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U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended February 28, 2005

For The Transition Period from              to             

Commission File Number: 0-11868

CARDIODYNAMICS INTERNATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

(858) 535-0202

(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

As of April 1, 2005, 48,781,910 shares of common stock and no shares of preferred stock were outstanding.

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CARDIODYNAMICS INTERNATIONAL CORPORATION

FORM 10-Q

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

CARDIODYNAMICS INTERNATIONAL CORPORATION

Consolidated Balance Sheets

(In thousands)

(Continued)

See accompanying notes to consolidated financial statements.

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CARDIODYNAMICS INTERNATIONAL CORPORATION

Consolidated Balance Sheets (Continued)

(In thousands)

See accompanying notes to consolidated financial statements.

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CARDIODYNAMICS INTERNATIONAL CORPORATION

Consolidated Statements of Operations

(Unaudited - In thousands, except per share data)

See accompanying notes to consolidated financial statements.

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Consolidated Statements of Cash Flows

(Unaudited - In thousands)

Continued

See accompanying notes to consolidated financial statements.

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Consolidated Statements of Cash Flows (Continued)

(Unaudited - In thousands)

See accompanying notes to consolidated financial statements.

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CARDIODYNAMICS INTERNATIONAL CORPORATION

Notes to Consolidated Financial Statements

(Unaudited)

1. General

Description of Business

CardioDynamics International Corporation (“CardioDynamics” or “the Company”) is an innovator of an important medical technology called Impedance Cardiography (ICG). The Company develops, manufactures and markets noninvasive ICG diagnostic and monitoring technologies and electrocardiograph (ECG) electrode sensors. The Company was incorporated as a California corporation in June 1980 and changed its name to CardioDynamics International Corporation in October 1993.

2004 Acquisitions

On March 22, 2004, the Company completed the acquisition of substantially all of the assets and certain liabilities (the “Acquired Assets”) of the Vermed subsidiary (“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 develops, manufactures and sells noninvasive diagnostic and monitoring devices that use ICG technology for cardiovascular diagnostics sold.

Basis of Presentation

The information contained in this report is unaudited, but in our opinion reflects all adjustments necessary to make the financial position and results of operations for the interim periods a fair presentation of our consolidated operations and cash flows. All such adjustments are of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. All intercompany balances and transactions have been eliminated in consolidation.

These consolidated financial statements should be read along with the financial statements and notes that go along with the Company’s audited financial statements, as well as other financial information for the fiscal year ended November 30, 2004 as presented in our Annual Report on Form 10-K/A. Financial presentations for prior periods have been reclassified to conform to current period presentation. The consolidated results of operations for the three months ended February 28, 2005 and cash flows for the three months ended February 28, 2005 are not necessarily indicative of the results that may be expected for the full fiscal year ending November 30, 2005.

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Notes to Consolidated Financial Statements

(Unaudited)

1. General - (Continued)

Stock-Based Compensation

The Company has implemented the disclosure provisions of SFAS No. 148 Accounting for Stock-Based Compensation - Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation. The Company accounts for stock options granted to employees in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, as amended. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price.

At February 28, 2005, we had two stock-based employee compensation plans and applied APB Opinion No. 25 in accounting for the plans. Under APB Opinion No. 25, stock-based employee compensation costs are not reflected in net income when the options are granted under the plans and have an exercise price equal to or greater than the market value of the underlying common stock on the date of the grant. Awards under the plan vest over periods of up to four years.

The weighted-average fair value of options granted during the following periods was $2.29 and $3.50, respectively, using the Black-Scholes option pricing model with the following assumptions:

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Notes to Consolidated Financial Statements

(Unaudited)

1. General - (Continued)

The following table illustrates the effect on net income (loss) and net income (loss) per common share as if we had applied the fair value recognition provisions of SFAS No. 148 and SFAS No. 123 to all outstanding and unvested awards in each period (In thousands except per share data):

Net Income (Loss) Per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is calculated by including the additional shares of common stock issuable upon exercise of outstanding options and warrants in the weighted average share calculation. Basic and diluted loss per share are the same for the three months ended February 28, 2005 as all potentially dilutive securities are antidilutive. The following table lists the potentially dilutive equity instruments, each convertible into one share of common stock (In thousands):

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Notes to Consolidated Financial Statements

(Unaudited)

1. General - (Continued)

The following potentially dilutive instruments were not included in the diluted per share calculation for the three months ended February 28, 2005 and February 29, 2004 as their effect was antidilutive (In thousands):

2. Business Combinations

Vermed Acquisition

On March 22, 2004, the Company acquired substantially all of the assets and certain liabilities of Vermed. Vermed is a manufacturer of electrodes and related supplies used in electrocardiogram and other diagnostic procedures for cardiology, electrotherapy, sleep testing, neurology and general purpose diagnostic testing. Vermed is located in Bellow Falls, Vermont. The purchase price consisted of $12 million in cash, $529,000 of estimated acquisition costs, and the issuance to Vermont Medical, Inc. of 745,733 shares of the Company’s common stock valued at $4.5 million. The Vermed acquisition was accounted for using the purchase method of accounting whereby the total purchase price was allocated to tangible and identifiable intangible assets based on their fair values as of the date of acquisition. The excess of the purchase price over the fair value of tangible and identifiable intangible assets has been recorded as goodwill.

The following unaudited pro forma consolidated information is presented as if the March 2004 acquisition of Vermed occurred on December 1, 2003. These unaudited pro forma consolidated results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that would have actually resulted had the acquisition been in effect in the periods indicated above, or of the future results of operations. The unaudited pro forma consolidated results for the three months ended February 29, 2004 are as follows (In thousands):

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Notes to Consolidated Financial Statements

(Unaudited)

2. Business Combinations – (Continued)

Medis Acquisition

On June 2, 2004, the Company acquired 80% of all outstanding shares of Medis, a privately held European cardiology and vascular device company. Medis is located in Ilmenau, Germany and develops, manufactures and sells ICG and venous blood flow products. Medis operates as a majority-owned subsidiary of CardioDynamics and Dr. Olaf Solbrig, co-founder of Medis, continues as Managing Director. Dr. Solbrig and his partner retain a 20% minority interest in Medis. The purchase price consisted of Euros 800,000 ($985,000) in cash at the date of acquisition, Euros 760,000 (at present value of $806,000 using a 5% discount rate) to be paid over five years in equal installments, the issuance of 100,000 shares of the Company’s common stock valued at $636,000 and $411,000 of estimated acquisition costs. The Medis acquisition was accounted for using the purchase method of accounting whereby the total purchase price was allocated to tangible and identifiable intangible assets based on their fair values as of the date of acquisition. The excess of the purchase price over the fair value of net tangible and identifiable intangible assets has been recorded as goodwill. The Company funded the cash portion of the transaction with available cash. The acquisition was not considered material to the overall consolidated financial statements, or pro forma financial statements.

The Company has engaged an independent nationally recognized firm to assist in the valuation of amortizable intangible assets acquired and expects to complete the final purchase price allocation in the second quarter 2005.

3. Segment and Related Information

The Company’s reportable operating segments are as follows:

Impedance Cardiography (“ICG”)

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 and are used principally by physicians to assess, diagnose, and treat cardiovascular disease and are sold through our direct sales force and distributors to physicians and hospitals throughout the world. With the acquisition of Medis in June 2004, the ICG segment also includes diagnostic and monitoring devices such as the Niccomo and Cardioscreen monitors and the Rheoscreen family of measurement devices.

In December 2004, we received FDA 510(k) clearance on the BioZ Dx. The BioZ Dx has improved signal processing 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.

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Notes to Consolidated Financial Statements

(Unaudited)

3. Segment and Related Information – (Continued)

Electrocardiography (“ECG”).

The ECG segment designs, manufactures and sells electrocardiogram electrodes and related supplies through our Vermed subsidiary acquired in March 2004. These products are used principally in electrocardiogram and other diagnostic procedures for cardiology, electrotherapy, sleep testing, neurology and general purpose diagnostic testing. The products are sold to a diverse client base of medical suppliers, facilities and physicians.

Set forth below is segment information for the Company’s reporting segments for the three months ended February 28, 2005 and February 29, 2004. The Corporate unallocated items are comprised of general corporate expenses of a non-segment related nature (In thousands):

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Notes to Consolidated Financial Statements

(Unaudited)

3. Segment and Related Information – (Continued)

During the three months ended February 28, 2005, the Company had a single major customer that exceeded 10% of total net sales. The net revenues of that customer included in both ICG and ECG segment net sales totaled $2,381,000. For the three months ended February 29, 2004, we did not have any individual customer or distributor that accounted for 10% or more of total net sales.

4. Inventory

Inventory consists of the following (In thousands):

5. Long-Term Receivables

In fiscal 2000, the Company offered its customers no-interest financing with maturities ranging from 24 to 60 months. Revenue is recorded on these contracts at the time of sale based on the present value of the minimum payments using market interest rates or the rate implicit in the financing arrangement. Interest income is deferred and recognized on a monthly basis over the term of the contract. In fiscal 2001, the Company established a similar program through a third party financing company to replace the internal equipment-financing program. Under certain circumstances, the Company continues to provide in-house financing to its customers, although the contracts now typically include market rate interest provisions. The long-term receivables resulting from internal financing are collateralized by the individual systems.

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Notes to Consolidated Financial Statements

(Unaudited)

5. Long-Term Receivables – (Continued)

Long-term receivables consist of the following (In thousands):

6. Property, Plant and Equipment

Property, plant and equipment consists of the following (In thousands):

7. Goodwill and Intangible Assets

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, which became effective January 2002, goodwill and other intangible assets with indefinite lives are no longer subject to amortization but are tested for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. Other identifiable intangible assets with finite lives continue to be subject to amortization, and any impairment is determined in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Estimated amortization expense for the years ending November 30, 2006, 2007, 2008, 2009 and 2010 is $547,000, $547,000, $546,000, $546,000 and $546,000, respectively.

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Notes to Consolidated Financial Statements

(Unaudited)

7. Goodwill and Intangible Assets – (Continued)

The Company recorded $9,500,000 of goodwill at the acquisition date related to the Vermed and $1,555,000 related to Medis and identifiable intangible assets which consists of the following (In thousands):

8. Product Warranties

The Company warrants that their stand-alone BioZ Systems 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 13 months on systems sold internationally (including Medis) and on refurbished or demonstration systems. Options and accessories purchased with the system are covered for a period of 90 days. The Company records a provision for warranty repairs on all systems sold, which is included in cost of sales in the consolidated statements of operations and is recorded in the same period the related revenue is recognized.

The warranty provision is calculated using historical data to estimate the percentage of systems that will require repairs during the warranty period and the average cost to repair a system. This financial model is then used to calculate the future probable expenses related to warranty and the required warranty provision. The estimates used in this model are reviewed and updated as actual warranty expenditures change over the product’s life cycle. If actual warranty expenditures differ substantially from our estimates, revisions to the warranty provision would be required.

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Notes to Consolidated Financial Statements

(Unaudited)

8. Product Warranties - (Continued)

The following table summarizes information related to our warranty provision for the three months ended February 28, 2005 and the year ended November 30, 2004 (In thousands):

9. Long-term Debt

Long-term debt consists of the following (In thousands):

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Notes to Consolidated Financial Statements

(Unaudited)

10. Other Comprehensive Income

Other comprehensive income (loss) consists of the following (In thousands):

11. Financing Agreements

The Company’s revolving credit line with Comerica Bank is currently $5 million and matures September 14, 2005. We also have an outstanding term loan with Comerica Bank related to the acquisition of Vermed that 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. Under the terms of the revolving credit line, we are required to maintain tangible net worth, liabilities to tangible net worth and debt service coverage ratios, as well as maintain a minimum liquidity balance. 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. As of February 28, 2005, we are 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. There are no outstanding borrowings under the revolving credit line at February 28, 2005 or February 29, 2004.

With the acquisition of Medis in June 2004, the Company issued letters of credit for $1,007,000 (760,000 Euro) to secure the deferred acquisition payments due to the minority shareholders of Medis to be paid annually over five years from 2005 to 2009. The credit available under our revolving credit line is reduced by $1.1 million to cover these letters of credit. In addition, the Company assumed two bank loans with the Sparkasse Arnstadt-Ilmenau bank, which total 315,000 Euros ($386,000) at the acquisition date. One of the loans bears interest at a fixed rate of 5.5% through July 2006, and then the bank has the option to adjust the rate. The other loan bears a fixed rate of 5.9% through July 2011, and then the bank has the right to adjust the rate. Both loans mature in August 2021 and are secured by a pledge of the building.

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Notes to Consolidated Financial Statements

(Unaudited)

12. Commitments and Contingencies

Letters of credit

The Company had outstanding letters of credit at February 28, 2005 of $1,007,000 (Euros 760,000), which expire in June, 2009 to secure the deferred acquisition payments due to the minority shareholders of Medis to be paid annually over five years from 2005 to 2009. The deferred acquisition payments are included in current and long-term liabilities in the consolidated balance sheet as of February 28, 2005.

Operating leases

In June 2004, the Company amended the operating lease for the existing 18,000 square-foot facility in San Diego, California to extend the terms of the lease December 31, 2007. The amended lease terms provide for additional expansion space of approximately 15,000 square-feet and include a tenant improvement allowance of $225,000 for the construction of building improvements. The lease payments on the original space remained at $22,000 per month. The lease payments on the expansion space commenced on November 1, 2004 at $6,000 per month and then increase to $13,000 per month on November 1, 2005 with a 3% annual increase on each anniversary thereafter. The total additional lease commitments that the Company will incur from the amended lease through December 31, 2007 are approximately $532,000.

Assets pledged on bank revolving credit line and term loan

In March 2004, the revolving line of credit was increased to $5 million and the Company borrowed $7 million on a term loan in connection with the Vermed acquisition. The Company has pledged all assets as collateral and security in connection with the bank term loan and revolving credit line agreement.

Contingent obligation

As part of the acquisition of Medis, the Company assumed a contingent obligation to repay the German government for public grant subsidies of $412,000 (310,800 Euros, which represents the Company’s 80% share) if it does not meet certain conditions through December 31, 2007. The minority shareholders are personally liable for the other 20% share of the contingent obligation.

The grant subsidies were used to assist with the construction of the building now occupied and used for Medis’ business operations. The following conditions must be maintained:

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

FORWARD LOOKING STATEMENTS: NO ASSURANCES INTENDED

This Form 10-Q 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. This filing includes statements regarding our plans, goals, strategies, intent, beliefs or current expectations. These statements are expressed in good faith and based upon a reasonable basis when made, but there can be no assurance that these expectations will be achieved or accomplished. Sentences in this document containing verbs such as “believe,” “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.

Although forward-looking statements in this Report on Form 10-Q reflects the good faith judgment of management, such statements can only be based on facts and factors currently known by management. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in, or anticipated by, the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes, include without limitation, those discussed in our Annual Report on Form 10-K/A for the year ended November 30, 2004. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Report. Readers are urged to carefully review and consider the various disclosures made by us in our Annual Report on Form 10-K/A for the year ended November 30, 2004, which attempts to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and cash flows.

The following discussion should be read along with the Financial Statements and Notes to our audited financial statements for the fiscal year ended November 30, 2004, as well as the other interim unaudited financial information for the current fiscal year.

RESULTS OF OPERATIONS

(Quarters referred to herein are fiscal quarters ended February 28, 2005 and February 29, 2004)

Overview

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.

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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 and the amount of fluid in the chest. Our ICG products measure 12 hemodynamic 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 Monitors 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. In December 2004, we received FDA 510(k) clearance on the BioZ Dx ICG Monitor. The new BioZ Dx ICG Monitor 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.

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 we co-developed the BioZ Dx with Philips. 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 inability to hire, train, motivate, focus and retain the necessary sales and clinical personnel to meet our sales productivity and sales 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 of our Annual Report on Form 10-K/A, to the greatest extent possible.

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Following is a list of some of the key milestones we achieved in the first quarter of 2005:

We 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 Monitors, 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 acquisition of Medis in June, 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. In the first quarter of 2005, 22% of our total ICG revenue came from our disposable sensors, and that percentage has increased each year from approximately 4% in 1999, to 6% in 2000, 9% in 2001, 12% in 2002, 17% in 2003 and 19% in 2004. We have now shipped more than 3.5 million 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 maintain 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 in March, 2004. Revenue is generated primarily by ECG sensor sales that are used principally in electrocardiogram and other diagnostic procedures for cardiology, electrotherapy, 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 continue to 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 42% of our overall Company revenue in the first quarter 2005.

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Net Sales of ICG Segment – Net sales for the first quarter of 2005 were $7,246,000 compared with $8,015,000 in the same quarter last year in 2004, a decrease of $769,000 or 10%. The decrease in sales was due primarily to lower BioZ^® placements by our domestic direct sales force. We sold 176 BioZ Systems (includes 83 new BioZ Dx systems) in the first quarter of 2005, down from 201 BioZ Systems in the same period last year. We sold 238 ICG Monitors and Modules in the first quarter of 2005, down from 255 ICG Monitors and Modules, sold in the same period last year, bringing the total number of stand-alone ICG Monitors and ICG Modules sold to over 5,200.

Net sales by our domestic direct sales force, which targets physician offices and hospitals, decreased by $1,161,000 in the first quarter of 2005 to $6,233,000, down from $7,394,000 in the same quarter last year. Although we have increased our investment in our direct sales force, broadened our usage of U.S. distributors and expanded the number of sales regions, we experienced a decline in our domestic sales force productivity. We believe that this decline is a result of several factors including:

The shortfall in the domestic ICG market was partially offset by a 110% increase in international sales, including sales by our Medis division. First quarter 2005 international sales were $945,000, up from $451,000 from the same quarter last year as a result of utilizing our international sales team to expand the sales growth of Medis ICG products.

Each time our BioZ products are used, disposable sets of four BioZtect sensors are required. This recurring ICG sensor revenue increased 6% in the first quarter of 2005 to $1,624,000, representing 22% of ICG net sales (17% of consolidated net sales), up from $1,538,000 or 19% of ICG net sales in the same quarter last year. We offer a Discount Sensor Program to our domestic outpatient customers that provides 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.

Included in ICG net sales is revenue derived from extended warranty contracts, spare parts, accessories and non-warranty repairs of our BioZ Systems of $108,000 and $233,000 for the first quarter 2005 and 2004, respectively.

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Net Sales of ECG Segment – Net sales of ECG electrodes by our Vermed division for the first quarter of 2005 were $2,432,000. Vermed was acquired during the second quarter of 2004, therefore there are no comparable first quarter 2004 results.

Gross Margin of ICG Segment – Gross margin for the first quarter 2005 and 2004 was $5,262,000 and $6,160,000, respectively. As a percentage of sales, the gross margin was 73% as compared with 77% in the same quarter last year. The decrease in gross margin in the first quarter 2005 was primarily due to higher costs associated with sales of the BioZ Dx. This was partially offset by an increase in gross margin on ICG sensor revenue as a result of the lower manufacturing costs at our Vermed plant.

As the market matures 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 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 is higher than the BioZ.com.

Gross Margin of ECG Segment – We acquired Vermed in the second quarter of 2004 and it contributed gross margin of $1,069,000 in the first quarter of 2005, which was 44% as a percentage of net ECG sales. Based on its current customer base, we do not anticipate significant changes in the gross margin percentage for this business in the near term.

Research and Development for ICG Segment - Research and development expenses in the ICG segment decreased 24% in the first quarter of 2005 to $630,000 from $833,000 in the same quarter in 2004. The decrease is primarily attributed to reduced investments required for the development and testing of the BioZ Dx. In addition, we spent less on clinical studies in comparison to the prior year. This was offset somewhat by $79,000 of Medis research and development spending.

Research and Development for ECG Segment – Vermed’s investment in research, product development in the ECG segment was $34,000 in the first quarter 2005. These expenditures are primarily related to research, design and testing of product enhancements and extensions as well as modifications for private label products.

Selling and Marketing for ICG Segment - Selling and marketing expenses for the ICG segment in the first quarter of 2005 was $4,897,000, compared with $3,939,000 in the comparable quarter last year, an increase of 24%. As a percentage of ICG net sales, selling and marketing expenses increased to 68% for the first quarter 2005, compared with 49% for the same quarter last year.

The ICG segment expense growth was due primarily to an overall 14% increase in the average number of field sales personnel compared with the same period last year and higher expensed product material costs related to the launch of the new BioZ Dx product. During the first quarter of 2005, as a continuation of our efforts towards the expansion of our sales and clinical team, we created two new sales regions that we believe will allow us to better manage our sales associates and serve our customer base. In addition, we have made a concerted effort to broaden our sales reach through our distributors. These factors required additional investment in the education and training of our direct sales force and distributors, which we believe will improve our ability to generate increased equipment and recurring sensor revenue in the longer term. One of our primary objectives over the next several years is to increase field sales productivity and to reduce selling and marketing expenses as a percentage of net sales. With the operating leverage in our business, we believe this provides a significant opportunity to improve earnings and cash flow.

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Selling and Marketing for ECG Segment - Selling and marketing expenses for the ECG segment was $222,000 for the first quarter of 2005, representing 9% of net ECG sales. These expenditures are primarily for Vermed’s telemarketing, customer service and the OEM sales team.

Selling and Marketing for Corporate Unallocated – Corporate unallocated selling and marketing expenses for the first quarter 2005 were $65,000 as compared to $74,000 in the prior year. These expenses primarily relate to our corporate business development function, which assists in targeting new market opportunities through acquisitions, complementary technologies and technology development.

General and Administrative for ICG Segment – General and administrative expenses for the ICG segment in the first quarter of 2005 was $549,000, up 46% from $376,000 from the same quarter last year. The overall expense increases are due to additional headcount and year-end audit fees, as well as the inclusion of Medis administrative expenses. As a percentage of ICG net sales, general and administrative expenses during the first quarter of 2005 increased to 8% from 5% in the prior year.

General and Administrative for ECG Segment - General and administrative expenses for the ECG segment in the first quarter of 2005 were $166,000, representing 7% of net ECG sales.

General and Administrative for Corporate Unallocated - Corporate unallocated items are comprised of general corporate expenses of a non-segment related nature. In the first quarter of 2005, these unallocated expenses were $622,000, up from $201,000 from the same quarter last year. The significant increase 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.

Amortization of Intangible Assets for ICG Segment – In the first quarter of 2005, the ICG segment had $33,000 of amortization expense, which is related to identified intangible assets obtained in the acquisition of Medis.