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

FORM 10-K

(Mark One)

Commission file number:  0-11868

CARDIODYNAMICS INTERNATIONAL CORPORATION
(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) 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.

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

The aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant was approximately $111,813,000 based on the average bid and asked price of such Common Stock, as of the last business day of the registrant’s most recently completed second fiscal quarter as reported for such date on the Nasdaq Stock Market.  For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by directors and officers of the registrant have been excluded because such persons may be deemed to be affiliates.  

At February 15, 2003, 46,186,297 shares of registrant’s Common Stock were outstanding.

Documents Incorporated by Reference:  None

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 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. x

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CardioDynamics
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This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These statements include statements regarding our plans, goals, strategies, intent, beliefs or current expectations.  These statements are expressed in good faith and we believe had a reasonable basis when expressed, but there can be no assurance that these expectations will be achieved or accomplished.  Sentences in this document containing verbs such as “plan”, “intend”, “anticipate”, “target”, “estimate”, “expect”, etc., and/or future-tense or conditional constructions (“will”, “may”, “could”, “should”, etc.) constitute forward-looking statements that involve risks and uncertainties.  Items contemplating, or making assumptions about, actual or potential future sales, market size, collaborations, trends or operating results also constitute such forward-looking statements.  These statements are only predictions and actual results could differ materially.  Certain factors that might cause such a difference are discussed throughout this Form 10-K, including the section entitled “Risk Factors” on pages 22 to 29 of this document.  Any forward-looking statement speaks only as of the date we made the statement, and we do not undertake to update the disclosures contained in this document or reflect events or circumstances that occur subsequently or the occurrence of unanticipated events.

PART I

ITEM 1.           BUSINESS

CardioDynamics International Corporation (“CardioDynamics”, or “CardioDynamics - The ICG Company”) is the innovator and market leader of a breakthrough technology called Impedance Cardiography (ICG).  We develop, manufacture, and market noninvasive heart-monitoring devices using our proprietary ICG technology.

Our proprietary, patented technology non-invasively monitors the heart’s ability to deliver blood to the body and the amount of fluid in the chest.  Our products measure 12 hemodynamic (blood flow) parameters, the most significant of which is cardiac output, or the amount of blood pumped by the heart each minute.  Our lead product, the BioZ^® ICG Monitor (previously know as the BioZ.com^®), has been cleared by the Federal Drug Administration (FDA) and carries the CE mark.  We sell to physicians and hospitals in the United States through our own direct sales force and distribute our products to domestic hospitals and targeted international markets through a strategic alliance with GE Medical Systems Information Technologies (GEMS-IT) and a network of international distributors.  In November 1998, Health Care Finance Administration (HCFA), now known as the Center for Medicare & Medicaid Services (CMS), mandated Medicare reimbursement for our BioZ^® procedures and in January 2001, implemented national uniform pricing throughout the United States.  To date, we have sold over 2,200 ICG systems to over 1,500 physician offices and hospital sites throughout the world.

Our products help physicians assess, diagnose, and treat cardiovascular disease, which is the number one killer of adults in the United States.  According to the American Heart Association (AHA), approximately one in five Americans has some form of cardiovascular disease.  The AHA estimated that over $329 billion would be spent in the United States during 2002 as a result of cardiovascular disease and stroke.  This figure includes both the direct costs associated with physicians and other professionals, hospital and nursing home services and medication and the indirect costs associated with lost productivity resulting from morbidity and mortality.

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Electrocardiogram (ECG) is a widely used noninvasive assessment of the electrical characteristics of the heart. Our ICG technology non-invasively quantifies the mechanical functioning of the heart.  Conditions that can interfere with the proper mechanical functioning of the heart include hypertension, congestive heart failure, pulmonary disease, high-risk pregnancy and kidney dysfunction. Our technology complements ECG and supplements information obtained through five vital signs – heart rate, respiration rate, body temperature, blood pressure and oxygen saturation – immediately, safely and cost effectively.  Our customers have suggested noninvasive cardiac output to be the “Sixth Vital Sign.”

Currently, the primary method used to measure hemodynamic parameters is pulmonary artery catheterization (PAC).  The invasive PAC procedure requires hospitalization and involves an incision into the patient’s neck or groin region and the insertion of a catheter (plastic tube) through the heart directly into the pulmonary artery.  Complications associated with this procedure occur in as many as one in four reported cases and include irregular heartbeats, infection, pulmonary artery rupture and death.

Because of the high risk of complications, physicians generally prescribe PAC only for critically ill patients.  In the non-sterile environment of a physician’s office or outpatient clinic, PAC is simply unavailable.  As a result, in the great majority of situations, the physician seeking to diagnose cardiovascular disease must indirectly assess the patient’s hemodynamic status by measuring blood pressure, checking the pulse, looking at neck veins and employing subjective examination techniques that are prone to human error.  A compelling need exists for objective, noninvasive measurement tools, such as our BioZ^®  ICG systems.

During ICG monitoring using our BioZ^® ICG systems, an undetectable electrical signal is sent through our proprietary sensors on the patient’s neck and chest.  Our sophisticated DISQ^® (Digital Impedance Signal Quantifier) processing and Z MARC^® Algorithm analyze and record significant hemodynamic parameters.  Based on this data, a physician can quickly and safely identify underlying cardiovascular disorder, assess and diagnose, customize and target treatment, monitor the effectiveness of prescribed medications and more accurately identify potential complications.

Our objective is to establish our BioZ^® ICG technology as a standard of care in cardiovascular medicine.  Key elements of our strategy include:

We were incorporated as a California corporation in 1980 and changed our name to CardioDynamics International Corporation in 1993.  Our principal executive offices are located at 6175 Nancy Ridge Drive, Suite 300, San Diego, California 92121, and our telephone number is 858-535-0202.  Our common stock trades under the symbol CDIC on the Nasdaq National Market System.

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Industry Overview and Company History

Cardiovascular disease is the number one killer of adults in the United States and in 31 of the 35 countries reporting mortality statistics.  In the United States alone, the AHA estimated that there were 65 million physician office visits, another 7 million outpatient visits, and over 4 million emergency room visits in 2000 with a primary diagnosis of cardiovascular disease.  In 1999, $26 billion in payments were made to Medicare beneficiaries for hospital expenses due to cardiovascular problems.  Our proprietary technology provides medical professionals in the hospital and physician’s office with noninvasive access to the objective patient data they need to effectively assess, diagnose and treat congestive heart failure and hypertension, and to evaluate emergency, pacemaker and dialysis patients. 

In the hospital setting, the BioZ^® is a noninvasive, cost-effective and safe alternative to the invasive PAC procedure and may also be used in many situations in which PAC is not feasible.  However, advantages of our proprietary technology are not limited to the hospital or the critically ill.  We believe that the greatest potential for the BioZ^® product line is in the new uses the medical community will have for noninvasive hemodynamic measurements.  We believe that the total market opportunity is over $5 billion for our BioZ^® product line. 

We envision expanding the domestic market from the current two million annual invasive PAC procedures to over 72 million annual noninvasive ICG procedures, as summarized in the chart below.  Assuming total worldwide procedures are approximately double those in the United States, there would be over 140 million procedures worldwide.  These numbers do not include home healthcare monitoring, which we believe would, if implemented, significantly increase demand for our technology.

Potential Annual Noninvasive Monitoring Procedures
US Patients

Strategy

Our objective is to establish our BioZ^® ICG technology as a standard of care in cardiovascular medicine.  Our objective will be achieved if and when noninvasive cardiac output, our primary measurement, becomes the Sixth Vital Sign,as oxygen saturation became the fifth vital sign in the late-1980s.  We intend to position Bioz^® ICG technology as a key diagnostic and monitoring tool in assessing and treating congestive heart failure, hypertension, pacemaker, emergency, critically ill, surgical, high-risk obstetric, dialysis, cardiac rehabilitation, immune suppressed and home healthcare patients.  Key elements of our corporate strategy include:

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          Accelerate market penetration through our direct sales force

We intend to utilize our direct sales force to capitalize on our first-to-market position in the United States and to further penetrate the physician office market.  We believe that a strong direct sales force is best suited to educate the medical community about how the various applications of our technology improve patient outcomes and decrease costs.  We currently have 45 direct sales representatives who focus exclusively on our products.  During fiscal 2000 we began recruiting clinical application specialists to supplement our field sales team by enhancing customer understanding, usage and satisfaction.  We currently have 13 clinical application specialists onboard.  We believe that the resulting improved device utilization will strengthen customer loyalty and increase recurring revenue from our proprietary sensors.

          Broaden our distribution channels through strategic relationships

We intend to establish strategic relationships with major patient monitoring and diagnostic cardiology companies, pacemaker manufacturers and other medical products and technology companies to increase the availability of our proprietary technology.  We believe that strategic relationships can accelerate market penetration of BioZ^® ICG technology in markets not served by our direct sales team and provide us with access to large installed bases of patient monitoring, cardiology and other complementary medical equipment.  We believe that these strategic relationships can provide increased distribution capabilities and collaborative product development programs.

          Grow recurring revenue through increased use of our proprietary disposable sensors 

During fiscal 2000 we successfully developed and received FDA 510(k) clearance on our proprietary BioZtect^® sensor technology that provides notable improvements in performance and features.  Its unique shape and chemical composition, adhesion characteristics and more user-friendly design optimize signal transmission and detection sensitivity.  The new sensor and cable system has a proprietary interface, which promotes the exclusive use of our proprietary sensors with our equipment.  As our installed base of BioZ^® products grows, we expect that the recurring revenue stream from our proprietary sensors could account for as much as 30% to 40% of our total net sales within five years.  For the fiscal year ended November 30, 2002, recurring revenue accounted for approximately 12% of our total net sales.

          Maintain market leadership through product improvements and extensions

We intend to advance the development of our core algorithms to provide physicians with improved cardiac function measurement capabilities on a broad class of patients.  We believe that continued advances in our ICG technology will increase physician usage and loyalty and strengthen our industry position.  We will capitalize on our expertise in ICG signal processing and sensor technology to improve system performance in the presence of noise and patient movement and that these improvements will lead to additional applications for cardiovascular disease management.  In the future, we also plan to adapt our current measurement algorithm and to develop a smaller BioZtect^® sensor tailored for pediatric patients weighing less than 66 pounds.

In 2001, we released the BioZ^® ICG Module for GEMS-IT bedside monitoring systems.  This product is distributed worldwide by GEMS-IT for their Solar^® 7000, 8000, 8000M, and DASH 3000, 4000 patient monitors.  Currently, our domestic direct sales force sells the GEMS-IT module to the installed base. Current products in development include a joint ECG-ICG device with Philips Medical Systems.

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          Target new market opportunities through technology development

We will continue to focus on new applications for our core technology.  Advances in ICG technology could be applied in the areas of pacemaker optimization, fluid management (including dialysis), oncology, drug noncompliance, and pharmaceutical development and testing.  Pharmaceutical companies such as GlaxoSmithKline, Eli Lilly and Co. and Pfizer Inc. are currently using our technology to document the cardiovascular effects of their pharmaceutical agents in both animals and humans. 

In July 2002, the Company signed a Co-Development and OEM Agreement with Philips Medical Systems (Philips), a worldwide leader in clinical measurement and diagnostic solutions for the healthcare industry and a division of Royal Philips Electronics (AEX: PHI, NYSE: PHG).  The joint product development will combine CardioDynamics’ proprietary ICG technology with Philips’ diagnostic 12-lead ECG.  Both companies will market the combined ICG/ECG product after completion.

Continued innovation and commercialization of new proprietary products are essential elements in our long-term growth strategy.  We also intend to maintain our competitive advantage through acquisitions of new technologies, and to seek additional patents and other proprietary rights, as we deem appropriate.

ICG Technology

As ECG technology non-invasively measures the heart’s electrical characteristics, our ICG technology makes it possible to measure the heart’s mechanical or blood flow characteristics.  By using our products, physicians have an easy, non-invasive and cost-effective way to monitor the heart’s ability to deliver blood to the body.

ICG technology is based on Ohm’s Law and the fact that blood is the most electrically conductive substance in the body.  Blood volume and velocity change with each heart beat and results in a change in the electrical conductivity, or impedance, of the chest. 

In order to measure this conductivity change, our BioZ^® products use four dual sensors (two on the neck and two on the chest) to deliver an undetectable, high frequency (70 kHz), low magnitude (4 mA), alternating current through the chest.  Use of a high frequency current eliminates the possibility of interference with bioelectrical activity of the heart and brain.  Additionally, at a high frequency, there is no sensation to the patient.  By setting the current at a constant magnitude, variations in blood volume and velocity in the descending thoracic aorta which cause a proportional voltage change may be measured.

Our BioZ^® ICG Monitor generates the impedance signal with CS2™ (Crystal Signal Stabilization) Technology and after the signal travels harmlessly through the body, our proprietary DISQ^® processing measures the changes in impedance to the electrical signal.  The changes in impedance are then applied to the Z MARC^® Algorithm to provide the following 12 hemodynamic parameters:

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*Index means that the results are normalized for body surface area.

Of these 12 parameters, the ones most widely used by physicians are cardiac output, systemic vascular resistance and thoracic fluid content.  Another important hemodynamic measure, the speed and strength of the heart’s contraction (also known as contractility), may be derived from the velocity index, acceleration index and systolic time ratio.

ICG technology measures the change in conductivity, or the inverse, which is impedance, over a change in time and calculates stroke volume, or the volume of blood pumped with each heartbeat.  The physician receives a report with vital patient data that allows him or her to customize and optimize treatment.

Some physical and medical conditions may diminish the accuracy of the measurements provided by our products and therefore we discourage their use.  We believe that inaccuracies most frequently occur in patients who are experiencing severe septic shock, severe aortic valve regurgitation, severe irregular ventricular heartbeats or heart rates greater than 180 beats per minute.  In addition, there is inadequate data demonstrating the accuracy of our products in patients who are shorter than 47 inches or who weigh less than 66 pounds or more than 342 pounds, as well as in patients who move excessively during the BioZ^® procedure.

Our Products, Services and Solutions

          Pricing

Our stand-alone BioZ^®ICG Monitors, as sold to end users, range in list price from $36,710 to $38,710 depending upon configuration. We discount the list prices of our products in some circumstances based primarily upon volume commitments.  We also provide discounts on the purchase of demo equipment and to distributors who perform sales and customer service functions for us.  The list price for our sensors is $10.95 for the BioZ^® ICG Monitor and $19.95 per set for the BioZ^® ICG Module.  We offer a sensor auto-ship program that allows discounts on sensor purchases based on minimum monthly volume commitments.

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          BioZ® ICG Monitor

Our lead noninvasive cardiac function monitoring device features a portable design, transport battery and integrated blood pressure.  New BioZ^® ICG Monitors are sold with a pole cart, printer and keyboard for end user data entry and include a standard five-year warranty. 

          BioZtect® Sensors

We also market disposable sensors designed specifically for use with the BioZ^® products.  With each monitoring session, four dual sensors are utilized.  The proprietary sensor and cable system provides enhanced features to our customers and promotes the exclusive use of our proprietary sensors with our equipment.

          BioZ^® ICG Module

The BioZ^® ICG Module was jointly developed with GEMS-IT.  The module integrates our proprietary BioZ^®  ICG technology  into GE’s Solar and Dash patient monitoring systems.  We commenced shipments of the BioZ^®  ICG Module in May 2001. 

          BioZ.sim^® ICG Simulator

The BioZ.sim^® ICG Simulator is a simulation and calibration tool specifically designed to allow end-users and hospital biomedical engineering departments to test and verify the functionality of their BioZ^® ICG systems.

          BioZ^® System  & BioZ.pc System

The BioZ^® system is our original noninvasive cardiac ICG monitoring device.  It consists of a Pentium-based central processing unit, 15-inch high-resolution medical grade color monitor and keyboard.  Included in the central processing unit is our proprietary digital signal processing circuit board and software. The BioZ.pc system is a customized noninvasive ICG monitoring device that we developed through a collaborative research and development program with Profiles in Health, Inc. These systems are no longer in production.

          Z Care^®

In addition to our standard warranty, we offer extended service agreements, called Z Care^®.  This extended service agreement covers hardware and software maintenance beyond the warranty period.  Also included in the agreement is a next-day loaner unit while a device is under repair, free shipping for the loaner unit and repaired device, and free software upgrades.

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Sales and Distribution

The United States medical marketplace consists of two distinct segments: the hospital market and the outpatient market.  The outpatient market for BioZ^® products include physician offices and hospital-based and free-standing outpatient facilities.  Our direct sales force is targeted at both the hospital and outpatient markets in the majority of the United States.  During fiscal 2000, we began hiring clinical application specialists to supplement our field sales team and to enhance customer understanding, usage and satisfaction.  We believe that the resulting improved device utilization strengthens customer loyalty and increases our recurring revenue from proprietary sensors.

The majority of our direct sales force penetration is in the outpatient market.  In contrast to the hospital market, there are few, if any, formal capital equipment budget processes and purchasing decisions can therefore be made more quickly.  Consequently, we focused our direct sales force primarily on the outpatient markets and sought an alliance with a hospital-based industry leader, GEMS-IT, to penetrate the hospital market.  Currently, we have a U.S. direct sales force of 45 territory managers focused primarily on the outpatient market.

Strategic Relationships

From August 1999 through September 2000, we entered into several strategic distribution agreements with GEMS-IT for exclusive distribution of our BioZ^® ICG Monitor to select countries around the world.  Through GEMS-IT and our other international distributors, ICG technology is now represented in over 70 countries throughout Europe, Asia Pacific, Africa, the Middle East, Australia, New Zealand and Latin America.  In May 2001, GEMS-IT, GmbH, agreed to provide up to $600,000 of funding over the next twenty months (May 2001 to December 2002) to support ICG clinical application specialists in Germany, Benelux and the Middle East.

In October 1999, we entered into an agreement with GEMS-IT for distribution of the BioZ^® ICG Monitors in the domestic hospital market.  The agreement gave GEMS-IT exclusive rights through July 2001, to market and sell our BioZ^® ICG Monitors in hospitals with over 100 beds, a market in which GEMS-IT has a significant presence.

During the fourth quarter of fiscal 2000, we entered into an agreement with GEMS-IT for the development of a custom plug-in module for the GEMS-IT series of bedside monitors.  This product was introduced to the market in June 2001 and extends the capabilities of the GEMS-IT Solar product family to provide all of the hemodynamic parameters of the BioZ^® ICG Monitor to GEMS-IT’s installed customer base of over 30,000 units. This product is distributed worldwide by GEMS-IT for their Solar^® 7000, 8000, 8000M, and DASH 3000, 4000 patient monitors.  We believe that other patient monitoring companies could benefit from the addition of similar modules to their estimated installed base of over 300,000 modular bedside monitors.

In March 2000, we entered into an agreement to provide BioZ^® monitors and sensor sets to Profiles in Health, Inc., a privately held California corporation.  Under the terms of the agreement, we were to manufacture and sell customized BioZ^® monitors called BioZ.pc, which would be integrated into the Profiles in Health Proveillance™ system.  The contract contemplated a three-phase development program during which we would develop and provide to Profiles in Health, Inc. ICG components and sensors.  Although Profiles in Health, Inc. continues to pursue funding, we established a 100% allowance for the note receivable, accounts receivable and inventory unique to this contract as Profiles in Health Inc.’s inability to pay became apparent in our fourth quarter of 2000.

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In April 2001, we entered into a co-promotional agreement with Vasomedical, Inc. (Vasomedical) which allows our direct sales force, along with Vasomedical’s sales force, to jointly market our BioZ^® ICG Monitors and Vasomedical’s EECP^® enhanced external counterpulsation systems to physicians and hospitals throughout the United States.  That same month, we entered into an agreement with Spacelabs Medical, Inc. (Spacelabs) for development of an interface using Spacelabs’ Universal Flexport^® to integrate and display our ICG technology on their Ultraview Care Network Ô monitoring system.

On March 22, 2002, we announced an agreement between our company and Medtronic, Inc. (Medtronic) that provided for the evaluation of clinical utility of our proprietary ICG technology in optimizing the programming of Medtronic’s implantable device for Cardiac Resynchronization Therapy (CRT).  The six-month research project, now concluded, involved a collaborative effort of the two companies and University of Kentucky Medical Centers and Iowa Heart Center.  While they maintain a willingness to reconsider their decision in the future, Medtronic has chosen not to integrate this technology into current pacemaker programmers at this time due to other priorities within their organization.

In July 2002, the Company signed a Co-Development and OEM Agreement with Philips a worldwide leader in clinical measurement and diagnostic solutions for the healthcare industry and a division of Royal Philips Electronics.  The joint product development will combine CardioDynamics’ proprietary ICG technology with Philips’ diagnostic 12-lead electrocardiograph. Both companies will market the combined ICG/ECG product when available.

In August 2002, the Company signed an Agreement to integrate CardioDynamics’ proprietary BioZ^® ICG technology into Vasomedical’s EECP^® enhanced external counterpulsation systems. By monitoring cardiac output before and after EECP therapy, physicians will have objective data to ascertain treatment effectiveness.  Recent research supports this combined approach as a useful tool.  Under the terms of the agreement, CardioDynamics would receive a licensing fee for each Original Equipment Manufacturer (OEM) board purchased by Vasomedical.

In November 2002, the Company signed a Distribution Agreement with SunTech Medical Instruments, Inc. (SunTech), the world leader in motion-tolerant noninvasive blood pressure monitoring products and technology.  Under the terms of the Agreement, SunTech’s new ambulatory blood pressure (ABP) monitor will be sold by CardioDynamics’ U.S. direct sales force and it’s distributors throughout North, Central, and South America.

Medicare and Other Third-Party Reimbursement

In the outpatient market, most medical procedures are reimbursed by a variety of insurance sources, including Medicare, Medicaid and private insurers.  The Center for Medicare & Medicaid Services (CMS), which is the governmental body that approves medical services for financial reimbursement under Medicare determines whether to reimburse for a given procedure and assigns an amount allowed.  In September 1998, the CMS mandated Medicare coverage of Electrical Bioimpedance services, such as the CardioDynamics BioZ^® on a national basis.  The established Medicare coverage for BioZ^® ICG systems has improved our ability to penetrate the outpatient market, as Medicare provides health insurance to some 75 million people in the United States.  In November 2000, the CMS established a uniform national pricing level for the use of our equipment.  In January 2002, the American Medical Association issued a formal Level I HCPCS procedure code for BioZ^® ICG technology. The 2003 national average allowable by the CMS for BioZ^® ICG is $ 46.01 per procedure, adjusted geographically based on pre-determined cost of living factors.

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In the United States hospital market, the financial and healthcare cost containment pressures resulting from per-capita compensation techniques required by health maintenance organizations and the CMS, with payment based on DRG or diagnosis-related groups, are driving hospitals to decrease costs.  A managed care system involving capitation rewards healthcare providers who utilize the most cost-effective methods available in order to maintain per-patient costs within the monthly fees.  When the BioZ is used instead of an invasive PAC, our product could reduce direct procedural costs by $600 per test and total hospitalization costs by an average of $13,600 per patient.  As a result, we believe a financial incentive exists, independent of third-party reimbursement circumstances, for hospitals to purchase and use our noninvasive products.

Marketing

Until recently, comprehensive hemodynamic information has been available only in acute care settings, such as an intensive care unit or operating room, through the use of PAC.  The BioZ^® ICG systems make obtaining and assessing this type of information simple, fast, cost-effective, safe, continuous and painless.  For these reasons, the utilization of noninvasive ICG technology is expanding in both hospital and outpatient environments.

Our primary prospects in the outpatient market include cardiologists, internal medicine physicians and family practitioners caring for congestive heart failure, hypertension and pacemaker patients.  Patients in the United States who may benefit from our technology include the 50 million hypertension patients, five million congestive heart failure patients, over one million pacemaker patients, 20 million emergency patients and many patients requiring fluid management.  The AHA estimates that over $329 billion will be spent in the United States during 2002 as a result of cardiovascular disease and stroke. Our marketing strategy is designed to:

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We believe that acceptance of our products within the outpatient and hospital markets will lay the foundation for the introduction of ICG technology into the home healthcare market which will allow patients with chronic illnesses, such as congestive heart failure, to monitor their hemodynamic status simply and inexpensively and to transmit this information, via telephone or Internet, to their physicians on a regular basis.  We believe that this “telemedicine” application has the potential to alert the physician effectively and efficiently to any changes in status, the need to adjust medications or patient noncompliance with prescribed treatment.

Our marketing promotion strategy is based on key medical conference participation, facsimile and mail direct response programs, select medical journal advertising and product and clinical education literature.

We actively support research utilizing the BioZ^® ICG systems to provide further clinical validation for ICG.  We seek to have these studies published in a peer-reviewed journal or presented at a major medical conference.  Clinical publications and presentations at major medical conferences provide us with increased exposure necessary to establish credibility for ICG technology and the BioZ^® ICG systems.

Research and Development

Our research and development team has extensive experience in the areas of ICG, physiologic signal processing, hardware and software development and regulatory compliance.  The team is responsible for on-going product engineering, new product development and basic research into ICG technology and additional noninvasive monitoring applications. 

We continue to upgrade the software of our core product, the BioZ^® ICG Monitor, as new applications arise.  Our hospital module, the BioZ ICG^® Module, was market released in 2001 and a new product platform is under development in a joint partnership with Philips to provide combined ECG and ICG patient assessment. Our research staff consists of both scientific and engineering professionals.  They have investigated the physiologic mechanisms underlying our ICG signal as a means of developing new diagnostic parameters.  They have also utilized digital signal processing methodology to improve the quality of signal acquisition and analysis algorithms.  The results of some of this research are included in several United States pending patents that will issue in 2003.

To supplement our engineering staff, we utilize Rivertek Medical Systems, Inc. (Rivertek), located in Minneapolis, Minnesota, as an adjunct to our internal research and development team.  Rivertek serves as an engineering consulting firm for medical device manufacturers, including Guidant Corporation and Medtronic, Inc., as well as emerging medical technology companies.  Dennis Hepp, our chief technology officer, founded Rivertek in 1988.  Rivertek employs 11 full time medical hardware, software and biomedical engineers.

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          Previous generation technology

More than 200 research papers on ICG technology have been published since 1993.  In general, these studies reported favorable results when comparing cardiac output measurements with those of other techniques, such as PAC.

Previous generation technology worked reasonably well in a select group of patients.  However, significant limitations on the technology became evident when monitoring ventilated patients and those with increasing heart rates, high heart rates, abnormal heartbeats, high respiration rates and pacemakers.  These limitations related to both hardware and software inadequacies.  As a result of intense research and development focus and concerted effort, combined with advances in computer processing power, we have addressed these limitations by improving the electronics and digital signal processing algorithms.

          New technology

As studies are conducted with our new technology, their results are summarized first as abstracts, and then as manuscripts that move through the peer review process towards publication.  This process can take two years or more to complete.  In 2002, several BioZ^® manuscripts began to reach the end of this process.  Studies detailing favorable comparisons with PAC and utility in hypertension monitoring were published in the Journal of Cardiothoracic and Vascular Anesthesia, the American Journal of Cardiology, and Hypertension.  Another comparison study will be published in Chest in 2003.

Clinical Studies

Our research and development team participates in monitoring and analysis of company-sponsored clinical trials, for which we employ clinical research specialists.  Each of these individuals has a strong clinical background and is responsible for monitoring clinical studies and assisting in research and customer training.

We are committed to supporting well-designed clinical research studies utilizing ICG technology that demonstrate validity, reproducibility, clinical utility and cost-effectiveness.  The results of several major studies addressing each of these areas have been released with positive results.  In May 2001, the results of a significant 100+ patient Mayo Clinic study was released at the American Society of Hypertension meeting held in San Francisco.  In May 2002, the study was published in the peer-review journal, Hypertension, and demonstrated a 70% superiority in effectively treating previously-uncontrolled hypertension patients when our BioZ^® ICG was used as compared to traditional management by high blood pressure specialist physicians.  In the study, one-half of the 104 resistant (uncontrolled) hypertension patients were treated with prescribed drugs based on traditional hypertension specialist evaluation and one-half of the patients were treated with prescribed drugs based upon the BioZ^®’s hemodynamic data.  The BioZ^® augmented-patient group reached goal (140/90 mm Hg) blood pressure 70% more often than the patients being treated without BioZ^® data.  The study’s investigators concluded, “noninvasive hemodynamic management achieved superior blood pressure levels and control rates, when compared to management by experienced hypertension clinicians.”

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In September 2001, we announced the results of a significant ICG clinical study (the Study) presented at the Fifth Annual Heart Failure (HFSA) Scientific Meeting in Washington, D.C.  The Study, presented by researchers from the Iowa Heart Center, demonstrated CardioDynamics ICG technology’s benefit in caring for pacemaker patients.  Optimization of the pacemaker setting using the BioZ^® ICG benefited 89% of all patients in the Study.  Small changes in pacemaker settings have the potential to create dramatic improvement in the heart’s ability to deliver blood to the body while reducing the amount of effort required.  The Study demonstrates the value of BioZ^®’s noninvasive measurements to document possible improvement in heart function for pacemaker patients.  The results confirmed that benefits could be obtained and allows identifying optimal settings for the pacemaker.  Based on the results of this study it appears that ICG technology may be more useful than the commonly used echocardiographic measurements.  In addition to completed studies, we are involved in a number of additional studies:

PREDICT - Prospective Evaluation and Identification of Cardiac Decompensation in Heart Failure by Impedance Cardiography Test.  Twenty-one research sites participated in this company-sponsored study with over 200 patients that have completed six months of monitoring.  The study design of PREDICT includes serial blinded measurements of ICG that are performed at two week intervals for 26 weeks.  All patients are managed according to the judgment of physicians and nurses responsible for the patients care, who are not aware of the ICG data.  The statistical analyses are underway and involve determining if changes in specific ICG variables reliably precede the development of worsening heart failure and also characterize how ICG hemodynamic parameters track with medication changes.

ESCAPE BIG - Evaluation Study of Congestive Heart Failure and Pulmonary Artery Catheterization Effectiveness Bio-Impedance Cardiography in Advanced Heart Failure.  We are participating as a sub-study with a primary objective of evaluating how accurately hemodynamics parameters obtained from ICG predict clinical outcomes and to evaluate the relationship between hemodynamic data derived from ICG with hemodynamic data obtained from invasive monitoring.  There are currently 139 patients enrolled in this sub-study, with a study goal of 300.

ED-IMPACT - Impedance Cardiography-Aided Assessment Changes Therapy in Emergent Dyspnea.  We are sponsoring an Emergency-Department-based study to show the impact upon diagnosis and treatment following the addition of BioZ^® data to the physician’s initial clinical impression and therapeutic plan.  Secondary endpoints will include an analysis of the changes in cost that resulted as a consequence of learning the hemodynamic data.  We also anticipate evaluating ICG data corresponding to initial chest x-ray, echocardiography, and BNP (B-type Natriuretic Peptide) diagnostic results.

CONTROL - Consideration Of Noninvasive Hemodynamic Monitoring to Target Reduction Of Blood Pressure Levels.  We are sponsoring a community-based study to replicate the results of our significant Mayo Clinic Study in a non-hypertension-specialist environment.  We are comparing the amount of time it takes to control blood pressure and the number and cost of hypertensive medications required.  This study is being conducted in two groups within each of four physicians’ patient populations where each physician has access to the BioZ^® data in only half of the study patients.

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Medical Advisory Board

We have established a distinguished medical advisory board consisting of 19 physicians, many of whom are affiliated with prestigious universities and well-known medical institutions throughout the United States such as Stanford University School of Medicine, Cleveland Clinic, Scripps Clinic, University of California, San Diego and Christ Hospital and Medical Center.  Our members, who have expertise in disciplines such as; cardiology, electrophysiology, anesthesiology, hypertension, pulmonary and critical care, internal medicine, heart failure and emergency medicine, are as follows: 

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Medical Advisory Board -continued

Our medical advisory board provides guidance regarding clinical trials, technological improvements and potential uses for our products.  Members of the medical advisory board receive reimbursement for their expenses in attending CardioDynamics-sponsored meetings and, in some cases, receive consulting fees for time spent working on our behalf.  No fees were paid to the members during fiscal 2002, 2001 or 2000 for services on our medical advisory board, however, in some cases, members received options to purchase shares of our common stock for participating in meetings and studies.

Manufacturing

We are licensed as a healthcare device manufacturer by the Food and Drug Branch of the California Department of Health Services, which is the State of California equivalent of the FDA, and operate under the FDA Good Manufacturing Practice regulation.

Our production process for the BioZ^® ICG Monitors consists primarily of final assembly, integration and testing of standard and custom components. We currently outsource to a third-party the production of our BioZtect^® sensors and patient boards to qualified subcontractors, who have met our supplier certification process and are placed on an approved vendor list.

We have implemented quality procedures and documentation required for successful International Organization for Standardization (ISO) 9001 certification.  In June 1998, we received ISO 9001 and EN 46001 quality certification for developing and marketing medical devices.

We maintain a quality-assurance program covering our manufacturing operations. Suppliers of purchased components are required to meet stated specifications.  We certify suppliers prior to use by conducting audits and product inspections.  We engage in ongoing evaluations of the performance of our suppliers by evaluating the results of inspections and tests as well as the timeliness of product deliveries.  We employ numerous quality-assurance procedures during our in-house manufacturing processes to ensure that our finished products meet our specifications.  Quality assurance procedures include operator training, process validation, equipment calibration, inspection and testing.  All manufacturing procedures and processes are formally approved and updated using established revision control procedures.  Documentation of in-house and final testing results is maintained in device history records for every unit.  We maintain an ongoing post-sale performance-monitoring program.

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Warranty and Service

Our new BioZ^® ICG systems come with a standard five-year, parts and labor warranty commencing at the date of shipment.  When warranty repairs are necessary, we generally perform them at our headquarters.  In some cases, our distributors perform repairs in authorized service centers.  We also provide field clinical support specialists as necessary, as well as 24-hour on-call technical support.  In addition to the standard warranty, we offer Zcare^® extended service agreements for hardware and software maintenance beyond the warranty period.  We also service equipment on a time and materials basis.

Competition

          Direct competition

We are aware of three domestic and two international manufacturers of ICG monitors.  Since all five companies are privately held, sales and financial figures for these competitors are not available.  We believe that our BioZ^® products provide the most advanced ICG monitoring and commercially attractive designs, at prices that are competitive.  Thus far, we have not observed sales and marketing efforts by  these companies in the market place and to our knowledge we have not lost a single sale in direct competition with any of these competitors.

          Indirect competition

          PAC

Also known as thermodilution, right heart catheterization or Swan-Ganz™ catheterization, the PAC procedure was introduced in the early 1970’s.  Despite its limitations, costs and risks, PAC remains the most commonly used technology for monitoring hemodynamic status.  Medical Data International estimates that PAC procedures are used nearly 2 million times per year worldwide.  The estimated cost of PAC to the United States healthcare system in 1997 was $2 billion for the cost of the catheters and their insertion and $15 billion per year for the cost of complications arising from the procedure.  Edwards Lifesciences, Abbott Laboratories and Datex-Ohmeda produce the majority of right heart catheters used in the United States.

PAC is an invasive procedure involving an incision into a patient’s neck or groin region and the insertion of a catheter (plastic tube) through the vascular system and through the heart directly into the pulmonary artery.  Complications associated with this procedure occur in as many as one in four reported cases and include irregular heartbeats, infection, pulmonary artery rupture and death.  Additionally, a September 1996 study published in the Journal of the American Medical Association (JAMA) determined that the use of PAC to monitor cardiac output significantly increased the risk of death in critically ill patients.  This study, which examined data from 5,735 intensive-care patients treated at five United States medical centers, reported that patients who underwent PAC had a 21% higher risk of death within 30 days of discharge, as compared to those who did not undergo the procedure.  The importance of this finding is underscored by the fact that patients in both groups were matched for disease severity and prognosis.

Another significant drawback in the use of PAC is cost.  The PAC procedure requires a hospital to allocate valuable resources in terms of an intensive care unit bed, a cardiac catheterization laboratory or operating room, highly skilled medical personnel and expensive equipment to obtain non-continuous hemodynamic data.  According to the JAMA study, the mean cost of the hospital stay for critically-ill patients having a PAC was $13,600 greater than the $35,700 cost for similar critically-ill patients who did not undergo a PAC.

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Many patients who might otherwise benefit from hemodynamic monitoring are excluded presently because the risks and costs associated with PAC often outweigh the potential benefits.  ICG technology eliminates PAC-caused complications and death, lowers costs, reduces procedure time, expands clinical applications and offers immediate availability of vital, real-time and continuous hemodynamic data.

          Echocardiography

Echocardiography (echo) is a medical diagnostic tool utilizing ultrasound frequency waves to detect anatomical abnormalities of the heart and blood vessels.  Echo technology was developed during the 1970’s and has advanced through the years with the addition of sophisticated electronics and digitalization for acquisition of better images.  A continuous wave suprasternal Doppler echo measures cardiac output noninvasively by placing a Doppler transducer on the chest, aiming it toward the ascending aorta and measuring aortic blood flow velocity.  Specifically, echo measures the aortic diameter and the movement of red blood cells to determine the velocity and direction of blood flow to calculate stroke volume and thus calculate cardiac output.

Limitations in measuring cardiac output via echo include:

In addition, echo is a time-consuming procedure that typically requires 30-45 minutes, and in some patients, reliable, accurate images simply cannot be obtained for unknown reasons.

          Trans-esophageal echo

Trans-esophageal echo has been developed in recent years to obtain closer images of the heart.  It is useful in patients for whom examination from the usual position is technically impossible and for hospitalized patients undergoing cardiac surgery.  Trans-esophageal echo is performed with the ultrasound transducer placed invasively in the esophagus through the mouth.  Although this procedure enables more direct, accurate images of the heart, disadvantages include its invasive nature, increased patient discomfort and the requirement for patient sedation to promote procedure tolerance.  In addition, patient airway complications may result, therefore emergency equipment, such as oxygen, intubation equipment and ECG monitoring must be available.  The procedure is customarily performed with several attendants, including an echo technician, a nurse and a physician.

          Direct Fick

Direct Fick was the original method conceived in the late 1800’s to measure cardiac output.  It is based on calculating the oxygen difference between the arterial and venous blood, along with oxygen inhalation and expiration.  The Direct Fick method is seldom used because it is time consuming, costly and complicated.  A variation of the Direct Fick method is called CO₂ Re-breathing, or Indirect Fick.  It was introduced in 1980’s to the hospital surgical market.  The CO₂ Re-breathing method is limited to patients who are mechanically ventilated, which severely restricts the number of patients who are candidates for the procedure.  In addition, lack of CMS-mandated reimbursement creates a barrier for adoption by the medical community.

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Intellectual Property

Our success will, to some extent, depend on our ability to maintain patent protection for our products and processes, to preserve our trade secrets and proprietary technology and to operate without infringing upon the patents or proprietary rights of others.  Currently, we hold one United States patent issued prior to the re-engineering of our products to incorporate digital signal processing that will expire in 2009.  Our research department has developed new technologies for which we have filed five United States utility patent applications; three of which will issue in 2003.  To protect our electrode technology, we hold one United States design patent, licensed two patents, and have filed two other United States design patents that will issue in 2003.  We also have developed proprietary software, which we have elected not to disclose through the patent application process.  Other research is being conducted that may lead us in the future to file new patent applications.

Government Regulation

In November 1996, we received 510(k) clearance from the FDA to market the BioZ^® system.  In September 1997, the FDA granted 510(k) clearance to market the BioZ Portable and to implement our proprietary DISQ^® technology into redesigned monitors.  DISQ^® provides improved measurement of impedance waveforms through enhanced digital signal processing and automatic calibration. 

In March 1998, we received 510(k) marketing clearance for our BioZ^® ICG Monitor (previously called the BioZ.com^®).  The BioZ^® ICG Monitor incorporates our Z MARC^® algorithm, which allows the system to sense and modulate values on patients with over-compliant or under-compliant aortas.

Our products and activities are subject to extensive, ongoing regulation by the FDA and other governmental and foreign regulatory agencies.  Under the Federal Food, Drug and Cosmetic Act, the FDA regulates the clinical testing, manufacture, labeling, packaging, marketing, distribution and record keeping for medical devices.  Delays in receipt of, or failure to obtain or maintain, regulatory clearances and approvals, or any failure to comply with regulatory requirements, could delay or prevent our ability to market our product line.

The Federal Food, Drug and Cosmetic Act require that medical devices be manufactured in accordance with good manufacturing practice requirements.  Good manufacturing practice requirements specify, among other things, that:

Before a new device may be introduced or marketed, the manufacturer generally must obtain either FDA 510(k) clearance or approval of a pre-market approval application.  FDA clearance or approval may entail an expensive, lengthy and uncertain process.  We have received a marketing clearance for the BioZ^® system, the BioZ.pc and the BioZ^® ICG Monitor and BioZ^® ICG Module. These clearances are nevertheless subject to continued FDA audits and may be rescinded if we change the design of our technology.  Further, we plan to submit additional new products for FDA clearance or approval in the future.  It is possible that our future products may not gain FDA clearance or approval in a timely fashion, or at all.

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We are also subject to routine inspection by the FDA and state agencies, such as the California Department of Health Services, for compliance with good manufacturing practice requirements, medical device reporting requirements and other applicable regulations.  Violation or alleged violation of these regulations may result in government action ranging from warning letters to criminal prosecution.  Companies who violate these regulations are also subject to penalties of up to $500,000. As of February 24, 2003, we have not been cited for any violations.

Manufacturing facilities are subject to FDA inspection on a periodic basis to monitor compliance with current good manufacturing practice requirements.  Labeling and promotional activities are regulated by the FDA and, in some circumstances, by the Federal Trade Commission.  Modifications or enhancements that could significantly affect the safety or effectiveness of a device or that constitute a major change to the intended use of the device require a new 510(k) submission.  If the FDA requires us to submit a new 510(k) notice for any product modification, even one that addresses device performance issues, we may be prohibited from marketing the modified product until the 510(k) notice is cleared by the FDA.

Laws and regulations regarding the manufacture, sale and use of medical devices are subject to change and depend heavily on administrative interpretations.  Future changes in the regulations or interpretations made by the FDA or other regulatory bodies may have retroactive effect and may adversely affect us.

In order to sell our products within the European community, we must comply with the European Commission’s medical device directive.  In late 1998 we received authorization from TUV Rhineland of North America to place the CE mark on our BioZ^® ICG Monitor.  The CE mark is recognized worldwide as an essential European regulatory approval and enables us to expand our sales and distribution of the BioZ^® ICG Monitor throughout Europe.  Future regulatory changes could limit our ability to use the CE mark, and any new products we develop may not qualify for the CE mark.  If we fail to obtain authorization to use the CE mark or lose this authorization, we will not be able to sell our products in the European community.  In December 2001, we had our annual compliance review and we passed without any significant issues.  In May 2000, we received approval from the State Drug Administration of the People’s Republic of China and in November 2000, we received a Canadian Medical Device License. 

Employees

As of February 1, 2003, we had 133 employees, two of which are considered part-time.  Of this number, 79 are sales and marketing, 19 are manufacturing, 17 are research and development, and the balance are management or administration.

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RISK FACTORS

We depend upon on our BioZ^® product line, the market acceptance of which is in its early stages.

Our future is dependent upon the success of the BioZ^® product line and similar products that are based on the same core technology.  The market for these products is in a relatively early stage of development and may never fully develop as we expect.  The long-term commercial success of the BioZ^® product line requires widespread acceptance of our products as safe, efficient and cost-effective.  Widespread acceptance would represent a significant change in medical practice patterns.  In the past, some medical professionals have hesitated to use ICG products because of limitations experienced with older, analog-based monitors.  Invasive procedures, such as PAC, are generally accepted in the medical community and have a long history of use.

We have sponsored, and will continue to sponsor or conduct clinical trials.  We cannot be certain that clinical trials will be completed, that they will have a positive outcome or that a positive outcome in these trials will be sufficient to promote widespread acceptance of our products within the medical community.

Our success depends in part upon the availability of third-party reimbursement at adequate price levels.

Our success will depend in part on the availability of adequate reimbursement from third-party healthcare payers, such as Medicare, private health insurers and managed care organizations.  Third-party payers increasingly challenge the pricing of medical products and services.  Third-party payers may not cover the cost of a device and related services, or they may place significant restrictions on the circumstances in which coverage will be available.  In addition, reimbursement may not be at or remain at price levels adequate to allow medical professionals to realize an appropriate return on the purchase of our products. 

If we are required to account for options under our employee stock plans as a compensation expense, our net income and earnings per share would be significantly reduced.

There has been increasing public debate about the proper accounting treatment for employee stock options.  Currently we record compensation expense only in conjunction with option grants to non-employees.  For employee option grants we calculate compensation expense and disclose the impact on net income (loss) and net income (loss) per share in a footnote to our financial statements.  It is possible that future laws and regulations will require us to record compensation expense for employee stock option grants in our statement of operations.  Note 8, “Stock Options”, of our financial statements reflects the impact that such a change in accounting treatment would have had on our net income (loss) and net income (loss) per share if it had been in effect during the past three years.

Technological change is difficult to predict and to manage.

We face the challenges that are typically faced by companies emerging from the development phase.  Our product line has required, and any future products will require, substantial development efforts and compliance with governmental clearance or approval requirements.  We may encounter unforeseen technological or scientific problems that force abandonment or substantial change in the development of a specific product or process.

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We must maintain and develop strategic relationships with third parties to increase market penetration of our product lines.

We distribute our products to targeted international markets through our strategic alliance with GEMS-IT and a network of regional distributors.  We intend to enter into similar agreements with other companies and to establish technology partnerships with pacemaker and other medical product and technology companies.  Widespread acceptance of our BioZ^® products is dependent on our establishing and maintaining these strategic relationships with third parties and on the successful distribution efforts of third parties.

Many aspects of our relationships with third parties, and the success with which third parties promote distribution of our products, are beyond our control.  We may be unsuccessful in maintaining our existing strategic relationships and in identifying and entering into future development and distribution agreements with third parties.

We depend on management and other key personnel.

We are dependent on a limited number of key management and technical personnel.  The loss of one or more of our key employees may hurt our business if we are unable to identify other individuals to provide us with similar services.  We do not maintain “key person” insurance on any of our employees.  In addition, our success depends upon our ability to attract and retain additional highly qualified sales, management, manufacturing and research and development personnel.  We face intense competition in our recruiting activities and may not be able to attract or retain qualified personnel.

We depend on Rivertek Medical Systems and other third parties for development and manufacturing services.

Our strategy for development and commercialization of some of our products depends upon entering into various arrangements with third parties and upon the subsequent success of these parties in performing their obligations.  We may not be able to negotiate acceptable arrangements in the future, and our existing arrangements may not be successful.  We rely on contracted development services, particularly from Rivertek Medical Systems, Inc.  Also, we currently assemble our products from components manufactured by a limited number of manufacturers.  Therefore, we are dependent on component and subassembly manufacturers.  If we experience a termination, modification or disruption of any of our development or manufacturing arrangements, we may be unable to deliver products to our customers on a timely basis, which may lead to customer dissatisfaction and damage to our reputation. 

We may not have adequate intellectual property protection.

Our patents and proprietary technology may not be able to prevent competition by others.  In addition, in the future, our products may be found to infringe upon the rights of others.  From time to time, we have received communications from third parties asserting that features of some of our products may infringe on the intellectual property rights of others.  Any claims resulting in intellectual property litigation, whether defensive or offensive, would have no certain outcome other than to drain our resources.

The validity and breadth of claims in medical technology patents involve complex legal and factual questions.  Future patent applications may not be issued, the scope of any patent protection may not exclude competitors, and our patents may not provide competitive advantages to us.  Our patents may be found to be invalid and other companies may claim rights in or ownership of the patents and other proprietary rights held or licensed by us.  Also, our existing patents may not cover products that we develop in the future.  Moreover, when our patents expire, the inventions will enter the public domain.  See “Business – Intellectual Property.”

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Since patent applications in the United States are maintained in secrecy until patents are issued, our patent applications may infringe patents that may be issued to others.  If our products were found to infringe patents held by competitors, we may have to modify our products to avoid infringement, and it is possible that our modified products would not be commercially successful.

We are subject to stock exchange and government regulation.

Recent Sarbanes-Oxley legislation and stock exchange regulations have increased disclosure control, financial reporting, corporate governance and internal control requirements that will increase the  administrative costs of documenting and auditing internal processes, gathering data, and reporting information.  Our inability to comply with the requirements would significantly impact our market valuation. 

We face competition from other companies and technologies.

We compete with other companies that are developing and marketing noninvasive hemodynamic monitors.  We are also subject to competition from companies that support invasive technologies.  Many of these companies have more established and larger marketing and sales organizations, significantly greater financial and technical resources and a larger installed base of customers than we do.  The introduction by others of products embodying new technologies and the emergence of new industry standards may render our products obsolete and unmarketable.  In addition, other technologies or products may be developed that have an entirely different approach or means of accomplishing the intended purposes of our products.  Accordingly, the life cycles of our products are difficult to estimate.  To compete successfully, we must develop and introduce new products that keep pace with technological advancements, respond to evolving consumer requirements and achieve market acceptance.  We may be unable to develop new products that address our competition.

Our business plan contemplates an income stream from sales of disposable sensors that are compatible with an installed base of our monitors.  We may be subject to price competition from other sensor manufacturers whose products are also compatible with our monitors. To mitigate this we successfully developed proprietary sensor technology that provides enhanced features to our customers and promotes the exclusive use of our proprietary sensors with our equipment.

In addition, our current and potential competitors may establish cooperative relationships with large medical equipment companies to gain access to greater research and development or marketing resources.  Competition may result in price reductions, reduced gross margins and loss of market share.

We have a history of losses and may experience continued losses.

With the exception of fiscal 2002, we have experienced losses every year.  These losses have resulted because we have expended more money in the course of researching, developing and enhancing our technology and products and establishing our sales, marketing and administrative organizations than we have generated in revenues.  We expect that our operating expenses will continue to increase in the foreseeable future as we increase our sales and marketing activities, expand our operations and continue to develop our technology. It is possible that we will not be able to achieve the revenue levels required to sustain profitability.

We may need additional capital, which may be unavailable.

The commercialization of our current product line and the development and commercialization of any additional products may require greater expenditures than expected in our current business plan.  Our capital requirements will depend on numerous factors, including:

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We may be unable to predict accurately the timing and amount of our capital requirements.  We may be required to raise additional funds through public or private financing, bank loans, collaborative relationships or other arrangements earlier than expected.  It is possible that banks, venture capitalists and other investors may perceive our capital structure, our history of losses or the need to achieve widespread acceptance of our technology as too great a risk to bear.  As a result, additional funding may not be available on attractive terms, or at all.  If we cannot obtain additional capital when needed, we may be forced to agree to unattractive financing terms, to change our method of operation or to curtail our operations.

We may not be able to manage growth.

If successful, we will experience a period of growth that could place a significant strain upon our managerial, financial and operational resources.  Our infrastructure, procedures, controls and information systems may not be adequate to support our operations and to achieve the rapid execution necessary to successfully market our products.  Our future operating results will also depend on our ability to successfully upgrade our information systems, expand our direct sales force and our internal sales, marketing and support staff.  For example, we intend to implement a new software system during 2003 to assist in the management of our business, and there can be no assurance that we will be able to do so successfully or without disruption in our business.  If we are unable to manage future expansion effectively, our business, results of operations and financial condition will suffer, our senior management will be less effective, and our revenues and product development efforts may decrease.

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Our quarterly operating results frequently vary due to factors outside our control.

We have experienced and expect to continue to experience fluctuations in quarterly operating results as a result of a number of factors.  We cannot control many of these factors, which include the following:

For these reasons, you should not rely on period-to-period comparisons of our financial results as indications of future results.

We may not continue to receive necessary FDA clearances or approvals.

Our products and activities are subject to extensive, ongoing regulation by the Food and Drug Administration and other governmental authorities.  Delays in receipt of, or failure to obtain or maintain, regulatory clearances and approvals, or any failure to comply with regulatory requirements, could delay or prevent our ability to market or distribute our product line.

We may not receive approvals by foreign regulators that are necessary for international sales.

Sales of medical devices outside the United States are subject to foreign regulatory requirements that vary from country to country.  If we, or our international distributors, fail to obtain or maintain required pre-market approvals or fail to comply with foreign regulations, foreign regulatory authorities may require us to file revised governmental notifications, cease commercial sales of our products in the applicable countries or otherwise cure the problem.  Such enforcement action by regulatory authorities may be costly.

In order to sell our products within the European community, we must comply with the European community’s medical device directive.  The CE marking on our products attests to this compliance.  Future regulatory changes may limit our ability to use the CE mark, and any new products we develop may not qualify for the CE mark.  If we lose this authorization or fail to obtain authorization on future products, we will not be able to sell our products in the European community.

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We do not know the effects of healthcare reform proposals.

The healthcare industry is undergoing fundamental changes resulting from political, economic and regulatory influences.  In the United States, comprehensive programs have been suggested seeking to increase access to healthcare for the uninsured, control the escalation of healthcare expenditures within the economy and use healthcare reimbursement policies to balance the federal budget.

We expect that the United States Congress and state legislatures will continue to review and assess various healthcare reform proposals, and public debate of these issues will likely continue.  We cannot predict which, if any, of such reform proposals will be adopted and when they might be effective.  Other countries also are considering healthcare reform.  Significant changes in healthcare systems could have a substantial impact on the manner in which we conduct our business and could require us to revise our strategies.

We are subject to product liability claims and product recalls that may not be covered by insurance.

The nature of our business exposes us to risks of product liability claims and product recalls.  Medical devices as complex as ours frequently experience errors or failures, especially when first introduced or when new versions are released.  For example, we voluntarily retrieved 43 units of our new BioZ^® ICG monitor’s from purchasers in December 2001 due to performance issues identified in conjunction with early users of this product.  All units were replaced and we have retrofitted the retrieved units to address the performance issues.  Our products are sometimes used in procedures where there is a high risk of serious injury or death.  These risks will exist even with respect to those products that have received, or may in the future receive, regulatory clearance for commercial sale.

We did not carry product liability insurance during some periods before May 15, 1995. We currently maintain product liability insurance at $9,000,000 per occurrence and $10,000,000 in the aggregate.  Our product liability insurance may not be adequate.  In the future, insurance coverage may not be available on commercially reasonable terms, or at all.  In addition, product liability claims or product recalls could damage our reputation even if we have adequate insurance coverage.

Our common stock is subject to price volatility.

The market price of our common stock has been and is likely to continue to be highly volatile.  Our stock price could be subject to wide fluctuations in response to various factors beyond our control, including:

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Our future operating results may fall below the expectations of securities industry analysts or investors.  Any such shortfall could result in a significant decline in the market price of our common stock.  In addition, the stock market has experienced significant price and volume fluctuations that have affected the market prices of the stock of many medical device companies and that often have been unrelated to the operating performance of such companies.  These broad market fluctuations may directly influence the market price of our common stock.

We may be required to issue additional shares of common stock at prices that are below then market value.

The holders of warrants to purchase our common stock could require us to issue additional shares of common stock to them pursuant to anti-dilution rights.  These rights would cause us to issue additional common stock upon exercise of their warrants if we sell common stock at a price less than the exercise price of their warrants.  If we need to sell common stock at a time when the market price for our shares is depressed, these anti-dilution rights could further depress the market price and impair our ability to raise needed capital. As of February 15, 2003 there were warrants for 2,379,536 shares of common stock outstanding.

Our international sales expose us to unique risks.

In fiscal 2002, international sales accounted for approximately 5% of our net sales.  We believe that international sales will represent a meaningful portion of our revenue in the future.  We rely on GEMS-IT and other regional distributors to assist us with our international sales efforts.  We are exposed to risks from international sales, which include unexpected changes in regulatory requirements, tariffs and other barriers and restrictions and reduced protection for intellectual property rights.  Moreover, fluctuations in the rates of exchange may increase the price in local currencies of our products in foreign markets and make our products relatively more expensive than competitive products.

Terrorist attacks in the United States and the threat of war have affected travel, the stock market, the postal service and the general economy.

On September 11, 2001, terrorists carried out attacks that destroyed the World Trade Center in New York and badly damaged the Pentagon outside Washington, D.C.  In the wake of these attacks, stock prices broadly declined from the prices that existed prior to the attacks.  In addition to affecting the stock markets, the terrorist attacks may affect the United states and international economies because of the uncertainties that exist as to how the United States will respond in the future and as to whether additional attacks will be carried out against the United States.  For example, the United States has undertaken to enforce compliance with the United Nations resolutions seeking to enforce the disarmament of Iraq.  Such enforcement could lead to hostilities and an adverse effect on the stock markets and United States and international economies.  These uncertainties brought about challenges in travel, mail delivery and contributed to a slowdown in economic activity in the United States and beyond.  Limitations on travel by our sales and clinical staff could negatively effect our ability to achieve our revenue goals.  Additionally, travel closures or delays could negatively impact deliveries of raw materials from our vendor required to manufacture our products including the disposable sensors and deliver them in a timely way to our customers.  Delays in the delivery of mail could inhibit our ability to invoice and collect amounts owed to us.  The weakened economy may have the effect of and impacting the ability of our management and sales staff to conduct business and, as a result, decreasing our sales.

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Recent corporate scandals involving alleged accounting irregularities have resulted in unavailability of, or significantly higher premiums for director and officer liability insurance.

As a result of recent well publicized corporate business failures alleged to have involved improper acts by executives and accounting irregularities, director and officer liability insurance has become more difficult to obtain and the premiums for such insurance have increased significantly.  If we are unable to obtain director and officer liability insurance at rates that are reasonable or at all, we may not be able to retain our current officers and directors or attract qualified directors and officers in the future.

Common stock that is available for immediate resale may depress our market price.

We have filed registration statements with the Securities and Exchange Commission covering the potential resale by our shareholders of up to 18,700,000 shares of common stock, much of which may not have been sold.  The existence of a substantial number of shares of common stock subject to immediate resale could depress the market price for our common stock and impair our ability to raise needed capital.

A low stock price could result in our being de-listed from the Nasdaq Market and subject us to regulations that could reduce our ability to raise funds.

If our stock price were to drop below $1.00 per share and remain below $1.00 per share for an extended period of time, or if we fail to maintain other Nasdaq criteria, Nasdaq may de-list our common stock from the Nasdaq National Market.  In such an event, our shares could only be traded on over-the-counter bulletin board system.  This method of trading could significantly impair our ability to raise new capital.

In the event that our common stock was de-listed from the Nasdaq National Market due to low stock price, we may become subject to special rules, called penny stock rules that impose additional sales practice requirements on broker-dealers who sell our common stock.  The rules require, among other things, the delivery, prior to the transaction, of a disclosure schedule required by the Securities and Exchange Commission relating to the market for penny stocks.  The broker-dealer also must disclose the commissions payable both to the broker-dealer and the registered representative and current quotations for the securities, and monthly statements must be sent disclosing recent price information.

In the event that our common stock becomes characterized as a penny stock, our market liquidity could be severely affected.  The regulations relating to penny stocks could limit the ability of broker-dealers to sell our common stock and thus the ability of purchasers in this offering to sell their common stock in the secondary market.

We have no experience with home healthcare.

We intend to enter the home healthcare market through pursuit of strategic relationships with other parties.  We have not concluded any agreements or understandings with any third parties, and we may not be able to enter into any arrangements on terms satisfactory to us.  Even if we are successful in negotiating acceptable arrangements with third parties, the parties may not perform their obligations to us for reasons beyond our control.  If we are not able to negotiate arrangements with other parties to implement our home healthcare strategy, or if such arrangements, once negotiated, are not successful, we will not be able to expand our business in this market.

We do not intend to pay dividends in the foreseeable future.

We do not intend to pay any cash dividends on our common stock in the foreseeable future.  Payment of such cash dividends would, in any event, be prohibited or limited under the terms of our line of credit with Comerica Bank.

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ITEM 2.           PROPERTIES

Our executive offices are located in an approximately 18,000 square foot leased facility in San Diego, California.  This facility houses all of our research, development, manufacturing, marketing, sales and administrative activities except for field and contract personnel.  Approximately 12,000 square feet of the facility is being utilized by our research, development and manufacturing functions with the balance occupied by our marketing, sales and administrative staff.  The five-year lease expires on August 1, 2007.

ITEM 3.           LEGAL PROCEEDINGS

We are from time to time subject to legal proceedings and claims, which arise in the ordinary course of our business.  Management believes that resolution of these matters will not have a material adverse effect on our results of operations or financial condition. 

ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended November 30, 2002.

PART II

ITEM 5.           MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is quoted on the Nasdaq National Market^SM under the symbol CDIC.  The following table sets forth for the periods indicated the high and low closing prices per share of common stock as furnished by The Nasdaq National Market^SM.

On February 11, 2003 there were 522 holders of record of our common stock with 46,186,297 shares outstanding.  Our total shareholder base is just over 13,000.  We have not declared or paid any cash dividends on shares of our common stock and do not anticipate paying any cash dividends in the foreseeable future.  We currently intend to retain any future earnings for use in the operation of our business.

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ITEM 6.           SELECTED FINANCIAL DATA

The following table summarizes certain selected financial information for, and as of the end of, each of the fiscal years in the five-year period ended November 30, 2002.  The information set forth below is derived from the financial statements of the Company which were audited by KPMG LLP, independent auditors, and should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Financial Statements and related Notes.

(1) On July 25, 2000, we completed an $18,700,000 private placement of approximately 3,300,000 shares of common stock to institutional and other accredited investors.  The investors purchased unregistered common stock at $5.59 per share.  In addition, portions of the proceeds were used to repurchase, at $5.59 per share, and retire 418,908 shares from the estate of Allen E. Paulson.  In connection with the private placement, the Company incurred issuance costs totaling $1,382,000.

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ITEM 7.           MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following management’s discussion and analysis of financial condition and results of operation should be read together with our Financial Statements and the Notes related to those statements, as well as the other financial information included in this Form 10-K.  Some of our discussion is forward-looking and involves risks and uncertainties.  For information regarding risk factors that could have a material adverse effect on our business, refer to Part I, Item 1 of this Form 10-K, Business - Risk Factors.

Results of Operations (This discussion refers to fiscal years which ended on November 30)

Net Sales were $23,523,000, $19,598,000, and $13,102,000 for fiscal years 2002, 2001 and 2000, respectively.  The annual sales growth was achieved primarily by increased unit sales by our domestic direct sales force, higher average unit sales prices and increased recurring sensor sales as our installed base continues to grow.  In fiscal 2001, initial purchases of $2,263,000 in BioZ^® ICG module kits from our strategic partner, GEMS-IT added to the sales growth.  We believe demand for our products continues to grow as the medical community’s recognition of the clinical usefulness of our BioZ^® increases.

In March 1998, we received FDA 510(k) marketing clearance for our BioZ® ICG Monitor (previously called the BioZ.com^®).  The BioZ^® ICG Monitoris compact and features a transport battery, integrated blood pressure, pole cart and printer.  The BioZ^® ICG Monitor utilizes our proprietary ICG technology, DISQ^® technology and Z MARC^® algorithm for improved measurement of impedance waveforms and automatic electronic calibration.  The BioZ^® ICG systems accounted for 85% of our overall revenues in fiscal 2002, compared with 78% and 92% of our overall sales in fiscal 2001 and 2000, respectively.  The fluctuation in the percentage of equipment sales is due to increasing sales of sensors and in 2001, a larger percentage of our net sales were from the initial shipments of the BioZ^® ICG modules to GEMS-IT.

Sales by our domestic direct sales force, which targets physician offices and US hospitals, increased 43% in fiscal 2002 as compared to fiscal 2001, with sales of $22,212,000 and $15,571,000, respectively.  When comparing fiscal 2001 sales of $15,571,000 to fiscal 2000 sales of $9,677,000 the increase was 61%.  The average price per unit sold by our direct sales force has increased 28% in the last three years, from approximately $25,000 in the fourth quarter of fiscal 1999, to $32,000 in the fourth quarter of fiscal 2002.  There are several reasons for this increase in price per unit, which include greater awareness and acceptance of ICG technology, uniform nationwide Medicare reimbursement, inclusion of additional options, inclusion of a five-year warranty and certain accessories, and the absence of competitive products or cost-effective alternative technologies.  In fiscal 2000, we began to hire clinical application specialists to supplement the direct sales force.  These clinical application specialists assist in three primary areas: pre-sales activities including demonstrations, initial set-up and training for physician and staff, in-servicing customers post-sale, and on-going customer support to increase customer satisfaction and increase recurring sales from our proprietary disposable sensors.

In November of 1998, we received CE Mark approval for our BioZ^® ICG Monitor, which expanded our opportunities for distribution in Europe.  In 1999 and 2000, we developed and expanded our strategic alliance with GEMS-IT for exclusive distribution of our BioZ^® ICG Monitorto select countries around the world.  Through GEMS-IT and our other international distributors, we now have representation in over 70 countries throughout Europe, Asia Pacific, Africa, the Middle East, Australia, New Zealand and Latin America.  In May 2000, we received State Drug Administration approval from the People’s Republic of China and in November 2000, a license to sell medical devices in Canada.

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Results of Operations - (Continued)

Sales to our international distributors and strategic partner internationally were $1,181,000, $914,000, and $1,140,000 for fiscal years 2002, 2001 and 2000, respectively.

Sales to our domestic strategic partners were $130,000, $3,113,000 and $2,264,000 for fiscal years 2002, 2001 and 2000, respectively.  Our agreement with GEMS-IT called for yearly minimum purchase commitments that expired in 2001 and therefore sales in fiscal 2002 were significantly less.  In the second quarter of fiscal 2001, we commenced shipments to GEMS-IT of the BioZ^® ICG Module, a custom plug-in module for the GEMS-IT series of bedside monitors.  This product extends the capabilities of the GEMS-IT Solar product family to provide all of the hemodynamic parameters of the BioZ^® ICG Monitor.  The BioZ^® ICG Module is distributed worldwide by GEMS-IT for their Solar^® 7000, 8000, 8000M, and DASH 3000, 4000 patient monitors.  In the second quarter of fiscal 2002, we entered into an OEM agreement with GEMS-IT which provides our direct sales force exclusive rights to sell BioZ^® ICG modules directly into the GEMS-IT installed customer base of over 30,000 units while allowing the GEMS-IT sales force to continue to sell the BioZ^® ICG Module as an additional high-value parameter for new system sales.  The modules we sell will be manufactured jointly by GEMS-IT and CardioDynamics and will be carried in our inventory until sold to the end-user.

Included in domestic strategic partner sales in fiscal 2000, is $644,000 of sales to Profiles in Health, Inc. Under the terms of the agreement, we manufactured and sold customized ICG monitors called BioZ.pc, for integration into the Profiles in Health Proveillance™ system for use by healthcare providers and managed care organizations throughout the United States.  Although Profiles in Health, Inc. continues to pursue funding, we established a 100% allowance for the note receivable and accounts receivable and inventory unique to this contract as Profiles in Health Inc.’s inability to pay became apparent in our fourth quarter of 2000.  We did not sell or manufacture any inventory related to this agreement in fiscal 2001 or 2002.

In April 2001, we entered into a co-promotional agreement with Vasomedical, Inc. which allows our direct sales force, along with Vasomedical’s sales force, to jointly market our BioZ^® ICG Monitors and Vasomedical’s EECP^® enhanced external counterpulsation systems to physicians and hospitals throughout the United States.  That same month, we entered into an agreement with Spacelabs Medical, Inc. for development of an interface using Spacelab’s Universal Flexport^® to integrate and display our ICG technology on their Ultraview Care Network™ monitoring system.  In August 2001, we launched the Government Market Initiative Program to target and further penetrate Government markets. The program provides tools and incentives to our direct sales force to promote sales to VA hospitals. 

On March 22, 2002, we announced an agreement between our company and Medtronic, Inc. that provided for the evaluation of clinical utility of our proprietary IGC technology in optimizing the programming of Medtronic’s implantable device for Cardiac Resynchronization Therapy (CRT).  The six-month research project, now concluded, involved a collaborative effort of the two companies and University of Kentucky medical centers and Iowa Heart Center.  While they maintain a willingness to reconsider their decision in the future, Medtronic has chosen not to integrate this technology into current pacemaker programmers at this time due to other priorities within their organization.

In July 2002, the Company signed a Co-Development and OEM Agreement with Philips Medical Systems (Philips), a worldwide leader in clinical measurement and diagnostic solutions for the healthcare industry and a division of Royal Philips Electronics (AEX: PHI, NYSE: PHG).  The joint product development will combine CardioDynamics’ proprietary ICG technology with Philips’ diagnostic 12-lead ECG.  Both companies will market the combined ICG/ECG product after completion. We do not anticipate that this agreement will require significant additional development resources, nor do we expect to derive any product revenue from the jointly developed products in fiscal 2003.

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In August 2002, the Company signed an Agreement to integrate CardioDynamics’ proprietary BioZ^® ICG technology into Vasomedical’s EECP^® enhanced external counterpulsation systems. By monitoring cardiac output before and after EECP therapy, physicians will have objective data to ascertain treatment effectiveness.  Recent research supports this combined approach as a useful tool.  Under the terms of the agreement, CardioDynamics would receive a licensing fee for each Original Equipment Manufacturer (OEM) board purchased by Vasomedical.

In November 2002, the Company signed a Distribution Agreement with SunTech Medical Instruments, Inc., the world leader in motion-tolerant noninvasive blood pressure monitoring products and technology.  Under the terms of the Agreement, SunTech’s new ambulatory blood pressure (ABP) monitor will be sold by CardioDynamics’ United States direct sales force and our distributors throughout North, Central, and South America.

Each time our BioZ^® products are used, disposable sets of four dual sensors are required.  In May 2000, we received FDA 510(k) clearance on the BioZtect^® sensor and cable system, which provides enhanced features to our customers and promotes the exclusive use of our proprietary sensors with our equipment.  To protect our electrode technology, we hold one United States design patent, and have filed two additional United States design patent applications.  During fiscal 2000 we implemented an auto-ship sensor program that allows customers to receive sensor pricing discounts in exchange for minimum monthly sensor purchase commitments.  The BioZtect^® sensors for our stand-alone BioZ^® ICG Monitors have a list price of $10.95 per application and $19.95 per application for the BioZ^® ICG Module.  Sensor and other non-system sales for fiscal years 2002, 2001 and 2000 were $3,514,000, $2,042,000 and $1,060,000, respectively.  As the installed base of BioZ^® systems grows, we expect the sales generated by our disposable sensors to continue to comprise a larger portion of our overall revenue stream.

Gross Margins were $17,378,000, $13,984,000 and  $8,557,000 for the fiscal years ended 2002, 2001 and 2000, respectively.  As a percentage of net sales, gross margins have improved steadily to 74% in 2002 from 71% in 2001 and 65% in 2000.  Late in the fourth quarter of fiscal 2001, we commenced shipments of our re-engineered BioZ^® ICG Monitor which has a manufactured cost that is approximately 30% lower than the previous generation BioZ.com^® System.  In addition, during fiscal 2001 and 2000 we reduced our direct material cost per unit by approximately 15% in each of the two years through material procurement cost reduction initiatives. This direct material cost reduction, along with higher average sales price per unit accounted for the majority of the gross margin improvement. 

Research and Development expenses for the fiscal years ended November 30, 2002, 2001 and 2000 were $2,423,000, $3,215,000 and $2,758,000, respectively.  The 25% decrease in 2002 when compared with 2001 can be attributed to a reduction in outside engineering services required for the development of the GEMS-IT BioZ^® ICG module and expenditures on clinical studies.  The increase in fiscal year 2001 over 2000 of 17% is largely the result of the sponsorship of two clinical studies, PREDICT (Prospective Evaluation and Identification of Cardiac Decompensation in Heart Failure by Impedance Cardiography Test) and ESCAPE (Evaluation Study of Congestive Heart Failure and Pulmonary Artery Catheterization Effectiveness). 

Selling and Marketing expenses increased 29% to $13,124,000 in 2002.  This increase over 2001 is related to the addition of 15 sales and marketing personnel during the past year.  We ended fiscal 2002 with 83 sales and marketing personnel, including 49 domestic sales representatives, 15 marketing and sales support employees, 14 clinical sales specialists and 5 international distribution managers.   Selling and marketing expenses in fiscal 2000 included a non-cash charge of $3,382,000 related to the vesting of 1,000,000 performance-based warrants issued to GEMS-ITand a provision of $1,928,000 for uncollectible accounts receivable, including a 100% provision for amounts due from Profiles in Health, Inc.

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General and Administrative expenses were $1,821,000, $1,747,000 and $1,662,000 for fiscal years 2002, 2001 and 2000 respectively.  The increase in general and administrative expenses from year to year was primarily attributable to additional staffing needs and a stronger focus on investor and public relations.  We continue to focus on ongoing cost containment in all areas of our business with specific emphasis in the areas that are not directly related to sales growth and as a result, general and administrative expenses as a percentage of sales, continued to decrease to 8% in fiscal 2002, from 9% in fiscal 2001 and 13% in fiscal 2000.

Other Income and Expense includes interest income of $361,000, $584,000, and $481,000 for the fiscal years 2002, 2001 and 2000, respectively.  The decrease in fiscal 2002 from fiscal 2001 was due to lower rates of interest earned on invested funds and decreased interest income from internally financed leases as the contracts mature.  Despite lower interest rates during 2001, interest income increased 21% in fiscal 2001 when compared to fiscal 2000, due to the improvement in cash flows from operations and the interest income recognized from the internal financing program we offered during the third and fourth quarters of fiscal 2000. 

We incurred interest expense of $10,000, $47,000 and $226,000 for fiscal years 2002, 2001 and 2000, respectively.  The decrease in interest expense in 2002 over 2001 is due to several capital leases coming to the end of their terms during 2002.  The decrease of $179,000 in interest expense in 2001, as compared with 2000, is primarily because in August 2000, we repaid our term loan with City National Bank and our line of credit agreement with both of our Chairmen. 

Provision For Income Taxes for fiscal years 2002, 2001 and 2000, were recorded in the amounts of $1,000, $1,000 and  $11,000, respectively.  As we expanded our direct sales force, we incurred filing obligations in various states other than California; therefore, the income tax provision for fiscal 2000 included initial payments to these states.  As a result of the budget shortfall, California has suspended the use of net operating loss carryforwards for 2003 and 2004, which will require us to pay franchise taxes on any income earned in California in those years.

Net Income (Loss) was of $310,000, or $.01, per share in 2002.  In 2001 we recorded a net loss of $659,000, or $.01 per share.  Fiscal 2000’s net loss was $8,267,000, or $.19 per share.  The fiscal 2000 net loss included non-cash charges of  $3,382,000 related to the GEMS-IT warrants that vested in the fourth quarter and a provision of $1,928,000 for uncollectible accounts receivable including a 100% provision for amounts due from Profiles in Health, Inc.

Liquidity and Capital Resources

Our working capital at November 30, 2002 was $17,897,000, up from $15,957,000 at November 30, 2001.  The increase over fiscal 2001 is primarily due to increased cash balances, accounts receivables and inventory.  At November 30, 2002 we had $6,879,000 of cash, an increase of $485,000 from $6,394,000 at November 30, 2001.  The increase was attributed primarily to improved accounts receivable collections.

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In June 1997, we entered into a five-year lease for an 18,000 square-foot manufacturing facility that also houses our research, development, marketing, sales and administrative activities.  The lease was renewed in March 2002 for the period commencing August 1, 2002 and continuing through July 31, 2007.  The current lease payments are approximately $22,000 per month, including common area maintenance charges and property taxes.  In fiscal 2002, 2001 and 2000, we invested $228,000, $200,000 and $381,000 respectively, in property and equipment, principally for new computers, software and equipment.

In July 2000, we sold $18,700,000 of common stock in a private placement of approximately 3,300,000 shares of our common stock to institutional and other accredited investors. The investors purchased unregistered common stock for $5.59 per share.  Portions of the proceeds were used to repurchase, for $5.59 per share, and retire 418,908 shares from the estate of Allen E. Paulson.  The financing was exempt from the registration requirement of the Securities Act of 1933, as amended, in reliance upon Regulation D promulgated under the Act.  In connection with the private placement, we incurred issuance costs totaling  $1,382,086.

In May 2000, we moved from the Nasdaq Small Cap Market to the Nasdaq National Market System (NMS).  We believe trading on the NMS enables companies to address a broader investor base and to increase the liquidity of their stock.

We have a secured revolving credit line with Comerica Bank.  The credit line provides for borrowings of up to $4,000,000 at the bank’s prime rate through September 2003.  Under the terms of the agreement, we are required to maintain minimum ratios of current assets to liabilities and not to exceed certain loss levels.  All assets of the Company collateralize the credit line. During fiscal 2002 and 2001 there were no outstanding borrowings under the line of credit.

Our long-term liquidity will depend on our ability to commercialize the BioZ^® and other diagnostic products and to raise additional funds through public or private financing, bank loans, collaborative relationships or other arrangements.  We can give no assurance that such additional funding will be available on terms attractive to us, or at all.

We have operating loss carryforwards of approximately $24,427,000 for federal income tax purposes.  The Tax Reform Act of 1986 contains provisions which limit the federal net operating loss carryforwards that can be used in any given year in the event of specified occurrences, including significant ownership changes. If these specified events occur we may lose some or all of the tax benefits of these carryforwards.  A valuation allowance has been recognized for the full amount of the deferred tax asset created by these carryforwards.  As a result of the California state budget shortfall, California has suspended the use of net operating loss carryforwards for fiscal years 2003 and 2004, which will require us to pay franchise tax on any income earned in California in those years.

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Critical Accounting Principles and Estimates

In response to the SEC’s Release numbers 33-8040 “Cautionary Advice Regarding Disclosure About Critical Accounting Policies” and 33-8056, “Commission Statement about Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we have identified the following critical accounting policies that affect the more significant judgments and estimates used in the preparation of our financial statements.  The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and judgments that affect our reported amounts of assets and liabilities, revenues and expenses and related disclosures of contingent assets and liabilities.  On an ongoing basis we evaluate our estimates, including those related to allowance for doubtful accounts receivable, sales returns, revenue recognition, inventory obsolescence and warranty reserve.  We state these accounting policies in the notes to the financial statements and at relevant sections in this discussion and analysis.  The estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances.  Actual results could vary from those estimates under difference assumptions or conditions.

We believe that the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements:

We maintain an allowance for doubtful accounts receivable for estimated losses resulting from the inability of our customers to make required payments.  We determine the adequacy of this allowance by regularly reviewing our accounts receivable aging and evaluating individual customer receivables, considering customer’s financial condition, credit history and current economic conditions.  If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances for doubtful accounts may be required.

We also maintain an estimate of potential future product returns related to current period product sales.  We analyze the rate of historical returns when evaluating the adequacy of the allowance for product returns, which is included with the allowance for doubtful accounts receivable on our balance sheet.  At November 30, 2002 gross trade accounts receivable totaled $10,075,000 and the allowance for doubtful accounts was $1,726,000, which included an allowance for sales returns of $746,000.

We recognize revenue from the sale of product when persuasive evidence of a sale exists, the product has been shipped, the sales price is fixed and determinable and collection of the resulting receivable is reasonably assured.  We sell some products under long-term financing arrangements and recognize the present value of the minimum payments as revenue at the time of sale and recognize interest income over the term of the contract.

We maintain a reserve for excess, slow-moving, and obsolete inventory as well as inventory with a carrying value in excess of its net realizable value.  We value our inventory at the lower of cost, using the first-in, first-out method, or market.  We review inventory on hand at least quarterly and record provisions for excess and obsolete inventory based on several factors, including current assessment of future product demand, historical experience, and product expiration. 

We also maintain a reserve for product warranties. Estimates for warranty costs are calculated based primarily upon historical warranty experience, but may include assumptions related to anticipated changes in warranty costs, failure rates, etc. Assumptions and historical warranty experience are evaluated on at least a quarterly basis to determine the appropriateness of such assumptions. Warranty cost accruals are adjusted from time to time when warranty claim experience differs from estimates.

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Our management has discussed the development and selection of the critical accounting estimates with the audit committee and our board of directors and the audit committee has reviewed our disclosure relating to in this MD&A.

New Accounting Standards

In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities.  SFAS No. 146 addresses issues regarding the recognition, measurement and reporting of costs associated with exit or disposal activities.  SFAS No.146 is effective prospectively for exit or disposal activities initiated after December 31, 2002.  We do not expect the adoption of this statement will have a material effect on our results of operations and financial position.

In November 2002, the FASB issued Interpretation No.145 (FIN No. 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others.  FIN No. 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued.  FIN No. 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN No. 45 are applicable to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 31, 2002.   The adoption of FIN No. 45 is not expected to have a material effect on our results of operations and financial position. 

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123. SFAS No. 148 amends SFAS No. 123 by providing alternative methods of transition for a voluntary change to the fair value method of accounting for stock based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2002. 

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interest in variable interest entities created after January 31, 2003, and to variable interests in variable interests entities obtained after January 31, 2003. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that the Company will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. The application of this Interpretation is not expected to have a material effect on our results of operations and financial position.

OTHER ITEMS

The Company is not a party to off-balance sheet arrangements, does not engage in trading activities involving non-exchange traded contracts, and is not a party to any transaction with persons or activities that derive benefits, except as disclosed herein, from their non-independent relationships with the Company.

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ITEM 7A.           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate sensitivity

The primary objective of our investment activities is to preserve principal, while at the same time, maximize the income we receive from our investments without significantly increasing risk.  In the normal course of business, we employ established policies and procedures to manage our exposure to changes in the fair value of our investments.  Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes.  We attempt to ensure the safety and preservation of our invested principal funds by limiting default risks, market risk and reinvestment risk.  We mitigate default risk by investing in investment grade securities.  Some of the securities that we have invested in may be subject to market risk.  This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate.  For example, if we hold a security that was issued with a fixed rate equal to the then-prevailing interest rate and the prevailing interest rate later rises, the fair value of our investment will decline.  To minimize this risk, we maintain substantially our entire portfolio of cash equivalents in commercial paper, certificates of deposit, money market and mutual funds.  Our interest income is sensitive to changes in the general level of U.S. interest rates, however, due to the nature of our short-term investments, we have concluded that there is no material market risk exposure.

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ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEPENDENT AUDITORS’ REPORT

The Board of Directors and Shareholders
CardioDynamics International Corporation:

We have audited the accompanying balance sheets of CardioDynamics International Corporation as of November 30, 2002 and 2001, and the related statements of operations, shareholders’ equity, and cash flows for each of the years in the three-year period ended November 30, 2002.  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 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 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 CardioDynamics International Corporation as of November 30, 2002 and 2001 and the results of its operations and its cash flows for each of the years in the three-year period ended November 30, 2002, in conformity with accounting principles generally accepted in the United States of America.

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CARDIODYNAMICS INTERNATIONAL CORPORATION

Balance Sheets

November 30, 2002 and 2001
(In thousands, except share data)

See accompanying notes to financial statements.

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CARDIODYNAMICS INTERNATIONAL CORPORATION

Statements of Operations

For the years ended November 30, 2002, 2001 and 2000
(In thousands, except per share data)

See accompanying notes to financial statements.

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CARDIODYNAMICS INTERNATIONAL CORPORATION

Statements of Shareholders’ Equity

For the years ended November 30, 2002, 2001 and 2000
(In thousands, except share data)