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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the fiscal year ended December 31, 2008 | ||
or | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
Commission File Number:000-51512
Cardiac Science Corporation
(Exact Name of Registrant as Specified in its Charter)
| Delaware (State or Other Jurisdiction of Incorporation or Organization) | 94-3300396 (I.R.S. Employer Identification No.) | |
| 3303 Monte Villa Parkway, Bothell, WA (Address of Principal Executive Offices) | 98021 (Zip Code) |
(425) 402-2000
(Registrant’s Telephone Number, Including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered | |
| Common Stock, $0.001 par value | NASDAQ Global Market |
Securities Registered Pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to thisForm 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o |
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant, based on the closing price of the registrant’s Common Stock on June 30, 2008 as reported on the NASDAQ Global Market, was approximately $159,159,860.
The number of shares of the registrant’s Common Stock outstanding at March 3, 2009 was 23,074,655.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Report, to the extent not set forth herein, is incorporated herein by reference to the registrant’s definitive Proxy Statement relating to the registrant’s 2009 annual meeting of shareholders. Such definitive Proxy Statement or an amendment to this Report providing the information required by Part III of this Report shall be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates.
CARDIAC SCIENCE CORPORATION
2008FORM 10-K ANNUAL REPORT
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PART 1
This Annual Report onForm 10-K contains forward-looking statements relating to Cardiac Science Corporation. Except for historical information, the following discussion contains forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “intend,” “anticipate”,” will,” “may,” variations of such words, and similar expressions identify forward-looking statements, but their absence does not mean that the statement is not forward-looking. These forward-looking statements reflect management’s current expectations and involve risks and uncertainties. Our actual results could differ materially from results that may be anticipated by such forward-looking statements. The principal factors that could cause or contribute to such differences include, but are not limited to, those discussed under the heading “Risk Factors” on Item 1A of this report and those discussed elsewhere in this report. Readers are cautioned 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 any forward-looking statements to reflect events or circumstances that may subsequently arise. Readers are urged to review and consider carefully the various disclosures made in this report and in our other filings made with the SEC that disclose and describe the risks and factors that may affect our business, prospects and results of operations. The terms “the Company,” “us,” “we,” and “our” refer to Cardiac Science Corporation and its majority-owned subsidiaries.
| Item 1. | Business |
Overview
We develop, manufacture, and market a family of advanced diagnostic and therapeutic cardiology devices and systems, including automated external defibrillators (“AEDs”), electrocardiograph systems, stress test systems, Holter monitoring systems, hospital defibrillators, cardiac rehabilitation telemetry systems, and cardiology data management systems (“Informatics”) that connect with hospital information (“HIS”), electronic medical record (“EMR”) and other information systems. We sell a variety of related products and consumables, and provide a portfolio of training, maintenance, and support services. We are the successor to the cardiac businesses that established the trusted Burdick®, HeartCentrix®, Powerheart®, and Quinton® brands and are headquartered in Bothell, Washington. We distribute our products in nearly 100 countries worldwide, with operations in North America, Europe, and Asia.
We were incorporated in Delaware on February 24, 2005 as CSQ Holding Company to effect the business combination of Quinton Cardiology Systems, Inc. (“Quinton”) and Cardiac Science, Inc. (“CSI”) pursuant to a merger transaction. The merger was consummated on September 1, 2005 at which time the Company’s name was changed to Cardiac Science Corporation.
Industry Background
The American Heart Association (“AHA”) reports that there are over 64 million patients in the U.S. with active or developing heart disease. Cardiovascular disease (“CVD”) is the leading cause of death in the U.S. and statistics published by the AHA show that one out of every three Americans has some form of CVD. In 2009, the AHA estimated that as many as 295,000 people in the United States alone die each year from sudden cardiac arrest (“SCA”). The AHA also estimates the direct cost of treating CVD in the U.S. at more than $400 billion annually. With risk factors such as obesity and sedentary lifestyle on the rise, the prevalence of CVD is expected to increase as well.
Our Markets
We are a global leader in advanced cardiac diagnosis, resuscitation, rehabilitation, and informatics products. We characterize the systems used by healthcare providers to diagnose, monitor, and manage heart disease as the “cardiac monitoring” market. We characterize the devices used to automatically or manually resuscitate victims of cardiac arrest as the “defibrillation” market.
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Based on industry reports and management estimates, we believe that sales in the markets in which we compete will approach or exceed $3 billion during the next several years. We believe the worldwide market for cardiac monitoring systems is at least $1 billion and is growing at 2-3% annually, with portions of that market, cardiology management systems and certain international markets, growing at more than 5% annually. We believe the worldwide market for AEDs currently exceeds $350 million and will more than double over the next five years. We believe the worldwide market for manual (or traditional) external defibrillators is currently more than $700 million and is growing at approximately 5% annually.
Cardiac Monitoring Market
What is Cardiac Monitoring?
Cardiac monitoring systems are crucial to cardiovascular care. Clinicians use cardiac monitoring systems to assess the presence and severity of cardiac disease and to evaluate the efficacy of treatments such as drugs, interventions, operations, and device implants. Effective delivery of cardiovascular care requires that the entire process of recording, storing, analyzing, retrieving, and distributing cardiology data be as rapid and cost effective as possible.
How is Cardiac Monitoring Performed?
The core of cardiac monitoring is the electrocardiogram, or ECG waveform, a representation of the electrical activity of the heart. Clinicians use ECG waveform recordings and analyses to assess the presence and severity of cardiac disease and to monitor the efficacy of treatments such as drugs, interventions, operations, and device implants.
What are the Challenges Related to Cardiac Monitoring?
Despite the technological and clinical advances in cardiology, healthcare providers face significant challenges in delivering consistent and high quality cardiovascular care. Healthcare reform and declining reimbursement rates continue to place increasing pressure on providers to treat more patients faster. Increasingly, healthcare is moving outside of the hospital setting and into physician offices and other outpatient facilities. In addition, the need to control costs, increase efficiencies, and manage data introduces new factors into the decision making process for technology utilization.
These healthcare changes prompt a number of emerging critical needs and create opportunities for Cardiac Science. These include creating systems and services tailored to the clinician workflow, developing products that are intuitive and easy to use, using proven communication standards for connectivity, improving the management of healthcare delivery resources, and utilizing emerging technologies from multiple vendors — all within a security structure that meets Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) requirements.
Defibrillation Market
What is Defibrillation?
Defibrillation is the delivery of electrical current to the heart to restore a normal heartbeat. Defibrillation systems enable the detection and identification of life-threatening arrhythmias which can lead to death from SCA and, when appropriate, deliver a shock to restore the normal heartbeat. Sophisticated algorithms within defibrillators filter noise and artifact from a patient’s electrocardiogram signal to enable correct identification of heart rhythms that are life-threatening (i.e. shockable), or non-life-threatening (i.e. not shockable).
How is Defibrillation Performed?
A normal electrocardiogram consists of wave forms that are referred to as P-QRS-T waves. The QRS wave complexes correspond with a person’s heart rate. In the case of the chaotic and disorganized rhythm, which can lead to SCA, these QRS complexes are absent or indistinguishable.
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Analysis performed by a defibrillator determines the type of arrhythmia, whether a shock is required, and the appropriate type of shock (either synchronous or asynchronous). A shock will be indicated if the heart rhythm is considered shockable, and the condition persists. During the delivery of any defibrillation shock, the cell membranes of the heart are charged until the cells depolarize. This allows normal electrical pathways to reestablish control and produce a coordinated rhythm.
What Are the Challenges Related to Defibrillation?
Technical challenges abound in delivering current to the heart with external defibrillation. Impedance is one. Tissue such as skin, fat, muscle, and bone, surround the heart and impede the energy flow from a defibrillator. Impedance varies from person to person, so adjustments must be made to accommodate each person’s impedance. Another technical challenge is overcoming the victim’s defibrillation threshold, the minimum current required to defibrillate the victim’s heart and establish a normal rhythm. Finally, to provide effective defibrillation, the cell membranes of the heart must be fully depolarized to minimize the likelihood of re-fibrillation and provide an optimal environment to defibrillate the heart. If any residual charge remains on the cells (i.e., they do not fully depolarize), re-fibrillation may occur.
Death from SCA occurs without warning or immediately after the onset of symptoms. The AHA estimates that 50% of SCA victims have no prior indication of heart disease, so the first symptom is the SCA event. For those with a known history of cardiac disease, the chance of sudden cardiac death is four to six times greater than that of the general population.
Surviving SCA is linked directly to the amount of time between the onset of SCA and defibrillation shock. Following SCA, every minute without a defibrillation shock decreases chance of survival by approximately 10%. Approximately two thirds of the estimated annual deaths from SCA occur outside a hospital in the United States. Almost 60% of these incidents are witnessed, yet 95% of these victims do not survive, according to the AHA.
In hospital and pre-hospital (e.g. ambulance) settings, trained professionals typically deploy manual or semi-automatic defibrillators to treat SCA victims. These standard defibrillators require operation or supervision by highly skilled medical personnel to analyze and interpret the patient’s electrocardiogram and to manually deliver a shock using handheld paddles.
Over the past several years, more people have become aware that AEDs can be used safely by lay people. Communities that strategically place AEDs in public buildings, arenas, airports, and emergency vehicles reduce response times and, therefore, improve survival rates for SCA. Communities with public access defibrillation (“PAD”) programs report community survival rates approaching 50%. In highly trafficked or monitored venues such as casinos and corporate workplaces, survival rates have ranged even higher since the time for the first defibrillation shock can be accelerated in these venues.
Numerous AED-related laws and regulations at the federal and state level and in some countries outside the United States have facilitated significant growth in both new and existing markets for AEDs. During the last several years, these initiatives have resulted in certain protections from civil liability arising from emergency use of AEDs, funding programs for PAD program implementation and the mandatory deployment of AEDs in some settings. In addition, the AHA has publicly encouraged widespread deployment of AEDs in workplaces, communities, and homes.
Our Products and Services
We address our markets through a broad range of cardiac monitoring and defibrillation products and services. In recent years, we introduced new versions of products or upgraded capabilities in most of our product lines, and we are currently developing additional new versions of products in many of these product lines.
See Note 2 — Segment Reporting to our Consolidated Financial Statements included elsewhere in this report for a list of product lines contributing revenues of 10% or more in each of the last three fiscal years.
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Cardiac Monitoring Products
Our cardiac monitoring products deliver reliable, cost-effective solutions and improve workflow for healthcare providers worldwide in multiple settings. Our products are easy to use, with simple, intuitive user interfaces. Many of our products are built on a Microsoft Windows-based software architecture designed to integrate critical data capture, provide enterprise level access to data, and scale to meet the requirements of a variety of cardiovascular care environments.
Our principal cardiac monitoring products include:
Resting ECG systems
We offer a variety of ECG systems that allow physicians to record and analyze patient ECG waveforms at rest to assess the presence of cardiac disease. These products are designed to improve workflow and are offered at various price points and configurations, and cover the spectrum of market needs, ranging fromlow-cost units targeting physicians’ offices to fully featured units that are designed for the most rigorous clinical and hospital settings.
Cardiac stress testing systems
Our stress testing systems allow cardiologists and other healthcare providers to monitor and analyze the performance of the heart under stress. Our stress systems record a patient’s heart rate, heart rhythm, blood pressure, and other vital signs during induced stress. Our treadmills, specifically designed for cardiac monitoring procedures, provide precise and replicable levels of exertion. Our systems provide real time analysis, charting, and reporting, all of which enable cardiologists and other healthcare providers to diagnose patients’ heart disease more accurately and efficiently.
Holter monitoring systems
Our Holter products and systems record and assess the performance of a patient’s heart during various activities over extended periods of time. The Holter recorder, an ambulatory monitor typically worn for 24 hours or more, records the patient’s heart rate, heart rhythm, and ECG waveform data. Our Holter offering includes systems with multiple diagnostic capabilities.
Cardiac rehabilitation telemetry systems
Our telemetry devices and database products monitor the patient’s heart rate, heart rhythm, and ECG waveform data during rehabilitation exercises. These rehabilitation devices and database products, used with our treadmills, provide real-time clinical data and trend analysis to enable cardiologists and other healthcare providers to track and assess improvements in cardiovascular function.
Cardiology data management systems (informatics)
We provide cardiology data management systems that automate the processing, storage, retrieval, and editing of electrocardiograms and other patient data. Our open architecture strategy provides customers with the flexibility to integrate with an increasing number of devices and data management systems while retaining their current equipment.
Related products and supplies
Cardiac monitoring products often require lead wires and electrodes to be attached to the patient to retrieve and process patient ECGs, as well as thermal chart paper to generate reports. We sell these items, including our Quik-Prep electrodes, and provide an array of complementary cardiology related products, such as blood pressure monitors and spirometers.
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Services
We provide a comprehensive portfolio of training, maintenance, and other services to medical andnon-medical customers. Our services organization provides installation, repair, maintenance, and technical services, as well as hardware and software upgrades to our installed base of products. We provide call-center access 24 hours per day, seven days per week, depot repair, andon-site maintenance and repair through our extensive field service organization.
Advantages of our cardiac monitoring products:
We believe our cardiac monitoring products provide our customers with solutions for overcoming many of the challenges they face, including the following key benefits:
Ease of use. Our user interfaces, designed with significant input from clinicians and technologists, are intuitive and easy to use. Many of our products automate the data collection functions, use standard computer components, and require minimal configuration. We generally design our interfaces to conform to the particular clinical procedure rather than adapting the procedure to the device, and users can customize the interface to meet their unique requirements. We believe this functionality enhances clinical success by allowing the user to concentrate on the patient and procedure. In addition, we believe the ease of use features of our products enable our customers to use our systems with significantly lower training requirements and higher productivity than competing products that do not offer customizable user interfaces.
Effective data capture. Many of our products automate and assist in the collection, interpretation, and retrieval of data and can effectively display, forside-by-side comparison, the results of tests performed over an extended period. These products improve clinical productivity and throughput, which is the number of reimbursable procedures completed per hour of system use. For our customers, greater throughput translates into greater return on investment from our products.
Improved diagnostic speed and accuracy. As a result of easy to use controls, effective data capture, and computer assisted diagnosis, we believe our products allow for improved diagnostic accuracy. The availability of historical results for comparison allows for a greater understanding of changes in a patient’s physical condition. In addition, we believe that by enabling the review and assessment of test results remotely, our systems can greatly speed the time of diagnosis.
Wireless and network compatibility. Arguably the next most important feature after accuracy and dependability, most of our monitoring products support a clinical network environment. This enables cardiologists to assimilate, collate, and interpret data and disseminate results to facilitate diagnosis, patient monitoring and patient management. These products collect data that may be stored in a local or network server database. Most of our monitoring products also connect to larger enterprise networks that allow data to be shared with other users, both within the facility and remotely via secure networks.
To facilitate these connections, we rely primarily on commonly used formats and protocols. These formats, such as portable document format (“PDF”) and extensible markup language (“XML”) enable the storage and dissemination of clinical information.
Flexible open technology for integration with EMR, HIS, and other information systems. Our Microsoft Windows-based technology adheres to established standards for image, waveform, data and report generation, and dissemination, enabling healthcare providers to share data across a private network or via the Internet. This Windows-based technology platform was designed to support data integration activities with otherthird-party clinical systems. We believe this technology will permit our customers to easily integrate our products and systems with their existing infrastructure, and scale to meet the needs of larger healthcare organizations.
Defibrillation Products
We design our defibrillation products using advanced technology in order to deliver superior performance, reliability, flexibility, and ease of use. All of our defibrillation products incorporate our proprietary RHYTHMx
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technology. This platform technology is designed to detect ventricular fibrillation and other life-threatening arrhythmias. Our Self-Tracking Active Response (“STAR®”) biphasic technology is designed to optimize the delivery of a potentially life-saving electric shock to victims of SCA.
We have integrated our core technology, along with other proprietary technology, into our AEDs and hospital defibrillation product lines. We also market our proprietary disposable defibrillator electrode pads and a variety of accessories, including long-life batteries, carrying cases, wall cabinets, and other related items. In addition, we also license certain components of our core technology to third-parties for integration into other products. Our AEDs comply with the latest CPR and defibrillation protocols established by the AHA and related organizations in 2005.
Our principal defibrillation products include:
Public Access AEDs
AEDs designed for public access are deployed in numerous settings, including educational institutions, federal, state and local municipal agencies, fire and police departments, ambulances, railroads, airports, airlines, military bases, hospitals, nursing homes, health clubs, physician and dental offices, and leading corporations. Our AEDs have also been chosen by many local governments and municipalities for use in community based PAD programs in cities such as London, England, San Diego, California, Miami, Florida, Minneapolis, Minnesota, St. Louis, Missouri, and throughout the entire state of Nevada.
Public access AEDs are available in both automatic and semi-automatic models with varying levels of cardiopulmonary resuscitation (“CPR”) voice prompts. Our advanced voice prompts include detailed rescue code voice prompts and metronome guidance for CPR compressions which are designed to direct a minimally trained user through CPR and AED use to potentially save a life.
Professional AEDs
Our professional AEDs are technologically advanced and are designed for use by sophisticated users of lifesaving equipment, such as hospital personnel, medical professionals, and emergency medical technicians. These products display the victim’s heart rhythm on a built-in high resolution color ECG display and give professional users the option of delivering defibrillation shocks either semi-automatically or manually during the emergency treatment of a victim of sudden cardiac arrest. These products also include continuous cardiac monitoring capability via an ECG patient cable, multiple rescue data storage, clear and comprehensive voice prompts, infrared data transfer, and optional rechargeable batteries.
Traditional Defibrillators
Traditional defibrillators are typically positioned in the hospital at locations such as critical care and cardiac care units, emergency and operating rooms, electrophysiology labs, medical transport environments and alternate care facilities.
In 2008, we expanded our presence in the hospital defibrillation market with the Powerheart ECD, a traditional hospital “crash cart” defibrillator. The product is designed for use in hospital settings by skilled medical personnel and incorporates our proprietary technology. The ECD, which received 510(k) clearance in early 2006, is sold exclusively through GE Healthcare, a division of General Electric (“GE”). GE markets this product in North America and in the rest of the world as the GE Responder 2000.
Defibrillation Supplies and Accessories
We provide an extensive line of supplies and accessories to support our customers’ defibrillation programs. These include replacement electrodes and batteries, training devices, wall cabinets, carrying cases, and more.
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Services
We provide a full range of AED training, maintenance, and support services. Our services include training in the use of AEDs and related training in CPR. We deliver these AED/CPR training services in the field through a U.S. field staff of over 120 part-time employees. We also provide medical direction and information management necessary for AED users to be in compliance with various state laws and regulations.
Advantages of our defibrillation products:
We believe that our defibrillation products offer the following competitive advantages:
Dependability. Our patented Rescue Ready® technology distinguishes us among competitors. Every day, to ensure anytime functionality, the Powerheart AED self checks all main components (battery, hardware, software, and electrode pads). Every week, the AED completes a partial charge of the high-voltage electronics. And every month, the AED charges the high-voltage electronics to full energy. If anything is amiss, the Rescue Ready status indicator on the AED handle changes from green to red and the device emits an audible alert for the owner to service the unit. This is important because a Powerheart AED may not be used for months or even years.
Arrhythmia Detection. Our patented RHYTHMx software algorithm technology allows for the accurate detection and discrimination of life-threatening ventricular tachyarrhythmias and can also be used to treat patients with supraventricular arrhythmias. RHYTHMx filters noise and artifact from a patient’s electrocardiogram signal without compromising sensitivity or specificity. RHYTHMx technology has been clinically validated by leading researchers in numerous clinical studies and received the U.S. Food and Drug Administration (“FDA”) clearance in 1998. In these studies, RHYTHMx demonstrated 100% sensitivity (correct identification of shockable rhythms) and 99.4% specificity (the ability to identify and not shock non-lethal rhythms).
Variable Escalating Biphasic Defibrillation Energy. Our patented STAR biphasic waveform technology instantly determines a patient’s impedance, defibrillation threshold, and cellular response characteristics in order to optimize and adjust the magnitude of the defibrillation shock based on a patient’s unique size and weight. STAR biphasic also facilitates the escalation of energy if subsequent shocks are necessary. We believe this feature reduces the total number of shocks required to convert patients to a normal rhythm. In addition to the use of STAR biphasic waveform technology in our defibrillator devices, we also license this technology to selected partners.
Ease of Use. Time is critical during cardiac defibrillation. Our defibrillators are recognized as having industrial designs and user interfaces that facilitate ease of use. This uncompromising commitment to ease of use allows a wide variety of users in a multitude of medical and public access environments to successfully operate our devices. Our AEDs have one button or no button operation and provide clear, concise voice prompts that provide detailed instructions to guide the user through the rescue process.
Flexibility. Our various defibrillators allow for fully-automatic, semi-automatic, or manual delivery of defibrillation therapy. Operators can easily customize their device settings to suit their particular requirements. Our most popular AED offers patented, fully-automatic delivery of shocks, which differentiates it from competitive devices.
Rugged design. Durability and low cost of ownership are key features of our defibrillators. Designed for the most rugged applications our devices can withstand the demands of daily use by hospitals as well as deployments in military settings, fire trucks, police vehicles, and ambulances.
Growth Strategy
Our growth strategy is to: (1) exploit under-penetrated and emerging market segments; (2) create opportunities through innovation; (3) broaden our distribution; (4) leverage our services capabilities; and (5) pursue strategic mergers or acquisitions.
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Exploit under-penetrated and emerging market segments
Despite our relatively broad product line, we do not currently have offerings for a number of segments and sub-segments within our core markets. We intend to address many of these areas in the future, which would include offering suitable products at both higher and lower price points within these markets. Based on industry reports and management estimates, we also believe the global market for AEDs is significantly under-penetrated. We intend to focus our global AED selling efforts in the school, corporate workplace, government, first responder, and medical markets. We believe that, by continuing to focus the efforts of our direct sales force and distribution partners on these markets, we can increase our AED sales.
Create opportunities through innovation
We have made significant investment in research and development over the last several years, and we expect to continue to make significant investment in this area. By continuing to innovate, we believe that we will be able to attract new customers and sell replacement products, product upgrades, consumables and services to our existing customers. We intend to focus our research and development activities on new technologies, new clinical applications and other enhancements to our products that will make them easier to use, less expensive and provide better technical, clinical or connectivity functionality. In addition, we expect to continue to localize our products, with languages and other relevant features, to expand our sales internationally.
Broaden our distribution
We sell our AEDs in the U.S. market principally through a direct sales force, complementing this with the use of select third party distributors. We believe we can increase our sales of AEDs in the U.S. market by increasing our use of third party distributors.
We also believe that we can increase sales of both cardiac monitoring and defibrillation products outside of the United States by continuing to develop and improve our international distribution network, as well as leveraging our direct presence in locations such as the United Kingdom, France, Germany and China.
We expect to continue to enter into selling alliances, where appropriate, with industry players whose distribution capabilities can be effectively utilized, such as our agreements with Nihon Kohden in Japan to distribute certain cardiac monitoring and defibrillator products, and with GE globally to distribute certain defibrillator products. We also expect to selectively enter alliances in which we can leverage our existing distribution to sell products manufactured by other companies.
Leverage our services capabilities
We believe our focused repair, call center, and field service capabilities distinguish us from our competitors in cardiac monitoring. In addition, we believe our extensive capabilities to provide training, medical direction and information management relating to the deployment and maintenance of AEDs allows us to provide a unique, single source, turnkey solution to our customers. These capabilities offer the potential for additional revenue growth as part of new product selling efforts, as well as independently through billable, training, maintenance activities, and service contracts.
Pursue strategic mergers and acquisitions
Our growth strategy contemplates mergers and other acquisitions of businesses, product lines, assets, or technologies that are complementary to our business or offer us other strategic benefits, such as enhanced clinical or technological value, expanded geographical reach, and additional sales or research and development capabilities. We plan to expand our product lines, leverage the capabilities of our existing sales force and increase sales of our existing and new product lines by selectively acquiring those companies, or assets of companies, with strong differentiated technologies or complementary product lines. In addition to acquisitions of distinct product lines or smaller companies, we may pursue growth through merger with companies of more significant size. We believe the fragmentation of many areas of the cardiology industry offers an excellent
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opportunity for growth through selective acquisitions. We also believe our product brands and distribution capabilities, as well as the acquisition integration experience of our management team; put us in a position to take advantage of these opportunities.
Business Advantages
We believe our business has several advantages, including:
Cardiology focus. We concentrate exclusively on noninvasive cardiac care and thoroughly know our categories. We believe this singular focus elevates our product and service offerings, and differentiates us in the medical devices field. Our management and research and development teams have significant experience in cardiology products, which enables rapid innovation and commercialization of products and services. Similarly, our sales and service organizations also possess substantial domain knowledge.
Industry leading brands. We believe Burdick, HeartCentrix, Powerheart and Quinton, the four principal names under which we market our products, are highly respected names in the field of cardiology. The Burdick name has been associated with innovation in medical devices since 1913, and in cardiology since 1949. Our Powerheart AEDs are feature rich and known for their sophisticated but easy to use technology. Wayne Quinton developed the first treadmill designed for cardiac stress testing in 1953 and the Quinton name has been highly regarded for its advanced high quality and reliable cardiology products. We believe we have enjoyed strong brand recognition for all of our products and that we are known for a high level of service, which drives strong relationships with our customers.
Commitment to innovation. We invest a significant percentage of our revenues on research and development efforts to release new versions of most of our major product categories. We believe many of our products represent the leading technology in many of the principal markets we serve. We have also been recognized for our product innovation by various industry organizations.
Leading market positions. We believe we have a leading position in several domestic and international market segments in both cardiac monitoring and defibrillation. In AEDs, we have a substantial presence in U.S. corporate and government workplaces, as well as internationally in the United Kingdom and Japan. We believe our AED installed base is nearly 300,000 units worldwide.
In cardiac monitoring, we have a large installed base of stress test systems and rehabilitation telemetry systems and a significant presence in Holter monitors, electrocardiograph devices, and cardiology data management systems. We estimate that our installed base exceeds 65,000 monitoring units worldwide. Our installed base presents an excellent target market for future sales of products, systems, software upgrades, and related service and consumables.
Global distribution and service network. We believe that our comprehensive global distribution network focused on cardiology products and services distinguishes us from our competitors. Our sales organizations possess extensive experience and expertise in advanced cardiology products. In addition, our service organizations enhance customer satisfaction and retention, and also support our sales efforts with cross-selling capabilities. We believe our global distribution and service network has the ability to support the sale of additional new products, whether developed internally or acquired.
Our Organization
Sales and Marketing
We have structured our sales organization into four primary channels: (1) our U.S. acute care sales force, which sells cardiac monitoring products and services directly to hospitals; (2) our U.S. primary care sales force, which supports a network of independent distributors in selling both cardiac monitoring and defibrillation products to primary care physicians and cardiologists; (3) our North American defibrillation sales force, which consists of an integrated network of direct sales representatives and third party distributors who work together to optimize our sales of AEDs in this market; and (4) our international sales team, which consists of
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direct presences in China, Denmark, France, Germany, Canada and the United Kingdom, with a network of distributors that provide sales and service relating to all of our products in nearly 100 countries.
Our U.S. acute care sales team principally sells cardiac monitoring products to hospitals. Each sales representative is responsible for a region and a sales quota for that region. Our sales efforts in the acute care market increasingly target system sales opportunities. Our sales efforts have historically promoted stand-alone product sales and were most successful in small and midsize hospitals, and rehabilitation clinics. We believe improvements in our technology and changes in customer needs make our products attractive to larger hospitals, as well.
Our U.S. primary care sales force principally sells cardiac monitoring and defibrillation products outside of hospitals. Each sales specialists within this channel is responsible for a specific geographic territory and has a sales quota in supporting our independent distributor network in making sales to primary care physicians, cardiology offices, and all other alternate care facilities in that territory. We provide our distributors with discounts and promotional marketing support, based on a variety of factors including the annual volume of orders.
Our North American defibrillation sales force sells our defibrillation products, primarily AEDs and training services to corporate and government workplace markets, as well as through school, military, and first responder (police/fire) markets. Our sales representatives in this channel are responsible for territories that are defined by a combination of geographic and market segment characteristics. Each sales representative, selling directly and working with distributors in their territories, is responsible for a sales quota in that territory.
Internationally, we sell both our cardiac monitoring and defibrillation products primarily through country specific distributors, except in areas where we have direct sales operations or where we have a strategic selling alliance, such as Japan. Our international distribution network is managed by a team of employees and agents living abroad.
In addition to these sales channels, we have distribution arrangements with various partners such as GE, whereby we sell our AEDs and in-hospital defibrillation products in the North American hospital market and in all international markets. In North America, the products will be branded as Cardiac Science, while outside of North America, the products will be sold by GE under its own brand.
We support all of our sales efforts with a variety of targeted marketing activities, including direct mail, telemarketing, publications, trade shows, training, and other promotional activities.
We do not have significant sales backlog. At both December 31, 2008 and 2007, our total sales backlog represented less than 30 days of anticipated sales volume.
Customer Service and Support
We believe that our comprehensive training and services capabilities differentiate us from our competitors. Our extensive capabilities to provide AED and CPR training, medical direction, and information management relating to the deployment and maintenance of AEDs allows us to provide a unique, single source, turnkey AED solution to our customers. In addition, we believe our focused, dedicated cardiology customer and field service capabilities distinguish us from our competitors in competing for advanced cardiac monitoring product sales.
Our large installed base facilitates the sale of service contracts and post — warranty support and presents a cross-selling opportunity for products that are complementary to our customers’ existing installations. In international markets, our distributors provide support and other services.
Research and Development
We believe that strong product development capabilities are essential to our strategy of enhancing, developing, and incorporating improved functionality into our products and maintaining the competitiveness of our products in our core markets. We believe our team of experienced engineers is on the leading edge of software and other technologies in our core markets. Our research and development process is dependent on
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assessment of customer needs, identification, and evaluation of new technologies, and monitoring market acceptance and demand. We have a structured process for undertaking product development projects that involves functional groups at all levels within our company. This process is designed to provide a framework for defining and addressing the steps, tasks, and activities required to bring product concepts and development projects to market.
Our research and development expenses were $16.4 million in 2008, $13.0 million in 2007 and $11.7 million in 2006. This represents approximately 7.6% of our revenues over that three-year period. From 2006 to 2008, our research and development efforts focused on enhancing and expanding the proven capabilities of our existing product lines, introducing new versions of our products and reducing costs relating to our existing products. Beginning in 2009 we expect that the nature of our spending will change somewhat with reduced internal staffing in favor of external resources for certain products.
Technology
Our engineering teams have specific expertise in ECG algorithms, signal processing, artifact filtering, electrical systems, software development, high voltage waveforms, and data management. Software algorithms for analyzing the electrical activity of the heart are the basis for both our cardiac monitoring and our defibrillation product lines. Almost all of our products include hardware components that connect to the patient and digitize ECG waveform signals.
In our cardiac monitoring systems we generally use object-oriented design based on Microsoft technologies to create the software. We develop our systems’ user interfaces for many of our products using Microsoft tools. Many of our systems have been designed for network operation and many of our software modules have also been developed as objects that can be reused in our other products as needed. In addition, we have designed many of our cardiac monitoring systems to meet emerging industry standards, from reports rendered in PDF or XML format, to the use of Health Level 7 (“HL7”) and Serial Communication Protocol format for communications and ECG waveform data.
All of our defibrillation products incorporate our proprietary RHYTHMx technology. This platform technology is designed to detect and discriminate life-threatening arrhythmias. Our STAR biphasic technology is designed to optimize the delivery of a potentially life-saving electric shock to victims of SCA. We integrated our core technology, along with other proprietary technology, into our AED and hospital defibrillation product lines. We license certain components of our core technology to third-parties for integration into other products.
Manufacturing and Supply
Our manufacturing process consists primarily of assembly and testing of AEDs, electrocardiograph devices, stress test systems, Holter monitoring systems, cardiac rehabilitation telemetry systems, medical treadmills, electrodes, and various other products. During 2008, we performed these manufacturing activities at our Deerfield, Wisconsin facility and, to a lesser extent, at the facilities of our majority-owned joint venture operation in Shanghai, China.
We also rely upon other third-party suppliers to provide us with various materials used in the production and assembly of our devices and systems. We have long-standing supply relationships for essentially all of our outsourced product components. We purchase a portion of our products from third parties on an original equipment manufacturer (“OEM”) basis.
We maintain a comprehensive quality assurance and quality control program that includes documentation of all material specifications, operating procedures, equipment maintenance, and quality control methods. Our quality systems are based on and are in compliance with the requirements of ISO 13485:2003 and the applicable U.S. laws and regulations governing medical device manufacturers.
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Our Competition
The following chart indicates who we believe are the most significant competitors for each of our major product lines:
Product | Competitors | |
| AEDs | Philips, Medtronic, Zoll Medical, Schiller, Welch Allyn | |
| Resting ECG systems | General Electric, Philips, Midmark, Welch Allyn, Schiller | |
| Cardiac stress testing systems | General Electric, Philips, Midmark, Welch Allyn, Schiller | |
| Holter monitoring systems | SpaceLabs, General Electric, Philips, Midmark, Schiller | |
| Cardiac rehabilitation telemetry systems | Life Sensing Instruments, Scott Care | |
| Cardiology data management systems | General Electric, Philips | |
| Traditional (non-AED) defibrillators | Zoll, Medtronic, Philips |
We believe that, depending on the products and situation, our customers consider some or all of the following factors in determining which products to purchase:
| • | quality, accuracy, and reliability; | |
| • | reputation of the provider; | |
| • | relative ease of use; | |
| • | depth and breadth of features; | |
| • | quality of customer support; | |
| • | capability to assist in deployment and training; | |
| • | frequency of updates; | |
| • | flexibility to integrate products with other devices and systems from multiple vendors; | |
| • | availability of third-party reimbursement; | |
| • | conformity to standards of care; and | |
| • | price. |
We believe our products compete favorably on these factors. We believe that our Rescue Ready, RHYTHMx, and STAR biphasic technologies set our AEDs apart from the competition. We believe our investment in connected data informatics and corresponding new EMR system alliances will also benefit us. We believe our service capabilities, comprehensive program management services, warranties, service plans, and technical support distinguish us and provide us with a competitive advantage over some of our competitors. However, products and services offered by some of our competitors offer features that may compete favorably on these factors as well. Our markets are highly competitive and competition may intensify. Some competitors enjoy advantages, including greater resources that can be devoted to the development, promotion, and sale of their products; more established sales channels; deeper product development experience;and/or greater name recognition.
Third-Party Reimbursement
In the U.S., as well as in foreign countries, government-funded or private insurance programs, commonly known as third-party payers, pay a significant portion of the cost of a patient’s medical expenses. A uniform policy of reimbursement does not exist among all these payers. We believe that reimbursement is an important factor in the success of many medical devices.
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All U.S. and foreign third-party reimbursement programs, whether government funded or commercially insured, are developing increasingly sophisticated methods of controlling healthcare costs through prospective reimbursement and capitation programs, group purchasing, redesign of benefits, second opinions required prior to major surgery, careful review of bills, encouraging healthier lifestyles, and exploring more cost-effective methods of delivering healthcare. These types of programs can potentially limit the amount which healthcare providers may be willing to pay for medical devices.
Government Regulation of Medical Devices
Our products are medical devices subject to extensive regulation by the FDA, as well as other global regulatory agencies. FDA regulations govern, among other things, the following activities we perform and will continue to perform in connection with medical devices:
| • | product design and development; | |
| • | product testing; | |
| • | product manufacturing; | |
| • | product labeling and packaging; | |
| • | product handling, storage, and installation; | |
| • | pre-market clearance or approval; | |
| • | advertising and promotion; | |
| • | product sales, distribution, and servicing; and | |
| • | post-market surveillance. |
FDA’s Pre-market Clearance and Approval Requirements. Each medical device we seek to commercially distribute in the U.S. must first receive 510(k) clearance or pre-market approval from the FDA, unless specifically exempted by the agency. The FDA classifies all medical devices into one of three classes. Devices deemed to pose lower risk are categorized as either Class I or II, which requires the manufacturer to submit to the FDA a 510(k) pre-market notification requesting clearance of the device for commercial distribution in the U.S. Some low risk devices are exempted from this requirement. Devices deemed by the FDA to pose the greatest risk, such as life sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a previously 510(k) cleared device are categorized as Class III, requiring pre-market approval. In rare cases, as with our AEDs, the devices are categorized as Class III and still cleared under the 510(k) pre-market notification process. Class III devices which can be marketed with a pre-market notification 510(k) are those that arepost-amendment (i.e., introduced to the U.S. market after May 28, 1976), Class III devices which are substantially equivalent topre-amendment (i.e., introduced to the U.S. market before May 28, 1976) Class III devices and for which the regulation calling for the pre-market approval application has not been published in 21 CFR.
510(k) Clearance Process. The 510(k) clearance process is the process applicable to our current products. To obtain 510(k) clearance, we must submit a pre-market notification to the FDA demonstrating the proposed device to be substantially equivalent to a previously cleared 510(k) device, a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of pre-market approval applications, or is a device that has been reclassified from Class III to either Class II or I. In rare cases, as described in the prior paragraph, Class III devices, including our AEDs, are cleared through the 510(k) process. The FDA’s 510(k) clearance process usually takes at least three months from the date the application is submitted and filed with the FDA, but may take significantly longer.
After a device receives 510(k) clearance, any subsequent modification of the device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, will require a new 510(k) clearance or could require pre-market approval. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a
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manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA may require the manufacturer to cease marketingand/or recall the modified device until 510(k) clearance or pre-market approval is obtained. We have modified aspects of some of our devices since receiving regulatory clearance. Some of those modifications we believe are not significant, and therefore, new 510(k) clearances or pre-market approvals are not required. Other modifications we believe are significant and we have obtained new 510(k) clearances from the FDA for these modifications. In the future, we may make additional modifications to our products after they have received FDA clearance or approval, and in appropriate circumstances, determine if new clearance or approval is unnecessary. However, the FDA may disagree with our determination and if the FDA requires us to seek 510(k) clearance or pre-market approval for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain the required clearance or approval. Under these circumstances, we may also be subject to significant regulatory fines or other penalties.
Pre-market Approval Process. A pre-market approval application must be submitted if the medical device is in Class III (although the FDA has the discretion to continue to allow certainpre-amendment Class III devices to use the 510(k) process) or cannot be cleared through the 510(k) process. A pre-market approval application must be supported by, among other things, extensive technical, preclinical, clinical trials, manufacturing and labeling data to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device.
After a pre-market approval application is submitted and filed, the FDA begins an in-depth review of the submitted information, which typically takes between one and three years, but may take significantly longer. During this review period, the FDA may request additional information or clarification of information already provided. Also during the review period, an advisory panel of experts from outside the FDA will usually be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a pre-approval inspection of the manufacturing facility to ensure compliance with Quality System regulations. New pre-market approval applications or pre-market approval application supplements are required for significant modifications to the manufacturing process, labeling of the product and design of a device that is approved through the pre-market approval process. Pre-market approval supplements often require submission of the same type of information as a pre-market approval application, except that the supplement is limited to information needed to support any changes from the device covered by the original pre-market approval application, and may not require as extensive clinical data or the convening of an advisory panel.
As described previously, certain of our devices have been classified as Class IIIpre-amendment devices. These devices include our AED product line. Although we currently have 510(k) clearance for these devices, the FDA has the discretion at any time to request pre-market approval applications from us and all manufacturers of similar devices. If the FDA calls for pre-market approval applications, we will be required to submit and obtain approvals for such devices within a specified period of time. If we fail to do so, we will not be allowed to continue marketing these products.
Clinical or Market Trials. A clinical or market trial is typically required to support a pre-market approval application and is sometimes required for a 510(k) pre-market notification. Clinical and market trials generally require submission of an application for an Investigational Device Exemption (“IDE”) to the FDA. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the investigational protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of patients, unless the product is deemed a non-significant risk device and eligible for more abbreviated investigational device exemption requirements. Clinical and market trials for a significant risk device may begin once the investigational device exemption application is approved by the FDA as well as the appropriate institutional review boards at the clinical or market trial sites, and the informed consent of the patients participating in the clinical trial is obtained.
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Pervasive and continuing FDA regulation. After a medical device is placed on the market, numerous FDA regulatory requirements apply, including, but not limited to the following:
| • | Quality System regulation, which requires manufacturers to follow design, testing, control, documentation and other quality assurance procedures during the manufacturing process; | |
| • | Establishment Registration, which requires establishments involved in the production and distribution of medical devices, intended for commercial distribution in the U.S., to register with the FDA; | |
| • | Medical Device Listing, which requires manufacturers to list the devices they have in commercial distribution with the FDA; | |
| • | Labeling regulations, which prohibit “misbranded” devices from entering the market, as well as prohibit the promotion of products for unapproved or “off-label” uses and impose other restrictions on labeling; and | |
| • | Post-market surveillance including Medical Device Reporting (MDR), which requires manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury, or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur. |
Failure to comply with applicable regulatory requirements may result in enforcement action by the FDA, which may include one or more of the following sanctions:
| • | fines, injunctions, and civil penalties; | |
| • | mandatory recall or seizure of our products; | |
| • | administrative detention or banning of our products; | |
| • | operating restrictions, partial suspension or total shutdown of production; | |
| • | refusing our request for 510(k) clearance or pre-market approval of new product versions; | |
| • | revocation of 510(k) clearance or pre-market approvals previously granted; and | |
| • | criminal penalties. |
International Regulation. Sales of medical devices outside the United States are subject to foreign government regulations, which vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ significantly.
European Union. The European Union has adopted legislation, in the form of directives to be implemented in each member state, concerning the regulation of medical devices within the European Union. The directives include, among others, the Medical Device Directive that establishes standards for regulating the design, manufacture, clinical trials, labeling, and vigilance reporting for medical devices. Under the European Union Medical Device Directive, medical devices are classified into four Classes, I, IIa, IIb, and III, with Class I being the lowest risk and Class III being the highest risk. Under the Medical Device Directive, a competent authority is nominated by the government of each member state to monitor and ensure compliance with the Directive. The competent authority of each member state then designates a notified body to oversee the conformity assessment procedures set forth in the Directive, whereby manufacturers demonstrate that their devices comply with the requirements of the Directive and are entitled to bear the CE mark. CE is an abbreviation for Conformité Européene (or European Conformity) and the CE mark, when placed on a product, indicates compliance with the requirements of the applicable directive. Medical devices properly bearing the CE mark may be commercially distributed throughout the European Union. We have received CE certification from the British Standards Institute for conformity with the European Union Medical Device Directive allowing us to place the CE mark on our product lines. This quality system has been developed by the International Organization for Standardization to ensure companies are aware of the standards of quality to which their products will be held worldwide. Additional pre-market approvals in individual European Union
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countries are sometimes required prior to marketing of a product. Failure to maintain the CE mark would preclude us from selling our products in the European Union, as could failure to comply with the specific requirements of member states.
Canada. Under the Canadian Medical Devices Regulations, all medical devices are classified into four classes, Class I being the lowest risk class and Class IV being the highest risk. Class I devices include among others, devices that make only non-invasive contact with the patient. Classes II, III and IV include devices of increasingly higher risk as determined by such factors as degree of invasiveness and the potential consequences to the patient if the device fails or malfunctions. Our current products sold in Canada generally fall into Classes II and III. All Class II, III and IV medical devices must have a valid Medical Device License issued by the Therapeutic Products Directorate of Health Canada before they may be sold in Canada (Class I devices do not require such a license). We have obtained applicable Medical Device Licenses for many of our products. Failure to maintain required Medical Device Licenses in Canada or to meet other requirements of the Canadian Medical Devices Regulations (such as quality system standards and labeling requirements) for our products will preclude us from selling our products in Canada. We may not be successful in continuing to meet the medical device licensing requirements necessary for distribution of our products in Canada.
Other Countries. Many other countries have specific requirements for classification, registration, and post-marketing surveillance that are independent of the countries already listed. We obtain what we believe is the appropriate clearances and conduct business in accordance with the applicable laws of each country. This landscape is constantly changing, and, we could be found in violation if we interpret the laws incorrectly or fail to keep pace with changes. In the event of either of these occurrences, we could be instructed to recall products, cease distribution,and/or be subject to civil or criminal penalties.
Intellectual Property
We believe that our intellectual property assets, including trademarks, patents, trade secrets and proprietary technology, are extremely valuable and constitute a cornerstone of our business. As of December 31, 2008, we held 110 U.S. and foreign patents, which expire at various times between 2010 and 2026. We also have 22 patent applications pending before U.S. and foreign governmental bodies. We believe our patents and proprietary technology provide us with a competitive advantage over our competitors. We intend to continue to aggressively defend our inventions and also look for opportunities to license our technology to generate royalty income.
Our wide range of patents and patent applications cover much of the technology found in our defibrillation products, including our Rescue Ready technology, which features one button operation, pre-connected disposable therapy electrode pads, and self-test capabilities. Other patents relating to our defibrillation products include our proprietary RHYTHMx arrhythmia detection software technology, our STAR biphasic defibrillation waveform technology, and our disposable therapy electrode pads. Our patents protect many features of our cardiac monitoring products, including filters for ECG signals, monitoring electrodes and methods of interfacing the monitoring electrodes to a patient, and devices and methods for obtaining, analyzing, and presenting certain physiological data. We also have perpetual rights to certain patented technology relating to our medical treadmills. In addition, we have registered or applied to register certain trademarks with domestic and certain foreign trademark authorities.
Our business also depends, in part, on licenses to use third parties’ software in our product offerings. We believe the agreements we have in place with third parties generally provides for such software at fair market value and that, if any such agreements expire or terminate, we would be able to obtain alternative software at comparable prices.
Customers
In the U.S. and abroad, we sell many of our products through distributors and other third party organizations. One of these distributors is located in Japan, Nihon Kohden Corporation, and accounted for approximately 19% of the Company’s revenues in 2008 and 11% in both 2007 and 2006.
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Employees
As of December 31, 2008, we had 594 full time employees plus 24 contract employees. This combined total of 618 full time positions includes 83 in research and development, 186 in sales and marketing, 96 in technical and support services, 138 in manufacturing and supplies operations, 17 in regulatory affairs and 98 in finance and administration. These employee totals include 23 employees in our majority owned Cardiac Science Shanghai joint venture. In addition, we had approximately 124 part-time employees, most of whom provide training to our customers on an as-needed basis. None of our employees are represented by a labor union, except in China, where substantially all employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good. On January 14, 2009, we announced the implementation of a restructuring of our work force. The restructuring was implemented to proactively respond to a weak economic environment. This restructuring reduced our headcount by 12%, primarily impacting employees in customer service, product development and manufacturing.
Foreign Operations
Sales to customers located outside the United States were approximately $81.0 million, $46.5 million and $37.9 million for the years ended December 31, 2008, 2007 and 2006, respectively. Additional financial information is provided in Item 8, Note 2 to the Consolidated Financial Statements, “Segment Reporting.” Also, for a discussion of risks associated with our foreign operations see Item 1A risk factors — “Our international business is subject to risk that could adversely affect our profitability and operating results.”
Available Information
We maintain an Internet site athttp://www.cardiacscience.com. We make available free of charge on or through our Internet site, our annual report onForm 10-K, quarterly reports onForm 10-Q, current reports onForm 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We will voluntarily provide electronic or paper copies of our filings free of charge upon request. Our web site and the information contained therein or connected thereto are not incorporated by reference into this report. These reports may also be obtained at the SEC’s public reference room at 100 F Street, NE Washington, DC 20549. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including the Company.
| Item 1.A. | Risk Factors |
Our business may be adversely affected by deteriorating economic conditions.
Economic conditions in both the United States and other countries in which we sell our products have deteriorated significantly in the past year and are expected to continue to deteriorate in the foreseeable future. Deteriorating economic conditions in the markets in which we operate may result in declining demand for our products and services, longer sales cycles, increased order cancellations and declining pricing due to customers’ reduced capital budgets, difficulties encountered in securing financing needed to purchase our products, or other factors. Moreover, such conditions may result in increased excess or obsolete inventories and difficulties collecting customer receivables. All of these factors could materially adversely affect our future operating results and financial condition.
We rely significantly on our distributors and strategic selling alliances to generate sales of our products; if we do not maintain our relationships with these parties or they fail to successfully distribute our products, our sales and operating results will likely suffer.
In the U.S. and abroad, we sell many of our products through distributors, strategic selling alliances and other third party organizations. Generally, we have little or no control over these sales processes, and in many cases our contracts are short-term or may be terminated on little or no notice. If any of our key distributor agreements or selling alliance agreements are cancelled or if we are unable to renew them as they expire, or if
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our distributors or selling alliances fail to develop relationships with important target customers, our sales and operating results may suffer materially.
In Japan, a market which accounted for approximately 19% of our net sales in 2008, we rely exclusively on one distributor, Nihon Koden Corporation, for sales of our products in that market under an OEM (“original equipment manufacturer”) relationship. Our contract with Nihon Koden is terminable for convenience by either party on one year’s notice. The termination or unfavorable modification of this OEM relationship would adversely affect our operating results, particularly our sales in Japan. Moreover, we expect that this distributor will begin selling certain closely related products in the near future that may lead to reduced sales of our products in Japan.
We are dependent upon licensed and purchased technology for some of our products, and we may not be able to renew these licenses or purchase agreements in the future.
We license and purchase technology from third parties for features in some of our products. We anticipate that we will need to license and purchase additional technology to remain competitive. We may not be able to renew existing licenses and purchase agreements or to license and purchase other technologies on commercially reasonable terms or at all. If we are unable to renew existing licenses and purchase agreements or to license or purchase new technologies, we may not be able to offer competitive products, which could negatively impact our revenues.
Our international business is subject to risks that could adversely affect our profitability and operating results.
Our international operations, which accounted for 39% of our revenues in 2008, are accompanied by certain financial and other risks. In recent years, we have pursued growth opportunities internationally and intend to continue pursuing such opportunities in the future , which could expose us to greater risks associated with international sales and operations. Our international operations are, and will continue to be, subject to a number of risks and potential costs, including:
| • | changes in foreign medical reimbursement programs and policies; | |
| • | changes in foreign regulatory requirements; | |
| • | local product preferences and product requirements; | |
| • | longer-term receivables than are typical in the U.S.; | |
| • | fluctuations in foreign currency exchange rates; | |
| • | less protection of intellectual property in some countries outside of the U.S.; | |
| • | trade protection measures and import and export licensing requirements; | |
| • | work force instability; | |
| • | political and economic instability; | |
| • | inherent control risks associated with operations based outside the U.S.; and | |
| • | complex tax and cash management issues. |
Also, like the U.S., economic conditions in the foreign countries in which we operate have deteriorated significantly in the last year and are expected to continue declining for the foreseeable future. For example, economic conditions in Japan, a market that accounted for 19% of our net sales in 2008, have declined rapidly in the last several months. In the fourth quarter of 2008 alone, Japan’s gross domestic product contracted at an annualized pace in excess of 12%. Economic conditions in Japan are expected to remain weak for the foreseeable future. As a result, our sales in this market may decline, perhaps significantly, during 2009 and beyond. We may also experience declining sales in other international markets due to deteriorating economic conditions.
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Our business is subject to intense competition, which may reduce the demand for our products.
The cardiac monitoring and defibrillation markets are highly competitive, and we expect competition to intensify in the future. Some of our competitors are larger companies, such as General Electric Company, Medtronic Emergency Response Systems, a unit of Medtronic, Inc., and Philips Medical Systems, a unit of Koninklijke Philips Electronics N.V., who may have:
| • | greater financial and technical resources; | |
| • | greater variety of products; | |
| • | greater product pricing, discounting and bundling flexibility; | |
| • | patent portfolios that may present an obstacle to our conduct of business; | |
| • | stronger brand recognition and marketing resources; and | |
| • | larger distribution and sales networks. |
In addition, the timing of the introduction of competing products into the market could affect the market acceptance and market share of our products. If we are unable to develop competitive products that obtain market acceptance, our revenues and financial results may suffer.
Medtronic, Inc. previously announced that its wholly owned external defibrillation business,Physio-Control (“Physio”) suspended U.S. product shipments in January 2007 due to internal quality control issues. Physio subsequently announced that international shipments would be limited, as well. Physio appears to have resumed some shipments since these announcements, and we expect that Physio will resume full shipments at some point in the future. This resumption of full shipments will increase competition in the market and this increased competition may result in a decrease in our sales of defibrillation products.
We may be unable to increase sales of our cardiac monitoring products and services, which could cause our stock price to decrease.
The market for Cardiac monitoring products and services is generally mature and stable and our 2008 revenues from products and services in this market decreased 3% from 2007. Our ability to revitalize this line of products depends on our restructuring efforts, the development and commercialization of competitive new products and service offerings, and our success in increasing sales and gaining market share from our competitors. Current economic conditions may provide particular challenges to our efforts to revitalize this line. If we are unsuccessful in these efforts, our sales revenues from this line of products and services may decrease, our financial results may suffer, and our stock price may decline.
Our financial results could be impacted by the credit risk of our customers.
We have exposure to the credit risks of some of our customers. Although we have programs in place that are designed to monitor and mitigate the associated risk, there can be no assurance that such programs will be effective in reducing our credit risks adequately. We monitor individual payment capability in granting credit arrangements, seek to limit the total credit to amounts we believe our customers can pay, and maintain reserves we believe are adequate to cover exposure for potential losses. If there is a deterioration of a major customer’s creditworthiness or actual defaults are higher than expected, future resulting losses, if incurred, could harm our business and have a material adverse effect on our operating results. These risks may become more pronounced if economic conditions continue to deteriorate.
Our stock price is volatile, and you may not be able to sell your shares for a profit.
The trading price of our common stock is volatile. Our common stock price could be subject to fluctuations in response to a number of factors, including:
| • | actual or anticipated variations in quarterly operating results; | |
| • | changes in financial estimates or recommendations by securities analysts; |
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| • | conditions or trends in medical devices and diagnostic cardiology products markets; | |
| • | announcements by us or our competitors of significant customer wins or losses, gains or losses of distributors, technological innovations, new products or services; | |
| • | announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; | |
| • | additions or departures of key personnel; | |
| • | sales of a large number of shares of our common stock; | |
| • | adverse litigation; | |
| • | unfavorable legislative or regulatory decisions; | |
| • | general market conditions: and | |
| • | timing of major competitors return to the AED market. |
In the past, companies that have experienced volatility in the market price of their stock have been the target of securities class action litigation. We may become the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert management attention, which could seriously harm our business.
We were not profitable in 2008 and we may be unable to return to profitability in the future, which could result in a decline in our stock price.
We had a net loss of $98.4 million in 2008 due to a non-cash impairment charge related to goodwill of $107.4 million, net of tax and net income of $8.5 million in 2007 and $49,000 in 2006. Although we expect to become profitable again in 2009, our ability to generate net income will depend on our ability to increase our revenues and contain our expenses. In order to generate additional revenues, we will need to continue developing and offering competitive products and services, maintain our sales and distribution network and expand our customer base. Also, we will need to contain costs associated with investing in product development and marketing, and protecting our intellectual property. We may be unable to accomplish some, or any, of these goals because of the risks identified in this report or for other unforeseen reasons. If we are unable to attain profitability in the future, our stock price could decline.
Our business may be adversely affected by our recently announced restructuring.
On January 14, 2009, we announced a restructuring involving a 12% reduction in our staff. The reductions primarily affected customer service, product development and manufacturing. Implementation of the restructuring will likely place significant strains on management during the first quarter of 2009 and may adversely affect the effectiveness of the functional areas impacted by the staff reductions, as well as adversely impact our relationships with customers and suppliers. The costs of implementing this restructuring resulted in charges of $1.2 million that adversely affected our results of operations in 2008. Finally, the restructuring may not result in all of the cost savings and operational and strategic benefits that we currently anticipate.
We are subject to many laws and governmental regulations and any adverse regulatory action may materially adversely affect our business operations and financial results.
Our medical devices are subject to regulation by numerous government agencies, including the FDA and comparable foreign agencies. To varying degrees, each of these agencies requires us to comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of our medical devices. We cannot guarantee that we will be able to obtain marketing clearance from the FDA for our new products, or enhancements or modifications to existing products, and if we do, such approval may:
| • | take a significant amount of time; | |
| • | require the expenditure of substantial resources; |
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| • | involve stringent clinical and pre-clinical testing; | |
| • | involve modifications, repairs or replacements of our products; and | |
| • | result in limitations on the proposed uses of our products. |
Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could ban such medical devices, detain or seize adulterated or misbranded medical devices, order a recall, repair, replacement, or refund of such devices and require us to notify health professionals and others that the devices present unreasonable risks of substantial harm to the public health. The FDA may also impose operating restrictions, enjoin and restrain certain violations of applicable law pertaining to medical devices and assess civil or criminal penalties against our officers, employees, or us. The FDA may also recommend prosecution to the Department of Justice. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively marketing and selling our products.
Foreign governmental regulations have become increasingly stringent, and we may become subject to more rigorous regulation by foreign governmental authorities in the future. Penalties for a company’s noncompliance with foreign governmental regulation could be severe, including revocation or suspension of a company’s business license and criminal sanctions. Any domestic or foreign governmental law or regulation imposed in the future may have a material adverse effect on us.
We may be required to implement a costly product recall or corrective action.
In the event that any of our products prove to be defective or deficient, we can voluntarily recall or otherwise take corrective action, or the FDA could require us to redesign or implement a recall of or take other action regarding, any of our products. For example, during the third quarter of 2008, we implemented a voluntary field corrective action related to certain of our AED products. Costs related to this voluntary field corrective action were estimated at $800,000 and there have been no changes to this estimate during the fourth quarter of 2008. Should we be required or choose to implement any additional recalls or corrective actions in future periods, we could incur substantial costs as well as face significant adverse publicity or regulatory consequences, which could harm our business, including our ability to market our products in the future. The financial impact of a recall could have a material adverse effect on our business, financial condition and results of operations.
Our quarterly revenues and operating results are unpredictable and may vary significantly.
Our quarterly revenues and operating results have varied in the past and our quarterly revenues and operating results may continue to vary in the future due to a number of factors, many of which are outside of our control. Factors contributing to these fluctuations may include:
| • | effects of domestic and foreign economic conditions on our industryand/or customers, which conditions have significantly deteriorated in the last year and are expected to continue to decline for the foreseeable future; | |
| • | the impact of acquisitions, divestitures, strategic alliances, and other significant corporate events; | |
| • | changes in our ability to obtain products and product components that are manufactured for us by third parties; | |
| • | delays in the development or commercial introduction of new versions of products; | |
| • | the ability to attain and maintain production volumes and quality levels for our products and product components; | |
| • | changes in the demand for our products; | |
| • | varying sales cycles that can take up to a year or more; |
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| • | changes in the mix of products we sell, which could affect our revenue levels as well as our gross margins; | |
| • | unpredictable budgeting cycles of our customers; | |
| • | delays in obtaining regulatory clearance for new versions of our products; | |
| • | increased product and price competition; | |
| • | the impact of regulatory changes on the availability of third-party reimbursement to customers of our products; | |
| • | the loss of key personnel; | |
| • | the loss of key distributors or distribution companies; | |
| • | seasonality in the sales of our products; | |
| • | the impact of longer buying cycles; and | |
| • | the impact of employee turnover. |
Historically, our quarterly financial results have often been impacted by the receipt of a large number of customer orders in the last weeks of a quarter. If these orders are delayed to the following quarter or canceled, our sales could fall short of our targets and our stock price could decline. Due to the factors summarized above, we believe that period-to-period comparisons of our operating results are not a good indication of future performance and should not be relied upon to predict future operating results.
If we are unsuccessful in developing and commercializing new versions of our products, our operating results will suffer.
To be successful, we must develop and commercialize new versions of our products for both domestic and international markets. Our products must keep pace with rapid industry change, comply with rapidly evolving industry standards and government regulations and compete effectively with new product introductions of our competitors. Because our products are technologically complex, developing new products requires extensive design, development and testing at the technological, product and manufacturing stages. To successfully develop and commercialize new versions of our products, we need to:
| • | accurately assess and provide compelling solutions to customer needs; | |
| • | develop products that are functional and easy to use; | |
| • | quickly and cost-effectively obtain regulatory clearance or approval; | |
| • | price competitively; | |
| • | manufacture and deliver on time; | |
| • | control costs associated with manufacturing, installation, warranty and maintenance; | |
| • | manage customer acceptance and payment; | |
| • | limit demands by our customers for retrofits; | |
| • | access new interface standards needed for product connectivity; | |
| • | anticipate and meet demands of our international customers for products featuring local language capabilities; and | |
| • | anticipate and compete effectively with our competitors’ efforts. |
Our failure to accomplish any of these items, or others involved in developing and commercializing new products, could delay or prevent the release of new products. These difficulties and delays could cause our development expenses to increase and harm our financial and operating results.
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Interruption or cancellation of supply, and our inability to secure alternative suppliers on a timely basis, would likely harm our ability to ship products to our customers, decrease our revenues and increase our costs.
If our suppliers reduce, delay or discontinue production of component parts for our products, we will be forced to seek replacement parts from alternative sources. We purchase many of the components and raw materials used in manufacturing our products from numerous suppliers in various countries. Generally we have been able to obtain adequate supplies of such raw materials and components. In some cases, for reasons of quality assurance, cost effectiveness or availability, we procure certain components and raw materials only from a sole supplier. While we work closely with our suppliers to try to ensure continuity of supply while maintaining high quality and reliability, we cannot guarantee that our supplies will be uninterrupted. In addition, due to the stringent regulations and requirements of the FDA regarding the manufacture of our products, we may not be able to quickly establish additional or replacement sources for certain components or materials. A reduction or interruption in supply, and an inability to develop alternative sources for such supply, could result in significant delays or cancellations of product shipments and the need to modify our products to utilize available components. This could result in reduced revenues, higher costs or both.
Inadequate levels of reimbursement from governmental or other third-party payers for procedures using our products may cause revenues to decrease.
Healthcare costs have risen significantly over the past decade. Federal, state and local governments have adopted a number of healthcare policies intended to curb rising healthcare costs. There have been and may continue to be proposals by legislators, regulators and third-party payers to keep these costs down. Certain proposals, if passed, could impose limitations on the prices we will be able to charge for our products, or the amounts of reimbursement available for our products from governmental agencies or third-party payers. These limitations could have a material adverse effect on our financial position and results of operations.
In the U.S., healthcare providers that purchase certain of our products often rely on governmental and other third-party payers, such as federal Medicare, state Medicaid, and private health insurance plans to pay for all or a portion of the cost of the procedures that utilize those products. The availability of this reimbursement affects customers’ decisions to purchase capital equipment. Denial of coverage or reductions in levels of reimbursement for procedures performed using our products by governmental or other third-party payers would cause our revenues to decrease.
Quality problems with our processes, goods and services could harm our reputation for producing high quality products and erode our competitive advantage.
Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our quality certifications are critical to the marketing success of our goods and services. If we fail to meet these standards our reputation could be damaged, we could lose customers and our revenue could decline. Aside from specific customer standards, our success depends generally on our ability to manufacture to exact tolerances, precision engineered components, subassemblies and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high quality components will be harmed, our competitive advantage could be damaged, and we could lose customers and market share.
If we do not maintain or grow revenues from our support services or consumables, our operating and financial results may be negatively impacted.
A significant portion of our revenues is generated from post-sale support services we provide for our products and from the sale of ancillary cardiology products and consumables related to our products, such as patented electrodes, pads, cables, leads, and thermal chart paper. As hospitals expand their in-house capabilities to service diagnostic equipment and systems, they may be able to service our products without additional support from us. In addition, our customers may express an increasing preference for ancillary cardiology
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products and consumables that are manufactured or provided by other vendors. Any of these events could result in a decline in our revenues and adversely affect our financial and operating results.
Our lack of customer purchase contracts and our limited order backlog make it difficult to predict sales and plan manufacturing requirements, which can lead to lower revenues, higher expenses and reduced margins.
Our customers typically order products on a purchase order basis, and we do not generally havelong-term purchase contracts. In limited circumstances, customer orders may be cancelled, changed or delayed on short notice. Lack of significant order backlog makes it difficult for us to forecast future sales with certainty. Long and varying sales cycles with our customers make it difficult to accurately forecast component and product requirements. These factors expose us to a number of risks:
| • | if we overestimate our requirements we may be obligated to purchase more components or third-party products than is required; | |
| • | if we underestimate our requirements, our third-party manufacturers and suppliers may have an inadequate product or product component inventory, which could interrupt manufacturing of our products and result in delays or cancellations in shipments and loss of revenues; | |
| • | we may also experience shortages of product components from time to time, which also could delay the manufacturing of our products; and | |
| • | over or under production can lead to higher expense, lower than anticipated revenues, and reduced margins. |
If market conditions cause us to reduce the selling price of our products, or our market share is negatively affected by the activities of our competitors, our margins and operating results will decrease.
The selling price of our products and our market share are subject to market conditions. Major shifts in industry market share have occurred in connection with product problems, physician advisories and safety alerts, reflecting the importance of product quality in the medical device industry. Many healthcare industry companies, including medical device companies, are consolidating to create new companies with greater market power. As the healthcare industry consolidates, competition to provide goods and services to industry participants will become more intense. These industry participants may try to use their market power to negotiate price concessions or reductions for medical devices that incorporate components produced by us. We may experience decreasing prices for the goods and services we offer due to pricing pressure experienced by our customers from managed care organizations and other third-party payers; increased market power of our customers as the medical device industry consolidates; and increased competition among medical engineering and manufacturing services providers. If the prices for our goods and services decrease and we are unable to reduce our expenses, we may lose market share and our results of operations will be adversely affected.
If we are unable to retain our executive officers and hire and retain other key personnel, we may not be able to sustain or grow our business.
Our success is dependent in large part on the continued employment and performance of key executive, managerial, sales and technical personnel and our ability to attract and retain additional highly qualified personnel. We compete for key personnel with other companies, academic institutions, government entities and other organizations. Our ability to maintain and expand our business may be impaired if we are unable to retain our key personnel, hire or retain other qualified personnel in the future, or if our key personnel decide to join a competitor or otherwise compete with us. We recently announced that our long-time chief executive officer plans to step down and also announced the appointment of his successor. The leadership change could present challenges to the management of the business, including relationships with key customers and vendors.
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Warranty and product liability claims could adversely impact our earnings and reputation.
The manufacturing, marketing and sale of medical devices expose us to the risk of warranty claims, product liability claims or product recalls. We are, from time to time, subject to warranty claims with regard to product performance, which expose us to unexpected repair and replacement costs. In addition, component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information with respect to products we manufacture or sell could result in an unsafe condition or injury to, or death of, a patient. The occurrence of such a problem could result in product liability claims, product recalls or a safety alert relating to one or more of our products. Although we maintain product liability insurance, the coverage may not be adequate or may not be available at affordable rates. Warranty claims, product liability claims or product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers for our products.
Failure to adequately protect our intellectual property rights may cause our expenses to increase and our business to suffer.
Our success depends in part on obtaining, maintaining, and enforcing our patents, trademarks and other proprietary rights, and our ability to avoid infringing the proprietary rights of others. We take precautionary steps to protect our technological advantages and intellectual property rights and rely, in part. on patent, trade secret, copyright, know-how, trademark laws, license agreements and contractual provisions to establish our intellectual property rights and protect our products. We require our new employees, consultants, and corporate partners to execute confidentiality agreements at the commencement of their employment or consulting relationship with us. However, these agreements may be breached or, in the event of unauthorized use or disclosure, they may not provide adequate remedies. While we intend to defend against any threats to our intellectual property, there can be no assurance that these patents, trade secrets or other agreements will adequately protect our intellectual property.
In addition, the validity and breadth of claims covered in medical technology patents involve complex legal and factual questions and are often highly uncertain. There can also be no assurance that pending patent applications owned by us will result in patents issuing to us, that patents issued to or licensed by us in the past or in the future will not be challenged or circumvented by competitors or that such patents will be found to be valid or sufficiently broad to protect our technology or to provide us with any competitive advantage. Third parties could also obtain patents that may require us to negotiate licenses to conduct our business, and there can be no assurance that the required licenses would be available on reasonable terms or at all. In some cases, we rely upon trade secrets instead of patents to protect our proprietary technology. Others may independently develop or otherwise acquire substantially equivalent know-how, or gain access to and disclose our proprietary technology. If we are not able to adequately protect our intellectual property and other proprietary rights, our product offerings may lose their competitive edge, which would negatively impact our revenues.
Our technology may become obsolete, which would negatively impact our ability to sell our products.
The medical equipment and healthcare industries are characterized by extensive research and rapid technological change. The development by others of new or improved products, processes, or technologies may make our products obsolete or less competitive. Accordingly, we plan to devote continued resources, to the extent available, to further develop and enhance existing products and to develop new products. If these efforts are not successful, we may not be able to meet our financial goals and our stock price may suffer.
Our reliance on a principal manufacturing facility may impair our ability to respond to natural disasters or other unforeseen catastrophic events.
We manufacture substantially all of our products in one principal manufacturing facility, located in a single building in Deerfield, Wisconsin. Despite precautions taken by us, a natural disaster or other unanticipated catastrophic events at this building could significantly impair our ability to manufacture our products and operate our business. Our facility and certain manufacturing equipment located in that facility
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would be difficult to replace and could require substantial replacement lead-time. Catastrophic events may also destroy any inventory of product or components located in our facility. While we carry insurance for natural disasters and business interruption, the occurrence of such an event could result in losses that exceed the amount of this insurance coverage, which would impair our financial results.
We may make future acquisitions, which involve numerous risks that could impact our business and results of operations.
As part of our growth strategy, we intend to selectively acquire other businesses, product lines, assets, or technologies, which are complementary to our product offerings. Successful execution of our acquisition strategy depends upon our ability to identify, negotiate, complete and integrate suitable acquisitions. Acquisitions involve numerous risks, including:
| • | difficulties in integrating the operations, technologies, and products of the acquired companies; | |
| • | the risk of diverting management’s attention from normal daily operations of the business; | |
| • | potential difficulties in completing projects associated with in-process research and development; | |
| • | risks of entering markets in which we have no, or limited, direct prior experience and where competitors in such markets have stronger market positions; | |
| • | initial dependence on unfamiliar supply chains or relatively small supply partners; | |
| • | insufficient revenues to offset increased expenses associated with acquisitions; | |
| • | the risk that acquired lines of business may reduce or replace the sales of existing products; and | |
| • | the potential loss of key employees of the acquired companies. |
Future acquisitions may not be successful and, if we are unable to effectively manage the risks described above, our business, operating results or financial condition may be negatively affected.
We may need additional capital to continue our acquisition growth strategy.
Successful continued execution of our acquisition strategy may also depend upon our ability to obtain satisfactory debt or equity financing. We likely would require additional debt or equity financing to make any further significant acquisitions. Such financing may not be available on terms that are acceptable to us or at all, particularly in light of current adverse conditions in the capital markets. If we are required to incur additional indebtedness to fund acquisitions in the future, our cash flow may be negatively affected by additional debt servicing requirements and the terms of such indebtedness may impose covenants and restrictions that provide us less flexibility in how we operate our business. Fluctuations in our stock price may make it difficult to make acquisitions using our stock as consideration. Moreover, use of our stock to fund acquisitions may have a significant dilutive effect on existing shareholders.
Our internal research and product development activities are complemented by acquisitions, investments and alliances. We cannot guarantee that any previous or future acquisitions, investments or alliances will be successful for the purposes of complementing our internal research and product development activities.
A component of our growth strategy is to enter into strategic alliances in order to complement and expand our current product and service offerings and distribution. The rapid pace of technological development in the medical industry and the specialized expertise required in different areas of medicine make it difficult for one company alone to develop a broad portfolio of technological solutions. In addition to internally generated growth through our research and development efforts, historically we have relied, and expect to continue to rely, upon acquisitions, investments and alliances to provide us access to new technologies both in areas served by our existing businesses as well as in new areas. We may make future investments where we believe that we can stimulate the development of, or acquire, new technologies and products to further our strategic objectives and strengthen our existing businesses. Investments and alliances in and with medical technology companies are inherently risky, and we cannot guarantee that any of our previous or future acquisitions, investments or
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alliances will be successful or will not materially adversely affect our consolidated earnings, financial condition or cash flows.
Future issuances of our common stock could dilute existing stockholders and cause our stock price to decline.
As of December 31, 2008 we have reserved 4,880,725 shares of common stock for issuance under our stock-based compensation plans and arrangements, including pursuant to options that are outstanding or may be granted in the future. Future stock awards under our plans and the issuance of stock upon exercise of options would have a dilutive effect on our stockholders and may adversely affect the market price of our common stock.
Our charter documents and Delaware law contain provisions that could make it more difficult for a third party to acquire us.
Certain provisions of our certificate of incorporation and bylaws could make it harder for a third party to acquire us without the consent of our board of directors. Our certificate of incorporation authorizes the issuance of preferred stock with the designations, rights, and preferences as may be determined from time to time by our board of directors, without any further vote or action by our stockholders. In addition, our board of directors is divided into three classes with staggered terms, which makes it difficult for stockholders to change the control of our board. Lastly, Section 203 of the Delaware General Corporation Law limits business combination transactions with interested stockholders that have not been previously approved by the issuer’s board of directors. Our board of directors could choose not to negotiate with an acquirer that it did not feel was in our strategic interest. If the acquirer was discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by the anti-takeover measures described above, our stockholders could lose the opportunity to sell their shares at a favorable price.
Utilization of our deferred tax assets may be limited and is dependent on future taxable income.
In connection with the merger of Quinton and CSI in 2005, and at the end of 2004, deferred tax assets were recognized on our balance sheet. The deferred tax assets primarily represent the income tax benefit of net operating loss (“NOL”) and credit carryforwards of Quinton and CSI from prior periods. If we fail to generate profits in the foreseeable future, our deferred tax assets may not be fully utilized.
We will evaluate our ability to utilize our NOL and tax credit carryforwards in future periods and, in compliance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes” (“SFAS 109”) record any resulting adjustments that may be required to deferred income tax expense. In addition, we will reduce the deferred income tax asset for the benefits of NOL and tax credit carryforwards actually used in future periods and will recognize and record federal and state income tax expense at statutory rates in future periods. If, in the future, we determine, based on our assessment of both positive and negative evidence and objective and subjective evidence, which takes into consideration our forecasted taxable income, that it is more likely than not that we will not realize all or a portion of the deferred tax assets, we will record a valuation allowance against deferred tax assets which would result in a charge to income tax expense.
Our future financial results could be adversely impacted by asset impairments.
SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) requires us to not amortize goodwill and other intangible assets determined to have indefinite lives, and established a method of testing these assets for impairment on an annual or on an interim basis if certain events occur or circumstances change that would reduce the fair value of a reporting unit below its carrying value or if the fair value of intangible assets with indefinite lives falls below their carrying value. We also need to evaluate intangible assets determined to have finite lives for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business, or other factors such as a decline in our market value below its book
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value for an extended period of time. A significant decline in our stock price could require us to evaluate intangible assets for recoverability during the quarter in which the decline occurred. In the case of intangible assets with indefinite lives, we will need to evaluate whether events or circumstances continue to support an indefinite useful life. We will need to evaluate the estimated lives of all intangible assets on an annual basis, including those with indefinite lives, to determine if events and circumstances continue to support an indefinite useful life or the remaining useful life, as applicable, or if a revision in the remaining period of amortization is required. The amount of any such annual or interim impairment charge could be significant, and could have a material adverse effect on our reported financial results for the period in which the charge is taken.
| Item 1B. | Unresolved Staff Comments |
None.
| Item 2. | Properties |
We lease a facility in Bothell, Washington, which houses our corporate offices and certain of our research and development and customer support services, as well as marketing, finance and administrative functions. This facility occupies approximately 56,000 square feet and is under lease through 2013.
We also lease a facility in Deerfield, Wisconsin, which houses our manufacturing operations and certain of our research and development, customer support services, marketing, finance and administrative functions. This facility is approximately 100,000 square feet. The lease expires in 2018 with two five-year renewal options.
We have other facilities under lease in Laguna Hills, California, which houses certain of our research and development operations, as well as in other locations such as Manchester, United Kingdom, Shanghai, China, Copenhagen, Denmark, Cologne, Germany and Paris, France.
| Item 3. | Legal Proceedings |
We are subject to various legal proceedings arising in the normal course of business. In the opinion of management, the ultimate resolution of these proceedings is not expected to have a material effect on our consolidated financial position, results of operations or cash flows.
| Item 4. | Submission of Matters to a Vote of Security Holders |
No matters were submitted to a vote of the shareholders during the fourth quarter of the fiscal year ended December 31, 2008.
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PART II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Our common stock is traded on the NASDAQ Global Market (symbol “CSCX”). The number of shareholders of record of our common stock at March 3, 2009, was 835.
Quarterly high and low bid quotations for our common stock as quoted on NASDAQ for the periods indicated are set forth in the table below.
| Stock Price | ||||||||
| High | Low | |||||||
| Fiscal 2008 | ||||||||
| First Quarter | $ | 9.75 | $ | 7.60 | ||||
| Second Quarter | 9.75 | 7.60 | ||||||
| Third Quarter | 11.00 | 7.57 | ||||||
| Fourth Quarter | 10.31 | 5.00 | ||||||
| Fiscal 2007 | ||||||||
| First Quarter | $ | 9.64 | $ | 7.40 | ||||
| Second Quarter | 11.45 | 8.93 | ||||||
| Third Quarter | 11.50 | 8.55 | ||||||
| Fourth Quarter | 10.75 | 7.35 | ||||||
We have never declared or paid any cash dividends on our common stock. We currently anticipate that we will retain any future earnings for use in the expansion and operations of our business and do not anticipate paying cash dividends in the foreseeable future.
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Performance Comparison Graph
The following graph depicts the Company’s total return to shareholders from August 31, 2005 through December 31, 2008, relative to the performance of the NASDAQ Composite Index and the Standard & Poor’s Health Care Equipment Index. All indices shown in the graph have been reset to a base of 100 as of September 1, 2005, and assume an investment of $100 on that date and the reinvestment of dividends paid since that date. We have never paid a dividend on our common stock. The stock price performance shown in the graph is not necessarily indicative of future price performance.
COMPARISON OF 40 MONTH CUMULATIVE TOTAL RETURN*
Among Cardiac Science Corporation, The NASDAQ Composite Index
And The S&P Health Care Equipment Index
| * | $100 invested on 9/1/05 in stock & 8/31/05 in index-including reinvestment of dividends. Fiscal year ending December 31. |
Copyright© 2009 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.
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| Item 6. | Selected Financial Data |
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto and the information contained herein in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historical results are not necessarily indicative of future results. Our company is the result of the combination of Quinton and CSI pursuant to a merger transaction that was completed on September 1, 2005. Since we are deemed to be the successor to Quinton for accounting purposes, our selected consolidated financial data in the table below represents the historical financial data of Quinton through September 1, 2005 and includes CSI’s results of operations since September 1, 2005.
| Year Ended December 31, | ||||||||||||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||||||
| (In thousands, except share and per share data) | ||||||||||||||||||||||||
Consolidated Statements of Operations Data(1): | ||||||||||||||||||||||||
| Revenues | $ | 206,153 | $ | 182,131 | $ | 155,429 | $ | 106,650 | $ | 89,603 | ||||||||||||||
| Cost of revenues | 103,870 | 93,715 | 82,195 | 59,794 | 50,302 | |||||||||||||||||||
| Gross profit | 102,283 | 88,416 | 73,234 | 46,856 | 39,301 | |||||||||||||||||||
| Operating Expenses: | ||||||||||||||||||||||||
| Research and development | 16,426 | 13,020 | 11,733 | 9,353 | 7,397 | |||||||||||||||||||
| Sales and marketing | 50,733 | 46,195 | 39,960 | 24,957 | 18,378 | |||||||||||||||||||
| General and administrative | 22,417 | 19,176 | 19,072 | 14,233 | 8,348 | |||||||||||||||||||
| Impairment of goodwill | 107,671 | — | — | — | — | |||||||||||||||||||
| Litigation and related expenses | — | 3,808 | 3,855 | 893 | — | |||||||||||||||||||
| Licensing income and litigation settlement | — | (6,000 | ) | — | — | — | ||||||||||||||||||
| Total operating expenses | 197,247 | 76,199 | 74,620 | 49,436 | 34,123 | |||||||||||||||||||
| Operating income (loss) | (94,964 | ) | 12,217 | (1,386 | ) | (2,580 | ) | 5,178 | ||||||||||||||||
| Other Income (Expense): | ||||||||||||||||||||||||
| Interest income (expense), net | 489 | 402 | (16 | ) | 325 | (70 | ) | |||||||||||||||||
| Other income (expense), net | 635 | 799 | 782 | (487 | ) | 1,031 | ||||||||||||||||||
| Total other income (expense) | 1,124 | 1,201 | 766 | (162 | ) | 961 | ||||||||||||||||||
| Income (loss) before income tax (expense) benefit and minority interest | (93,840 | ) | 13,418 | (620 | ) | (2,742 | ) | 6,139 | ||||||||||||||||
| Income tax (expense) benefit | (4,093 | ) | (4,924 | ) | 615 | 1,473 | 8,890 | |||||||||||||||||
| Income (loss) before minority interests | (97,933 | ) | 8,494 | (5 | ) | (1,269 | ) | 15,029 | ||||||||||||||||
| Minority interests | (451 | ) | (4 | ) | 54 | 31 | 39 | |||||||||||||||||
| Net income (loss) | $ | (98,384 | ) | $ | 8,490 | $ | 49 | $ | (1,238 | ) | $ | 15,068 | ||||||||||||
| Basic income (loss) per share(2) | $ | (4.30 | ) | $ | 0.37 | $ | 0.00 | $ | (0.08 | ) | $ | 1.47 | ||||||||||||
| Diluted income (loss) per share(2) | $ | (4.30 | ) | $ | 0.37 | $ | 0.00 | $ | (0.08 | ) | $ | 1.39 | ||||||||||||
| Shares used in computing basic income (loss) per share(2) | 22,869,920 | 22,697,113 | 22,502,040 | 14,695,261 | 10,236,838 | |||||||||||||||||||
| Shares used in computing diluted income (loss) per share(2) | 22,869,920 | 23,197,911 | 22,555,326 | 14,695,261 | 10,814,680 | |||||||||||||||||||
Consolidated Statements of Cash Flows Data: | ||||||||||||||||||||||||
| Cash provided by (used in) operating activities | $ | 17,743 | $ | 13,348 | $ | 8,764 | $ | (850 | ) | $ | 6,259 | |||||||||||||
| Cash used in investing activities | $ | (4,352 | ) | $ | (3,788 | ) | $ | (3,307 | ) | $ | (18,053 | ) | $ | (41 | ) | |||||||||
| Cash provided by financing activities | $ | 859 | $ | 780 | $ | 816 | $ | 547 | $ | 15,499 | ||||||||||||||
| Effect of exchange rate changes on cash | $ | 246 | $ | — | $ | — | $ | — | $ | — | ||||||||||||||
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| Year Ended December 31, | ||||||||||||||||||||||||||||
| 2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
Consolidated Balance Sheet Data: | ||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 34,655 | $ | 20,159 | $ | 9,819 | $ | 3,546 | $ | 21,902 | ||||||||||||||||||
| Total assets | 170,208 | 262,671 | 247,645 | 248,557 | 77,175 | |||||||||||||||||||||||
| Current liabilities | 37,960 | 35,219 | 31,294 | 33,832 | 18,682 | |||||||||||||||||||||||
| Long-term liabilities | — | 54 | 679 | 1,806 | — | |||||||||||||||||||||||
| Total shareholders’ equity | 131,703 | 227,271 | 215,597 | 212,791 | 58,334 | |||||||||||||||||||||||
| (1) | The business combination of Quinton and CSI in September 2005 materially affects the comparability of information contained in this table. | |
| (2) | Shares prior to September 1, 2005 have been retroactively adjusted to reflect the conversion of Quinton shares into Cardiac Science Corporation shares at a ratio of 0.77184895 Cardiac Science Corporation shares for each Quinton share. See Item 8, Note 1 to the Consolidated Financial Statements for a reconciliation of the denominators used in computing basic and diluted income (loss) per share for 2008, 2007 and 2006. |
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this report. Except for historical information, the following discussion contains forward-looking statements within the meaning of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including future results of operations or financial position, made in this Annual Report onForm 10-K are forward looking. The words “believe,” “expect,” “intend,” “anticipate,” “will,” “may,” variations of such words, and similar expressions identify forward-looking statements, but their absence does not mean that the statement is not forward-looking. These forward-looking statements reflect management’s current expectations and involve risks and uncertainties. Our actual results could differ materially from results that may be anticipated by such forward-looking statements due to various uncertainties. The principal factors that could cause or contribute to such differences include, but are not limited to, the factors discussed in the section entitled “Risk Factors” and those discussed elsewhere in this report. Readers are cautioned 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 any forward-looking statements to reflect events or circumstances that may subsequently arise. Readers are urged to review and consider carefully the various disclosures made in this report and in our other filings made with the SEC that disclose and describe the risks and factors that may affect our business, prospects and results of operations. The terms “the Company,” “us,” “we” and “our” refer to Cardiac Science Corporation and our majority-owned subsidiaries.
Business Overview
We develop, manufacture, and market a family of advanced diagnostic and therapeutic cardiology devices and systems, including automated external defibrillators (AEDs), electrocardiograph systems (ECGs), stress test systems, Holter monitoring systems, hospital defibrillators, cardiac rehabilitation telemetry systems, and cardiology data management systems (Informatics) that connect with hospital information (HIS), electronic medical record (EMR), and other information systems. We sell a variety of related products and consumables, and provide a portfolio of training, maintenance, and support services. We are the successor to the cardiac businesses that established the trusted Burdick®, HeartCentrix®, Powerheart®, and Quinton® brands and are headquartered in Bothell, Washington. We distribute our products in nearly 100 countries worldwide, with operations in North America, Europe, and Asia.
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Critical Accounting Estimates and Policies
To prepare financial statements that conform with U.S. generally accepted accounting principles, we must select and apply accounting policies and make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our accounting estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
There are certain critical accounting estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if it requires us to make assumptions because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate,andchanges in the estimate or different estimates that we reasonably could have selected would have had a material impact on our financial condition or results of operations.
Goodwill. Goodwill represents the excess of cost over the estimated fair value of net assets acquired in connection with acquisitions of our medical treadmill product line, Burdick and CSI. We test goodwill for impairment on an annual basis, and between annual tests in certain circumstances, for each reporting unit identified for purposes of accounting for goodwill. A reporting unit represents a portion of our business for which we regularly review certain discrete financial information and operational results. The Company has determined that it has one reporting unit, consisting of general cardiology products, which also includes the product service business.
Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit, and potentially result in recognition of an impairment of goodwill, which would be reflected as a loss on our statement of operations and as a reduction in the carrying value of goodwill.
We performed a test for goodwill impairment at November 30, 2008 in accordance with our policy for performing this test annually. We recorded a pre-tax impairment charge of $107.7 million, equivalent to the full amount of previously acquired goodwill, during the fourth quarter of 2008. See Note 8 — Goodwill to the Consolidated Financial Statements in Item 8 of this report for further discussion of the impairment charge.
Deferred Tax Assets and Income Taxes. As part of the process of preparing our consolidated financial statements, we are required to account for our income taxes. This process involves calculating our current tax obligation or refund and assessing the nature and measurements of temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. In each period, we assess the likelihood that our deferred tax assets will be recovered from existing deferred tax liabilities or future taxable income. If required, we will recognize a valuation allowance to reduce such deferred tax assets to amounts that are more likely than not to be ultimately realized. To the extent that we establish a valuation allowance or change this allowance in a period, we adjust our tax provision or tax benefit in the statement of operations. We use our judgment to determine our provision or benefit for income taxes, and any valuation allowance recorded against our net deferred tax assets.
Factors we consider in making such an assessment include, but are not limited to past performance, including our recent history of operating results on a GAAP basis, our recent history of generating taxable income, our history of recovering net operating loss carryforwards for tax purposes and our expectation of future taxable income, both considering our past history in predicting future results and considering current macroeconomic conditions and issues facing our industry.
Stock-based Compensation. As of January 1, 2006, we account for stock-based compensation in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based
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Payment” (“SFAS 123R”), and applied the provisions of Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating future volatility, expected term and the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.
Intangible Assets. Our intangible assets are comprised primarily of trade names, developed technology, patent rights and customer relationships, all of which were acquired in our acquisition of Burdick in 2003, the merger transaction with CSI in 2005 and the cross-licensing agreement with Koninklijke Philips Electronics N.V. (“Philips”) in 2007. We use our judgment to estimate the fair value of each of these intangible assets. Our judgment about fair value is based on our expectation of future cash flows and an appropriate discount rate. We also use our judgment to estimate the useful lives of each intangible asset.
We believe the Burdick and Cardiac Science trade names have indefinite lives and, accordingly, we do not amortize the trade names. We evaluate this conclusion annually or more frequently if events and circumstances indicate that the asset might be impaired and make a judgment about whether there are factors that would limit our ability to benefit from the trade name in the future. If there were such factors, we would start amortizing the trade name over the expected remaining period in which we believed it would continue to provide benefit. With respect to our developed technology, customer relationship and patent rights, we also evaluate the remaining useful lives annually.
We periodically evaluate whether our intangible assets are impaired. For our trade names, this evaluation is performed annually, or more frequently if events occur that suggest there may be an impairment loss, and involves comparing the carrying amount to our estimate of fair value. For intangible assets related to developed technology, customer relationship and patent rights, this evaluation would be performed if events occur that suggest there may be an impairment loss. If we conclude that any of our intangible assets are impaired, we would record a loss on our statement of operations and reduce the value of the intangible asset.
We performed a test for impairment of our indefinite-lived intangibles as of November 30, 2008. We did not record an impairment charge as a result of the analysis.
Accounts Receivable. Accounts receivable represent a significant portion of our assets. We must make estimates of the collectability of accounts receivable. We analyze historical write-offs, changes in our internal credit policies and customer concentrations when evaluating the adequacy of our allowance for doubtful accounts. Different estimates regarding the collectability of accounts receivable may have a material impact on the timing and amount of reported bad debt expense and on the carrying value of accounts receivable.
Valuation of Long-Lived Assets. We review long-lived assets, such as machinery and equipment, and intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of asset groups to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized on our statement of operations and as a reduction to value of the asset group on our balance sheet. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.
Inventories. Inventories represent a significant portion of our assets. We value inventories at the lower of cost, on an average cost basis, or market. We regularly perform a detailed analysis of our inventories to determine whether adjustments are necessary to reduce inventory values to estimated net realizable value. We consider various factors in making this determination, including the salability of individual items or classes of items, recent sales history and predicted trends, industry market conditions and general economic conditions. Different estimates regarding the net realizable value of inventories could have a material impact on our
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reported net inventory and cost of sales, and thus could have a material impact on the financial statements as a whole.
Warranty. We provide warranty service covering many of the products and systems we sell. We estimate and accrue for future costs of providing warranty service, which relate principally to the hardware components of the systems, when the systems are sold. Our estimates are based, in part, on our warranty claims history and our cost to perform warranty service. Differences could result in the amount of the recorded warranty liability and cost of sales if we made different judgments or used different estimates.
Software Revenue Recognition. We account for the licensing of software in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”)97-2(“SOP 97-2”), “Software Revenue Recognition”, as amended bySOP 98-9, “Modification ofSOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions”(“SOP 98-9”). The application ofSOP 97-2 requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence (“VSOE”) of fair value exists for those elements. Customers may receive certain elements of our products over a period of time. These elements include post-delivery telephone support and the right to receive unspecified upgrades/enhancements (on awhen-and-if available basis), the fair value of which is recognized over the service period. Changes to the elements in a software arrangement and the ability to identify VSOE of fair value for those elements could materially impact the amount of earned and unearned revenue.
With respect to arrangements where software is considered more than incidental to the product, the vendor specific objective evidence of fair value for undelivered support is deferred and the residual fair value of delivered software is recognized. Revenue from software implementation services is recognized as the services are provided (based on vendor specific objective evidence of fair value). When significant implementation activities are required, we recognize revenue from software and services upon installation. We occasionally sell software and hardware upgrades on a stand alone basis.
Revenue Recognition. Revenue from sales of hardware products is generally recognized when title transfers to the customer, typically upon shipment. Some of our customers are distributors that sell goods to third party end users. Except for certain identified distributors where collection may be contingent on distributor resale, we recognize revenue on sales of products made to distributors when title transfers to the distributor and all significant obligations have been satisfied. In making a determination of whether significant obligations have been met, we evaluate any installation or integration obligations to determine whether those obligations are inconsequential or perfunctory. In cases where the remaining installation or integration obligation is not determined to be inconsequential or perfunctory, we defer the portion of revenue associated with the fair value of the installation and integration obligation until these services have been completed.
Distributors do not have price protection and generally do not have product return rights, except if the product is defective upon shipment or shipped in error, and in some cases upon termination of the distributor agreement. For certain identified distributors where collection may be contingent on the distributor’s resale, revenue recognition is deferred and recognized on a “sell through” or cash basis. The determination of whether sales to distributors are contingent on resale is subjective because we must assess the financial wherewithal of the distributor to pay regardless of resale. For sales to distributors, we consider several factors, including past payment history, where available, trade references, bank account balances, Dun & Bradstreet reports and any other financial information provided by the distributor, in assessing whether the distributor has the financial wherewithal to pay regardless of, or prior to, resale of the product and that collection of the receivable is not contingent on resale.
We offer limited volume price discounts and rebates to certain distributors. Volume price discounts are on a per order basis based on the size of the order and are netted against the revenue recorded at the time of shipment. We have some arrangements that provide for volume discounts based on meeting certain quarterly or annual purchase levels. Rebates are paid quarterly or annually and are accrued for as incurred.
We consider program management packages and training and other services as separate units of accounting and apply the provisions of Emerging Issues Task Force (“EITF”) consensus on IssueNo. 00-21,
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“Revenue arrangements with Multiple Deliverables”(“EITF 00-21”) when sold with an AED based on the fact that the items have value to the customer on a stand alone basis and could be acquired from another vendor. Fair value is determined to be the price at which they are sold to customers on a stand alone basis. Training revenue is deferred and recognized at the time the training occurs. AED program management services revenue, pursuant to agreements that exist with some customers pursuant to annual or multi-year terms, are deferred and amortized on a straight-line basis over the related contract period.
We offer optional extended service contracts to customers. Fair value is determined to be the price at which they are sold to customers on a stand alone basis. Service contract revenues are recognized on a straight-line basis over the term of the extended service contracts, which generally begin after the expiration of the original warranty period. For services performed, other than pursuant to warranty and extended service contract obligations, revenue is recognized when the service is performed and collection of the resulting receivable is reasonably assured.
Recent Accounting Pronouncements
In April 2008, the Financial Accounting Standards Board issued FASB Staff PositionFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSPFAS 142-3”), which amends the factors that should be considered in renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, Goodwill and Other Intangible Assets. This statement also establishes disclosure requirements designed to assess the extent to which the expected future cash flows associated with the asset are affected by the entity’s intentand/or ability to renew or extend the arrangement. The requirements of FSPFAS 142-3 are effective for financial statements issued for fiscal years beginning after December 15, 2008. We are currently assessing the impact FSPFAS 142-3 will have on our financial position and results of operations upon adoption.
In March of 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement 133” (“SFAS 161”). SFAS 161 requires entities to provide greater transparency about how and why the entity uses derivative instruments, how the instruments and related hedged items are accounted for under FASB Statement 133, and how the instruments and related hedged items affect the financial position, results of operations, and cash flows of the entity. SFAS 161 is effective for fiscal years beginning after November 15, 2008. Adoption of SFAS 161 will not have a material impact on our financial position or results of operations, but will require additional disclosure requirements.
In December 2007, the FASB issued SFAS 141R, “Business Combinations” (“SFAS 141R”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS 141(R) also requires an acquirer to record an adjustment to income tax expense for changes in valuation allowances or uncertain tax positions related to the acquired businesses. The requirements of SFAS 141R are effective for periods beginning after December 15, 2008. We are required to and plan to adopt the provisions of SFAS 141R beginning in the first quarter of 2009. The impact of adopting SFAS 141R will depend upon acquisitions, if any, we consummate after the effective date.
In December 2007, the FASB issued SFAS 160, “Noncontrolling Interest in Consolidated Financial Statements”, an amendment of ARB 51 (“SFAS 160”), which will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of shareholders’ equity within the consolidated balance sheets. The requirements of SFAS 160 are effective for periods beginning after December 15, 2008. The adoption of SFAS 160 is not expected to have a material impact on our financial position or results of operations.
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS 157”), which establishes a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. In February 2008, the FASB issued FASB Staff PositionFAS 157-2, “Effective Date of FASB Statement 157” (“FSPFAS 157-2”), which allows for the deferral of the adoption date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in
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the financial statements on a recurring basis. We elected to defer the adoption of SFAS 157 for the assets and liabilities within the scope of FSPFAS 157-2. Refer to Note 15, Fair Value Measurements, of thisForm 10-K for our disclosures pursuant to the effective portion of SFAS 157. The adoption of SFAS 157 for those assets and liabilities within the scope of FSPFAS 157-2 is not expected to have a material impact on our financial position or results of operations.
In June 2008, the FASB ratified EITF Issue07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”(“EITF 07-5”). Paragraph 11(a) of Statement of Financial Accounting Standard No 133, Accounting for Derivatives and Hedging Activities (“SFAS 133”) specifies that a contract that would otherwise meet the definition of a derivative, but is both (a) indexed our own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument.EITF 07-5 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock, including evaluating the instrument’s contingent exercise and settlement provisions, and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception. It also clarifies the impact of foreign-currency-denominated strike prices and market-based employee stock option valuation instruments on the evaluation.EITF 07-5 will be effective for the first annual reporting period beginning after December 15, 2008, and early adoption is prohibited. The impact of adoptingEITF 07-5, if any, is not expected to be material.
Results of Operations
Overview of 2008 Results
During the year we:
| • | Posted record revenue of $206.2 million, representing 13% growth over 2007 | |
| • | Expanded global AED distribution, particularly in Europe and Japan, and achieved significant market share increases | |
| • | Introduced new and updated products, including a new cardiac rehabilitation system, increased connectivity options for stress systems and new non-English language versions of a number of products | |
| • | Achieved record operating cash flow | |
| • | Were added to the Russell 3000® Index | |
| • | Incurred a full pre-tax write-off of previously acquired goodwill totaling $107.7 million, resulting primarily from the significant downturn in the global economy and related decreases in our market capitalization during the fourth quarter of 2008 and the first quarter of 2009. | |
| • | Recorded a $1.2 million charge related to the reorganization of our marketing and product development organizations, including a 12% reduction in work force, in order to realign our cost structure, become more flexible and efficient in our operations, and operate profitably in a range of scenarios related to economic uncertainty |
In early 2009, we:
| • | Announced an alliance with Syncroness that will allow us to be quicker to market with product solutions that meet the needs of existing customers as well as broader markets we are addressing |
Looking Forward
There are a number of factors that may negatively affect revenue growth in future periods, most notably the significant downturn in the global economy, in particular in the U.S. and Japan. We continue to expect long-term growth in AED revenues over time, both domestically and overseas. However, we do not expect growth at the same level as recent years in the near term due to deteriorating global economic conditions which are having an impact on the speed of AED deployments domestically and internationally, including softness in the U.S. and Japanese markets, in particular. In addition to weak economic conditions in Japan, our operating performance in
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that market could be negatively impacted by our exclusive distributor’s expected introduction of new products that may erode sales of our products in that market. We believe the long-term outlook for AED sales in the U.S. and in Japan is very positive. However sales in the near term in both countries will likely be down in 2009. We believe our direct presence in several countries in Europe will result in continued growth in sales in these markets over time, though again we may experience softness in the near term due to general economic factors. Although, we expect to continue to see meaningful revenue from the GE hospital defibrillator, we are cautious due to the economic environment creating challenges in the world-wide hospital market. We expect our cardiac monitoring line to ultimately grow over time though, again, due to the weak economy, our cardiac monitoring revenues may decline in 2009. We expect that service revenue and related gross profit will remain flat or grow somewhat in 2009 and will continue to grow thereafter. Additionally, GE’s level of success in selling our new hospital defibrillator, the results of our continued effort to revitalize our cardiac monitoring line and our ability to continue to capture a sizeable share of the global AED market as it rapidly evolves will all be factors of our success going forward.
We expect continued growth in gross profit over the longer term. However a number of the factors discussed above relating to revenue will negatively affect our gross profit in the near term.
Operating expenses in 2008 included a pre-tax charge $107.7 million relating to the impairment of goodwill. As all of our goodwill was written off in 2008, we do not expect a similar charge in the foreseeable future. We expect our operating expenses, other than the goodwill impairment charge, to decrease in the short-term due to steps taken to realign our cost structure in 2009 which will enhance our ability to operate profitably under a range of scenarios during this period of increased economic uncertainty. We expect operating expenses, other than the goodwill impairment charge, will increase over time if and when economic conditions improve and we resume revenue growth. We are continuing to devote substantial resources to the continued development of new versions of our products to meet the changing requirements of our customers.
In addition, we intend to expand our sales and marketing activities over time, both domestically and internationally, in order to increase sales of our products and services. We expect that sales and marketing expenses will decrease in the near term in line with expected short term declines in revenue. We expect general and administrative expenses to decrease in the near term. Finally, we expect sales and marketing as well as general and administrative expenses to grow in the long run, as our revenues resume growth.
Revenues
We derive our revenues primarily from the sale of our non-invasive cardiology products and related consumables, and to a lesser extent, from services related to these products, including training. We categorize our revenues as (1) defibrillation products, which include our AEDs, hospital defibrillators and related accessories; (2) cardiac monitoring products, which include capital equipment, software products and related accessories and supplies; and (3) service, which includes service contracts, CPR/AED training services, AED program management services, equipment maintenance and repair, replacement part sales and other services. We derive a portion of our service revenue from sales of separate extended maintenance arrangements. We defer and recognize these revenues over the applicable maintenance period.
Revenues for the years ended December 31, 2008, 2007 and 2006 were as follows:
| Year Ended | Year Ended | Year Ended | ||||||||||||||||||
| December 31, | % Change | December 31, | % Change | December 31, | ||||||||||||||||
| 2008 | 2007 to 2008 | 2007 | 2006 to 2007 | 2006 | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
Defibrillation products | $ | 121,946 | 25.2 | % | $ | 97,382 | 44.5 | % | $ | 67,414 | ||||||||||
| % of revenue | 59.2 | % | 53.5 | % | 43.4 | % | ||||||||||||||
Cardiac monitoring products | 65,556 | (4.5 | )% | 68,624 | (3.4 | )% | 71,016 | |||||||||||||
| % of revenue | 31.8 | % | 37.7 | % | 45.7 | % | ||||||||||||||
Service | 18,651 | 15.7 | % | 16,125 | (5.1 | )% | 16,999 | |||||||||||||
| % of revenue | 9.0 | % | 8.9 | % | 10.9 | % | ||||||||||||||
Total revenues | $ | 206,153 | 13.2 | % | $ | 182,131 | 17.2 | % | $ | 155,429 | ||||||||||
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Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Defibrillation products revenue increased significantly for 2008 from the comparable period in 2007 due to strong growth throughout Europe and Asia (particularly in Japan), which increased by 86% during the period. This increase was partially offset by decreases in domestic defibrillation products revenue of 18% during the year ended December 31, 2008, as compared to the same period in 2007. This decrease was due in part to exceptionally high revenue in the prior year that included multi-million dollar school and corporate AED deployments, which did not recur at the same levels in 2008. The weak U.S. economy negatively impacted defibrillation product sales, especially in the latter part of 2008.
Cardiac monitoring products revenue decreased by 4.5% for 2008 from the comparable period in 2007. We believe this is due, in part, to weakening of general economic conditions, resulting in longer buying cycles and deferred purchasing decisions for customers in this portion of our business.
Service revenue increased for 2008 from the comparable period in 2007 due primarily to the success of our continued focus on, and promotion of, our AED training and program management services, and to a lesser extent on growth in our cardiac monitoring service contract sales.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Defibrillation products revenue increased significantly for 2007 from the comparable period in 2006 due to higher sales both internationally and domestically, as we continued to leverage our public access programs in various municipalities and schools, increase our national accounts sales, expand through distribution and take advantage of competitive opportunities in the market. Domestic defibrillation sales increased by 60% and international sales grew by 28%.
Cardiac monitoring products revenue decreased by 3.4% for 2007 from the comparable period in 2006, although revenue for the three months ended December 31, 2007 increased by 16.5%. The decrease in our cardiac monitoring revenue was due primarily to increased competition in the U.S. market for cardiology equipment and supplies.
Service revenue decreased for 2007 from the comparable period in 2006 due primarily to the discontinuation in the second quarter of 2006 of certain non-core service contracts acquired in the merger transaction with CSI in 2005 and to a lesser degree to a reduction of product support in some areas, which was done in order to stimulate sales of new products.
Gross Profit
Gross profit is revenues less the cost of revenues. Cost of revenues consists primarily of the costs associated with manufacturing, assembling and testing our products, amortization of certain intangibles, overhead costs, compensation, including stock-based compensation and other costs related to manufacturing support and logistics. We rely on third parties to manufacture certain of our product components. Accordingly, a significant portion of our cost of revenues consists of payments to these manufacturers. Cost of service revenue consists of customer support costs, training and professional service expenses, parts and compensation. Our hardware products include a warranty period that includes factory repair services or replacement parts. We accrue estimated expenses for warranty obligations at the time products are shipped.
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Gross profit for the years ended December 31, 2008, 2007 and 2006 was as follows:
| Year Ended | Year Ended | Year Ended | ||||||||||||||||||
| December 31, | % Change | December 31, | % Change | December 31, | ||||||||||||||||
| 2008 | 2007 to 2008 | 2007 | 2006 to 2007 | 2006 | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
Defibrillation products | $ | 67,053 | 27.3 | % | $ | 52,664 | 45.5 | % | $ | 36,183 | ||||||||||
| % of defibrillation products revenue | 55.0 | % | 54.1 | % | 53.7 | % | ||||||||||||||
Cardiac monitoring products | 29,260 | (8.6 | )% | 32,000 | (1.2 | )% | 32,390 | |||||||||||||
| % of cardiac monitoring products revenue | 44.6 | % | 46.6 | % | 45.6 | % | ||||||||||||||
Service | 5,970 | 59.1 | % | 3,752 | (19.5 | )% | 4,661 | |||||||||||||
| % of service revenue | 32.0 | % | 23.3 | % | 27.4 | % | ||||||||||||||
Total gross profit | $ | 102,283 | 15.7 | % | $ | 88,416 | 20.7 | % | $ | 73,234 | ||||||||||
| % of total revenue | 49.6 | % | 48.5 | % | 47.1 | % | ||||||||||||||
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Gross profit from products increased for 2008 from the comparable period in 2007 due principally to efficiencies associated with increased volumes and a shift in overall product mix to a higher proportion of defibrillation products, for which gross profit is generally higher than for cardiac monitoring products. The slight increase in defibrillation products gross margin during 2008 was due efficiencies associated with increased volumes and a combination of favorable changes in product mix and cost reductions. The decrease in cardiac monitoring products gross margin was due principally to changes in product mix.
Gross profit from service increased as a percentage of service revenue for year ended December 31, 2008 from the comparable period in 2007 due in part to increased sales of higher value-added offerings and general growth in service revenue while costs remained relatively fixed.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Gross profit from products increased for 2007 from the comparable period in 2006 due principally to a shift in overall product mix to a higher proportion of defibrillation products, for which gross margin is generally higher than for cardiac monitoring products, and from cost savings and productivity increases that resulted from planned improvements in our manufacturing processes.
Gross profit from service decreased for 2007 from the comparable period in 2006 due principally to lower revenues on service contracts that were acquired in the merger transaction. These contracts expired in the first half of 2006.
Operating Expenses
Operating expenses include expenses related to research and development, sales, marketing and other general and administrative expenses required to run our business, including stock-based compensation.
Research and development expenses consist primarily of salaries and related expenses for development and engineering personnel, fees paid to consultants, and prototype costs related to the design, development, testing and enhancement of products. Several components of our research and development activities require significant funding, the timing of which can cause significant quarterly variability in our expenses.
Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in sales, marketing and sales support functions as well as costs associated with corporate and product branding, promotional and other marketing activities.
General and administrative expenses consist primarily of employee salaries and related expenses for executive, finance, accounting, information technology, regulatory and human resources personnel as well as
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bad debt expense, professional fees, legal fees, excluding fees associated with significant litigation matters, and other corporate expenses.
Impairment of goodwill consists of pre-tax charges of $107.7 million, representing a write-off of the entire amount of our previously acquired goodwill, primarily resulting from our merger transaction with CSI in 2005. See Note 8 — Goodwill to the Consolidated Financial Statements in Item 8 of this report for further discussion of the impairment charge.
Litigation and related expenses include settlement costs and legal fees related primarily to three cases which were settled in the first half of 2007.
Licensing income and litigation settlement consists of non-cash income of $5.5 million for the license rights given to Philips as part of the litigation settlement and a non-cash gain on the transaction of $0.5 million. See Note 1 — Summary of Significant Accounting Policies to the Consolidated Financial Statements in Item 8 of this report for further discussion.
Operating expenses for the years ended December 31, 2008, 2007 and 2006 were as follows:
| Year Ended | Year Ended | Year Ended | ||||||||||||||||||
| December 31, | % Change | December 31, | % Change | December 31, | ||||||||||||||||
| 2008 | 2007 to 2008 | 2007 | 2006 to 2007 | 2006 | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
Research and development | $ | 16,426 | 26.2 | % | $ | 13,020 | 11.0 | % | $ | 11,733 | ||||||||||
| % of total revenue | 8.0 | % | 7.1 | % | 7.5 | % | ||||||||||||||
Sales and marketing | 50,733 | 9.8 | % | 46,195 | 15.6 | % | 39,960 | |||||||||||||
| % of total revenue | 24.6 | % | 25.4 | % | 25.7 | % | ||||||||||||||
General and administrative | 22,417 | 16.9 | % | 19,176 | 0.5 | % | 19,072 | |||||||||||||
| % of total revenue | 10.9 | % | 10.5 | % | 12.3 | % | ||||||||||||||
Impairment of goodwill | 107,671 | n/m | — | n/m | — | |||||||||||||||
| % of total revenue | 52.2 | % | 0.0 | % | ||||||||||||||||
Litigation and related expenses | — | n/m | 3,808 | (1.2 | )% | 3,855 | ||||||||||||||
| % of total revenue | 0.0 | % | 2.1 | % | 2.5 | % | ||||||||||||||
Licensing income and litigation settlement | — | n/m | (6,000 | ) | n/m | — | ||||||||||||||
| % of total revenue | 0.0 | % | (3.3 | )% | 0.0 | % | ||||||||||||||
Total operating expenses | $ | 197,247 | 158.9 | % | $ | 76,199 | 2.1 | % | $ | 74,620 | ||||||||||
| % of total revenue | 95.7 | % | 41.8 | % | 48.0 | % | ||||||||||||||
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
The increase in research and development expenses for 2008 compared to 2007 was due primarily to higher labor and outside contractor costs related to increased investment in future versions of our products. Additionally, research and development expenses included significant costs resulting from a planned reduction in the number of research and development personnel in order to reduce internal staffing in favor of external resources for certain products.
The increase in sales and marketing expenses for 2008 compared to 2007 was due primarily to higher commissions related to higher total revenues and higher selling expenses from foreign subsidiaries where we have added a direct presence. In addition, payroll and benefit related costs increased due to higher staffing.
The increase in general and administrative expenses for 2008 compared to 2007 was due primarily to increases in payroll and benefit related costs, including temporary labor as well as increased bad debt expense and legal expenses, partially offset by lower professional service fees related to audit, tax and consulting fees.
Impairment of goodwill during 2008 totaled $107.7 million and represented a pre-tax full write-off of previously acquired goodwill related primarily to the merger transaction with CSI in 2005. The impairment
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was a result of a number of factors that existed during the fourth quarter of 2008, and primarily driven by the significant downtown in global economic conditions during this period and the related impact on our market capitalization. See Note 8 — Goodwill to the Consolidated Financial Statements in Item 8 of this report for further discussion. We had no similar expense related to impairment of goodwill or other intangible assets in 2007 or 2006.
In 2008, we had no litigation expenses associated with the three cases for which specific costs were incurred in 2007. Litigation and related expenses for 2007 totaled $3.8 million which were comprised of settlement costs and legal fees related primarily to three cases which were settled between April and July. We had no expenses related to these same cases for the year ended December 31, 2008.
We had no licensing income and litigation settlement benefit in 2008. Licensing income and litigation settlement for 2007 included non-cash income of $5.5 million for the license rights granted to Philips as part of the litigation settlement and a non-cash gain on the transaction of $0.5 million.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
The increase in research and development expenses for 2007 compared to 2006 was due primarily to labor and outside developer costs related to development of new versions of certain of our products.
The increase in sales and marketing expenses for 2007 compared to 2006 was due primarily to higher commissions related to increased sales of domestic defibrillation products, which increased approximately 60% from the comparable period in 2006. The increase for 2007 was also due to higher staffing levels to promote growth and increased investments in marketing programs and activities to facilitate future growth, including corporate and product branding.
The increase in general and administrative expenses for 2007 compared to 2006 was due primarily to increased costs for tax services related to various projects as well as higher sales and use tax expenses.
Litigation and related expenses for 2007 totaled $3.8 million which were comprised of settlement costs and legal fees related primarily to three cases which were settled between April and July. Spending on these same cases for 2006 amounted to $3.9 million.
Licensing income and litigation settlement for 2007 included non-cash income of $5.5 million for the license rights granted to Philips as part of the litigation settlement and a non-cash gain on the transaction of $0.5 million. There was no benefit in 2006 for activity related to this settlement in 2007.
Other Income and Expense
Other income for 2008 consisted primarily of income from royalty agreements of $0.5 million and interest income on invested cash of $0.5 million. Additionally, other income included realized foreign currency gains related to forward exchange contracts associated with cash and accounts receivable that are denominated in currencies other than the U.S. Dollar. These realized gains were substantially offset by foreign currency losses on intercompany payables denominated in U.S. dollars owed by foreign subsidiaries.
Other income for 2007 consisted primarily of income from sub-lease agreements at facilities, royalty income, and foreign currency transaction gains. Interest income on invested cash was $0.5 million in 2007 compared to $0.2 million in 2006 due primarily to increased average cash balances during 2007.
Other income for 2006 consisted primarily of income of $0.2 million related to the release of a liability to the city of Deerfield, Wisconsin (the location of our manufacturing facilities) and $0.2 million received during the period representing contingent consideration relating to the sale of our hemodynamic monitoring business in an earlier period. Interest income on invested cash was $0.2 million during 2006.
Income Taxes
During 2008 we recorded income tax expense of $4.1 million compared to income tax expense of $4.9 million in 2007 and income tax benefit of $0.6 million in 2006. Our worldwide effective tax rate for
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2008 was (4%) and was materially affected by the pre-tax goodwill impairment charge of $107.7 million, of which only $0.3 million is deductible for federal and state income tax purposes. Accordingly, substantially all of our 2008 income tax expense is based on income excluding this impairment charge. Our worldwide effective tax rate applicable to income excluding the goodwill impairment charge was approximately 31%. This worldwide effective tax rate is down from our 2007 worldwide effective tax rate of 37% due in part to a shift in income from the U.S. to foreign jurisdictions with lower income tax rates, an increase in federal and state research and development credits as well as a slight decrease in our 2008 state effective tax rate.
The worldwide effective tax rate for 2007 was 37% and resulted from our federal and state effective tax rates, partially offset by research and development credits earned during the same period.
The worldwide effective tax rate benefit for 2006 was 99% and resulted primarily from the reinstatement of federal and state research and development credits resulting in a disproportionately high tax benefit relative to our 2006 pretax loss.
Liquidity and Capital Resources
Cash flows for the years ended December 31, 2008, 2007 and 2006 were as follows:
| Year Ended | Year Ended | Year Ended | ||||||||||||||||||
| December 31, | % Change | December 31, | % Change | December 31, | ||||||||||||||||
| 2008 | 2007 to 2008 | 2007 | 2006 to 2007 | 2006 | ||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||
Cash provided by operating activities | $ | 17,743 | 32.9 | % | $ | 13,348 | 52.3 | % | $ | 8,764 | ||||||||||
Cash used in investing activities | (4,352 | ) | (14.9 | )% | (3,788 | ) | (14.5 | )% | (3,307 | ) | ||||||||||
Cash provided by financing activities | 859 | 10.1 | % | 780 | (4.4 | )% | 816 | |||||||||||||
Effect of exchange rate changes on cash | 246 | n/m | — | n/m | — | |||||||||||||||
Total change in cash and cash equivalents | $ | 14,496 | 40.2 | % | $ | 10,340 | 64.8 | % | $ | 6,273 | ||||||||||
Cash provided by operating activities of $17.7 million for 2008 resulted from our net loss of $98.4 million plus net non-cash items included in net loss of $119.7 million (including the pre-tax goodwill impairment charge of $107.7 million) and a net increase in working capital, excluding cash, of $3.6 million. Cash provided by operating activities of $13.3 million for 2007 resulted from our net income of $8.5 million plus net non-cash items included in net income of $7.5 million, reduced by a net increase in working capital of $2.7 million. Cash provided by operating activities of $13.3 million increased $4.5 million in 2007 compared to cash flows provided by operating activities of $8.8 million in 2006 due primarily to the improvement in our net income.
Net cash used in investing activities of $4.4 million for 2008 consisted primarily of payments for capital expenditures of $3.9 million related primarily to leasehold improvements at our new location in Laguna Hills, CA as well as investments in information technology and new manufacturing equipment and tooling for products under development.
Net cash used in investing activities in 2007 consisted of payments for capital expenditures of $2.0 million, purchases of short-term investments of $1.2 million, payments of acquisition related costs associated with the merger transaction of $1.0 million, and payment of $1.0 million in consideration of certain patent rights received as part of the Philips settlement agreement. These investing outflows were partially offset by proceeds from maturities of short-term investments of $1.4 million.
Net cash used in investing activities in 2006 consisted of payments for capital expenditures of $1.2 million and purchases of short-term investments of $0.8 million, partially offset by proceeds from maturities of short-term investments of $0.3 million and collection of a note receivable related to a royalty agreement acquired in connection with the merger transaction with CSI of $0.2 million. In addition, net cash used in investing
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activities in 2006 included payments of acquisition costs related to the merger transaction with CSI of $1.7 million.
Net cash provided by financing activities for 2008, 2007 and 2006 consisted of proceeds from exercises of stock options and sales of common stock under our Employee Stock Purchase Plan less minimum tax withholdings on restricted stock awards remitted to taxing authorities.
As of December 31, 2008, our cash and cash equivalents totaled $34.7 million. We anticipate that our existing cash and cash equivalents and future expected operating cash flow will be sufficient to meet operating expenses, working capital requirements, capital expenditures and other obligations for at least 12 months.
We have a $10.0 million line of credit with Silicon Valley Bank with minimal restrictions on the amount eligible for borrowing. This line of credit bears interest, based on our quarterly adjusted EBITDA, at the lender’s prime rate or LIBOR plus 1.75%. At December 31, 2008, we did not have any borrowings under this line of credit.
We may be affected by economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. For more information on the factors that may impact our financial results, please see Part I, Item 1A Risk Factors included in this Annual Report onForm 10-K. In addition, we are continually considering other acquisitions that would complement or expand our existing business or that may enable us to expand into new markets. Future acquisitions may require additional debt, equity financing or both. We may not be able to obtain any additional financing, or may not be able to obtain additional financing on acceptable terms.
Contractual Obligations
The table below summarizes our contractual obligations and other commercial commitments as of December 31, 2008 (amounts in thousands):
| Less Than | 1-3 | 3-5 | After | |||||||||||||||||
Contractual Obligations | Total | 1 Year | Years | Years | 5 Years | |||||||||||||||
| Operating leases | $ | 14,377 | $ | 1,830 | $ | 4,058 | $ | 4,144 | $ | 4,345 | ||||||||||
| Purchase obligations | 42,066 | 42,066 | — | — | — | |||||||||||||||
| Total contractual obligations | $ | 56,443 | $ | 43,896 | $ | 4,058 | $ | 4,144 | $ | 4,345 | ||||||||||
Purchase obligations consist of outstanding purchase orders issued in the normal course of business.
At December 31, 2008 we had performance bonds of $0.1 million outstanding which were collateralized by letters of credit issued by Silicon Valley Bank in connection with various sales contracts or financing arrangements.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
We develop products in the U.S. and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since the majority of our revenues are currently priced in U.S. dollars and are translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets.
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| Item 8. | Financial Statements and Supplementary Data |
CARDIAC SCIENCE CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| 47 | ||||
| 48 | ||||
| 50 | ||||
| 51 | ||||
| 52 | ||||
| 53 | ||||
| 54 | ||||
| 83 |
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange ActRules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework as of December 31, 2007 inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.
KPMG LLP, an independent registered public accounting firm, has issued an attestation report on the Company’s internal control over financial reporting as of December 31, 2008.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Cardiac Science Corporation:
We have audited the accompanying consolidated balance sheets of Cardiac Science Corporation and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2008. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule II. We also have audited Cardiac Science Corporation’s internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Cardiac Science Corporation’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cardiac Science Corporation and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, Cardiac Science Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ KPMG LLP
Seattle, Washington
March 16, 2009
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CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
| December 31, | ||||||||||||
| 2008 | 2007 | |||||||||||
| (In thousands) | ||||||||||||
ASSETS | ||||||||||||
| Current Assets: | ||||||||||||
| Cash and cash equivalents | $ | 34,655 | $ | 20,159 | ||||||||
| Short-term investments | — | 350 | ||||||||||
| Accounts receivable, net of allowance for doubtful accounts of $1,186 and $500, respectively | 31,665 | 29,439 | ||||||||||
| Inventories | 24,692 | 21,794 | ||||||||||
| Deferred income taxes | 8,366 | 9,558 | ||||||||||
| Prepaid expenses and other current assets | 3,144 | 2,509 | ||||||||||
| Total current assets | 102,522 | 83,809 | ||||||||||
| Other assets | 428 | 125 | ||||||||||
| Machinery and equipment, net of accumulated depreciation of $15,190 and $13,065, respectively | 6,994 | 5,056 | ||||||||||
| Deferred income taxes | 28,452 | 30,288 | ||||||||||
| Intangible assets, net of accumulated amortization of $13,889 and $9,927, respectively | 31,278 | 35,053 | ||||||||||
| Investments in unconsolidated entities | 534 | 727 | ||||||||||
| Goodwill | — | 107,613 | ||||||||||
| Total assets | $ | 170,208 | $ | 262,671 | ||||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||
| Current Liabilities: | ||||||||||||
| Accounts payable | $ | 12,711 | $ | 12,792 | ||||||||
| Accrued liabilities | 13,535 | 11,075 | ||||||||||
| Warranty liability | 3,796 | 3,211 | ||||||||||
| Deferred revenue | 7,918 | 8,141 | ||||||||||
| Total current liabilities | 37,960 | 35,219 | ||||||||||
| Other liabilities | — | 54 | ||||||||||
| Total liabilities | 37,960 | 35,273 | ||||||||||
| Minority interests | 545 | 127 | ||||||||||
| Commitments and contingencies | ||||||||||||
| Shareholders’ Equity: | ||||||||||||
| Preferred stock (10,000,000 shares authorized), $0.001 par value, no shares issued or outstanding as of December 31, 2008 and 2007, respectively | — | — | ||||||||||
| Common stock (65,000,000 shares authorized), $0.001 par value, 22,998,364 and 22,781,648 shares issued and outstanding at December 31, 2008 and 2007, respectively | 227,303 | 224,250 | ||||||||||
| Accumulated other comprehensive income (loss) | (70 | ) | 167 | |||||||||
| Retained earnings (deficit) | (95,530 | ) | 2,854 | |||||||||
| Total shareholders’ equity | 131,703 | 227,271 | ||||||||||
| Total liabilities and shareholders’ equity | $ | 170,208 | $ | 262,671 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (In thousands, except share and per share data) | ||||||||||||
| Revenues: | ||||||||||||
| Products | $ | 187,502 | $ | 166,006 | $ | 138,430 | ||||||
| Service | 18,651 | 16,125 | 16,999 | |||||||||
| Total revenues | 206,153 | 182,131 | 155,429 | |||||||||
| Cost of Revenues: | ||||||||||||
| Products | 91,189 | 81,342 | 69,857 | |||||||||
| Service | 12,681 | 12,373 | 12,338 | |||||||||
| Total cost of revenues | 103,870 | 93,715 | 82,195 | |||||||||
| Gross profit | 102,283 | 88,416 | 73,234 | |||||||||
| Operating Expenses: | ||||||||||||
| Research and development | 16,426 | 13,020 | 11,733 | |||||||||
| Sales and marketing | 50,733 | 46,195 | 39,960 | |||||||||
| General and administrative | 22,417 | 19,176 | 19,072 | |||||||||
| Impairment of goodwill | 107,671 | — | — | |||||||||
| Litigation and related expenses | — | 3,808 | 3,855 | |||||||||
| Licensing income and litigation settlement | — | (6,000 | ) | — | ||||||||
| Total operating expenses | 197,247 | 76,199 | 74,620 | |||||||||
| Operating income (loss) | (94,964 | ) | 12,217 | (1,386 | ) | |||||||
| Other Income: | ||||||||||||
| Interest income | 489 | 479 | 242 | |||||||||
| Interest expense | — | (77 | ) | (258 | ) | |||||||
| Other income, net | 635 | 799 | 782 | |||||||||
| Total other income | 1,124 | 1,201 | 766 | |||||||||
| Income (loss) before income tax (expense) benefit and minority interests | (93,840 | ) | 13,418 | (620 | ) | |||||||
| Income tax (expense) benefit | (4,093 | ) | (4,924 | ) | 615 | |||||||
| Income (loss) before minority interests | (97,933 | ) | 8,494 | (5 | ) | |||||||
| Minority interests | (451 | ) | (4 | ) | 54 | |||||||
| Net income (loss) | $ | (98,384 | ) | $ | 8,490 | $ | 49 | |||||
| Net income (loss) per share — basic | $ | (4.30 | ) | $ | 0.37 | $ | 0.00 | |||||
| Net income (loss) per share — diluted | $ | (4.30 | ) | $ | 0.37 | $ | 0.00 | |||||
| Weighted average shares outstanding — basic | 22,869,920 | 22,697,113 | 22,502,040 | |||||||||
| Weighted average shares outstanding — diluted | 22,869,920 | 23,197,911 | 22,555,326 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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| Accumulated | ||||||||||||||||||||
| Other | Retained | |||||||||||||||||||
| Comprehensive | Earnings | |||||||||||||||||||
| Shares | Amount | Income (Loss) | (Deficit) | Total | ||||||||||||||||
| (In thousands, except share amounts) | ||||||||||||||||||||
Balance, December 31, 2005 | 22,410,344 | $ | 218,335 | $ | 5 | $ | (5,549 | ) | $ | 212,791 | ||||||||||
| Cumulative effect of adjustment resulting from the adoption of SAB No. 108, net of tax | — | — | — | (136 | ) | (136 | ) | |||||||||||||
| Issuance of common stock upon exercise of stock options | 79,012 | 232 | — | — | 232 | |||||||||||||||
| Stock-based compensation | — | 2,062 | — | — | 2,062 | |||||||||||||||
| Proceeds from issuance of stock under employee stock purchase plan | 92,199 | 665 | — | — | 665 | |||||||||||||||
| Stock awards | 23,516 | — | — | — | — | |||||||||||||||
| Minimum tax withholding on stock awards | (7,057 | ) | (81 | ) | — | — | (81 | ) | ||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net income | — | — | — | 49 | 49 | |||||||||||||||
Unrealized gain onavailable-for-sale securities, net of income tax effect of $12 | — | — | 20 | — | 20 | |||||||||||||||
| Foreign currency translation adjustments | — | — | (5 | ) | — | (5 | ) | |||||||||||||
| Total comprehensive income | 64 | |||||||||||||||||||
Balance, December 31, 2006 | 22,598,014 | 221,213 | 20 | (5,636 | ) | 215,597 | ||||||||||||||
| Issuance of common stock upon | ||||||||||||||||||||
| exercise of stock options | 73,693 | 368 | — | — | 368 | |||||||||||||||
| Stock-based compensation | — | 2,257 | — | — | 2,257 | |||||||||||||||
| Proceeds from issuance of stock under employee stock purchase plan | 80,078 | 553 | — | — | 553 | |||||||||||||||
| Stock awards | 43,927 | — | — | — | — | |||||||||||||||
| Minimum tax withholding on stock awards | (14,064 | ) | (141 | ) | — | — | (141 | ) | ||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net income | — | — | — | 8,490 | 8,490 | |||||||||||||||
Unrealized gain onavailable-for-sale securities, net of income tax effect of $87 | — | — | 147 | — | 147 | |||||||||||||||
| Total comprehensive income | 8,637 | |||||||||||||||||||
Balance, December 31, 2007 | 22,781,648 | $ | 224,250 | $ | 167 | $ | 2,854 | $ | 227,271 | |||||||||||
| Issuance of common stock upon exercise of stock options | 86,232 | 500 | — | — | 500 | |||||||||||||||
| Stock-based compensation | — | 2,194 | — | — | 2,194 | |||||||||||||||
| Proceeds from issuance of stock under employee stock purchase plan | 89,670 | 603 | — | — | 603 | |||||||||||||||
| Stock awards | 60,476 | — | — | — | — | |||||||||||||||
| Minimum tax withholding on stock awards | (19,662 | ) | (244 | ) | — | — | (244 | ) | ||||||||||||
| Comprehensive loss: | ||||||||||||||||||||
| Net loss | — | — | — | (98,384 | ) | (98,384 | ) | |||||||||||||
Unrealized loss onavailable-for-sale securities, net of income tax effect of $65 | — | — | (128 | ) | — | (128 | ) | |||||||||||||
| Foreign currency translation adjustments | — | — | (109 | ) | — | (109 | ) | |||||||||||||
| Total comprehensive loss | (98,621 | ) | ||||||||||||||||||
Balance, December 31, 2008 | 22,998,364 | $ | 227,303 | $ | (70 | ) | $ | (95,530 | ) | $ | 131,703 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (In thousands) | ||||||||||||
| Operating Activities: | ||||||||||||
| Net income (loss) | $ | (98,384 | ) | $ | 8,490 | $ | 49 | |||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||||||
| Stock-based compensation | 2,173 | 2,233 | 2,028 | |||||||||
| (Gain) loss on disposal of machinery and equipment | — | (16 | ) | 58 | ||||||||
| Depreciation and amortization | 6,327 | 6,746 | 6,261 | |||||||||
| Impairment of goodwill | 107,671 | — | — | |||||||||
| Licensing income and litigation settlement | — | (6,000 | ) | — | ||||||||
| Deferred income taxes | 3,093 | 4,494 | (781 | ) | ||||||||
| Minority interests | 451 | 55 | (54 | ) | ||||||||
| Changes in operating assets and liabilities, net of businesses acquired: | ||||||||||||
| Accounts receivable, net | (2,825 | ) | (2,468 | ) | (1,189 | ) | ||||||
| Inventories | (2,877 | ) | (4,153 | ) | 2,956 | |||||||
| Prepaid expenses and other assets | (645 | ) | (304 | ) | 1,189 | |||||||
| Accounts payable | (543 | ) | 1,031 | 411 | ||||||||
| Accrued liabilities | 2,940 | 1,531 | (1,604 | ) | ||||||||
| Warranty liability | 585 | 679 | (95 | ) | ||||||||
| Deferred revenue | (223 | ) | 1,030 | (465 | ) | |||||||
| Net cash provided by operating activities | 17,743 | 13,348 | 8,764 | |||||||||
| Investing Activities: | ||||||||||||
| Purchases of short-term investments | (845 | ) | (1,240 | ) | (839 | ) | ||||||
| Maturities of short-term investments | 1,195 | 1,437 | 292 | |||||||||
| Purchase of patents as part of litigation settlement | — | (1,000 | ) | — | ||||||||
| Purchases of machinery and equipment | (3,911 | ) | (2,014 | ) | (1,249 | ) | ||||||
| Proceeds from repayment of notes | 38 | — | 238 | |||||||||
| Cash paid for acquisitions | (829 | ) | (971 | ) | (1,749 | ) | ||||||
| Net cash used in investing activities | (4,352 | ) | (3,788 | ) | (3,307 | ) | ||||||
| Financing Activities: | ||||||||||||
| Proceeds from exercise of stock options and issuance of shares under employee stock purchase plan | 1,103 | 921 | 897 | |||||||||
| Minimum tax withholding on stock awards | (244 | ) | (141 | ) | (81 | ) | ||||||
| Net cash provided by financing activities | 859 | 780 | 816 | |||||||||
| Effect of exchange rate changes on cash | 246 | — | — | |||||||||
| Net change in cash and cash equivalents | 14,496 | 10,340 | 6,273 | |||||||||
| Cash and cash equivalents, beginning of period | 20,159 | 9,819 | 3,546 | |||||||||
| Cash and cash equivalents, end of period | $ | 34,655 | $ | 20,159 | $ | 9,819 | ||||||
| Supplemental disclosures of cash flow information: | ||||||||||||
| Cash paid for income taxes, net of refunds | $ | 1,026 | $ | 338 | $ | 204 | ||||||
| Cash paid for interest | — | $ | 25 | $ | 54 | |||||||
| Supplemental disclosures of noncash investing and financing activities: | ||||||||||||
| Intangible assets acquired in licensing income and litigation settlement | — | $ | 6,000 | — | ||||||||
| Machinery and equipment purchases accrued but not yet paid for | $ | 396 | — | — | ||||||||
| Conversion of accounts receivable note to note receivable | $ | 330 | — | — | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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| 1. | Summary of Significant Accounting Policies |
Organization and Description of Business
Cardiac Science Corporation (“the Company”) develops, manufactures, and markets a family of advanced diagnostic and therapeutic cardiology devices and systems, including automated external defibrillators (AEDs), electrocardiograph systems (ECGs), stress test systems, Holter monitoring systems, hospital defibrillators, cardiac rehabilitation telemetry systems, and cardiology data management systems (Informatics) that connect with hospital information (HIS), electronic medical record (EMR), and other information systems. The Company sells a variety of related products and consumables, and provides a portfolio of training, maintenance, and support services. Cardiac Science, the successor to the cardiac businesses that established the trusted Burdick®, HeartCentrix®, Powerheart®, and Quinton® brands, is headquartered in Bothell, Washington. The Company distributes its products in nearly 100 countries worldwide, with operations in North America, Europe, and Asia.
The Company is the result of the combination of Quinton Cardiology Systems, Inc. (“Quinton”) and Cardiac Science, Inc. (“CSI”) pursuant to a merger transaction (“Merger”) that was completed on September 1, 2005.
Basis of Presentation
The accompanying consolidated financial statements present the Company on a consolidated basis, including the Company’s wholly owned subsidiaries and its majority owned joint ventures. All intercompany accounts and transactions have been eliminated.
The Company, in accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”), adjusted its beginning retained earnings for fiscal 2006 in the accompanying consolidated financial statements. See Note 19 for additional information on the adoption of SAB 108.
Use of Estimates
The preparation of the financial statements and related disclosures in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the periods reported. These estimates include the allocation of the purchase price in acquisitions, collectibility of accounts receivable, the recoverability of inventory, the adequacy of warranty liabilities, the valuation of stock awards, the fair value of patent rights, intra-period tax allocation, the realizability of investments, the realizability of deferred tax assets and valuation and useful lives of tangible and intangible assets, including goodwill, among others. The market for the Company’s products is characterized by intense competition, rapid technological development and frequent new product introductions, all of which could affect the future realizability of the Company’s assets. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
Cash Equivalents
Highly liquid investments with a maturity at the date of purchase of three months or less are considered cash equivalents.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Short-term Investments
The Company’s short-term investments are classified asavailable-for-sale as defined by Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). At December 31, 2007 short-term investments consisted of investment grade commercial paper and U.S. government and agencies’ discount notes maturing within one year. The securities are carried at fair value, with the unrealized gains and losses included in accumulated other comprehensive income (loss), net of tax. Realized gains or losses on the sale of marketable securities are identified on a specific identification basis and are reflected as a component of interest income or expense. There have been noother-than-temporary declines in the securities.
Short-term investments totaled $350,000 at December 31, 2007, the Company had no similar investments at December 31, 2008. There were no significant realized gains or losses on the sale of short-term investments during the years ended December 31, 2008 and 2007. Gross unrealized gains and losses at December 31, 2008 and 2007 were not significant.
Accounts Receivable
Accounts receivable are recorded at invoiced amount and do not bear interest. The Company performs initial and ongoing evaluations of its customers’ financial position, and generally extends credit on open account. The Company maintains an allowance for doubtful accounts which is reflective of management’s best estimate of probable accounts receivable losses. Management determines the allowance based on known troubled accounts, historical experience, and other currently available evidence. Trade receivable balances are charged against the allowance at the time management determines such balances to be uncollectible.
Inventories
Inventories are stated at the lower of cost, determined on a weighted-average basis, or market. Costs include materials, labor and overhead. The Company records inventory write-downs based on its estimate of excessand/or obsolete inventory.
Machinery and Equipment
Machinery and equipment are stated at cost. Machinery and equipment are depreciated using the straight-line method over the estimated useful lives of the assets of 2 to 14 years. Leasehold improvements are capitalized and amortized over the shorter of the estimated useful lives or the remaining lease term. Expenditures for maintenance and repairs are expensed as incurred. Upon retirement or disposal, the cost and accumulated depreciation of machinery and equipment are reduced and any gain or loss is recorded relative to cash proceeds received, if any.
Intangible Assets
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), intangible assets with indeterminate lives are not subject to amortization but are tested for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. Other intangible assets with finite lives are subject to amortization, and any impairment is determined in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”).
The Company’s intangible assets are comprised primarily of the Burdick and Cardiac Science trade names, developed technology, patent rights and customer relationships, all of which were acquired in the Company’s acquisitions of Spacelabs Burdick, Inc. (“Burdick”) in 2003, the merger transaction between Quinton and CSI in 2005 and the Philips cross-licensing agreement in 2007. Management uses judgment to estimate the useful lives of each intangible asset. The Company believes the Burdick and Cardiac Science
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
trade names have indefinite lives, and accordingly, values of the trade names are not amortized. The useful lives of developed technologies were based on the estimated remaining economic lives of the related products. The useful lives of the patent rights were based on the estimated remaining economic life of the patents. The useful lives of customer relationships were based on expected turnover experience, among other factors. The Company evaluates the remaining useful lives of amortizable intangibles annually.
The Company periodically re-evaluates its conclusion that the trade names have indefinite lives and makes a judgment about whether there are factors that would limit the ability to benefit from the trade names in the future. If there were such factors, the Company would amortize the value of the trade names. Management annually reviews trade name intangible assets for impairment by comparing the fair value of the asset to its carrying value. The Company uses judgment to estimate the fair value of trade names. The judgment about fair value is based on expectations of future cash flows and an appropriate discount rate. The Company evaluates the remaining useful lives of the developed technology, patent rights and customer relationship intangible assets annually.
The Company performed a test for impairment of indefinite lived intangibles other than goodwill as of November 30, 2008. We did not record an impairment charge as a result of the analysis.
Goodwill
Goodwill represents the excess of cost over the estimated fair value of net assets acquired in connection with Quinton’s acquisitions of a medical treadmill manufacturing line in 2002 and Burdick in 2003 and in connection with the merger transaction between Quinton and CSI in September 2005. In accordance with SFAS 142 goodwill is not being amortized and the Company tests goodwill for impairment at the reporting unit level on an annual basis and between annual tests in certain circumstances. The Company has determined that it has one reporting unit, consisting of general cardiology products, which also includes the product service business.
SFAS 142 requires a two-step goodwill impairment test whereby the first step, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is potentially impaired, thus the second step of the goodwill impairment test is used to quantify the amount of any impairment that exists. Management estimated the fair value of the Company’s reporting unit was less than the carrying value during the fourth quarter of 2008 and ultimately recorded a write-off of all previously acquired goodwill totaling $107.7 million. See Note 8 — Goodwill to the Consolidated Financial Statements for further discussion of the impairment charge.
Valuation of Long-Lived Assets
In accordance with SFAS 144, long-lived assets, such as property, plant, and equipment, and intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of asset groups to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized on our statement of operations and as a reduction to the asset group if it is concluded that the fair market value of the asset group is less than its carrying value. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. We evaluated our long lived assets for impairment during 2008 and determined that no impairment was necessary.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Purchase Price Allocations
SFAS No. 141, “Business Combinations,” (“SFAS 141”) requires that the purchase method of accounting be used for all business combinations and establishes specific criteria for the recognition of intangible assets separately from goodwill. The merger transaction was accounted for as an acquisition by Quinton of CSI under the purchase method of accounting in accordance with SFAS 141, and the Company allocated the respective purchase price plus transaction costs to estimated fair values of assets acquired and liabilities assumed. These purchase price allocation estimates were made based on the Company’s estimates of fair values. In connection with the Company’s acquisitions of the medical treadmill manufacturing line and Burdick, the Company allocated the respective purchase prices plus transaction costs to estimated fair values of assets acquired and liabilities assumed.
Deferred Tax Assets and Income Taxes
The Company accounts for income taxes under the asset and liability method as set forth in SFAS No. 109, “Accounting for Income Taxes,” (“SFAS 109”) under which deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities and operating loss and tax credit carryforwards. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled.
Litigation and Other Contingencies
The Company regularly evaluates its exposure to threatened or pending litigation and other business contingencies. Because of the uncertainties related to the amount of loss from litigation and other business contingencies, the recording of losses related to such exposures requires significant judgment about the potential range of outcomes. As additional information about current or future litigation or other contingencies becomes available, the Company will assess whether such information warrants the recording of additional expense relating to these contingencies. A loss contingency, to be recorded as an expense, must be both probable and measurable.
Restructuring Costs
In December 2008, the Company decided to implement a restructuring plan. The restructuring plan includes a 12% reduction in work force, primarily impacting the Company’s product development, manufacturing, and customer service organizations. The restructuring was implemented in order to realign the Company’s cost structure, become more flexible and efficient in operations, and operate profitably in a range of scenarios related to economic uncertainty. The Company recorded severance charges of approximately $1,203,000 in the fourth quarter of 2008 related to this restructuring and other terminations resulting from the realignment of the research and development organization.
Revenue Recognition
The Company’s revenue recognition policies are based on the requirements of SEC Staff Accounting Bulletin No. 104, “Revenue Recognition,” (“SAB 104”) and the Emerging Issues Task Force consensus on IssueNo. 00-21, “Revenue arrangements with Multiple Deliverables”(“EITF 00-21”), and, in addition, to the extent an arrangement contains software that is more than incidental to the arrangement, the Company follows the provisions of AICPA Statement of Position97-2, “Software Revenue Recognition”(“SOP 97-2”) as amended by AICPA Statement of Position98-9, “Software Revenue Recognition with Respect to Certain Arrangements”(SOP 98-9”).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Revenue from sales of hardware products is generally recognized when title transfers to the customer, typically upon shipment. Some of the Company’s customers are distributors that sell goods to third party end users. Except for certain identified distributors where collection may be contingent on distributor resale, the Company recognizes revenue on sales of products made to distributors when title transfers to the distributor and all significant obligations have been satisfied. In making a determination of whether significant obligations have been met, the Company evaluates any installation or integration obligations to determine whether those obligations are inconsequential or perfunctory. In cases where the remaining installation or integration obligation is not determined to be inconsequential or perfunctory, the Company defers the portion of revenue associated with the fair value of the installation and integration obligation until these services have been completed.
Distributors do not have price protection and generally do not have product return rights, except if the product is defective upon shipment or shipped in error, and in some cases upon termination of the distributor agreement. For certain identified distributors where collection may be contingent on the distributor’s resale, revenue recognition is deferred and recognized on a “sell through” or cash basis. The determination of whether sales to distributors are contingent on resale is subjective because the Company must assess the financial wherewithal of the distributor to pay regardless of resale. For sales to distributors, the Company considers several factors, including past payment history, where available, trade references, bank account balances, Dun & Bradstreet reports and any other financial information provided by the distributor, in assessing whether the distributor has the financial wherewithal to pay regardless of, or prior to, resale of the product and that collection of the receivable is not contingent on resale.
The Company offers limited volume price discounts and rebates to certain distributors. Volume price discounts are on a per order basis based on the size of the order and are netted against the revenue recorded at the time of shipment. Rebates are accrued for as incurred and are recorded as offset to revenue.
With respect to arrangements where software is considered more than incidental to the product, the vendor specific objective evidence of undelivered support is deferred and the residual fair value of delivered software is recognized. Revenue from software implementation services is recognized as the services are provided (based on vendor specific objective evidence of fair value). When significant implementation activities are required, the Company recognizes revenue from software and services upon installation. The Company sells software and hardware upgrades on a stand alone basis.
The Company considers program management packages and training and other services as separate units of accounting and applies the provisions ofEITF 00-21 when sold with an AED based on the fact that the items have value to the customer on a stand alone basis and could be acquired from another vendor. Fair value is determined to be the price at which they are sold to customers on a stand alone basis. Training revenue is deferred and recognized at the time the training occurs. AED program management services revenue, pursuant to agreements that exist with some customers pursuant to annual or multi-year terms, are deferred and amortized on a straight-line basis over the related contract period.
The Company offers optional extended service contracts to customers. Fair value is determined to be the price at which they are sold to customers on a stand alone basis. Service contract revenues are recognized on a straight-line basis over the term of the extended service contracts, which generally begin after the expiration of the original warranty period. For services performed, other than pursuant to warranty and extended service contract obligations, revenue is recognized when the service is performed and collection of the resulting receivable is reasonably assured.
Upfront license fees are deferred and recognized as revenue using the straight-line method over the term of the related license agreement. Royalty revenues are due and payable quarterly (generally 60 days after period end) pursuant to the related license agreements. An estimate of royalty revenues is recorded quarterly
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
in the period earned based on the prior quarter’s historical results adjusted for any new information or trends known to management at the time of estimation.
Freight charges billed to customers and included in revenue were approximately $2,259,000, $2,306,000 and $2,237,000 in 2008, 2007 and 2006, respectively. The associated expense is classified within cost of revenues in the accompanying consolidated statements of operations.
The Company accounts for the licensing of software in accordance withSOP 97-2, as amended bySOP 98-9. The application ofSOP 97-2 requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence (VSOE) of fair value exists for those elements. Customers may receive certain elements of the Company’s products over a period of time. These elements include post-delivery telephone support and the right to receive unspecified upgrades/enhancements (on awhen-and-if available basis), the fair value of which is recognized over the service period. Changes to the elements in a software arrangement and the ability to identify VSOE of fair value for those elements could materially impact the amount of earned and unearned revenue.
Sales Returns
The Company provides a reserve against revenue for estimated product returns. The amount of this reserve is evaluated quarterly based upon historical trends.
Segment Reporting
Accounting standards require public companies to disclose certain information about each of their reportable segments. Based on the similar economic and operating characteristics of the components of our business, we have determined that we currently have only one reportable segment, which markets variousnon-invasive cardiology products and services.
Export Sales
For the years ended December 31, 2008, 2007 and 2006, export sales were 39%, 26% and 24%, respectively, of total revenues. Export sales are denominated in U.S. dollars. Accordingly, the Company did not incur significant foreign currency transaction gains or losses.
Foreign Currency Translation
The functional currency of the Company’s foreign operations in Denmark is the U.S. dollar and therefore, the financial statements of this entity are maintained in U.S. dollars. Any assets and liabilities in foreign currencies, such as bank accounts and certain payables, are re-measured in U.S. dollars at period-end exchange rates in effect. Any transactions in foreign currencies, such as wages paid in local currencies, are re-measured in U.S. dollars using an average monthly exchange rate. Any resulting gains and losses are included in operations and were not significant in any period.
The Company maintains the financial statements in the local currency of the countries in which its consolidated joint ventures, Cardiac Science Shanghai and Cardiac Science France are located, as well as its wholly owned subsidiaries in the U.K. and Germany. Thus, assets and liabilities are translated to U.S. dollars at exchange rates in effect at period end for consolidated reporting. Translation adjustments are included in accumulated other comprehensive income (loss) in shareholders’ equity. Gains and losses on foreign currency transactions are included in operations and were not significant in any period.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Advertising Costs
The cost of advertising is expensed as incurred. During the years ended December 31, 2008, 2007 and 2006, the Company incurred advertising expenses of $870,000, $1,327,000 and $996,000, respectively.
Warranty
The Company provides warranty service covering many of the products and systems it sells. Estimated future costs of providing warranty service, which relate principally to the hardware components of the systems, are provided when the systems are sold. Estimated future costs are based on warranty claims history and other relevant information.
The Company’s sales to customers generally include certain provisions for indemnifying customers against liabilities if the Company’s software products infringe a third party’s intellectual property rights. To date, the Company has not incurred any material costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in the consolidated financial statements.
Research and Development Costs
Research and development costs are expensed as incurred.
Comprehensive Income (Loss)
The Company computes comprehensive income in accordance with SFAS No. 130, “Reporting Comprehensive Income,” (“SFAS 130”). SFAS 130 establishes standards for the reporting and display of comprehensive income or loss and its components in the financial statements.
For the Company, components of other comprehensive income consist of unrealized gains and losses onavailable-for-sale securities, net of related income tax effects and translation gains and losses related to consolidation of financial statements from international operations.
The following table sets forth comprehensive income (loss):
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (In thousands) | ||||||||||||
| Net income (loss) | $ | (98,384 | ) | $ | 8,490 | $ | 49 | |||||
| Other comprehensive income (loss) | (237 | ) | 147 | 15 | ||||||||
| Total comprehensive income (loss) | $ | (98,621 | ) | $ | 8,637 | $ | 64 | |||||
Financial Instruments and Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities. Financial instruments that are short-termand/or that have little or no market risk are estimated to have a fair value equal to book value. The assets and liabilities listed above fall under this category.
Stock-Based Compensation
Effective January 1, 2006 the Company adopted the fair value recognition provisions of SFAS 123R, and applied the provisions of Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”), using the modified-prospective transition method. Under this transition method, stock-based compensation expense is recognized in the consolidated financial statements for granted stock options and for expense related to the Employee Stock Purchase Plan (“ESPP”), since the related
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
purchase discounts exceeded the amount allowed under SFAS 123R for non-compensatory treatment. Compensation expense recognized included the estimated expense for stock options granted on and subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R, and the estimated expense for the portion vesting in the period for options granted prior to, but not vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Further, as required under SFAS 123R, forfeitures are estimated for share-based awards that are not expected to vest. Compensation expense for non-vested stock awards is based on the market price on the grant date and is recorded equally over the vesting period.
Determining the fair value of share-based awards at the grant date requires judgment, including estimating future volatility, expected term and the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and the Company’s results of operations could be materially impacted.
Net Income (Loss) Per Share
In accordance with SFAS No. 128, “Computation of Earnings Per Share” (“SFAS 128”), basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted income (loss) per share is computed by dividing net income (loss) by the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of shares issuable upon the exercise of stock options, non-vested stock awards, warrants and issuance of shares under the ESPP using the treasury stock method. Common equivalent shares are excluded from the calculation if their effect is antidilutive.
The following table sets forth the computation of basic and diluted net income (loss) per share:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (In thousands, except share data) | ||||||||||||
| Numerator: | ||||||||||||
| Net income (loss) | $ | (98,384 | ) | $ | 8,490 | $ | 49 | |||||
| Denominator: | ||||||||||||
| Weighted average shares for basic calculation | 22,869,920 | 22,697,113 | 22,502,040 | |||||||||
| Incremental shares from employee stock options, non-vested stock awards and ESPP | — | 500,798 | 53,286 | |||||||||
| Weighted average shares for diluted calculation | 22,869,920 | 23,197,911 | 22,555,326 | |||||||||
The following table sets forth the number of antidilutive shares issuable upon exercise of stock options, non-vested stock awards, ESPP and warrants excluded from the computation of diluted income (loss) per share:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Antidilutive shares issuable upon exercise of stock options | 2,896,877 | 2,459,875 | 2,296,587 | |||||||||
| Antidilutive shares issuable upon exercise of warrants | 237,775 | 288,984 | 330,834 | |||||||||
| Antidilutive shares related to non-vested stock awards and ESPP | 289,836 | 194,904 | — | |||||||||
| Total | 3,424,488 | 2,943,763 | 2,627,421 | |||||||||
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Accounting for Licensing Income and Litigation Settlement
During the second quarter of fiscal 2007, the Company entered into a Settlement Agreement with Koninklijke Philips Electronics N.V. (“Philips”) pursuant to which the parties agreed to dismiss all pending claims between the parties in consideration for cross-licenses of certain patents between the parties and a $1,000,000 payment from the Company to Philips. The transaction was valued in accordance with Accounting Principals Board Opinion No. 29, “Accounting for Nonmonetary Transactions,” (“APB 29”), as amended by SFAS No. 153, “Exchanges of Nonmonetary Assets an amendment of APB Opinion No. 29,” (“SFAS 153”). The fair value of the intangible assets acquired of $7,000,000 and royalty income received of $5,500,000 was measured based upon estimated future royalty streams that would have been due to both parties for the use of their patents. The Company determined that because there are no future activities or obligations required by the Company with respect to the patent rights granted to Philips the $5,500,000 was realized and earned at completion of the transaction. This fair value was then limited to the net present value of the payment streams. The Company also recorded a gain on the transaction of $500,000, included in licensing income and litigation settlement, because the fair value of the intangible assets received in the transaction was estimated to exceed the fair value of the intangible assets given up and, in the case of the Company, the cash paid. The intangible assets’ value will be amortized to cost of product revenues based upon the estimated remaining economic life of the patents of 13 years, which will approximate $500,000 annually.
Litigation and Related Expenses
Litigation and related expenses included settlement costs and legal fees related primarily to three cases which were settled between April 2007 and July 2007, including the case with Philips. These expenses were included in general and administrative expenses in previous periods and have been reclassified to their own line item.
On April 30, 2007, the Company entered into a Settlement Agreement and Mutual Release (“Agreement”) with the Institute of Applied Management and Law, Inc. (“IAML”) in connection with the Company’s previously disclosed arbitration against CSI for alleged failure to perform on a marketing agreement. The Agreement was a complete and final resolution and settlement of respective differences, positions and claims. As consideration for the Agreement, the Company paid IAML $500,000, which has been included as part of litigation and related expenses in 2007.
On July 26, 2007, the Company entered into a settlement agreement with William S. Parker (“Parker”) in connection with the Company’s previously disclosed patent litigation, providing for a full release of the Company from all claims made in the lawsuit. Costs relating to this settlement were included as part of litigation and related expenses in 2007.
Customer and Vendor Concentrations
The following table summarizes the customers accounting for 10% or more of our total revenues:
| Year Ended December 31, | ||||||||||||
Customer | 2008 | 2007 | 2006 | |||||||||
| Nihon Kohden Corporation | 19 | % | 11 | % | 11 | % | ||||||
| * | Did not exceed 10%. |
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The following table summarizes the vendors accounting for 10% or more of our purchases:
| Year Ended December 31, | ||||||||||||
Vendor | 2008 | 2007 | 2006 | |||||||||
| Vendor 1 | 18 | % | 16 | % | 12 | % | ||||||
| Vendor 2 | * | * | 10 | % | ||||||||
| * | Did not exceed 10%. |
Although components are available from other sources, a key vendor’s inability or unwillingness to supply components in a timely manner or on terms acceptable to the Company could adversely affect the Company’s ability to meet customers’ demands.
Taxes Collected from Customers and Remitted to Governmental Authorities
The Company uses the net method (excluded from revenue) for reporting taxes that are assessed by a governmental authority that are directly imposed on revenue-producing transactions, i.e. sales, use and value-added taxes.
Reclassifications
Certain reclassifications of prior period amounts have been made for consistent presentation with the current period. These reclassifications had no impact on net income (loss) or shareholders’ equity as previously reported.
Recent Accounting Pronouncements
In April 2008, the Financial Accounting Standards Board issued FASB Staff PositionFAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSPFAS 142-3”), which amends the factors that should be considered in renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, Goodwill and Other Intangible Assets. This statement also establishes disclosure requirements designed to assess the extent to which the expected future cash flows associated with the asset are affected by the entity’s intentand/or ability to renew or extend the arrangement. The requirements of FSPFAS 142-3 are effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company is currently assessing the impact FSPFAS 142-3 will have on our financial position and results of operations upon adoption.
In March of 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement 133” (“SFAS 161”). SFAS 161 requires entities to provide greater transparency about how and why the entity uses derivative instruments, how the instruments and related hedged items are accounted for under FASB Statement 133, and how the instruments and related hedged items affect the financial position, results of operations, and cash flows of the entity. SFAS 161 is effective for fiscal years beginning after November 15, 2008. Adoption of SFAS 161 will not have a material impact on the Company’s financial position or results of operations, but will require additional disclosure requirements.
In December 2007, the FASB issued SFAS 141R, “Business Combinations” (“SFAS 141R”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS 141(R) also requires an acquirer to record an adjustment to income tax expense for changes in valuation allowances or uncertain tax positions related to the acquired businesses. The requirements of SFAS 141R are effective for
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periods beginning after December 15, 2008. We are required to and plan to adopt the provisions of SFAS 141R beginning in the first quarter of 2009. The impact of adopting SFAS 141R will depend upon the acquisitions, if any, the Company consummates after the effective date.
In December 2007, the FASB issued SFAS 160, “Noncontrolling Interest in Consolidated Financial Statements”, an amendment of ARB 51 (“SFAS 160”), which will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity within the consolidated balance sheets. The requirements of SFAS 160 are effective for periods beginning after December 15, 2008. The adoption of SFAS 160 is not expected to have a material impact on our financial position or results of operations.
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS 157”), which establishes a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. In February 2008, the FASB issued FASB Staff PositionFAS 157-2, “Effective Date of FASB Statement 157” (“FSPFAS 157-2”), which allows for the deferral of the adoption date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. We elected to defer the adoption of SFAS 157 for the assets and liabilities within the scope of FSPFAS 157-2. Refer to Note 15, Fair Value Measurements, of thisForm 10-K for our disclosures pursuant to the effective portion of SFAS 157. The adoption of SFAS 157 for those assets and liabilities within the scope of FSPFAS 157-2 is not expected to have a material impact on our financial position or results of operations.
In June 2008, the FASB ratified EITF Issue07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”(“EITF 07-5”). Paragraph 11(a) of Statement of Financial Accounting Standard No 133, Accounting for Derivatives and Hedging Activities (“SFAS 133”) specifies that a contract that would otherwise meet the definition of a derivative, but is both (a) indexed our own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument.EITF 07-5 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock, including evaluating the instrument’s contingent exercise and settlement provisions, and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception. It also clarifies the impact of foreign-currency-denominated strike prices and market-based employee stock option valuation instruments on the evaluation.EITF 07-5 will be effective for the first annual reporting period beginning after December 15, 2008, and early adoption is prohibited. The Company is currently evaluation the impact on our financial position or results of operations for the adoption ofEITF 07-5. The impact, if any, is not expected to be material
| 2. | Segment Reporting |
The Company follows the provisions of SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”) which established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments to be reported in interim financial reports issued to stockholders. It also established standards for related disclosures about products and services, geographic areas and major customers. An operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses whose separate financial information is available and is evaluated regularly by the Company’s chief operating decision makers, or decision making group, to perform resource allocations and performance assessments.
The Company’s chief operating decision makers are the Chief Executive Officer and other senior executive officers of the Company. Based on evaluation of the Company’s financial information, management believes that the Company operates in one reportable segment with its various cardiology products and services.
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The Company’s chief operating decision makers evaluate revenue performance of product lines, both domestically and internationally. However, operating, strategic and resource allocation decisions are based primarily on the Company’s overall performance in its operating segment.
The following table summarizes revenues by product line:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (In thousands) | ||||||||||||
| Defibrillation products | $ | 121,946 | $ | 97,382 | $ | 67,414 | ||||||
| Cardiac monitoring products | 65,556 | 68,624 | 71,016 | |||||||||
| Service | 18,651 | 16,125 | 16,999 | |||||||||
| Total | $ | 206,153 | $ | 182,131 | $ | 155,429 | ||||||
The following table summarizes revenues, which are attributed based on the geographic location of the customers:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| (In thousands) | ||||||||||||
| Domestic | $ | 125,172 | $ | 135,646 | $ | 117,497 | ||||||
| Foreign | 80,981 | 46,485 | 37,932 | |||||||||
| Total | $ | 206,153 | $ | 182,131 | $ | 155,429 | ||||||
Foreign revenues include $39,033,000, $19,787,000 and $16,438,000 attributed to Nihon Kohden Corporation in Japan during 2008, 2007 and 2006, respectively.
Substantially all intangible assets are domestic. Long-lived assets located outside of the United States are not material.
| 3. | Restructuring Costs |
In December 2008, the Company decided to implement a restructuring plan. The restructuring plan includes a 12% reduction in work force, primarily impacting the Company’s product development, manufacturing, and customer service organizations. The restructuring was implemented in order to realign the Company’s cost structure, become more flexible and efficient in operations, and operate profitably in a range of scenarios related to economic uncertainty. The Company recorded severance charges of approximately $1,203,000 in the fourth quarter of 2008 as management having the appropriate authority determined the amount of benefits were probable and estimable as of December 31, 2008.
The Company’s 2005 merger transaction with CSI resulted in excess facilities and redundant employee positions. The Company accrued $1,418,000 of restructuring costs as part of the merger transaction purchase price for lease exit costs associated with the Irvine, California and Minnetonka, Minnesota facilities and other operating leases. In addition, a restructuring liability with an estimated fair value of $1,291,000 was acquired in the merger transaction for facilities in Solon and Warrensville, Ohio, which had been previously vacated by CSI.
Accrued exit costs relating to the Irvine, California lease were paid mainly in the first quarter of 2006. Accrued amounts for other vacated facilities will be paid over the lease terms ending in January 2009.
Restructuring costs accrued at December 31, 2008 totaled $1,009,000 and are included in accrued liabilities on the consolidated balance sheet.
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The following tables summarize restructuring activity during the years ended December 31, 2006, 2007 and 2008:
| Balance at | Balance at | |||||||||||||||||||
| December 31, | Cash | December 31, | ||||||||||||||||||
| 2005 | Additions | Expenditures | Adjustments | 2006 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Vacated facilities | $ | 2,251 | $ | 93 | $ | (808 | ) | $ | (152 | ) | $ | 1,384 | ||||||||
| Employee severance and retention costs | 1,813 | 233 | (1,780 | ) | — | 266 | ||||||||||||||
| Total | $ | 4,064 | $ | 326 | $ | (2,588 | ) | $ | (152 | ) | $ | 1,650 | ||||||||
| Balance at | Balance at | |||||||||||||||||||
| December 31, | Cash | December 31, | ||||||||||||||||||
| 2006 | Additions | Expenditures | Adjustments | 2007 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Vacated facilities | $ | 1,384 | $ | — | $ | (705 | ) | $ | — | $ | 679 | |||||||||
| Employee severance and retention costs | 266 | — | (266 | ) | — | — | ||||||||||||||
| Total | $ | 1,650 | $ | — | $ | (971 | ) | $ | — | $ | 679 | |||||||||
| December 31, | Cash | December 31, | ||||||||||||||||||
| 2007 | Additions | Expenditures | Adjustments | 2008 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Vacated facilities | $ | 679 | $ | — | $ | (625 | ) | $ | — | $ | 54 | |||||||||
| Employee severance and retention | — | 1,203 | (248 | ) | — | 955 | ||||||||||||||
| Total | $ | 679 | $ | 1,203 | $ | (873 | ) | $ | — | $ | 1,009 | |||||||||
| 4. | Inventories |
Inventories are valued at the lower of cost, on an average cost basis, or market and were comprised of the following as of December 31:
| 2008 | 2007 | |||||||
| (In thousands) | ||||||||
| Raw materials | $ | 20,871 | $ | 16,543 | ||||
| Finished goods | 3,821 | 5,251 | ||||||
| Total inventories | $ | 24,692 | $ | 21,794 | ||||
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| 5. | Machinery and Equipment |
Machinery and equipment includes the following as of December 31 (amounts in thousands):
| Depreciable | ||||||||||||
| Lives | 2008 | 2007 | ||||||||||
| Equipment | (2-14 years | ) | $ | 16,853 | $ | 13,786 | ||||||
| Furniture and fixtures | (2-13 years | ) | 2,444 | 2,022 | ||||||||
| Leasehold improvements | (1-10 years | ) | 2,887 | 2,313 | ||||||||
| Subtotal | 22,184 | 18,121 | ||||||||||
| Less: Accumulated depreciation | (15,190 | ) | (13,065 | ) | ||||||||
| Net machinery and equipment | $ | 6,994 | $ | 5,056 | ||||||||
During the years ended December 31, 2008, 2007 and 2006, the Company recorded depreciation expense related to machinery and equipment of $2,369,000, $2,930,000 and $2,792,000, respectively.
| 6. | Intangible Assets |
The following table sets forth the balances of intangible assets at December 31, 2008 (in thousands):
| Accumulated | ||||||||||||||||
| Useful life | Cost | Amortization | Net | |||||||||||||
| Intangible assets not subject to amortization: | ||||||||||||||||
| Burdick trade name | $ | 3,400 | $ | — | $ | 3,400 | ||||||||||
| Cardiac Science trade name | 11,380 | — | 11,380 | |||||||||||||
| Cardiac Science Deutschland trade name | 183 | — | 183 | |||||||||||||
| Total intangible assets not subject to amortization | 14,963 | — | 14,963 | |||||||||||||
| Intangible assets subject to amortization: | ||||||||||||||||
| Cardiac Science customer relationships | 5 years | 8,650 | (5,767 | ) | 2,883 | |||||||||||
| Cardiac Science developed technology | 8 years | 11,330 | (4,721 | ) | 6,609 | |||||||||||
| Burdick distributor relationships | 10 years | 1,400 | (840 | ) | 560 | |||||||||||
| Burdick developed technology | 7 years | 860 | (737 | ) | 123 | |||||||||||
| Patents and patent applications | 5-10 years | 960 | (923 | ) | 37 | |||||||||||
| Patent rights | 13 years | 7,000 | (897 | ) | 6,103 | |||||||||||
| Total intangible assets subject to amortization | 30,200 | (13,885 | ) | 16,315 | ||||||||||||
| Total | $ | 45,163 | $ | (13,885 | ) | $ | 31,278 | |||||||||
The Company recorded amortization expense related to identifiable intangibles of $3,958,000, $3,816,000, and $3,469,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
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The Company’s estimated expense for the amortization of intangibles for each of the next five years is summarized as follows (in thousands):
| 2009 | 3,957 | |||
| 2010 | 3,258 | |||
| 2011 | 2,104 | |||
| 2012 | 2,102 | |||
| 2013 | 1,483 | |||
| Thereafter | 3,410 |
| 7. | Investments in Unconsolidated Entities |
In connection with the acquisition of certain entities, the Company received investments in certain unconsolidated entities. These are generally accounted for under either the cost method, for illiquid investments, or asavailable-for-sale, for investments with a readily determinable market value.
As of December 31, the Company held the following investments (in thousands):
| 2008 | 2007 | |||||||
| ScImage | $ | 84 | $ | 84 | ||||
| Biotel | 371 | 605 | ||||||
| Other | 79 | 38 | ||||||
| Total investment in unconsolidated entities | $ | 534 | $ | 727 | ||||
ScImage
The Company owns a preferred ownership investment in ScImage, a privately held company. The Company is entitled to earn commissions if it sells ScImage’s products. The Company has accounted for this investment using the cost method.
Biotel, Inc.
As of December 31, 2008 the Company owns approximately 6.5% of the outstanding shares of Biotel, a publicly traded company engaged in the development, manufacturing, and marketing of medical devices and related software. These shares were received through the merger transaction with CSI in 2005 and are valued based on quoted market price.
| 8. | Goodwill |
In October 2002, the Company acquired the medical treadmill manufacturing business and related assets and technology rights from its previous supplier of these treadmills. The Company accounted for this transaction as a business combination and recorded goodwill of $926,000 in connection with this purchase, all of which was deductible for tax purposes.
In January 2003, the Company purchased 100% of the stock of Spacelabs Burdick, Inc. (“Burdick”). The Company recorded goodwill of $9,027,000 in connection with this purchase, none of which was deductible for tax purposes.
In June 2004, the Company reduced its goodwill by $263,000 in connection with the sale of its hemodynamic monitoring product line. In December 2004, in connection with reversing its valuation allowance against deferred tax assets, the Company decreased goodwill by approximately $618,000 due to net operating loss carryforwards resulting from the Company’s acquisition of Burdick.
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In connection with the September 2005 acquisition of Cardiac Science, Inc., the Company recorded goodwill of $98,990,000 and reduced acquired goodwill by $449,000 due to adjustments to registration costs. Goodwill associated with this acquisition was not deductible for tax purposes.
In November 2008, the Company purchased an additional 10% ownership in the Cardiac Science Shanghai joint venture for $90,000 and increased its ownership in the joint venture to 66%. The Company recorded goodwill of $58,000 related to this transaction.
The following table summarizes changes in goodwill (amounts in thousands):
| Increases Due to | ||||||||||||||||
| Beginning of Period | Acquisitions | Impairment | End of Period | |||||||||||||
| Year ended December 31, 2007 | $ | 107,613 | — | — | $ | 107,613 | ||||||||||
| Year ended December 31, 2008 | $ | 107,613 | $ | 58 | $ | (107,671 | ) | — | ||||||||
Goodwill impairment
Goodwill is tested for impairment annually or more frequently when events or circumstances indicate that the carrying value of a reporting unit more likely than not exceeds its fair value. The Company’s annual goodwill impairment testing date is November 30. The Company has determined that it has a single reporting unit, general cardiology products and services.
SFAS No. 142 requires a two-step goodwill impairment test whereby the first step, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount including goodwill. Goodwill is considered potentially impaired if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of impairment from step one, step two is performed to determine the amount of the impairment. The second step involves an analysis reflecting the allocation of the fair value determined in the first step (as if it was the purchase price in a business combination). This process may result in the determination of a new amount of goodwill. If the calculated fair value of the goodwill resulting from this allocation is lower than the carrying value of the goodwill in the reporting unit, the difference is reflected as an impairment loss.
To estimate the fair value of the reporting unit for step-one, the Company utilized a combination of “market” and “income” valuation approaches. Under the “market approach”, the estimated fair value of the single reporting unit is based on the Company’s market capitalization using quoted market prices of its stock, and the number of shares outstanding for the Company’s common stock. The Company also considers a control premium that represents the estimated amount an investor would pay for our equity securities to obtain a controlling interest. Under the “income approach”, the company estimates the fair value of our single reporting unit using a net present value model, which discounts projected free cash flows (DCF) of the business at a computed weighted average cost of capital as the discount rate.
Estimating the fair value of reporting units is a subjective process that involves the use of estimates and judgments, particularly related to cash flows, the appropriate discount rates and an applicable control premium. The Company considered the following assumptions, among others, in performing the DCF analysis: forecasted revenues, gross profit margins, operating profit margins, working capital cash flow, growth rates, new product release dates and long term discount rates. All of these assumptions require significant judgments by the Company.
The requirements of the goodwill impairment testing process are such that, in the Company’s situation, if the first step of the impairment testing process indicates that the fair value of our single reporting unit is below its carrying value, the requirements of the second step of the test result in a significant decrease in the amount of goodwill recorded on the balance sheet.
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During the fourth quarter ended December 31, 2008, the Company experienced a significant decline in its stock price due primarily to the continued weakness in the global economic environment and the potential future impact of that weakness on the Company. As a result, the Company’s market capitalization fell significantly below the recorded value of its consolidated net equity.
In conducting an annual impairment test during the fourth quarter of 2008, as a result of completing the first step of the goodwill impairment test, the Company determined that the carrying value of its single reporting unit exceeded its fair value, which required us to perform the second step of the goodwill impairment test. After completing step two and allocating the estimated fair value to the net assets, the remaining fair value that was allocated to goodwill was reduced to zero and the Company recorded a non-cash charge to impair all of our previously acquired goodwill totaling $107.7 million before tax; net of tax the non-cash goodwill impairment charge totaled $107.4 million.
| 9. | Accrued Liabilities and Warranty |
Accrued liabilities are comprised of the following as of December 31 (amounts in thousands):
| 2008 | 2007 | |||||||
| Accrued compensation and benefits | $ | 5,862 | $ | 5,713 | ||||
| Other accrued liabilities | 7,673 | 5,362 | ||||||
| Total accrued liabilities | $ | 13,535 | $ | 11,075 | ||||
The Company’s warranty liability is summarized as follows (amounts in thousands):
| Purchase | ||||||||||||||||||||
| Accounting | ||||||||||||||||||||
| Adjustments | ||||||||||||||||||||
| Charged to | to Estimated | |||||||||||||||||||
| Beginning | Product Cost | Fair Value of | Warranty | End of | ||||||||||||||||
| of Period | of Revenues | Acquired Warranty | Expenditures | Period | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Year ended December 31, 2006 | $ | 2,348 | $ | 2,042 | $ | 279 | $ | (2,137 | ) | $ | 2,532 | |||||||||
| Year ended December 31, 2007 | 2,532 | 2,986 | — | (2,307 | ) | 3,211 | ||||||||||||||
| Year ended December 31, 2008 | 3,211 | 3,890 | — | (3,305 | ) | 3,796 | ||||||||||||||
| 10. | Credit Facility |
The Company has a $10.0 million line of credit with Silicon Valley Bank with minimal restrictions on the amount eligible for borrowing. This line of credit bears interest, based on our quarterly adjusted EBITDA, at the lender’s prime rate or LIBOR plus 1.75%. At December 31, 2008 and 2007 the Company did not have any borrowings under this or any other line of credit.
| 11. | Income Taxes |
The domestic and foreign components of pre-tax earnings (losses) were as follows for the years ended December 31 (in thousands):
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| U.S. | $ | (94,968 | ) | $ | 12,866 | $ | (1,184 | ) | ||||
| Foreign | 1,128 | 552 | 564 | |||||||||
| Total | $ | (93,840 | ) | $ | 13,418 | $ | (620 | ) | ||||
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Income tax expense (benefit) for 2008, 2007 and 2006 includes the following components (amounts in thousands):
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Current: | ||||||||||||
| Federal | $ | 492 | $ | 338 | $ | — | ||||||
| State | 190 | 84 | — | |||||||||
| Foreign | 318 | 8 | 166 | |||||||||
| Total current income tax expense | 1,000 | 430 | 166 | |||||||||
| Deferred: | ||||||||||||
| Federal | 3,383 | 4,452 | (490 | ) | ||||||||
| State | (290 | ) | 42 | (291 | ) | |||||||
| Total deferred expense (benefit) | 3,093 | 4,494 | (781 | ) | ||||||||
| Total income tax expense (benefit) | $ | 4,093 | $ | 4,924 | $ | (615 | ) | |||||
A reconciliation of the United States statutory rate of 34% to the effective tax rates attributable to continuing operations follows:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Federal income tax provision (benefit) at U.S. statutory rates | (34.0 | )% | 34.0 | % | (34.0 | )% | ||||||
| Nondeductible impairment of goodwill | 38.6 | % | — | — | ||||||||
| Meals and entertainment | 0.2 | % | 1.3 | % | 23.2 | % | ||||||
| Stock-based compensation | 0.1 | % | 2.1 | % | 44.3 | % | ||||||
| Research and development credits | (0.8 | )% | (4.4 | )% | (124.7 | )% | ||||||
| State income taxes, net of federal benefit | 0.2 | % | 2.9 | % | — | |||||||
| Foreign rate difference | (0.1 | )% | (0.7 | )% | (4.1 | )% | ||||||
| Other, net | 0.1 | % | 1.5 | % | (3.9 | )% | ||||||
| Provision (benefit) for income taxes | 4.4 | % | 36.7 | % | (99.2 | )% | ||||||
At December 31, 2008 and 2007, the Company had Federal net operating loss carryforwards of approximately $76,509,000 and $91,007,000, respectively, and state net operating loss carryforwards of approximately $75,196,000 and $61,383,000, respectively. SFAS 109 requires the Company to reduce the deferred tax asset resulting from these (and other) future tax benefits by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has determined that it is more likely than not that it will realize the benefit of all of its deferred tax assets, and accordingly, no valuation allowance against its deferred tax assets is required. The Federal and state net operating loss carryforwards expire in varying amounts between 2009 and 2027.
In addition, the Company has Federal credit carryforwards of $5,232,000 and state credit carryforwards of $2,666,000. The Federal tax credit carryforwards expire in varying amounts between 2018 and 2027, while most of the state credits have no expiration.
Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, provide for limitations on the utilization of net operating loss and research and experimentation credit carryforwards if the Company were to
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undergo an ownership change, as defined in Section 382. The acquisitions by the Company of Quinton Cardiology Systems, Inc., and Cardiac Science, Inc., resulted in such an ownership change. Accordingly, the estimated annual utilization of net operating loss and credit carryforwards is limited to an amount between $7,500,000 and $9,750,000 in years 2008 through 2010, and $3,279,000 from 2011 through 2025.
The Company uses the“with-and-without” or “incremental” approach for ordering tax benefits derived from the share-based payment awards. Using thewith-and-without approach, actual income taxes payable for the period are compared to the amount of tax payable that would have been incurred absent the deduction for employee share-based payments in excess of the amount of stock-based compensation cost recognized for the period. As a result of this approach, net operating loss carryforwards not generated from share-based payments and which were in excess of stock-based compensation cost recognized during the period are utilized before the current period’s share-based deduction. For the years ended December 31, 2008, 2007 and 2006, no excess tax benefits have been included in shareholders’ equity.
Deferred tax assets (liabilities) are comprised of the following as of December 31 (amounts in thousands):
| 2008 | 2007 | |||||||
| Deferred tax assets: | ||||||||
| Net operating loss carryforwards | $ | 29,971 | $ | 35,041 | ||||
| Stock-based compensation | 2,122 | 1,704 | ||||||
| Research and experimentation and alternative minimum tax credits | 7,897 | 6,887 | ||||||
| Inventory basis difference | 995 | 1,079 | ||||||
| Warranty liability | 1,369 | 1,162 | ||||||
| Deferred revenue | 799 | 913 | ||||||
| Accrued compensation, severance, relocation | 660 | 632 | ||||||
| Other assets | 1,518 | 1,450 | ||||||
| Other | 1,450 | 988 | ||||||
| Gross deferred tax assets | 46,781 | 49,856 | ||||||
| Deferred tax liabilities: | ||||||||
| Burdick intangible assets | (246 | ) | (342 | ) | ||||
| Burdick trade name intangible asset | (1,226 | ) | (1,230 | ) | ||||
| Cardiac Science intangible assets | (4,350 | ) | (4,125 | ) | ||||
| Cardiac Science trade name | (4,104 | ) | (4,117 | ) | ||||
| Goodwill from treadmill line acquisition | — | (97 | ) | |||||
| Marketable equity securities | (37 | ) | (99 | ) | ||||
| Gross deferred tax liabilities | (9,963 | ) | (10,010 | ) | ||||
| Net deferred tax assets | $ | 36,818 | $ | 39,846 | ||||
| Current deferred tax assets | $ | 8,366 | $ | 9,558 | ||||
| Deferred tax assets, non-current | 28,452 | 30,288 | ||||||
| Net deferred tax assets | $ | 36,818 | $ | 39,846 | ||||
The Company has not provided for U.S. federal income and foreign withholding taxes on any undistributed earnings fromnon-U.S. operations because such earnings are intended to be reinvested indefinitely outside of the United States. If these earnings were distributed, foreign tax credits may become available under
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current law to reduce or eliminate the resulting U.S. income tax liability. The amount of unrecognized deferred tax liability related to these earnings or investments is not significant.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB 109” (“FIN 48”) on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the Company’s financial statements in accordance with SFAS No. 109. The interpretation established guidelines for recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. Based on management’s review of the Company’s tax positions the Company had no significant unrecognized tax benefits as of December 31, 2008 and 2007.
The Company is subject to U.S. Federal income tax as well as income tax in multiple state and foreign jurisdictions as well as Federal, state and foreign filings related to Quinton and CSI. As a result of the net operating loss carryforwards, substantially all tax years are open for U.S. federal and state income tax matters. Foreign tax filings are open for years 2001 forward.
The Company’s continuing practice is to recognize interestand/or penalties related to income tax matters in income tax expense which were insignificant for all periods presented. At December 31, 2008, the Company had no accrued interest related to uncertain tax positions and no accrued penalties.
| 12. | Commitments and Contingencies |
Lease Commitments
The Company leases its office facilities in the U.S. and its international sales offices under operating leases. The operating lease related to the Bothell, Washington corporate headquarters is a non-cancelable facility lease agreement that expires on December 31, 2013. The operating lease for the office, production and warehouse facilities in Deerfield, Wisconsin is a non-cancelable facility lease agreement that expires on November 30, 2018 with two five-year renewal options. The Company leases a facility in Laguna Hills, California, which houses certain research and development operations. This facility comprises approximately 13,000 square feet and the lease expires in 2014. Additionally, the Company acquired international sales and marketing offices under operating leases in Shanghai, China, Copenhagen, Denmark and Manchester, United Kingdom. The Company also leases equipment under non-cancelable operating leases.
Future minimum lease payments for all non-cancelable leases are as follows (amounts in thousands):
| Operating | ||||
| Leases | ||||
| Year: | ||||
| 2009 | $ | 1,830 | ||
| 2010 | 2,023 | |||
| 2011 | 2,035 | |||
| 2012 | 2,046 | |||
| 2013 | 2,098 | |||
| Thereafter | 4,345 | |||
| Total | $ | 14,377 | ||
Net rental expense, including common area maintenance costs, during 2008, 2007 and 2006 was approximately $1,991,000, $1,709,000 and $1,601,000, respectively.
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Other Commitments
As of December 31, 2008, the Company had purchase obligations of approximately $42,066,000 consisting of outstanding purchase orders issued in the normal course of business.
Guarantees and Indemnities
During its normal course of business, the Company has made certain guarantees, indemnities and commitments under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property and other indemnities to the Company’s customers and suppliers in connection with the sales of its products, and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware. Historically, the Company has not incurred any losses or recorded any liabilities related to performance under these types of indemnities.
Legal Proceedings
We are subject to other various legal proceedings arising in the normal course of business. In the opinion of management, the ultimate resolution of these proceedings is not expected to have a material effect on our consolidated financial position, results of operations or cash flows.
| 13. | Shareholders’ Equity |
Preferred Stock
The Company is authorized to issue a total of 10,000,000 shares of preferred stock, no shares of which were issued or outstanding as of December 31, 2008 and 2007. The Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued series of preferred stock.
Common Stock
The Company is authorized to issue a total of 65,000,000 shares of common stock.
On September 1, 2005, in conjunction with the merger between Quinton and CSI, stockholders of Quinton received 0.77184895 shares of Company common stock (“common stock”) for each common share of Quinton held on the closing date, or approximately 48.8% of the total outstanding common stock of the Company. Stockholders of CSI received 0.10 shares of common stock for each common share of CSI held on the closing date, or approximately 51.2% of the total outstanding common stock of the Company, which percentage includes 2,843,915 shares of common stock issued to the CSI senior note holder on the closing date. In addition, each outstanding stock option, warrant and right to purchase common stock issued by Quinton and CSI prior to the merger transaction assumed by the Company became a right to purchase a number of shares of Company common stock at an exercise price adjusted in accordance with the appropriate exchange ratio in the merger transaction.
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The following table summarizes warrants assumed in connection with the merger transaction that were outstanding and exercisable at December 31, 2008:
| Warrants | ||||||||||||
| Outstanding and | Exercise Price | Expiration | ||||||||||
Grant Date | Exercisable | per Share | Date | |||||||||
| 2002 | 2,500 | 17.50 | 2012 | |||||||||
| 2004 | 1,500 | 19.50 | 2009 | |||||||||
| 2004 | 208,776 | 25.00 | 2009 | |||||||||
| Total | 212,776 | |||||||||||
| Weighted average exercise price | $ | 24.87 | ||||||||||
| 14. | Stock-Based Compensation Plans |
The Company maintains several stock equity incentive plans under which it may grant non-qualified stock options, incentive stock options and non-vested stock awards to employees, non-employee directors and consultants. The Company also has an employee stock purchase plan (“ESPP”).
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified-prospective transition method and applied the provisions of Securities and Exchange Commission Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). Under this transition method, stock-based compensation expense is recognized in the consolidated financial statements for grants of stock options and for purchases under the ESPP since the ESPP purchase discounts exceed the amount allowed under SFAS 123R for non-compensatory treatment. Compensation expense recognized includes the estimated expense for stock options granted on and subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R, and the estimated expense for the portion vesting in the period for options granted prior to, but not vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Further, as required under SFAS 123R, forfeitures are estimated for share-based awards that are not expected to vest. Results for prior periods have not been restated, in accordance with the modified-prospective transition method. Prior to the adoption of SFAS 123R, benefits of tax deductions in excess of recognized compensation costs were reported as operating cash flows. SFAS 123R requires the benefits of tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash inflows rather than operating cash inflows, on a prospective basis. This amount would be shown as “Excess tax benefit from exercise of stock options” on the consolidated statement of cash flows. There were no realized excess tax benefits in the years ended December 31, 2008 or 2007.
Total stock-based compensation expense recognized in the consolidated statement of operations for the years ended December 31, 2008, 2007 and 2006 was approximately $2,173,000, $2,233,000 and $2,028,000, respectively. The Company recognizes tax benefits related to exercises of non-qualified stock options and vesting of non-vested stock awards. The related tax benefit recognized in the consolidated statement of operations for the years ended December 31, 2008, 2007 and 2006 was approximately $394,000, $358,000 and $375,000.
Stock-based compensation of $21,000 was capitalized and included in inventory in the consolidated balance sheet at December 31, 2008. Total stock-based compensation (including capitalized costs) consisted of stock option, ESPP, non-vested stock awards and vested stock awards expense totaling $1,053,000, $179,000, $936,000 and $25,000, respectively for the year ended December 31, 2008. Total stock-based compensation (including capitalized costs) consisted of stock option, ESPP, non-vested stock awards and vested stock awards expense totaling $1,638,000, $169,000, $423,000 and $27,000, respectively for the year ended December 31, 2007. Total stock-based compensation (including capitalized costs) consisted of stock option, ESPP, non-vested
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stock awards and vested stock awards expense totaling $1,548,000, $216,000, $285,000 and $13,000, respectively for the year ended December 31, 2006. The Company issues new shares upon the exercise of stock options, grants of stock awards and purchases through the ESPP.
The fair value of each option grant and ESPP purchase is estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions, and the fair value of the non-vested stock awards is calculated based on the market value of the shares awarded at date of grant:
| Year Ended December 31, | ||||||||||||
| 2008 | 2007 | 2006 | ||||||||||
| Stock options plans: | ||||||||||||
| Volatility | 48.2 | %-48.5% | 48.6 | %-50.9% | 52.6 | %-56.0% | ||||||
| Expected term (years) | 6.25 | 6.25 | 6.25 | |||||||||
| Risk-free interest rate | 3.4 | % | 4.8 | % | 4.6 | % | ||||||
| Expected dividend yield | — | — | — | |||||||||
| Fair value of options granted | $ | 4.63 | $ | 5.31 | $ | 4.99 | ||||||
| Employee stock purchase plan: | ||||||||||||
| Volatility | 27.0 | % | 37.0 | % | 34.0 | % | ||||||
| Expected term (years) | 0.5 | 0.5 | 0.5 | |||||||||
| Risk-free interest rate | 4.5 | % | 4.5 | % | 4.4 | % | ||||||
| Expected dividend yield | — | — | — | |||||||||
| Fair value of employee stock purchase rights | $ | 2.01 | $ | 2.14 | $ | 2.37 | ||||||
| Non-vested stock: | ||||||||||||
| Fair value of non-vested stock awards granted | $ | 9.04 | $ | 9.35 | $ | 8.25 | ||||||
Volatility is based exclusively on historical volatility of the Company’s common stock as the Company believes this is representative of future volatility. The expected term is determined based on the Company’s best estimate of the expected term considering historical exercise and forfeiture history. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term. The Company has not paid dividends in the past and does not plan to pay any dividends in the near future.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, particularly for the expected term and expected stock price volatility. The Company’s employee stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate. While estimates of fair value and the associated charge to earnings materially affect the Company’s results of operations, it has no impact on the Company’s cash position. Because Company stock options do not trade on a secondary exchange, employees do not derive a benefit from holding stock options unless there is an increase, above the exercise price, in the market price of the Company’s stock. Such an increase in stock price would benefit all shareholders commensurately.
Stock Option Plans — Stock options to purchase the Company’s common stock are granted at prices at or above the fair market value on the date of grant. Options held by employees generally vest 25% after one year from the date of the grant and then monthly thereafter for 36 months and generally expire 10 years from the date of grant. Options granted to non-employee directors generally vest over one year.
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option valuation model. The assumptions used to calculate the fair value of options granted are evaluated and
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revised, as necessary, to reflect market conditions and the Company’s experience. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations.
The aggregate intrinsic values indicated in the tables below are before applicable income taxes, based on the Company’s closing stock price of $7.50 as of the last business day of the year ended December 31, 2008, which would have been received by the optionees had all options been exercised on that date.
As of December 31, 2008, total unrecognized stock-based compensation expense related to nonvested stock options was approximately $1,969,000, which is expected to be recognized over a weighted average period of approximately 2.8 years. The total intrinsic value of stock options exercised during the years ended December 31, 2008, 2007 and 2006 was $364,000, $327,000 and $521,000, respectively. The total fair value of shares vested during the years ended December 31, 2008, 2007 and 2006 was $1,053,000, $1,585,000 and 1,438,000, respectively. The Company issues new shares of common stock upon the exercise of options.
The following shares of common stock have been reserved for issuance under the Company’s stock-based compensation plans as of December 31, 2008:
| Outstanding shares — 2002 Plan | 2,063,065 | |||
| Outstanding shares — 1997 Plan | 833,812 | |||
| Stock options available for grant | 824,610 | |||
| Outstanding restricted stock grants | 388,002 | |||
| Employee stock purchase plan shares available for issuance | 749,986 | |||
| Total common shares reserved for future issuance | 4,859,475 | |||
2002 Plan —In February 2002, Quinton’s board of directors adopted and Quinton’s shareholders approved the 2002 Stock Incentive Plan (the “2002 Plan”), which became effective upon completion of Quinton’s initial public offering in May 2002 and was assumed by the Company in connection with the merger transaction. The 2002 Plan replaced Quinton’s 1998 Equity Incentive Plan (the “1998 Plan”) for purposes of all future incentive stock awards. The 2002 Plan allows the Company to issue awards of incentive or nonqualified stock options, shares of common stock or units denominated in common stock, all of which may be subject to restrictions. The 2002 Plan authorizes annual increases in shares for issuance equal to the lesser of (i) 526,261 shares, (ii) 3% of the number of shares of common stock outstanding on a fully diluted basis as of the end of the Company’s immediately preceding fiscal year, and (iii) a lesser amount established by the Company’s board of directors. Any shares from increases in previous years that are not issued will continue to be included in the aggregate number of shares available for future issuance.
Options held by employees generally vest 25% after one year from the date of the grant and then monthly thereafter over a four year period. The term of the options is for a period of ten years or less. Options generally expire 90 days after termination of employment. The Company has also adopted a stock option grant program for non-employee directors, administered under the terms and conditions of the 2002 Plan.
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The following table summarizes information about the 2002 Plan option activity during the year ended December 31, 2008:
| Shares | Weighted Average | Weighted Average | ||||||||||||||
| Subject to | Exercise Price | Remaining | Aggregate Intrinsic | |||||||||||||
| Options | per Share | Contractual Life | Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Outstanding, December 31, 2007 | 2,106,842 | $ | 7.96 | |||||||||||||
| Granted | 180,000 | 9.04 | ||||||||||||||
| Exercised | (86,232 | ) | 5.28 | |||||||||||||
| Forfeited | (137,545 | ) | 10.57 | |||||||||||||
| Outstanding, December 31, 2008 | 2,063,065 | $ | 8.00 | 7.4 | $ | 4,844,000 | ||||||||||
| Exercisable, December 31, 2008 | 1,623,564 | $ | 7.69 | 6.9 | $ | 3,700,000 | ||||||||||
1997 Plan —The Company assumed CSI’s 1997 Stock Option/Stock Issuance Plan (the “1997 Plan”) in connection with the merger transaction. The 1997 Plan provides for the granting of incentive or nonqualified stock options, subject to the limitations under applicable NASDAQ rules described below, to employees of the Company, including officers, and nonqualified stock options to employees, including officers and directors of the Company, as well as to certain consultants and advisors. Shares authorized under the 1997 Plan are subject to adjustment upon the occurrence of certain events, including, but not limited to, stock dividends, stock splits, combinations, mergers, consolidations, reorganizations, reclassifications, exchanges, or other capital adjustments.
All options outstanding under the 1997 Plan immediately prior to the merger transaction became fully vested and immediately exercisable as a result of the merger transaction. Pursuant to NASDAQ rules, (a) employees, directors, independent contractors, and advisors of CSI prior to the merger transaction and any new employees, directors, independent contractors, and advisors of the Company after the merger transaction, will be eligible to receive awards under the 1997 Plan and (b) any employees, directors, independent contractors, or advisors of Quinton prior to the merger transaction will not be eligible to receive awards under the 1997 Plan.
The following table summarizes information about the 1997 Plan option activity during the year ended December 31, 2008:
| Shares | Weighted Average | Weighted Average | ||||||||||||||
| Subject to | Exercise Price | Remaining | Aggregate Intrinsic | |||||||||||||
| Options | per Share | Contractual Life | Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Outstanding, December 31, 2007 | 858,262 | $ | 24.11 | |||||||||||||
| Exercised | — | — | ||||||||||||||
| Forfeited or expired | (24,450 | ) | 24.11 | |||||||||||||
| Outstanding, December 31, 2008 | 833,812 | $ | 24.11 | 3.9 | $ | — | ||||||||||
| Exercisable, December 31, 2008 | 807,562 | $ | 24.62 | 3.8 | $ | — | ||||||||||
Non-vested Stock Awards —In the fourth quarter of 2005, the Company began granting employees and directors non-vested stock awards in addition to stock options. The stock award program offers employees the opportunity to earn shares of our stock over time, rather than options that give employees the right to purchase stock at a set price. Non-vested stock awards require no payment from the employee, with the exception of
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employee-related taxes upon vesting of the stock award. Employees can elect to have stock awards withheld to cover minimum tax withholdings upon vesting.
Non-vested stock awards are grants that entitle the holder to shares of common stock as the award vests. Our stock awards generally vest ratably over a four-year period in annual increments. Compensation cost is recorded based on the market price on the grant date and is recorded equally over the vesting period of four years. Compensation expense related to non-vested stock awards approximated $963,000, $423,000 and $285,000 during the years ended December 31, 2008, 2007 and 2006, respectively.
As of December 31, 2008, total unrecognized stock-based compensation expense related to non-vested stock awards was approximately $2,141,000 which is expected to be recognized over a weighted average period of approximately 3.0 years.
The following table summarizes information about the non-vested stock awards activity during the year ended December 31, 2008:
| Weighted Average | ||||||||
| Shares | Grant-Date Fair Value | |||||||
| Non-vested balance, December 31, 2007 | 152,974 | $ | 8.94 | |||||
| Granted | 338,127 | 9.04 | ||||||
| Vested | (60,401 | ) | 8.94 | |||||
| Forfeited | (42,698 | ) | 9.03 | |||||
| Non-vested balance, December 31, 2008 | 388,002 | $ | 9.02 | |||||
Employee Stock Purchase Plan —The Company has an Employee Stock Purchase Plan (“ESPP”) which was established by Quinton in 2002 and was assumed by the Company in connection with the merger transaction. The ESPP permits eligible employees to purchase common stock through payroll deductions. Shares of our common stock may presently be purchased by employees at three month intervals at 85% of the lower of fair market value on first day of the offering period or the last day of each three month purchase period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period, not to exceed 525 shares during an offering period. The Company initially reserved 175,420 shares for issuance under the ESPP. In addition, the ESPP authorizes annual increases in shares for issuance equal to the lesser of (i) 175,420 shares, (ii) 2% of the number of shares of common stock outstanding on a fully diluted basis as of the end of the Company’s immediately preceding fiscal year, and (iii) a lesser amount established by the Company’s board of directors. Any shares from increases in previous years that are not actually issued will continue to be included in the aggregate number of shares available for future issuance.
The Company issued 89,670, 80,078 and 92,199 shares of common stock during the years ended December 31, 2008, 2007 and 2006, respectively, in connection with the ESPP and received total proceeds of $603,000 , $553,000 and $665,000, respectively. During the years ended December 31, 2008, 2007 and 2006, the Company recorded stock-based compensation expense for the ESPP of approximately $179,000, $169,000 and $216,000, respectively.
| 15. | Fair Value Measurement |
The Company adopted SFAS 157 as of January 1, 2008, with the exception of the application of the Statement to non-recurring fair value measurement relating to nonfinancial assets and nonfinancial liabilities.
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Valuation Hierarchy
SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value. Classification of a financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The Company’s assets and liabilities that are carried at fair value and are accounted for under SFAS 157 are recorded on the balance sheet in cash and cash equivalents, short-term investments and investments in unconsolidated entities
The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of December 31, 2008:
| Fair Value Measurements at December 31, 2008 Using: | ||||||||||||||||
| Total Carrying | Quoted Prices in | Significant Other | Significant | |||||||||||||
| Value at December 31, | Active Markets | Observable Events | Unobservable Inputs | |||||||||||||
| 2008 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
| (In thousands of dollars) | ||||||||||||||||
| Assets: | ||||||||||||||||
| Cash equivalents | $ | 26,593 | $ | 26,593 | — | — | ||||||||||
| Investments in unconsolidated entities | $ | 450 | $ | 450 | — | — | ||||||||||
| 16. | Derivatives |
In 2008, the Company entered into foreign currency forward exchange contracts that are not designated as hedging instruments for accounting purposes, to mitigate the foreign exchange risk of certain balance sheet items. These forward exchange contracts resulted in net realized gains of $1,379,000 in the year ended December 31, 2008. The net realized gains were partially offset by foreign currency losses on intercompany payables denominated in U.S. dollars owed by foreign subsidiaries. The assets for these contracts are recorded in prepaid expenses and other current assets or accrued liabilities and the net realized and unrealized gains or losses are recorded in other income, net. There were no foreign currency exchange contracts outstanding as of December 31, 2008 and no similar contracts were held as of December 31, 2007.
| 17. | Acquisitions |
On April 23, 2008, the Company completed an acquisition of a former distributor in Germany, under the purchase method of accounting. The total estimated purchase price was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed in connection with the acquisition, based on their fair values as of the closing date. The purchase consideration of $148,000 was allocated to the Cardiac Science Deutschland trade name valued at $202,000, other assets of $12,000, and accounts payable of $66,000. Management has concluded that no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of the trade name and accordingly has considered the useful life of the trade name to be indefinite.
| 18. | Employee Benefit Plans |
The Company is the sponsor of the Cardiac Science Corporation (formerly Quinton Cardiology Inc.) 401(k) Plan (“401(k) Plan”). The 401(k) Plan covers all regular employees of the Company who satisfy certain
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age and service requirements as specified in the 401(k) Plan. The 401(k) Plan includes provision for an employee deferral of up to 50% of pre-tax compensation to the maximum deferral allowed under IRC 2005 guidelines, and up to 50% of compensation for after-tax deferral. On behalf of eligible participants, the Company may make a matching contribution equal to a discretionary percentage of the elective deferral up to the Plan’s established limits and is subject to the Plan’s vesting schedule. The Company made matching contributions of approximately $941,000, $910,000 and $761,000 for the years ended December 31, 2008, 2007 and 2006, respectively. As of December 31, 2008 and 2007, the Company had accrued $56,000 and $48,000, respectively, for matching plan contributions.
| 19. | SEC Staff Accounting Bulletin No. 108 |
As discussed under Recent Accounting Pronouncements in Note 1, in September 2006, the SEC released SAB 108. The transition provisions of SAB 108 permit the Company to adjust for the cumulative effect on its retained earnings or deficit of errors relating to prior years which were previously considered immaterial under the rollover method of evaluating errors. Such adjustments do not require previously filed reports with the SEC to be amended. Effective the beginning of the fiscal year ended December 31, 2006, the Company adopted SAB 108. In accordance with SAB 108, the Company has adjusted the beginning retained deficit for an error which has been material under the iron curtain method for fiscal 2006 in the accompanying consolidated financial statements for the item described below. The Company considers this adjustment to be immaterial to prior periods under the rollover method.
Lease Accounting
Accounting for a lease was not in accordance with U.S. generally accepted accounting principles, for which a SAB 108 adjustment was made to deferred rent in the amount of $216,000 for the year ended December 31, 2006. This was recorded as an adjustment to accumulated deficit in the amount of $136,000 and deferred taxes in the amount of $80,000, to properly reflect the amount, net of tax, as an adjustment to beginning retained deficit on January 1, 2006.
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| 20. | Quarterly Results of Operations (Unaudited) |
The following table sets forth selected unaudited quarterly operating data for the last eight quarters. This information has been prepared on the same basis as our audited consolidated financial statements and includes, in the opinion of management, all normal and recurring adjustments that management considers necessary for a fair statement of the quarterly results for the periods. The operating results and data for any quarter are not necessarily indicative of the results for future periods.
The table below presents quarterly data for the years ended December 31, 2007 and 2008 (in thousands, except per share data):
| March 31, | June 30, | September 30, | December 31, | March 31, | June 30, | September 30, | December 31, | |||||||||||||||||||||||||
| 2007 | 2007 | 2007 | 2007 | 2008 | 2008 | 2008 | 2008 | |||||||||||||||||||||||||
Consolidated Statements of Operations Data: | ||||||||||||||||||||||||||||||||
| Revenues | $ | 41,670 | $ | 44,889 | $ | 45,144 | $ | 50,428 | $ | 48,959 | $ | 52,132 | $ | 54,006 | $ | 51,056 | ||||||||||||||||
| Cost of Revenues | 21,790 | 23,123 | 23,001 | 25,801 | 24,761 | 26,169 | 27,887 | 25,053 | ||||||||||||||||||||||||
| Gross profit | 19,880 | 21,766 | 22,143 | 24,627 | 24,198 | 25,963 | 26,119 | 26,003 | ||||||||||||||||||||||||
| Operating Expenses: | ||||||||||||||||||||||||||||||||
| Research and development | 2,982 | 3,090 | 3,391 | 3,557 | 3,863 | 3,796 | 4,103 | 4,664 | ||||||||||||||||||||||||
| Sales and marketing | 11,108 | 11,445 | 11,913 | 11,729 | 12,189 | 13,047 | 12,934 | 12,563 | ||||||||||||||||||||||||
| General and administrative | 4,512 | 4,933 | 4,462 | 5,269 | 5,125 | 5,347 | 5,096 | 6,849 | ||||||||||||||||||||||||
| Impairment of goodwill | — | — | — | — | — | — | — | 107,671 | ||||||||||||||||||||||||
| Litigation and related expenses | 1,688 | 2,029 | 91 | — | — | — | — | — | ||||||||||||||||||||||||
| Licensing income and litigation settlement | — | (6,000 | ) | — | — | — | — | — | — | |||||||||||||||||||||||
| Total operating expenses | 20,290 | 15,497 | 19,857 | 20,555 | 21,177 | 22,190 | 22,133 | 131,747 | ||||||||||||||||||||||||
| Operating income (loss) | (410 | ) | 6,269 | 2,286 | 4,072 | 3,021 | 3,773 | 3,986 | (105,744 | ) | ||||||||||||||||||||||
| Other Income (Expense): | ||||||||||||||||||||||||||||||||
| Interest income (expense), net | 22 | 74 | 103 | 203 | 115 | 163 | 156 | 55 | ||||||||||||||||||||||||
| Other income (expense), net | 125 | 327 | 406 | (59 | ) | 211 | (125 | ) | 20 | 529 | ||||||||||||||||||||||
| Total other income | 147 | 401 | 509 | 144 | 326 | 38 | 176 | 584 | ||||||||||||||||||||||||
| Income (loss) before income tax benefit (expense) and minority interests | (263 | ) | 6,670 | 2,795 | 4,216 | 3,347 | 3,811 | 4,162 | (105,160 | ) | ||||||||||||||||||||||
| Income tax benefit (expense) | 75 | (2,155 | ) | (1,023 | ) | (1,821 | ) | (1,240 | ) | (1,407 | ) | (1,598 | ) | 152 | ||||||||||||||||||
| Income (loss) before minority interests | (188 | ) | 4,515 | 1,772 | 2,395 | 2,107 | 2,404 | 2,564 | (105,008 | ) | ||||||||||||||||||||||
| Minority interests | 22 | 15 | (13 | ) | (28 | ) | (53 | ) | (118 | ) | (86 | ) | (194 | ) | ||||||||||||||||||
| �� | ||||||||||||||||||||||||||||||||
| Net income (loss) | $ | (166 | ) | $ | 4,530 | $ | 1,759 | $ | 2,367 | $ | 2,054 | $ | 2,286 | $ | 2,478 | $ | (105,202 | ) | ||||||||||||||
| Net income (loss) per share — basic | $ | (0.01 | ) | $ | 0.20 | $ | 0.08 | $ | 0.10 | $ | 0.09 | $ | 0.10 | $ | 0.11 | $ | (4.58 | ) | ||||||||||||||
| Net income (loss) per share — diluted | $ | (0.01 | ) | $ | 0.19 | $ | 0.08 | $ | 0.10 | $ | 0.09 | $ | 0.10 | $ | 0.11 | $ | (4.58 | ) | ||||||||||||||
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SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
(In Thousands)
(In Thousands)
A summary of the activity in the allowance for doubtful accounts follows:
| Expenses | ||||||||||||||||
| Beginning | and | End of | ||||||||||||||
| of Period | Adjustments | Write-offs | Period | |||||||||||||
| (In thousands) | ||||||||||||||||
| Year Ended December 31, 2008 | $ | 500 | $ | 972 | $ | (286 | ) | $ | 1,186 | |||||||
| Year Ended December 31, 2007 | 907 | 236 | (643 | ) | 500 | |||||||||||
| Year Ended December 31, 2006 | 3,455 | 216 | (2,764 | ) | 907 | |||||||||||
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| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
| Item 9A. | Controls and Procedures |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted as of December 31, 2008, an evaluation of our disclosure controls and procedures, as such term is defined underRule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation as of December 31, 2008, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective for ensuring that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. In addition, our Chief Executive Officer and Chief Financial Officer concluded as of December 31, 2008, that our disclosure controls and procedures are also effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
Management’s report on internal control over financial reporting is set forth in Item 8 in our consolidated financial statements included elsewhere in this report.
KPMG LLP, an independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting as of December 31, 2008, which is included in Item 8.
Changes in Internal Controls
There were no changes in our internal control over financial reporting that occurred during our fiscal quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
| Item 9B. | Other Information |
On November 26, 2008, the Company entered into a lease agreement with Carl Ruedebusch LLC for 100,000 rentable square feet at Deerfield Industrial Park in Deerfield, Wisconsin (the “Lease Agreement”) for light manufacturing, warehouse and office use with an option to expand the rentable square feet pursuant to the terms of the Lease Agreement. The Lease Agreement is for a ten year term, expiring on November 30, 2018, with Company options to extend the lease for two additional five year terms pursuant to the terms of the Lease Agreement. Under the Lease Agreement, the Company is required to pay monthly rent of $51,500 per month escalating over time pursuant to the terms of the Lease Agreement. The Lease Agreement contains other terms and conditions that are customary for leases of this nature.
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PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
The information called for by Part III, Item 10, is incorporated by reference to the sections entitled “Election of Directors,” “Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Code of Ethics” and “Other Information as to Directors — Board Committees and Meetings — Audit Committee” included in our definitive Proxy Statement relating to our 2009 annual meeting of stockholders. We will file the information called for by this item by an amendment to this report no later than the end of the 120 day period following the fiscal year end to which this report relates if our Proxy Statement is not filed by such date.
| Item 11. | Executive Compensation |
Information called for by Part III, Item 11, is incorporated by reference to the sections entitled “Other Information as to Directors — Directors Compensation,” “Executive Compensation” and “Compensation Committee Report” included in our definitive Proxy Statement relating to our 2009 annual meeting of stockholders. We will file the information called for by this item by an amendment to this report no later than the end of the 120 day period following the fiscal year end to which this report relates if our Proxy Statement is not filed by such date.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
Information called for by Part III, Item 12, is incorporated by reference to the sections entitled “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” included in our definitive Proxy Statement relating to our 2009 annual meeting of stockholders. We will file the information called for by this item by an amendment to this report no later than the end of the 120 day period following the fiscal year end to which this report relates if our Proxy Statement is not filed by such date.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
Information called for by Part III, Item 13, is incorporated by reference to the sections entitled “Certain Relationships and Related Person Transaction” and “Other Information as to Directors — Director Independence” included in our definitive Proxy Statement relating to our 2009 annual meeting of stockholders. We will file the information called for by this item by an amendment to this report no later than the end of the 120 day period following the fiscal year end to which this report relates if our Proxy Statement is not filed by such date.
| Item 14. | Principal Accountant Fees and Services. |
Information called for by Part III, Item 14, is incorporated by reference to the section entitled “Audit and Related Fees” included in our definitive Proxy Statement relating to our 2009 annual meeting of stockholders. We will file the information called for by this item by an amendment to this report no later than the end of the 120 day period following the fiscal year end to which this report relates if our Proxy Statement is not filed by such date.
PART IV
| ITEM 15. | Exhibits and Financial Statement Schedules |
(a) The following financial statements, financial statement schedule and exhibits are filed as part of this report:
(1) Consolidated Financial Statements: See Index to Financial Statements at Item 8.
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(2) Financial Statement Schedule: See Schedule II — Valuation and Qualifying Accounts.
(3) Exhibits are incorporated herein by reference or are filed with this report: See Index to Exhibits following the signature page of this report.
All other schedules have been omitted because they are not applicable, not required, or because the information required to be set forth therein is included in the consolidated financial statements or in notes thereto.
(b) Exhibits.
The Exhibit Index is included on pages88-91.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Cardiac Science Corporation
| By: | /s/ Michael K. Matysik |
Michael K. Matysik
Chief Financial Officer
Date: March 16, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated and on the dates indicated.
Signature | Title | Date | ||||
/s/ JOHN R. HINSON John R. Hinson | President, Chief Executive Officer and Director (Principal Executive Officer) | March 16, 2009 | ||||
/s/ MICHAEL K. MATYSIK Michael K. Matysik | Senior Vice President, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | March 16, 2009 | ||||
/s/ RUEDIGER NAUMANN-ETIENNE Ruediger Naumann-Etienne | Chairman of the Board | March 16, 2009 | ||||
/s/ W. ROBERT BERG W. Robert Berg | Director | March 16, 2009 | ||||
/s/ JUE-HSIEN CHERN Jue-Hsien Chern | Director | March 16, 2009 | ||||
/s/ RAYMOND W. COHEN Raymond W. Cohen | Director | March 16, 2009 | ||||
/s/ TIMOTHY C. MICKELSON Timothy C. Mickelson | Director | March 16, 2009 | ||||
/s/ CHRISTOPHER J. DAVIS Christopher J. Davis | Director | March 16, 2009 | ||||
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| Exhibit | ||||
Number | Description | |||
| 2 | .1 | Agreement and Plan of Merger dated as of February 28, 2005, as amended on June 23, 2005, among Quinton Cardiology Systems, Inc., Cardiac Science, Inc., CSQ Holding Company, Rhythm Acquisition Corporation, and Heart Acquisition Corporation(1) | ||
| 2 | .2 | Stock Purchase Agreement dated December 23, 2002 by and among Spacelabs Medical, Inc., Spacelabs Burdick, Inc., Quinton Cardiology Systems, Inc. and Datex-Ohmeda, Inc.(3) | ||
| 3 | .1 | Amended and Restated Certificate of Incorporation(2) | ||
| 3 | .2 | Amended and Restated Bylaws(12) | ||
| 4 | .1 | Specimen Stock Certificate(2) | ||
| 4 | .2 | Common Stock and Warrant Purchase Agreement, dated July 20, 2004, by and among Cardiac Science, Inc., Perseus Market Opportunity Fund, L.P., Winterset Master Fund, L.P., Mill River Master Fund, L.P., Massachusetts Mutual Life Insurance Company and Walter Villager(10) | ||
| 4 | .3 | Second Amended and Restated Registration Rights Agreement, dated as of February 28, 2005, by and among Cardiac Science, Inc., and the investors listed on the signature pages thereto(16) | ||
| 4 | .4 | Form of Warrant(10) | ||
| 4 | .5 | Form of Warrant issued to Perseus Acquisition/Recapitalization Fund, L.L.C., Perseus Market Opportunity Fund, L.P. and Cardiac Science Co-Investment, L.P.(11) | ||
| 10 | .1* | Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and John R. Hinson(15) | ||
| 10 | .2* | Quinton Cardiology Systems, Inc. 1998 Amended and Restated Equity Incentive Plan(4) | ||
| 10 | .3* | Quinton Cardiology Systems, Inc. 2002 Stock Incentive Plan(4) | ||
| 10 | .4* | Quinton Cardiology Systems, Inc. 2002 Employee Stock Purchase Plan(4) | ||
| 10 | .5* | Cardiac Science Corporation Stock Option Grant Program for Nonemployee Directors(17) | ||
| 10 | .6* | Cardiac Science, Inc. 1997 Stock Option/Stock Issuance Plan, as amended(9) | ||
| 10 | .7* | Quinton Cardiology Systems, Inc. Stock Option Grant Notice and Stock Option Agreement between Quinton Cardiology Systems, Inc. and Feroze Motafram dated as of July 23, 2003(8) | ||
| 10 | .8* | Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and Kurt Lemvigh(15) | ||
| 10 | .9* | Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and Feroze Motafram | ||
| 10 | .10* | Form of Quinton Cardiology Systems, Inc. Stock Option Grant Notice and Stock Option Agreement (This exhibit represents other substantially identical documents that have been omitted because they are substantially identical to this document in all material respects and an Appendix attached to this exhibit sets forth material details by which the omitted documents differ from this exhibit.)(7) | ||
| 10 | .11* | Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and Michael K. Matysik(15) | ||
| 10 | .12* | Form of Stock Option Grant Notice and Stock Option Agreement for grants made pursuant to the Quinton Cardiology Systems, Inc. 2002 Stock Incentive Plan(14) | ||
| 10 | .13* | Form of Indemnification Agreement(12) | ||
| 10 | .14* | Equity Grant Program for Nonemployee Directors under the Cardiac Science Corporation 2002 Stock Incentive Plan | ||
| 10 | .15* | Cardiac Science Corporation Management Incentive Plan (MIP) — 2009 | ||
| 10 | .16* | Form of 1997 Stock Option/Stock Issuance Plan Grant Notice and Option Agreement (13) | ||
| 10 | .17* | Form of Cardiac Science Corporation Stock Option Grant Notice under 2002 Stock Incentive Plan for Non-Employee Directors(17) | ||
| 10 | .18* | Form of 2009 Compensation Incentive Plan for Kurt Lemvigh | ||
| 10 | .19* | Form of Restricted Stock Unit Agreement under the Cardiac Science Corporation 2002 Stock Incentive Plan | ||
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| Exhibit | ||||
Number | Description | |||
| 10 | .20 | Senior Note and Warrant Conversion Agreement dated as of February 28, 2005 among CSQ Holding Company, Cardiac Science, Inc. and the purchasers listed on the signature pages thereto(16) | ||
| 10 | .21 | OEM Agreement between Quinton Inc. and Mortara Instrument, Inc. dated August 1, 2000(4) | ||
| 10 | .22 | Addendum No. 1 to the OEM Agreement between Mortara Instrument, Inc. and Quinton Inc. dated August 1, 2001(4) | ||
| 10 | .23 | OEM Agreement between Quinton Inc. and Mortara Instrument, Inc. dated October 17, 2000(4) | ||
| 10 | .24 | OEM Agreement between Quinton Inc. and Mortara Instrument, Inc. dated October 1, 2001(5) | ||
| 10 | .25 | Lease Agreement between Carl Ruedebusch LLC and Burdick, Inc. regarding premises at Deerfield Industrial Park in Deerfield, Wisconsin dated as of November 26, 2008 | ||
| 10 | .26 | Lease Agreement between Quinton Cardiology Systems, Inc. and Hibbs/Woodinville Associates, L.L.C. regarding premises at Bothell, Washington, dated August 29, 2003(6) | ||
| 10 | .27++ | OEM Purchase and Supply Agreement between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .28++ | Addendum 1 dated as of March 24, 2004 to OEM Purchase and Supply Agreement between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .29 | Amendment One dated August 10, 2004 to OEM Purchase and Supply Agreement between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .30 | Second Amendment dated February 14, 2005 to OEM Purchase and Supply Agreement between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .33+ | Third Amendment, dated June 10, 2005, to the OEM Purchase and Supply Agreement dated July 29, 2003, as amended, between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc.(11) | ||
| 10 | .32++ | OEM Purchase Agreement between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .33 | Amendment One dated August 10, 2004 to OEM Purchase Agreement between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .34 | Second Amendment dated February 14, 2005 to OEM Purchase Agreement between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .35 | Third Amendment, dated June 10, 2005, to the OEM Purchase Agreement dated July 29, 2003, as amended, between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc.(11) | ||
| 10 | .36++ | Fourth Amendment dated October 25, 2006 to OEM Purchase Agreement between Cardiac Science Corporation and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(17) | ||
| 10 | .37++ | Fifth Amendment dated September 7, 2007 to OEM Purchase Agreement between Cardiac Science Corporation and GE Medical Systems Information Technologies, Inc. dated July 29, 2003(19) | ||
| 10 | .38+ | Exclusive Distribution Agreement for United States and Canadian Hospitals dated June 13, 2005, between Cardiac Science, Inc. and GE Medical Systems Information Technologies, Inc.(11) | ||
| 10 | .39 | First Amendment dated as of September 5, 2007 to Exclusivity Agreement by and between Cardiac Science Corporation and GE Medical Systems Information Technologies, Inc. dated June 10, 2005(19) | ||
| 10 | .40 | Settlement Agreement by and between Cardiac Science Corporation, Koninklijke Philips Electronics N.V. and Philips Electronics North America Corporation, dated April 24, 2007(18) | ||
| 10 | .41++ | Cross-License Agreement by and between Cardiac Science Corporation, Koninklijke Philips Electronics N.V. and Philips Electronics North America Corporation, dated April 24, 2007(18) | ||
| 10 | .42++ | Form of OEM Supply and Purchase Agreement between Cardiac Science Corporation and Nihon Kohden Corporation entered into July 29, 2008, effective January 1, 2008(20) | ||
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| Exhibit | ||||
Number | Description | |||
| 10 | .43++ | OEM Supply and Purchase Agreement between Cardiac Science Corporation and Nihon Kohden Corporation entered into March 31, 2005 | ||
| 21 | .1 | Subsidiaries | ||
| 23 | .1 | Consent of Independent Registered Public Accounting Firm | ||
| 31 | .1 | Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002 | ||
| 31 | .2 | Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. | ||
| 32 | .1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| 32 | .2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| * | Indicates management contract or compensatory plan or arrangement. | |
| + | Portions of this exhibit are omitted and were filed separately with the Securities and Exchange Commission pursuant to Cardiac Science Inc.’s application requesting confidential treatment underRule 24b-2 of the Securities Exchange Act of 1934, as amended. | |
| ++ | Portions of this exhibit are omitted and were filed separately with the Securities and Exchange Commission pursuant to Cardiac Science Corporation’s application requesting confidential treatment under Rule 24b-2 of the Securities Exchange Act of 1934, as amended. | |
| (1) | Incorporated by reference to the Registrant’s Amendment No. 3 to the Registration Statement onForm S-4/A (FileNo. 333-124514) filed on July 28, 2005. | |
| (2) | Incorporated by reference to the Registrant’s Current Report onForm 8-K (FileNo. 000-51512) filed on September 1, 2005. | |
| (3) | Incorporated by reference to Quinton Cardiology Systems, Inc.’s Current Report onForm 8-K (FileNo. 000-49755) filed on January 17, 2003. | |
| (4) | Incorporated by reference to Quinton Cardiology Systems, Inc.’s Registration Statement onForm S-1 (FileNo. 333-83272) filed on February 22, 2002. | |
| (5) | Incorporated by reference to Quinton Cardiology Systems, Inc.’s Amendment No. 3 to the Registration Statement onForm S-1/A (FileNo. 333-83272) filed on April 3, 2002. | |
| (6) | Incorporated by reference to Quinton Cardiology Systems, Inc.’s Quarterly Report onForm 10-Q for the quarter ended September 30, 2003 (File No.000-49755). | |
| (7) | Incorporated by reference to Quinton Cardiology Systems, Inc.’s Annual Report onForm 10-K for the year ended December 31, 2003 (File No.000-49755). | |
| (8) | Incorporated by reference to Quinton Cardiology Systems, Inc.’s Annual Report onForm 10-K for the year ended December 31, 2004 (File No.000-49755). | |
| (9) | Incorporated by reference to Cardiac Science, Inc.’s Definitive Proxy Statement for the Annual Meeting of Stockholders (FileNo. 000-19567) held on September 9, 2002. | |
| (10) | Incorporated by reference to Cardiac Science, Inc.’s Current Report onForm 8-K (FileNo. 000-19567) filed on July 22, 2004. | |
| (11) | Incorporated by reference to Cardiac Science, Inc.’s Quarterly Report onForm 10-Q for the quarter ended June 30, 2005 (FileNo. 000-19567). | |
| (12) | Incorporated by reference to the Registrant’s Current Report onForm 8-K (FileNo. 000-51512) filed November 15, 2005. | |
| (13) | Incorporated by reference to the Registrant’s Quarterly Report on Form10-Q for the quarter ended March 31, 2006 (FileNo. 000-51512). |
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| (14) | Incorporated by reference to the Registrant’s Quarterly Report on Form10-Q for the quarter ended June 30, 2006 (FileNo. 000-51512). | |
| (15) | Incorporated by reference to the Registrant’s Current Report onForm 8-K (FileNo. 000-51512) filed September 22, 2006. | |
| (16) | Incorporated by reference to Registrant’s Registration Statement on FormS-4 (FileNo. 333-124514) filed on May 2, 2005. | |
| (17) | Incorporated by reference to Registrant’s Annual Report onForm 10-K for the year ended December 31, 2006 (FileNo. 000-51512). | |
| (18) | Incorporated by reference to the Registrant’s Quarterly Report on Form10-Q for the quarter ended June 30, 2007 (FileNo. 000-51512). | |
| (19) | Incorporated by reference to the Registrant’s Quarterly Report on Form10-Q for the quarter ended September 30, 2007 (FileNo. 000-51512). | |
| (20) | Incorporated by reference to the Registrant’s Amendment No. 1 to its Quarterly Report for the quarter ended September 30, 2008 (File No.000-51512) filed on December 31, 2008. |
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