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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended: November 30, 2004

OR

For the transition period from             to             

Commission file number: 0-11868

CARDIODYNAMICS INTERNATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (858) 535-0202

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

None

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

Common Stock, no par value

(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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 (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant was approximately $269,704,000 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.

In accordance with Securities Exchange Act of 1934 Release No. 50754, the information entitled Management’s annual report on internal control over financial reporting, required by Item 308(b) of Regulation S-K, have not been included herein and will be filed by amendment.

At February 15, 2005, 48,773,239 shares of registrant’s Common Stock were outstanding.

Documents Incorporated by Reference: None

CardioDynamics International Corporation

Form 10-K

TABLE OF CONTENTS

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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 based upon reasonable assumptions when made, 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,” and the like, 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 Annual Report on Form 10-K, including the section entitled “Risk Factors” in this Form 10-K 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

CardioDynamics International Corporation (“CardioDynamics” or “the Company”) is the innovator and market leader of an important medical technology called Impedance Cardiography (ICG). We develop, manufacture and market noninvasive ICG diagnostic and monitoring technologies and electrocardiograph (ECG) electrode sensors.

Our proprietary and patented ICG technology noninvasively monitors the heart’s ability to deliver blood to the body. Our systems provide 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 known as the BioZ.com^®), has received 510(k) clearance by the U.S. Federal Drug Administration (FDA) and carries the CE mark, which is a required certification of essential environmental and safety compliance by the European Community for sale of electronic equipment. We sell to physicians and hospitals in the United States through our own direct sales force and distribute our products to domestic and targeted international markets through a network of 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 3,800 ICG systems to over 2,900 physician offices and hospital sites throughout the world.

The Company was incorporated as a California corporation in June 1980 and changed its name to CardioDynamics International Corporation in October 1993. On March 22, 2004, the Company completed the acquisition of substantially all of the assets and certain liabilities (the “Acquired Assets”) of the Vermed Division (“Vermed”) of Vermont Medical, Inc. Vermed is a manufacturer of electrodes and related supplies used in electrocardiograms and other diagnostic procedures for cardiology, electrotherapy, sleep testing, neurology and general purpose diagnostic testing. On June 2, 2004, the Company completed the acquisition of 80% of all outstanding shares of Medis Medizinische Messtechnik GmbH (“Medis”). Medis is a manufacturer of diagnostic and monitoring devices, which uses ICG technology for cardiovascular diagnostics sold internationally.

Our products help physicians assess, diagnose, and treat patients with heart failure, hypertension (high blood pressure), and those who are short of breath. It is estimated that there are over 5 million heart failure patients in the United States and over 65 million patients with high blood pressure.

Electrocardiography (ECG) is a widely used noninvasive process to assess the electrical characteristics of the heart. Our ICG technology noninvasively quantifies the mechanical functioning of the heart. Conditions

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related to the improper 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 the five vital signs—heart rate, respiration rate, body temperature, blood pressure and oxygen saturation—quickly, safely and cost effectively.

Currently, the primary method used to measure hemodynamic parameters is pulmonary artery catheterization (PAC), which is an invasive procedure that requires insertion of a catheter (plastic tube) into the heart itself. Complications associated with this procedure occur in as many as one in four reported cases and typically include irregular heartbeats or infection, but in some cases, pulmonary artery rupture or even 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 majority of situations, a physician seeking to assess hemodynamics normally must do so through indirect means, such as 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 placed on the patient’s neck and chest. Our 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 fundamentally change drug management and make a genuine contribution to healthcare economics with our noninvasive technologies. Key elements of our strategy include efforts to:

Investors wishing to obtain more information about CardioDynamics may access our annual, quarterly and other reports and information filed with the SEC. Investors can read and copy any information we have filed with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. We also maintain an Internet site (www.cdic.com) where we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and any amendments to those reports, as well as Section 16 filings, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The information on our website is not incorporated by reference into this annual report on Form 10-K.

Industry Overview and Company History

Our proprietary technology provides medical professionals in the hospital and physician’s office with noninvasive access to objective patient data to effectively assess, diagnose and treat congestive heart failure and hypertension and to evaluate emergency, pacemaker and dialysis patients.

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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, the advantages of our proprietary technology are not limited to the hospital or the critically ill. We believe that the greatest current potential for the BioZ product line lies in the use of noninvasive hemodynamic measurements in the physician office. We believe that the worldwide market opportunity is over five billion dollars for our BioZ product line.

We envision expanding the domestic market from the current 2 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 figures do not include home healthcare monitoring, which we believe could, if implemented, significantly increase demand for our technology.

Potential Annual Noninvasive Monitoring Procedures

Patients in the United States

Strategy

Our objective is to fundamentally change patient care and make a genuine contribution to healthcare economics with our noninvasive technologies. Our objective will be achieved if and when noninvasive ICG technology becomes the Sixth Vital Sign, just 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 for assessing and treating congestive heart failure, hypertension, pacemaker, emergency, critically ill, surgical, high-risk obstetric, dialysis and home healthcare. Our corporate strategy includes:

Aggressively market and sell ICG products through our direct and distributor sales force.

We intend to leverage our direct sales force to capitalize on our first-to-market position in the United States to further penetrate the physician office market. We believe that a strong direct sales force supplemented by our clinical application specialists are best suited to educate the medical community about how our technology can improve patient outcomes and decrease costs. We currently have 52 domestic direct sales representatives who sell our products, as well as 6 regional managers, 1 national sales trainer, and a vice president of sales. In addition, we have 23 clinical application specialists and a national clinical applications manager to supplement our field sales team by enhancing customer understanding, usage and satisfaction. By improving device utilization, we believe we can 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 the large installed bases of patient monitoring, cardiology and other complementary medical equipment.

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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 patented 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 ICG sensor and cable system has a proprietary interface, which promotes the exclusive use of our sensors with our ICG equipment. During fiscal 2004, we acquired Vermed, an ECG electrode manufacturer that accounted for 16% of our net sales in 2004. As our installed base of BioZ products grows, and our ECG sensor business grows, we expect that the disposable sensor revenue stream could account for more than half of our total net sales within the next several years.

Expand evidence of the technology’s validity and clinical application in our target markets.

While a significant amount of evidence substantiating ICG’s validity and clinical application is now available, we will continue to invest in supporting clinical trials to further expand this evidence and provide prospective customers with data regarding the efficacy of ICG. Several multi-center clinical trials including studies in outpatient heart failure (PREDICT) and emergency department shortness of breath (ED-IMPACT) were released in 2004. A multi-center trial in hypertension (CONTROL) is expected to be released in 2005.

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 signal noise and patient movement thereby leading to additional applications for cardiovascular disease management.

In 2001, we released the BioZ^® ICG Module for the GE Medical Systems Information Technologies (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. In July 2002, we signed a Co-Development and OEM Agreement with Philips Medical Systems, a division of Royal Philips Electronics (Philips), a worldwide leader in clinical measurement and diagnostic solutions for the healthcare industry. CardioDynamics and Philips are actively working on the BioZ Dx ICG Diagnostics device, which was released in the beginning of 2005. When the BioZ Dx incorporates ECG measurements, expected by the end of 2005, Philips has the right to purchase ICG modules from us and sell the combined ECG/ICG product in their key markets.

Target new market opportunities through acquisitions of complementary technologies and technology development.

In 2004, we acquired two companies, Medis (a German ICG device design and manufacturer) and Vermed (a Vermont-based electrode manufacturer). The Medis acquisition strengthens our core ICG technology development capabilities and provides us with a European partner for market development opportunities in that region. The Vermed acquisition provides vertical integration of our disposable sensor business, protecting and increasing the margin on that revenue source.

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.

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

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ICG Technology

While ECG technology noninvasively 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, noninvasive, safe, painless and cost-effective way to monitor the heart’s ability to deliver blood to the body.

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 a high frequency (70 kHz), low magnitude (4 mA), alternating current through the chest that is not felt by the patient. Our BioZ ICG Monitor uses proprietary DISQ^® processing which measures the changes in impedance to the electrical signal. The changes in impedance are then applied to the Z MARC^® Algorithm to provide stroke volume, the volume of blood pumped with each heartbeat. Additional parameters that are provided include those indicating blood flow from the heart, the resistance the heart is pumping against, the force the heart is contracting, and the amount of fluid in the chest. These parameters are printed on a report that allows the doctor to customize and optimize treatment for a particular patient.

Some physical and medical conditions may diminish the accuracy of the measurements provided by our products; therefore, use of our BioZ ICG products in such cases is not appropriate. We believe that inaccuracies are most likely to 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

Pricing

Our products have established list prices and we discount the list prices of our products in some circumstances based primarily upon volume commitments or seasonal promotions. We also provide discounts on the purchase of refurbished equipment and to distributors who perform sales and customer service functions for us.

Products

We focus our business on two principal operating segments: Impedance Cardiography (“ICG”) and Electrocardiography (“ECG”) described below:

· ICG Segment—The principal products in the ICG segment consists of the following:

BioZ^® ICG Monitor

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

In December 2004, we received FDA 510(k) clearance on the BioZ Dx. The BioZ Dx has significant signal processing improvements and future 12-lead ECG capability. It also features an integrated full-page thermal printer, color display screen, and a new reporting function that allows physicians to automatically compare a patient’s last ICG report to the current ICG report. Commercial shipments of the BioZ Dx commenced in the first quarter of 2005.

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.

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BioZtect^® Sensors

We market disposable sensors designed specifically for use with our BioZ^® products. Four of our patented dual sensors are used in each monitoring session. Our proprietary sensor and cable systems provide enhanced features to our customers and promote the exclusive use of our proprietary sensors with our equipment.

Niccomo ICG Monitor

The Medis Niccomo ICG monitor is sold through Medis outside the United States and incorporates a color touch screen and integrated strip printer. Medis also manufactures and sells the Cardioscreen and Rheoscreen product lines of venous blood flow products.

· ECG segment—The principal product in the ECG segment consists of the following:

ECG Electrodes

Vermed manufactures and markets a large number of ECG electrodes for resting, stress, and ambulatory applications. They also manufacture private label ECG electrodes for distributors and medical device companies.

Sales and Distribution

We view the United States medical marketplace as two distinct segments: the outpatient market and the hospital market. In the outpatient market, we target physician offices and hospital-based and freestanding outpatient facilities for our stand-alone BioZ^® products through our direct sales force and distributors. In 2004, we initiated distributor sales efforts with Physician Sales and Service (PSS) and Caligor Medical (Henry Schein, Inc.). 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, our direct and distributor sales force is focused primarily on the outpatient markets.

We continue to believe that the hospital market represents a large and viable market for our products. In 2004, we piloted a program targeted to increase hospital market penetration. We may expand this program in 2005 by employing direct sales representatives to focus on this segment of the market.

Internationally, we sell our products through local medical distributors. Currently, we have distribution partners and end-users in more than 30 countries around the world. Additionally, our international sales team supports GEMS-IT sales teams in selling our ICG Module that interfaces with the GEMS-IT Solar and DASH monitoring systems. We do not offer product return rights to our distributors.

Strategic Relationships

During the fourth quarter of fiscal 2000, we entered into an agreement with GE Medical Systems (GEMS-IT) for the development of a custom plug-in module for the GEMS-IT Solar^® and DASH 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 CardioDynamics and 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 200,000 modular bedside monitors.

In July 2002, we signed a Co-Development and OEM Agreement with Philips Medical Systems, 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 ECG. We released an ICG-only monitor on the Philips platform in the beginning of 2005. The Co-Development and OEM agreement will allow both companies to market the combined ICG/ECG product.

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Medis entered into a technology licensing relationship with Analogic Corporation in March 2001. Under the agreement, Medis licensed their ICG board and software design to Analogic as a key component to their own ICG monitor. This product, called the LifeGard Monitor, was released in 2004, and is also sold by Philips Medical Systems Monitoring Division (Philips) as a stand-alone ICG monitor under the Philips brand. We will receive a licensing fee each time an Analogic or Philips ICG device is sold.

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 approximately 50 million people in the United States.

In November 2000, 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, (also referred to as a CPT Code) for BioZ ICG technology.

In 2002, CMS initiated a reconsideration of ICG’s indications for use. In January 2004, CMS issued an updated national coverage determination. Of the six indications previously indicated, five are substantially unchanged. One indication, “suspected or known cardiovascular disease,” has been revised to specifically allow CMS carrier coverage of resistant hypertension. Resistant hypertension is defined by CMS to include patients with uncontrolled blood pressure (greater than or equal to 140 mm Hg systolic blood pressure and/or 90 mm Hg diastolic blood pressure) on three or more anti-hypertensive medications. The other current CMS indications are as follows:

Some private insurers cover the BioZ ICG test, including Aetna, Humana, BlueCross BlueShield and others (in select states). We continue active discussions with CMS and private insurers to maintain and expand reimbursement indications for ICG.

Marketing

Our primary prospects in the outpatient market include cardiologists, internal medicine physicians and family practitioners caring for congestive heart failure, hypertension, shortness of breath, 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. Our marketing strategy is designed to:

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

Research and Development

Our research and development team, which consists of both scientific and engineering professionals, 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.

Our team continues to investigate the physiologic mechanisms underlying our ICG signal as a means of developing new diagnostic parameters. In addition, we are continuously researching the application of digital signal processing methodologies to improve the quality of signal acquisition and analysis algorithms. Some of this research has resulted in several U.S. patents issued and patents pending.

To supplement our internal development team, we retain Rivertek Medical Systems, Inc. (Rivertek) as an adjunct to our development efforts, of which the Chief Technology Officer of the Company is a 100% beneficial owner. See Item 13. Certain Relationships and Related Transactions in this Report on Form 10-K. Rivertek is located in Minneapolis, Minnesota and serves as an engineering consulting firm for medical device manufacturers, including Guidant Corporation and Medtronic, Inc., as well as emerging medical technology companies.

Intellectual Property

Our success, to some extent, depends 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. We have developed proprietary software for which we have not filed patents. We generally file patent applications in the United States and foreign countries where patent protection for our technology is appropriate and available. We have filed nine U.S. utility patent applications and three design patent applications, six of which were issued in 2003. Of the three utility patents that were issued, a key patent is U.S. Patent Number 6,561,986, “Method and Apparatus for Hemodynamic Assessment Including Fiducial Point Detection,” which contains 46 claims and is a strategic patent underlying the Company’s novel AERIS^TM (Adaptive Extraction & Recognition of Impedance Signals) processing. AERIS utilizes breakthrough techniques in time-scale signal processing to filter and accurately determine key ICG and ECG waveform characteristics, known as “fiducial points.” ICG and ECG fiducial points form the core measurements from which BioZ parameters are determined. AERIS processing provides enhanced stability, accuracy, and reproducibility in a broader range of patient monitoring conditions.

Another utility patent, U.S. 6,636,754, is the foundation of our electrode technology protection. Our three design patents that were issued in 2003 cover various design aspects of the Company’s BioZtect sensors. The intellectual property protection applies to sensors for use with both its BioZ ICG Monitor and BioZ ICG Module. The BioZtect sensors offer notable improvements in safety and signal transmission and detection, which are critical for device performance. We also rely on nondisclosure and noncompetition agreements with employees, consultants and other parties to protect trade secrets and other proprietary technology.

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Clinical Studies

We are committed to supporting well-designed clinical research studies utilizing ICG technology that demonstrate validity, reproducibility, clinical utility and cost-effectiveness. Our clinical research team participates in monitoring and analysis of company-sponsored clinical trials, for which we employ clinical research associates, and the support of multiple investigator-initiated trials. Each of these individuals has a strong clinical research background and is responsible for monitoring clinical studies and assisting in research and customer training.

Previous generation technology

Several hundred 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.

The previous generation technology we acquired in 1993 worked reasonably well in a select group of patients. However, significant technological limitations 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, CardioDynamics has 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. The results of several major studies addressing each of these areas have been released with positive results.

In May 2002, the results of a significant Mayo Clinic study were published in the peer-review journal, Hypertension. The results of the study demonstrated 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 September 2004, the results of the ED-IMPACT trial (Impedance Cardiography-Aided Assessment Changes Therapy in Emergent Dyspnea) were presented at the Heart Failure Society of America. The study demonstrated the impact of ICG data upon diagnosis and treatment in patients short of breath in the emergency department. The results demonstrated a 39% change in therapeutic plan and 12% change in diagnosis, which were considered very significant findings.

In November of 2004, the results of the PREDICT (Prospective Evaluation and Identification of Cardiac Decompensation in Patients with Heart Failure by Impedance Cardiography Test) were presented at the American Heart Association by principal investigator, Dr. Milton Packer, who led 21 top U.S. heart failure centers in the study. The study was designed to show whether ICG variables could predict whether a heart failure patient would die or be hospitalized, and the results showed that of all the variables measured in the study, ICG was the most powerful predictor of death or hospitalization. A patient with a high risk ICG test was over 8 times more likely to die or be hospitalized in the short-term (2 weeks) than a patient with a low risk ICG test.

In addition, multiple ICG studies have been published in journals such as Academic Emergency Medicine, Chest, American Journal of Cardiology and Congestive Heart Failure.

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Current Trial

CONTROL—Consideration Of Noninvasive Hemodynamic Monitoring to Target Reduction Of Blood Pressure Levels. We are sponsoring an 11-center trial in community-based treatment of hypertension to replicate the results of the significant Mayo Clinic Study in a non-hypertension-specialist environment. We are comparing the amount of time it takes to control blood pressure as well as 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.

Manufacturing

Our products are manufactured in San Diego, California; Bellows Falls, Vermont; and Illmenau, Germany. The CardioDynamics headquarters in San Diego includes the manufacturing and service facility for the CardioDynamics BioZ ICG systems. The Vermed subsidiary in Bellows Falls is a wholly owned subsidiary that manufactures and packages disposable electrodes and related supplies utilized in ECG, ICG and other diagnostic procedures. The Medis subsidiary in Illmenau is a majority owned subsidiary that manufactures ICG and venous blood flow products, including the Rheoscreen product line, Cardioscreen and Niccomo ICG monitors.

Each location has established procedures and controls intended to ensure that both products and purchased parts are designed and manufactured to meet customers’ requirements. We purchase the components and raw materials used in manufacturing our products from various suppliers. Our suppliers are evaluated, qualified and monitored to assure continuity of supply while maintaining high quality and reliability. We have systems and procedures in place to ensure timely and effective corrective and preventive actions are taken if we, or our customers, identify non-conformities.

Warranty and Repair

We warrant that our stand-alone BioZ System shall be free from defects for a period of 60 months from the date of shipment on each new system sold in the United States and for 12 months on systems sold internationally and on refurbished or demonstration systems. The warranty includes all options and accessories purchased with the system, except for the external patient cables, the external printer, and inflatable blood pressure cuffs that are covered for a period of 90 days. When warranty repairs are necessary, we generally perform them at our San Diego facility. In some cases, our distributors perform repairs in authorized service centers. In 2004, we added an additional International service center in Dubai, United Arab Emirates to fulfill the needs of the growing Middle-eastern market for ICG.

We provide on-call technical support and, on occasion, offer field clinical support specialists. In addition to our standard warranty, we offer Z Care^® extended warranty agreements for maintenance beyond the standard warranty period. We repair equipment that is out of warranty on a time and materials basis.

Competition

Direct competition

To date, we have experienced virtually no direct competition, however, we are aware of at least two domestic and one international manufacturer of ICG monitors. None of these companies have direct sales or clinical teams, and thus far, have had very little visibility in the market. We believe that our BioZ products provide the most advanced ICG monitoring and commercially attractive designs, at prices that are competitive.

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

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commonly used technology for monitoring hemodynamic status. Medical Data International estimates that PAC procedures are used nearly two million times per year worldwide. Edwards Lifesciences, Abbott Laboratories and Datex-Ohmeda produce the majority of right heart catheters used in the United States.

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 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. While it is possible, echo is not routinely used to measure cardiac output because of its technological limitations, cost, time, and lack of reimbursement for this purpose.

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 external position is technically impossible or for hospitalized patients undergoing cardiac surgery. Trans-esophageal echo is performed with the ultrasound transducer placed 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 immediately available. The procedure is customarily performed with several attendants, including an echo technician, a nurse and a physician.

Direct and Indirect 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 the 1980’s to the hospital surgical market. Because CO₂ Re-breathing method is limited to patients who are mechanically ventilated, the number of patients who are candidates for the procedure is severely limited.

Government Regulation

Our products are classified as medical devices subject to regulation in the United States by the Food and Drug Administration (FDA). New products generally required FDA clearance under a procedure known as 510(k) pre-market notification. A 510(k) pre-market notification clearance indicates FDA agreement with an applicant’s determination that the product is substantially equivalent to another marketed medical device. Our products generally are Class II products with the FDA. 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, its subsequent amendments and modernization acts, and similar foreign regulations, require that medical devices be manufactured in accordance with good manufacturing

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practices and quality system requirements. Our manufacturing processes and facilities are subject to periodic on-site inspections and continuing review by applicable regulatory bodies to ensure compliance with Quality System regulations. We believe that our products currently meet applicable standards for the countries in which they are marketed.

We are required to report to the FDA and international agencies information that a device has or may contribute to a death or a serious injury. We also may be subject to product recalls. No such report or recall has had a material effect on our financial condition, but there can be no assurance regulatory issues may not have a material adverse effect in the future.

We are subject to various environmental laws and regulations. Like other medical device companies, our operations involve the use of substances regulated under environmental laws, primarily in manufacturing processes. While it is difficult to quantify the potential impact of compliance with environmental protection laws, we believe that we are in material compliance with current environmental standards and that continued compliance will not have a material impact on our financial position, results of operations or liquidity.

Failure to comply with applicable governmental regulations can result in various penalties, including fines, recalls or seizure of product, total or partial suspension of production, refusal or delay in product approvals or clearances, increased quality control costs or criminal prosecution. Any change in existing federal, state or foreign laws or regulations, or in the interpretation or enforcement thereof, of the promulgation of any additional laws or regulations could have an adverse effect on our business, financial condition, results of operations or cash flows.

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 enabled 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 October 2004, 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. In February 2002, our distribution partners received MHLW and KFDA approvals, enabling our products to be sold in Japan and Korea.

Employees

As of November 30, 2004, we had 262 employees, none of which are covered by a collective bargaining union agreement. We consider our employee relations with our employees to be good.

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RISK FACTORS

In addition to the other information contained in this Form 10-K, you should consider the following risk factors which could affect our business, financial condition and results of operations. The risks and uncertainties described below are not the only risks facing us and additional risks and uncertainties may also harm our business.

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

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 support 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 adequate third-party reimbursement.

Our success will depend in part on the availability of adequate reimbursement for our customers from third-party healthcare payors, such as Medicare, private health insurers and managed care organizations. Third-party payors increasingly are challenging the pricing of medical products and services. Third-party payors may not cover all or a portion of the cost of our products 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.

Effective September 1, 2005, we will be required to account for stock options under our employee stock plans as a compensation expense, our net income and earnings per share will be significantly reduced.

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. Recent accounting pronouncements will require us to record compensation expense for employee stock option grants in our statement of operations. Note 1, “Stock-Based Compensation,” to our financial statements, reflects the impact that adoption of FAS 123 would have had on our net income (loss) and net income (loss) per share had we adopted this provision during the past three years. We have not yet determined the impact of FAS 123R but would expect the results to be similar to those disclosed in Note 1 to our financial statements.

Technological change is difficult to predict and to manage.

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.

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 and to the US market through our direct sales force and several regional

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and national distributors. We intend to enter into similar agreements with other companies and to establish technology partnerships with other medical product, distribution and technology companies. Widespread acceptance of our BioZ products is largely 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, finance, manufacturing, research and development personnel. We face intense competition in our recruiting activities and may not be able to attract or retain qualified personnel.

We are subject to stock exchange and government regulation.

Recent Sarbanes-Oxley legislation and stock exchange regulations have increased financial reporting and disclosure requirements, corporate governance and internal control requirements, including future compliance of our acquired businesses that have significantly increased the administrative costs of documenting and auditing internal processes, gathering data, and reporting information. In addition, the reporting timeframes have been, and will continue to be, compressed. The need to commit substantial resources and management attention in these areas could impact our ability to deploy those same resources to other areas of our business. If we are unable to comply with the requirements, it could significantly impact our market valuation.

We depend on 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 engineering 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 sufficient to protect our intellectual property rights. In addition, in the future, our products may be found to infringe 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 the intellectual property rights of others. Any claims resulting in intellectual property litigation, whether defensive or offensive would have no certain outcome and would be costly and time-consuming. In addition, if our products were found to infringe the intellectual property rights of others, we may be required to pay damages to such parties and/or to obtain licenses from such parties, either of which could be costly and could harm our business.

The validity and breadth of claims in medical technology patents involve complex legal and factual questions. There can be no assurance that pending patent applications will result in issued patents, that future

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patent applications will be issued, that patents issued to or licensed by us will not be challenged or circumvented by competitors or that such patents will be found to be valid or sufficiently broad to protect our technology or to provide us with a competitive advantage. 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.

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 also rely on nondisclosure and noncompetition agreements with employees, consultants and other parties to protect trade secrets and other proprietary technology. There can be no assurance that these agreements will not be breached, that we will have adequate remedies for any breach, that others will not independently develop equivalent proprietary information or that third parties will not otherwise gain access to our trade secrets and proprietary knowledge.

We face competition from other companies and technologies.

We compete with other companies that are developing and marketing noninvasive hemodynamic monitors. In early 2004, Analogic released the LifeGard ICG Monitor which is also available to be sold by Philips. 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 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 the last three fiscal years, we have experienced losses every year 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.

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We may need additional capital, which may be unavailable.

The commercialization of our current product line, acquisition of complimentary technologies 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:

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 at 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 successfully.

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 continually upgrade our information systems, expand our direct sales force and our internal sales, marketing and support staff. 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.

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

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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.

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 due to 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 or other regulatory 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 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 retrofitted 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, however 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.

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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:

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 at times experienced significant price and volume fluctuations that have affected the market prices of the stock of many medical device companies 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.

Our international sales expose us to unique risks.

In fiscal 2004, international sales accounted for approximately 8% of our net sales. We believe that international sales could represent a meaningful portion of our revenue in the future. We rely on regional distributors and GEMS-IT to assist us with our international sales efforts. In June of 2004, we purchased 80% of the outstanding common stock of Medis, which is located in Ilmenau, Germany. As such, 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.

We may not be able to execute our acquisition strategy or successfully integrate future acquisitions.

We expect to continue to pursue opportunities to acquire or make investments in other technologies, products and businesses that could enhance our technical capabilities, complement our current products or expand the breadth of our markets or customer base. We have limited experience in acquiring other businesses and technologies.

Potential and completed acquisitions and strategic investments involve numerous risks, including:

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If we fail to properly evaluate and execute acquisitions and strategic investments, our management team may be distracted from our day-to-day operations, our business may be disrupted, and our operating results may suffer. In addition, if we finance acquisitions by incurring debt or issuing equity, our existing shareholders would be diluted or we would have to generate additional profits to cover the interest expense.

Utilization of our deferred tax assets may be limited and is dependant on future taxable income.

We have federal operating loss carryforwards of approximately $23,300,000 for federal income tax purposes. The Tax Reform Act of 1986 contains provisions under section 382 of the Internal Revenue Code that limit the federal net operating loss carryforwards that may 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.

We determined, based on our assessment of both positive and negative evidence and objective and subjective evidence, which takes into consideration our forecasted taxable income, that it is more likely than not that we will benefit from the use of the deferred tax assets, and therefore we reduced our valuation allowance on the existing deferred tax assets related to these NOL’s to zero in the fourth quarter of fiscal 2004. Upon reducing the valuation allowance and recognizing the deferred tax assets, we recognized the tax benefit of deferred tax assets. The favorable impact of the tax benefit distorts the trends in our operating results and impacts the comparability of our current period results of operations with other periods. If in the future we determine, based on our assessment of both positive and negative evidence and objective and subjective evidence, which takes into consideration our forecasted taxable income, that it is more likely than not that we will not realize all or a portion of the deferred tax assets, we will record a valuation allowance on the deferred tax assets which would result in recognition of income tax expense.

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

In the wake of the terrorist attacks that occurred in the United States on September 11, 2001, 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. 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 affect our ability to achieve our revenue goals. Additionally, travel closures or delays could negatively impact deliveries of raw materials from our vendors 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.

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 well-publicized corporate business failures involving improper acts by executives and accounting irregularities, director and officer liability insurance has become more difficult to obtain. If we are unable to obtain sufficient director and officer liability insurance at rates that are reasonable or at all or if the possibility of director and officer liability is expanded by regulatory or judicial developments, we may not be able to retain our current officers and directors or attract qualified directors and officers in the future.

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 that would 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.

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We expect that the U.S. 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.

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 SEC 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 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 bank line of credit.

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We are headquartered in San Diego, California and operate manufacturing locations in San Diego, California; Bellow Falls, Vermont; and Ilmenau, Germany. In 2004, we amended the operating lease in San Diego, California to provide for additional expansion space of approximately 15,000 square-feet.

We are from time to time subject to legal proceedings and claims, which arise in the ordinary course of our business, none of which is required to be disclosed under this Item 3. Management believes that resolution of these matters will not have a material adverse effect on our results of operations or financial condition.

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended November 30, 2004.

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EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth information with respect to our executive officers:

Michael K. Perry, age 44, has been our chief executive officer and a director since April 1998. From 1994 to 1997, Mr. Perry was vice president of operations at Pyxis Corporation, a leading provider of healthcare automation, information management services and pharmacy management services to hospitals and outpatient facilities. Pyxis was acquired by Cardinal Health, Inc. in 1996. Prior to joining Pyxis, Mr. Perry served in various management positions with the medical products group of Hewlett Packard Company. Additionally, he was director of quality for a division of Hewlett-Packard’s deskjet printer group. Mr. Perry holds a bachelor’s degree in mechanical engineering from General Motors Institute and a master’s degree in business administration from Harvard University. Mr. Perry serves on the advisory board of the University of California San Diego Cardiovascular Center.

Rhonda F. Rhyne, age 44, has been our president since June 1997, previously serving as chief operating officer from 1996 to 1997 and as vice president of operations from 1995 to 1996. From 1992 until 1995, Ms. Rhyne was president, chief executive officer and vice president of sales and marketing for Culture Technology, Inc. Ms. Rhyne has also held sales positions at GE Medical Systems and Quinton Instrument Company, both medical device subsidiaries of publicly held companies. Ms. Rhyne holds a bachelor’s degree in pharmacy from Washington State University and a master’s degree in business administration, executive program, from University of California Los Angeles, Anderson School of Business.

Steve P. Loomis, age 44, joined the Company in September 1996 as vice president of finance and has held the positions of chief financial officer and corporate secretary since April 1997. From 1993 until 1996, he served as director of financial reporting at Kinko’s Inc. From 1988 to 1993, Mr. Loomis was chief financial officer for Terminal Data Corporation, a publicly traded company. He earned his bachelor’s degree in business administration from California State University at Northridge. Mr. Loomis is a certified public accountant.

Russell H. Bergen, age 57, has served as our vice president of operations since joining us in September 1998. From 1971 to 1998, Mr. Bergen held management positions in the instrument group, peripheral products group and inkjet business unit of Hewlett Packard Company. Previously, Mr. Bergen was employed at Honeywell, Inc. as a procurement engineer. Mr. Bergen earned bachelor degrees in aerospace engineering and manpower management from the University of Colorado at Boulder.

Dennis G. Hepp, age 55, has been our chief technology officer since June 1997 and has served as a consultant to us since July 1995. From 1974 to 1986, Mr. Hepp held engineering and management positions at Medtronic, Inc. In 1989, Mr. Hepp founded, and remains a key employee and managing director of Rivertek Medical Systems, Inc., an engineering consulting firm to medical device manufacturers. Mr. Hepp has a bachelor’s degree in electrical engineering from the University of Detroit.

Patrick W. Bradley, Ph.D., age 51, joined CardioDynamics in September 2000 as vice president of business development. Dr. Bradley served as director of new technologies for Cardiac Science, Inc. from 1999 to 2000 and from 1993 to 1999; Dr. Bradley was associate vice president for OEM Technologies at VitalCom, Inc.

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Prior to that, he was director of product management at Quinton Instrument Company. Dr. Bradley has served on the Scientific Peer Review Committee for the American Heart Association and on the Sports Science Research Group for the United States Olympic Committee. He has a bachelor’s degree in biology from Texas A&M University and a master’s degree and Ph.D. in physiology from University of Houston.

Richard E. Trayler, age 54, is our vice president of international operations and served as our chief operating officer from July 1997 to January 2003. From 1982 to 1997, Mr. Trayler held sales management positions at Quinton Instrument Company. He has also held positions at the Heart Institute for CARE, the University of Washington and the Boeing Company. Mr. Trayler earned a bachelor’s degree from Texas A&M University and a master’s degree from the University of Washington.

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PART II

Our common stock trades on the Nasdaq Stock Market under the symbol “CDIC.” The following table provides the high and low sales prices per share of our common stock as reported by the Nasdaq Stock Market.

On January 14, 2005 there were approximately 500 holders of record of our common stock. 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 data and has been derived from our audited financial statements and should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and related Notes.

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The following management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and related Notes, 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

CardioDynamics is the innovator and market leader of an important medical technology called Impedance Cardiography (ICG). We develop, manufacture, and market noninvasive diagnostic and monitoring technologies and electrocardiograph (ECG) electrode sensors. Unlike other traditional cardiac function monitoring technologies, our monitors are noninvasive (without cutting into the body). Our BioZ ICG Systems obtain data in a safe, efficient and cost-effective manner not previously available in the physician’s office and many hospital settings.

Just as electrocardiography noninvasively measures the heart’s electrical characteristics, ICG makes it possible to noninvasively measure the heart’s mechanical characteristics by monitoring the heart’s ability to deliver blood to the body. Our ICG 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 products, the BioZ ICG Monitor and the BioZ ICG Module for GE Healthcare patient monitoring systems, have been cleared by the U.S. Food and Drug Administration (FDA) and carry the CE Mark, which is a required certification of environmental and safety compliance by the European Community for sale of electronic equipment.

The aging of the worldwide population along with continued cost containment pressures on healthcare systems and the desire of clinicians and administrators to use less invasive (or noninvasive) procedures are important trends that are helping drive adoption of our BioZ ICG Systems. These trends are likely to continue into the foreseeable future and should provide continued growth prospects for our Company.

There is often a slow adoption of new technologies in the healthcare industry, even technologies that ultimately become widely accepted. Making physicians aware of the availability and benefits of a new technology, changing physician habits, the time required to secure adequate reimbursement levels, and the malpractice and legal issues that overlay the healthcare industry are all factors that tend to slow the rate of adoption for new medical technologies. We have invested a significant amount of our resources in clinical trials, which, if results prove successful, should contribute to further physician acceptance and market adoption of our technology. As with any clinical trial, there is not absolute assurance of the desired positive outcome.

We continue to invest in our partnerships to increase the presence and adoption of ICG technology. Our principal strategic partners include GE Healthcare and Philips Medical Systems (“Philips”), both of which are among the premier medical technology companies in the world and have a substantial installed base of medical devices. We are currently selling the BioZ ICG Module through GE Healthcare and are co-developing the BioZ Dx with Philips, the next generation ICG monitor. These strategic relationships further validate the importance of our technology to the clinical community and provide additional distribution channels for our systems. We intend to seek additional strategic partnerships over time to further the validation, distribution, and adoption of our technology.

We believe that the greatest risks in executing our business plan in the near term include: an adverse change in U.S. reimbursement policies for our technology, negative clinical trial results, competition from emerging ICG companies or other new technologies that could yield similar or superior clinical outcomes at reduced cost, or the

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inability to hire, train, and retain the necessary sales and clinical personnel to meet our growth objectives. Our management team devotes a considerable amount of time to assuring that we are mitigating these and other risks, described in the risk factor section in Part I, Item 1 of this Form 10-K, to the greatest extent possible.

Following is a list of some of the key milestones we achieved in 2004:

During 2004, we began to focus our business on the following two principal operating segments:

ICG Segment

The ICG segment consists primarily of the development, manufacture and sales of the BioZ ICG Monitor, BioZ ICG Module and associated BioZtect sensors. These devices use ICG technology to noninvasively measure the heart’s mechanical characteristics by monitoring the heart’s ability to deliver blood to the body. These products are used principally by physicians to assess, diagnose, and treat cardiovascular disease and are sold to physicians and hospitals throughout the world. With the recent acquisition of Medis on June 2, 2004, the ICG segment now also includes the Medis diagnostic and monitoring devices such as the Niccomo, Cardioscreen monitor and the Rheoscreen family of measurement devices. Medis products are sold internationally to physicians, researchers and equipment manufacturers. We derive our ICG segment revenue primarily from the sale of our BioZ ICG Monitors and associated sensors, which are consumed each time a patient test is performed. During 2004, 19% of our ICG revenue came from our disposable ICG sensors, and that percentage has increased each year from approximately 4% in 1999, to 6% in 2000, 9% in 2001, 12% in 2002 and 17% in 2003. We have now shipped nearly 3.3 million ICG sensor sets to customers since introducing the BioZ in 1997. We employ a workforce of clinical application specialists (CAS) who are responsible for driving customer satisfaction and use of the BioZ ICG Systems. We believe our CAS investment has served to accelerate the growth of our ICG sensor business, which should improve the predictability of our revenue, earnings, and cash flow.

ECG Segment

The ECG segment designs, manufactures and sells electrocardiogram electrode sensors and related supplies through our Vermed division acquired on March 22, 2004. Revenue is generated primarily by ECG sensor sales that are used principally in electrocardiogram and other diagnostic procedures for cardiology, electrotherapy,

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sleep testing, neurology and general purpose diagnostic testing. The products are sold to a diverse client base of medical suppliers, facilities and physicians. We believe that the acquisition will improve on our predictability of operating results by increasing the recurring sensor revenue mix of our business. When combined with our ICG sensor sales, the disposable sensor revenue stream comprised 32% of our overall Company revenue in 2004.

Net Sales of ICG Segment—Net sales were $34,260,000, $30,332,000, and $23,523,000 for 2004, 2003, and 2002, respectively, representing growth of 13% in 2004 over 2003 and 29% growth in 2003 over 2002. The sales growth in both years was achieved primarily through more BioZ placements by our domestic direct sales force and distributors and increasing disposable BioZtect^® sensor revenue from our growing installed base of ICG monitors. In addition, the Medis acquisition contributed about two percentage points of growth in 2004 over 2003.

Altogether, we sold 1,124 ICG Monitors and Modules in 2004, up from 805 in 2003 and 645 in 2002, increasing the total number of BioZ Monitors and ICG Modules to over 5,000.

In March 1998, we received 510(k) marketing clearance for our BioZ ICG Monitor. 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. The BioZ ICG Monitor accounted for 75% of our overall ICG revenues in 2004, compared with 80% and 85% of our sales in 2003 and 2002, respectively. The fluctuation in the percentage of BioZ sales is due to increasing sales of our disposable sensors and BioZ ICG Modules, as well as the addition of Medis ICG product sales during the second half of 2004.

The BioZ ICG Module is a custom plug-in module for the GE Healthcare Solar and Dash patient monitors. During 2004, we sold 233 BioZ ICG Modules, up from 8 Modules in 2003. There were no Modules sold in 2002. The significant increase in the current year is primarily due to BioZ ICG Module placements by our strategic partner GE Healthcare along with a 13 BioZ ICG module end user sale to the VA Hospital in San Antonio, Texas sold by our direct sales force. GE Healthcare has now sold to end users the inventory of 761 BioZ ICG Modules purchased from us under a minimum purchase commitment made by GE in 2001.

Net sales by our domestic direct sales force, which targets physician offices and hospitals, increased 8% in 2004 with sales of $30,889,000, from $28,542,000 in 2003, and increased 28% in 2003 over 2002 sales of $22,212,000.

Following an 18% increase in unit productivity by our direct sales force in 2003, we experienced a 17% decline in unit productivity in 2004 due to the hiring of new sales associates and clinical application specialists in the second half of 2004, increasing the average number of our field sales force by 20%. We believe that this investment in personnel will result in more rapid unit placement growth in the future as the newer sales associates gain experience in selling the BioZ products.

BioZ sales are also affected by third-party leasing incentive programs, targeted sales promotions, and the sales support of our clinical application specialists. These clinical application specialists assist in three primary areas: pre-sales activities including demonstrations, post-sales activities such as initial set-up and training for physician and staff, and ongoing customer support to maintain customer satisfaction and increase recurring sales of our proprietary disposable sensor.

Each time our BioZ ICG products are used, disposable sets of four BioZtect sensors are required. This recurring ICG sensor revenue continued to grow in 2004 as a percentage of our overall ICG sales, up 26% to $6,520,000, representing 19% of ICG net sales (16% of consolidated net sales). ICG sensor sales for 2003 were $5,170,000, representing 17% of net sales, up from $2,858,000 or 12% of net sales in 2002. We offer a Discount Sensor Program to our domestic outpatient customers that provide significant discounts and a fixed price on sensor purchases in exchange for minimum monthly sensor purchase commitments. As the installed base of BioZ equipment grows, we expect the revenue generated by our disposable BioZtect sensors will continue to increase as well.

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Net sales of our ICG products internationally, including Medis product sales, increased by $1,280,000 in 2004 to $2,839,000, up 82% from 2003. In 2004, Medis contributed $730,000 of this increase. In 2003, international sales totaled $1,559,000, an increase of $378,000 or 32% over international sales of $1,181,000 in 2002.

Sales to our domestic strategic partners were $532,000, $231,000 and $130,000 for 2004, 2003 and 2002, respectively. Our agreement with GEMS-IT called for annual minimum purchase commitments that expired in 2001 and therefore sales in 2002 and 2003 were significantly less as they sold products from their inventory.

Included in ICG net sales is revenue derived from extended warranty contracts, spare parts, accessories and non-warranty repairs of our BioZ systems of $739,000 in 2004, $764,000 in 2003 and $657,000 in 2002.

Net Sales of ECG Segment—Net sales of ECG electrodes for 2004 was $6,728,000, which resulted from the acquisition of Vermed during the second quarter 2004. The acquisition of Vermed contributed 22 percentage points to the consolidated net sales growth in 2004.

Gross Margin of ICG Segment—Gross margin was $26,665,000, $23,210,000 and $17,378,000 for the years ended 2004, 2003 and 2002, respectively. As a percentage of net sales, gross margins have improved steadily to 77.8% in 2004 from 76.5% in 2003 and 73.9% in 2002. The improved gross margin percentage has resulted from several factors including:

During the fourth quarter 2004, we commenced the transition of the BioZtect ICG disposable sensor manufacturing to our recently acquired Vermed division. We believe that this will not only allow us to benefit from the synergies of the efficiencies in sensor manufacturing, but should reduce our future cost of disposable sensors.

In the long term, we do not expect our gross margin percentage to continue to increase. As the market begins to mature and penetration increases, we believe that prices will naturally decline, as ICG technology becomes more of a standard of care, driving our gross margin to lower levels. The commercial release of our BioZ Dx, which received FDA 510(k) clearance in December 2004, should serve to support our BioZ System average sales prices, however, because we purchase a portion of the system from Philips, the manufactured cost of the BioZ Dx will be higher than the BioZ.com.

Gross Margin of ECG Segment—We acquired Vermed in the second quarter 2004 and it contributed gross margin of $2,686,000 in 2004, representing 39.9% of net ECG sales. Based on its current customer base, we do not anticipate significant changes in the gross margin percentage for this business

Research and Development of ICG Segment—Our investment in research and development for the years ended 2004, 2003 and 2002 were $4,268,000, $3,272,000 and $2,423,000, respectively. The 30% increase in 2004 over 2003 and 35% increase in comparing 2003 to 2002 are due primarily to the hiring of additional engineering and research personnel, including the Medis personnel in the second half of 2004. This provides us with the capacity to focus increased attention on the development of new products and product enhancements including the development and testing of the BioZ Dx, which is a joint ICG/ECG product development with Philips. Phase I, the ICG portion, of the co-developed Philips ICG/ECG monitor received FDA 510(k) clearance

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in December 2004. Development of the BioZ Dx consumed most of these resources in 2003 and 2004. Our investments in research, product development and clinical studies were lower in 2002, as the development of the GEMS-IT BioZ ICG Module, which required substantial outside engineering services was concluded and initial expenditures on several clinical studies leveled out.

Research and Development for ECG Segment—Our investment in research, product development in the ECG segment was $85,000 in 2004. These expenditures are primarily related to research, design and testing of product enhancements and extensions as well as custom modifications for private label products.

Selling and Marketing for ICG Segment—Selling and marketing expenses for the ICG segment increased to $17,514,000 in 2004 from $15,249,000 in 2003 and $12,892,000 in 2002, up 15% and 18% respectively. The ICG segment expense growth in both years was primarily due to an overall 20% increase in the average number of field sales personnel, higher commissions earned on increased sales by our direct sales force and additional provision for doubtful accounts resulting from higher accounts receivable balances and slower payments by our customers.

As a percentage of ICG net sales, these expenses were 51% in 2004, 50% in 2003, and 55% in 2002. Higher net ICG sales and increased sales productivity in 2003, coupled with the 81% growth in recurring sensor revenue, contributed to the improvement in sales and marketing as a percentage of net sales. The second half of 2004 was one of investment in the expansion of our sales and clinical team, which we believe will improve productivity by allowing our territory sales managers to focus on new systems sales, as our clinical team drives recurring revenue through support of our expanding customer base.

Over the next several years, our objective is to increase field sales productivity and thereby reduce selling and marketing expenses as a percentage of net sales. With the current operating leverage in our business, we believe this provides a significant opportunity to improve net income and cash flow.

Selling and Marketing for ECG Segment—Selling and marketing expenses for the ECG segment were $582,000 representing 9% as a percentage of ECG net sales in 2004. These expenditures are primarily for our ECG telemarketing, customer service and the OEM sales team.

Selling and Marketing for Corporate Unallocated—Corporate unallocated selling and marketing expenses were $261,000, $299,000 and $232,000 for 2004, 2003 and 2002, respectively. These expenses include costs for the corporate business development function, which assists in targeting new market opportunities through acquisitions and complementary technologies and technology development.

General and Administrative for ICG Segment—General and administrative expenses for the ICG segment were $1,654,000, $1,545,000 and $1,366,000 in 2004, 2003 and 2002 respectively. As a percentage of net sales, general and administrative expenses remained relatively flat at 5% in 2004 and 2003 and 6% in 2002. The overall expense increase in each of the three years is primarily due to additional headcount and in 2004, the inclusion of Medis administrative expenses of $66,000. 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.

General and Administrative for ECG Segment—General and administrative expenses for the ECG segment in 2004 were $412,000, or 6% as a percentage of ECG net sales.

General and Administrative for Corporate Unallocated—Corporate unallocated items are comprised of general corporate expenses of a non-segment related nature. These unallocated expenses were $1,317,000, $517,000 and $455,000 for 2004, 2003 and 2002. The significant increase in 2004 is primarily due to internal costs including additional headcount, outside consulting and accounting service fees related to compliance with the provisions of the Sarbanes-Oxley Act of 2002, including Section 404 relating to internal controls. We anticipate that these increased regulatory compliance requirements will continue to negatively impact our general and administrative costs in future periods. Also included are tax consulting fees related to the IRS Section 382 analysis of our net operating loss carry-forwards.

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Amortization of Intangible Assets for ICG Segment—In 2004, the ICG segment had $66,000 of amortization expense, which is primarily due to identified intangible assets resulting from the acquisition of Medis during the second half of 2004. There was no intangible asset amortization in 2003 or 2002.

Amortization of Intangible Assets for ECG Segment—Amortization expense for intangible assets for the ECG segment was $268,000 in 2004 related to identified intangible assets obtained in the Vermed acquisition in the second quarter 2004. There was no intangible asset amortization in 2003 or 2002.

Other Income (Expense) for the ICG segment—Other ICG income (expense) was $171,000, $230,000, and ($60,000) in 2004, 2003 and 2002, respectively. In 2004, other income included interest income of $255,000 offset by a $56,000 foreign currency translation loss resulting from the revaluation of the Medis deferred acquisition liability. The higher interest income in 2004 and 2003 is primarily due to more interest earned on internally financed equipment leases. Interest expense for the ICG segment was $27,000, $15,000 and $10,000 for 2004, 2003 and 2002, respectively and is related to interest on capital leases.

Other Income (Expense) for Corporate Unallocated—Corporate unallocated net other expense was ($147,000) in 2004 compared with net other income of $121,000 and $361,000, respectively in 2003 and 2002. The increased net other expense in 2004 is primarily the result of $228,000 in interest expense which includes interest expense and a commitment fee related to the bank term loan in connection with the Vermed acquisition.

Income Before Income Taxes and Minority Interest for ICG Segment—Income before income taxes and minority interest for the ICG segment was $3,404,000, $3,374,000 and $637,000 in 2004, 2003 and 2002, respectively. The improvement for 2004 over 2003 was primarily the result of higher sales, improved gross margins offset by higher operating expenses. The improvement for 2003 over 2002 also resulted from higher ICG sales and improved gross margins.

Income Before Income Taxes for ECG Segment—Income before income taxes for the ECG segment for 2004 was $1,271,000 representing a 19% before tax return on ECG net sales.

Income Tax Benefit (Provision)—Based on a growing history of profitability and our projections of future taxable earnings and other factors, in 2004 we determined that it is more likely than not that we will benefit from the use of our net operating loss carryforwards and therefore, eliminated our valuation allowance on our related deferred tax assets by $13,801,000 and realized a net income tax benefit of $7,209,000 in 2004. In 2003 and 2002, we provided $227,000 and $1,000 for income taxes, respectively.

Minority Interest in Income of Subsidiary—Minority interest in income of Medis was $37,000 and represents the 20% minority share interests retained by the sellers.

Net Income was $10,123,000 in 2004, up 313% from $2,452,000 in 2003. The improvement in net income for 2004 was primarily the result of an income tax benefit of $7,209,000, higher ICG sales, along with the net income contributed by the acquisitions of Vermed and Medis. Net income was $2,452,000 in 2003, up 691% from $310,000 in 2002 as a result of higher ICG sales, improved gross margin, and controlled operating expense growth.

Liquidity and Capital Resources

Net cash provided by (used in) operating activities was $4,365,000, $2,229,000 and $(143,000) in 2004, 2003 and 2002, respectively. In 2004, the net cash provided by operations was due to an increase in net income, higher accounts payable and accrued compensation and expense balances and the tax benefit from the exercise of stock options and warrants offset by deferred income tax and increased accounts receivable balances. In addition, the increase in deferred rent is due to a tenant improvement allowance received as reimbursement of leasehold improvements in accordance with the amended lease of our San Diego facility that was accounted for as a lease

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incentive in the fourth quarter 2004. The increase in 2003 as compared to 2002 operating cash flow is primarily due to increased net income, improved accounts receivable collections and tighter inventory flow management, offset partially by quicker payments to our vendors. In 2004, we used excess cash for the acquisitions of Vermed and Medis. In 2003 and 2002, we invested our excess cash and cash equivalents in short-term highly liquid investments.

In 2004, 2003 and 2002, we invested $1,392,000, $510,000 and $228,000, respectively, in property, plant and equipment. In 2004, the increase was due to investment in ICG sensor manufacturing equipment at our Vermed division, leasehold improvements due to the expansion of our San Diego facility, continued investments in computer software and equipment to continually upgrade our network, information system safeguarding and security capabilities in order to comply with the more stringent requirements of the Sarbanes-Oxley Act. In 2003, much of the increased investment in capital assets was for a new computer information system that was implemented in the fourth quarter 2003. 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 amended in June 2004 to extend the lease through December 31, 2007, and includes an additional 15,000 square-feet of expansion space. The original contractual lease payments are $22,000 per month, but with the expansion space, it increased in November 2004 to $28,000 per month for 12 months and then increases to $35,000 per month in November 2005 with a 3% annual increase on each anniversary.

We generated $8,203,000, $767,000 and $849,000 from financing activities in 2004, 2003 and 2002, respectively. This includes the exercise of stock options and warrants of $2,937,000, $757,000 and $944,000 in 2004, 2003 and 2002, respectively. In 2004, we borrowed $7,000,000 on a new term loan for the Vermed acquisition in March 2004, and paid the balance down by $1,767,000, which included fixed principal repayments of $1,167,000 and pre-payments of $600,000.

In connection with the acquisition of Vermed on March 22, 2004, we modified our revolving credit line to increase the amount available under the line to $5 million. Under the terms of the revolving credit line, we are required to maintain certain tangible net worth, liabilities to tangible net worth and debt service coverage ratios, as well as maintain a minimum liquidity balance. At November 30, 2004, we were in compliance with the covenants and do not believe that any covenants are reasonably likely to materially limit our ability to borrow on the credit line. As of November 30, 2004, 2003 and 2002, there were no outstanding borrowings under the revolving credit line.

The revolving credit line was extended in August 2004 to a maturity date of September 14, 2005 and the term loan has a maturity date of March 22, 2008. The revolving credit line and the term loan each bear interest at a rate of one half percent above the bank’s monthly prime rate and are subject to adjustment on a monthly basis. The obligations of the Company under the revolving credit line and the term loan are secured by a pledge of all of the Company’s assets. Additionally, with the acquisition of Medis on June 2, 2004, we issued letters of credit for $1,009,000 (760,000 Euros) to secure the deferred acquisition payments due to the minority shareholders of Medis to be paid annually over five years through 2009. The credit available under our credit line is reduced by $1.1 million to cover these letters of credit.

We have net operating loss carryforwards of approximately $23.3 million for federal income tax purposes that begin to expire in 2011. The Tax Reform Act of 1986 contains provisions that limit the amount of federal net operating loss carryforwards that can be used in any given year in the event of specified occurrences, including significant ownership changes. We retained independent tax specialists to perform an analysis to determine the applicable annual limitation applied to the utilization of the net operating loss carryforwards due to ownership changes as defined in Internal Revenue Code (IRC) Section 382 that may have occurred. The IRC Section 382 study and analysis was completed in the fourth quarter 2004, and as a result of this study, we do not believe that the ownership change limitations would impair our ability to use our net operating losses against our current forecasted taxable income. A valuation allowance had been established for the full amount of the deferred tax asset created by these carryforwards. However, based on historical and forecasted taxable earnings, the

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conclusion of identified uncertainties such as the integration of recent acquisitions, increased regulatory compliance requirements, manufacturing transition of our ICG sensors to Vermed, conclusion of multi-year clinical studies, and completion of the development and FDA approval of our BioZ Dx, the valuation allowance was removed, resulting in a significant income tax benefit in the current year.

We believe that over the next 12 months our current cash and cash equivalents, operating cash flows and availability under our revolving line of credit will be sufficient to support our ongoing operating and investing requirements such as ongoing research and development efforts, expansion of our direct sales force, capital expenditures and to meet the our working capital requirements of anticipated future growth. As we continue to pursue opportunities to acquire or make investments in other technologies, products and businesses, we may choose to finance such acquisitions or investments by incurring debt or issuing equity. Our long-term liquidity will depend on our ability to commercialize the BioZ and other diagnostic products and may require us to raise additional funds through public or private financing, bank loans, collaborative relationships or other arrangements.

Contractual Obligations

The following table summarizes our contractual obligations at November 30, 2004, and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

Off-Balance Sheet Arrangements

We are not a party to off-balance sheet arrangements other than operating leases, and have not engaged in trading activities involving non-exchange traded contracts, and are 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.

Critical Accounting Policies and Estimates

Revenue Recognition—We recognize revenue from the sale of product when persuasive evidence of a sale exists, the product has been shipped which coincides with transfer of title and risk of loss, 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 using the rate implicit in the financing agreement as revenue at the time of sale and recognize interest income over the term of the contract. Revenue for extended warranty contracts beyond our standard warranty is recognized evenly over the life of the contract. Amounts received for warranty contracts that have not yet been earned, are recorded as deferred revenue.

Use of Estimates—The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. We base these estimates and assumptions upon historical experience and existing, known circumstances we believe to be reasonable. Actual results could vary from those estimates under different assumptions or conditions.

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We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements and this discussion and analysis of our financial condition and results of operations:

Allowance for Doubtful Accounts and Sales Returns—We maintain an allowance for doubtful accounts to cover estimated losses resulting from the inability of our customers to make required payments. We determine the adequacy of this allowance by regularly reviewing the accounts receivable aging and historical write-off rates. If customer payment timeframes were to deteriorate, additional allowances for doubtful accounts would be required.

Also included in the allowance for doubtful accounts is an estimate of potential future product returns related to current period product sales recorded as a reduction of revenue. We analyze the rate of historical returns when evaluating the adequacy of the allowance for product returns.

Inventory Obsolescence—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 quarterly and record provisions for excess and obsolete inventory based on several factors, including our current assessment of future product demand, historical experience, and product expiration.

Valuation of Goodwill and Other Intangible Assets—We are required to perform an annual review for impairment of goodwill in accordance with Statement of Financial Accounting Standards No. 142 (SFAS No. 142), “Goodwill and Other Intangible Assets”. Goodwill is considered to be impaired if we determine that the carrying value of the reporting unit exceeds its fair value. In addition to the annual review, an interim review is required if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances include:

Valuation of Long-Lived Assets—We assess the impairment of long-lived assets, consisting of property, plant and equipment, whenever events or circumstances indicate that the carrying value may not be recoverable. Examples of such events or circumstances include:

There were no such impairments in the current year. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, we base useful lives and amortization or depreciation expense on our estimate of the period that the assets will generate revenue or otherwise be used by us.

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We also periodically review the lives assigned to our intangible assets to ensure that our initial estimates do not exceed any revised estimated periods from which we expect to realize cash flows from the technologies. If a change were to occur in any of the above-mentioned factors or estimates, the likelihood of a material change in our reported results would increase.

Warranty Cost—We maintain a provision for product warranties. Estimates for warranty costs are calculated based primarily upon historical warranty experience and are evaluated on a quarterly basis to determine the appropriateness of such assumptions. Warranty provisions are adjusted from time to time when actual warranty claim experience differs from our estimates.

Income Taxes—We use the asset and liability approach to account for income taxes. This methodology recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax base of assets and liabilities and operating loss and tax credit carryforwards. We then record a valuation allowance to reduce deferred tax assets to an amount that more likely than not will be realized. We consider future taxable income in assessing the need for the valuation allowance, which requires the use of estimates. If we determine during any period that we could realize a larger net deferred tax asset than the recorded amount, we would adjust the deferred tax asset to record a charge to income for the period.

Recent Accounting Pronouncements

In December 2003, the FASB issued SFAS 132(R), Employers’ Disclosures about Pensions and Other Postretirement Benefits. This statement revises employers’ disclosures about pension plans and other postretirement benefit plans, but retains the disclosure requirements contained in SFAS 132, which it replaces. It requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2003. The adoption of this statement had no effect on our financial statement disclosures, financial position or results of operations.

In December 2003, the FASB issued Interpretation No. 46(R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This interpretation replaces Interpretation No. 46 issued in January 2003. It addresses consolidation by business enterprises of variable interest entities, which have certain characteristics. This interpretation is required in financial statements of public entities that have interests in variable interest entities or potential variable interest entities for periods ending after December 15, 2003. The application of this interpretation had no effect on our financial position or results of operations.

In November 2003, the FASB issued EITF 03-12, Impact of FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. EITF 03-12 states that the minimum lease payments are the difference between the proceeds upon the equipment’s initial transfer and the amount of the residual value guarantee as of the first exercise date of the guarantee. The application of this guidance had no effect on our financial position or results of operations.

In December 2003, the FASB issued EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. A consensus was reached regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, and SFAS 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. The application of this guidance had no effect on our financial position or results of operations.

In December 2004, the FASB issued SFAS 123R, Share-Based Payment. This statement is a revision of SFAS 123, Accounting for Stock-Based Compensation and supercedes APB 25, Accounting for Stock Issued to Employees, and is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. SFAS 123R establishes standards on accounting for transactions in which an entity obtains

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employee services in share-based payment transactions. This statement requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award, which is usually the vesting period. SFAS 123R also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. We are currently evaluating what the impact of the adoption of this statement will have on our financial position and results of operations. We intend to implement this statement in our fourth quarter of 2005.

In December 2004, the FASB issued SFAS 151, Inventory Costs, which is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. This statement amends ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS 151 requires that these items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal”. In addition, allocation of fixed production overheads to the costs of conversion must be based on the normal capacity of the production facilities. We are currently evaluating what the impact, if any, of the adoption of this statement will have on our financial position and results of operations and plan to implement this effective fiscal year 2005.

In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, which is effective for fiscal years beginning after June 15, 2005. SFAS 153 amends APB 29, Accounting for Nonmonetary Transactions, which is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in APB 29 included certain exceptions to that principle. SFAS 153 amends APB 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of this statement had no effect on our financial position or results of operations.

In November 2004, the FASB issued EITF 03-13, “Applying the Conditions in Paragraph 42 of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued Operations”. This guidance is applied to a component of an enterprise that is either disposed of or classified as “held for sale” in fiscal periods after December 15, 2004. The application of this guidance had no effect on our financial position or results of operations.

In November 2004, the FASB issued EITF 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” which is effective for reporting periods ending after December 15, 2004. This consensus addresses when contingently convertible instruments should be included in diluted earnings per share. The application of this guidance had no effect on our financial position or results of operations.

In October 2004, the FASB issued EITF 04-10, “Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds”. The consensus addresses the issue of how an enterprise should evaluate the aggregation criteria in paragraph 17 of SFAS 131, Disclosures about Segments of an Enterprise and Related Information, when determining whether operating segments that do not meet the quantitative thresholds may be aggregated. The effective date of this issue has been delayed and is anticipated to occur in 2005 to coincide with the final issuance of the FSP (FASB Staff Position), which will provide guidance in determining whether two or more operating segments have similar economic characteristics. However, earlier adoption is permitted. The application of this guidance had no effect on our financial position or results of operations.

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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. 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. As of November 30, 2004, we do not have any short-term investments.

During 2004, our primary exposure to market risk was interest rate risk associated with our variable rate debt. See “Item 7. Management’s Discussion and Analysis—Liquidity and Capital Resources” for further description of this debt instrument. A 1% change in interest rates on variable rate debt would have resulted in interest expense fluctuating by approximately $43,000 in fiscal 2004.

Foreign Currency Exchange Rate Risk

We are exposed to market risks related to foreign currency exchange rates, and have concluded that the market risk exposure is not material at this time.

39

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

CardioDynamics International Corporation:

We have audited the accompanying consolidated balance sheets of CardioDynamics International Corporation and subsidiaries as of November 30, 2004 and 2003, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended November 30, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of CardioDynamics International Corporation and subsidiaries as of November 30, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended November 30, 2004, in conformity with U.S. generally accepted accounting principles.

/s/ KPMG LLP

San Diego, California

February 28, 2005

40

CARDIODYNAMICS INTERNATIONAL CORPORATION

Consolidated Balance Sheets

(In thousands)

See accompanying notes to consolidated financial statements.

41

CARDIODYNAMICS INTERNATIONAL CORPORATION

Consolidated Statements of Operations

(In thousands, except per share data)

See accompanying notes to consolidated financial statements.

42

CARDIODYNAMICS INTERNATIONAL CORPORATION

Consolidated Statements of Shareholders’ Equity and Comprehensive Income

(In thousands)