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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

OR

Commission file number: 000–33001

NATUS MEDICAL INCORPORATED

(Exact name of Registrant as specified in its charter)

1501 Industrial Road, San Carlos, California 94070

(Address of principal executive offices, including zip code)

(650) 802–0400

(Registrant’s Telephone Number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value

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 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 the Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨    No x

As of June 30, 2002, the last business day of Registrant’s most recently completed second fiscal quarter there were 16,079,894 shares of Registrant’s common stock outstanding and the aggregate market value of such shares held by non-affiliates of Registrant (based upon the closing sale price of such shares on the Nasdaq National Market on June 28, 2002) was approximately $48,429,496. Shares of Registrant’s common stock held by each executive officer and director and by each entity that owns 5% or more of Registrant’s outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

On March 19, 2003, 16,337,569 shares of Registrant’s common stock, $0.001 par value, were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for the 2003 Annual Meeting of Stockholders.

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NATUS MEDICAL INCORPORATED

ANNUAL REPORT ON FORM 10-K

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PART I

This Annual Report on 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 about Natus Medical Incorporated (“Natus,” “we,” “us” or “our Company”). These statements include, among other things, statements concerning our expectations, beliefs, plans, intentions, future operations, financial condition and prospects, and business strategies. The words “may,” “will,” “continue,” “estimate,” “project,” “intend,” “believe,” “expect,” “anticipate” and other similar expressions generally identify forward-looking statements. Forward-looking statements in this Item 1 include, but are not limited to, statements regarding the following: the effectiveness and advantages of our products, status, marketing and support of our CO-Stat^® End-Tidal Breath Analyzer products and clinical studies related to the CO-Stat product, as a platform technology, the factors for acceptance of screening, incidence of newborn jaundice and hearing loss, bidding and selection processes, future results of clinical trials, our introduction of new disposable products for hearing screening, our marketing, technology enhancement and product development strategies, including additional applications for our CO-Stat product, our intention to enter into agreements with group purchasing organizations, future third party reimbursement for our products, factors relating to demand for and economic advantages of our products, the effect of Medicare reform legislation, implementation of newborn hearing screening and jaundice management, future manufacturing quality and cost, hiring of additional personnel, quality of materials from suppliers, future availability of components and materials and related production delays, the proprietary nature of our products, including infringement and enforcement of proprietary rights, future competition and our ability to compete, our compliance with regulatory requirements and laws, sufficiency of our facilities, resolution and effect of legal proceedings and our dividend policy.

You are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements are not guarantees of future performance. The forward-looking statements are subject to substantial risks and uncertainties that could cause our future business, financial condition, or results of operations to differ materially from our historical results or currently anticipated results. Investors should carefully review the information contained under the caption “Risk Factors,” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in, or incorporated by reference into, this report. All forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update forward-looking statements. These forward-looking statements are made in reliance upon the safe harbor provision of The Private Securities Litigation Reform Act of 1995.

Overview

We are primarily focused on developing, manufacturing and marketing screening products for the identification, monitoring and treatment of common medical disorders that may occur during the time from conception to a baby’s first birthday. This period is critical to every child’s development. By allowing for early detection and treatment, we believe our products can improve clinical outcomes, may help reduce costs and may minimize the duration of treatment, unnecessary retesting or hospital readmission. We design our screening products to deliver accurate results in a rapid and reliable manner. In addition, our products address the policies and guidelines for standard medical practices adopted by the American Academy of Pediatrics.

We have three product lines the Food and Drug Administration, or FDA, has cleared for marketing: the ALGO^® Newborn Hearing Screener, a product line for hearing screening, the CO-Stat analyzer, a product line for the detection of hemolysis that can be used for the management of newborn jaundice, and the neoBLUE^™ LED Phototherapy device, a product for the treatment of newborn jaundice. The ALGO screener and CO-Stat analyzer product lines are comprised of hardware units and single use disposable components.

Our ALGO screening products use our clinically validated AABR^® technology to enable simple, noninvasive and accurate screening for hearing impairment in newborns. The ALGO screener delivers sound

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stimuli to a newborn’s ears and analyzes the resulting brain wave responses to produce a “Pass” or “Refer” result. The procedure can be performed within hours after birth. In addition, our ALGO screening products meet the American Academy of Pediatrics’ guidelines without requiring a trained clinician to conduct the screening or interpret the results. We currently sell our ALGO screening products in over 20 countries worldwide, including the United States, Europe and Asia.

Our CO-Stat analyzer products enable physicians, within hours after birth, to assess the likelihood that serious newborn jaundice will not occur, thereby allowing physicians to keep newborns with higher risk of developing serious newborn jaundice in the hospital or under observation and to discharge those newborns with a lower risk. In the majority of cases, serious jaundice is the result of an abnormally high rate of hemolysis. Our CO-Stat analyzers accurately and non-invasively measure the rate of hemolysis by detecting the level of carbon monoxide in exhaled breath. The CO-Stat analyzer can be used on infants, children and adults and therefore may have applications, besides newborn jaundice, where assessing hemolysis is important. We are currently investigating the use of the CO-Stat analyzer for monitoring and assessing other clinical conditions, including pregnancy induced hypertension. We began commercially marketing our CO-Stat products in January 2001. To date, we have not achieved the level of sales of our CO-Stat products that we had anticipated, and in the third quarter of 2002, we began to reduce marketing and sales expenses associated with our CO-Stat products in order to more accurately reflect our expectations regarding near term revenues. We continue to believe that our CO-Stat technology represents a platform technology and are moving forward with clinical research for additional applications, most notably its use for the detection of medical conditions leading to pre-term delivery. While we intend to continue to support the user base now in place, we are currently evaluating the viability of marketing our CO-Stat products in the newborn jaundice market. We expect to continue to support clinical research in the field of newborn jaundice management and for additional clinical applications other than neonatal jaundice.

In October of 2002 we introduced our neoBLUE phototherapy device, for use in the treatment of newborn jaundice. Phototherapy is the standard of care treatment for newborn jaundice and consists of exposing the skin of a patient to a light source to accelerate the elimination of bilirubin from the body. Our neoBLUE phototherapy device is based on Light Emitting Diode technology and generates a narrow spectrum of light that is effective in converting bilirubin to a form that is easily excreted by the body. Compared to other available light sources, we believe the neoBLUE phototherapy device has the advantages of emitting less ultraviolet and infrared light, sustaining longer bulb life and generating less heat.

We were incorporated in California in May 1987 and reincorporated in the State of Delaware in August 2000. Our principal executive offices are located at 1501 Industrial Road, San Carlos, California 94070 and our telephone number at that location is (650) 802-0400. Our website is www.natus.com. The contents of our website are not incorporated by reference in this Annual Report on Form 10-K. We make our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on From 8-K, and amendments to those reports, available on our website as soon as reasonably practicable after we electronically file them with the Securities and Exchange Commission.

Clinical Background

Hearing Impairment

Overview

Approximately 4.0 million babies are born each year in the United States, and hearing impairment affects up to five per every 1,000 of those newborns. Until the introduction of universal newborn hearing screening programs, screening was generally performed only on those newborns who had risk factors for hearing impairment, including a family history of hearing impairment, infection prior to birth, low birth weight, skull or facial anomalies or bacterial meningitis. However, screening only those newborns with risk factors for hearing impairment overlooks approximately half of newborns with some level of hearing impairment.

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Early identification of hearing impairment and early intervention has been shown to improve language development significantly. Babies identified at birth as deaf or hearing impaired, who begin immediate therapy, can learn and progress at a rate comparable to children with normal hearing, regardless of the severity of hearing loss. However, undetected hearing impairment often results in the failure to learn, process spoken language and speak. A 1997 study conducted at the University of Colorado, Boulder evaluated the impact of hearing impairment on language and speech. All of the children evaluated in the study were born with a hearing impairment but differed by the age at which the hearing impairment was detected. The study concluded that those children whose hearing loss was detected and who received treatment early had significantly better language skills and vocabularies than those children whose hearing loss was detected later.

Newborn Hearing Screening

Newborn hearing screening has been performed in the United States since 1964 but has been generally limited to babies with risk factors for hearing impairment. We believe the lack of accurate, low cost screening devices and the subjective nature of other currently used tests, has limited the willingness of governments and physicians to adopt hearing screening as a standard of care for all newborns. In recent years, the clinical evidence in support of early detection for hearing impairment combined with the introduction of new screening technology has increased support for universal newborn hearing screening programs. In 1993, the National Institutes of Health and, in 1994, the Joint Committee on Infant Hearing endorsed universal newborn hearing screening. The combined clinical benefit and cost savings encouraged additional highly populated states to adopt mandates for universal newborn hearing screening as early as 1997.

In the United States, 37 states and the District of Columbia have universal newborn hearing screening mandates in place. The majority of the mandates currently allow for implementation over a two to three-year period. An additional 5 states have voluntary programs in place. We define states that voluntarily comply to be states without mandated universal newborn screening but in which we estimate at least 50% of newborns are screened. In some states, the state health departments may purchase and distribute hearing screening equipment. We estimate that approximately 98% of births in the United States in 2002 occurred in states that currently have mandates or voluntary programs in place. Due in part to the implementation periods in states with mandates, only 69% of newborns born in the United States were screened for hearing loss as of May 2002.

Recognizing that only 50% of children with hearing impairment have a risk factor, the American Academy of Pediatrics stated that selectively screening babies at high risk was inadequate, and it has recommended that all babies be screened for hearing impairment. In 1999, the American Academy of Pediatrics’ Task Force on Newborn and Infant Hearing published guidelines for universal newborn hearing screening programs. These guidelines are intended to establish the standard of care and provide that:

Because positive results are referred to an audiologist or physician for additional testing and evaluation, limiting the number of further evaluations stemming from false positive results reduces the cost of a newborn screening program. In addition, false positive results can cause unnecessary emotional trauma for parents.

In order to meet the standard of care guidelines set forth by the American Academy of Pediatrics, a hearing screening program needs to employ a screening method that focuses on two parameters: sensitivity and

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specificity. Sensitivity is the capacity to detect the disease or disorder in those infants with the disease or disorder. A sensitivity of 100% indicates that no newborns with a hearing impairment receive results indicating the absence of a hearing impairment. Specificity is the capacity to detect those infants without the disease or disorder. A specificity of 100% indicates that no newborn that actually has normal hearing receive results suggesting the presence of a hearing impairment.

Screening Techniques

Traditional methods of screening for hearing impairment include subjective behavioral tests and more expensive objective diagnostic processes. We believe widespread acceptance of screening newborns for hearing impairment requires a relatively inexpensive screening method that produces sensitive, specific and reliable results. The two traditional technologies used to screen newborns for hearing impairment are auditory brainstem response and otoacoustic emissions.

Auditory brainstem response.    Auditory brainstem response technology is the most accurate and comprehensive method for characterizing hearing impairment in adults and infants. Auditory brainstem response technology uses sensors placed on the head to measure the response of the brain and auditory nerves to sounds delivered through earphones. Hearing impairment is evaluated by monitoring the brain’s response to varying the frequency and volume of sounds. Trained clinicians must operate the auditory brainstem response screening equipment, and the screening results must be interpreted by an audiologist or trained physician. Auditory brainstem response technology is primarily used to assess the degree of hearing impairment in adults and children and is not widely used for newborn screening due to the high cost, lengthy procedure time and unavailability of trained specialists in many neonatal nurseries. Enhanced auditory brainstem response devices automate portions of the screening process, such as providing pre-determined parameter menus, to make these devices easier to use or the results easier to interpret. The user has discretion to set some or all of the screening parameters and, as a result, many enhanced auditory brainstem response devices require substantial user training. A physician, audiologist or other trained specialist may also be required to review a pass or refer result because these products permit discretion in setting screening parameters.

Otoacoustic emissions.    Otoacoustic emissions screening is a method of detecting hearing impairment in adults and children. Otoacoustic emissions are sounds created by the active biomechanical processes within the sensory cells of normal ears. Since otoacoustic emissions are present in normal ears, an absence of otoacoustic emissions is a sign of irregular function of these sensory cells, which could result in hearing impairment. Otoacoustic emissions screening uses a probe placed in the ear to deliver auditory stimulus and measures the response of the sensory cells with a sensitive microphone. Otoacoustic emissions screening does not evaluate the function of the entire hearing pathway because it does not assess the neural pathways. Therefore, otoacoustic emissions technology can fail to detect hearing disorders affecting the neural pathways, such as auditory neuropathy. An individual otoacoustic emissions screening is relatively inexpensive. However, a number of clinical studies have documented that otoacoustic emissions screening can result in an excessive number of false positive results, which require retesting. For example, a study conducted by researchers at the University of Michigan, reported in the December 2000 American Journal of Audiology, concluded that otoacoustic emissions screening of newborns had an 11% to 35% false referral rate, far in excess of the recommendations of the American Academy of Pediatrics. For otoacoustic emissions screening, these false positive results occur because in the first days after birth newborns commonly have fluid in their ears from the birth process, which can impair the ability to accurately assess hearing impairment with one screening.

Natus AABR Technology.    In order to address the limitations of other screening techniques, our ALGO screening product family utilizes proprietary Natus AABR Technology to provide accurate and non-invasive hearing screening for newborns. The ALGO screener, like traditional and enhanced auditory brainstem response devices, utilizes a number of sensors placed on the newborn’s head to measure the response of the brain and auditory nerves to sounds delivered through specially designed earphones. However, unlike traditional auditory brainstem response devices and most enhanced auditory brainstem response devices, our ALGO screener does

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not require a trained clinician to conduct the screening or an audiologist or physician to interpret the results. The ALGO screener uses our proprietary algorithms to perform the screening and draw a conclusion as to whether a baby needs to be referred to an audiologist for further evaluation.

Hemolysis and Jaundice

Overview

Babies are generally born with a quantity of red blood cells necessary for fetal life but in excess of their needs as newborns. These excess red blood cells are normally broken down by the body in a process known as hemolysis. The two products of hemolysis are a yellow pigment called bilirubin and a proportional amount of carbon monoxide. Abnormal rates of hemolysis cause abnormal levels of carbon monoxide and bilirubin. An abnormal rate of hemolysis may also be an indicator of a number of other disorders including anemia, infection and some genetic disorders.

High amounts of bilirubin in the body can cause a yellowing of the skin and eyes called jaundice. The high level of bilirubin can result either from too much bilirubin being produced by hemolysis or from the body’s failure to excrete the bilirubin. Extremely high levels of bilirubin, or hyperbilirubinemia, are toxic and may cause irreversible brain damage and potentially result in death.

The American Academy of Pediatrics Committee on Fetus and Newborns estimates that each year 60% of the four million newborns in the United States become jaundiced. According to the Journal of the American Medical Association, neonatal jaundice is the single largest cause for hospital readmission of newborns in the United States and accounts for 50% of readmissions. A study of 391 readmitted newborns at nine New York hospitals, reported in the Journal of Perinatal Medicine in 1999, found that of the readmissions, 65% in the first week of life and 39% overall were due to hyperbilirubinemia. Hyperbilirubinemia occurs in approximately 6% to 10% of newborns. Because of the serious consequences of hyperbilirubinemia, the American Academy of Pediatrics recommends that all newborns be closely monitored for jaundice and has called for the physician to determine the presence or absence of an abnormal rate of hemolysis to establish the appropriate treatment for the newborn. In a 1996 study we commissioned, the Churchill Madison Group estimated that annual inpatient hospital charges for neonatal jaundice were approximately $1.3 billion. By identifying those infants with high rates of hemolysis before they are discharged, fewer newborns would need to be readmitted and treatment could begin earlier.

Depending on its cause, jaundice can be treated by helping the newborn to excrete the bilirubin or to reduce bilirubin production. In the early stages, jaundice can be treated with blue light, known as phototherapy, hydration and frequent feedings. Dangerous or toxic levels of bilirubin are treated by blood exchange transfusion, which is a high-risk procedure for newborns. If a physician can assess the amount of bilirubin being produced and excreted by a newborn, the physician can better tailor the newborn’s treatment appropriately, reduce the number of invasive tests required to monitor the levels of bilirubin, and determine the appropriate term of hospitalization. In full term infants, the level of bilirubin in their blood is highest at approximately 72 hours after birth. However, infants are being discharged from the hospital before 72 hours after birth due to cost considerations. The National Hospital Discharge Survey estimated that for 1998 approximately 73% of all newborns in the United States were discharged before 72 hours after birth. In addition, it estimated that 24% of all newborns in the United States were discharged before 48 hours after birth. Thus, some infants may develop a potentially dangerous elevation in bilirubin levels after discharge. An article in the February 22, 2001 New England Journal of Medicine reported that early discharge and a reluctance to treat jaundice aggressively has led to an increase in the reports of brain damage caused by severe hyperbilirubinemia. In April 2001, the Joint Commission on Accreditation of Healthcare Organizations, a healthcare accrediting body in the United States, issued a Sentinel Event Alert emphasizing the need for hospitals to review current policies and procedures relating to hyperbilirubinemia in newborns and suggesting steps to prevent its occurrence in the future. In June 2001, the Center for Disease Control’s Morbidity and Mortality Weekly Report published four case studies of

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kernicterus. Kernicterus is a completely preventable condition that often results in permanent neurological damage brought on by the known toxic effects of excessively high levels of bilirubin.

The standard of care treatment for severe jaundice is phototherapy. During phototherapy the patient is exposed to a light source which converts the bilirubin to a form that is more easily excreted by the body. The optimal color of light to cause this conversion is in the blue range at a wavelength of approximately 450 nanometers. Most phototherapy lights use either fluorescent or halogen light sources. While these other light sources produce light that is effective in converting bilirubin they also produce light outside the optimal color range that may include harmful ultraviolet and/or infrared light. Ultraviolet light can cause skin damage similar to that which results from overexposure to the sun. Fluorescent and in particular, halogen light sources generate heat energy, which can result in dehydration.

Our neoBLUE phototherapy device is a phototherapy light that uses Light Emitting Diode or LED, technology to generate a narrow spectrum of light that, we believe, is optimal for the conversion of bilirubin, and produces a negligible amount of both ultraviolet and infrared light. These LEDs emit a high-intensity band of blue light, which is clinically proven to be most effective in the breakdown of bilirubin. Because the neoBLUE phototherapy device emits significantly less ultraviolet light and heat than conventional phototherapy devices, it may reduce the risk of skin damage and dehydration for infants undergoing treatment. Also, the utilization of this light may result in a more rapid reduction of bilirubin levels in newborns and potentially reduce the treatment time associated with phototherapy.

Our CO-Stat analyzer measures a baby’s exhaled carbon monoxide to indicate the rate at which bilirubin is being produced and may assist the clinician in determining the cause of neonatal jaundice. If the rate of red blood cell break-down, or hemolysis, is normal or low, the baby is not producing excessive levels of bilirubin and may be a candidate for early discharge. If the rate of hemolysis is high, this may be an indication of potentially serious disorders and increases the likelihood of neonatal jaundice. If the baby is producing high levels of bilirubin and does not develop jaundice in the first few days, the baby is presumed to be eliminating bilirubin efficiently but the underlying cause of the hemolysis may require treatment. If the baby develops jaundice, monitoring the rate of hemolysis with our CO-Stat analyzer product can help determine if jaundice is caused by excessive bilirubin production or inadequate bilirubin excretion.

Screening Techniques

Current means of identifying newborns with high or increasing bilirubin levels include visual observation, blood tests to assess bilirubin levels, antibody tests and the use of devices that measure the amount of yellow color in the skin.

Total Serum Bilirubin Test.    The total serum bilirubin test is a blood test that measures the total amount of bilirubin in the blood but does not differentiate between increased bilirubin production or decreased bilirubin elimination. As a result, the test does not give the clinician the information necessary to determine the cause of the increased bilirubin level and the most appropriate treatment for the newborn.

The Coombs Test.    The Coombs test is another frequently administered blood test that determines whether an antibody is affixed to the baby’s red blood cells. Antibodies on red blood cells are often associated with a high rate of hemolysis in newborns. However, other conditions may result in the presence of the antibodies, and the antibodies’ absence does not rule out a high rate of hemolysis or excessive levels of bilirubin. In addition, the Coombs test does not measure the rate of hemolysis. Even given these limitations, the Coombs test remains the most frequently used indicator of high levels of hemolysis and, in developed countries, it is currently administered to 50% to 60% of newborns prior to hospital discharge.

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Skin Color Assessment.    In recent years, a number of devices have been introduced to monitor changes in bilirubin levels by measuring the amount of yellow color in the skin. They are convenient because they do not require a blood sample. However, the reliability of tests performed with these devices is complicated by the variations in skin pigmentation, the baby’s age and birth weight. As with the blood sampling methods, measuring the amount of yellow color in the skin does not identify the factors contributing to the elevated bilirubin level.

CO-Stat End-Tidal Breath Analyzer.    In order to address the limitations of other means of analyzing hemolysis, our CO-Stat analyzer measures a baby’s exhaled carbon monoxide to assess the rate of hemolysis accurately. Hemolysis produces bilirubin and carbon monoxide in equal amounts, so that the rate of bilirubin production can be estimated by an analysis of the carbon monoxide in a newborn’s exhaled breath, while correcting for the carbon monoxide existing in the screening environment. Our CO-Stat analyzer can be used by a clinician with minimal training to conduct hemolysis testing. The physician can use the results of our CO-Stat analyzer to assess the rate of hemolysis. An assessment of how rapidly a newborn is producing bilirubin can help to identify those newborns who are more likely to develop jaundice after discharge from the hospital. If a newborn develops jaundice, knowing how rapidly a newborn is producing bilirubin can also help physicians determine whether jaundice stems from excessive bilirubin production or failure to excrete bilirubin adequately, which may guide further evaluation and patient management.

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Our Products

Our products include the ALGO screener, MiniMuffs^® Neonatal Noise Attenuators, CO-Stat analyzer and neoBLUE^™ phototherapy device product lines. The ALGO screeners and related single use disposable supplies are designed to objectively test newborn hearing shortly after birth and prior to discharge. The CO-Stat analyzer and disposable supplies are designed to provide a measure of the rate of hemolysis in order to assess the cause of elevation in the level of bilirubin. MiniMuffs, single use protective ear covers, reduce the level of noise to which newborns are exposed. The neoBLUE phototherapy device is a phototherapy light, incorporating a blue LED light source for the treatment of newborn jaundice. The following table provides a list of our current products.

Hearing Products

ALGO Newborn Hearing Screening Product Family

Our ALGO screening product family utilizes automated auditory brainstem response technology to provide accurate and non-invasive hearing screening for newborns. The ALGO screener delivers thousands of soft clicking sounds to the newborn’s ears through sound cables and disposable ear phones connected to the instrument. Each click elicits a series of identifiable brain waves, which are detected by disposable sensors placed on the baby’s forehead, shoulder, and at the nape of the neck. This methodology will detect hearing loss at 35 dBnHL or higher. The ALGO screener automatically extracts the infant’s brainwave responses from the background noise and noise caused by muscle activity. These brainwave responses are then compared to a template based on the brainwave responses of infants with normal hearing. The ALGO screener displays a “Pass” message when it collects sufficient data to establish that the baby’s responses are consistent with the responses of

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a normal hearing child to a 99.96% level of statistical confidence. If a determination cannot be reached after 15,000 clicks, the ALGO screener displays a “Refer” message, indicating that the infant should be referred for more detailed evaluation, including repeating the hearing screening by an audiologist or other specialist. Once the results of the second hearing screening are available, if the results still “Refer” the specialist will conduct additional tests to determine the type and severity of the hearing impairment. While the per test disposable costs of otoacoustic emissions screening may be lower than the per screening costs of our ALGO disposable supplies, published clinical studies have shown that ALGO-only screening programs are no more expensive than OAE-only programs or “two-step” (testing using OAE first, followed by ALGO screening for only the newborns that can not pass the OAE test) programs for hospitals with established screening programs, and that ALGO-only screening programs are lower in cost and achieve the lowest referral rates for hospitals just starting a newborn hearing screening program. We believe that by universally using automated auditory brainstem response technology our ALGO screening products have a number of advantages that include:

The ALGO screener line was first introduced in 1985. We acquired the ALGO screener product line in 1987, and we have since introduced six new versions of the ALGO screener and currently market the ALGO 3 screener, the ALGO 2e Color screener and the ALGO Portable screener.

ALGO 3 Newborn Hearing Screener.    In October 2001, we introduced the ALGO 3 screener. The ALGO 3 screener incorporates a laptop computer that interfaces our custom circuit boards and uses commercially available operating system software. This system uses our proprietary software to conduct simultaneous screening of both ears and conducts tests at 35 and 40 dBnHL. The ALGO 3 screener uses our software to store results from every test automatically, which facilitates prompt follow-up and tracking of patient results. Users can print daily, weekly or monthly reports, create backup files and integrate screening results into statewide databases. The ALGO 3 screener is also designed to allow for future software and hardware upgrades. The ALGO 3 screener uses an enhanced software program that makes it faster and easier to use. For example, the ALGO 3 screener lowered the initial refer rate of the already efficient ALGO 2e Color screener by an additional 50%.

ALGO 2e Newborn Hearing Screener.    In December 1998, we introduced the ALGO 2e Color screener. The ALGO 2e Color screener is similar in configuration, but not in feature and functionality, to the ALGO 3 screener. This system uses its software to conduct simultaneous screening of both ears and conducts tests at 35 and 40 dBnHL. It uses software to store results from every test automatically, which facilitates prompt follow-up and tracking of patient results.

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ALGO Portable Newborn Hearing Screener.    In June 1998, we introduced the ALGO Portable screener, which is compact and weighs less than five pounds. The ALGO Portable screener provides the flexibility to screen newborns in the newborn nursery, doctor’s office, clinic or home. The ALGO Portable comes with an attachable printer and is sold primarily in Europe and in Japan and to low volume birthing centers and hospitals.

ALGO Disposable Kit(s).    For infection control, accuracy, and ease of use, each hearing impairment test conducted with the ALGO screener is carried out with ALGO disposable kit(s) that include single use earphones, which we call Ear Couplers or FlexiCouplers, and electrodes, which we call Jelly Button or Jelly Tab Sensors. All of our screening supplies are alcohol and latex-free, and our adhesives are specially formulated for newborns.

Currently some hospitals use our ALGO screening products to screen only those newborns with risk factors for hearing loss while other hospitals use our ALGO screening products in their universal newborn screening programs.

MiniMuffs Neonatal Noise Attenuators

In 1995, we introduced our MiniMuffs, which are disposable earmuffs designed to decrease noise exposure for babies in neonatal intensive care units. The MiniMuffs fit securely over a baby’s ear and reduces sound levels by at least seven decibels, representing a reduction of sound pressure by more than 50%. Our MiniMuffs products are sold in the United States, Europe, Australia and New Zealand and meet health care infection control standards through a single use design. They adhere to the baby’s head with a non-toxic adhesive and are designed for a single use on a single patient for one day.

Jaundice/Hemolysis Products

NeoBLUE LED Phototherapy device

Our neoBLUE phototherapy device is a crib-side unit used for the treatment of jaundice. We believe that the neoBLUE phototherapy device is the only commercially available product that uses blue LED’s as its light source, providing reduced ultraviolet light and reduced heat emissions compared to other currently available phototherapy devices. We received FDA clearance for use of our neoBLUE phototherapy device in October 2002. We began to commercially market our neoBLUE phototherapy device in October 2002.

CO-Stat End-Tidal Breath Analyzer Product Family

CO-Stat End-Tidal Breath Analyzer.    Our CO-Stat analyzer is a point of care device used in well baby nurseries and newborn intensive care nurseries to measure a baby’s exhaled carbon monoxide concentration to indicate the rate at which bilirubin is being produced and may assist the clinician in determining the cause of neonatal jaundice. In order to conduct a complete assessment of a newborn’s risk of jaundice, the clinician would need to measure the rate at which bilirubin is being produced, the level of bilirubin in the blood and the rate at which the baby is excreting bilirubin. No currently available laboratory test or medical instrument is capable of assessing all of these clinical indicators. We received FDA clearance in March 1998 for use of our CO-Stat analyzer products to monitor hemolysis, or the rate at which red blood cell breakdown occurs and bilirubin is produced. We believe our CO-Stat analyzer is the only FDA-cleared device for this purpose. By measuring and subtracting the environmental level of carbon monoxide during the screening procedure, our CO-Stat analyzer identifies trace levels of carbon monoxide produced primarily through the breakdown of red blood cells. This information helps physicians distinguish between the jaundice stemming from bilirubin production and the body’s failure to excrete bilirubin. The CO-Stat analyzer assists clinicians in assessing bilirubin production, but does not determine the level of bilirubin in the blood.

CO-Stat Disposables.    A small plastic tube containing filters attaches to the CO-Stat analyzer and is placed at the opening of the baby’s nostril. To ensure proper infection control and accuracy of the test, the tube and

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filters used to sample the baby’s breath and environmental carbon monoxide are disposed of after a single use. The sampling of environmental carbon monoxide alters the tube and filters so that they cannot be reused for another test.

CO-Stat Analyzer Product Status

CO-Stat Analyzer.    We began to commercially market our CO-Stat analyzer products in January 2001. To date, we have not achieved the level of sales of our CO-Stat products that we had anticipated, and in the third quarter of 2002, began to reduce marketing and sales expenses associated with our CO-Stat products in order to more accurately reflect our expectations regarding near term revenues. While we intend to continue to support the user base now in place, we are currently evaluating the viability of marketing our CO-Stat products in the newborn jaundice market.

We have supported clinical studies relating to the use of our CO-Stat product in the newborn jaundice market. For instance, we conducted a two-year study of the CO-Stat analyzer at ten sites with 1,300 newborns to evaluate the ability of the carbon monoxide analysis alone and in combination with blood-based bilirubin testing to identify newborns who are at risk for developing hyperbilirubinemia. Principal clinical investigators in the United States included researchers from Stanford University, University Hospital of Cleveland, Women & Infants’ Hospital in Providence, Rhode Island, the University of Pennsylvania and William Beaumont Hospital in Royal Oak, Michigan. Investigators from hospitals in Israel, Hong Kong and Japan also participated. Based on the data gathered during the study, the investigators concluded that a high rate of hemolysis is an important contributing factor in the majority of cases of hyperbilirubinemia. In addition, the investigators concluded that the CO-Stat analyzer enables clinicians to rule out excessive rates of hemolysis and thereby identify those babies who potentially may be discharged early because they are not likely to develop hyperbilirubinemia. The study, which was published in Pediatrics in July 2001, also concluded that the preferred means of conducting pre-symptomatic jaundice monitoring is assessing bilirubin production and elimination concurrently. The CO-Stat analyzer assists clinicians to assess bilirubin production, but does not determine the level of bilirubin in the blood or bilirubin elimination.

In addition, the University of Chicago conducted a clinical study of approximately 660 babies to assess the cost-effectiveness and clinical reliability of the CO-Stat analyzer as compared to the Coombs test. The principal investigators presented the results of the study in March 2001 at the California Association of Neonatologists Annual Meeting and the study was published in the Journal of Perinatology in July 2002. The principal investigators concluded that the Coombs test is not as accurate as the CO-Stat analyzer for the identification of hemolysis in newborns. In addition, the principal investigators concluded that the cost of the Coombs test is approximately 1.5 times more per infant for identification and evaluation of hemolysis as compared to the CO-Stat analyzer.

We continue to support clinical research in the field of neonatal jaundice management. Additionally, we have initiated clinical trials with the CO-Stat analyzer designed to evaluate the rate of carbon monoxide production as an indicator for pre-eclampsia and pre-term labor. In addition, we commenced a separate small trial for use of the CO-Stat analyzer in the management of sickle cell disease. These trials are in their early phases and results are not expected until later in 2003, or beyond. We can not predict the results of these trials.

Customers

Our customers include physicians, nurses, audiologists, hospitals and government agencies. We have sold approximately 4,355 ALGO screeners worldwide. We believe that there are approximately 4,000 birthing and children’s hospitals in the United States. Our ALGO screening products have been installed in at least 2,000 of these facilities. We have sold a total of 14 neoBLUE phototherapy devices during the two months since the product was introduced. To date, our CO-Stat analyzer sales have not been significant.

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We sold disposable supplies to conduct approximately 2.1 million hearing screenings in 2002, 2.0 million hearing screenings in 2001 and approximately 1.7 million hearing screenings in 2000. While the majority of our sales have been to customers in the United States, we have also sold ALGO screeners in 22 countries, including, but not limited to, Austria, Australia, Belgium, Germany, Japan, New Zealand and the United Kingdom. From time to time we participate in bidding and other selection processes for country or statewide hearing screening programs. For example, we participated in the National Health Service’s selection process in the United Kingdom for newborn hearing screening equipment vendors for England, Scotland and Wales. The selection process was finalized in 2002 and Natus shares the award as a vendor for newborn hearing screening equipment with five other vendors and to date, we have received the majority of the orders placed under that award. In September 2002, Natus also participated in the selection process for a province in Australia, sharing the award with one other vendor.

We began to commercially market our CO-Stat analyzer in January 2001 and our neoBLUE phototherapy device in October 2002. In 2002, 2001 and 2000, no single end customer comprised more than 10% of our revenues.

Marketing and Sales

Our ALGO screening products have been commercially available since 1985, and we began selling our MiniMuffs products in 1995. We began marketing our CO-Stat analyzer products for commercial use in January 2001. To date, our CO-Stat product has not achieved the commercial success that we had anticipated; however, we continue to support clinical research in the field of newborn jaundice management and for additional clinical applications. We only recently began marketing our neoBLUE phototherapy device in October 2002. We are using methods to sell our MiniMuffs and neoBLUE phototherapy devices that are similar to the methods we currently use to sell our ALGO screening products. We are currently evaluating the methods and viability of marketing our CO-Stat products in the newborn jaundice markets. Any future successful marketing of our CO-Stat product will require our use of strategies to establish and grow a market for the product.

Marketing

Our marketing strategy is to differentiate our products by their level of performance including sensitivity, specificity and reliability, ease of use and pre-discharge cost-impact testing advantages. We educate customers and potential customers about our products through:

We believe that educational efforts directed at government agencies and other third party payors about the benefits of universal screening in terms of patient outcomes and long-term treatment costs are a key element of our marketing strategy.

Direct Sales

In the United States, we sell our products to three groups of potential purchasers:

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Although we previously relied exclusively on distributors in Japan, we established a Japanese subsidiary in July 2000 and assumed the activities of our top-tier Japanese distributor in July 2001. We commenced sales to re-distributors in Japan in July 2001. We established a subsidiary in the United Kingdom in December 2000, which acquired our distributor in the United Kingdom in January 2001.

Distributor Sales

In addition to our direct sales force, outside the United States we have relied heavily on our distributor sales channel. Revenues from sales through distributors were approximately 13% of our revenues in 2002 and 14% of our revenues in 2001 and 2000, including sales to sub-distributors in Japan. Our distributors either assist our sales staff or are our sole sales and support representatives in their territories. We have established a network of distributors in Europe, Asia and Australia, numbering over 20 at the end of 2002. Our distributors typically perform marketing, sales and technical support functions in their country or region. Each one may distribute directly to the customer, via other distributors or resellers or both. We actively train our distributors in both product and sales methods.

Group Purchasing Organizations

In addition, approximately 90% of the hospitals in the United States are members of group purchasing organizations, which negotiate large volume purchase prices for member hospitals, group practices and other clinics. We have entered into agreements with several group purchasing organizations, and we intend to enter into similar agreements with other group purchasing organizations in the future. These group purchasing organizations are not required to continue to negotiate prices with us, and the members of these organizations are not required to purchase our products. For example, members of Novation, a group purchasing organization, receive specially negotiated prices, volume discounts and other preferential terms on their member’s direct purchases from us. Our agreement with Novation requires Novation to promote our hearing screening products to its members and to inform its members about the special terms we have negotiated. We have agreed to pay Novation marketing fees for these efforts, which fees are based on a percentage of our net sales to Novation’s members. Our agreement with Novation continues until January 31, 2004, but we or Novation may cancel it with notice or agree to extend it for up to two additional one-year terms. Direct purchases by members of Novation accounted for approximately 29% of our revenues in 2002, 25% of our revenues in 2001 and approximately 22% of our revenues in 2000. Novation’s members purchase products directly from us under the terms negotiated in the group purchasing agreement, and Novation does not purchase and resell our products to its members. Direct purchases by members of group purchasing organizations accounted for approximately 47% of our revenues in 2002, 35% of our revenues in 2001 and approximately 23% of our revenues in 2000.

Customer Service and Support

Our ALGO screening products, CO-Stat analyzer and neoBLUE phototherapy device are sold with a one-year warranty. We also sell extended warranty agreements for all of our products. We provide service to our

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domestic customer base through our Redding, California service center. This facility is equipped to perform full service, repair, and calibration services to customers on a warranty and fee basis. Service for our international customers is provided either by TriVirix International, Inc., our European contract manufacturer, our Japanese subsidiary or our Redding facility. We have certified TriVirix to perform all levels of service and repair on ALGO screening products.

Third Party Reimbursement

In the United States, health care providers that purchase products like ours generally rely on third party payors, including private health insurance plans, federal Medicare, state Medicaid and managed care organizations, to reimburse all or part of the cost of the procedure in which the product is used. Our ability to commercialize our products successfully in the United States will depend, in part, on the extent to which reimbursement is available for screenings, tests or treatments performed with the ALGO screener, CO-Stat analyzer or neoBLUE phototherapy device. Third party payors can affect the pricing or the relative attractiveness of our products by regulating the maximum amount of reimbursement these payors, such as insurance companies or health maintenance organizations, provide for testing services. In general, reimbursement for hearing impairment screening and jaundice assessment for newborns is included in the lump sum payment for the newborn’s birth and hospitalization. For this reason, we are not able to measure a reimbursement success rate for our products.

The current cost reduction orientation of third party payors makes it difficult for new medical screening and testing devices and tests performed with them to be eligible for reimbursement. Often, it is necessary to convince these payors that the new devices or procedures will establish an overall cost savings compared to the cost of those that are currently reimbursed or long-term treatment for the condition if the screening does not occur early. While we believe that our products possess economic advantages that will be attractive, third party payors may not make reimbursement decisions based upon these advantages. Third party payors are increasingly scrutinizing and challenging the prices charged for medical products and services.

Effective October 1, 1991, the United States’ The Centers for Medicare and Medicaid Services adopted regulations that provide for the inclusion of capital related costs in the prospective payment system for hospital inpatient services. Under this system most hospitals are reimbursed by Medicare on a per diagnosis basis at fixed rates unrelated to actual costs incurred in making the diagnosis. Under this system of reimbursement, equipment costs generally are not reimbursed separately, but rather are included in a single, fixed rate per patient reimbursement for screening based on approved current procedural terminology codes. Some states, such as California and Florida, reimburse clinicians for hearing screenings conducted with ALGO screening products as a separate reimbursement group from the birth and initial hospitalization reimbursement group. These regulations are being phased in over a ten-year period. Medicare reform legislation required The Centers for Medicare and Medicaid Services to implement a prospective payment system for outpatient hospital services. This system also provides for a per-patient fixed rate reimbursement for outpatient department capital costs. Although the full implications of these changes cannot be known, we believe that the regulations will place more pressure on hospitals’ operating margins, causing them to limit capital expenditures and reduce operating budgets. These regulations could cause hospitals to decide to defer purchasing equipment like our products as a result of limitations on their capital expenditures. The recent Medicare legislation also requires The Centers for Medicare and Medicaid Services to adopt uniform coverage and administration policies for laboratory tests.

In addition to traditional third party reimbursement, universal newborn hearing screening may be either paid for directly by the state or through private insurance coverage required by state legislation. Thirty-seven states and the District of Columbia have passed legislation requiring newborns to be screened for hear