. Warranty Liability

     Changes in the warranty liability for the three months ended March 31, 2004 and 2005 were as follows:

6. Comprehensive Income

     The Company records all changes in equity during the period from non-owner sources as other comprehensive income or loss, such as unrealized gains and losses on the Company’s available-for-sale securities. Comprehensive income, net of any related tax effects, was as follows:

7. Contingencies

     Legal Matters

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

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8. Merger with Cardiac Science

     On February 28, 2005, the Company entered into a definitive agreement to combine with Cardiac Science, Inc, a manufacturer of automated external defibrillators based in Irvine, California. The transaction, which was unanimously approved by the boards of directors of both companies, requires the approval of the Company’s stockholders and Cardiac Science’s stockholders and is subject to regulatory review and other customary closing conditions. The Company anticipates that the merger will close during the third quarter of 2005. To effect the combination, the parties have formed CSQ Holding Company, which is sometimes referred to herein as Newco. Quinton Cardiology Systems and Cardiac Science will be merged with newly formed acquisition subsidiaries of Newco. Upon the closing of the transaction, each outstanding share of the Company’s common stock will be converted to the right to receive 0.77184895 share of common stock of Newco and each outstanding share of Cardiac Science’s common stock will be converted to the right to receive 0.10 share of common stock of Newco. In connection with the transaction, the holders of Cardiac Science’s outstanding senior debt and related warrants have agreed to cancel those securities in exchange for 2,843,915 shares of Newco common stock and a cash payment in the amount of $20 million, pursuant to a note and warrant conversion agreement between Newco, Cardiac Science and such holders. Based on the exchange ratios and the companies’ outstanding shares at February 28, 2005, Newco will have approximately 22.3 million shares of common stock outstanding after consummation of the transaction, including shares issued in connection with the conversion of Cardiac Science’s senior notes and related warrants pursuant to the note and warrant conversion agreement, of which our stockholders will hold approximately 48.7% and Cardiac Science’s stockholders, together with the holders of its outstanding senior debt and warrants, will hold approximately 51.3%. The common stock of Newco, which will be renamed Cardiac Science Corporation at the time of closing, is expected to trade on the Nasdaq National Market under the symbol “CSCX” subject to the approval of the Nasdaq Stock Market. The transaction will be accounted for as an acquisition of Cardiac Science by Quinton Cardiology Systems under the purchase method of accounting in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations.” Quinton Cardiology Systems will be the acquiring entity for financial reporting purposes based on our review of the criteria for determining the accounting acquirer as set forth in Statement 141. These criteria include but are not limited to; relative share ownership of the combined entity, composition of and ability to elect the board of directors, and the entity from which senior management positions are filled. A majority of Newco’s proposed board of directors will be comprised of current Quinton Cardiology Systems directors. In addition, Quinton Cardiology Systems executives will fill a majority of Newco’s senior management positions, thereby directing policies, strategic direction, and day-to-day operations.

     If the planned merger with Cardiac Science is not completed, the Company would be required to expense the deferred acquisition related costs, which totaled $885,000 at March 31, 2005. In addition, if the Company terminates the merger agreement with Cardiac Science under specified conditions, the Company would be liable for $4.0 million in breakup fees.

     In the event that the transaction with Cardiac Science is consummated, the Company anticipates that Newco will use approximately $20 million of our cash to make the cash payment contemplated by the note and warrant conversion agreement to the holders of Cardiac Science’s senior debt and related warrants.

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

     You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this report. Except for historical information, the following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact made in this Quarterly Report on Form 10-Q, including future results of operations or financial position, are forward-looking. We use words such as anticipate, believe, expect, future, intend and similar expressions to identify forward-looking statements. These forward-looking statements reflect management’s current expectations and involve risks and uncertainties. Our actual results could differ materially from results that may be anticipated by such forward-looking statements. The principal factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Certain Factors That May Affect Future Results” below, those discussed elsewhere in this report and those discussed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 16, 2005, as amended on Form 10-K/A filed on April 22, 2005. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements to reflect events or circumstances that may subsequently arise. Readers are urged to review and consider carefully the various disclosures made in this report and in our other filings made with the SEC that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.

     Critical Accounting Estimates

     The discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those affecting revenues, the allowance for doubtful accounts, the salability and recoverability of inventory, the adequacy of warranty liabilities, the realizability of investments, the calculation of our effective tax rate, the impairment of long-lived assets, the useful lives of tangible and intangible assets and the likelihood of closing a potential business combination for which related transaction costs have been deferred. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A more complete description of our critical accounting estimates established prior to the end of the fiscal year ended December 31, 2004 is contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004 filed with the SEC on March 16, 2005, as amended on Form 10-K/A filed on April 22, 2005. In addition to those critical accounting estimates described in our Annual Report on Form 10-K, we have established the following critical accounting estimate:

     Business Combinations.  We must make an estimate of the likelihood of closing our potential business combination with Cardiac Science, Inc. Because we believe that we will consummate this transaction, we have deferred certain costs incurred in connection with the transaction until the combination is consummated, at which time the deferred transaction related costs will be included in the cost of the entity acquired. Changes in our estimate of the likelihood of consummating this transaction may cause us to charge the related deferred costs to operations, which could have a material impact on our results of operations and financial position.

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Results of Operations

Three-Month Period Ended March 31, 2005 Compared to the Three-Month Period Ended March 31, 2004

     Revenues

     Revenues decreased by $322,000, or 1.5%, to $21,330,000 for the three-month period ended March 31, 2005 from $21,652,000 for the comparable period in 2004.

     Systems revenues decreased by $182,000, or 1.0%, to $18,344,000 for the three-month period ended March 31, 2005 from $18,526,000 for the comparable period in 2004. The decline was primarily due to delays in order cycles in our acute care channel for our cardiac rehabilitation systems and, to a lesser extent, to temporary problems in obtaining component parts for certain versions of our electrocardiographs, resulting in lower than expected sales. This decline was partially offset by stronger sales in our primary care and international channels.

     Service revenues decreased by $140,000, or 4.5%, to $2,986,000 for the three-month period ended March 31, 2005 from $3,126,000 for the comparable period in 2004. Service revenues for the three-month period ended March 31, 2004 included $154,000 related to our divested hemodynamic monitoring product line. Service revenues for the three-month period ended March 31, 2005 did not include any sales from the divested line.

     Gross Profit

     Gross profit increased by $314,000, or 3.3%, to $9,766,000 for the three-month period ended March 31, 2005, from $9,452,000 for the comparable period in 2004. Gross margin increased to 45.8% for the three-month period ended March 31, 2005 from 43.7% for the comparable period in 2004. The increase in gross margin was primarily attributable to the

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results of ongoing cost reduction initiatives, including design cost reductions and other reductions in the cost of purchased components of our products, combined with changes in product mix, partially offset by a decrease in service margin.

     Gross profit from systems revenues increased by $411,000, or 5.0%, to $8,662,000 for the three-month period ended March 31, 2005 from $8,251,000 for the comparable period in 2004. Gross margin from systems revenues increased to 47.2% for the three-month period ended March 31, 2005 from 44.5% for the comparable period in 2004. The increase in gross margin was primarily attributable to the results of ongoing cost reduction initiatives, combined with changes in product mix.

     Gross profit from service revenues decreased by $97,000, or 8.1%, to $1,104,000 for the three-month period ended March 31, 2005 from $1,201,000 for the comparable period in 2004. Gross margin from service revenues decreased to 37.0% for the three-month period ended March 31, 2005 from 38.4% for the comparable period in 2004. The decrease in gross margin was principally attributable to a decrease in service revenues, referred to above, without a corresponding decrease in service staffing levels, which have been maintained to provide enhanced support to our customers.

     Operating Expenses

     Research and development expenses decreased by $22,000, or 1.2%, to $1,809,000 for the three-month period ended March 31, 2005 from $1,831,000 for the comparable period in 2004. This decrease was the net effect of a variety of factors, none of which were individually material. As a percentage of revenues, research and development expenses remained flat at 8.5% for the three-month period ended March 31, 2005 and for the comparable period in 2004.

     Sales and marketing expenses increased by $286,000, or 6.5%, to $4,657,000 for the three-month period ended March 31, 2005 from $4,371,000 for the comparable period in 2004. This increase was due principally to increased sales and marketing headcount and related expenses in 2005 over the comparable period in 2004. As a percentage of revenues, sales and marketing expenses increased to 21.8% for the three-month period ended March 31, 2005 from 20.2% for the comparable period in 2004. This primarily reflects an increase in expenses in 2005 over the comparable period in 2004.

     General and administrative expenses decreased by $61,000, or 2.9%, to $2,045,000 for the three-month period ended March 31, 2005, from $2,106,000 for the comparable period in 2004. This decrease was the net effect of a variety of factors, none of which were individually material. As a percentage of revenues, general and administrative expenses decreased to 9.6% for the three-month period ended March 31, 2005 from 9.7% for the comparable period in 2004.

     Other Income and Expense

     Total other income was $174,000 for the three-month period ended March 31, 2005, compared to other expense of $41,000 for the comparable period in 2004. This change was principally due to an increase in interest income earned on our substantially increased average cash balances for the three-month period ended March 31, 2005 over the comparable period in 2004 and the result of a decrease in interest expense related to our credit line in 2005 as compared to the same period in 2004. In addition, other income during the three-month period ended March 31, 2005 includes $61,000 in contingent consideration we earned during the period under the terms of the definitive agreement relating to the October 2003 sale of our divested hemodynamic monitoring line.

     Income Taxes

     Our year-to-date effective tax rate for the three-month period ended March 31, 2005 was 33.0%, and we reduced deferred income tax assets for the benefits of NOL carryforwards actually used in the period. During the three-month period ended March 31, 2004, income taxes were recorded for estimated federal alternative minimum tax and state income tax liabilities.

     During the fourth quarter of 2004, we reduced all of the valuation allowance against our net deferred tax assets and liabilities. We will continue to evaluate our ability to utilize our NOL carryforwards in future periods and, in compliance with SFAS No. 109, Accounting for Income Taxes, record any resulting adjustments to deferred income tax expense. In addition, we will reduce deferred income tax assets for the benefits of NOL carryforwards actually used in future periods.

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Liquidity and Capital Resources

     Net cash flows from operating activities were $1,000,000 for the three-month period ended March 31, 2005, compared to net cash flows used in operating activities of $565,000 for the comparable period in 2004. Net cash flows from operating activities of $1,000,000 for the three-month period ended March 31, 2005 resulted primarily from net income, excluding non-cash income and non-cash expenses, of $1,821,000, a decrease in accounts receivable of $1,427,000 and an increase in accounts payable of $397,000, which were partially offset by an increase in inventories of $692,000 and a decrease in accrued liabilities of $1,864,000.

     Cash and cash equivalents at March 31, 2005 increased from balances at December 31, 2004 due primarily to cash generated from operations during the three-month period ended March 31, 2005. Accounts receivable balances at March 31, 2005 decreased from balances at December 31, 2004 due principally to a decline in revenues during the first quarter of 2005, as compared to the fourth quarter of 2004. Inventories increased at March 31, 2005 from balances at December 31, 2004 due principally to lower than expected sales resulting from delays in order cycles for cardiac rehabilitation systems and, to a lesser extent, to temporary problems in obtaining component parts for certain versions of our electrocardiographs. Accounts payable balances at March 31, 2005 increased from balances at December 31, 2004 due primarily to accrued merger costs related to the proposed merger with Cardiac Science, Inc., which we announced on February 28, 2005. Accrued liabilities at March 31, 2005 decreased from balances at December 31, 2004 due principally to payments during the three-month period ended March 31, 2005 of accrued year-end compensation relating to 2004 sales and operating results and other accrued liabilities.

     Net cash flows used in investing activities of $266,000 for the three-month period ended March 31, 2005 consisted of $187,000 for capital expenditures and $79,000 for payments of costs related to the proposed merger with Cardiac Science. Capital expenditures primarily consist of leasehold improvements made within our corporate headquarters in Bothell, Washington. Net cash flows used in investing activities of $161,000 for the three-month period ended March 31, 2004 related primarily to our purchase of technology and, to a lesser extent, to purchases of capital equipment.

     Net cash flows from financing activities of $185,000 for the three-month period ended March 31, 2005 resulted from proceeds from exercises of stock options and issuances of common stock under our employee stock purchase plan. Net cash flows from financing activities of $704,000 for the three-month period ended March 31, 2004 resulted primarily from net borrowings on our line of credit and, to a lesser extent, proceeds from exercises of stock options and issuances of common stock under our employee stock purchase plan, which were offset slightly by a debt payment related to a note payable issued in connection with the purchase of the treadmill manufacturing business acquisition.

     We anticipate that our future operating cash flow, existing cash balances and borrowings available to us under credit facilities will be sufficient to meet our operating expenses, working capital requirements, capital expenditures and other obligations for at least twelve months. We anticipate that our credit facility will be renewed or replaced upon its expiration on December 30, 2005. However, we believe that failure to renew or replace this facility would not have a material adverse effect on our liquidity.

Merger Agreement with Cardiac Science, Inc.

     On February 28, 2005, we entered into a definitive agreement to combine with Cardiac Science, Inc, a manufacturer of automated external defibrillators, or AEDs, based in Irvine, California. The transaction, which was unanimously approved by the boards of directors of both companies, requires the approval of our stockholders and Cardiac Science’s stockholders and is subject to regulatory review and other customary closing conditions. We currently anticipate that the merger will close during the third quarter of 2005. To effect the combination, the parties have formed CSQ Holding Company, which we sometimes refer to herein as Newco. Quinton Cardiology Systems and Cardiac Science will be merged with newly formed acquisition subsidiaries of Newco. Upon the closing of the transaction, each outstanding share of our common stock will be converted to the right to receive 0.77184895 share of common stock of Newco and each outstanding share of Cardiac Science’s common stock will be converted to the right to receive 0.10 share of common stock of Newco. In connection with the transaction, the holders of Cardiac Science’s outstanding senior debt and related

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warrants have agreed to cancel those securities in exchange for 2,843,915 shares of Newco common stock and a cash payment in the amount of $20 million, pursuant to a note and warrant conversion agreement between Newco, Cardiac Science and such holders. Based on the exchange ratios and the companies’ outstanding shares at February 28, 2005, Newco will have approximately 22.3 million shares of common stock outstanding after consummation of the transaction, including shares issued in connection with the conversion of Cardiac Science’s senior notes and related warrants pursuant to the note and warrant conversion agreement, of which our stockholders will hold approximately 48.7% and Cardiac Science’s stockholders, together with the holders of its outstanding senior debt and warrants, will hold approximately 51.3%. The common stock of Newco, which will be renamed Cardiac Science Corporation at the time of closing, is expected to trade on the Nasdaq National Market under the symbol “CSCX” subject to the approval of the Nasdaq Stock Market.

     The transaction will be accounted for as an acquisition of Cardiac Science by Quinton Cardiology Systems under the purchase method of accounting in accordance with Statement of Financial Accounting Standards No. 141, “Business Combinations.” Quinton Cardiology Systems will be the acquiring entity for financial reporting purposes based on our review of the criteria for determining the accounting acquirer as set forth in Statement 141. These criteria include but are not limited to; relative share ownership of the combined entity, composition of and ability to elect the board of directors, and the entity from which senior management positions are filled. A majority of Newco’s proposed board of directors will be comprised of current Quinton Cardiology Systems directors. In addition, Quinton Cardiology Systems executives will fill a majority of Newco’s senior management positions, thereby directing policies, strategic direction, and day-to-day operations.

     Our liquidity may be affected in future periods due to legal, accounting, financial expert and other expenses relating to the our proposed transaction with Cardiac Science, Inc. As of March 31, 2005, $885,000 of acquisition related costs were incurred, of which $806,000 were unpaid. In addition, if we terminate the merger agreement with Cardiac Science under specified conditions, we would be liable for $4.0 million in breakup fees. The payment of the breakup fees may adversely affect our liquidity.

     In the event that the transaction with Cardiac Science is consummated, we anticipate that Newco will use approximately $20 million of our cash to make the cash payment contemplated by the note and warrant conversion agreement to the holders of Cardiac Science’s senior debt and related warrants.

Certain Factors that May Affect Future Results

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

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

     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 may include:

	•	the impact of acquisitions, divestitures, strategic alliances, and other significant corporate events;
	•	changes in our ability to obtain products and product components that are manufactured for us by third parties, such as Holter monitors, as well as variations in prices of these products and product components;
	•	delays in the development or commercial introduction of new versions of products and systems;
	•	the ability to attain and maintain production volumes and quality levels for our products and product components;
	•	effects of domestic and foreign economic conditions on our industry and/or customers;

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	•	the successful implementation of our system-oriented sales approach;
	•	changes in the demand for our products and systems;
	•	varying sales cycles that can take up to a year or more;
	•	changes in the mix of products and systems we sell, which could affect our revenue levels as well as our gross margins;
	•	unpredictable budgeting cycles of our customers;
	•	delays in obtaining regulatory clearance for new versions of our products and systems;
	•	increased product and price competition;
	•	the impact of regulatory changes on the availability of third-party reimbursement to customers of our products and systems;
	•	the loss of key personnel;
	•	the loss of key distributors or distribution companies; and
	•	seasonality in the sales of our products and systems.

     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.

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.

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

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

If 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:

	•	lengthening of buying or selling cycles;
	•	the introduction of competing products;
	•	price reductions by our competitors;
	•	development of more effective products by our competitors;
	•	hospital budgetary constraints; and

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•

changes in the reimbursement policies of government and third-party payers.

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

Our business and results of operations may be affected by our announced merger with Cardiac Science, Inc.

     Our announcement of the transaction with Cardiac Science, Inc. may create uncertainty among customers such that one or more large customers, or a significant group of small customers, delays purchase decisions pending consummation of the planned transaction, which could negatively affect our results of operations in future quarters. Decreased revenue could have a variety of adverse effects, including negative consequences to our relationships with, and ongoing obligations to, customers, suppliers, business partners, and others with whom we have business relationships. In addition, our quarterly operating results and revenue could be substantially below the expectations of market analysts, which could cause a decline in our stock price. Cardiac Science’s operations could be similarly impacted by uncertainties created by the pending transaction, which could negatively impact the future operating results of the combined entity assuming the transaction is consummated.

We may suffer additional adverse consequences if the proposed transaction with Cardiac Science is not completed.

     If the planned merger with Cardiac Science is not completed, we could suffer a number of consequences that may adversely affect our business, results of operations and stock price, including the following:

	•	we would not realize the benefits we expect from becoming part of a combined company with Cardiac Science, such as the potentially enhanced financial position, enhanced product diversity and sales, marketing and distribution capabilities;
	•	activities relating to the merger and related uncertainties may divert our management’s attention from our day-to-day business and other potential acquisition opportunities, cause disruptions among our employees and negatively impact our relationships with customers and business partners, thus detracting from our ability to increase revenue and minimize costs and possibly leading to a loss of revenue and market position that we may not be able to regain if the transaction does not occur;
	•	the market price of our common stock could decline following an announcement that the merger has been abandoned, to the extent that the current market price reflects a market assumption that the merger will be completed;
	•	we could be required to pay Cardiac Science a $4.0 million termination fee if the merger agreement is terminated under certain specified conditions;
	•	we would be required to expense approximately $1.0 million or more in transaction related costs that would otherwise be treated as part of the purchase price;
	•	we would remain liable for certain costs related to the transaction, such as legal, accounting, financial advisor and financial printing fees; and
	•	we may not be able to take advantage of alternative business opportunities or effectively respond to competitive pressures.

Even if we consummate our pending transaction with Cardiac Science, the combined company may experience difficulties in integrating the two companies and may not achieve the anticipated benefits of the combination.

     Achieving the benefits of our pending transaction with Cardiac Science will depend on the ability of management of the combined company to successfully integrate the operations of the two companies. The integration of Quinton Cardiology Systems and Cardiac Science will be a complex, time-consuming and expensive process and may disrupt both

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companies’ businesses if not completed in a timely and efficient manner. Risks to the successful integration of the companies include:

	•	the impairment of relationships with employees, customers, distributors, strategic partners and suppliers as a result of integration of management and other key personnel;
	•	the potential disruption of the combined company’s ongoing business and distraction of its management;
	•	the difficulty of incorporating acquired technology and rights into the product offerings of the combined company;
	•	not achieving expected synergies; and
	•	unanticipated expenses related to integration of the two companies.

     The combined company may not succeed in addressing these risks or any other problems encountered in connection with the transaction, may not grow at a rate equivalent to the historical growth rates of the two companies, and may not achieve any other benefits anticipated from the merger.

We may make future acquisitions, which involve numerous risks that could impact our business and results of operations.

     As part of our growth strategy, we intend to selectively acquire other businesses, product lines, assets, or technologies. Successful execution of our acquisition strategy depends upon our ability to identify, negotiate, complete and integrate suitable acquisitions. Acquisitions involve numerous risks, including the following:

	•	difficulties in integrating the operations, technologies, and products of the acquired companies;
	•	the risk of diverting management’s attention from normal daily operations of the business;
	•	potential difficulties in completing projects associated with in-process research and development;
	•	risks of entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;
	•	initial dependence on unfamiliar supply chains or relatively small supply partners;
	•	insufficient revenues to offset increased expenses associated with acquisitions;
	•	the risk that acquired lines of business may reduce or replace the sales of existing products; and
	•	the potential loss of key employees of the acquired companies.

     Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. We must also manage any growth effectively. Failure to manage growth effectively and successfully integrate acquisitions we make could harm our business and operating results in a material way.

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

     Successful continued execution of our acquisition strategy also depends upon our ability to obtain satisfactory debt or equity financing. We likely would 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. Fluctuations in 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.

If we fail to successfully enter into strategic alliances to generate growth, our operating results may be negatively affected.

     A component of our growth strategy is to enter into strategic alliances in order to complement and expand our current product and service offerings and distribution. There can be no assurances that a strategic alliance will perform as

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expected or generate significant revenues or profits. If we do not identify potential strategic alliances or enter into strategic alliances that fail to generate additional revenue, our operating and financial results may be negatively impacted.

Future changes in the accounting treatment for employee stock options may cause adverse fluctuations and affect our reported results of operations.

     We currently elect to apply the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). In accordance with the provisions of SFAS No. 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. Under this election, we account for stock options granted to employees using the intrinsic value method of accounting. Under this method, employee stock-based compensation expense is based on the difference, if any, between the fair value of our stock and the exercise price of the award on the grant date. In December 2004, the Financial Accounting Standards Board, or FASB, the principal United States accounting standards setting organization, issued SFAS 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) which, will require us to record an expense for all outstanding unvested stock options and grants of new stock options. In April 2005, the U.S. Securities and Exchange Commission adopted a new rule amending the compliance dates for SFAS No. 123R. In accordance with the new rule, the accounting provisions of SFAS No. 123R will be effective for us in the first quarter of 2006. The pronouncement will also require us to record an expense for our employee stock purchase plan. As a result of changing our accounting policy in accordance with this pronouncement, our reported earnings, beginning in the first quarter of 2006, will be significantly negatively impacted.

Compliance with changing regulation of corporate governance, public disclosure and accounting matters may result in additional expenses.

     Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new rules subsequently implemented by the SEC and The NASDAQ Stock Market, as well as new accounting pronouncements, are creating uncertainty and additional complexities for companies. To maintain high standards of corporate governance, public disclosure and financial reporting, we continue to invest resources to comply with evolving standards. This investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue generating and cost management activities.

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, our products may suffer declines in market acceptance or may become obsolete. In that event, our market share and revenues would likely decrease.

If we fail to maintain our relationships with distribution organizations, our sales and operating results may suffer.

     We sell our products to the domestic primary care market and to substantially all international markets principally through third party distribution organizations. While we have well established relationships with these distribution organizations, the underlying agreements are generally for periods of one year or less. One of these domestic distribution organizations, Physicians Sales and Service, Inc., accounted for 14% and 15% of our revenues in 2003 and 2004, respectively, and 21% of our revenues in the first quarter of 2005. If these agreements are cancelled or if we are unable to renew them as they expire, our sales and operating results may suffer materially. Our international distribution relationships may be terminated on little or no notice because we do not generally have long-term contracts with these distributors. Consequently, our success in expanding international sales may be limited if our international distributors lack, or are unable to develop, relationships with important target customers in international markets. If our relationships change with any significant distribution organization, or if any of our distribution organizations devote more effort to selling competing products and systems, our sales and operating results may suffer and our growth may be limited.

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

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

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

     The rate of market acceptance of our current or future products and systems may impact our operating results. In addition, we may experience design, manufacturing, marketing or other difficulties that could delay or prevent our development, introduction or marketing of new versions of our products. Such difficulties and delays could adversely affect our gross profit expectations and/or cause our development expenses to increase and harm our operating results.

We depend on the expertise of key personnel to manage our businesses effectively in a changing market, and if we lose one or more members of our senior management team or if our management team does not work together effectively, our business could be harmed.

     The success of our business depends in part on key managerial, sales and technical personnel, as well as our ability to continue to attract and retain additional highly qualified personnel. We compete for such key personnel with other companies, academic institutions, government entities, and other organizations. We do not have agreements whereby our employees agree not to compete with us, nor do we maintain key person life insurance on any of our executive officers. Our ability to maintain and expand our business may be impaired if we are unable to retain our current key personnel, hire or retain other qualified personnel in the future, or if our key personnel decided to join a competitor or otherwise compete with us.

     Several of our existing management personnel have held their current positions for less than two years, including our Vice President, Acute Care, Vice President, Marketing and Vice President, Engineering. Our future success depends to a significant extent on the ability of our executive officers and other members of our management team to operate effectively, both individually and as a group. Our business may be harmed if we do not successfully allocate responsibilities among our management team or if some of our management do not succeed in their roles.

If we do not maintain or grow revenues from our support services or consumables, our operating and financial results may be negatively impacted.

     A significant portion of our revenues is generated from post-sale support services we provide for our products and from the sale of ancillary cardiology products and consumables related to our products and systems, such as patented electrodes, pads, cables, leads, and thermal chart paper. As hospitals expand their in-house capabilities to service

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diagnostic equipment and systems, they may be able to service our products without additional support from us. In addition, our customers may express an increasing preference for ancillary cardiology products and consumables that are manufactured or provided by other vendors. Any of these events could result in a decline in our revenues and a resulting adverse effect on our financial and operating results.

Competition may decrease our market share and cause our revenues to decrease.

     The diagnostic cardiology systems market is highly competitive and we expect competition to intensify in the future. Some of our competitors are larger companies, such as General Electric Company and Koninklijke Philips Electronics N.V., and may have:

	•	greater financial and other resources;
	•	greater variety of products;
	•	greater pricing flexibility;
	•	more extensive technical capabilities;
	•	patent portfolios that may present an obstacle to our conduct of business;
	•	stronger name recognition; and
	•	larger distribution networks.

     As a result, we may be unable to offer products similar to, or more desirable than, those offered by our competitors, market our products as effectively as our competitors, price our products competitively or otherwise respond successfully to competitive pressures. In addition, our competitors may be able to offer discounts on competing products as part of a “bundle” of non-competing products, systems, and services that they sell to our customers, and we may not be able to profitably match those discounts. Our competitors may develop technologies and products that are more effective than those we currently offer or that render our products obsolete or noncompetitive. In addition, the timing of the introduction of competing products into the market could affect the market acceptance and market share of our products. If we are unable to develop competitive products, gain regulatory approval or clearance and supply sufficient quantities of such products to the market as quickly and effectively as our competitors, market acceptance of our products may be limited, and our revenues and operating results may suffer.

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

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

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.

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

     Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” requires that we cease amortization of goodwill and other intangible assets determined to have indefinite lives, and established a method of testing these assets for impairment on an annual or on an interim basis if certain events occur or circumstances change that would reduce the fair value of a reporting unit below its carrying value or if the fair value of intangible assets with indefinite lives falls below their carrying value. We also evaluate intangible assets determined to have finite lives and other long-lived assets for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business, or other factors such as a decline in our market value below our book value for an extended period of time. In the case of intangible assets with indefinite lives, we evaluate whether events or circumstances continue to support an indefinite useful life. We evaluate the estimated lives of all intangible assets on an annual basis, including those with indefinite lives, to determine if events and circumstances continue to support an indefinite useful life or the remaining useful life, as applicable, or if a revision in the remaining period of amortization is required. The amount of any such annual or interim impairment charge could be significant, and could have a material adverse effect on our reported financial results for the period in which the charge is taken.

     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. There can be no assurance that the estimated fair value of this investment will not decline to an amount below its carrying amount, in which case we would be required to record a loss on this investment.

Inadequate levels of reimbursement from governmental or other third-party payers for procedures using our products and systems may cause our revenues to decrease.

     Significant changes in the healthcare systems in the U.S. or elsewhere could have a significant impact on the demand for our products and services as well as the way we conduct business. Federal, state, and local governments have adopted a number of healthcare policies intended to curb rising healthcare costs. In the U.S., healthcare providers that purchase our products and systems generally rely on governmental and other third-party payers, such as Federal Medicare, state Medicaid, and private health insurance plans, to pay for all or a portion of the cost of heart-monitoring procedures and consumable products utilized in those procedures. The availability of such reimbursement affects our customers’ decisions to purchase capital equipment. Denial of coverage or reductions in levels of reimbursement for procedures performed using our products and systems by governmental or other third-party payers would cause our revenues to decrease. We are unable to predict whether Federal, state or local healthcare reform legislation or regulation affecting our business may be proposed or enacted in the future, or what effect any such legislation or regulation would have on our business.

If we fail to obtain or maintain applicable regulatory clearances or approvals for our products, or if clearances or approvals are delayed, we will be unable to commercially distribute and market our products in the U.S. and other jurisdictions.

     Our products are medical devices that are subject to significant regulation in the U.S. and in foreign countries where we do business. The processes for obtaining regulatory approval can be lengthy and expensive, and the results are unpredictable. If we are unable to obtain clearances or approvals needed to market existing or new products, or obtain such clearances or approvals in a timely fashion, it could adversely affect our revenues and profitability.

Failure to adequately protect our intellectual property rights will cause our business to suffer.

     Our success depends in part on obtaining, maintaining, and enforcing our copyrights, patents and other proprietary rights, and our ability to avoid infringing the proprietary rights of others. We take precautionary steps to protect our technological advantages and intellectual property and rely in part on patent, trade secret, copyright, know-how, and trademark laws, license agreements and contractual provisions to establish our intellectual property rights and protect our products. The precautionary steps we have taken may not adequately protect our intellectual property rights.

     Our patents may not provide commercially meaningful protection, as competitors may be able to design around our patents. We may not be able to protect our rights in unpatented technology, trade secrets, and confidential information

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effectively. We require our new employees, consultants, and corporate partners to execute a confidentiality agreement at the commencement of their employment or consulting relationship with us. However, these agreements may not provide effective protection of our information or, in the event of unauthorized use or disclosure, they may not provide adequate remedies.

If third parties claim that our products infringe their intellectual property rights, we may be forced to expend significant financial resources and management time and our operating results would suffer.

     Third parties may claim that our products and systems infringe on third-party patents and other intellectual property rights. Identifying third-party patent rights can be particularly difficult because, in the U.S., patent applications are maintained in secrecy for up to eighteen months after their filing dates. Moreover, patent applications can be maintained in secrecy until they issue, if they were filed before November 29, 2000, are not subject to publication in any country, or have otherwise properly requested maintaining secrecy to issuance. Some companies in the medical device industry have used intellectual property infringement litigation to gain a competitive advantage. In the event a competitor were to challenge our patents or licenses, or assert that our products infringe its patent or other intellectual property rights, we could incur substantial litigation costs, be forced to make expensive changes to our product designs, license rights in order to continue manufacturing and selling our products, or pay substantial damages. Third-party infringement claims, regardless of their outcome, would not only drain our financial resources but also divert the time and effort of our management and could result in our customers or potential customers deferring or limiting their purchase or use of the affected products until resolution of the litigation.

We are dependent upon licensed and purchased technology for some of our products, and we may not be able to renew these licenses or purchase agreements in the future.

     We license and purchase technology from third parties for features in some of our products. We anticipate that we will need to license and purchase additional technology to remain competitive. We may not be able to renew our existing licenses and purchase agreements or to license and purchase other technologies on commercially reasonable terms or at all. If we are unable to renew our existing licenses and purchase agreements or we are unable to license or purchase new technologies, we may not be able to offer competitive products.

Our reliance on a principal manufacturing facility may impair our ability to respond to natural disasters or other unforeseen catastrophic events.

     Our principal manufacturing facility is located in a single building in Deerfield, Wisconsin. Despite precautions taken by us, a natural disaster or other unanticipated catastrophic events at this building could significantly impair our ability to manufacture our products and operate our business. Our facility and certain manufacturing equipment would be difficult to replace and could require substantial replacement lead-time. Such catastrophic events may also destroy any inventory of product or components. While we carry insurance for natural disasters and business interruption, the occurrence of such an event could result in losses that exceed the amount of our insurance coverage, which would impair our financial results.

Recent and future Federal and state regulations in the U.S. relating to patient privacy could impose burdens on us.

     Federal and state laws regulate the confidentiality of certain patient health information, including patient records, and the use and disclosure of that “protected health information.” We are subject to these regulations when we access, collect, and analyze patient data. Our compliance obligations with these regulations would include agreeing, typically by contract, to use that protected health information only for certain purposes, to safeguard that information from misuse and to help those providers comply with their duties to provide patients with access to their health information. Failure to comply with these regulations could restrict our ability to sell products to customers and could result in penalties, which could negatively impact our financial results. In addition, our products must have features that permit health care providers to comply with these regulations. We continually evaluate the applicability of these regulations to our existing and new products and services and our compliance obligations. To the extent these regulations change in the future, we may need to devote additional resources in the future in order to comply with these regulations.

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Delaware law and provisions in our charter could make the acquisition of our company by another company more difficult.

     Certain provisions of our certificate of incorporation and bylaws may make it more difficult for a third party to acquire, or discourage a third party from attempting to acquire us. This could limit the price that certain investors might be willing to pay in the future for             shares of our common stock. Our certificate of incorporation and bylaws allow us to issue preferred stock without any vote or further action by the stockholders, eliminate the right of stockholders to act by written consent without a meeting, provide that special meetings of stockholders may be called only by our board of directors, the chairman of our board, or our president, specify advance notice procedures for director nominations by stockholders and submission of other proposals for consideration at stockholder meetings, and eliminate cumulative voting in the election of directors. Moreover, our board of directors is divided into three classes, with directors in each class elected to staggered three year terms, and directors may only be removed by the stockholders for cause. Some provisions of Delaware law could also delay or make more difficult a third party’s efforts to effect a merger with or tender offer for us, including Section 203 of the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met. Similar provisions under Washington law may also apply. The possible issuance of preferred stock, our classified board, procedures required for director nominations and stockholder proposals and Delaware law could have the effect of delaying, deferring or preventing a change in control of our company, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of our common stock.

The market price of our stock may be highly volatile.

     During the twelve months ended March 31, 2005, our common stock traded between a range of $6.80 and $14.80 per share. The market price of our common stock could continue to fluctuate substantially due to a variety of factors, including:

	•	uncertainties created by our pending transaction with Cardiac Science;
	•	quarterly fluctuations in results of our operations;
	•	our ability to successfully commercialize our products;
	•	changes in coverage or earnings estimates by analysts;
	•	impact of other acquisitions, divestitures, strategic alliances, and other significant corporate events;
	•	changes in the mix of products and systems we sell, which could affect our gross margins;
	•	the loss of key distributors or distribution companies; and
	•	seasonality in the sales of our products and systems.

     The market price for our common stock may also be affected by our ability to meet analysts’ expectations. Any failure to meet such expectations, even slightly, could have an adverse effect on the market price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against the company. If similar litigation were instituted against us, it could result in substantial costs and a diversion of our management’s attention and resources, which could have an adverse effect on our business, results of operations and financial condition.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We develop products in the U.S. and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since our revenues are currently priced in U.S. dollars and are translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets. Interest income 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 marketable equity securities which we classify as available-for-sale and, as such, carry the investments at fair value. At March 31, 2005, the fair value was $607,000. These investments are exposed to market risks. Unrealized holding gains or losses related to fluctuations in fair values are reflected in other accumulated comprehensive income or loss. If we had a decline in fair value that was judged to be other than temporary, we would record a loss.

     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 $1.0 million carrying amount of this investment is appropriate, though our belief is necessarily based on our estimate of fair value.

     Item 4. Controls and Procedures

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

     There has been no change in our internal control over financial reporting during the three-month period ended March 31, 2005 in connection with this evaluation that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     We are subject to various legal proceedings arising in the normal course of business. In the opinion of management, the ultimate resolution of these proceedings is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     None.

Item 3. Defaults Upon Senior Securities

     None.

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

     None.

Item 5. Other Information

     None.

Item 6. Exhibits

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SIGNATURE

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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