Home Diagnostics (HDIX) 10-K 2008 FY Annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

Form 10-K

(Mark one)
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
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from          to          .

Commission File Number:001-33027

HOME DIAGNOSTICS, INC.

(Exact name of registrant as specified in its charter)

DELAWARE	22-2594392
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
2400 NW 55thCourt Fort Lauderdale, Florida (Address of principal executive offices)	33309 (Zip Code)

Registrant’s telephone number, including area code:

954-677-9201

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

Title of Each Class	Name of Exchange on Which Registered
Common Stock, $0.01 par value	The NASDAQ Stock Market LLC

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.  Yes þ     No o

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 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” inRule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer þ Non-accelerated filer o
(Do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company. (as defined inRule 12b-2 of the Exchange Act).  Yes o     No þ

As of June 30, 2008, the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of the Registrant’s voting and nonvoting common equity held by non-affiliates was $63.9 million based on the last sales price of the Registrant’s common stock reported on the NASDAQ Global Market on that date. The determination of affiliate status for the purposes of this calculation is not necessarily a conclusive determination for other purposes. The calculation excludes approximately 9.4 million shares held by directors, officers and affiliates as of June 30, 2008. Exclusion of these shares should not be construed to indicate that any such person controls, is controlled by or is under common control with the Registrant.

As of March 8, 2009, there were 17,264,895 shares of common stock, par value $0.01 per share, of the Registrant issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement related to the Registrant’s 2009 Annual Meeting of Stockholders to be held on June 2, 2009, to be filed subsequently with the Securities and Exchange Commission, are incorporated by reference into Part III of this Annual Report onForm 10-K.

TABLE OF CONTENTS

PART I
	Item 1.	Business	3
	Item 1A.	Risk Factors	18
	Item 1B.	Unresolved Staff Comments	26
	Item 2.	Properties	27
	Item 3.	Legal Proceedings	27
	Item 4.	Submission of Matters to a Vote of Security Holders	27
PART II
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	28
	Item 6.	Selected Financial Data	31
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	42
	Item 8.	Financial Statements and Supplementary Data	43
	Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	71
	Item 9A.	Controls and Procedures	71
	Item 9B.	Other Information	72
PART III
	Item 10.	Directors, Executive Officers and Corporate Governance	72
	Item 11.	Executive Compensation	72
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	72
	Item 13.	Certain Relationships and Related Transactions, and Director Independence	72
	Item 14.	Principal Accountant Fees and Services	72
PART IV
	Item 15.	Exhibits, Financial Statement Schedules and Reports onForm 8-K	73
EX-10.14
EX-10.15
EX-10.16
EX-14
EX-21
EX-23.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

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PART I

In this Annual Report, “HDI,” or the “Company,” “we,” “us” and “our” refer to Home Diagnostics, Inc., and our wholly owned subsidiaries. Statements we make in this Annual Report that express a belief, expectation or intention, as well as those that are not historical fact, are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to various risks, uncertainties and assumptions, including those to which we refer under the heading “Cautionary Statement Concerning Forward-Looking Statements and Risk Factors” following Item 1 of Part I of this Annual Report. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” as well as those discussed elsewhere in this Annual Report. “TRUEtrack^®,” “Sidekick^®,” “Prestige IQ^®,” “Gentle Draw^®,” “TRUEread^tm,” “TRUEresult^tm,” “TRUE2go^tm“and “TRUEtest^tm” are our trademarks. Other product, service and company names mentioned in this Annual Report are the service marks or trademarks of their respective owners.

Item 1.   Business

Overview

We are a developer, manufacturer and marketer of blood glucose monitoring systems and disposable supplies for people with diabetes worldwide. Our blood glucose monitoring systems are high quality products with performance and features that are comparable to or better than our competitors’ products at substantially lower prices. We partner with leading food and drug retailers, mass merchandisers, distributors, mail service providers and third-party payors in the United States and internationally to deliver our products to people with diabetes. We market our products under our own brands, including TRUEresult, TRUE2go, TRUEtest, TRUEtrack, Sidekick, TRUEread, Prestige IQ, and under a co-branded format through which we add our customers’ store brand name to our brand name products. Our co-branding strategy creates substantial value for our partners, providing increased customer awareness of their brands. As a result of these benefits, our distribution partners are motivated to invest in the success of our products in their stores and within their distribution channels through promotion and advertising and attractive product placement in retail locations. We also market our products to managed care organizations including health plans and pharmacy benefits managers (PBMs) for inclusion on formularies, which are lists of approved products from which the insured or member and their physicians can choose, and granting of “preferred product” status by health plans. Co-branding also provides advantages with formulary access, as it is our brand name that appears on formularies, enabling us to leverage our national retail distribution without listing each product separately under the name of each of our co-brand partners.

For financial information about our company, refer to our consolidated financial statements in Part II “Item 8 Financial Statements and Supplementary Data” of this report.

Market opportunity

Diabetes

Diabetes is a chronic life-threatening disease for which there is no known cure. The disease is caused by the body’s inability to produce or effectively utilize the insulin hormone. This inability prevents the body from adequately regulating blood glucose levels. According to the International Diabetes Federation, more than 246 million people worldwide are estimated to have diabetes. This population is expected to grow significantly with increasing overall life expectancy, worsening diet trends, increasingly sedentary lifestyles and growing incidence of obesity. The World Health Organization, or WHO, estimates that the number of people with diabetes will reach 360 million worldwide by the year 2030. In the United States, The American Diabetes Association (ADA) estimates that in 2007 nearly 23.6 million people, or about 8% of the population, had diabetes, and about 17.9 million, or 76% of the total diabetic population, were diagnosed.

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Diabetes is typically classified as Type 1 or Type 2. Type 1 diabetes is characterized by near-complete absence of insulin secretion by the body. It is frequently diagnosed during childhood or adolescence. Individuals with Type 1 diabetes require daily insulin injections or insulin pump therapy to survive. The ADA estimates that in the United States between 5-10% of people diagnosed with diabetes were Type 1 in 2007.

Type 2 diabetes, the most common form of the disease, is characterized by insulin resistance (the body’s inability to properly utilize insulin) or defects in insulin secretion (the body’s inability to produce enough insulin). Initially, many patients with Type 2 diabetes attempt to manage their diabetes by improvements in their diets, exercise and oral medications. As their disease advances, they progress to multiple drug therapy, often including insulin. Type 2 diabetes historically has occurred in later adulthood, but its incidence is increasing among the younger population.

Importance of managing diabetes through blood glucose monitoring

The goal of intensive blood glucose management is to achieve near-normal blood glucose levels without risking hypoglycemia (low blood sugar level). The ADA recommends that people with Type 1 diabetes test their glucose levels three or more times per day. The American Academy of Family Physicians recommends that people with Type 2 diabetes who are insulin dependent test as frequently as people with Type 1 diabetes. However, people with Type 2 diabetes who are not insulin dependent typically test less often. Recent guidelines, including those published by the ADA, suggest more frequent testing for patients with Type 2 diabetes.

Managing diabetes can be frustrating and difficult. A range of factors can make diabetes overwhelming for patients and their families, including time spent managing the disease, swings in blood sugar and their effects on the patient’s feeling of well being, and fear of hypoglycemia. Effective diabetes management begins with frequent blood glucose measurements, which enable people with diabetes to avoid some of the debilitating effects stemming from either hypoglycemia or hyperglycemia (high blood sugar level). Blood sugar levels in people with diabetes tend to fluctuate from very high levels to very low levels over the course of a day, affected by carbohydrate and fat content of meals, exercise, stress, illness or impending illness, hormonal releases, variability in insulin absorption and changes in the effects of insulin on the body. These variations in blood glucose levels can be frequent, unpredictable and unsettling, and frequent blood glucose monitoring and management is required to maintain a patient’s health.

For people with diabetes, the administration of additional insulin, or oral medication, or ingestion of additional carbohydrates is required throughout the day to maintain blood glucose within normal ranges. A normal range is nearly impossible to maintain for a Type 1 diabetic without multiple daily injections or the use of an insulin pump.

According to the ADA, diabetes is the fifth leading cause of death by disease in the United States. Complications related to diabetes include heart disease, nerve damage, limb amputations, loss of kidney function and blindness. Glucose, the primary source of energy for cells, must be maintained at certain concentrations in the blood in order to permit optimal cell function and health. Normally, the pancreas controls blood glucose levels by secreting the insulin hormone, which enables the cells to absorb glucose and lower blood glucose levels. When concentrations are too high, patients often administer insulin in an effort to drive blood glucose levels down. Unfortunately, insulin administration can often drive blood glucose levels below the normal range, resulting in hypoglycemia. In cases of severe hypoglycemia, diabetes patients risk acute complications, such as loss of consciousness or death. Due to the drastic nature of acute complications associated with hypoglycemia, many patients are afraid of driving down blood glucose levels. Consequently, patients often remain in a hyperglycemic state, exposing themselves to long-term chronic complications. The total cost for the healthcare system associated with the treatment of diabetes and its complications in 2007 was $174 billion, according to the ADA.

The landmark Diabetes Control and Complications Trial, or DCCT, published in 1993, showed that the onset and progression of eye, kidney and nerve disease in people with Type 1 diabetes can be slowed by intensive therapy to maintain blood glucose levels as close to normal as possible. The DCCT demonstrated that the risk of complications could be reduced by 76% for eye disease, 50% for kidney disease and 60% for

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nerve disease. Similar studies in the United Kingdom and Japan involving people with Type 2 diabetes support the conclusion of the DCCT study that actively managing blood glucose levels reduces the risk of complications associated with diabetes.

We believe that our blood glucose monitoring solution positions us well to capitalize on the growing diabetes markets and the trends toward more active blood glucose monitoring.

The Home Diagnostics blood glucose monitoring solution

We believe that our blood glucose monitoring solution offers our customers and third-party payors a unique way to provide their diabetic customers with leading blood glucose monitoring technology at affordable prices. The key elements of our solution are:

High-quality products.  Our blood glucose monitoring systems are high quality products with substantially lower prices than competitors’ products. Our products offer a wide variety of features that address the particular needs of certain subsets of the diabetic population.

Unique distribution model.  We market our products under our own brands and in a co-branded format, in partnership with major food and drug retailers, mass merchandisers, distributors and mail service providers. We believe that our co-branded format provides our partners with an attractive opportunity to generate increased customer awareness of their brands that appear on our products. As a result of the added benefits of the co-branded format, we believe our partners have a significant incentive to invest in the success of our products in their stores and within their distribution networks. Our co-branding partners capitalize on these benefits through promotion and advertising and attractive product placement in retail locations. We also focus on marketing the benefits of our systems to third-party payors for inclusion of our products on their formularies on an exclusive or preferred basis. Third-party payors play an important role in influencing which blood glucose monitoring systems many people with diabetes buy.

Best Category Value.  We market our high-quality blood glucose monitoring systems at prices that are substantially lower than those of our principal competitors. For example, in retail pharmacies in the United States, our starter kits are sold at prices ranging from $9.99 to $39.99, and our 50 count vials of test strips at prices ranging from $29.99 to $39.99. This represents a substantial discount to the prices of our principal competitors, who sell their starting kits at prices ranging from $19.99 to $79.99, and their 50 count vials of test strips at prices ranging from $57.99 to $64.99.

Supply Chain Agility.  Our technology utilizes automation and robotics to reduce manufacturing costs and cycle time. This technology provides a competitive advantage facilitating fast packaging turnaround for our co-brand partners.

We are able to provide our best value solution primarily due to our distribution strategy, which allows us to benefit from our partners’ significant marketing investments. Our cost structure and manufacturing efficiency enable us to provide our distribution partners with a more profitable alternative than that offered by our competitors, and helps us maintain attractive operating margins.

Our strategy

Our objective is to be a leading provider of innovative blood glucose monitoring systems and supplies to retailers, distributors and third-party payors worldwide. We plan to achieve this objective by pursuing the following strategies:

Leverage our technology platform.  We believe that the quality of a blood glucose monitoring system is one of the most important factors in a customer’s selection of a system and believe that our success to date has been largely due to the strength of our technology. We intend to leverage our existing intellectual property and research and development to develop new blood glucose monitoring products withbest-in-class performance and features which address the specific needs of certain subsets of the diabetic population.

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In 2008, we launched our new blood glucose test strip platform called TRUEtest. TRUEtest strips utilize our proprietary on-strip coding technology that automatically calibrates with our TRUEresult and TRUE2go blood glucose meters. Our TRUEresult meter offers advanced performance features, while TRUE2go is the world’s smallest monitor foron-the-go testing giving people with diabetes the ability to choose the meter that best fits their needs. The new on-strip coding technology of TRUEtest strips eliminates the need for users to code their TRUEresult and TRUE2go meters with each new box of test strips. This enhancement reduces the risk of inaccurate glucose results caused by miscoding or failure to change the code when a new box of test strips is used.

Exploit our distribution strategy.  Our distribution strategy provides our customers with the opportunity to offer technologically advanced blood glucose monitoring systems at lower prices under our brands or in a co-branded format. Because of the attractive profitability and branding opportunity that our products provide, our retailer customers are motivated to allocate shelf space for our products comparable to that allocated to those of our major competitors, reducing our required marketing investments. We have developed co-branding partnerships with most major retailers and distributors in the United States, as well as with important retailers and distributors internationally. We plan to continue demonstrating the value that our products represent for our customers to help us drive continued growth of our business.

Establish ourselves as a preferred provider for third-party payors.  While managed care organizations are not our direct customers, they play a very important role in the selection of blood glucose monitoring systems for their members. Our efforts with managed care organizations have focused on demonstrating how our products can provide substantial cost savings within third-party payors’ networks while maintaining the highest quality of patient care. We have multiple formulary contracts with pharmacy benefits managers, managed care organizations and with important state Medicaid formularies. Our market presence and attractive solution have enabled us to obtain exclusive and preferred provider status for certain regional health plans.

Increase our penetration of international markets.  We currently market our products internationally through distributors and, in some cases, directly, as in the United Kingdom and Canada. Our partners among international distributors and retailers include Shoppers Drug Mart and Safeway in Canada, Farmacias Ahumadas S.A. (FASA) in Latin America, SuperDrug Stores plc in the United Kingdom, Diabetes Australia New South Wales in Australia, Hemopharm GmbH (a division of STADA AG) in Germany, Med Trust GmbH in Austria and Grace Medical, Inc. in China. Currently, international sales represent only 12.0% of our net sales. We believe that international markets represent a substantial growth opportunity for us, and we are focused on increasing our penetration in these markets.

Our products

We offer blood glucose systems based on both of the following accepted technology platforms: biosensor and photometric. Our state of the art biosensor meter technology measures glucose by using an amperometry method employing a glucose oxidase or glucose dehydrogenize pyrroloquinolinequinone (GDH-PQQ) reaction. The glucose in the sample reacts with chemicals and produces a proportional electrical current. The meter measures the electrical current and calculates the amount of glucose and displays the result. All of our meter systems utilize the biosensor technology with the exception of the Prestige IQ system, which utilizes photometric technology. Photometric meter technology measures blood glucose by using membrane technology that employs a glucose oxidase/peroxidase reaction. The magnitude of the color change produced from this reaction is proportional to the amount of glucose in the blood. The meter uses an optical sensor to read the amount of color produced and displays the corresponding result.

Our systems include proprietary monitors, test strips and control solutions. We have gained efficiencies in the manufacturing of test strips by making meters compatible with specific test strip platforms. We currently have three platforms for our meter systems. Our TRUEtrack, TRUEread and Sidekick products use test strips manufactured on the same test strip platform. Our new TRUE2go and TRUEresult meters are compatible with our TRUEtest strip platform. Our Prestige IQ meter is compatible with the Prestige Smart System test strips.

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Each lot of test strips is uniquely formulated so that the chemical reaction of the blood sample can be converted into a blood glucose measurement by the meter. In order to match the test strip’s specific characteristics with the meter, a code is assigned that conveys the test strip lot calibration information to the meter. Codes are generally in the form of either a button code system or a code chip system. Under a button code system, the user enters the applicable code number, printed on the test strip vial, to calibrate the meter. In a code chip system, each vial of test strips has a unique code chip included with the vial of test strips, which is inserted into the meter to calibrate the meter. Both methods require the user to remember to code the meter for each new vial of test strips.

Some of our competitors have introduced systems that have built-in discs or drums that dispense test strips automatically coded to the meter or that do not require coding. The meter of our disposable Sidekick system is pre-calibrated to the test strips included with the system, thus eliminating the need for the user to code the meter.

Our TRUEtest strip platform and corresponding TRUE2go and TRUEresult meters utilize our proprietary no coding technology. Eliminating the coding step simplifies patient education and training by removing the need for the user to remember to perform the coding procedure. Both new meters are compatible with the Company’s new TRUEtest platform of blood glucose test strips featuring the Company’s patent-pending,state-of-the-art GoldSensor^tm laser accuracy and TRUEfill^tm beveled tip. These advanced features ensure highly accurate test results and first test success by allowing for greater sampling precision and consistency.

We believe our monitors demonstratebest-in-class performance specifications, including:

•  no-coding capability;

•  small sample size of between less than 0.5 and 4.0 microliters;

•  rapid result processing speeds from under 4 to 50 seconds;

•  significant test memory of between 50 and 365 tests;

•  alternate testing site functionality (on the forearm); and

•  data management and communications capabilities.

Our biosensor products also feature a unique four-electrode system that both measures the glucose content in blood and indicates when enough blood has been drawn to complete the test.

The following table describes the key features of our current product portfolio.

	TRUEresult	TRUE2go	TRUEtrack	Sidekick	TRUEread	Prestige IQ
Description	Advanced, state-of-the-art, no coding system for fast, easy, accurate testing	World’s smallest blood glucose meter; easily twists on to vial of test strips for convenient on- the-go testing	High-quality technology and state of the art features	All-in-one, disposable blood glucose monitoring system	High-quality technology with basic data management features	Large and easy-to-read display with test strips that are wide and easy to handle
Technology	Biosensor	Biosensor	Biosensor	Biosensor	Biosensor	Photometric
Test strips
Enzyme	GDH PQQ	GDH PQQ	Glucose Oxidase	Glucose Oxidase	Glucose Oxidase	Glucose Oxidase
Sample size requirement	0.5 microliter	0.5 microleter	1 microliter	1 microliter	1 microliter	4 microliters
Alternate site testing	Yes	Yes	Yes	Yes	Yes	No
Sample fill detection	Yes	Yes	Yes	Yes	Yes	No
Set up & coding
Unit options	mg/dL or mmol/L	mg/dL or mmol/L	mg/dL or mmol/L	mg/dL or mmol/L	mg/dL or mmol/L	mg/dL or mmol/L
Date & time	Yes	No	Yes	No	Yes	Yes
Coding	On Strip	On Strip	Code chip	Automatic	Code chip	Button
Data management
Test speed	As fast as 4 seconds	As fast as 4 seconds	10 seconds	Less than 10 seconds	10 seconds	10-50 seconds
Memory	500	99	365 tests	50 tests	200 tests	365 tests
Test averaging	7, 14 & 30 day	No	14 & 30 day	No	No	14 & 30 day
Data communications	Forthcoming	No	Yes	No	Yes	Yes

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Blood glucose monitoring systems

TRUEresult.  TRUEresult, which was introduced in September 2008, is a no-coding system that offers state of the art performance and advanced features. One of the challenges for blood glucose testers is the calibration of test strips to the blood glucose monitor being used. Calibration is required to ensure that the monitor provides an accurate reading, but can be time consuming and cumbersome for patients with limited dexterity. We have developed our own proprietary on-strip coding technology, (“TRUEtest on-strip coding technology”) to provide the maximum user convenience and testing accuracy. The TRUEresult monitor uses TRUEtest strips and automatically reads the code and calibrates the system, which reduces the potential for inaccurate readings due to mis-coding. It requires a 0.5 microliter blood sample and yields test results in as fast as four seconds.

TRUE2go.  TRUE2go, which was introduced in September 2008, is the world’s smallest no-coding meter foron-the-go testing. The TRUE2go monitor uses TRUEtest strips and automatically calibrates the system, which makes testing easier and faster for users. TRUE2go requires a blood sample of 0.5 microliters and provides results in as fast as four seconds. The TRUE2go has a 99 test memory and provides alternate site testing

TRUEtrack.  The TRUEtrack blood glucose monitoring system, which was introduced in July 2003, offers one of the largest memory systems on the market, able to store 365 test results. It also has data uploading capability, a large andeasy-to-read display andeasy-to-handle capillary action test strips. An audible fill detection sensor lets the user know when enough blood has been drawn. Test results are provided in ten seconds, which compares favorably with other leading monitors on the market, which average 10 — 20 seconds or more. It requires only a 1.0 microliter blood sample size and can be used on an alternate testing site.

Sidekick.  Launched in August 2005, the Sidekick is ourall-in-one, disposable blood glucose monitoring system that combines a vial of 50 test strips with the world’s smallest blood glucose monitor. The unique design of the Sidekick features the monitor built into the flip-top cap of the strip vial. Its microchip was developed exclusively for us by Texas Instruments. The system is portable and conveniently sized, and can be discarded when the last test strip is used. The Sidekick is pre-coded and requires no user coding procedure, uses 1.0 microliters of blood, and can be used on an alternate testing site. Our Sidekick capillary action test strips feature a novel chemical formulation that provides accurate test results in less than 10 seconds. A fill detection sensor lets the user know when enough blood has been drawn.

TRUEread.  The TRUEread blood glucose monitoring system was launched in March of 2007. TRUEread has a 1.0 microliter blood sample requirement and provides test results in 10 seconds. In addition, the meter can hold up to 200 tests in its memory and has uploading data management capabilities. An audible fill detection sensor lets the user know when enough blood has been drawn and the system can be used on an alternate test site. TRUEread is exclusively available to Medicare and Medicaid customers in the mail service and distribution channels. TRUEread enables us to align product placement with specific market needs and diversify our product offering to meet market dynamics.

Prestige IQ.  Our Prestige IQ, which was introduced in June 2001, offers a large andeasy-to-read display with test strips that are wide and easy to handle. Given its features, the Prestige IQ is ideal for patients with dexterity or visual limitations, two of the most common side effects associated with diabetes. The test strip requires a 4.0 microliter blood sample size. The Prestige IQ offers a 365 test memory and data uploading capabilities. While we continue to support the Prestige line through ongoing customer support and the offering of corresponding strips, we have discontinued the manufacture of the PrestigeIQmeter.

Other products

In addition to our blood glucose monitoring systems, we offer several monitoring accessories designed to make the management of diabetes easier, including:

TrackRecord DMS.  TrackRecordDMS,for diabetes management, is a stand-alone optional data management software accessory supplied in CD format for use with our TRUEtrack, TRUEread and Prestige IQ Smart

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System meters. The software is installed onto a personal computer (PC) and the blood glucose meter is connected to the PC via a data cable. When used with TRUEtrack, TRUEread or Prestige IQ meters, TrackRecord DMS permits the management of blood glucose data transferred from the meter memory to the computer for enhanced data management capability. Software application features include data management for single at-home patient use and multiple-patient use for the healthcare professional in the clinical setting. Users can input patient healthcare and ID information, and select date range, glucose units, target glucose ranges, and meal time blocks.

Gentle Draw lancing device.  This device enables people with diabetes to obtain a blood sample for a blood glucose test. It features five depth settings to ensure optimum skin penetration. It is lightweight, portable and easy to use and features quick lancet insertion and disposal. We market this product through our distribution partners in a co-branded format.

Single-use sterile lancet.  Our sterile lancet fits most lancing devices and is easy to use. Its lancet cap provides safe disposal after use and its performance is comparable to that of repeat usage lancets. We market this product through our partners in a co-branded format.

Disposable ketone urinary test strips.  Our disposable urinary test strips are used to test ketone levels in urine. People with diabetes monitor ketone levels because high ketone measurements can lead to a complication called ketoacidosis, which can result in coma. We began developing the ketone disposable urinary test strip in late 2003 and began shipping the product commercially in May 2004. We sell ketone test strips in 50 or 100 strip count packages. The test features a 15 second test time, which we believe positions the product as a category leader.

Seasonality

Our quarterly sales and operating results may vary significantly from quarter to quarter as a result of seasonal variations in demand. Historically, sales are highest during the third quarter as a result of trade shows held by large domestic distributors. First quarter sales are typically the lowest due to the start of new deductible periods under health plans.

Sales and marketing

In the United States, we have a direct sales force that works with retail pharmacies, domestic distributors, mail service providers and managed care organizations in a collaborative effort to deliver our products to the diabetic end-user. Our sales team is a diverse group including telesales, managed care specialists and clinical support specialists, who are located throughout the country and provide our customers with ongoing clinical support for our products.

In addition to our direct sales efforts, we have been able to leverage the sales forces of our domestic distributor customers. Through our top three distributor customers (AmerisourceBergen Corporation, Cardinal Health Inc. and McKesson Corporation (“McKesson”)), we estimate that we gain access to approximately 1,400 sales people in the United States, who promote our products to food and drug retailers and mass merchandisers.

Our marketing team is responsible for product planning and management, advertising and promotion, market research, branding and public relations. Our marketing team is also involved in evaluating business strategies to exploit our competitive position.

Internationally, we sell our products through distributors located in Latin America, Europe, Australia and Asia, and on a direct basis in the United Kingdom and Canada. We sell our products in these markets under our own brands and under our co-branded format. We have multiple international co-branding partnerships, including Shoppers Drugmart in Canada, FASA in Latin America, SuperDrug Stores plc in the United Kingdom, Grace Medical, Inc. in China, Hemopharm GmbH (a division of STADA AG) in Germany, Med Trust GmbH in Austria, and Diabetes Australia New South Wales in Australia. We believe that the international markets represent a significant opportunity for us and are focused on expanding our co-branding and distribution relationships to capitalize on this opportunity.

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Distribution strategy

We market our products using a unique distribution strategy focused on four primary distribution channels: retail pharmacies, domestic distributors, mail service providers and international markets. We estimate that food and drug retailers, mass merchandisers, distributors and mail service providers sell approximately 90% of the blood glucose monitoring systems and supplies in the United States today. We believe our success in the retail pharmacy channel has been largely due to the quality of our products and our focus on the economic and branding benefits that our solution provides for retailers. Our unique co-branding strategy generates substantial value for our partners by generating increased customer awareness of their brand names that appear alongside our brand names on our products. As a result of these benefits, our distribution partners have the incentive to invest in the success of our products in their stores, within their distribution networks and among their members through promotion and advertising, attractive product placement in retail locations, inclusion on formularies and granting of “preferred product” status by health plans and PBMs. We have secured distribution partnerships with most of the leading drug store chains, retail supermarkets, mass merchandisers and drug distributors in the United States. We believe that our distribution strategy has created a significant competitive advantage for us and would be difficult for our competitors to replicate, given their significant overhead and dependence on marketing and brand promotion for success. In addition, we believe it would be difficult for our competitors to displace our market position given our growing installed base of end user consumers using our products and our overall value proposition.

We enter into agreements with certain of our customers from time to time addressing terms of sale, volume discounts, minimum requirements for maintaining exclusivity and the like. However, we do not rely on written agreements to any significant extent, but rather on our relationships with our customers. Most of our sales are made pursuant to purchase orders, and we do not have any agreements that require customers to purchase any minimum amount of our products. We have agreements with certain of our customers that provide for us to be the exclusive private label or co-brand distributor of our products, so long as certain minimum purchase thresholds are met. Generally, these agreements do not require our customers to purchase any minimum amount of our products, but do require them to maintain exclusivity.

Retail pharmacies

Retail pharmacies are the largest sales channel for the blood glucose monitoring market. We currently sell our products in most retail pharmacy chains in the United States. In 2008, we generated approximately $29.1 million of net sales through direct sales to the leading retail pharmacies, in which we sell our products under own brands and in the co-branded format. Retailers are very receptive to the value our products provide, given the attractive profitability and branding opportunity that our products provide. Our leading retail pharmacy customers in the United States include CVS Corporation, Rite Aid Corp. and Walgreen Co., which sell our products in the co-branded formats. In addition, we sell our TRUEtrack and Sidekick products under our own brand name to Walmart.

Our high-quality products are on average more profitable for the retailer and less expensive to the consumer, and are comparable to or better than the products of our competitors. This encourages retailers to allocate more shelf space for our products. Additionally, in our co-branding relationship, our retail partner pays for or subsidizes the cost of the promotional advertisements for our products, which we believe benefits us and the retailer and builds awareness of our products with the retailer’s diabetic customers.

Domestic distributors

Our domestic distributor customers include drug and medical supply wholesalers that sell products to food and drug retailers; durable medical equipment providers; long-term, acute and primary care facilities; and correctional facilities. In 2008, we generated $60.4 million of net sales through direct sales to domestic distributors. To date, we have established relationships with national medical products distributors, including AmerisourceBergen, Cardinal Health, McKesson (including its McKesson Medical Surgical division, which services the long-term care market) and Invacare Corporation, and with regional distributors such as Morris & Dickson Co., LLC and Kinray, Inc. Through our domestic distributors, we sell our products in leading

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supermarkets and mass merchandisers, including Safeway Inc., Winn-Dixie Stores, Inc. and Kmart, a subsidiary of Sears Holding Corporation.

This channel is important for the distribution of our products to all sizes of pharmacies, including the small to mid-tier chains. Our distributor partners also provide us with reach into the more than 17,000 independent pharmacies in the United States, which our direct retail pharmacy strategy would not otherwise access. Additionally, through our relationship with certain distributors, such as McKesson Medical Surgical, we have access to acute, primary and long-term care facilities in the United States.

Through our relationships with domestic distributors, we are able to leverage their significant market reach without having to invest significantly in building a sales force. For example, McKesson, the leading domestic distributor, currently has a direct sales force of approximately 900 people focused on retail pharmacies and acute, primary and long-term care centers.

Mail service

Our mail service customers include home care agencies providing comprehensive disease management services. In 2008, we generated approximately $19.3 million of net sales from our mail service customers. The target population of the mail service channel has historically been Medicare participants. We offer our mail service partners the same combination of our branded products and the co-branding formats that we offer our major retail and distributor partners. We currently sell our products through mail service organizations and home care organizations, which supply their customers and patients directly at home, such as Diabetes Care Club, CCS Medical, Liberty Medical Supply, Inc., Lincare Holdings, Inc., and Apria Healthcare Group, Inc.

International

We primarily market our products in international markets through regional distributors, who sell products to regional pharmacies and food mass retailers in their local markets. In the United Kingdom and Canada, we market our products directly to customers. In 2008, we generated $14.8 million of net sales internationally. Some of our retail and distribution partners in the international markets include Shoppers Drug Mart and Safeway in Canada, FASA in Latin America, SuperDrug Stores plc in the United Kingdom, Hemopharm GmbH (a division of STADA AG) in Germany, Med Trust GmbH in Austria, Grace Medical, Inc. in China and Diabetes Australia New South Wales in Australia.

Through our partnerships with international distributors, we are able to leverage their market reach without having to invest significantly in an international sales force.

Managed care strategy

Managed care is an important component of the diabetes management market. Because of the significant impact that managed care organizations can have on the selection of blood glucose monitoring systems, it is important that a company competing in this market achieve coverage penetration with these third-party payors. To obtain coverage, a company must provide managed care organizations, Medicaid or Medicare, with a high quality blood glucose monitoring system that is more cost effective for the insurer. However, quality and cost alone are not sufficient for formulary inclusion by a managed care plan. Given the large memberships of many managed care organizations, they also limit formulary inclusion to those companies and products that have a substantial market presence, to ensure adequate availability of products for their members. Until we achieved broad coverage with our products, we had limited participation in this segment.

Based on the affordability of our products and the strength of our technology, we have been able to generate substantial success with managed care organizations, including Medicaid and Medicare. The combination of our continuously increasing points of distribution and our high-quality, affordable product portfolio has enabled us to win formulary contracts with PBM’s, managed care organizations and important state Medicaid formularies. Our successes and growing recognition have been rewarded further with exclusive or preferred provider status for certain health plans. We plan to continue pursuing such opportunities and believe that our growing installed base will help us to be successful within this market segment.

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We are also one of two exclusive providers of diabetes supplies for 340B Programs, which enable qualified entities serving low income and uninsured populations to benefit from group purchasing discounts. We and Bayer Corp. have been named as the two diabetes supply vendors of the Prime Vendor Program (PVP) under Section 340B of the Veterans Health Care Act of 1992. Our contract runs through November 2009 and has allowed us to achieve success with some of the largest 340B participating entities.

Dependence on a limited number of major customers

In the year ended December 31, 2008, our two largest customers, McKesson Corporation (including its McKesson Medical Surgical division) and Walgreen Co., accounted for approximately 15.3% and 12.1%, respectively, of our total net sales. Our principal customers may not continue to purchase our products for competitive or other reasons. The loss of any of our principal customers could have a material adverse effect on our financial condition and results of operations.

Research and development

As of December 31, 2008, our research and development team was comprised of 53 scientists, engineers and associates dedicated to designing, manufacturing, engineering, and assessing the quality of promising new technologies. Our research and development team is exploring new technologies that we believe will broaden our product portfolio or target new markets that we are not currently addressing, enhance our current products and extend our technology into applications outside of diabetes. In addition to our extensive focus on improving our blood glucose monitoring product portfolio through research and development of new technologies, we are also focused on developing new ways to improve our manufacturing processes and technologies. To date, our manufacturing process research and development team has developed advanced systems for high throughput, precision manufacturing processes that significantly lower our cost per unit. These processes further support our strategy of helping people with diabetes better manage their healthcare cost by providing high-quality, high-performance diagnostic products at affordable prices.

Our direct and indirect expenditures on research, development and certain engineering activities relating to the design, development and significant modification of new and existing products and services and the formulation and design of new, and significant improvements to existing, manufacturing processes and equipment during the years-ended 2008, 2007 and 2006 were $8.6 million, $8.9 million, and $8.2 million, respectively.

Intellectual property

We rely on a combination of intellectual property laws, nondisclosure agreements and other measures to protect our proprietary rights. Currently, we have 29 issued United States patents, of which 9 are United States design patents. We also have 53 issued foreign patents, bringing our total number of issued patents world-wide to 82. In furtherance of our overall global intellectual property strategy, we have approximately 221 patent applications currently on file. We filed these patent applications in the United States and 20 other countries in Europe, Latin America, Asia and Australia. Our issued patents expire between 2012 and 2025.

Our patents and patent applications seek to protect new technologies developed by us in the blood glucose monitoring industry. These new core technologies include novel methods of fabricating biosensors (or test strips), new chemistry formulations and biosensor materials for superior testing accuracy, novel user features of our blood glucose meter systems and the incorporation of software, which interfaces blood glucose monitors with computers for data management.

Our issued patents and patent applications are directed to, among other things:

•  overall designs of the meters and test strips, including potential variations; and

•  manufacturing processes for the development of the Prestige IQ, TRUEtrack, Sidekick, TRUEtest, TRUEresult and TRUE2go systems.

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We also register trademarks for each of our products. Currently, we have 70 registered trademarks in the United States, Canada, Europe and Latin America. We also have approximately 119 pending trademark applications currently on file.

Sources and Availability of Raw Materials

With the exception of certain of our components, which are sourced from sole source vendors, we are not necessarily dependent on any one vendor for our components and raw materials. Although we believe we can secure other suppliers should the need arise, we would expect that the deterioration or cessation of any relationship would have a temporarily adverse effect, until new relationships are satisfactorily in place.

Manufacturing facilities and capacities

We have two manufacturing facilities, one located in Fort Lauderdale, Florida, and another Hsinchu City, Taiwan. Our Fort Lauderdale facility contains highly automated test strip and packaging equipment. Our Hsinchu City facility, which assembles our meters runs on a semi automated platform. We have verified and validated our manufacturing processes, as required by the FDA’s Quality System Regulation, and maintain rigorous quality controls

We assemble our monitors in our Taiwan facility, and label, assemble, perform quality control testing and shipment of our blood glucose monitoring systems in our Fort Lauderdale facility. We also manufacture, test and package our blood glucose and ketone test strips at our facility in Fort Lauderdale. In the third quarter of 2008, we installed and validated approximately $14 million of custom manufacturing equipment associated with manufacturing test strips for our TRUEtest platform.

In August 2008, our Board of Directors approved a significant expansion plan to spend approximately $16 million to $18 million on additional TRUEtest custom manufacturing equipment and facility improvements, in order to meet the expected long term demand for these products. For a more detailed discussion, see Liquidity and Capital resources.

Competition

The market for blood glucose monitoring devices is intensely competitive, subject to rapid change and significantly affected by new product introductions. Our competitors include Bayer Corp., LifeScan, Inc., a division of Johnson & Johnson, the MediSense, Inc. and TheraSense, Inc. divisions of Abbott Laboratories, and Roche Ltd. These competitors’ products, like ours, use a meter and disposable test strips to test blood obtained by pricking the finger or, in some cases, the forearm.

Within the last few years there have been a series of low-cost blood glucose monitoring systems introduced into the United States market, such as GlucoCheck, Easy Gluco, EZSmart, Senova, Control and GlucoLeader. Most of these systems are manufactured by companies based in Asia that have United States distribution partners. These manufacturers offer low-cost alternatives that are being marketed primarily within the mail service, long-term care and durable medical equipment distribution channels.

In addition, other companies are developing or marketing continuous blood glucose testing devices and technologies that could compete with our devices. To date, the FDA has approved several continuous monitors or sensors. Diabetic patients using these systems are still required to calibrate with finger-stick measurements to ensure reliable operation. Although the introduction of these continuous blood glucose testing devices could adversely affect our business, no device has yet been approved by the FDA, or, to our knowledge, developed as a replacement to the finger-stick testing method.

Government regulation and environmental matters

Our products are medical devices subject to extensive and ongoing regulation by the FDA and other regulatory bodies. FDA regulations govern product design and development, product testing, product manufacturing, product labeling, product storage, premarket clearance or approval, advertising and promotion, product sales and distribution, and complaint handling, including providing reports to the FDA if a device may have

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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.

FDA’s premarket clearance and approval requirements.  Unless an exemption applies, each medical device we wish to commercially distribute in the United States may require a 510(k) clearance from the FDA. We have obtained 510(k) clearance for each of our blood glucose monitoring systems.

•  510(k) clearance. To obtain 510(k) clearance for any of our products (or for certain modifications to devices that have received 510(k) clearance), we must submit a premarket notification demonstrating that the proposed device is substantially equivalent to a previously cleared 510(k) device. The FDA’s 510(k) clearance pathway usually takes from three to six months from the date the application is completed, but can take significantly longer. The Medical Device User Fee and Modernization Act (MDUFMA) provides a non-binding performance goal for 510(k) review by the FDA of 75 days, unless additional information is requested, and 90 days for final decisions.

•  PMA. 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 cleared 510(k) device are placed in class III, requiring a premarket approval, or PMA. We have never been required to obtain a PMA for any of our products, and do not expect to be required to obtain a PMA for any of our products currently under development. A PMA application must be supported by extensive data, including technical, preclinical, clinical trials, manufacturing, and labeling, to demonstrate the safety and effectiveness of the device to the FDA’s satisfaction. After a PMA application is complete, the FDA begins an in-depth review of the submitted information, which generally takes between one and three years, but may take significantly longer. The MDUFMA provides a non-binding performance goal for PMA review by the FDA of 180 days in exchange for a designated application fee paid by the sponsor that may be several hundred thousand dollars.

After a device is placed on the market, numerous regulatory requirements apply. These include:

•  Quality System Regulation, which requires manufacturers to follow design, testing, control, documentation and other quality assurance procedures during the manufacturing process;

•  labeling regulations, which prohibit the promotion of products for unapproved or “off-label” uses and impose other restrictions on labeling; and

•  medical device reporting regulations, which require that 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 can result in enforcement action by the FDA, which may include any of the following sanctions:

•  fines, injunctions and civil penalties;

•  recall or seizure of our products;

•  operating restrictions, partial suspension or total shutdown of production;

•  refusing requests for 510(k) clearance or premarket approval of new products;

•  withdrawing 510(k) clearance or premarket approvals that are already granted; and

•  criminal prosecution.

We are subject to announced and unannounced inspections by the FDA, which may include the manufacturing facilities of our subcontractors. Currently, because we are in good standing with the FDA, we are permitted to participate in the FDA’s third-party inspection program, under which we schedule an accredited third party to conduct an FDA Quality System Inspection on behalf of the FDA.

International sales of medical devices are subject to foreign government regulations, which may vary substantially from country to country. The time required to obtain approval by a foreign country may be longer

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or shorter than that required for FDA approval, and the requirements may differ. There is a trend towards harmonization of quality system standards among the European Union, United States, Canada, and various other industrialized countries.

The primary regulator in Europe is the European Union, which consists presently of 27 countries encompassing most of the major countries in Europe. Other countries, such as Switzerland and Norway, have voluntarily adopted laws and regulations that mirror those of the European Union with respect to medical devices. The European Union has adopted numerous directives and standards regulating the design, manufacture, clinical trials, labeling, and adverse event reporting for medical devices. Devices that comply with the requirements of a relevant directive will be entitled to bear the CE conformity marking, indicating that the device conforms to the essential requirements of the applicable directives and, accordingly, can be commercially distributed throughout Europe. The method of assessing conformity varies depending on the class of the product, but normally involves a combination of self-assessment by the manufacturer and a third-party assessment by a “Notified Body.” This third-party assessment may consist of an audit of the manufacturer’s quality system and specific testing of the manufacturer’s product. An assessment by a Notified Body of one country within the European Union is required in order for a manufacturer to commercially distribute the product throughout the region. In many international markets, commercialization requires both regulatory approval and reimbursement approval. While regulatory approval may be obtained for a country or group of countries, reimbursement approval may be required at the state, county or local level. Outside of the European Union, regulatory approval needs to be sought on acountry-by-country basis in order for us to market our products.

Fee-splitting; Corporate practice of medicine.  The laws of many states in which we maintain operations prohibit unlicensed persons or business entities, including corporations, from employing physicians and other healthcare professionals or engaging in certain financial arrangements, such as splitting professional fees with non-physicians. These laws and their interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion. Possible sanctions for violations of these restrictions include loss of a licensure, civil and criminal penalties and rescission of business arrangements that may violate these restrictions. We exercise care to structure our arrangements with healthcare providers to comply with the relevant state laws and believe our current arrangements comply with applicable laws. Government officials charged with responsibility for enforcing these laws may assert that we, or transactions in which we are involved, are in violation of such laws. Furthermore, such laws ultimately may be interpreted by the courts in a manner inconsistent with our interpretations.

Federal anti-kickback and self-referral laws.  The Federal Anti-Kickback Statute prohibits the knowing and willful offer, payment, solicitation, or receipt of any form of remuneration in return for, or to induce:

•  the referral of a person;

•  the furnishing or arranging for the furnishing of items or services reimbursable under Medicare, Medicaid or other governmental programs; or

•  the purchase, lease, or order of, or the arrangement or recommendation of the purchasing, leasing, or ordering of any item or service reimbursable under Medicare, Medicaid, or other governmental programs.

Similarly, the Federal Prohibition against Physician Self-referral Law (commonly referred to the “Stark”) prohibits a physician (or an immediate family member) who has a financial relationship with an entity from making a referral to that entity for furnishing a designated health service (DHS) for which Medicare or Medicaid would otherwise pay. Noncompliance with these federal laws can result in exclusion from Medicare, Medicaid, or other governmental programs, restrictions on our ability to operate in certain jurisdictions, as well as civil and criminal penalties, any of which could have an adverse effect on our business and results of operations. We exercise care to structure our arrangements with healthcare providers to comply with the relevant federal anti-kickback laws and believe our current arrangements comply with applicable laws.

Federal False Claims Act.  The Federal False Claims Act provides, in part, that the federal government may bring a lawsuit against any person whom it believes has knowingly presented, or caused to be presented,

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a false or fraudulent request for payment from the federal government, or who has made a false statement or used a false record to get a claim approved. In addition, amendments in 1986 to the Federal False Claims Act have made it easier for private parties to bring “qui tam” whistleblower lawsuits against companies. Penalties include fines ranging from $5,500 to $11,000 for each false claim, plus three times the amount of damages that the federal government sustained because of the act of that person. We believe that we are conforming to this law.

Civil Monetary Penalties Law.  The Federal Civil Monetary Penalties Law prohibits the offering or transferring of remuneration to a Medicare or Medicaid beneficiary that the person knows or should know is likely to influence the beneficiary’s selection of a particular supplier of Medicare or Medicaid payable items or services. Noncompliance can result in civil money penalties of up to $10,000 for each wrongful act, assessment of three times the amount claimed for each item or service and exclusion from the Federal healthcare programs. We believe that our arrangements comply with the requirements of the Federal Civil Monetary Penalties Law.

State fraud and abuse provisions.  Many states have also adopted some form of anti-kickback and anti-referral laws and false claims act. We believe that we are conforming to such laws. Nevertheless, a determination of liability under such laws could result in fines and penalties and restrictions on our ability to operate in these jurisdictions.

Third-party reimbursement

In the United States, our products are generally purchased directly by patients from food and drug retailers, mass merchandisers, distributors, mail service providers and, in some cases, military hospitals or managed care organizations. Under the Medicaid program, states generally reimburse for approved procedures on a reasonable cost or fee schedule basis. Currently, our products are reimbursed under Medicare and most Medicaid programs.

Health and safety matters

Our facilities and operations are also governed by laws and regulations, including the federal Occupational Safety and Health Act, or OSHA, relating to worker health and workplace safety. As an example, the OSHA has issued the Hazard Communication Standard, or HCS, requiring employers to identify the chemical hazards at their facilities and to educate employees about these hazards. HCS applies to all private-sector employers, including the medical device industry. HCS requires that employers assess their chemical hazards, obtain and maintain written descriptions of these hazards, develop a hazard communication program and train employees to work safely with the chemicals on site. Failure to comply with the requirements of the standard may result in administrative, civil and criminal penalties. We believe that appropriate precautions are taken to protect employees and others from harmful exposure to materials handled and managed at our facilities and that we operate in substantial compliance with all OSHA regulations.

Employees

As of December 31, 2008, we employed 571 people worldwide, of which approximately 281 were engaged in manufacturing, 53 in research and development, 128 in sales, marketing and distribution and 109 in general and administrative activities. We believe that our relationships with our employees are good. None of our employment arrangements are subject to collective bargaining arrangements.

Operating hazards and insurance

We maintain property, product and general liability, workers compensation and other commercial insurance policies with third-party insurance companies, subject to deductibles, exclusions and other restrictions, in accordance with standard insurance practice. We believe our insurance coverage is adequate based on our experience and the nature of our business.

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Available Information

We were incorporated in the State of Delaware in 1985. Our principal executive offices are located at 2400 NW 55th Court, Fort Lauderdale, Florida 33309. Our telephone number is(954) 677-9201.

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission, or SEC. You may read and copy our reports, proxy statements and other information at the SEC’s public reference room at Room 1580, 100 F Street NE, Washington, D.C. 20549. You can request copies of these documents by writing to the SEC and paying a fee for the copying cost. Please call the SEC at 1 800-SEC-0330 for more information about the operation of the public reference room. Our SEC filings are also available at the SEC’s web site at www.sec.gov. In addition, you can read and copy our SEC filings at the office of the National Association of Securities Dealers, Inc. at 1735 K Street N.W., Washington, D.C. 20006.

You may obtain a free copy of our annual reports onForm 10-K, quarterly reports onForm 10-Q and current reports onForm 8-K and amendments to those reports as soon as reasonably practicable after such reports have been filed with or furnished to the SEC on our website on the World Wide Web at www.homediagnostics.com or by contacting the Investor Relations Department at our corporate offices by calling(954) 332-2150. In addition, our Standards of Integrity, which includes our code of ethics for our senior officers, is available on our website.

CAUTIONARY STATEMENT CONCERNING
FORWARD-LOOKING STATEMENTS AND RISK FACTORS

We are including the following discussion to inform our existing and potential security holders generally of some of the risks and uncertainties that can affect our company and to take advantage of the “safe harbor” protection for forward-looking statements that applicable federal securities law affords.

From time to time, our management or persons acting on our behalf make forward-looking statements to inform existing and potential security holders about our company. These statements may include projections and estimates concerning the timing and success of specific projects and our future backlog, revenues, income and capital spending. Forward-looking statements are generally accompanied by words such as “estimate,” “project,” “predict,” “believe,” “expect,” “anticipate,” “plan,” “intend,” “seek,” “will,” “should,” “goal” or other words that convey the uncertainty of future events or outcomes. These forward-looking statements speak only as of the date on which they are first made, which in the case of forward-looking statements made in this report is the date of this report. Sometimes we will specifically describe a statement as being a forward-looking statement and refer to this cautionary statement.

In addition, various statements that this Annual Report onForm 10-K contains, including those that express a belief, expectation or intention, as well as those that are not statements of historical fact, are forward-looking statements. Those forward-looking statements appear in Item 1— “Business,” Item 2 — “Properties” and Item 3 — “Legal Proceedings” in Part I of this report and in Item 5 — “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities,” and in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Item 7A — “Quantitative and Qualitative Disclosures About Market Risk” and in the Notes to Consolidated Financial Statements we have included in Item 8 of Part II of this report and elsewhere in this report. These forward-looking statements speak only as of the date of this report. We disclaim any obligation to update these statements, and we caution you not to rely on them unduly. We have based these forward-looking statements on our current expectations and assumptions about future events. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond our control. These risks, contingencies and uncertainties relate to, among other matters, the following:

•  general economic and business conditions and industry trends;

•  the highly competitive nature of our business;

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•  our future financial performance, including availability, terms and deployment of capital;

•  the continued availability of qualified personnel; and

•  changes in, or our failure or inability to comply with, governmental regulations, including those relating to the environment.

We believe the items we have outlined above are important factors that could cause our actual results to differ materially from those expressed in a forward-looking statement contained in this report or elsewhere. We have discussed many of these factors in more detail elsewhere in this report. These factors are not necessarily all the important factors that could affect us. Unpredictable or unknown factors we have not discussed in this report could also have material adverse effects on actual results of matters that are the subject of our forward-looking statements. We do not intend to update our description of important factors each time a potential important factor arises. We advise our security holders that they should (1) be aware that important factors not referred to above could affect the accuracy of our forward-looking statements and (2) use caution and common sense when considering our forward-looking statements. Also, please read the risk factors set forth below.

Item 1A.   Risk Factors

Risks Related To Our Business

Current economic conditions and instability in the financial markets could negatively impact our business.

Our operations are impacted by local, national and worldwide economic conditions. The consequences of a prolonged recession may include a lower level of economic activity and uncertainty regarding the price of raw materials and the capital markets. A lower level of economic activity may result in a decline in demand for our products, which may adversely affect our liquidity, results of operations and future growth.

We operate in a highly competitive market. We face competition from large, well established medical device manufacturers with significant resources and from low-cost producers, predominantly in Asia, and we may not be able to compete effectively.

The market for blood glucose monitoring devices is intensely competitive, subject to rapid change and significantly affected by new product introductions. We compete directly with Bayer Corp., LifeScan, Inc., a division of Johnson & Johnson, the MediSense, Inc. and TheraSense, Inc. subsidiaries of Abbott Laboratories, and Roche Ltd. These competitors’ products, like ours, use a meter and disposable test strips to test blood obtained by pricking the finger or alternative blood sampling sites such as the forearm. Collectively, these companies currently account for approximately 90% of the blood glucose monitoring market, according to Frost & Sullivan, a nationally recognized market research firm. The companies marketing these competing devices are publicly traded companies or divisions of publicly traded companies, and have access to significantly greater resources than we do, which could prevent us from competing effectively against them.

Within the last few years there have been a series of low-cost blood glucose monitoring systems introduced into the United States market. Most of these systems are manufactured by companies based in Asia that have United States distribution partners. These manufacturers offer low-cost alternatives that are being marketed primarily within the mail service, long-term care and durable medical equipment distribution channels. If these companies succeed in penetrating our target market they could threaten our position in the market.

Technological breakthroughs in diabetes monitoring, treatment or prevention could render our products obsolete.

The diabetes treatment market is subject to rapid technological change and product innovation. Our products are based on our proprietary technology, but a number of companies and medical researchers are

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pursuing new delivery devices, delivery technologies, sensing technologies, procedures, drugs, and other therapeutics for the monitoring, treatment and prevention of diabetes.

Food and Drug Administration, or FDA, approval of a continuous glucose monitor or sensor, especially by one of our competitors, that provides accurate real-time data without the need to perform confirmatory finger-stick measurements, could have a material adverse effect on our net sales and future profitability. To date, the FDA has approved, for limited applications, several continuous monitors or sensors. None of these products are FDA approved for use as a substitute for finger-stick blood glucose testing. Diabetic patients using these continuous monitoring systems are still required to perform finger-stick measurements of glucose levels to calibrate or confirm readings. Although the introduction of these continuous blood glucose testing devices could adversely affect our business, no device has yet been approved or, to our knowledge, developed as a replacement to the finger-stick testing method.

Other companies are developing minimally invasive or noninvasive blood glucose testing devices and technologies that could also compete with our devices. We believe that the success of a minimally invasive or noninvasive blood glucose monitor could have an adverse effect on our business.

In addition, large pharmaceutical and biotechnology companies and research organizations like the National Institute of Health and other supporters of diabetes research are continually seeking ways to prevent, cure or improve the treatment of diabetes. Therefore, our products may be rendered obsolete by technological breakthroughs in diabetes treatment or prevention.

Any successful effort by one or more of our competitors to replicate our marketing strategy could have an adverse effect on our business.

Although we believe that none of our competitors have adopted a co-branding strategy similar to ours, there is no legal or regulatory impediment to their doing so. Therefore, one or more of our competitors may offer our current customers their own co-branded products as an alternative to our products. Any successful effort by them to replicate our marketing strategy could have an adverse effect on our business.

If we fail to develop new products or if the pace of our product development fails to keep up with that of our competitors, our net sales and future profitability could be adversely affected.

We are currently developing new products and enhancements to our current products. Development of these products requires additional research and development expenditures. Marketing of these products will require FDA and international regulatory clearancesand/or approvals. We may not be successful in developing, manufacturing or marketing these new products. Furthermore, if our pace of product development fails to keep up with that of our competitors, many of which have substantially greater resources than us, our net sales and future profitability could be adversely affected.

Our inability to adequately protect our intellectual property could allow our competitors and others to manufacture and market products based on our patented or proprietary technology and other intellectual property rights, which could substantially impair our ability to compete.

Our success and ability to compete is dependent, in part, upon our ability to maintain the proprietary nature of our technologies. We rely on a combination of patent, trade secret, copyright and trademark laws and nondisclosure agreements to protect our intellectual property. However, such methods may not be adequate to protect us. Despite our efforts to safeguard our intellectual property rights, we may not be successful in doing so, or the steps taken by us in this regard may not be adequate to detect or deter misappropriation of our technology or to prevent an unauthorized third party from copying or otherwise obtaining and using our products, technology or other proprietary information. Our inability to adequately protect our intellectual property could allow our competitors and others to manufacture and market products based on our patented or proprietary technology or other intellectual property rights, which could substantially impair our ability to compete.

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We may in the future need to assert claims of infringement against third parties to protect our intellectual property. Litigation to enforce our intellectual property rights in patents, copyrights, or trademarks is highly unpredictable, could result in substantial costs and diversion of resources, and could have a material adverse effect on our financial condition and results of operations regardless of the final outcome of such litigation. In the event of an adverse judgment, a court could hold that some or all of our asserted intellectual property rights have not been infringed, are invalid, or are unenforceable, and could award attorney fees.

We may become subject to claims of infringement or misappropriation of the intellectual property rights of others, which could prohibit us from shipping applicable products or require us to obtain licenses from third parties or to develop non-infringing alternatives, and could subject us to substantial monetary damages and injunctive relief.

Third parties could, in the future, assert infringement or misappropriation claims against us with respect to our current or future products. Although we perform investigations of the intellectual property of third parties, we cannot be certain that we have not infringed any such intellectual property rights. Any such infringement or misappropriation claim could result in significant costs, substantial damages and our inability to manufacture, market or sell our existing or future products. We could be prohibited from shipping products that are found to infringe. We also could be forced to obtain licenses from third parties or to develop a non-infringing alternative, which could be costly and time-consuming. A court could also order us to pay compensatory damages for such infringement, plus prejudgment interest, and could, in addition, treble the compensatory damages and award attorney fees. These damages could be substantial and could harm our reputation, business, financial condition and operating results. A court could also enter orders that temporarily, preliminarily or permanently enjoin us or our customers from making, using, selling, offering to sell or importing our products, or could enter an order mandating that we undertake certain remedial activities. Depending on the nature of the relief ordered by the court, we could become liable for additional damages to third parties.

In December 2007, we paid $3.5 million to Roche Diagnostics Corporation (“Roche”) in settlement of a patent infringement suit filed in February 2004. In the complaint, Roche alleged that our TrueTrack Smart System and TrackEASE Smart System blood glucose monitors infringed on U.S. Patent Nos. 5,366,609 and Re. 36,268, relating to biosensing blood glucose monitors. Among the terms of the settlement is a royalty free, fullypaid-up worldwide license under the patents at issue. In addition, the settlement terms include a covenant by Roche not to sue Home Diagnostics on the licensed patents. In April 2005, we paid $5.0 million to settle a claim by a competitor that one of our products infringed on one of their patents. See Note 16 to our consolidated financial statements included elsewhere in this Annual Report.

Competitive bidding for durable medical equipment suppliers could negatively affect our business.

On April 2, 2007, the Centers for Medicare & Medicaid Services (CMS) issued a final rule to implement a new competitive bidding program in Medicare. The new competitive bidding program, mandated by Congress in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA), will replace the current Medicare fee schedule for certain durable medical equipment, prosthetics, orthotics, and supplies (DMEPOS) in ten of the largest Metropolitan Statistical Areas (MSAs) across the country and will apply initially to ten categories of medical equipment and supplies, including diabetic supplies obtained via mail order arrangements (i.e. test strips and lancets used with blood glucose monitors). On July 15, 2008, the Medicare Improvements for Patients and Providers Act of 2008 (MIPPA) was enacted. This new law has delayed the Medicare DMEPOS Competitive Bidding Program for 18 to 24 months. The new law also mandated a 9.5% reduction in Medicare reimbursement for DMEPOS, including diabetic supplies obtained via mail order arrangements, effective January 1, 2009. In a January 16, 2009 Interim Final Rule, CMS further delayed implementation of the program to “allow Department officials the opportunity for further review of the issues discussed in the rule.” To the extent that the competitive bidding program exerts downward pressure on the prices our customers may be willing or able to pay for our products or imposes additional costs, our operating results could be negatively affected.

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A significant disruption by certain of our vendors could have a material adverse effect on our production output, net sales and overall financial performance.

We rely upon certain vendors to supply certain parts for our products on a sole source basis. Some of our arrangements with these vendors are not on a contractual basis and can be terminated by either party with no advance notice. Although we have identified alternative vendors for a majority of the parts supplied by these sole source vendors, if there is a sudden termination, we may not be able to qualify these alternative vendors under the FDA’s Quality System Regulation in sufficient time to prevent a disruption in production output. Such a disruption could have a material adverse effect on our production output, net sales, and overall financial performance.

If our manufacturing capabilities are insufficient to produce an adequate supply of products at appropriate quality levels, our growth could be limited and our business could be harmed.

We have made a significant investment in custom manufacturing equipment to produce our blood glucose monitoring systems, including our TRUEtest platform launched in September 2008. We continue to scale our manufacturing operations to meet current and future demand. During the installation and qualification process we experienced a combination of challenges that have negatively impacted the scaling of our manufacturing operation that resulted in lower than expected yields and increased scrap costs. We have focused significant effort on improvement programs in this new manufacturing operation, intended to improve quality, yields and throughput, as well as reduce cycle time. In order to meet long term demand for our products, our Board has approved an expansion plan, which will include the purchase of additional manufacturing equipment and a facilities expansion.

The scaling of manufacturing capacity is subject to numerous risks and uncertainties, such as design, installation and maintenance of manufacturing equipment, among others, which can lead to unexpected delaysand/or increased costs. There can be no assurance that we will be able to efficiently scale our manufacturing process and operations. If we are unable to manufacture a sufficient supply of our products, maintain control over expenses or otherwise adapt to anticipated growth, or if we under estimate growth, we may not have the capability to satisfy market demand and our business will suffer.

Product liability suits, whether or not meritorious, could be brought against us based on allegations of defective products or for the misuse of our products. These suits could result in expensive and time-consuming litigation, payment of substantial damages and an increase in our insurance rates.

If someone claims our products are defectively designed or manufactured, or contain defective components, whether or not such claims are meritorious, we may become subject to substantial and costly litigation. Misusing our products or failing to adhere to the operating guidelines of our product usage insert in our user guides could cause diabetics to improperly maintain their blood glucose levels, which could cause them significant harm, including death. In addition, if our operating guidelines are found to be inadequate, we may be subject to liability. Product liability claims could divert management’s attention from our core business, be expensive to defend and result in sizable damage awards against us. While we believe that we are reasonably insured against these risks, we may not have sufficient insurance coverage for all future claims. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage, could harm our reputation in the industry, could prevent or interfere with our product commercialization efforts, and could reduce product net sales. Product liability claims in excess of our insurance coverage would be paid out of cash reserves, harming our financial condition and reducing our operating results.

Failure to secure or retain third-party coverage or reduced reimbursement for our products by third-party payors could adversely affect our business and operating results.

Many of our products are ultimately paid for by third-party payors, including private insurance companies, health maintenance organizations, preferred provider organizations, Medicare and Medicaid. Healthcare market initiatives in the United States may lead third-party payors to decline or reduce

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reimbursement for our products. International market acceptance of our products may depend, in part, upon the availability of reimbursement within prevailing healthcare systems. Reimbursement and healthcare systems in international markets vary significantly by country, and include both government sponsored healthcare and private insurance. We may not obtain international reimbursement approvals in a timely manner, if at all. Our failure to receive international reimbursement approvals may negatively impact market acceptance of our products in the international markets in which those approvals are sought.

We believe that in the future reimbursement will be subject to increased restrictions both in the United States and in international markets. We further believe that the overall escalating cost of medical products and services will continue to lead to increased pressures on the healthcare industry, both domestic and international, to reduce the cost of products and services, including our current products and products under development. There can be no assurance that third-party reimbursement and coverage will be available or adequate in either the United States or international markets or that future legislation, regulation or reimbursement policies of third-party payors will not otherwise adversely affect the demand for our existing products or products currently under development by us or our ability to sell our products on a profitable basis. The unavailability of third-party payor coverage or the inadequacy of reimbursement could have a material adverse effect on our business, financial condition and results of operations.

Certain third-party payors are currently classifying our Sidekick disposable blood glucose monitoring system as a meter, rather than as test strips. Since third-party payors generally will reimburse for a new meter only once every year or two, these classifications could have an adverse effect on our ability to grow sales of our Sidekick system. We have persuaded some third-party payors and state Medicaid programs to reclassify our products for test strip reimbursement, which allows for the reimbursement of recurring purchases consistent with standard test strip reimbursement frequencies. However, we cannot be certain that our efforts to obtain additional coverage will be successful in the future.

We operate a manufacturing facility in Taiwan and may expand further into markets outside the United States, which subjects us to additional business and regulatory risks.

We operate a manufacturing facility in Taiwan and intend to increase our operations in international markets. We expect that an increasingly significant portion of our net sales and expenses will be derived from operations in foreign countries. Conducting business internationally subjects us to a number of risks and uncertainties, including:

•  fluctuations in foreign currencies;

•  unexpected delays or changes in regulatory requirements;

•  availability of reimbursement within prevailing healthcare payment systems;

•  delays and expenses associated with tariffs and other trade barriers;

•  restrictions on and impediments to repatriation of our funds and our distributors’ ability to make payments to us;

•  political and economic instability;

•  difficulties and costs associated with attracting and maintaining third-party distributors;

•  uncertainty in shipping and receiving products and product components;

•  increased difficulty in collecting accounts receivable and longer accounts receivable cycles in certain foreign countries; and

•  adverse tax consequences or overlapping tax structures.

Any of these risks could have an adverse effect on our financial condition and results of operations.

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We conduct business in a heavily regulated industry and if we fail to comply with applicable laws and government regulations, we could suffer penalties or be required to make significant changes to our operations.

The healthcare industry is subject to extensive federal, state and local laws and regulations relating to:

•  billing for services;

•  financial relationships with physicians and other referral sources;

•  inducements and courtesies being given to patients;

•  quality of medical equipment and services;

•  confidentiality, maintenance, and security issues associated with medical records and individually identifiable health information;

•  false claims;

•  professional licensure; and

•  labeling products.

These laws and regulations are extremely complex and, in some cases, still evolving. In many instances, the industry does not have the benefit of significant regulatory or judicial interpretation of these laws and regulations.

We believe that we are in compliance with all applicable healthcare industry regulations and laws. However, regulatory authorities that enforce the various statutes may determine that we are violating federal, state, or local laws and we may need to restructure some of our operations.

If our operations are found to be in violation of any of these federal, state, or local laws and regulations or the other governmental regulations which govern our activities, we may be subject to the applicable penalties associated with the violation, including civil and criminal penalties, damages, fines, or curtailment of our operations, which, individually or in the aggregate, could adversely affect our ability to operate our business and our financial results. The risk of us being found in violation of these laws and regulations is increased by the fact that many of these laws and regulations have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action against us for violation of these laws or regulations, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.

In addition, healthcare laws and regulations may change significantly in the future. We monitor these developments and modify our operations from time to time as the regulatory environment changes. Any new healthcare laws or regulations may adversely affect our business or restrict our operations. A review of our business by courts or regulatory authorities may result in a determination that could adversely affect our operations. Any future healthcare investigations of our executives, our managers, or us could result in significant liabilities or penalties, as well as adverse publicity.

All of our manufacturing operations are conducted at our facilities in the United States and in Taiwan. Any disruption at either of our facilities could increase our expenses and have a material adverse effect on our results of operations.

All of our manufacturing operations are conducted at our facilities in Fort Lauderdale, Florida, and in Hsinchu City, Taiwan. The concentration of much of our operations and manufacturing in Florida and Taiwan makes us more vulnerable than some other industry participants to the risks associated with adverse weather conditions such as hurricanes and tropical storms. A natural disaster, such as a hurricane, tropical storm, typhoon, tornado, earthquake, fire, or flood, could cause substantial delays in our operations, damage or destroy our manufacturing equipment or inventory, and cause us to incur additional expenses. The insurance we maintain against fires, floods, and other natural disasters may not be adequate to cover our losses in any particular case.

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For the year ended December 31, 2008, we derived approximately 27.4% of our total net sales from two customers. The loss of either of those customers could have a material adverse effect on our financial condition and results of operations.

In the year ended December 31, 2008, our two largest customers, McKesson Corporation (including its McKesson Medical Surgical division) and Walgreen Co., accounted for approximately 15.3% and 12.1%, respectively, of our total net sales. Our principal customers may not continue to purchase our products for competitive or other reasons. The loss of any of our principal customers could have a material adverse effect on our financial condition and results of operations.

To the extent we acquire complementary businesses or technologies in the future, we may experience difficulty integrating those acquisitions. Additionally, we may incur debt to finance those acquisitions, which adds additional financial risk to our business. To the extent we incur too much debt in undertaking acquisitions, we may adversely affect our financial position and operating results.

The process of integrating acquired businesses or technologies may involve unforeseen difficulties and may require significant financial and other resources and a disproportionate amount of management’s attention. We may not be able to successfully manage and integrate new businesses or technologies into our existing operations or successfully maintain the market share attributable to any acquired businesses. We may also encounter cost overruns related to such acquisitions. To the extent we experience some or all of these difficulties, our financial condition would be adversely affected. Any such acquisitions may cause us to incur indebtedness, increasing our debt service requirements and the amount of our cash flow that would have to be directed to the repayment of debt, which could adversely affect our operating results and financial position.

We may not be able to raise additional funds through public or private financings or additional borrowings, which could have a material adverse effect on our financial condition.

Our cash on hand, cash flow from operations and present borrowing capacity may not be sufficient to fund necessary capital expenditures and working capital requirements. We may from time to time seek additional financing, either in the form of bank borrowings, sales of debt or equity securities or otherwise. To the extent our capital resources and cash flow from operations are at any time insufficient to fund our activities or repay our indebtedness as it becomes due, we will need to raise additional funds through public or private financings or additional borrowings. We may not be able to obtain any such capital resources in sufficient amounts or on acceptable terms, if at all. If we are unable to obtain the necessary capital resources, our financial condition and results of operations could be materially adversely affected.

We could be adversely affected if we lost the services of our officers and key employees.

The success of our business is highly dependent upon the services, efforts and abilities of our officers and key employees. Our business could be materially and adversely affected by the loss of any of these individuals. We do not maintain key man life insurance on the lives of any of our executive officers or key employees.

We are incurring increased costs as a result of being a public company.

As a public company, we are incurring significant legal, accounting and other expenses that we did not incur as a private company. We will continue to incur costs associated with our public company reporting requirements and costs associated with corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, as well as rules implemented by the Securities and Exchange Commission, or SEC, and the National Association of Securities Dealers. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly.

Our debt agreement contains restrictions that limit our flexibility in operating our business.

Our debt agreement contains various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things:

•  create additional liens;

•  repurchase more than $5.5 million per year of our capital stock other than pursuant to employee compensation plans; and

•  participate in a change of control of the Company.

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The FDA has expressed concern over the use of blood glucose monitoring systems that use test strips with the GDH-PQQ enzyme. Failure to resolve the FDA’s concerns could materially harm our business.

The Food and Drug Administration (FDA) has requested meetings with manufacturers, including us, of blood glucose monitoring systems to discuss the FDA’s safety concerns about the continued use of glucose monitoring systems that use the GDH-PQQ enzyme. The FDA’s concerns relate to certain patients receiving other medical treatments or IV therapies that are known to contain maltose and maltose derivatives. In the past, regulatory agencies, including the FDA, have issued cautionary statements and medical device alerts to the health care community that explained the risk of using GDH-PQQ systems with dialysis patients receiving maltose, xylose or galactose. Our TRUEresult and TRUE2Go systems both use TRUEtest strips, which in turn use the GDH-PQQ enzyme. Prior to receiving 510(k) marketing clearance of these products from the FDA in August 2008, we modified our labeling and educational materials, in accordance with FDA recommendations, to mitigate these risks. During a meeting with the FDA in February 2009, we were asked to work with the FDA to develop a plan that addresses these concerns and further mitigate the risks associated with the use of these products by patients receiving other medical treatments or IV therapies that are known to contain maltose and maltose derivatives. This plan, if approved and required to be implemented by the FDA, may limit the distribution of these productsand/or require additional labeling and educational materials, may require that a different type of enzyme be utilized in these product, or may require the withdrawal of these products from the market. We are developing a risk mitigation plan to review with the FDA at the end of March 2009. At this time, management cannot reasonably estimate the amount of potential loss, if any, related to this matter. As more information becomes available, accruals, if any, for losses that may be considered probable and/or asset impairment charges may be necessary. An unfavorable outcome in this matter could have a material adverse effect on our financial position, liquidity and results of operations.

If we fail to obtain or maintain necessary FDA clearances or approvals for products, or if approvals are delayed, we will be unable to commercially distribute and market our products in the United States.

Our products are subject to extensive regulation in the United States and in foreign countries where we do business. Unless an exemption applies, each device that we wish to market in the United States must first receive either 510(k) clearance or premarket approval from the FDA. Either process can be lengthy and expensive. The FDA’s 510(k) clearance process usually takes from four to twelve months from the date the application is complete, but may take longer. Although we have obtained 510(k) clearance for our current products, our 510(k) clearance can be revoked if safety or effectiveness problems develop. New product introductions require 501(k) clearance prior to commercialization. The premarket approval process is much more costly, lengthy and uncertain. It generally takes from one to three years from the date the application is complete or even longer. However, achieving a completed application is a process that may take numerous clinical trials and require the filing of amendments over time. Delays in obtaining clearance or approval could adversely affect our revenues and profitability.

Modification to our marketed devices may require new 510(k) clearances or premarket approvals or that requires us to cease marketing or recall the modified devices until these clearances are obtained.

Any modification to an FDA cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new FDA 510(k) clearance or possibly premarket approval. The FDA requires every manufacturer to make this determination in the first instance, but the FDA can review any such decision. The FDA may not agree with any of our decisions not to seek new clearance or approval. If the FDA requires us to seek 510(k) clearance or premarket approval for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. Also, in these circumstances, we may be subject to significant regulatory fines or penalties.

If we or our suppliers fail to comply with the FDA’s Quality System Regulation, our manufacturing operations could be delayed, and our product sales and profitability could suffer.

Our manufacturing processes are required to comply with the FDA’s Quality System Regulation, which covers the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage and shipping of our products. The FDA enforces the Quality System Regulation through

25

announced or unannounced inspections. If we or one of our suppliers fail a Quality System inspection, or if our corrective action plan is not sufficient, our operations could be disrupted and our manufacturing delayed. If we fail to take adequate corrective action in response to any FDA observations, we could face various enforcement actions, which could include a shut-down of our manufacturing operations and a recall of our products, which would cause our product sales and profitability to suffer. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with applicable regulatory requirements. However, all components received from our suppliers undergo some level of inspection to assure that these components meet our established requirements as necessary to assure product quality.

Risks related to our Common Stock

We are controlled by our officers and directors and one large non-management stockholder.

As of March 1, 2009, our officers and directors and Judy Salem, individually our largest non-management stockholder, beneficially owned approximately 36.2% of our outstanding common stock. Accordingly, they may be able to control the outcome of stockholder votes, including votes concerning the election of directors, the adoption or amendment of provisions in our certificate of incorporation or bylaws and the approval of mergers and other significant corporate transactions. The existence of these levels of ownership concentration makes it unlikely that any other holder of our common stock will be able to affect our management or direction. These factors may also have the effect of delaying or preventing a change in the management or voting control of HDI.

Our existing dividend policy may limit our payment of dividends.

We have never declared a cash dividend on our common stock and do not expect to pay cash dividends in the foreseeable future. We expect that all cash flow generated from our operations in the foreseeable future will be retained and used to develop or expand our business.

Preferred stock, with rights and preferences adverse to the voting power or other rights of holders of our common stock, may be issued without stockholder approval.

Our certificate of incorporation authorizes the issuance of “blank check” preferred stock with such designations, rights and preferences as may be determined from time to time by our Board of Directors. Accordingly, our Board of Directors is empowered, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights which would adversely affect the voting power or other rights of our common stockholders. In the event of issuance, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control, which could have the effect of discouraging bids and thereby preventing common stockholders from receiving the maximum value for their shares. We have no present intention to issue any shares of preferred stock in order to discourage or delay a change of control. However, there can be no assurance that preferred stock will not be issued at some time in the future.

Provisions in our certificate of incorporation and bylaws and of Delaware corporate law may make a takeover difficult.

Provisions in our certificate of incorporation and bylaws and of Delaware corporate law may make it difficult and expensive for a third party to pursue a tender offer, change in control or takeover attempt that is opposed by our management and board of directors. These anti-takeover provisions could substantially impede the ability of public stockholders to benefit from a change of control or change our management and board of directors.

Item 1B.   Unresolved Staff Comments

None.

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Item 2.   Properties

We lease approximately 130,000 square feet of office and manufacturing space at our principal facility in Fort Lauderdale, Florida under a180-month lease, expiring February 2013, with monthly payments of approximately $150,000; and approximately 11,000 square feet of warehouse space in Fort Lauderdale, Florida, under a 25 month lease, expiring in March 2011, with monthly payments of approximately $8,000. We also lease approximately 20,000 square feet of office space in Fort Lauderdale, Florida under a60-month lease, expiring April 2012 with monthly payments of approximately $50,000.

We lease approximately 16,000 square feet of manufacturing space at our facility in Hsinchu City, Taiwan, under a12-month lease, expiring December 2009, with monthly payments of approximately $10,000.

Item 3.   Legal Proceedings

We are involved in certain legal proceedings arising in the ordinary course of business. In our opinion, the outcome of such proceedings will not materially affect our consolidated financial position, results of operations or cash flows. See Note 16 — Commitments and Contingencies.

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

We did not submit any matter to a vote of our security holders during the fourth quarter of fiscal 2008.

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PART II

Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

As of March 8, 2009, 17,264,895 shares of our common stock were outstanding. As of March 8, 2009, the number of holders of record of our common stock was 14,941.

Our common stock is listed on the NASDAQ Global Select Market under the symbol “HDIX”. The following table sets forth, for each of the periods indicated, the high and low sales prices per share on the NASDAQ Global Select Market:

	Low		High
Period
Fiscal Year Ended December 31, 2008
First Quarter	$	6.15	$	9.60
Second Quarter	$	6.81	$	9.07
Third Quarter	$	7.10	$	10.99
Fourth Quarter	$	4.41	$	10.09
Period
Fiscal Year Ended December 31, 2007
First Quarter	$	9.88	$	12.71
Second Quarter	$	10.16	$	11.89
Third Quarter	$	7.16	$	12.05
Fourth Quarter	$	6.18	$	10.24

The last reported sales price for our common stock on the NASDAQ Global Select Market on March 8, 2009 was $5.97 per share.

Dividends

We have not declared or paid any dividends on our common stock to date. The payment of dividends is within the discretion of our Board of Directors. Our Board of Directors currently intends to retain any earnings for use in our business operations and, accordingly, we do not anticipate the Board of Directors declaring any dividends in the foreseeable future.

Recent Sales of Unregistered Securities

During the fiscal year ended December 31, 2008, no equity securities of the Company were sold by us that were not registered under the Securities Act of 1933, as amended.

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Equity Compensation Plan Information

The following table provides information as of December 31, 2008 about HDI’s common stock that may be issued upon the exercise of options, warrants and rights granted to employees, consultants or members or the board of directors under all of our existing equity compensation plans:

						Number of Shares of
						Common Stock
						Remaining Available for
						Future Issuance under
	Number of Shares of					Equity
	Common Stock to be			Weighted-Average		Compensation Plans
	Issued upon Exercise of			Exercise Price per Share		(Excluding Shares
Plan Category	Outstanding Options			of Outstanding Options		Reflected in Column (a))
	(a)			(b)		(c)
Equity compensation plans approved by security holders		3,146,334	(1)	$	5.93		914,005	(2)

(1)

Includes 303,221 shares of common stock issuable upon the exercise of options that were outstanding under our 1992 Stock Option Plan, 1,204,448 shares of common stock issuable upon the exercise of options that were outstanding under our 2002 Stock Option Plan, 1, 085,995 shares of common stock issuable that were outstanding under our 2006 Equity Incentive Plan, and 552,670 shares of common stock issuable upon the exercise of outstanding options that were granted other than pursuant to such plans, the terms of which are substantially similar to those of such plans, in each case, as of December 31, 2008.

(2)

Represents the difference between the number of shares of our common stock issuable under our 2006 Equity Incentive Plan, and the number of shares of our common stock issued under such plans and options as of December 31, 2008, which consist of options to acquire 1,085,995 shares of common stock (net of forfeitures).

Issuer Purchase of Equity Securities

During the three months ended December 31, 2008, we purchased 37,198 shares of our common stock at an approximate cost of $0.4 million, under a $5,000,000 repurchase program (the “Common Stock Repurchase Program”) approved by our Board in March 2008, which completed our previously announced stock repurchase program. All purchases under the Common Stock Repurchase Program were made in the open market, subject to market conditions and trading restrictions.

							Approximate Dollar
							Value of Shares
					Total Number		that May
					of Shares		Yet Be Purchased
	Total Number		Average Price		Purchased as Part of		Under
	of Shares		Paid per		the Repurchase		the Repurchase
Period	Purchased		Share		Program		Program
October 1, 2008 to October 31, 2008		37,198	$	9.75		37,198	$	0
November 1, 2008 to November 30, 2008		—		—		—	$	0
December 1, 2008 to December 31, 2008		—		—		—	$	0
Total at December 31, 2008		37,198	$	9.75		37,198

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PERFORMANCE GRAPH

The following graph shows a comparison of the total cumulative returns of an investment of $100 in cash on September 21, 2006, the first trading day following our initial public offering, in (i) our common stock, (ii) the Nasdaq Composite Index, U.S. Companies, and (iii) the Russell 3000 Medical and Dental Supplies Index. The comparisons in the graph are required by the SEC and are not intended to forecast or be indicative of the possible future performance of our common stock. The graph assumes that all dividends have been reinvested (to date, the Company has not declared any dividends).

COMPARISON OF 27 MONTH CUMULATIVE TOTAL RETURN*
Among Home Diagnostics, Inc, The NASDAQ Composite Index
And The Russell 3000 Index

*  $100 invested on 9/21/06 in stock & 8/31/06 in index-including reinvestment of dividends.
Fiscal year ending December 31.

Year End	September 21, 2006		December 31, 2008
HDIX		100		39.41
Peer Index		100		86.78
NASDAQ		100		70.67

The Stock Price Performance Graph shall not be deemed incorporated by reference into any filing made by the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, notwithstanding any general statement contained in any such filing incorporating this Annual Report onForm 10-K by reference, except to the extent the Company incorporates the Graph by specific reference.

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Item 6.   Selected Financial Data

The following table sets forth selected financial and operating data on or as of the dates and for the periods indicated. The selected financial data presented below should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements, including the notes to those consolidated financial statements, included elsewhere in this Annual Report.

	Years Ended December 31,
	2004		2005			2006			2007			2008
	(In thousands, except for per share data)
Consolidated statement of operations data:
Net sales	$	85,082	$	100,165		$	112,628		$	115,601		$	123,582
Cost of sales		35,570		41,149			44,287			45,555			52,345
Gross profit		49,512		59,016			68,341			70,046			71,237
Operating expenses:
Selling, general and administrative(1)		29,021		37,259			42,603			46,827			51,448
Research and development		5,713		6,526			8,230			8,928			8,635
Litigation settlement, net of recoveries		5,000		—			3,000			3,050			—
Total operating expenses		39,734		43,785			53,833			58,805			60,083
Income from operations		9,778		15,231			14,508			11,241			11,154
Change in fair value of warrant put option		1,075		2,803			(59	)		—			—
Interest expense (income), net		4,658		712			(167	)		(1,656	)		(1,002	)
Other expense (income)		387		(198	)		44			(119	)		447
Income before income taxes		3,658		11,914			14,690			13,016			11,709
Provision for income taxes		1,692		5,982			4,381			3,388			2,065
Net income	$	1,966	$	5,932		$	10,309		$	9,628		$	9,644
Per share data:
Net income per common share:
Basic	$	0.14	$	0.43		$	0.70		$	0.54		$	0.54
Diluted	$	0.14	$	0.39		$	0.59		$	0.49		$	0.51
Weighted-average shares used in computing net income per common share:
Basic		13,815		13,740			14,811			17,953			17,707
Diluted		14,061		15,078			17,373			19,574			18,751

	Years Ended December 31,
	2004		2005		2006		2007		2008
Consolidated balance sheet data:
Cash and cash equivalents	$	6,939	$	3,483	$	26,487	$	32,696	$	30,367
Working capital		13,843		9,364		42,401		46,161		44,005
Total assets		81,018		85,615		117,676		130,251		141,340
Long-term debt, less current portion		10,250		1,250		—		—		—
Mandatorily redeemable preferred stock		1,153		1,152		—		—		—
Total stockholders’ equity		42,332		49,146		97,113		106,099		112,066

(1) Includes stock-based compensation expense of $12,882 in 2004, $1.6 million in 2005, $1.2 million in 2006, $1.1 million in 2007, and $1.3 million in 2008.

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

The following discussion highlights the principal factors that have affected our financial condition and results of operations as well as our liquidity and capital resources for the years described. This discussion contains forward-looking statements. Please see “Cautionary Statement Concerning Forward-looking Statements” and “Risk Factors” for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements and risk factors. The operating results for the years presented were not significantly affected by inflation.

Company Overview

We are a developer, manufacturer and marketer of technologically advanced blood glucose monitoring systems and disposable supplies for diabetics worldwide. We market our blood glucose monitoring systems both under our own HDI brands and through a unique co-branding strategy in partnership with the leading food and drug retailers, mass merchandisers, distributors, mail service providers and third-party payors in the United States and internationally.

Our co-branding distribution strategy allows our customers to leverage their brand strategy with ours and to deliver high quality, low cost blood glucose monitoring systems to their diabetic customers at attractive price points for the consumer and increased profit margins for the retailer or distributor.

Our company was founded in 1985 and has focused exclusively on the diabetes market since inception. We have two manufacturing facilities, one located in Fort Lauderdale, Florida, and the other in Hsinchu City, Taiwan. We manufacture, test and package our blood glucose test strips at our facility in Fort Lauderdale. Our blood glucose monitors are assembled in our Taiwan facility. Labeling, final assembly, quality control testing and shipment of our blood glucose monitoring systems are conducted in our Fort Lauderdale facility.

We sell our products in the following distribution channels:

•  Retail — the retail channel generates the majority of sales of blood glucose monitoring products in the United States and includes chain drug stores, food stores and mass merchandisers. We sell our products into the retail channel on a direct basis or through domestic distributors. Our retail net sales include products we sell directly into the retail channel for the larger food and drug retailers.

•  Domestic distribution — the domestic distribution channel includes sales to domestic wholesalers, including AmerisourceBergen, Cardinal Health, McKesson, and Invacare, who sell products to independent and chain food and drug retailers, primary and long-term care providers, durable medical equipment suppliers and mail service providers.

•  Mail service — the mail service channel includes sales to leading mail service providers, who market their products primarily to the Medicare population.

•  International — the international channel consists of sales on a direct basis in the United Kingdom and Canada and through distributors primarily in Latin America, Germany, Australia, and China.

Our net sales by channel were as follows for the years indicated:

	Years Ended December 31,
	2006				2007				2008
	(In thousands)
Retail	$	25,118	22.3	%	$	25,959	22.5	%	$	29,073	23.5	%
Domestic distribution*		61,199	54.3	%		58,546	50.6	%		60,433	48.9	%
Mail service*		14,988	13.3	%		16,570	14.3	%		19,274	15.6	%
International		11,323	10.1	%		14,526	12.6	%		14,802	12.0	%
	$	112,628	100	%	$	115,601	100	%	$	123,582	100	%

* Certain 2006 and 2007 sales have been reclassified to confirm to current year presentation

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We enter into agreements with certain of our customers from time to time addressing terms of sale, volume discounts, minimum requirements for maintaining exclusivity and the like. However, we do not rely on written agreements to any significant extent, but rather on our relationships with our customers. Most of our sales are made pursuant to purchase orders, and we do not have any agreements that require customers to purchase any minimum amount of our products.

Our gross margins over the past three years have been in the range of 58% to 61%. We strive to maximize our installed base of monitors to drive future sales of our test strips. Monitors, which are sold individually or in a starter kit with a sample of 10 test strips and other supplies, are typically sold at or below cost. It is also common for us to provide monitors free of charge in support of managed care initiatives and other market opportunities. Test strip sales are a significant driver of our overall gross margins. We measure our operating performance in many ways, including the ratio of test strips to monitors sold in a given period. Our gross margins are affected by several factors, including manufacturing costs, the ratio of test strips to monitors, free monitor distributions and product pricing. Our gross margins can be negatively impacted by new product introductions as we invest to build an installed base of users for our systems. This is due to several factors, including free or discounted monitors, lower ratio of test strip to monitor sales and cost inefficiencies during scale up of manufacturing. We expect the recent launch of our new no-code meter systems to continue to have a negative impact on our gross margins in 2009 as we continue to build an installed base of users.

Our selling, general and administrative expenses include sales and marketing expenses, legal and regulatory costs, customer and technical service, finance and administrative expenses and stock-based compensation expenses. We have been involved in patent related litigation concerning certain of our products. Our legal costs (excluding litigation settlements), which were 3.4%, 2.2% and 1.1% of net sales in 2006, 2007 and 2008, respectively, can be significant, and the timing difficult to predict. Our selling, general and administrative expenses have increased for costs associated with being a publicly traded company, including accounting and auditing, legal, insurance, director compensation, Sarbanes-Oxley compliance and other costs. In addition, our SG&A has increased due to marketing cost associated with the launch of new products.

We have made significant investments in our research and development initiatives. Our research and development costs have generally been in the range of 7.0% to 8.0% of our net sales and include salaries and related costs for our scientists and staff as well as costs for clinical studies, materials, consulting and other third-party services. Our research and development team is working to develop new technologies that we believe will broaden our product portfolio and enhance our current products.

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Results of operations

The following table sets forth, for the periods indicated, certain information related to our operations, expressed in dollars and as a percentage of our net sales:

	Years Ended December 31,
	2006					2007					2008
	(In thousands, except for per share data)
Net sales	$	112,628		100.0	%	$	115,601		100.0	%	$	123,582		100.0	%
Cost of sales		44,287		39.3	%		45,555		39.4	%		52,345		42.4	%
Gross profit		68,341		60.7	%		70,046		60.6	%		71,237		57.6	%
Operating expenses:
Selling, general and administrative		42,603		37.8	%		46,827		40.5	%		51,448		41.6	%
Research and development		8,230		7.3	%		8,928		7.7	%		8,635		7.0	%
Litigation settlement, net of recoveries		3,000		2.7	%		3,050		2.7	%		—		0.0	%
Total operating expenses		53,833		47.8	%		58,805		50.9	%		60,083		48.6	%
Income from operations		14,508		12.9	%		11,241		9.7	%		11,154		9.0	%
Change in fair value of warrant put option		(59	)	(0.0	)%		—		0.0	%		—		0.0	%
Interest income, net		(167	)	(0.1	)%		(1,656	)	(1.4	)%		(1,002	)	(0.8	)%
Other expense (income), net		44		0.0	%		(119	)	(0.1	)%		447		0.4	%
Income before income taxes		14,690		13.0	%		13,016		11.3	%		11,709		9.4	%
Provision for income taxes		4,381		3.8	%		3,388		3.0	%		2,065		1.7	%
Net income	$	10,309		9.2	%	$	9,628		8.3	%	$	9,644		7.7	%

Year ended December 31, 2008 as compared to year ended December 31, 2007

Net sales increased $8.0 million, or 6.9%, to $123.6 million for the year ended December 31, 2008, as compared to $115.6 million in 2007. The increase was due to higher sales volume of approximately $16.8 million, or 14.5%, partially offset by lower average selling prices of $7.4 million, or 6.4%, and increased managed care and other rebates of $1.4 million, or 1.2%. The increased volume of $16.8 million reflects the continued trend of increased distribution of our biosensor systems totaling approximately $22.7 million, partially offset by a decrease in our photometric system and other sales of approximately $5.9 million. The decrease in our average selling prices of $7.4 million was primarily due to price compression and volume based test strip pricing incentives within our mail service and domestic distribution channel. The increase in managed care rebates was due primarily to increased utilization within the third-party payor environment of our products.

Cost of sales increased $6.8 million, or 14.9%, to $52.3 million for the year ended December 31, 2008, as compared to $45.6 million for the same period in 2007. This $6.8 million increase was driven primarily by increased sales volume of $5.3 million and increased product manufacturing costs of $1.5 million. Increased product manufacturing costs were primarily associated with scaling our manufacturing process to launch the TRUEresult and TRUE2go biosensor systems as well as higher scrap and other costs related to our other biosensor test strip products. As a percentage of net sales, cost of sales increased to 42.4% for the year ended December 31, 2008, as compared to 39.4% for the same period in 2007. This 3.0% increase was due primarily to decreases in average selling prices which contributed 2.4%, increased product manufacturing costs which contributed 1.2% and increased managed care and other rebates which contributed 0.4%, offset by increases in the strip to meter ratio which contributed 1.0%.

Gross profit increased $1.2 million, or 1.7%, to $71.2 million for the year ended December 31, 2008, as compared to $70.0 million in 2007. The increase is due to higher sales volume of $11.5 million, partially offset by lower average selling prices of $7.4 million, increased product manufacturing costs of $1.5 million

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and increased managed care and other rebates of $1.4 million. As a percentage of net sales, gross profit decreased to 57.6% for the year ended December 31, 2008, as compared to 60.6% in 2007. The decrease in gross profit percentage is due to the increase in cost of sales as a percentage of net sales, as noted above.

Selling, general and administrative expenses increased $4.6 million, or 9.9%, to $51.4 million for the year ended December 31, 2008, as compared to $46.8 million in 2007. The increase is primarily due to an increase of $3.4 million in salaries and benefits related to increased sales and marketing and administrative personnel and higher sales and marketing costs of $3.2 million related primarily to increased advertising and promotions, including new product launch costs for TRUEresult and TRUE2go. These increases were partially offset by reduced overall legal costs of $1.1 million associated with the settlement of the Roche litigation and other corporate matters and a $1.1 million decrease associated with other professional fees. As a percentage of net sales, selling, general and administrative expenses increased to 41.6% as compared to 40.5% for the years ended December 31, 2008 and 2007, respectively. This increase was primarily due to higher salaries and benefits and higher sales and marketing costs partially offset by decreased legal and other professional fees, as described above.

Research and development expenses decreased $0.3 million, or 3.3%, to $8.6 million for the year ended December 31, 2008, as compared to $8.9 million in 2007. As a percentage of net sales, research and development costs were 7.0%, as compared to 7.7% for the years ended December 31, 2008 and 2007 respectively.

Litigation settlement expenses, net of recoveries were $3.0 million in 2007, primarily related to a $3.5 million patent litigation settlement with Roche, partially offset by $0.5 million in insurance proceeds relating to a recovery of losses incurred in the Brandt matter, which was settled in December 2006 (see note 16).

Operating income was $11.2 million, for each of the years ended December 31, 2008 and 2007 respectively. Operating income as a percentage of net sales decreased to 9.0% for the year ended December 31, 2008, as compared to 9.7% in 2007. The decrease in operating income as a percentage of sales was due to increased cost of sales and operating expenses, partially offset by overall sales growth, noted above.

Interest income was $1.0 million for the year ended December 31, 2008 as compared to $1.7 million for the same period in 2007. Interest income consists primarily of earnings on cash balances on hand during the period. The decrease is primarily due to transferring certain cash balances into lower pre-tax yielding tax exempt money market funds in order to maximize after tax investment returns and overall lower interest rates resulting in reduced interest income. There were no borrowings or outstanding amounts under our revolving credit facility at December 31, 2008 and December 31, 2007, respectively. See Liquidity and Capital Resources below.

Our effective tax rate for the years ended December 31, 2008 and 2007 was 17.7% and 26.0%, respectively. The effective tax rate for year ended December 31, 2008 was lower than the statutory federal rate (35%), primarily due to the reversal of previously accrued taxes resulting from the favorable resolution of various tax matters with the Internal Revenue Service and the reversal of certain tax contingencies for which the statute of limitations expired in 2008, which contributed to 8.5% of the decrease; and the research and development tax credit, which contributed to 4.5% of the decrease. The effective tax rate for the year ended December 31, 2007 was lower than the statutory federal rate (35%), primarily due to research and development tax credits, which contributed to 4.6% of the decrease and disqualifying dispositions on incentive stock options, which contributed to 3.2% of the decrease.

Net income was $9.6 million for each of the years ended December 31, 2008 and 2007. Litigation settlements reduced net income by $1.8 million, net of income taxes, for the year ended December 31, 2007.

Diluted net income per common share was $0.51 on weighted average shares of 18.8 million for the year ended December 31, 2008, as compared to $0.49 on weighted average shares of approximately 19.6 million in 2007.

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Year ended December 31, 2007 as compared to year ended December 31, 2006

Net sales increased $3.0 million, or 2.6%, to $115.6 million for the year ended December 31, 2007, as compared to $112.6 million in 2006. The increase was due to higher sales volume of $6.8 million, or 6.0%, partially offset by lower average selling prices of $2.5 million, or 2.2%, and increased managed care and other rebates of $1.3 million, or 1.2%. The increased volume of $6.8 million reflects the continued trend of increased distribution of our biosensor systems totaling approximately $17.5 million, partially offset by a decrease in our photometric system and other sales of approximately $10.7 million. The decrease in our average selling prices of $2.5 million was primarily due to a shift in our revenue mix driven by increased international and mail service volume and shifts in customer and product mix within our domestic distribution channel. The increase in managed care rebates was due primarily to increased awareness and acceptance within the third-party payor environment of our products.

Cost of sales increased $1.3 million, or 2.9%, to $45.6 million for the year ended December 31, 2007, as compared to $44.3 million in 2006. This $1.3 million increase was primarily due to increased costs of $2.2 million associated with higher sales volume and $1.7 million of costs associated with increased distribution of free monitors for managed care and other initiatives, partially offset by product cost savings of $2.6 million which relate to reduced manufacturing costs primarily related to test strips. As a percentage of net sales, cost of sales increased slightly to 39.4% for the year ended December 31, 2007, as compared to 39.3% in 2006. Increases in the distribution of free monitors, increased managed care rebates and lower average selling prices which contributed 2.5%, were offset by cost savings which contributed 2.4%.

Gross profit increased $1.7 million, or 2.5%, to $70.0 million for the year ended December 31, 2007, as compared to $68.3 million in 2006. The increase is due to higher sales volume of $4.6 million and product cost savings of $2.6 million, partially offset by $1.7 million associated with increased distribution of free monitors, lower average selling prices of $2.5 million and increased managed care rebates of $1.3 million. As a percentage of net sales, gross profit decreased slightly to 60.6% for the year ended December 31, 2007, as compared to 60.7% in 2006. The decrease in gross profit percentage is due to the increase in cost of sales as a percentage of net sales, as noted above.

Selling, general and administrative expenses increased $4.2 million, or 9.9%, to $46.8 million for the year ended December 31, 2007, as compared to $42.6 million in 2006. The increase is primarily due to an increase of $0.7 million in salaries and benefits related to increased sales and administrative personnel to support our continued growth, increased professional fees associated with being a publicly traded company of $1.4 million, higher sales and marketing costs of $2.8 million to support managed care related and other strategic sales growth initiatives as well as to support various customer related advertising and promotion programs, increased rent expense of $0.4 million to support expansion of our manufacturing and corporate office space and $0.5 million in other general and administrative expenses associated with supporting the continuing growth of our operations. These increases were partially offset by decreased legal costs of $1.6 million related to settlements of certain litigation matters during 2007. As a percentage of net sales, selling, general and administrative expenses increased to 40.5%, as compared to 37.8% for the years ended December 31, 2007 and 2006, respectively. This increase was primarily due to higher sales and marketing costs and increased professional fees, partially offset by decreased legal fees, as described above.

Research and development expenses increased $0.7 million, or 8.5%, to $8.9 million for the year ended December 31, 2007, as compared to $8.2 million in 2006. As a percentage of net sales, research and development costs were 7.7%, as compared to 7.3% for the years ended December 31, 2007 and 2006, respectively. The increase is primarily due to increased clinical trials associated with new product development.

Litigation settlement expenses, net of recoveries were $3.0 million in 2007, primarily related to a $3.5 million patent litigation settlement with Roche, partially offset by $0.5 million in insurance proceeds relating to a recovery of losses incurred in the Brandt matter which was settled in December 2006 (See Note 16). Litigation settlement expenses, net of recoveries were $3.0 million in 2006 and related to an accrual for the estimated settlement for litigation brought by Leonard Brandt in 2001 against us and two of our principal shareholders (See Note 16).

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Operating income was $11.2 million, or 9.7% of net sales for the year ended December 31, 2007, as compared to $14.5 million, or 12.9% of net sales, in 2006. The decrease in operating income in aggregate dollars and as a percentage of sales was due to higher operating expenses, partially offset by overall sales growth, noted above.

The adjustment to the fair value of the Warrant Put Option through our September 2006 the initial public offering (“IPO”) resulted in income of $58,700 for the year ended December 31, 2006.

Interest income increased from $0.2 million for the year ended December 31, 2006 to $1.7 million for the year ended December 31, 2007. The increase of $1.5 million was due to interest earned on higher average cash balances during the year ended December 31, 2007, as compared to 2006, related primarily to the net proceeds from the IPO and cash generated from operations. See“Liquidity and Capital Resources”below.

Our effective tax rate for the years ended December 31, 2007 and 2006 was 26.0% and 29.8%, respectively. The decrease in the effective rate was primarily due to disqualifying dispositions on incentive stock options. The effective tax rate for year ended December 31, 2006 was lower than the statutory federal rate (35%), primarily as a result of research and development tax credits.

Net income decreased to $9.6 million for the year ended December 31, 2007, as compared to $10.3 million in 2006. The decrease in net income for the year ended December 31, 2007 was due primarily to increased selling general and administrative expenses, partially offset by higher gross profit, interest income and the reduction in the effective tax rate, noted above. Litigation settlements, net reduced net income by $1.8 million and $2.8 million for the years ended December 31, 2007 and 2006, respectively.

Diluted net income per common share was $0.49 on weighted average shares of 19.6 million for the year ended December 31, 2007, as compared to $0.59 on weighted average shares of 17.4 million in 2006.

Liquidity and capital resources

On December 31, 2008, we had approximately $30.4 million of cash and cash equivalents on hand and $10.0 million of capacity under our unsecured revolving line of credit. Our primary capital requirements are to fund capital expenditures and fund common stock repurchases under our Board of Directors approved Common Stock Repurchase Program, as described below. Significant sources of liquidity are cash on hand, cash flows from operating activities, working capital and borrowings from our revolving line of credit.

Under our Fifth Amended and Restated Revolving Credit Agreement (the “Credit Facility”), we have a $10.0 million unsecured revolving line of credit (the “Revolver”) which matures on April 30, 2009. At December 31, 2008, there was no outstanding balance under the Revolver. Borrowings under the Credit Facility bear interest at the London Interbank Offered Rate or LIBOR plus 0.5%. Our Credit Facility contains a financial covenant and other covenants that restrict our ability to, among other things, incur liens, repurchase greater than $5.5 million of our common stock any calendar year and participate in a change in control. Our financial covenant requires us to maintain a ratio of total liabilities to tangible net worth of not more than 1.0 to 1.0. Failure to comply with this covenant and other restrictions would constitute an event of default under our Credit Facility. We believe we were in compliance with the financial covenant and other restrictions applicable to us under the Credit Facility at December 31, 2008.

In 2008, the Company completed two Board of Directors approved Common Stock Repurchase Programs (the “Common Stock Repurchase Program”) by repurchasing approximately 1.2 million shares of its common stock at an aggregate cost of $10.0 million, since August 2007. During the year ended December 31, 2008, the Company repurchased approximately 660,000 shares at a cost of approximately $5.5 million. During the year ended December 31, 2007, the Company repurchased approximately 505,000 shares at a cost of approximately $4.5 million. All purchases under the Common Stock Repurchase Program were made in the open market, subject to market conditions and trading restrictions. In December 2008, the Company’s Board of Directors authorized the Company under a new repurchase program to purchase $5.0 million of its common stock. Purchases under this program began in January 2009. As of March 8, 2009, the Company repurchased 317,000 shares at a cost of approximately $2.0 million.

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Cash flows provided by operating activities were approximately $11.1 million, $16.5 million and $15.5 million for the years ended December 31, 2006, 2007 and 2008, respectively. The decrease in cash provided by operating activities in 2008 as compared to 2007 was due to the continued investment in inventory associated with the launch of our new TRUEresult and TRUE2Go biosensor systems.

Cash flows used in investing activities were approximately $8.6 million, $8.7 million and $13.1 million for the years ended December 31, 2006, 2007 and 2008, respectively. These amounts consist primarily of capital expenditures including manufacturing equipment for our new TRUEtest strip platform which was launched in September 2008, deposits related to our expansion described below and additional manufacturing equipment used on our existing biosensor test strip manufacturing line. In order to meet the expected long term demand for our new TRUEtest platform, our Board of Directors, in August 2008 approved a plan to expand capacity. The expansion is expected to cost approximately $16 million to $18 million for custom manufacturing equipment and facility improvements, of which $7.1 million was spent in 2008. We have open purchase commitments totaling approximately $9.3 million for this expansion. We believe this new equipment will be fully operational in early 2010. We expect our full year 2009 capital expenditures to be in the range of $16 million to $19 million, including approximately $11 million related to the expansion.

Cash flows provided by (used in) financing activities were $20.0 million, ($1.6) million and ($4.2) million for the years ended December 31, 2006, 2007 and 2008, respectively. Cash flows used in financing activities in 2008 include $5.5 million used to repurchase shares of our common stock under our $10.0 million Common Stock Repurchase Program, offset by proceeds of $1.0 million from the exercise of stock options. Cash flows used in financing activities in 2007 include $4.5 million used to repurchase shares of our common stock under our Common Stock Repurchase Program , offset by proceeds of $3.0 million from the exercise of stock options. Cash flows provided by financing activities in 2006 include IPO proceeds of $35.1 million, offset by payments to redeem our preferred stock of $10.4 million and debt repayments of $5.1 million. At December 31, 2007 and 2008, there was no outstanding balance under the Revolver.

On September 26, 2006, we completed an IPO of 6,599,487 shares of common stock at a price of $12.00 per share, 3,300,000 of which were sold by us and the remainder by selling stockholders. We received net proceeds after underwriting discounts and offering expenses of approximately $35.1 million. We used $10.4 million of the net proceeds of the offering to redeem all the Series F Preferred Stock outstanding, $2.0 million to repay outstanding indebtedness and $4.8 million for manufacturing equipment for new product development. The redemption of the preferred stock resulted in a dividend charge to stockholders’ equity of $9.2 million. In addition, the holder of a warrant to purchase our common stock exercised its registration rights and exchanged the warrant for 614,303 shares of common stock. These shares were sold at $12 per share in connection with the IPO for a total of $7.4 million which is reflected in stockholders’ equity at December 31, 2006. On October 2, 2006, the underwriters on our IPO, exercised their over-allotment option to purchase 989,923 additional shares of common stock from certain selling stockholders at the public offering price of $12 per share. We did not issue any new shares of common stock or receive any proceeds from the sale of the over-allotment shares.

We expect that funds generated from operations, our current cash on hand and funds available under our revolving line of credit, which expires in April 2009 and is expected to be renewed at maturity, will be sufficient to finance our working capital requirements, fund capital expenditures, and meet our contractual obligations for at least the next twelve months.

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Contractual obligations

At December 31, 2008, we had the following contractual obligations and commitments:

	Payments Due
			Less than
Obligation(1)	Total		1 year		1-3 years		4-5 years		Thereafter
	(In thousands)
Operating leases	$	10,587	$	2,669	$	5,091	$	2,827	$	—
Purchase obligations		9,324		9,324		—		—		—
Future pension benefit payments		406		1		13		81		311
	$	20,317	$	11,994	$	5,104	$	2,908	$	311

(1) Amounts exclude certain income tax contingencies of approximately $0.7 million for which the timing of payments is not determinable.

Off-balance sheet arrangements

At December 31, 2008, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, sales or expenses, results of operations, liquidity, capital expenditures or capital resources.

Application of critical accounting policies and estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions that affect the reporting of assets, liabilities, sales and expenses, and the disclosure of contingent assets and liabilities. Note 2 to our consolidated financial statements provides a summary of our significant accounting policies, which are all in accordance with generally accepted accounting principles in the United States. Certain of our accounting policies are critical to understanding our consolidated financial statements, because their application requires management to make assumptions about future results and depends to a large extent on management’s judgment, because past results have fluctuated and are expected to continue to do so in the future.

We believe that the application of the accounting policies described in the following paragraphs is highly dependent on critical estimates and assumptions that are inherently uncertain and highly susceptible to change. For all these policies, we caution that future events rarely develop exactly as estimated, and the best estimates routinely require adjustment. On an ongoing basis, we evaluate our estimates and assumptions, including those discussed below.

Revenue recognition.  Revenue from sales of products is recognized when: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the sale price is fixed or determinable, and (4) collection of the related receivable is reasonably assured. We recognize revenue from product sales when goods are shipped or delivered and title and risk of loss pass to the customer. We generally arrange for the shipment of customer orders and it is our general business practice to replace products that may be damaged or lost while in transit at no additional cost to the customer. Therefore, revenue is generally recognized when goods are received by our customers.

We accept product returns primarily due to the expiration of product life. Revenue is recorded net of an allowance for estimated returns. We estimate returns based on an analysis of historical sales and returns, analyzing the actual return date of the product as compared to the original date of sale of the product. We have estimated based on historical return experience that a reserve is required for future returns covering the prior 18 to 24 months of sales, driven primarily by the 18 to 24 month expiration of our test strip products. Products that exhibit unusual sales or return patterns due to dating or other matters are specifically identified and analyzed as part of the accounting for sales return accruals.

We offer volume discount incentives to certain of our customers, which are recorded as a reduction of revenue in the same period as the revenue is earned. We also have reimbursement agreements with certain

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managed care providers, Medicaid programs and other third-party payors that require payment of rebates for products provided to their members. We accrue for these rebates as a reduction of revenue, at the time of sale. The determination of the rebate allowance is based on the reimbursement agreements as well as historical payment trends to these providers. We also offer meters, at no charge, to customers and third-party payors. The cost of these meters is recorded in cost of sales in the period the products are shipped.

We arrange with certain of our customers upfront cash payments to secure the right to distribute through those customers. We capitalize these payments, provided the payments are supported by a time or volume based arrangement with a retailer, and amortize the associated payment over the appropriate time or volume based term of the arrangement.

Long-lived and other intangible assets.  We periodically review our property and equipment and identifiable intangible assets for possible impairment whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of long-lived and other intangible assets, which could result in impairment charges in future periods. Significant assumptions and estimates include the projected cash flows based upon estimated revenue and expense growth rates and the discount rate applied to expected cash flows. In addition, our depreciation and amortization policies reflect judgments on the estimated useful lives of assets. Intangible assets that have finite useful lives continue to be amortized on a straight-line basis over their estimated useful lives.

Goodwill.  Goodwill represents the excess of the purchase price over the fair value of assets acquired net of liabilities assumed in a purchase business combination. We periodically evaluate acquired businesses for potential impairment indicators. Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and the operational performance of our business. We carry out an annual impairment review of goodwill unless an event occurs which triggers the need for an earlier review. Future events could cause us to conclude that impairment indicators exist and that goodwill associated with our business is impaired. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we test goodwill for impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. In determining the fair value, we utilize discounted future cash flows. Significant estimates used in the fair value calculation utilizing discounted future cash flows include, but are not limited to: (i) estimates of future revenue and expense growth; (ii) estimated average cost of capital; and (iii) the future terminal value of our reporting unit, which is based upon its ability to exist into perpetuity. The test for goodwill impairment requires significant estimates and judgment about future performance, cash flows and fair value. Our future results could be affected if our estimates of future performance and fair value change. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations. We completed our annual test during the quarter ended December 31, 2008 and no impairment charge resulted.

Contingencies.  We accrue for estimated losses from legal actions or claims when events exist that make the realization of the losses probable and the losses can be reasonably estimated. We analyze our litigation claims based on currently available information to assess potential liability. We develop our estimates of litigation costs in consultation with outside counsel handling our defense in these matters, which involves an analysis of potential results assuming a combination of litigation and settlement strategies. These estimates involve significant judgment based on the facts and circumstances of each case. Our future results could be affected if our estimated loss accruals, if any, are below the actual costs incurred. Any resulting loss could have a material adverse impact on our financial condition and results of operations. As disclosed in Note 16 to our consolidated financial statements included elsewhere in this Annual Report, we settled in 2007, litigation involving alleged patent infringement and other matters.

Stock-based compensation.  We adopted the provisions of SFAS No. 123R, “Share Based Payment,” or SFAS 123R, in the first quarter of 2006. This statement requires us to expense the cost of employee services received in exchange for an award of equity instruments, including stock options. This statement also provides guidance on valuing and expensing these awards, as well as disclosure requirements with respect to these equity arrangements. Under the provisions of SFAS 123R, we have estimated the fair value of new stock option grants using the Black-Scholes option-pricing model with assumptions for expected volatility, expected

40

life, risk-free interest rate and dividend yield. Significant changes in these assumptions could materially affect our operating results and financial position.

In accordance with SFAS 123R, we measure the cost of employee services received in exchange for equity-based awards based on grant date fair value. Pre-vesting forfeitures are estimated at the time of grant are periodically revised in subsequent periods if actual forfeitures differ from those estimates. Equity-based compensation is only recognized for equity-based awards expected to vest.

Income taxes.  We recognize our provision for income taxes at the applicable U.S. or international tax rates. Deferred income taxes are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are also established for the future tax benefits of loss and credit carryovers. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when it is more likely than not that such amounts will not be realized. U.S. income taxes have not been provided on undistributed earnings of foreign subsidiaries since it is management’s intention to utilize those earnings in the foreign operations for an indefinite period of time.

We account for income tax uncertainties under FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109” (“FIN 48”), which provides guidance on the recognition, de-recognition and measurement of potential tax benefits associated with tax positions. We recognize interest and penalties relating to income tax matters as a component of income tax expense.

As of December 31, 2008, we had unrecognized tax benefits of $0.6 million. It is reasonably possible that the total amount of unrecognized tax benefits may decrease by an immaterial amount within the next twelve months resulting from the expiration of the statute of limitations of certain tax years.

Recent accounting pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), Business Combinations (SFAS 141(R)) which replaces SFAS No. 141, Business Combinations (SFAS 141). SFAS 141(R)’s scope is broader than that of SFAS 141, which applied only to business combinations in which control was obtained by transferring consideration. SFAS 141(R) applies to all transactions and other events in which one entity obtains control over one or more other businesses. The standard requires the fair value of the purchase price, including the issuance of equity securities, to be determined on the acquisition date. SFAS 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interests in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the statement. SFAS 141(R) requires acquisition costs to be expensed as incurred and restructuring costs to be expensed in periods after the acquisition date. Earn-outs and other forms of contingent consideration are to be recorded at fair value on the acquisition date. Changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period will be recognized in earnings rather than as an adjustment to the cost of the acquisition. SFAS 141(R) generally applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 with early adoption prohibited. We do not expect the adoption of SFAS 141(R)to have a material effect on our future results of operations or financial position.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (SFAS 160). SFAS 160 requires non-controlling interests or minority interests to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. Upon a loss of control, the interest sold, as well as any interest retained, is required to be measured at fair value, with any gain or loss recognized in earnings. Based on SFAS 160, assets and liabilities will not change for subsequent purchase or sale transactions with non-controlling interests as long as control is maintained. Differences between the fair value of consideration paid or received and the carrying value of non-controlling interests are to be recognized as an adjustment to the parent interest’s equity. SFAS 160 is effective

41

for fiscal year beginning on or after December 15, 2008. Earlier adoption is prohibited. We do not expect the adoption of SFAS 160 to have a material effect on our future results of operations or financial position.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — An Amendment of SFAS No. 133” (“SFAS 161”). SFAS 161 seeks to improve financial reporting for derivative instruments and hedging activities by requiring enhanced disclosures regarding the impact on financial position, financial performance, and cash flows. To achieve this increased transparency, SFAS 161 requires (1) the disclosure of the fair value of derivative instruments and gains and losses in a tabular format; (2) the disclosure of derivative features that are credit risk-related; and (3) cross-referencing within the footnotes. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We do not expect the adoption of SFAS No. 161 to have a material effect on our future results of operations or financial position.

In October 2008, the FASB issued FSPNo. FAS 157-3,Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active(FSPFAS 157-3). This FSP clarifies the definition of fair value by stating that a transaction price is not necessarily indicative of fair value in a market that is not active or in a forced liquidation or distressed sale. The guidance in FSPFAS 157-3 was effective immediately upon issuance on Oct. 10, 2008, including prior periods for which financial statements have not been issued. Our fair value measurements are based upon Level 1 and Level 2 observable inputs and therefore the adoption of FSPFAS 157-3 did not impact our results of operations or financial position.

Seasonality

Our quarterly sales and operating results may vary significantly from quarter to quarter as a result of seasonal variations in demand. Historically, sales are highest during the third quarter as a result of trade shows held by large domestic distributors. First quarter sales are typically the lowest due to the start of new deductible periods under health plans.

Item 7A.   Quantitative and Qualitative Disclosures About Market Risk

Our Credit Facility is subject to market risk and interest rate changes. The Revolver under the Credit Facility bears interest at LIBOR plus 0.50%. At December 31, 2008, we did not have any borrowings outstanding under our Revolver.

Certain of our operations are domiciled outside the U.S., and we translate the results of operations and financial condition of these operations from their local functional currencies into U.S. dollars. Therefore, our reported consolidated results of operations and consolidated financial condition are affected by changes in the exchange rates between these currencies and the U.S. dollar. Assets and liabilities of foreign operations have been translated from the functional currencies of our foreign operations into U.S. dollars at the exchange rates in effect at the relevant balance sheet date, and revenue and expenses of our foreign operations have been translated into U.S. dollars at the average exchange rates prevailing during the period. Unrealized gains and losses on translation of these foreign operations into U.S. dollars are reported as a separate component of stockholders’ equity and are included in comprehensive income (loss). Monetary assets and liabilities denominated in U.S. dollars held by our foreign operations are re-measured from U.S. dollars into the functional currency of our foreign operations with the effect reported currently as a component of net income. For the years ended December 31, 2008 and 2007, we estimate that a 10% increase or decrease in the relationship of the functional currencies of our foreign operations to the U.S. dollar would increase or decrease our net income by approximately $0.3 million respectively. In April 2008, the Company entered into a Non-Deliverable Forward (“NDF”) contract for a notional amount of $4.0 million to reduce exposure of foreign currency fluctuations on transactions with it’s foreign subsidiary in Taiwan. The NDF contract matures in February 2009. At December 31, 2008, the fair value of the NDF is estimated to be a liability of approximately $0.3 million. Fair value of the NDF is estimated based on observable inputs for the current NDF forward rates for similar contracts. We estimate that a 10.0% increase or decrease in the NDF forward would increase or decrease our net income by approximately $0.2 million, offsetting the impact of foreign currency market risk described above.

42

Item 8.   Financial Statements and Supplementary Data

HOME DIAGNOSTICS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Report of Independent Registered Certified Public Accounting Firm		44
Consolidated Balance Sheets as of December 31, 2008 and 2007		45
Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007 and 2006		46
Consolidated Statement of Changes in Stockholders’ Equity for the Years Ended December 31, 2008, 2007 and 2006		47
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006		48
Notes to Consolidated Financial Statements		49

43

Report of Independent Registered Certified Public Accounting Firm

To the Board of Directors and Stockholders of

Home Diagnostics, Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, changes in stockholders’ equity and other comprehensive income and of cash flows present fairly, in all material respects, the financial position of Home Diagnostics, Inc. and its subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the Report of Management on Internal Control over Financial Reporting, appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our audits (which were integrated audits in 2008 and 2007). 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 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.

As discussed in Note 14 to the consolidated financial statements, the Company changed the manner in which it accounts for uncertain income taxes in 2007.

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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.

PricewaterhouseCoopers LLP

Fort Lauderdale, Florida

March 10, 2009

44

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2007 and 2008

	December 31,		December 31,
	2007		2008
ASSETS
Current assets:
Cash and cash equivalents	$	32,695,803	$	30,366,785
Accounts receivable, net		18,313,519		18,698,486
Inventory		12,379,668		17,131,156
Prepaid expenses and other current assets		1,013,025		1,683,658
Income taxes receivable		1,241,171		1,082,423
Deferred tax asset		4,669,774		4,316,688
Total current assets		70,312,960		73,279,196
Property and equipment, net		22,560,335		31,547,776
Goodwill		35,573,462		35,573,462
Other intangible assets, net		660,776		363,245
Deferred tax asset		1,004,638		439,865
Other assets, net		138,866		136,157
Total assets	$	130,251,037	$	141,339,701
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,103,535	$	7,746,180
Accrued liabilities		18,048,079		21,527,560
Total current liabilities		24,151,614		29,273,740
Commitments and contingencies (Note 16)
Stockholders’ equity:
Common stock, $.01 par value; 60,000,000 shares authorized; 17,878,691 and 17,482,144 shares issued and outstanding at December 31, 2007 and 2008, respectively		178,787		174,822
Additional paid-in capital		95,017,973		94,033,346
Retained earnings		10,858,415		18,568,582
Accumulated other comprehensive income (loss)		44,248		(710,789	)
Total stockholders’ equity		106,099,423		112,065,961
Total liabilities and stockholders’ equity	$	130,251,037	$	141,339,701

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

45

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

Years Ended December 31, 2006, 2007 and 2008

	2006			2007			2008
Net sales	$	112,628,368		$	115,601,256		$	123,582,443
Cost of sales		44,287,167			45,555,532			52,344,998
Gross profit		68,341,201			70,045,724			71,237,445
Operating expenses
Selling, general and administrative (including stock- based compensation expense of $1,176,627 in 2006 $1,146,984 in 2007 and $1,294,348 in 2008)		42,603,110			46,826,377			51,448,324
Research and development		8,229,913			8,927,969			8,635,081
Litigation settlement, net of recoveries		3,000,000			3,050,000			—
Total operating expenses		53,833,023			58,804,346			60,083,405
Income from operations		14,508,178			11,241,378			11,154,040
Other income (expense)
Change in fair value of warrant put option		58,700			—			—
Interest income, net		167,153			1,655,580			1,002,181
Other income (expense), net		(44,262	)		119,510			(447,411	)
Total other income		181,591			1,775,090			554,770
Income before provision for income taxes		14,689,769			13,016,468			11,708,810
Provision for income taxes		(4,380,340	)		(3,388,460	)		(2,064,372	)
Net income	$	10,309,429		$	9,628,008		$	9,644,438
Earnings per common share:
Basic	$	0.70		$	0.54		$	0.54
Diluted	$	0.59		$	0.49		$	0.51
Weighted average shares used in computing earnings per common share:
Basic		14,811,424			17,953,336			17,707,484
Diluted		17,373,401			19,574,305			18,751,483

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

46

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Stockholders’ Equity

Years Ended December 31, 2006, 2007 and 2008

										Retained			Accumulated
	Common Stock						Additional			Earnings			Other						Total
	Number of						Paid-in			(Accumulated			comprehensive			Treasury			Stockholders’
	shares			Amount			Capital			Deficit)			Income (Loss)			Stock			Equity
Balance at December 31, 2005		14,708,212		$	147,082		$	49,252,021			$435,394		$	(224,531	)	$	(464,262	)	$	49,145,704
Stock-based compensation expense		—			—			1,176,627			—			—			—			1,176,627
Exchange of warrant put option		614,303			6,143			7,365,501			—			—			—			7,371,644
Issuance of common stock, net		3,300,000			33,000			35,072,684			—			—			—			35,105,684
Issuance of common shares in distribution of deferred compensation obligation		22,418			224			228,116			—			—			—			228,340
Redemption of mandatorily redeemable preferred stock		—			—			(1,515,243	)		(7,703,797	)		—			—			(9,219,040	)
Stock options and warrants exercised, including tax benefit of $91,829		98,431			984			340,513			—			—			—			341,497
Deemed contribution from stockholders		—			—			2,400,000			—			—			—			2,400,000
Treasury stock retired		(1,045,673	)		(10,456	)		(353,156	)		(100,650	)		—			464,262			—
Comprehensive income:
Foreign currency translation adjustment		—			—			—			—			446,149			—			446,149
Net income		—			—			—			10,309,429			—			—			10,309,429
Total comprehensive income		—			—			—			—			—			—			10,755,578
Adoption of SFAS No. 158, net of tax		—			—			—			—			(193,411	)		—			(193,411	)
Balance at December 31, 2006		17,697,691			176,977			93,967,063			2,940,376			28,207			—			97,112,623
Stock-based compensation expense		—			—			1,146,984			—			—			—			1,146,984
Cumulative effect of change in accounting for uncertanities in income taxes (Note 14)		—			—			—			89,282			—			—			89,282
Deemed capital distribution to stockholders		—			—			(300,000	)		—			—			—			(300,000	)
Stock options and warrants exercised, including tax benefit of $719,219		686,068			6,861			2,906,192			—			—			—			2,913,053
Repurchases of common stock		(505,068	)		(5,051	)		(2,702,266	)		(1,799,251	)		—			—			(4,506,568	)
Comprehensive income:
Foreign currency translation adjustment		—			—			—			—			16,041			—			16,041
Net income		—			—			—			9,628,008			—			—			9,628,008
Total comprehensive income		—			—			—			—			—			—			9,644,049
Balance at December 31, 2007		17,878,691			178,787			95,017,973			10,858,415			44,248			—			106,099,423
Stock-based compensation expense		—			—			1,294,349			—			—			—			1,294,349
Stock options exercised, including tax benefit of $280,074		263,176			2,632			1,273,585			—			—			—			1,276,217
Repurchases of common stock		(659,723	)		(6,597	)		(3,552,561	)		(1,934,271	)		—			—			(5,493,429	)
Comprehensive income:
Foreign currency translation adjustment		—			—			—			—			(553,173	)		—			(553,173	)
Net change in pension liability														(201,864	)					(201,864	)
Net income		—			—			—			9,644,438			—			—			9,644,438
Total comprehensive income		—			—			—			—			—			—			8,889,401
Balance at December 31, 2008		17,482,144		$	174,822		$	94,033,346			$18,568,582		$	(710,789	)	$	—		$	112,065,961

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

47

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years Ended December 31, 2006, 2007 and 2008

	2006			2007			2008
Cash flows from operating activities
Net income	$	10,309,429		$	9,628,008		$	9,644,438
Adjustments to reconcile net income to net cash provided by operations Depreciation and amortization		4,403,977			3,936,175			4,360,439
Amortization of deferred financing and costs		65,026			8,626			—
Loss on asset disposal		54,892			41,446			106,909
Bad debt expense		89,448			48,263			30,000
Non-cash impact of insurance proceeds		—			(300,000	)		—
Deferred income taxes		(2,079,086	)		(690,724	)		917,859
Change in fair value of warrant put option		(58,700	)		—			—
Stock-based compensation expense		1,176,627			1,146,984			1,294,349
Change in pension liability		—			—			(201,864	)
Accrual of litigation settlement		3,000,000			—			—
Changes in assets and liabilities:
Accounts receivable		(4,792,446	)		(1,351,311	)		(409,312	)
Inventories		2,589,580			8,812			(4,796,280	)
Prepaid expenses and other current and non-current assets		(447,420	)		(103,742	)		(673,446	)
Income taxes receivable and curreny income taxes payable		(3,364,936	)		987,845			158,748
Accounts payable		(1,061,529	)		(99,195	)		1,642,646
Accrued liabilities		1,250,764			3,197,018			3,387,702
Net cash provided by operating activities		11,135,626			16,458,205			15,462,188
Cash flows from investing activities
Capital expenditures		(8,573,154	)		(8,668,474	)		(13,075,691	)
Net cash used in investing activities		(8,573,154	)		(8,668,474	)		(13,075,691	)
Cash flows from financing activities
Repayment of term loans and notes payable		(3,749,866	)		—			—
Repayment of notes payable to related party		(1,300,000	)		—			—
Payment of debt financing costs		(4,700	)		(4,317	)		—
Redemption of mandatorily redeemable preferred stock		(10,371,420	)		—			—
Proceeds from issuance of common stock		35,105,684			—			—
Proceeds from exercise of stock options		249,668			2,193,837			996,143
Excess tax benefits from stock-based compensation expense		91,829			719,219			280,074
Repurchases of common stock		—			(4,506,568	)		(5,493,429	)
Net cash provided by (used in) financing activities		20,021,195			(1,597,829	)		(4,217,212	)
Effect of exchange rate changes on cash and cash equivalents		420,072			16,738			(498,303	)
Net increase (decrease) in cash and cash equivalents		23,003,739			6,208,640			(2,329,018	)
Cash and cash equivalents
Beginning of year		3,483,424			26,487,163			32,695,803
End of year	$	26,487,163		$	32,695,803		$	30,366,785
Supplemental cash flows disclosures:
Cash paid during the year for:
Interest	$	223,238		$	—		$	—
Income taxes	$	9,916,191		$	2,750,441		$	3,355,872
Non-cash operating and financing activities:
Deemed capital contribution from (distribution to) shareholders	$	2,400,000		$	—		$	—
Issuance of common shares in distribution of deferred compensation obligation	$	228,340		$	—		$	—
Exchange of warrant put option	$	7,371,644		$	—		$	—

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

48

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2007 and 2008

1.   Description of business

Home Diagnostics, Inc. (the “Company”) was founded in 1985 and has focused exclusively on the diabetes market since inception. The Company is a developer, manufacturer and marketer of technologically advanced blood glucose monitoring systems and disposable supplies for diabetics worldwide.

2.   Summary of significant accounting policies

Basis of Presentation

The consolidated financial statements include the accounts of Home Diagnostics, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Cash and cash equivalents

The Company considers all highly liquid investments with maturities of three months or less, when purchased, to be cash equivalents. The Company maintains cash and cash equivalents, which consists principally of demand deposits with high credit quality financial institutions and amounts on deposit in money market funds. The Company holds a majority of its cash and cash equivalents with two financial institutions. Although at certain times these depository investments may exceed government insured depository limits, the Company has evaluated the credit worthiness of these applicable financial institutions, and determined the risk of material financial loss due to exposure of such credit risk to be minimal. The Company has not experienced any losses on these deposits.

Accounts receivable

The Company regularly evaluates the collectibility of its accounts receivable. An allowance for doubtful accounts is maintained for estimated credit losses. When estimating credit losses, the Company considers a number of factors including the aging of a customer’s account, creditworthiness of specific customers, historical trends and other information. Reserve policies are reviewed periodically, reflecting current risks, trends, and changes in industry conditions. The Company’s allowance for doubtful accounts consisted of the following at December 31:

	2006			2007			2008
Balance at beginning of year	$	438,363		$	305,819		$	281,937
Bad debt expense		89,448			48,263			31,189
Less: Write-offs, net of recoveries		(221,992	)		(72,145	)		(130,298	)
Balance at end of year	$	305,819		$	281,937		$	182,828

Inventory

Inventory is stated at the lower of cost or market value using thefirst-in, first-out method. Inventory cost includes direct materials and, where applicable, direct labor costs and those overheads that have been incurred in bringing the inventories to their present location and condition. A provision for potentially obsolete or slow-moving inventory is made based on management’s analysis of inventory levels and future sales forecast.

Property and equipment

Property and equipment, including leasehold improvements, is stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided for using the straight-line method over the

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Notes to Consolidated Financial Statements — (Continued)

estimated useful lives of the respective assets. Leasehold improvements are amortized over the lesser of their estimated useful life or the life of the lease. Estimated useful lives are as follows:

Category	Useful lives
Machinery and equipment		1-8 years
Furniture, fixtures and office equipment		1-8 years
Computer software		3 years

Equipment not yet placed in service at December 31, 2008, primarily consisted of deposits for custom manufacturing equipment for a Board of Directors approved test strip manufacturing expansion plan. The Company expects to spend approximately $16 to $18 million, under the plan, as it continues to scale up its TRUEtest strip manufacturing operations to meet expected long term demand for these products. These assets are expected to have an estimated useful life of 7-8 years. Depreciation expense on these assets will commence once the assets are substantially complete, ready for their intended use and when the Company begins to produce inventory ready for sale. Substantially complete and ready for use is at the point in which the asset has been received, installed and validated. The Company believes this new equipment will be fully operational in early 2010.

Equipment not yet placed in service at December 31, 2007, primarily consisted of expenditures for custom manufacturing equipment. During the three months ended September 30, 2008, the Company received FDA 510(k) clearance for it’s TRUEresult and TRUE2go testing systems, had substantially completed the installation and validation of the custom manufacturing equipment, and had begun to produce inventory ready for sale. The total cost of approximately $14.0 million related to these assets were placed into service and depreciation commenced during the three months ended September 30, 2008. These assets have an estimated useful life of 7 years, except for certain equipment as noted in Note 4.

Maintenance and repairs are expensed as incurred. Expenditures for significant renewals or betterments are capitalized. Upon disposition, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in current operations.

Long-lived assets and other intangible assets

The Company reviews long-lived and other intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of a long-lived asset or other intangible asset may not be recoverable. The Company periodically evaluates whether events and circumstances have occurred that may warrant revision of the estimated useful lives of its long-lived and intangible assets or whether the remaining balance of long-lived or intangible assets should be evaluated for possible impairment. Intangible assets that have finite useful lives are amortized using either a straight-line method over their estimated useful lives or on an accelerated basis, based on annual cash flows associated with the particular intangible asset. Except for the impairment of certain equipment discussed in Note 4, the Company does not believe that there were any other indicators of impairment that would require an adjustment to such assets or their estimated periods of recovery at December 31, 2007 or 2008.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of assets acquired net of liabilities assumed in a purchase business combination. The Company periodically evaluates the acquisition of its businesses for potential impairment indicators. The Company’s judgments regarding the existence of impairment indicators are based on legal factors, market conditions and the operational performance of its business. The Company does not amortize goodwill, but rather tests goodwill for impairment at least annually, unless an event occurs which triggers the need for an earlier review. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, the Company tested goodwill for impairment by comparing the fair

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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

value of the reporting unit with its carrying amount, including goodwill. In determining the fair value, the Company utilized discounted future cash flows. Significant estimates used in the fair value calculation utilizing discounted future cash flows include, but are not limited to: (i) estimates of future revenue and expense growth; (ii) estimated average cost of capital; and (iii) the future terminal value of our reporting unit, which is based upon its ability to exist into perpetuity. The test for goodwill impairment requires significant estimates and judgment about future performance, cash flows and fair value. The Company’s future results could be affected if its estimates of future performance and fair value change. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations. The Company completed its annual test at December 31, 2007 and 2008, utilizing a discounted cash flow analysis and no impairment was identified as a result of this test.

Product warranties

The Company warrants its products for various periods against defects in material or workmanship. The Company records a provision for product warranty, within cost of sales, based on historical experience and future expectations of the probable cost to be incurred in honoring its warranty commitment. The product warranty liability is included within accrued liabilities in the accompanying consolidated balance sheets and was $0.2 million at each of the periods ending December 31, 2006, 2007 and 2008, respectively. The warranty provision charged (credited) to warranty expense was $(0.1) million, $0.1 million, and zero, for each of the years ended December 31, 2006, 2007 and 2008, respectively.

Derivatives

The Company does not hold or issue derivative instruments for trading purposes. All derivative instruments are recognized at their fair value. In April 2008, the Company entered into a Non-Deliverable Forward (“NDF”) contract for a notional amount of $4.0 million to reduce exposure of foreign currency fluctuations on transactions with it’s foreign subsidiary in Taiwan. The NDF contract matures in February 2009. At December 31, 2008, the fair value of the NDF is estimated to be a liability of approximately $0.3 million. Fair value of the NDF is estimated based on observable inputs for the current NDF forward rates for similar contracts. See Note 12.

Contingencies

The Company accrues for estimated losses from legal actions or claims when events exist that make the realization of the losses probable and the losses can be reasonably estimated. The Company analyzes its litigation claims based on currently available information to assess potential liability. The Company develops its estimates for legal losses or claims for legal actions or claims in consultation with outside counsel handling its defense in these matters, which involves an analysis of potential results assuming a combination of litigation and settlement strategies. These estimates involve significant judgment based on the facts and circumstances of each case.

Fair value of financial instruments

The carrying values reported for cash equivalents, accounts receivable, accounts payable and accrued expenses approximated their respective fair values at each balance sheet date due to the short-term maturity of these financial instruments.

As noted above, in April 2008, the Company entered into an NDF contract to reduce exposure of foreign currency fluctuations on transactions with its foreign subsidiary in Taiwan. At December 31, 2008, the fair value of the NDF is estimated to be a liability of approximately $0.3 million. Net market value adjustments have been recorded in other income (expense).

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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

Revenue recognition

Revenue from sales of products is recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the sale price is fixed or determinable, and (4) collection of the related receivable is reasonably assured. The Company recognizes revenue from product sales usually when goods are deliveredand/or when title and risk of loss pass to the customer.

The Company accepts product returns primarily due to the expiration of product life. Revenue is recorded net of an allowance for estimated returns. Sales returns are generally estimated and recorded based on an analysis of historical sales and returns information, analyzing the actual return date of the product as compared to the original date of sale of the product. The Company has estimated based on historical return experience that a reserve is required for future returns covering the prior 18 to 24 months of sales, driven primarily by the 18 to 24 month expiration of the Company’s test strip products. Products that exhibit unusual sales or return patterns due to dating or other matters are specifically identified and analyzed as part of accounting for the sales return provision (See Note 6).

The sales returns reserve consisted of the following at December 31:

	2006			2007			2008
Balance at beginning of year	$	6,206,847		$	5,588,068		$	5,385,361
Provision charged to net sales		2,496,605			2,558,205			2,615,821
Less: Product returns		(3,115,384	)		(2,760,912	)		(3,372,126	)
Balance at end of year	$	5,588,068		$	5,385,361		$	4,629,056

Volume discount incentives are offered to certain customers. These volume discount incentives are recorded as a reduction of revenue in the same period as the revenue is earned. The Company also offers price reductions for certain retail and distribution customers for designated periods of time in support of customer product promotions. The Company estimates and accrues for these promotional allowances as a reduction of revenue at the later of time of sale or when the incentive is offered. Sales to customers are generally not subject to any price protection rights.

The Company arranges with certain of its customers upfront cash payments to secure the right to distribute through those customers. The Company capitalizes these payments, provided the payments are supported by a time or volume based arrangement with a retailer, and amortizes the associated payment over the appropriate time or volume based term of the arrangement.

The Company also has reimbursement agreements with certain managed care providers, Medicaid programs and other third-party payors that require payment of rebates for products provided to their members. The Company accrues for these rebates, as a reduction of revenue, at the time of sale. The determination of the rebate allowance is based on the terms of the reimbursement agreements as well as historical payment trends to these providers. In addition, under certain circumstances, the Company offers meters, at no charge, to customers and third-party payors. The cost of these meters is recorded in cost of sales in the period the products are shipped.

The managed care reserve consisted of the following at December 31:

	2006			2007			2008
Balance at beginning of year	$	515,504		$	944,866		$	2,337,155
Provision charged to net sales		1,649,702			2,773,404			3,895,000
Less: Payments		(1,220,340	)		(1,381,115	)		(3,500,275	)
Balance at end of year	$	944,866		$	2,337,155		$	2,731,880

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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

Advertising

The Company expenses advertising costs as incurred. Advertising expense, included in selling, general and administrative expenses, for the years ended December 31, 2006, 2007 and 2008 was approximately $2.1 million, $2.4 million and $4.5 million, respectively.

Shipping and handling costs

Shipping and handling costs associated with inbound freight are included in cost of inventory and expensed as cost of sales when the related inventory is sold. Shipping and handling costs associated with outbound freight are included in selling, general and administrative expenses and totaled approximately $1.9 million, $1.8 million and $2.2 million for the years ended December 31, 2006, 2007 and 2008, respectively. Amounts billed to customers for shipping and handling are recorded as revenue and were not significant for the years ended December 31, 2006, 2007 and 2008.

Research and development

Research and development costs are expensed as incurred and consist primarily of salaries and benefits, supplies and depreciation.

Stock-based compensation

Effective January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment,” (“SFAS 123R”), which revises SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and supersedes APB No. 25, “Accounting for Stock Issued to Employees” (“APB”).

In accordance with SFAS 123R, the Company measures the cost of employee services received in exchange for equity-based awards based on grant date fair value. Pre-vesting forfeitures are estimated at the time of grant and the Company periodically revises those estimates in subsequent periods if actual forfeitures differ from those estimates. Equity-based compensation is only recognized for equity-based awards expected to vest.

Certain employee stock options are accounted for as variable stock options due to a repricing in 2001. At December 31, 2008, the Company had approximately 80,000 variable stock options with exercise prices of $2.99. For these options, a non-cash charge representing the excess of the estimated fair market value or quoted market price of the underlying common stock at the end of each reporting period over the exercise price is recorded as stock-based compensation until the options are fully exercised. During the years ended December 31, 2006, 2007, and 2008, the Company recorded expense (income) of $0.3 million, $(0.2) million and $(0.3) million, respectively, to selling, general and administrative expense for employee stock-based compensation related to mark-to-market accounting for variable stock options.

Income taxes

The provision for income taxes is recognized at applicable U.S. or international tax rates. Deferred income taxes are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are also established for the future tax benefits of loss and credit carryovers. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when it is more likely than not that such amounts will not be realized. U.S. income taxes have not been provided on undistributed earnings of foreign subsidiaries since it is management’s intention to utilize those earnings in the foreign operations for an indefinite period of time. Commencing January 1, 2007, the Company accounts for income tax uncertainties under FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes-an

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Notes to Consolidated Financial Statements — (Continued)

Interpretation of FASB Statement No. 109 (“FIN 48”), which provides guidance on the recognition, derecognition and measurement of potential tax benefits associated with tax positions. The Company recognizes interest and penalties relating to income tax matters as a component of income tax expense.

Foreign currency translation

The functional currencies of the Company’s foreign operations are their respective local currencies. The assets and liabilities of these operations are translated into U.S. dollars at the end of the period exchange rates, and the revenues and expenses are translated at average exchange rates for the period. The gains and losses from these translations are included in other comprehensive income (loss) as a separate component of stockholders’ equity. See comprehensive income (loss) below.

Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the applicable functional currency of the Company or its subsidiaries are included in the results of operations as incurred. For the years ended December 31, 2006, 2007 and 2008, net foreign currency losses of approximately $50,000, $10,000, and $0.6 million respectively, were recognized and included in other income (expense) in the accompanying consolidated statements of operations.

In April 2008, the Company entered into a NDF contract to reduce exposure of foreign currency fluctuations on transactions with its foreign subsidiary in Taiwan. During the year ended December 31, 2008, the Company recorded approximately $0.3 million in net market value losses on this contract, offsetting the impact of foreign currency market risk. Net market value adjustments have been recorded in other income (expense).

Other comprehensive income (loss)

Comprehensive income (loss) consists of net income (loss) plus certain other items that are recorded directly to shareholders’ equity. Amounts included in other comprehensive loss for the Company are foreign currency translation adjustments and accumulated pension liability.

Earnings per share

Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding net of treasury shares during the period presented. Weighted average shares outstanding for 2006 includes 27,800 shares subject to a warrant with a deminimis exercise price of $0.01 per share.

Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period plus the effect of dilutive securities outstanding during the period. As described in Note 9, during 2006, the Company accounted for a Warrant Put Option as a liability carried at fair value. The common shares subject to the Warrant Put Option have been included in the computation of diluted earnings per share for the year ended December 31, 2006, because, after considering the effect of the change in fair value of the warrant put option on net income, their effect is dilutive.

Net income applicable to common stock used in calculating diluted net income per share for the year ended December 31, 2006 is as follows:

Net income applicable to common stock	$	10,309,429
Change in fair value of the warrant put option		(58,700	)
Adjusted net income applicable to common stock	$	10,250,729

The following summarizes the weighted average number of common shares outstanding during the years ended December 31, 2006, 2007 and 2008, that were used to calculate the basic earnings per common share as

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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

well as the dilutive impact of stock options and warrants, using the treasury stock method, as included in the calculation of diluted weighted average shares:

	Years Ended December 31,
	2006		2007		2008
Weighted average number of common shares outstanding for basic earnings per share		14,811,424		17,953,336		17,707,484
Effect of dilutive securities:
stock options and warrants		2,561,977		1,620,969		1,043,999
Weighted average number of common and common equivalent shares outstanding		17,373,401		19,574,305		18,751,483

At December 31, 2006, 2007, and 2008, the Company had approximately 0.3 million, 0.8 million and 1.2 million options, respectively, that have been excluded from the computation of diluted earnings per share because they are anti-dilutive.

Segment reporting

The Company has determined it operates in one segment. Operating segments are components of an enterprise for which separate financial information is available and are evaluated regularly by the Company in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker assesses the Company’s performance, and allocates its resources as a single operating segment. Net sales realized from the Company’s subsidiaries domiciled outside of the United States were approximately 2%, 3% and 2% of consolidated net sales for the years ended December 31, 2006, 2007 and 2008, respectively.

Use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recent accounting pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), Business Combinations (SFAS 141(R)) which replaces SFAS No. 141, Business Combinations (SFAS 141). SFAS 141(R)’s scope is broader than that of SFAS 141, which applied only to business combinations in which control was obtained by transferring consideration. SFAS 141(R) applies to all transactions and other events in which one entity obtains control over one or more other businesses. The standard requires the fair value of the purchase price, including the issuance of equity securities, to be determined on the acquisition date. SFAS 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interests in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the statement. SFAS 141(R) requires acquisition costs to be expensed as incurred and restructuring costs to be expensed in periods after the acquisition date. Earn-outs and other forms of contingent consideration are to be recorded at fair value on the acquisition date. Changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period will be recognized in earnings rather than as an adjustment to the cost of the acquisition. SFAS 141(R) generally applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after

55

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

December 15, 2008 with early adoption prohibited. The Company does not expect the the adoption of SFAS 141(R) to have a material effect on its future results of operations or financial position.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (SFAS 160). SFAS 160 requires non-controlling interests or minority interests to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. Upon a loss of control, the interest sold, as well as any interest retained, is required to be measured at fair value, with any gain or loss recognized in earnings. Based on SFAS 160, assets and liabilities will not change for subsequent purchase or sale transactions with non-controlling interests as long as control is maintained. Differences between the fair value of consideration paid or received and the carrying value of non-controlling interests are to be recognized as an adjustment to the parent interest’s equity. SFAS 160 is effective for fiscal year beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company does not expect the adoption of SFAS 160 to have a material effect on its future results of operations or financial position.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — An Amendment of SFAS No. 133” (“SFAS 161”). SFAS 161 seeks to improve financial reporting for derivative instruments and hedging activities by requiring enhanced disclosures regarding the impact on financial position, financial performance, and cash flows. To achieve this increased transparency, SFAS 161 requires (1) the disclosure of the fair value of derivative instruments and gains and losses in a tabular format; (2) the disclosure of derivative features that are credit risk-related; and (3) cross-referencing within the footnotes. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not expect the adoption of SFAS No. 161 to have a material effect on its future results of operations or financial position.

In October 2008, the FASB issued FSPNo. FAS 157-3,Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active(FSPFAS 157-3). This FSP clarifies the definition of fair value by stating that a transaction price is not necessarily indicative of fair value in a market that is not active or in a forced liquidation or distressed sale. The guidance in FSPFAS 157-3 was effective immediately upon issuance on Oct. 10, 2008, including prior periods for which financial statements have not been issued. The Company’s fair value measurements are based upon Level 1 and Level 2 observable inputs and therefore the adoption of FSPFAS 157-3 did not impact its results of operations or financial position.

3.   Inventory

Inventory consists of the following at December 31:

	2007		2008
Raw materials	$	7,589,107	$	10,059,194
Work-in-process		2,780,096		4,868,764
Finished goods		2,010,465		2,203,198
	$	12,379,668	$	17,131,156

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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

4.   Property and equipment, net

Property and equipment, net consists of the following at December 31:

	2007			2008
Machinery and equipment	$	15,931,806		$	32,119,057
Leasehold improvements		4,061,227			4,997,859
Furniture, fixtures, and office equipment		3,136,451			4,332,707
Computer software		1,912,733			2,102,246
Equipment not yet placed in service		15,272,616			9,340,174
		40,314,833			52,892,043
Less: Accumulated depreciation and amortization		(17,754,498	)		(21,344,267	)
	$	22,560,335		$	31,547,776

Depreciation expense for the years ended December 31, 2006, 2007 and 2008 was approximately $3.6 million, $3.3 million and $4.0 million, respectively. Amortization expense of computer software for the years ended December 31, 2006, 2007 and 2008 was approximately $0.3 million, $0.2 million and $0.1 million, respectively, and accumulated amortization relating to computer software was $1.7 million and $1.8 million at December 31, 2007 and 2008, respectively.

Equipment not yet placed in service at December 31, 2008, primarily consisted of deposits for custom manufacturing equipment related to the scaling up our TRUEtest test strip manufacturing operations. In August 2008, our Board of Directors approved to spend approximately $16 to $18 million on a test strip manufacturing expansion plan meet the expected long term demand for these products. These assets are expected to have an estimated useful life of 7-8 years. Depreciation expense on these assets will commence once the assets are substantially complete, ready for their intended use and we have begun to produce inventory ready for sale. Substantially complete and ready for use is at the point which the asset has been received, installed and validated. The Company believes this new equipment will be fully operational in early 2010.

Equipment not yet placed in service at December 31, 2007, primarily consisted of expenditures for custom manufacturing equipment. During the three months ended September 30, 2008, the Company received FDA 510(k) clearance for it’s TRUEresult and TRUE2go testing systems, had substantially completed the installation and validation of the custom manufacturing equipment, and had begun to produce inventory ready for sale. The total cost of approximately $14.0 million related to these assets were placed into service and depreciation commenced during the three months ended September 30, 2008. The majority of these assets have an estimated useful life of 7 years. Approximately $1.2 million of this equipment will be replaced in 2009 to improve production yields and is being depreciated on an accelerated basis through September 2009.

During the year ended December 31, 2006, the Company recorded an impairment charge of $425,000, included in research and development expense, related to a component of equipment not yet placed into service. The Company modified certain equipment specifications which resulted in impairment.

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Notes to Consolidated Financial Statements — (Continued)

5.   Other intangible assets

Other intangible assets consist of the following at December 31:

	2007			2008
Other intangible assets subject to amortization:
Customer relationships	$	1,472,954		$	1,472,954
Acquired technology		350,000			350,000
		1,822,954			1,822,954
Less: Accumulated amortization:
Customer relationships		(878,845	)		(1,109,709	)
Acquired technology		(283,333	)		(350,000	)
Other intangible assets subject to amortization, net	$	660,776		$	363,245

Customer relationships are amortized over a useful life of six years and acquired technology is amortized over a useful life of three years. Amortization expense, which is included in selling, general and administrative expenses, for the years ended December 31, 2006, 2007 and 2008, amounted to $0.5 million, $0.4 million and $0.3 million, respectively.

Estimated future amortization of other intangible assets based on balances existing at December 31, 2008, is as follows:

	Amount
2009	$	181,317
2010		142,633
2011		39,295
Total	$	363,245

6.   Accrued liabilities

Accrued liabilities consist of the following at December 31:

	2007		2008
Accrued salaries and benefits	$	3,975,898	$	4,757,671
Sales returns reserve		5,385,361		4,629,056
Accrued customer liabilities		4,030,499		7,782,322
Managed care rebates		2,337,154		2,731,880
Other accrued liabilities		2,319,167		1,626,631
	$	18,048,079	$	21,527,560

7.   Long-term debt

Credit facility

In March 2008, the Company amended its credit facility by increasing the amount available under its unsecured revolving line of credit from $7.0 million to $10.0 million (“Amended Credit Facility”). The Amended Credit Facility matures on April 30, 2009. At December 31, 2008, there was no outstanding balance. Borrowings bear interest at LIBOR plus 0.5% (0.9% at December 31, 2008). The Amended Credit Facility contains a financial covenant and other covenants that restrict the Company’s ability to, among other things,

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Notes to Consolidated Financial Statements — (Continued)

incur liens, repurchase greater than $5.5 million of its common stock in any calendar year and participate in a change in control. The financial covenant requires the Company to maintain a ratio of total liabilities to tangible net worth of not more than 1.0 to 1.0. Failure to comply with this covenant and other restrictions would constitute an event of default. The Company believes that it was in compliance with the financial covenant and other restrictions at December 31, 2008.

The Company’s foreign manufacturing subsidiary based in Taiwan has the ability to borrow up to $0.8 million under a foreign line of credit at an annual rate of 3.25%. The foreign subsidiary may use these borrowings for normal operating uses and material purchases. There were no outstanding balances under the line of credit as of December 31, 2007 and 2008.

Promissory notes

In September 2005, the Company issued $3.3 million of Promissory Notes (the “Promissory Notes”) bearing interest at 8% and payable to two related parties. Interest on the Promissory Notes was payable monthly and the principal balance was payable in five monthly installments beginning in October 2005. The Promissory Notes were repaid in full in February 2006.

8.   Warrant put option

In September 2002, the Company issued 13% Senior Secured Subordinated Notes (the “Senior Subordinated Notes”) due September 3, 2007 in the aggregate original principal amount of $5.0 million. Interest on the Senior Subordinated Notes was payable quarterly in arrears commencing on September 30, 2002. The Senior Subordinated Notes were fully repaid during 2004 with proceeds from the Company’s Amended Credit Facility. In connection with the issuance of the Senior Subordinated Notes, the Company issued the Warrant Put Option which gave the holder the right to put the Warrant Put Option to the Company after the fifth anniversary date at a redemption value, as defined in the agreement. The redemption value was based on the greater of the estimated fair value of the Company in a non-liquidation scenario or a value based upon a stated multiple of earnings before interest, taxes, depreciation and amortization, plus cash less certain indebtedness and the redemption value of the Company’s Class F mandatorily redeemable preferred stock, without regard to any marketability or liquidity discount. During the period from January 1, 2006 through the date of the Company’s IPO, the estimated fair value of the Warrant Put Option decreased by approximately $58,700. On September 20, 2006, the holder of the Warrant Put Option exercised its registration rights and exchanged the warrant for 614,303 shares of our common stock. These shares were sold by the holder of the Warrant Put Option in the IPO at $12.00 per share for a total of $7.4 million. As a result, the Company reclassed to equity the estimated fair value of the Warrant Put Option of approximately $7.4 million from the previously recorded liability balance.

9.   Mandatorily redeemable preferred stock

Prior to redemption in 2006, the Company had 165,000 shares of Class F preferred stock (the “Preferred Stock”) authorized and 115,238 outstanding. The Preferred Stock was redeemable at the option of the Company by resolution of its Board of Directors at any time, in whole or in part, at a cash redemption value equal to $90.00 per share. In addition, the Preferred Stock was mandatorily redeemable at $90.00 per share in the event of i) an initial public offering, ii) sale of substantially all of the assets or stock of the Company, or iii) a merger or consolidation of the Company. In September 2006, the Company used proceeds from its initial public offering to redeem all of the Preferred Stock outstanding at $90.00 per share.

10.   Stockholders’ equity

In September 2006, the Company completed an initial public offering (“IPO”) of 6,599,487 shares of common stock at a price of $12.00 per share, 3,300,000 of which were sold by the Company and the

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Notes to Consolidated Financial Statements — (Continued)

remainder by selling stockholders. The Company received net proceeds after underwriting discounts and offering expenses of approximately $35.1 million. The Company used $10.4 million of the net proceeds of the offering to redeem all the Series F Preferred Stock outstanding and $2.0 million to repay outstanding indebtedness. In October 2006, underwriters of the Company’s IPO,exercised their over-allotment option to purchase 989,923 additional shares of common stock from certain selling stockholders at the public offering price of $12 per share. The Company did not issue any new shares of common stock or receive any proceeds from the sale of the over-allotment shares.

In 2008, the Company completed two Board of Directors approved Common Stock Repurchase Programs by repurchasing approximately 1.2 million shares of its common stock at an aggregate cost of $10.0 million, since August 2007. During the year ended December 31, 2007, the Company repurchased approximately 505,000 shares at a cost of approximately $4.5 million. During the year ended December 31, 2008, the Company repurchased approximately 660,000 shares at a cost of approximately $5.5 million. All purchases under the Common Stock Repurchase Program were made in the open market, subject to market conditions and trading restrictions. In December 2008, the Company’s Board of Directors authorized the Company, under a new repurchase program, to purchase $5.0 million of its common stock. Purchases under this program began in January 2009. As of March 8, 2009, the Company repurchased 317,000 shares at a cost of approximately $2.0 million.

11.   Stock options and warrants

In July 2006, the Company’s Board of Director’s and stockholders approved the 2006 Equity Incentive Plan (the “2006 Plan”). Two million shares of common stock have been reserved for issuance under the 2006 Plan. The term of each option granted under the 2006 Plan cannot exceed ten years from the date of grant. The 2006 Plan authorizes a range of awards including but not limited to the following: stock options; stock appreciation rights; and restricted stock. Under the 2006 Plan, there are 914,000 options available for grant and 1,086,000 options outstanding at December 31, 2008. The options outstanding had a weighted average exercise price of $9.99. These options generally become exercisable on a pro rata basis over a three-year period from the date of grant.

The 2002 Stock Option Plan (“the “2002 Plan”) was the Company’s stock option plan that preceded the 2006 Plan. It provided for the granting of up to 2,340,000 shares of common stock. The term of each option granted under the 2002 Plan could not exceed ten years from the date of grant. Options under the 2002 Plan vest as determined by the Board of Directors, but in no event at a rate less than 20% per year. No additional stock options may be granted under the 2002 Plan. The Company also has outstanding options under a predecessor plan that expired in 2002. Options are no longer available for grant under this predecessor plan.

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Notes to Consolidated Financial Statements — (Continued)

A summary of the Company’s stock option activity and related information for the years ended December 31, 2007, and 2008 is as follows:

				Range of		Weighted Average
	Number of Shares			Exercise Prices		Exercise Prices
Outstanding at December 31, 2006		3,274,756		$	2.99 - 12.00	$	4.40
Granted		453,400		$	8.72 - 11.58	$	11.09
Exercised		(658,271	)	$	2.99 - 4.27	$	3.29
Forfeited/Cancelled		(59,478	)	$	3.85 - 12.00	$	10.70
Outstanding at December 31, 2007		3,010,407		$	2.99 - 12.00	$	5.53
Granted		443,000		$	6.85 - 7.88	$	7.85
Exercised		(263,176	)	$	2.99 - 4.27	$	3.78
Forfeited/Cancelled		(43,897	)	$	3.85 - 12.00	$	10.32
Outstanding at December 31, 2008		3,146,334		$	2.99 - 12.00	$	5.93
Exercisable at December 31, 2007		2,270,041		$	2.99 - 12.00	$	3.97
Exercisable at December 31, 2008		2,395,814		$	2.99 - 12.00	$	4.88

During the years ended December 31, 2006, 2007 and 2008, the weighted average fair values of options granted were $5.24, $3.73 and $2.72, respectively. The fair value of the grants were estimated on the date of grant using the Black-Scholes option-pricing model with assumptions for expected volatility, expected life, risk-free interest rate and dividend yield. The assumptions were as follows:

	Years ended December 31,
	2006			2007			2008
Weighted average expected term of options(using the simplified method in years)		6.0			4.6			4.5
Expected volatility factor(based on peer group volatility)		30	%		30	%		36	%
Expected dividend yield		none			none			none
Weighted average risk-free interest rate(based on applicable U.S. Treasury rates)		4.9	%		4.8	%		3.2	%

SFAS 123R requires the estimation of forfeitures when recognizing compensation expense and that this estimate of forfeitures be adjusted over the requisite service period should actual forfeitures differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative adjustment, which is recognized in the period of change and which impacts the amount of unamortized compensation expense to be recognized in future periods. The Company’s estimated forfeiture rate during the year ended December 31, 2008 was approximately 8%.

At December 31, 2008, there was $1.0 million of unrecognized share-based compensation expense, associated with non-vested stock option grants, subject to SFAS 123R. The Company has elected to recognize compensation expense for stock option awards using a graded vesting attribution methodology, whereby compensation expense is recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards. Stock based compensation expense is expected to be recognized over a weighted-average period of 3 years.

The Company recognized stock based compensation expense of $1.3 million, during the year ended December 31, 2008. Of the $1.3 million, approximately $1.6 million related to stock option compensation

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Notes to Consolidated Financial Statements — (Continued)

expense calculated in accordance with SFAS 123R for stock options granted or modified, partially offset by approximately $0.3 million in income related to the mark-to-market accounting for variable stock options accounted for under APB 25.

The Company recognized stock based compensation expense of $1.1 million, during the year ended December 31, 2007. Of the $1.1 million, approximately $1.3 million related to stock option compensation expense calculated in accordance with SFAS 123R, partially offset by approximately $0.2 million in income related to the mark-to-market accounting for variable stock options accounted for under APB 25.

The Company recognized stock based compensation expense of $1.2 million, during the year ended December 31, 2006. Of the $1.2 million, approximately $0.3 million related to the mark-to-market accounting for variable stock options accounted for under APB 25 and approximately $0.9 million related to compensation expense calculated in accordance with SFAS 123R for stock options and warrants granted or modified during the year ended December 31, 2006.

A summary of the Company’s stock options outstanding at December 31, 2008 is as follows:

					Weighted
			Weighted		Average				Weighted
			Average		Remaining				Average
Range Of			Exercise		Contractual				Exercise
Exercise Price	Outstanding		Price		Life		Exercisable		Price
$2.99 — 3.29		832,491	$	3.04		2.46		832,491	$	3.04
$3.42 — 3.76		524,040		3.59		4.41		524,038		3.59
$3.85 — 4.49		605,763		3.98		5.50		605,761		3.98
$6.85 — 9.26		442,800		7.87		9.40		4,025		8.79
$9.50 — 12.00		741,240		11.25		8.04		429,499		11.22
		3,146,334	$	5.93		5.66		2,395,814	$	4.88

The aggregate intrinsic value for both options outstanding and exercisable at December 31, 2008 was $2.9 million. The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between the quoted market price of the Company’s common stock and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2008. This amount changes based on the quoted market price of the Company’s common stock. The aggregate intrinsic value for options exercised during the year ended December 31, 2008 was approximately $0.3 million.

12.   Fair Value Measurements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (“SFAS 157”) which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 became effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued Staff Position (FSP)No. 157-2, which delayed the effective date of SFAS 157 one year for all non-financial assets and non-financial liabilities, except those recognized or disclosed at fair value in the financial statements on a recurring basis.

SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based upon assumptions that market participants

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Notes to Consolidated Financial Statements — (Continued)

would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1: Observable inputs such as quoted prices in active markets;

Level 2: Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and

Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

On January 1, 2008, the Company partially adopted the provisions of SFAS 157. There was no impact to the Company’s financial position or results of operations upon adoption of SFAS 157. The Company has elected to partially defer adoption of SFAS 157 related to our non-financial assets and liabilities in accordance with FASB Staff Position157-2.

As of December 31, 2008, the Company holds $30.4 million in cash and cash equivalents invested primarily in money market funds which trade at a net asset value (NAV) of $1 per share.

In April 2008, the Company entered into a Non-Deliverable Forward (“NDF”) contract for a notional amount of $4.0 million to reduce exposure of foreign currency fluctuations on transactions with its foreign subsidiary in Taiwan. The NDF contract matures in February 2009. At December 31, 2008, the fair value of the NDF is estimated to be a liability of approximately $0.3 million. Fair value is estimated based upon Level 2 observable inputs for the current NDF forward rates for similar contracts. During the year ended December 31, 2008, the Company recorded approximately $0.3 million in net market value losses on this contract. Net market value adjustments have been recorded in other income (expense).

13.   Related party transactions

The Company’s Vice Chairman of the Board of Directors, is of counsel to a law firm, which acts as legal counsel to the Company. During the years ended December 31, 2006, 2007, and 2008 the Company paid legal fees to this firm of $0.8 million $0.5 million and $0.3 million, respectively.

In September 2006, the Company used proceeds from its IPO to redeem all Preferred Stock outstanding at $90.00 per share. The Estate of one of the principal stockholders of the Company, received approximately $2.5 million in redemption of its 27,395 shares of Series F Preferred Stock, a director and one of the principal stockholders of the Company, received approximately $1.4 million in redemption of his 15,395 shares of Series F Preferred Stock, and the Vice Chairman of the Board of Directors and one of the principal stockholders of the Company, received approximately $1.1 million in redemption of his 12,592 shares of Series F Preferred Stock. The Series F Preferred Stock was purchased by these stockholders in 1992 for $10.00 per share.

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Notes to Consolidated Financial Statements — (Continued)

14.   Income taxes

The components of the provision for income taxes for the years ended December 31, are as follows:

	Years Ended December 31,
	2006			2007			2008
Current
Federal	$	5,627,006		$	3,319,654		$	326,341
State		513,001			236,535			299,307
Foreign		319,419			522,996			530,988
		6,459,426			4,079,185			1,156,636
Deferred
Federal		(1,812,015	)		(348,400	)		1,027,721
State		(125,085	)		(47,314	)		43,697
Foreign		(141,986	)		(295,011	)		(163,682	)
		(2,079,086	)		(690,725	)		907,736
Income tax expense	$	4,380,340		$	3,388,460		$	2,064,372

The differences between the effective rate and the U.S. federal income tax statutory rate (35%) are as follows for the years ended December 31:

	Years Ended December 31,
	2006			2007			2008
Tax provision computed at statutory rate	$	5,141,419		$	4,555,764		$	4,090,958
State taxes, net of federal benefit		206,383			156,042			222,953
Non-deductible litigation settlement (insurance recoveries)		840,000			(105,000	)
Research and development credit		(1,783,987	)		(597,942	)		(527,899	)
Change in fair value of Warrant Put Option		20,545			—
Stock-based compensation expense		93,525			(410,983	)		(86,184	)
Change in accruals related to uncertain tax positions		—			211,151			(989,182	)
Domestic production activities deduction		(211,921	)		(229,450	)		(146,223	)
Extraterritorial income exclusion		(187,741	)		10,663
Meals and entertainment expenses		94,615			110,286			97,576
Tax exempt interest		—			—			(151,353	)
Foreign and other tax credits		(20,989	)		—			(233,791	)
Other		188,491			(312,071	)		(212,483	)
Total provision for income taxes	$	4,380,340		$	3,388,460		$	2,064,372

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Notes to Consolidated Financial Statements — (Continued)

The significant components of deferred tax assets and liabilities are as follows as of December 31:

	2007					2008
	Current		Long-Term			Current		Long-Term
Deferred tax assets
Inventory reserve and Section 263A adjustment	$	682,174	$	—		$	720,601	$	—
Reserve for doubtful accounts		103,541		—			66,917		—
Accrued customer warranties and agreements		953,641		—			1,084,754		—
Sales returns accrual		1,997,942		—			1,722,472		—
Accruals not currently deductible		249,341		—			209,275		—
Stock based compensation		—		677,333			—		1,262,869
Accrued vacation pay		216,593		—			271,226		—
Basis difference in fixed assets		—		159,366			—		—
Other		466,542		334,290			241,443		419,692
Total deferred tax asset		4,669,774		1,170,989			4,316,688		1,682,561
Deferred tax liabilities
Basis difference in fixed assets		—		—			—		(994,572	)
Basis difference in intangible assets		—		(166,351	)		—		(101,709	)
Other		—		—			—		(146,415	)
Total deferred tax liability		—		(166,351	)		—		(1,242,696	)
Net deferred tax asset	$	4,669,774	$	1,004,638		$	4,316,688	$	439,865

The Company records a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management has determined that a valuation allowance is not necessary at December 31, 2007 or 2008.

Income before the provision for income taxes consisted of the following:

	For the Years Ended December 31,
	2006		2007		2008
United States	$	14,036,097	$	12,168,561	$	10,390,984
Foreign operations		653,672		847,907		1,317,826
	$	14,689,769	$	13,016,468	$	11,708,810

No provision has been made for the years ended December 31, 2006, 2007 and 2008 for U.S. income taxes on the undistributed earnings of the foreign subsidiary since it is management’s intention to utilize those earnings in the foreign operations for an indefinite period of time.

During the year ended December 31, 2006, the Company recognized an income tax benefit totaling approximately $1.5 million, related to the recognition of previously unclaimed research and development (“R&D”) tax credits associated with tax years 1998 through 2005. The Company elected to pursue the R&D tax credits in 2006 due to changes in economic circumstances including increased R&D spending to develop new products and to reduce its cash income tax payments which gradually increased since 2003 following the

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Notes to Consolidated Financial Statements — (Continued)

complete utilization of its net operating losses. The Company completed its R&D tax study during the year ended December 31, 2006.

During the first and third quarters of 2008, the Company reached settlements with the IRS with respect to the IRS audits of the tax returns for the years 2003 through 2005. As a result of these settlements, as well as the expiration of certain statutes of limitations, the Company recorded an income tax benefit in 2008 of approximately $1.3 million.

Effective January 1, 2007, the Company adopted FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes.” The adoption of FIN 48 also resulted in a $0.1 million cumulative effect adjustment to increase retained earnings. At December 31, 2008, the Company had approximately $0.6 million, of total gross unrecognized tax benefits. Under FIN 48, the Company has elected to continue its prior practice of accounting for interest and penalties on unrecognized tax benefits as income tax expense. A reconciliation of the beginning and ending balance for liabilities associated with unrecognized tax benefits is as follows:

	2007			2008
Adjusted balance at January 1	$	1,995,289		$	2,157,137
Additions for tax positions of current year		222,384			149,950
Reductions for tax positions of prior years		(60,536	)		(400,731	)
Statute expirations		—			(490,943	)
Settlements					(785,132	)
Balance at December 31	$	2,157,137		$	630,281

Included in the balance sheet at December 31, 2008 and 2007 are approximately $0.6 million and $1.7 million, respectively, of unrecognized tax benefits (net of federal benefit) that if recognized, would affect the effective income tax rate in future periods. Total interest recognized in the 2008 Consolidated Statement of Operations and the December 31, 2008 Consolidated Balance Sheet was not material.

The Company has taken positions in Federal income tax returns for which it is reasonably possible that the total amounts of unrecognized tax benefits may decrease by an immaterial amount within the next twelve months. The possible decrease could result from the expiration of the statute of limitations on certain years.

The Company and its subsidiaries file income tax returns in the U.S. Federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities in the United States, various states, Taiwan, the United Kingdom, Australia and Canada. In the Company’s most significant jurisdiction, the United States, it is no longer subject to IRS examination for periods prior to 2005.

15.   Employee benefit plan

The Company maintains a contributory profit sharing plan (the “Plan”) as defined under Section 401(k) of the U.S. Internal Revenue Code. All employees who meet certain eligibility requirements are able to participate in the Plan. An employee becomes 100% vested with respect to employer contributions after completing two years of service. Discretionary matching contributions are determined by the Company each year. During the years ended December 31, 2006, 2007 and 2008, the Company contributed $0.5 million, $0.5 million and $0.4 million, respectively, to the Plan.

In July 2006, the Company’s Board of Directors adopted a nonqualified deferred compensation plan. The plan is designed to provide participants the opportunity to elect to defer on an annual basis a portion of their base salary, bonus up to a certain amountand/or excess 401(k) deferrals. Contributions to the plan by the participants are made on a pre-tax basis and matching contributions by the Company are discretionary. Deferrals to the plan began in 2007. There were no Company matching contributions in 2007 or 2008. At December 31, 2007 and 2008, the unfunded plan liability was $0.3 million and $0.2 million, respectively.

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Notes to Consolidated Financial Statements — (Continued)

ASC, the Company’s wholly owned subsidiary based in Taiwan, has a defined benefit pension and retirement plan in place for all employees with dates of service prior to June 30, 2005. Effective December 31, 2006, the Company adopted SFAS 158. The effect of the adoption of SFAS 158, net of tax on the Company’s consolidated balance sheet as of December 31, 2006 was an increase to the accrued pension liability (included in accrued liabilities in the Company’s consolidated balance sheet) and accumulated other comprehensive income of $193,411 for the year ended December 31, 2006. At December 31, 2008 and 2007, the Company’s accrued pension liability was approximately $0.4 million and $0.2 million, respectively.

16.   Commitments and contingencies

Non-cancelable operating leases

The Company entered into a ten-year lease agreement for its operating facilities and a five year lease agreement for its corporate office space. The rent under the Company’s lease agreements is adjusted for changes in the Consumer Price Index annually. Total rent expense amounted to approximately $1.7 million, $2.2 million and $2.7 million for the years ended December 31, 2006, 2007 and 2008, respectively.

Future minimum lease payments on non-cancelable operating leases at December 31, 2008 are as follows:

2009	$	2,669,000
2010		2,576,000
2011		2,515,000
2012		2,469,000
2013 and thereafter		358,000
Total	$	10,587,000

At December 31, 2008 the Company had open purchase contracts and commitments primarily for equipment totaling approximately $9.3 million for or 2009.

Litigation

The Company is involved in certain legal proceedings arising in the ordinary course of business. In the opinion of management, except as disclosed below, the outcome of such proceedings will not materially affect the Company’s consolidated financial position, results of operations or cash flows.

Roche Litigation

In February 2004, Roche Diagnostics Corporation filed suit against the Company and three otherco-defendants in federal court in Indiana. The three co-defendants settled with Roche in January 2006. The suit alleges that the Company’s TrueTrack Smart System infringes claims in two Roche patents. These patents are related to Roche’s electrochemical biosensors and the methods they use to measure glucose levels in a blood sample. In its suit, Roche seeks damages including its lost profits or a reasonable royalty, or both, and a permanent injunction against the accused products. Roche also alleges willful infringement, which, if proven, could result in an award of up to three times its actual damages, as well as its legal fees and expenses. On June 20, 2005, the Court ruled that one of the Roche patents was procured by inequitable conduct before the Patent Office and is unenforceable. On March 2, 2007, the Court granted the Company’s motion for summary judgment for non-infringement with respect to the second patent and denied the Roche motion for a summary judgment. These rulings were subject to appeal by Roche. On December 20, 2007, the Company settled the ongoing litigation, agreeing to pay Roche a lump sum payment of $3.5 million in exchange for a royalty-free, fullypaid-up, world-wide license on both of the patents, as well as a covenant by Roche not to sue the Company on the licensed patents.

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Notes to Consolidated Financial Statements — (Continued)

Brandt Litigation

In March 2007, a settlement in principle was agreed by the parties to a lawsuit against the Company, MIT Development Corp. or MIT, George H. Holley and the Estate of Robert Salem, brought by Leonard Brandt. Mr. Brandt claimed that he was engaged in 1994 to provide financial consulting services for MIT, Mr. George Holley and Mr. Salem. Mr. Brandt claimed he was to receive at least $1,000 per month for consulting services plus 10% of the increase in the value of the assets of MIT, Holley or Robert Salem resulting from cash or other assets received from the Company in connection with any transaction with the Company. In November 1999, the Company acquired MIT from Messrs. Holley and Salem. The settlement provides for a total of $3.0 million of consideration to be paid by the defendants. The Company’s share of the settlement consideration is $0.6 million to be paid in cash, and the remaining $2.4 million will be funded by George H. Holley and the Estate of Robert Salem in common stock of the Company. The Company will grant Mr. Brandt “piggy-back” registration rights with respect to such stock for a period of one year from the date of settlement. In December 2006, pursuant to Staff Accounting Bulletin No. 107, Topic 5T “Accounting for Expenses or Liabilities Paid by Principal Stockholders”, the Company recorded a charge of $3.0 million to operating expense and recorded the $2.4 million funded by the other two defendants as additional paid-in capital. On July 19, 2007 and October 31, 2007, the court arbitrated the final payment terms of the settlement consistent with the foregoing description and ordered the immediate exchange of mutual releases and payment of cash and stock. The agreed settlement funds were delivered to an escrow agent in accordance with the court’s order of October 31, 2007; however, Mr. Brandt failed to comply with the court’s rulings. Instead, Mr. Brandt moved to vacate the settlement and sought a new trial, and the Company filed a motion with the court to uphold the settlement. In July 2007, the Company reached a settlement agreement with its’ directors and officers insurance provider, whereby, the Company received $450,000 in insurance proceeds relating to a recovery of losses incurred as part of the Brandt matter. The Company’s share of the insurance proceeds was $150,000 and the remaining $300,000 was distributed to George H. Holley and the Estate of Robert Salem. During the year ended December 31, 2007, the Company recorded a reduction to operating expenses of $450,000 and a distribution of capital of $300,000.

On February 28, 2008, the court, after a full argument, granted defendants’ motion to compel plaintiff to comply with the court’s outstanding orders and perform the settlement and denied plaintiff’s motion to vacate the settlement and obtain a new trial. On May 13, 2008 the Court issued a formal decision denying plaintiff’s motions seeking to set aside the Court’s prior rulings regarding disputed settlement terms and to re-open the case and compelling him to comply with the settlement previously approved by the Court. The Court also denied defendants’ motion for sanctions, but granted defendants the right to file a new motion for sanctions against plaintiff. The plaintiff filed a notice of appeal on June 9, 2008 to the United States Circuit Court for the Second Circuit, with respect to certain of those rulings by the Court. In the meanwhile on June 3, 2008, the escrow agent appointed to handle the settlement funds and property delivered releases running from the Mr. Brandt to the Company, George Holley and the Salem Estate and, in turn, releases running from the defendants to the plaintiff were also delivered together with $610,849.32 in cash paid by the Company, representing the $600,000 agreed payment plus certain accumulated interest and 249,579 shares of the Company’s stock delivered into escrow jointly by George Holley and the Salem Estate. Subsequently, the parties resolved to settle and discontinue the matter and entered into a written Agreement and Mutual Release dated as of June 17, 2008, under which the parties confirmed the transfer of releases, cash and shares out of the escrow created under the Escrow Agreement, pursuant to the settlement and, in addition, Mr. Brandt withdrew his appeal and delivered to the defendants a payment in the sum of $30,000 on account of their pending claim against plaintiff for sanctions. The parties also filed a consensual Stipulation of Dismissal dated

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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

June 23, 2008, which was duly filed with the Clerk of the United States District Court for the District of Connecticut on July 1, 2008, terminating the action.

FDA Matter

The Food and Drug Administration (FDA) has requested meetings with manufacturers, including the Company, of blood glucose monitoring systems to discuss the FDA’s safety concerns about the continued use of glucose monitoring systems that use the GDH-PQQ enzyme. The FDA’s concerns relate to certain patients receiving other medical treatments or IV therapies that are known to contain maltose and maltose derivatives. In the past, regulatory agencies, including the FDA, have issued cautionary statements and medical device alerts to the health care community that explained the risk of using GDH-PQQ systems with dialysis patients receiving maltose, xylose or galactose. The Company’s TRUEresult and TRUE2Go systems both use TRUEtest strips, which in turn use the GDH-PQQ enzyme. Prior to receiving 510(k) marketing clearance of these products from the FDA in August 2008, the Company modified its labeling and educational materials, in accordance with FDA recommendations, to mitigate these risks. During a meeting with the FDA in February 2009, the Company was asked to work with the FDA to develop a plan that addresses these concerns and further mitigate the risks associated with the use of these products by patients receiving other medical treatments or IV therapies that are known to contain maltose and maltose derivatives. This plan, if approved and required to be implemented by the FDA, may limit the distribution of these productsand/or require additional labeling and educational materials, may require that a different type of enzyme be utilized in these product, or may require the withdrawal of these products from the market. The Company is developing its risk mitigation plan to review with the FDA at the end of March 2009. At this time, management cannot reasonably estimate the amount of potential loss, if any, related to this matter. As more information becomes available, accruals, if any, for losses that may be considered probableand/or asset impairment charges may be necessary. An unfavorable outcome in this matter could have a material adverse effect on the Company’s financial position, liquidity and results of operations.

17.   Export sales

Export sales, principally throughout Europe and Latin America, accounted for approximately $11.3 million (10.1% of net sales), $14.5 million (12.6% of net sales) and $14.8 million (12% of net sales) for the years ended December 31, 2006, 2007 and 2008, respectively.

18.   Significant concentrations of business and credit risk

Evaluations of customers’ financial condition are performed regularly. The Company maintains reserves for potential credit losses and such losses, in the aggregate, have generally not exceeded management’s estimates.

Competition may result in changes in the Company’s customer base over time, and it is therefore possible that the Company may lose one or more of its largest customers and, as a result, operations could be impacted. The Company has one customer that accounted for approximately 15.5%, 14.7% and 15.3% of net sales for the years ended December 31, 2006, 2007 and 2008, respectively. In addition, the Company has another customer that accounted for approximately 11.9%, 12.9% and 12.1% of net sales for the years ended December 31, 2006, 2007, and 2008, respectively. At December 31, 2007 and 2008, accounts receivable included amounts owed from these customers of approximately $5.5 million and $8.5 million, respectively.

The Company exports its products throughout the world, and the financial results and financial condition of the Company have not been significantly impacted by the economic difficulties experienced by some of these countries.

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HOME DIAGNOSTICS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

19.   Quarterly Financial Data (Unaudited)

	Quarter
	1st		2nd		3rd		4th
Year Ended December 31, 2008
Net Sales	$	25,120,280	$	33,355,841	$	35,564,663	$	29,541,659
Gross Profit		14,588,347		19,886,765		21,629,234		15,133,099
Net Income		721,366		2,684,259		4,534,384		1,704,429
Earnings per common share:
Basic	$	0.04	$	0.15	$	0.26	$	0.10
Diluted	$	0.04	$	0.14	$	0.24	$	0.09
Year Ended December 31, 2007
Net Sales	$	28,100,050	$	28,050,322	$	31,684,101	$	27,766,783
Gross Profit		16,895,713		16,099,065		20,658,799		16,392,147
Net Income		2,475,313		1,839,277		5,204,148		109,270
Earnings per common share:
Basic	$	0.14	$	0.10	$	0.29	$	0.01
Diluted	$	0.13	$	0.09	$	0.27	$	0.01

During the first quarter of 2008, the Company recorded the following transactions which impacted results:

•  A charge of approximately $0.5 million to Other income (expense) due primarily to foreign exchange losses incurred by the Company’s Taiwan subsidiary due to declines in the value of the U.S. dollar.

•  An income tax benefit of $0.6 million related to the reversal of previously accrued taxes resulting from the favorable resolution of various tax matters with the Internal Revenue Service.

During the fourth quarter of 2008, the Company recorded an income tax benefit of $0.6 million related to the reversal of certain tax contingencies for which the statute of limitations has expired.

During the third quarter of 2007, the Company reached a settlement agreement with its directors and officers insurance provider, whereby, the Company received $450,000 in insurance proceeds relating to a recovery of losses incurred as part of the Brandt matter (See Note 16).

During the fourth quarter of 2007, the Company recorded a charge of $3.5 million to operating expense associated with the payment of a litigation settlement (See Note 16).

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Item 9.   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None

Item 9A.   Controls and Procedures

Disclosure Controls and Procedures

As of the December 31, 2008, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined inRules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined inRules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934, as amended) during the quarter ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Report of Management on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined inRules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934).

Our internal control over financial reporting was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those policies and procedures that:

•  pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

•  provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America;

•  provide reasonable assurance that receipts and expenditures are being made only in accordance with authorization of our management and directors; and

•  provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Our management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008.

Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management determined that, as of December 31, 2008, we maintained effective internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of our Board of Directors.

PricewaterhouseCoopers LLP, independent registered public accounting firm, who audited and reported on our consolidated financial statements included in this annual report, has also audited the effectiveness of our internal control over financial reporting as of December 31, 2008 as stated in its report appearing under Item 8 of part II of this annual report.

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Item 9B.   Other Information

None.

PART III

Item 10.   Directors, Executive Officers and Corporate Governance

We have adopted a code of ethics and business conduct, entitled “Standards of Integrity,” that applies to our employees including our principal executive officer, principal financial officer, principal accounting officer, and persons performing similar functions. Our Standards of Integrity can be found posted in the investor relations section on our website athttp://www.homediagnostics.com.

The other information required in response to this Item will be set forth in our definitive proxy statement for our 2009 Annual Meeting of Stockholders and is incorporated herein by reference. We intend to file our definitive proxy statement for our 2009 Annual Meeting of Stockholders by April 30, 2009.

Item 11.   Executive Compensation

The information required in response to this Item will be set forth in our definitive proxy statement for our 2009 Annual Meeting of Stockholders and is incorporated herein by reference. We intend to file our definitive proxy statement for our 2009 Annual Meeting of Stockholders by April 30, 2009.

Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required in response to this Item will be set forth in our definitive proxy statement for our 2009 Annual Meeting of Stockholders and is incorporated herein by reference. We intend to file our definitive proxy statement for our 2009 Annual Meeting of Stockholders by April 30, 2009.

Item 13.   Certain Relationships and Related Transactions, and Director Independence

The information required in response to this Item will be set forth in our definitive proxy statement for our 2009 Annual Meeting of Stockholders and is incorporated herein by reference. We intend to file our definitive proxy statement for our 2009 Annual Meeting of Stockholders by April 30, 2009.

Item 14.   Principal Accountant Fees and Services

The information required in response to this Item will be set forth in our definitive proxy statement for our 2009 Annual Meeting of Stockholders and is incorporated herein by reference. We intend to file our definitive proxy statement for our 2009 Annual Meeting of Stockholders by April 30, 2009.

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PART IV

Item 15.   Exhibits and Financial Statement Schedules and Reports onForm 8-K

(a) The following documents are filed as a part of this Report:

(1) Financial Statements.

(a).1.Financial Statements.

The financial statements listed in the accompanying Index to Consolidated Financial Statements on page 43.

(2) Financial Statement Schedules:

All financial statement schedules have been omitted because they are not applicable or the required information is presented in the consolidated financial statements or the notes to the consolidated financial statements.

(b) Exhibits.  The following exhibits are filed (or incorporated by reference) as part of this report:

Exhibit
Number				Description
	3	.1	—	Amended and Restated Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1 filed on May 1, 2006 (File No. 333-133713)).
	3	.2	—	Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on August 13, 2007).
	4	.1	—	Specimen Stock Certificate for the common stock, par value $0.01 per share, of the Registrant (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on September 28, 2006).
	10	.1	—	1992 Stock Option Plan of the Registrant (incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-1 filed on May 1, 2006 (File No. 333-133713)).
	10	.2	—	Form of stock option agreements under the 1992 Stock Option Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Registration Statement on Form S-1 filed on May 1, 2006 (File No. 333-133713)).
	10	.3	—	2002 Stock Option Plan of the Registrant (incorporated by reference to Exhibit 10.3 to the Registrant’s Registration Statement on Form S-1 filed on May 1, 2006 (File No. 333-133713)).
	10	.4	—	Form of stock option agreements under the 2002 Stock Option Plan (incorporated by reference to Exhibit 1004 to the Registrant’s Registration Statement on Form S-1 filed on May 1, 2006 (File No. 333-133713)).
	10	.5	—	2006 Equity Incentive Plan of the Registrant (incorporated by reference to Exhibit 10.13 to Amendment No. 2 filed on July 12, 2006 to the Registrant’s Registration Statement on Form S-1 (File No. 333-133713)).
	10	.6	—	Form of stock option agreements under the 2006 Equity Incentive Plan (incorporated by reference to Exhibit 10.6 to the Registrants Quarterly Report on Form 10-Q filed on November 14, 2006).
	10	.7	—	Fifth Amended and Restated Loan Agreement with Wachovia Bank N.A, dated March 20, 2008 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on March 20, 2008).
	10	.8	—	Office/Distribution Building Lease, dated May 2, 1997, between the Registrant and Corporate Center Developers (incorporated by reference to Exhibit 10.6 to the Registrant’s Registration Statement on Form S-1 filed on May 1, 2006 (File No. 333-133713)).
	10	.9	—	Amendment dated March 13, 2007, to Office/Distribution Building Lease, dated May 2, 1997, between the Registrant and Boywic Farms as successor in interest to Corporate Center Developers (incorporated by reference to Exhibit No. 10.18 to the Registrant’s Annual Report on Form 10-K filed with the SEC on March 23, 2007).

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Exhibit
Number				Description
	10	.10	—	ECI Project Development Agreement, dated January 1, 2002, between the Registrant and George Holley (incorporated by reference to Exhibit 10.14 to Amendment No. 3 filed on August 21, 2006 to the Registrant’s Registration Statement on Form S-1 (File No. 333-133713)).
	10	.11	—	Forms of Indemnification Agreement with the Registrant directors and certain of its officers (incorporated by reference to Exhibit 10.9 to the Registrant’s Registration Statement on Form S-l filed on May 1, 2006 (File No. 333-133713)).
	10	.12	—	Employment Agreement, dated November 7, 2008, between the Registrant and J. Richard Damron, Jr. (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on November 7, 2008 (File No. 001-33027)).
	10	.13		Income Protection Continuation Letter Agreement dated November 4, 2008 between the Registrant and Ronald Rubin (incorporated by reference to Exhibit No. 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on December 22, 2006).
	10	.14*		Offer letter including Income Protection Continuation provision, dated July 30, 2007 between the Registrant and Scott Verner.
	10	.15*		Income Protection Continuation Letter Agreement, dated September 25, 2007 between the Registrant and George Godfrey.
	10	.16*		Income Protection Continuation Letter Agreement, dated March 6, 2008 between the Registrant and Gary Neel.
	10	.17	—	Income Protection Continuation Letter Agreement, dated November 4, 2008 between the Registrant and Gregg Johnson (incorporated by reference to Exhibit No. 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on November 6, 2008).
	10	.18	—	Employment Agreement, dated February 23, 2009 by and between the Registrant and Joseph H. Capper (incorporated by reference to Exhibit No. 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 25, 2009).
	14*			Standards of Integrity
	17			J. Richard Damron, Jr. Resignation Letter dated, February 23, 2009 (incorporated by reference to Exhibit No. 99.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on February 25, 2009).
	21		—	List of Subsidiaries
	23	.1	—	Consent of PricewaterhouseCoopers, LLP
	31	.1	—	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
	31	.2	—	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
	32	.1**	—	Certification of Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350.
	32	.2**	—	Certification of Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350.

*	Filed herewith
**	This certification is being furnished solely to accompany this Annual Report pursuant to 18 U.S.C. § 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference to any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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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.

HOME DIAGNOSTICS, INC.

By:  /s/  JOSEPH H. CAPPER

Joseph H. Capper

President and Chief Executive Officer

March 11, 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 and on the dates indicated.

Signature	Title	Date
/s/  Joseph H. Capper Joseph H. Capper	President and Chief Executive Officer (principal executive officer) and Director	March 11, 2009
/s/  Ronald L. Rubin Ronald L. Rubin	Sr. Vice President and, Chief Financial Officer (principal financial and accounting officer)	March 11, 2009
/s/  George H. Holley George H. Holley	Chairman of the Board	March 11, 2009
/s/  Donald P. Parson Donald P. Parson	Vice Chairman of the Board	March 11, 2009
/s/  G. Douglas Lindgren G. Douglas Lindgren	Director	March 11, 2009
/s/  Richard A. Upton Richard A. Upton	Director	March 11, 2009
/s/  Tom Watlington Tom Watlington	Director	March 11, 2009

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