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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

LIFELINE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

(508) 988-1000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

Common stock $0.02 par value

(Title of Class)

Indicate by check mark whether the registrant (i) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) 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

Indicate by check mark whether the registrant is an accelerated filer    Yes  x    No  ¨

As of February 28, 2004, 13,423,628 shares of the Registrant’s Common Stock were outstanding and the aggregate market value of such Common Stock held by non-affiliates of the Registrant (based on the closing price for the common stock in the Nasdaq National Market on June 30, 2003) was approximately $187,000,000.

Exhibit index is located on pages 58 through 62 of this Report.

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Part III is incorporated by reference to specified portions of the Registrant’s definitive Proxy Statement to be issued in conjunction with the Registrant’s 2004 Annual Meeting of Stockholders, which is expected to be filed not later than 120 days after the Registrant’s fiscal year ended December 31, 2003.

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PART I

ITEM 1. Business

General

Lifeline Systems, Inc. (the “Company”) provides 24-hour personal response monitoring services associated with its products to subscribers, primarily elderly individuals with medical or age-related conditions as well as physically challenged individuals. The Company’s products consist principally of a communicator which connects to the telephone line in the subscriber’s home and a personal help button which is worn or carried by the individual subscriber and which, when activated, initiates a telephone call from the subscriber’s communicator to the Company’s central monitoring facilities. The Company believes it is a major provider of these services since as of December 31, 2003 it was monitoring approximately 386,000 subscribers on its own central monitoring call center platforms with approximately an additional 100,000 subscribers monitored by customers on monitoring platforms purchased by the customers for self-monitoring at their locations.

The Company was organized in Massachusetts in March 1974. The Company’s principal offices are located at 111 Lawrence Street, Framingham, Massachusetts 01702. Its corporate Internet address is www.lifelinesys.com and copies of its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, are made available through the Company’s website, free of charge, as soon as reasonably practicable following the electronic filing or furnishing of such materials by the Company to the Securities and Exchange Commission (SEC).

Business Developments

At a special meeting of shareholders held on December 3, 2003, the Company received the requisite votes to increase the number of its authorized shares from 20,0000,000 to 50,000,000. With this approval, effective December 17, 2003 the Company affected a two-for-one split of its common stock in the form of a stock dividend of one additional share for each share held to shareholders of record on December 3, 2003. All per share amounts and numbers of shares outstanding in this report have been adjusted for the stock split for all periods presented.

In July 2003, the Company completed the acquisition of the assets of the Emergency Response Systems business unit of March Networks Corporation, a privately held developer of broadband IP applications and delivery platforms. The terms of the all cash acquisition include an earn-out provision. The results of the acquired business have been included in the Company’s consolidated financial statements from the date of acquisition with no material effect on the Company’s results of operations for the year ended December 31, 2003.

On May 1, 2003, the Company reached an agreement with one of its former vendors related to the Company’s previously announced erroneous low battery signal problem. The vendor agreed to pay the Company $700,000 in exchange for a mutual release of claims. The payment reimburses the Company for some of the costs it incurred in addressing the problem.

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Industry Segments

The Company operates in one industry segment. Its operations consist of providing personal response services associated with its products. The Company maintains sales, marketing and monitoring operations in both the United States and Canada. Foreign revenues, from Canada, comprised less than 10% of the Company’s total revenues in 2003, and tangible assets in foreign countries (Canada) represent less than 10% of the Company’s total assets as of December 31, 2003.

The Lifeline Service

The Company’s principal offering, called LIFELINE^®, consists of a monitoring service utilizing equipment designed, assembled and marketed by the Company. The Company’s monitoring service is a personal response service which provides 24-hour monitoring and personalized support to elderly individuals (“subscribers”) with medical or age-related conditions and to physically challenged subscribers throughout the United States and Canada. Through use of the LIFELINE service, subscribers in need of help are able to signal monitoring personnel in one of the Company’s response centers. These trained people identify the nature and extent of the subscriber’s particular need and manage the situation by notifying the subscriber’s friends, neighbors, and/or emergency personnel, as set forth in a predetermined protocol established by the Company. In many situations, this service can also provide social support for elderly subscribers who live alone since the Company’s trained monitoring personnel are often contacted via the monitoring equipment by these elders on a non-emergency basis, who utilize the Lifeline service as an important social connection.

The equipment used for the LIFELINE service includes a communicator, which connects to the telephone line in the subscriber’s home, and a personal help button, which is worn or carried by the individual subscriber. When pressed, the personal help button sends a radio signal to the communicator; the communicator automatically dials a response center where monitoring personnel answer the call and dispatch the designated responders, typically a friend or relative of the subscriber and/or emergency service, when help is needed. Most of the time, however, subscribers’ calls do not require the Company to dispatch a responder but instead require the Company to provide reassurance and support as a result of the subscriber’s isolation or loneliness.

The Company’s primary monitoring center in Framingham, Massachusetts is supported by its proprietary CareSystem call center technology platform. This call center platform is a specially designed computer and telecommunications hardware and software system used to identify, track and respond to subscriber calls. CareSystem receives incoming signals from subscribers’ communicators, matches and retrieves the appropriate subscriber data records from a central database, and routes both the call and the data record to monitoring personnel in the Lifeline Call Center. The Company also has a second United States call center in Framingham, which has the capability of providing call center redundancy by utilizing the CareSystem platform.

To provide its services, the Company develops relationships with hospitals or other healthcare providers (“customers”) who establish a Lifeline program generally for the benefit of subscribers in their coverage area or with respect to senior living facilities in their coverage area, for the benefit of their residents. The type of Lifeline program established by the customer for the benefit of subscribers determines the type of product or service offering they select from the Company. These offerings consist of the following:

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Customers

The Company primarily markets its services and products to hospitals, senior living facilities and other service providers in a variety of healthcare related fields. Hospitals have historically been the Company’s primary market. The Company believes that hospitals offer Lifeline’s services and products to create an additional revenue source, enhance community relations, and/or reduce their costs of caring for their patients.

The Company has increased its presence in the senior living housing market and currently has telephony-based emergency call systems, which may include response center equipment, in more than 350 senior living communities throughout the United States and Canada. These communities range in size from smaller group homes to 1,900 resident Continuing Care Retirement Communities. Residents in need of help are able to signal resident staff on site, or if monitored by the Company, one of the Company’s call centers.

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Sales and Marketing

The Company sells its services and products through its sales organization in the United States and Canada.

In support of the sales effort, the Company’s sales professionals assist customers in developing a marketing plan for the Lifeline program, monitoring progress against that plan, and providing training to the customer’s staff on the management of their local Lifeline program. Programs’ marketing plans typically address the introduction of Lifeline’s services to the prospective customer’s key decision makers; and the development of local referral networks of elder care and other service organizations to position the LIFELINE service as part of a continued care plan. Lifeline personnel also provide continuing operational support, ongoing consultation, and program evaluations.

Source of Raw Materials

The Company assembles all of its products, relying on outside vendors for components and enclosures. The Company currently purchases components from a variety of qualified vendors to provide maximum flexibility and ensure adequate sources of supply. There can be no assurance however, that these vendors will not incur delays in providing the necessary components for the Company as a result of process difficulties, component shortages or for other reasons. Any such delay could have a material adverse effect on the Company’s business, financial condition, or results of operations.

Patents, Licenses and Trademarks

The Company considers its proprietary know-how with respect to the development and marketing of its personal response services and products and in providing the Lifeline service, to be a valuable asset. The Company believes that continued development of new services and products and the improvement of existing services and products are important in maintaining a competitive advantage.

Although the Company owns numerous patents and patent applications in the United States and Canada, the Company does not believe that its business as a whole is or will be materially dependent upon the protection afforded by its patents.

The Company’s LIFELINE trademark and servicemark are registered at the United States Patent and Trademark Office and in most states and some foreign countries. The Company also has a number of other trademarks.

Research and Development

Research and development efforts are geared towards enhancing and augmenting the Company’s products and services. Research and development expenses were $1,816,000, $1,642,000, and $1,610,000 for the years ended December 31, 2003, 2002, and 2001, respectively.

Backlog/Seasonality

Because of the nature of the Company’s service, the Company endeavors to minimize the time that elapses from the receipt of a purchase order to the date of delivery of the products. Accordingly, the Company’s backlog as of the end of any period represents only a small portion of the Company’s expected sales for the succeeding period and is not significant in understanding the Company’s business. The Company does not believe that the industry in which it operates is seasonal.

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Government Regulation

The Company’s products are registered with the Federal Communication Commission (“FCC”) and comply with FCC regulations pertaining to radio frequency devices (Part 15) connected to the telephone system (Part 68). The Company has also received registrations of equipment from Canadian agencies. As new models are developed, they are submitted to appropriate agencies for registration as required.

The Company has registered its communicator products with the United States Food and Drug Administration.

None of the Company’s business is subject to re-negotiation of profits or termination of contract at the election of the government, nor is it impacted by any existing environmental laws.

Competition

The Company believes that it is a major provider of personal response services since as of December 31, 2003 it was monitoring approximately 386,000 subscribers on its own central monitoring call center platforms with approximately an additional 100,000 subscribers monitored by customers on monitoring platforms purchased by the customers for self-monitoring at their locations. Other companies offer services and products competitive with those offered by the Company. These companies offer personal response services on a regional or national basis through both healthcare providers and directly to the subscribers themselves.

The Company believes that the competitive factors its customers consider when choosing a personal response service are the high quality of service, product performance and reliability; customer support and service; price; and reputation and experience in the industry. The Company believes it competes favorably with respect to these factors.

Employees

As of February 29, 2004 the Company employed approximately 799 full-time and 58 part-time employees. None of the Company’s employees is represented by a collective bargaining unit, and the Company believes its relations with its employees are good.

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Executive Officers of the Registrant

The following table sets forth certain information regarding the executive officers of the Company as of March 1, 2004:

L. Dennis Shapiro, Chairman of the Board, has served the Company in this capacity since 1978, and at various times has served as President and Chief Executive Officer.

Ronald Feinstein became Executive Vice President and Chief Operating Officer in August 1992. He was appointed President and Chief Executive Officer in January 1993. Mr. Feinstein has served as a director of the Company since 1985.

Richard M. Reich is Senior Vice President, Chief Information Officer. He became Vice President, Chief Information Officer in September 1999. He had been Vice President, Technology and Advanced Services since August 1994. From June 1990 to August 1994, Mr. Reich had served as Vice President, Product Planning and Development. He had held the position of Vice President, Engineering when he joined the Company in April 1986.

Donald G. Strange is Senior Vice President, Sales. He was Vice President, Sales and Marketing from December 1996 to June 2000. He joined the Company in February 1993 as Vice President, Sales.

Ellen R. Berezin joined the Company in March 2001 as Vice President, Human Resources. From July 1997 to March 2001, Ms. Berezin worked at Harvard Vanguard Medical Associates, a physician group practice based in Massachusetts, where she served as Vice President, Human Resources. From November 1995 to June 1997, Ms. Berezin was Vice President of Healthsource Massachusetts, a New Hampshire-based HMO.

Mark G. Beucler joined the Company as Vice President, Finance and Corporate Controller in April 2002 and became Vice President, Finance, Chief Financial Officer and Treasurer in May 2003. Before joining the Company, Mr. Beucler served as Senior Vice President, Corporate Controller for Thomson Financial. He joined Thomson Financial in 2000 when it acquired Primark Corporation, a publicly held NYSE-listed company where he served as corporate controller. From 1995 through 1997, Mr. Beucler was with The Gillette Company. Mr. Beucler is a certified public accountant and previously was an audit manager at Deloitte and Touche.

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Edward M. Bolesky has been Senior Vice President, Customer Care since joining the Company in May 2002. Prior to joining the Company, Mr. Bolesky worked for 20 years at New England Business Service, Inc. (“NEBS”), an international direct marketing and manufacturing organization serving small business customers with printed checks and forms, personalized apparel, retail and shipping supplies and payroll services. Mr. Bolesky held a variety of positions at NEBS, most recently as Senior Vice President/President-NEBS Direct Marketing.

Leonard E. Wechsler is President, Lifeline Systems, Canada and Vice President Lifeline Systems, Inc. He joined the Company in July 1996 as President, Lifeline Systems Canada when the Company purchased CareTel, Inc. CareTel provided monitoring services similar to those offered by the Company.

Jeffrey A. Stein has been the Clerk of the Company since February 2000. Mr. Stein has been a partner of the law firm of Hale and Dorr LLP since 1994, which has been general counsel to the Company since 1976.

ITEM 2. Properties

The Company is party to a fifteen-year lease for an 84,000 square foot facility in Framingham, Massachusetts for its corporate headquarters, including its United States based monitoring operations. Average annual base rental payments under the lease approximate $941,000. The initial lease term expires in 2013. The Company has two five-year renewal options contained within the lease.

The Company is party to a ten-year lease to occupy up to 29,000 square feet of a second facility in Framingham, Massachusetts for its second United States call center. Average annual base rental payments under the lease approximate $246,000. The initial lease term expires in 2012 and the Company has two five-year renewal options contained within the lease.

The Company also leases facilities in other locations to support its corporate, field and Canadian operations.

ITEM 3. Legal Proceedings

The Company is not party to any material litigation.

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

The Company held a special meeting of stockholders on December 3, 2003 to consider an amendment to the Company’s Articles of Organization increasing the authorized number of shares of common stock from 20,000,000 to 50,000,000. Stockholders approved the amendment to the Articles of Organization. Shares representing a total of 5,904,149 shares of common stock voted in favor of the amendment, holders of 280,484 shares of common stock voted against the amendment and holders of 17,572 shares of common stock abstained from voting.

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PART II

ITEM 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

Quarterly Market Information and Related Matters

The Company’s common stock is traded on the Nasdaq Stock Market under the symbol “LIFE.”

On February 29, 2004, the Company had 440 registered shareholders.

The following table sets forth the high and low stock prices for each quarter as provided by the NASDAQ Stock Market, as adjusted to reflect a two-for-one stock split in the form of a stock dividend of one additional share for each share held, effected by the Company on December 17, 2003.

During the periods presented, the Company has not paid or declared any cash dividends on its common stock. While the payment of dividends is within the discretion of the Company’s Board of Directors, the Company presently expects to retain all of its earnings for use in financing the future growth of the Company.

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ITEM 6. Selected Financial Data

All share and per share amounts have been adjusted to reflect a two-for-one stock split in the form of a stock dividend of one additional share for each share held, effected by the Company on December 17, 2003.

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ITEM 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition

This Annual Report on Form 10-K may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, with respect to, among other things, the Company’s future revenues, operating income, or earnings per share. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” and similar expressions are intended to identify forward-looking statements. There are a number of factors that may cause the Company’s actual results to vary materially from those forecast or projected in any such forward-looking statement. These factors include, without limitation, those set forth below under the caption “Certain Factors That May Affect Future Results.” The Company’s failure to successfully address any of these factors could have a material adverse effect on the Company’s future results of operations.

RESULTS OF OPERATIONS

2003 Compared with 2002

Total revenues for the year ended December 31, 2003 increased approximately 11% to $116.2 million, from $105.0 million recorded in 2002.

Service Revenue

The Company’s focus on increasing service revenues, which the Company considers a key metric of its performance, continues to provide positive results as service revenues increased by approximately 16% to $90.7 million for the year ended December 31, 2003 compared to $78.0 million for the prior year. The increase in the Company’s recurring service revenues, which represented approximately 78% of total revenues for the year ended December 31, 2003, up from 74% for the prior year, is a result of its effective pricing strategies, the organic growth it experienced in its monitored subscriber base and the conversion of hospital programs to the Company’s higher revenue service offerings such as its Lifeline OneSource offering. As a result, the Company grew its monitored subscriber base by approximately 6% to 386,000 subscribers at December 31, 2003 from 366,000 subscribers at December 31, 2002. The Company’s ability to sustain the current level of service revenue growth depends on its ability to continue with enhancements in service delivery, retain subscribers for longer periods of time, develop strategies to increase the revenue each subscriber generates, expand the market for its personal response services and convert community hospital programs to services provided by the Company. In addition, the Company is developing new subscriber growth opportunities that are intended to increase market penetration and build more awareness of the services the Company provides, thereby facilitating growth in subscribers. The Company believes that the high quality of its services, quality of its equipment and its commitment to providing caring and rapid response to the at-risk elderly will be factors in meeting its growth objective.

Net Product Sales

With the Company’s focus on increasing its recurring service revenue, it experienced an anticipated decrease in net product sales of 6% to $24.2 million for the year ended December 31, 2003, from $25.6 million in the prior year. The expected decline is a result of a lower volume of home communicator sales by the Company to its traditional hospital channel for the year ended December 31, 2003 as compared to the year ended December 31, 2002 reflecting the continuing trend of its healthcare channel to convert to

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the Company’s Lifeline OneSource offering. Many of the Company’s hospital customers are also experiencing capital constraints when needing to purchase new home communicators. This decline in volume was mitigated in part by growth the Company experienced with sales to its senior living facility customers as a result of its senior living focus in 2003. The Company expects that equipment sales may remain flat or decline in periods subsequent to December 31, 2003.

Finance Income

Finance income, representing income earned from the Company’s portfolio of sales-type leases decreased 6% to $1.3 million for the year ended December 31, 2003 as compared to $1.4 million for the year ended December 31, 2002.

In December 2003, the Company entered into a program agreement with a third party to underwrite new equipment leases for its new Senior Living initiative and its traditional personal response services (“PERS”) equipment business. In the initial transaction under this agreement, the Company assigned approximately $1.5 million of its lease-portfolio net investment to the third party for approximately $1.6 million in cash. For accounting purposes the net investment of the assigned portfolio remains with the Company with an offsetting liability which will be amortized over the remaining terms of the leases. The Company also recorded a deferred gain on the assignment that will be recognized as part of finance income as the leases expire.

With the Company’s focus on its service offerings and the program agreement with the third party, by which the third party will underwrite future leases, the Company expects finance income to decline in future periods because such income is directly related to product sales.

Cost of Services

The Company believes that service gross margin is a key driver of profitability in its business. As a result, the Company has focused on continued improvement in its service gross margins in part by lowering its service costs as a percentage of its service revenues. These cost reductions have resulted from improved productivity in its call center, greater efficiency of subscriber enrollment and by leveraging the capabilities of its CareSystem monitoring platform.

Cost of services, as a percentage of service revenues, improved 3% to 53% for the year ended December 31, 2003 from 56% for the year ended December 31, 2002. On a dollar basis, cost of services increased by approximately $4.6 million for the year ended December 31, 2003 as compared to the prior year due to the following factors. The Company incurred expenditures associated with its new back-up United States call monitoring facility, such as rent and building operating costs that it did not incur during 2002. Also, the growth in the number of subscribers serviced under the Company’s Lifeline OneSource offering resulted in an increase in related expenses such as depreciation of the cost of home communicators provided to Lifeline OneSource subscribers and certain operational costs including data entry, customer service and information technology operations. The Company expects to continue focusing on improving its service gross margins in periods subsequent to 2003.

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Cost of Product Sales

For the year ended December 31, 2003 cost of product sales, as a percentage of net product sales, was 33% as compared to 32% for the year ended December 31, 2002. The percentage increase was mainly due to increased sales of emergency call systems to senior living facilities and sales generated as a result of the Company’s July 2003 acquisition of the personal emergency response business unit of March Networks. The products associated with these sales have higher costs as percentages of product sales than the Company’s traditional home communicator healthcare sales. The Company expects that it will experience an increase in cost of product sales, as a percentage of net product sales for the year ended December 31, 2004, as it continues with its Senior Living initiative.

Selling, General and Administrative Expenses

SG&A expenses were 36% of total revenues for the years ended December 31, 2003 and 2002, despite a dollar increase of approximately $4.1 million to $41.9 million for the year ended December 31, 2003. The percentage consistency can be attributed to growth in the Company’s year-over-year revenues coupled with its focus on controlling SG&A expenses.

The Company incurred increased expenditures associated with the first full year of its direct marketing campaigns and other marketing initiatives. It also continues to experience the impact of increases in insurance and healthcare benefit costs as it did in 2002. For 2003, the Company incurred increased expenses in support of its Senior Living initiative as well as operational costs associated with the aforementioned March Networks acquisition. The Company expects that SG&A expenses, as a percentage of total revenues will remain constant or may increase slightly as a percentage of total revenues in 2004 as it continues with its business initiatives, such as its direct marketing campaigns and its senior living focus.

During 2002, the Company was audited by Revenue Canada asserting deficiencies in goods and services tax and sales tax for the Company’s 1993 to 1999 tax years. In 2002, the Company paid an assessment of CAN$523,000 (approximately US$333,000 based on exchange rates at December 31, 2002). During 2003, the Company successfully appealed the assessment and in May 2003, it received a refund of approximately CAN$386,000 (approximately US$290,000 based on exchange rates at December 31, 2003) as a result of the successful appeal. The Company recorded this refund in SG&A expenses.

Research and Development Expenses

Research and development expenses represented approximately 2% of total revenues in 2003 and 2002. Research and development efforts are focused on ongoing product improvements and developments. The Company expects to maintain these expenses, as a percentage of total revenues, at a relatively consistent level.

Non-Recurring Item

In September 2000, the Company recorded a pre-tax non-recurring charge of approximately $2.7 million for costs it expected to incur to address erroneous low-battery signals in some of its personal help buttons. Included in the non-recurring charge were material and mailing costs for exchanging buttons, providing hospital programs with higher inventory levels for the planned swap, and the cost of installer visits to subscriber homes to replace the buttons.

On May 1, 2003, the Company reached an agreement with one of its former vendors related to the

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Company’s aforementioned erroneous low battery signal. The vendor paid the Company $0.7 million in exchange for a mutual release of claims and the Company recorded this settlement as an other non-recurring item. The payment reimburses the Company for some of the costs it incurred in addressing this matter.

Taxes

The Company’s effective tax rate was 40% for the years ended December 31, 2003 and 2002.

2002 Compared with 2001

Total revenues for the year ended December 31, 2002 increased approximately 9% to $105.0 million, from $96.6 million recorded in 2001.

Service Revenue

The Company’s focus on increasing service revenues provided positive results as service revenues increased by just over 14% to $78.0 million for the year ended December 31, 2002 compared to $68.2 million for the prior year and represented over 74% of the Company’s total 2002 revenues, compared to 71% in 2001. The Company experienced positive results with its pricing strategies and grew its monitored subscriber base by approximately 6% to 366,000 subscribers at December 31, 2002 from 345,000 subscribers at December 31, 2001.

Product Revenue

Net product revenues decreased by 5% to $25.6 million for 2002, from $27.0 million in 2001. The majority of the decrease for 2002 was the result of strong sales of the Company’s site-monitoring platform in 2001 for those customers who perform their own monitoring at their local facilities. These sales represented approximately $2.8 million of total product sales during that year as compared to approximately $1.4 million for 2002. The Company had been anticipating a decline in sales of its site-monitoring platform since it has a finite number of customers for this product. During 2002, the Company launched its new Senior Living initiative, under which it began to develop alliances with senior living facilities to provide them with a cost-effective and distinctive emergency call system to appeal to residents and their families.

Finance Income

Finance income, representing income earned from the Company’s portfolio of sales-type leases, remained consistent at $1.4 million for the years ended December 31, 2002 and 2001.

Cost of Services

Cost of services, as a percentage of service revenues, improved 5% to 56% for the year ended December 31, 2002 from 61% for the year ended December 31, 2001. On a dollar basis, cost of services increased by approximately $2.2 million for the year ended December 31, 2002 as compared to the prior year as a result of the growth in the number of subscribers serviced under the Company’s Lifeline OneSource offering. However, the percentage improvement was consistent with the Company’s goal of making its service offerings more profitable through productivity and pricing, including through faster response times, and improved efficiency of subscriber enrollment.

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The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets,” in January 2002, which requires, among other things, the discontinuance of goodwill amortization. As a result, the Company did not record approximately $837,000 of goodwill amortization expense for the year ended December 31, 2002 which resulted in an additional 1% improvement to service margins in 2002 as compared to 2001.

Cost of Product Sales

For the year ended December 31, 2002 cost of product sales, as a percentage of net product sales, was 32% as compared to 33% in 2001. The improvement in 2002 was directly related to the significant amount of sales of the Company’s site-monitored platform in 2001 which has a cost that is higher as a percentage of revenue than the cost of the Company’s home communicators.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (“SG&A”) as a percentage of total revenues were 36% for the year ended December 31, 2002 as compared to 35% for the year ended December 31, 2001. On a dollar basis, SG&A expenditures increased $3.9 million to $37.8 million for the year ended December 31, 2002 from $33.9 million for the same period in 2001. The Company incurred increased costs associated with its new Senior Living initiative which was launched in the beginning of 2002. It also experienced start-up costs associated with new marketing and business initiatives, including direct mail, coupled with information technology costs associated with these initiatives. During 2002, the Company also experienced the impact of increases in insurance and healthcare benefit costs as compared to 2001. Approximately $0.5 million of additional costs associated with the erroneous low-battery signals in some of the Company’s personal help buttons (See Note J to Consolidated Financial Statements) were incurred in 2002 and charged to SG&A.

Research and Development Expenses

Research and development expenses represented 2% of total revenues in 2002 and 2001. Research and development efforts are focused on ongoing product improvements and developments.

Taxes

The Company’s effective tax rate was 40% for the year ended December 31, 2002 as compared to 38% for the same period in 2001. The lower effective tax rate in 2001 was due to the benefit of recording a previously disclosed tax credit earned under a Tax Increment Finance (“TIF”) agreement with the town of Framingham, Massachusetts.

LIQUIDITY AND CAPITAL RESOURCES

During the year ended December 31, 2003, the Company’s portfolio of cash and cash equivalents increased $10.3 million to $21.4 million from $11.1 million at December 31, 2002. The majority of the increase is a direct result of cash provided by operating activities of $18.5 million and reflected the impact of continued improvements in collections of the Company’s accounts receivable portfolio where it

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experienced a decrease in its days sales outstanding (DSO) to 35 days at December 31, 2003 from 38 days at December 31, 2002. In addition to proceeds provided by operating activities, proceeds from stock option and employee stock purchase plan option exercises of $5.4 million and cash received of $1.6 million for the assignment of a portion of the Company’s lease portfolio to a third party also contributed to the increase. Offsetting these increases was an income tax receivable of approximately $3.1 million recorded during 2003 which the Company expects to receive during 2004, purchases of property and equipment of $11.2 million, which included expenditures for the build-out of the Company’s second United States call center and $4.1 million for acquisitions of the assets of the Emergency Response Systems business unit of March Networks Corporation and Lifeline OneSource businesses and for provider agreements for LMS or PSF offerings.

In August 2002, the Company entered into a $15.0 million revolving credit agreement. The agreement has two components, the first of which is the ability to obtain a revolving credit loan with an interest rate based on the London Interbank Offered Rate (LIBOR). The second component is the ability to obtain a revolving credit loan with an interest rate based on the lender’s prime interest rate. The Company has the option to elect to convert any outstanding revolving credit loan to a revolving credit loan of the other type. The agreement contains several covenants, including the Company maintaining certain levels of financial performance. These financial covenants include a requirement for a current ratio of at least 1.5 to 1.0 and an operating cash flow to total debt service ratio of no less than 1.75 to 1.0.

In addition, there are certain negative covenants that include restrictions on the disposition of the Company’s assets, restrictions on the Company’s capacity to obtain additional debt financing, and restrictions on its investment portfolio. The agreement also requires the Company to pay a commitment fee of one quarter of one percent (1/4%) per annum on the unused amount of the credit facility.

As a result of certain restrictions on the disposition of the Company’s assets, during the fourth quarter of 2003 the Company obtained a consent from its bank to enter into a lease program agreement with a third party. This revolving credit agreement matures in August 2005 and as of December 31, 2003 the Company did not have any debt outstanding under this line.

The following summarizes the Company’s existing contractual lease obligations as of December 31, 2003 and the effect such obligations are expected to have on its liquidity and cash flows in future periods:

(Dollars in thousands)

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The Company expects that funding requirements for operations and in support of future growth are expected to be met primarily from operating cash flow, existing cash and marketable securities and the availability from time to time under its line of credit. The Company expects these sources will be sufficient to finance the operating cash needs of the Company through the next twelve months. This includes the continued investments in its response center platform and its back-up United States call monitoring facility, the requirements of its internally funded lease financing program and other investments in support of its current business. The Company may from time to time consider potential strategic acquisitions that may not be able to be financed through these sources. In such an event, the Company may consider appropriate alternative financing vehicles.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of financial condition and results of operations are based upon the Company’s consolidated financial statements. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The Company has identified the following accounting policies as critical to understanding the preparation of its consolidated financial statements and results of operations.

Allowance for doubtful accounts

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. It estimates the allowance based upon historical collection experience, analysis of accounts receivable by aging categories, customer credit quality and analytics. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Goodwill and intangible assets

Acquisition accounting requires extensive use of estimates and judgments to allocate the purchase price to the fair market value of the assets and liabilities purchased. The cost of acquisitions is allocated first to their identifiable tangible assets based on estimated fair values at the date of acquisition. Costs are then allocated to identifiable intangible assets and are generally amortized on a straight-line basis over the estimated useful lives of the assets. The excess of the purchase price over the fair value of identifiable assets acquired, net of liabilities assumed, is recorded as goodwill.

During the year ended December 31, 2003, the Company entered into a variety of LMS and PSF provider agreements and purchased several Lifeline OneSource businesses. The Company used accounting estimates and judgments to determine the fair value of assets and liabilities, if any. The Company did not record any cost in excess of net asset value (i.e., goodwill) as a result of the acquisition accounting for these arrangements; however, it did record intangible assets related to the specific arrangement and is amortizing these costs over the expected life of the identified intangible asset, which ranges from five to fifteen years. Any change in assumptions could either result in a decrease or increase in the estimated life. A decrease in estimated life would reduce the Company’s net income and an increase in estimated life would increase the Company’s net income. Also, a change in assumptions could result in the Company recording non-amortizable goodwill as a result of acquisition accounting.

The Company obtained the guidance of an independent valuation expert in its assessment of the fair value

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of assets acquired for the acquisition of the assets of the Emergency Response Systems business unit of March Networks Corporation. As a result, the Company recorded approximately $0.8 million of non-amortizable goodwill and $0.2 million of intangible assets which the Company will amortize over an estimated life of 15 years.

The Company assesses the impairment of goodwill and other intangibles on an annual basis or, along with long-lived assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. It uses an estimate of the future undiscounted net cash flows of the related asset or asset grouping over the remaining life in measuring whether assets are recoverable. Based on the Company’s expectation of future undiscounted net cash flows, an impairment loss would be recorded by writing down the assets to their estimated realizable values. Any resulting impairment loss could have a material adverse effect on the Company’s results of operations.

Inventories

The Company values its inventories at the lower of cost or market, as determined by the first-in, first-out method. It regularly reviews inventory quantities on hand and records a provision for excess or obsolete inventory based upon its estimated forecast of product demand. If actual future demand is less than the projections made by management, then additional provisions may be required. In connection with the termination of the Company’s manufacturing outsourcing arrangement in 2002, the Company increased its inventory. The Company believes that substantially all of this additional inventory will be useable in the ordinary course of business.

Warranty

The Company’s products are generally under warranty against defects in material and workmanship. The Company provides an accrual for estimated warranty costs at the time of sale of the related products based upon historical return rates and repair costs at the time of the sale. A significant increase in product return rates could have a material adverse effect on the Company’s results of operations.

Net investment in sales-type leases

The Company considered the requirements of SFAS 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” when considering the accounting treatment associated with the assignment of approximately $1.5 million of its lease portfolio net investment to a third party. Paragraph 9 of SFAS 140 outlines the conditions that are required to be met for specific accounting treatment to be applied to this assignment. As a result of its research of these requirements, the Company concluded that the appropriate accounting treatment was for the net investment of the assigned portfolio to remain on its books with an offsetting liability which will be amortized over the remaining terms of the leases. The Company also recorded a deferred gain on the assignment that will be recognized as part of finance income as the leases expire.

NEWLY ISSUED ACCOUNTING STANDARDS

In July 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 replaces Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” SFAS 146 requires the recognition of costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not have significant impact on the Company’s financial position, results of operations, or cash flows in 2003.

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On November 25, 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34.” FIN 45 clarifies the requirements of SFAS No. 5, “Accounting for Contingencies” (SFAS 5), relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that, upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation. FIN 45 is applicable to guarantees that encompass guarantees based on changes in an underlying asset (such as the Company’s product warranty), liability or equity security, guarantees that are made on behalf of another entity’s performance, certain indemnification agreements and indirect guarantees of the indebtedness of others. The recognition and measurement provisions of FIN 45 are effective prospectively for guarantees issued or modified after December 31, 2002. The disclosure requirements were effective for reporting periods ending after December 15, 2002. The recognition and measurement provisions of FIN 45 did not have a material impact on the Company’s consolidated financial statements in 2003.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS 123 to require prominent disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on reported financial results. SFAS 148 amends Accounting Principles Board (“APB”) Opinion No. 28, “Interim Financial Reporting,” to require these disclosures in interim financial information. The Company continues to account for their stock-based employee compensation under APB Opinion 25, but has adopted the new disclosure requirements of SFAS 148. Additional information related to the Company’s stock option plans is detailed in Note E of the Notes to the Consolidated Financial Statements.

On January 17, 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” The primary objective of the Interpretation is to provide guidance on the identification of, and financial reporting for, entities over which control is achieved through means other than voting rights; such entities are known as variable-interest entities (VIEs). In December 2003, the FASB released a revised version of FIN 46 (FIN 46R) clarifying certain aspects of FIN 46 and providing certain entities with exemptions from the requirements of FIN 46. The variable interest model looks to identify the “primary beneficiary” (PB) of a VIE. The PB is the party that is exposed to the majority of the risk or stands to benefit the most from the VIE’s activities. A VIE would be required to be consolidated if certain specified conditions are met. While FIN 46R only slightly modified the variable interest model from that contained in FIN 46, it did change guidance in many other areas. Some of the differences between FIN 46 and FIN 46R include, among others, (i) the addition of a scope exception for certain entities that meet the definition of business provided that specified criteria are met, (ii) the addition of a scope exception in situations whereby an enterprise is unable to obtain certain information pertaining to the entity to comply with FIN 46R and (iii) the addition of a list of events that require reconsideration of whether and entity is VIE and whether an enterprise is the primary beneficiary of a VIE, rather than stating a general principle with examples as had been previously provided. Additionally, FIN 46R incorporates the guidance found in the eight final FASB Staff Positions (FSPs) that were issued as of the release of FIN 46R. For entities that exist prior to December 31, 2003, FIN 46R must be adopted no later than the beginning of the first interim period of Fiscal 2005 and the provisions of FIN 46 are not required to be adopted. For new entities created after December 31, 2003, the Company will apply FIN 46R from the first date the Company becomes involved in the potential variable interest entity. The Company is in the process of determining the impact of the provisions of FIN 46R on the consolidated financial statements.

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On December 17, 2003, the Staff of the Securities and Exchange Commission (SEC or the Staff) issued Staff Accounting Bulletin No. 104 (SAB 104), “Revenue Recognition,” which supercedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s “Revenue Recognition in Financial Statements Frequently Asked Questions and Answers” (the FAQ) issued with SAB 101 that had been codified in SEC Topic 13, “Revenue Recognition.” Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The Company does not believe that the adoption of SAB 104 will have a significant impact on its financial position, results of operations, or cash flows.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

The following important factors, among others, could cause actual results to differ materially from those indicated by forward-looking statements made in this Annual Report on Form 10-K and presented elsewhere by management from time to time.

The Company has recently launched a number of marketing initiatives intended to increase its market penetration. These initiatives include a direct marketing campaign, which is targeted primarily toward market development, and a campaign to increase the Company’s market among senior living facilities. These sales initiatives will require management’s attention and financial resources, including the incurrence of fixed costs, and the return to the Company from these initiatives could be less than anticipated by the Company, or could take longer to realize than expected by the Company.

The Company’s results are partially dependent on its ability to develop services and products that keep pace with continuing technological changes, evolving industry standards, changing subscriber preferences and new service and product introductions by the Company’s competitors. There can be no assurance that services, products or technologies developed by others will not render the Company’s services or products noncompetitive or obsolete.

The Company’s ability to continue to increase service revenue is a key factor in its long-term growth, and there can be no assurance that the Company will be able to do so. The Company’s service revenue growth is partially dependent on its ability to increase the number of subscribers served by its monitoring centers by an amount which exceeds the number of subscribers lost. The Company’s failure to increase service revenue could have a material adverse effect on the Company’s business, financial condition, or results of operations.

In order to mitigate the negative effect of a disruption of service of its monitoring services (including as a result of system failures, the disruption of service at its monitoring facility, whether due to telephone or electrical failures, earthquakes, fire, weather or other similar events or for any other reason), the Company recently opened a second United States call center, which is also located in Framingham, Massachusetts. There can be no assurance, however, that the second call center will not be affected by the same disruption that affects the corporate headquarters facility.

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The Company may expand its operations through the acquisition of additional businesses, such as the recent acquisition of the assets of the Emergency Response Systems business unit of March Networks Corporation, a privately held developer of broadband IP applications and delivery platforms. There can be no assurance that the Company will be able to identify, acquire or profitably manage additional businesses or successfully integrate any acquired businesses into the Company without substantial expenses, delays or other operational or financial problems. In addition, acquisitions may involve a number of special risks, including diversion of management’s attention, higher than anticipated integration costs, failure to retain key acquired personnel, unanticipated events, contingent liabilities and amortization of acquired intangible assets. There can be no assurance that the acquired businesses, if any, will achieve anticipated revenues or earnings.

Item 7a – Quantitative and Qualitative Disclosures about Market Risk

The Company has considered the provisions of Financial Reporting Release No. 48 “Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments.” The Company had no holdings of derivative financial or commodity-based instruments or other market risk sensitive instruments entered into for trading purposes at December 31, 2003. As described in the following paragraphs, the Company believes that it currently has no material exposure to interest rate and foreign currency exchange rate risks in its instruments entered into for other than trading purposes.

Interest rates

The Company’s balance sheet periodically includes an outstanding balance associated with a revolving credit facility that is subject to interest rate risk. The Company has the ability to obtain a Revolving Credit Loan with an interest rate based on the London Interbank Offered Rate (LIBOR) or a Revolving Credit Loan with an interest rate based on the lender’s prime interest rate. As a result of these factors, at any given time, a change in interest rates could result in either an increase or decrease in the Company’s interest expense. As of December 31, 2003, the Company did not have any outstanding balances associated with its credit facility and therefore its consolidated financial position, results of operations or cash flows would not be affected by near-term changes in interest rates.

Foreign currency exchange rates

The Company’s earnings are affected by fluctuations in the value of the U.S. Dollar as compared to the Canadian Dollar, as a result of the sale of its products and services in Canada and translation adjustments associated with the conversion of the Company’s Canadian subsidiary currency into the reporting currency (U.S. Dollar). As such, the Company’s exposure to changes in Canadian exchange rates could impact the Company’s consolidated financial position, results of operations or cash flows. The Company performed a sensitivity analysis as of December 31, 2003 to assess the potential effect of a 10% increase or decrease in Canadian foreign exchange rates and concluded that short-term changes in Canadian exchange rates should not materially affect the Company’s consolidated financial position, results of operations or cash flows. The Company’s sensitivity analysis of the effects of changes in foreign currency exchange rates in such magnitude did not factor in a potential change in sales levels or local prices for its services/products as a result of the currency fluctuations or otherwise.

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ITEM 8. Financial Statements and Supplementary Data

Quarterly Results of Operations

(Unaudited)

(Dollars in thousands, except per share data)

All per share amounts have been adjusted to reflect a two-for-one stock split in the form of a stock dividend of one additional share for each share held, effected by the Company on December 17, 2003.

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REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of Lifeline Systems, Inc.

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Lifeline Systems, Inc. and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note A to the financial statements, the Company ceased amortizing goodwill in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” This standard was adopted January 1, 2002.

/s/PricewaterhouseCoopers LLP

Boston, Massachusetts

February 9, 2004

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LIFELINE SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2003 and 2002

(Dollars in thousands)

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

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LIFELINE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

For the years ended December 31, 2003, 2002 and 2001

(In thousands except for per share data)

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

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LIFELINE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

For the years ended December 31, 2003, 2002 and 2001

(Dollars in thousands)

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

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LIFELINE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended December 31, 2003, 2002, and 2001

(Dollars in thousands)