UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

Commission File Number: 000-51512

 

Cardiac Science Corporation

(Exact Name of Registrant as Specified in its Charter)

 

 

(425) 402-2000

(Registrant’s Telephone Number, Including Area Code)

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

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

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  o Yes     o No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  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 definition of “accelerated filer, large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

 

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant, based on the closing price of the registrant’s Common Stock on June 30, 2009 as reported on the NASDAQ Global Market, was approximately $81,565,474.

 

The number of shares of the registrant’s Common Stock outstanding at March 8, 2010 was 23,621,445.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The information required by Part III of this Report, to the extent not set forth herein, is incorporated herein by reference to the registrant’s definitive Proxy Statement relating to the registrant’s 2010 annual meeting of shareholders. Such definitive Proxy Statement or an amendment to this Report providing the information required by Part III of this Report shall be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates.

 

 

CARDIAC SCIENCE CORPORATION

 

2009 FORM 10-K ANNUAL REPORT

 

TABLE OF CONTENTS

 

 

This Annual Report on Form 10-K contains forward-looking statements relating to Cardiac Science Corporation. Except for historical information, the following discussion contains forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “intend,” “anticipate”,” will,” “may,” variations of such words, and similar expressions identify forward-looking statements, but their absence does not mean that the statement is not forward-looking. These forward-looking statements reflect management’s current expectations and involve risks and uncertainties. Our actual results could differ materially from results that may be anticipated by such forward-looking statements. The principal factors that could cause or contribute to such differences include, but are not limited to, those discussed under the heading “Risk Factors” on Item 1A of this report and those discussed elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements to reflect events or circumstances that may subsequently arise. Readers are urged to review and consider carefully the various disclosures made in this report and in our other filings made with the SEC that disclose and describe the risks and factors that may affect our business, prospects and results of operations. The terms “the Company,” “us,” “we,” and “our” refer to Cardiac Science Corporation and its majority-owned subsidiaries.

 

 

Overview

 

We develop, manufacture, and market a family of advanced diagnostic and therapeutic cardiology devices and systems, including automated external defibrillators (“AEDs”), electrocardiograph devices (“ECG/EKG”), cardiac stress testing treadmills and systems, Holter monitoring systems, hospital defibrillators, cardiac rehabilitation telemetry systems, vital signs monitors and cardiology data management systems (“Informatics”) that connect with hospital information (“HIS”), electronic medical record (“EMR”), and other information systems. We sell a variety of related products and consumables, and provide a portfolio of training, maintenance, and support services. We are the successor to the cardiac businesses that established the trusted Burdick^®, Quinton^® and Powerheart^® brands and are headquartered in Bothell, Washington. With customers in more than 100 countries worldwide, we have operations in North America, Europe, and Asia.

 

We were incorporated in Delaware on February 24, 2005 as CSQ Holding Company to effect the business combination of Quinton Cardiology Systems, Inc. (“Quinton”) and Cardiac Science, Inc. (“CSI”) pursuant to a merger transaction. The merger was consummated on September 1, 2005 at which time the Company’s name was changed to Cardiac Science Corporation.

 

Industry Background

 

The American Heart Association (“AHA”) reports that there are more than 64 million patients in the U.S. with active or developing heart disease. Cardiovascular disease (“CVD”) is the leading cause of death in the U.S. and statistics published by the AHA show that one out of every three Americans has some form of CVD. In 2009, the AHA estimated that as many as 295,000 people in the United States alone die each year from sudden cardiac arrest (“SCA”). The AHA also estimates the direct cost of treating CVD in the U.S. at more than $400 billion annually. With risk factors such as obesity and sedentary lifestyle on the rise, the prevalence of CVD is expected to increase as well.

 

Our Markets

 

We are a global leader in advanced cardiac diagnosis, resuscitation, rehabilitation, and informatics products. We characterize the systems used by healthcare providers to diagnose, monitor, and manage heart disease as the “cardiac monitoring” market. We characterize the devices used to automatically or manually resuscitate victims of cardiac arrest as the “defibrillation” market.

 

Based on industry reports and management estimates, we believe that sales in the markets in which we compete will approach or exceed $3 billion during the next several years. We believe the worldwide market for

cardiac monitoring systems is at least $1 billion and is growing at 2-3% annually, with portions of that market, cardiology management systems and certain international markets, growing at more than 5% annually. We believe the worldwide market for AEDs currently exceeds $350 million and will more than double over the next five years. We believe the worldwide market for manual (or traditional) external defibrillators is currently more than $700 million and is growing at approximately 5% annually.

 

Cardiac Monitoring Market

 

What is Cardiac Monitoring?

 

Cardiac monitoring systems are crucial to cardiovascular care. Clinicians use cardiac monitoring systems to assess the presence and severity of cardiac disease and to evaluate the efficacy of treatments such as drugs, interventions, operations, and device implants. Effective delivery of cardiovascular care requires that the entire process of recording, storing, analyzing, retrieving, and distributing cardiology data be as rapid and cost effective as possible.

 

How is Cardiac Monitoring Performed?

 

The core of cardiac monitoring is the electrocardiogram, or ECG waveform, a representation of the electrical activity of the heart. Clinicians use ECG waveform recordings and analyses to assess the presence and severity of cardiac disease and to monitor the efficacy of treatments such as drugs, interventions, operations, and device implants.

 

What are the Challenges Related to Cardiac Monitoring?

 

Despite the technological and clinical advances in cardiology, healthcare providers face significant challenges in delivering consistent and high quality cardiovascular care. Healthcare reform and declining reimbursement rates continue to place increasing pressure on providers to treat more patients faster. In addition, the need to control costs, increase efficiencies, and manage data introduces new factors into the decision making process for technology utilization.

 

These healthcare changes prompt a number of emerging critical needs and create opportunities for Cardiac Science. These include creating systems and services tailored to the clinician workflow, developing products that are intuitive and easy to use, using proven communication standards for connectivity, improving the management of healthcare delivery resources, and utilizing emerging technologies from multiple vendors — all within a security structure that meets Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) requirements.

 

Defibrillation Market

 

What is Defibrillation?

 

Defibrillation is the delivery of electrical current to the heart to restore a normal heartbeat. Defibrillation systems enable the detection and identification of life-threatening arrhythmias which can lead to death from SCA and, when appropriate, deliver a shock to restore the normal heartbeat. Sophisticated algorithms within defibrillators filter noise and artifact from a patient’s electrocardiogram signal to enable correct identification of heart rhythms that are life-threatening (i.e. shockable), or non-life-threatening (i.e. not shockable).

 

How is Defibrillation Performed?

 

A normal electrocardiogram consists of wave forms that are referred to as P-QRS-T waves. The QRS wave complexes correspond with a person’s heart rate. In the case of the chaotic and disorganized rhythm, which can lead to SCA, these QRS complexes are absent or indistinguishable.

 

Analysis performed by a defibrillator determines the type of arrhythmia, whether a shock is required, and the appropriate type of shock (either synchronous or asynchronous). A shock will be indicated if the heart rhythm is considered shockable, and the condition persists. During the delivery of any defibrillation shock, the cell

membranes of the heart are charged until the cells depolarize. This allows normal electrical pathways to reestablish control and produce a coordinated rhythm.

 

What Are the Challenges Related to Defibrillation?

 

Technical challenges abound in delivering current to the heart with external defibrillation. Impedance is one. Tissue such as skin, fat, muscle, and bone, surround the heart and impede the energy flow from a defibrillator. Impedance varies from person to person, so adjustments must be made to accommodate each person’s impedance. Another technical challenge is overcoming the victim’s defibrillation threshold, the minimum current required to defibrillate the victim’s heart and establish a normal rhythm. Finally, to provide effective defibrillation, the cell membranes of the heart must be fully depolarized to minimize the likelihood of re-fibrillation and provide an optimal environment to defibrillate the heart. If any residual charge remains on the cells (i.e., they do not fully depolarize), re-fibrillation may occur.

 

Death from SCA occurs without warning or immediately after the onset of symptoms. The AHA estimates that 50% of SCA victims have no prior indication of heart disease, so the first symptom is the SCA event. For those with a known history of cardiac disease, the chance of sudden cardiac death is four to six times greater than that of the general population.

 

Surviving SCA is linked directly to the amount of time between the onset of SCA and defibrillation shock. Following SCA, the AHA estimates that every minute without a defibrillation shock decreases chance of survival by approximately 10%. Approximately two thirds of the estimated annual deaths from SCA occur outside a hospital in the United States. Almost 60% of these incidents are witnessed, yet 95% of these victims do not survive, according to the AHA.

 

In hospital and pre-hospital (e.g. ambulance) settings, trained professionals typically deploy manual or semi-automatic defibrillators to treat SCA victims. These standard defibrillators require operation or supervision by highly skilled medical personnel to analyze and interpret the patient’s electrocardiogram and to manually deliver a shock using handheld paddles.

 

Over the past several years, more people have become aware that AEDs can be used safely by lay people. Communities that strategically place AEDs in public buildings, arenas, airports, and emergency vehicles reduce response times and, therefore, improve survival rates for SCA. According to the AHA, communities with public access defibrillation (“PAD”) programs report community survival rates approaching 50%. In highly trafficked or monitored venues such as casinos and corporate workplaces, survival rates have ranged even higher since the time for the first defibrillation shock can be accelerated in these venues.

 

Numerous AED-related laws and regulations at the federal and state level and in some countries outside the United States have facilitated significant growth in both new and existing markets for AEDs. During the last several years, these initiatives have resulted in certain protections from civil liability arising from emergency use of AEDs, funding programs for PAD program implementation and the mandatory deployment of AEDs in some settings. In addition, the AHA has publicly encouraged widespread deployment of AEDs in workplaces, communities, and homes.

 

Our Products and Services

 

We address our markets through a broad range of cardiac monitoring and defibrillation products and services. In recent years, we introduced new versions of products or upgraded capabilities in most of our product lines, and we are currently developing additional new versions of products in many of these product lines.

 

See Note 3 — Segment Reporting, to our Consolidated Financial Statements included elsewhere in this report for a list of product lines contributing revenues of 10% or more in each of the last three fiscal years.

 

Cardiac Monitoring Products

 

Our cardiac monitoring products deliver reliable, cost-effective solutions and improve workflow for healthcare providers worldwide in multiple settings. Our cardiac monitoring products are easy to use, with simple, intuitive

user interfaces. Many of our cardiac monitoring products are built on a Microsoft Windows-based software architecture designed to integrate critical data capture, provide enterprise level access to data, and scale to meet the requirements of a variety of cardiovascular care environments.

 

Our principal cardiac monitoring products include:

 

Resting ECG systems

 

We offer a variety of ECG systems that allow physicians to record and analyze patient ECG waveforms at rest to assess the presence of cardiac disease. These products are designed to improve workflow and are offered at various price points and configurations, and cover the spectrum of market needs, ranging from low-cost units targeting physicians’ offices to fully featured units that are designed for the most rigorous clinical and hospital settings.

 

Cardiac stress testing systems

 

Our stress testing systems allow cardiologists and other healthcare providers to monitor and analyze the performance of the heart under stress. Our stress systems record a patient’s heart rate, heart rhythm, blood pressure, and other vital signs during induced stress. Our treadmills, specifically designed for cardiac monitoring procedures, provide precise and replicable levels of exertion. Our systems provide real time analysis, charting, and reporting, all of which enable cardiologists and other healthcare providers to diagnose patients’ heart disease more accurately and efficiently.

 

Holter monitoring systems

 

Our Holter products and systems record and assess the performance of a patient’s heart during various activities over extended periods of time. The Holter recorder, an ambulatory monitor typically worn for 24 hours or more, records the patient’s heart rate, heart rhythm, and ECG waveform data. Our Holter offering includes systems with multiple diagnostic capabilities.

 

Cardiac rehabilitation telemetry systems

 

Our telemetry devices and database products monitor the patient’s heart rate, heart rhythm, and ECG waveform data during rehabilitation exercises. These rehabilitation devices and database products, used with our treadmills, provide real-time clinical data and trend analysis to enable cardiologists and other healthcare providers to track and assess improvements in cardiovascular function.

 

Vital signs monitors

 

In October 2009, we introduced a line of vital signs and spot check monitors under the Cardiac Science brand based on proven technology from Omron Healthcare, Inc. The devices monitor noninvasive blood pressure, pulse rate, temperature, and oxygen saturation (SpO₂).

 

Cardiology data management systems (informatics)

 

We provide cardiology data management systems that automate the processing, storage, retrieval, and editing of electrocardiograms and other patient data. Our open architecture strategy provides customers with the flexibility to integrate with an increasing number of devices and data management systems while retaining their current equipment.

 

Related products and supplies

 

Cardiac monitoring products often require lead wires and electrodes to be attached to the patient to retrieve and process patient ECGs, as well as thermal chart paper to generate reports. We sell these items, including our Quik-Prep electrodes, and provide an array of complementary products, such as temperature and blood pressure monitors, spirometers and pulse oximeters.

Services

 

We provide a comprehensive portfolio of training, maintenance, and other services to medical and non-medical customers. Our services organization provides installation, repair, maintenance, and technical services, as well as hardware and software upgrades to our installed base of products. We provide call-center access 24 hours per day, seven days per week, depot repair, and on-site maintenance and repair through our extensive field service organization.

 

Advantages of our cardiac monitoring products:

 

We believe our cardiac monitoring products provide our customers with solutions for overcoming many of the challenges they face, including the following key benefits:

 

Ease of use.  Our user interfaces, designed with significant input from clinicians and technologists, are intuitive and easy to use. Many of our products automate the data collection functions, use standard computer components, and require minimal configuration. We generally design our interfaces to conform to the particular clinical procedure rather than adapting the procedure to the device, and users can customize the interface to meet their unique requirements. We believe this functionality enhances clinical success by allowing the user to concentrate on the patient and procedure. In addition, we believe the ease of use features of our products enable our customers to use our systems with significantly lower training requirements and higher productivity than competing products that do not offer customizable user interfaces.

 

Effective data capture.  Many of our products automate and assist in the collection, interpretation, and retrieval of data and can effectively display, for side-by-side comparison, the results of tests performed over an extended period. These products improve clinical productivity and throughput, which is the number of reimbursable procedures completed per hour of system use. For our customers, greater throughput translates into greater return on investment from our products.

 

Improved diagnostic speed and accuracy.  As a result of easy to use controls, effective data capture, and computer assisted diagnosis, we believe our products allow for improved diagnostic accuracy. The availability of historical results for comparison allows for a greater understanding of changes in a patient’s physical condition. In addition, we believe that by enabling the review and assessment of test results remotely, our systems can greatly speed the time of diagnosis.

 

Wireless and network compatibility.  Arguably the next most important feature after accuracy and dependability, most of our monitoring products support a clinical network environment. This enables cardiologists to assimilate, collate, and interpret data and disseminate results to facilitate diagnosis, patient monitoring and patient management. These products collect data that may be stored in a local or network server database. Most of our monitoring products also connect to larger enterprise networks that allow data to be shared with other users, both within the facility and remotely via secure networks.

 

To facilitate these connections, we rely primarily on commonly used formats and protocols. These formats, such as portable document format (“PDF”) and extensible markup language (“XML”) enable the storage and dissemination of clinical information.

 

Flexible open technology for integration with EMR, HIS, and other information systems.  Our Microsoft Windows-based technology adheres to established standards for image, waveform, data and report generation, and dissemination, enabling healthcare providers to share data across a private network or via the Internet. This Windows-based technology platform was designed to support data integration activities with other third-party clinical systems. We believe this technology will permit our customers to easily integrate our products and systems with their existing infrastructure, and scale to meet the needs of larger healthcare organizations.

 

Defibrillation Products

 

We design our defibrillation products using advanced technology in order to deliver superior performance, reliability, flexibility, and ease of use. All of our defibrillation products incorporate our proprietary RHYTHMx technology. This platform technology is designed to detect ventricular fibrillation and other life-threatening

arrhythmias. Our Self-Tracking Active Response (“STAR^®”) biphasic technology is designed to optimize the delivery of a potentially life-saving electric shock to victims of SCA.

 

We have integrated our core technology, along with other proprietary technology, into our AEDs and hospital defibrillation product lines. We also market our proprietary disposable defibrillator electrode pads and a variety of accessories, including long-life batteries, carrying cases, wall cabinets, and other related items. In addition, we also license certain components of our core technology to third-parties for integration into other products. Our AEDs comply with the latest CPR and defibrillation protocols established by the AHA and related organizations in 2005.

 

Our principal defibrillation products include:

 

Public Access AEDs

 

AEDs designed for public access are deployed in numerous settings, including educational institutions, federal, state and local municipal agencies, fire and police departments, ambulances, railroads, airports, airlines, military bases, hospitals, nursing homes, health clubs, physician and dental offices, and leading corporations. Our AEDs have also been chosen by many local governments and municipalities for use in community based PAD programs in cities such as London, England, San Diego, California, Miami, Florida, Minneapolis, Minnesota, St. Louis, Missouri, and throughout the entire state of Nevada.

 

Public access AEDs are available in both automatic and semi-automatic models with varying levels of cardiopulmonary resuscitation (“CPR”) voice prompts. Our advanced voice prompts include detailed rescue code voice prompts and metronome guidance for CPR compressions which are designed to direct a minimally trained user through CPR and AED use to potentially save a life.

 

Professional AEDs

 

Our professional AEDs are technologically advanced and are designed for use by sophisticated users of lifesaving equipment, such as hospital personnel, medical professionals, and emergency medical technicians. These products display the victim’s heart rhythm on a built-in high resolution color ECG display and give professional users the option of delivering defibrillation shocks either semi-automatically or manually during the emergency treatment of a victim of sudden cardiac arrest. These products also include continuous cardiac monitoring capability via an ECG patient cable, multiple rescue data storage, clear and comprehensive voice prompts, infrared data transfer, and optional rechargeable batteries.

 

Traditional Defibrillators

 

Traditional defibrillators are typically positioned in the hospital at locations such as critical care and cardiac care units, emergency and operating rooms, electrophysiology labs, medical transport environments and alternate care facilities.

 

Our Powerheart ECD, a traditional hospital “crash cart” defibrillator. The product is designed for use in hospital settings by skilled medical personnel and incorporates our proprietary technology. The Powerheart ECD, which received 510(k) clearance in early 2006, is sold exclusively through GE Healthcare, a division of General Electric (“GE”). GE markets this product in North America and in the rest of the world as the GE Responder 2000.

 

Defibrillation Supplies and Accessories

 

We provide an extensive line of supplies and accessories to support our customers’ defibrillation programs. These include replacement electrodes and batteries, training devices, wall cabinets, carrying cases, and more.

 

Services

 

We provide a full range of AED training, maintenance, and support services. Our services include training in the use of AEDs and related training in CPR. We deliver these AED/CPR training services in the field through a U.S. field staff of over 120 part-time employees. We also provide medical direction and information management necessary for AED users to be in compliance with various state laws and regulations.

Advantages of our defibrillation products:

 

We believe that our defibrillation products offer the following competitive advantages:

 

Dependability.  Our patented Rescue Ready^® technology distinguishes us among competitors. Every day, to ensure anytime functionality, the Powerheart AED self checks all main components (battery, hardware, software, and electrode pads). Every week, the AED completes a partial charge of the high-voltage electronics. And every month, the AED charges the high-voltage electronics to full energy. If anything is amiss, the Rescue Ready status indicator on the AED handle changes from green to red and the device emits an audible alert for the owner to service the unit. This is important because a Powerheart AED may not be used for months or even years.

 

Arrhythmia Detection.  Our patented RHYTHMx software algorithm technology allows for the accurate detection and discrimination of life-threatening ventricular tachyarrhythmias and can also be used to treat patients with supraventricular arrhythmias. RHYTHMx filters noise and artifact from a patient’s electrocardiogram signal without compromising sensitivity or specificity. RHYTHMx technology has been clinically validated by leading researchers in numerous clinical studies and received clearance from the U.S. Food and Drug Administration (“FDA”) in 1998. In these studies, RHYTHMx demonstrated 100% sensitivity (correct identification of shockable rhythms) and 99.4% specificity (the ability to identify and not shock non-lethal rhythms).

 

Variable Escalating Biphasic Defibrillation Energy.  Our patented STAR biphasic waveform technology instantly determines a patient’s impedance, defibrillation threshold, and cellular response characteristics in order to optimize and adjust the magnitude of the defibrillation shock based on a patient’s unique size and weight. STAR biphasic also facilitates the escalation of energy if subsequent shocks are necessary. We believe this feature reduces the total number of shocks required to convert patients to a normal rhythm. In addition to the use of STAR biphasic waveform technology in our defibrillator devices, we also license this technology to selected partners.

 

Ease of Use.  Time is critical during cardiac defibrillation. Our defibrillators are recognized as having industrial designs and user interfaces that facilitate ease of use. This uncompromising commitment to ease of use allows a wide variety of users in a multitude of medical and public access environments to successfully operate our devices. Our AEDs have one button or no button operation and provide clear, concise voice prompts that provide detailed instructions to guide the user through the rescue process.

 

Flexibility.  Our various defibrillators allow for fully-automatic, semi-automatic, or manual delivery of defibrillation therapy. Operators can easily customize their device settings to suit their particular requirements. Our most popular AED offers patented, fully-automatic delivery of shocks, which differentiates it from competitive devices.

 

Rugged design.  Durability and low cost of ownership are key features of our defibrillators. Designed for the most rugged applications our devices can withstand the demands of daily use by hospitals as well as deployments in military settings, fire trucks, police vehicles, and ambulances.

 

Growth Strategy

 

Our growth strategy is to:  (1) enhance our cardiac monitoring product portfolio; (2) broaden our AED portfolio to include products at multiple price points; (3) bring new and simplified procedures to primary care physicians; (4) deepen our distribution into international markets; (5) leverage our services capabilities; and (6) pursue strategic mergers or acquisitions.

 

Enhance our monitoring portfolio

 

We believe our distribution capabilities into the US acute care (hospitals and cardiology clinics) and, especially, primary care (physician general practice and family health clinics) markets represent a unique strategic asset. We believe that we can successfully reach smaller hospitals, cardiology clinics and approximately 200,000 primary care physicians through our distribution channels and that we can successfully grow our revenue by selling additional cardiology and related monitoring products through these channels.

Broaden our AED portfolio

 

We currently sell products that are positioned at the higher end of the pricing spectrum in the public access AED market. We believe we compete effectively in this segment of the market due to superior features of our products compared to those of our competitors. We believe that a significant component of the future growth of the AED market will be at the lower end of the pricing spectrum, as the number of state and local mandates requiring that AEDs be available in certain venues such as schools, assisted living centers and other facilities increases. We believe that buyers who are acting in response to these mandates are driven more by price than by product features. Accordingly, we intend to develop and add lower priced AEDs to complement our existing line in the future and expect that this will lead to additional revenue growth.

 

Bring new and simplified procedures to primary care physicians

 

Using currently available technology and under established billing codes, we intend to simplify and otherwise make available to primary care physicians diagnostic procedures that have more traditionally been performed by physician specialists. We believe that we can help physicians improve effectiveness and enhance medical care by performing diagnostic and monitoring procedures earlier, before patients are referred downstream to specialists. We believe that our research and development capabilities, combined with our distribution, make us uniquely well positioned to either develop these procedures ourselves or to be sought out as a partner to others with compelling technologies that can be so developed.

 

Deepen our distribution into international markets

 

We believe that we can increase sales of both cardiac monitoring and defibrillation products outside of the United States by continuing to develop and improve our international distribution network through increased direct presence and oversight in countries in Western Europe, Asia and Latin America.

 

Leverage our services capabilities

 

We believe our focused repair, call center, and field service capabilities distinguish us from our competitors in cardiac monitoring. In addition, we believe our extensive capabilities to provide training, medical direction and information management relating to the deployment and maintenance of AEDs allows us to provide a unique, single source, turnkey solution to our customers. These capabilities offer the potential for additional revenue growth as part of new product selling efforts, as well as independently with existing customers, through billable training, maintenance and other activities.

 

Pursue strategic mergers and acquisitions

 

Our growth strategy contemplates mergers and other acquisitions of businesses, product lines, assets, or technologies that are complementary to our business or offer us other strategic benefits, such as enhanced clinical or technological value, expanded geographical reach, and additional sales or research and development capabilities. We plan to expand our product lines, leverage the capabilities of our existing sales force and increase sales of our existing and new product lines by selectively acquiring those companies, or assets of companies, with strong differentiated technologies or complementary product lines. In addition to acquisitions of distinct product lines or smaller companies, we may pursue growth through merger with companies of more significant size. We believe the fragmentation of many areas of the cardiology industry offers an excellent opportunity for growth through selective acquisitions. We also believe our product brands and distribution capabilities, as well as the acquisition integration experience of our management team; put us in a position to take advantage of these opportunities.

Business Advantages

 

We believe our business has several advantages, including:

 

Cardiology focus

 

We concentrate principally on noninvasive cardiac care and thoroughly know our categories. We believe this focus elevates our product and service offerings and differentiates us in the medical devices field. Our management and research and development teams have significant experience in cardiology products, which enables rapid innovation and commercialization of products and services. Similarly, our sales and service organizations also possess substantial domain knowledge.

 

Leading brands and market positions

 

The Burdick, Quinton and Powerheart brands are highly respected names in the field of cardiology and we believe we have a leading position in several domestic and international market segments in both cardiac monitoring and defibrillation.

 

In cardiac monitoring, we believe we have the number one market share in US primary care markets for ECG, Holter and cardiac stress testing products. We also believe we have the number one worldwide market share for cardiac rehabilitation monitoring products. We estimate that our installed base of cardiac monitoring devices and systems exceeds 65,000 units worldwide.

 

In AEDs, we believe we have the number two worldwide market share. We have a substantial presence in U.S. schools, corporate and government workplaces, as well as internationally in the United Kingdom, France, Germany and Japan. We believe our AED installed base exceeds 325,000 units worldwide.

 

Our installed base presents an excellent target market for future sales of products, systems, software upgrades, and related services and consumables.

 

Global distribution and service network

 

We believe that our comprehensive global distribution network focused on cardiology products and services distinguishes us from our competitors.

 

We believe our U.S. cardiac monitoring distribution is particularly strong, especially in primary care physician offices. We have approximately 129 U.S. based sales and support representatives that possess extensive experience and expertise in advanced cardiology products. We believe that our U.S. monitoring distribution is among the strongest in the markets which we serve.

 

We believe we have the largest independent sales force selling AEDs into the public access market in North America. Our sales force, consisting of approximately 160 professionals, sells both directly to end customers and through third party distributors that extend our coverage of the market.

 

Our international distribution blends a direct presence in countries such as China, Denmark, Germany, France and the United Kingdom with an extensive distributor network that reaches nearly 100 countries.

 

Commitment to innovation

 

We invest a significant percentage of our revenues on research and development efforts to release new versions of most of our major product categories. We believe many of our products represent the leading technology in many of the principal markets we serve. We have also been recognized for our product innovation by various industry organizations.

Our Organization

 

Sales and Marketing

 

We have structured our sales organization into four primary channels: (1) our U.S. acute care sales force, which sells cardiac monitoring products and services directly to hospitals; (2) our U.S. primary care sales force, which supports a network of independent distributors in selling both cardiac monitoring and defibrillation products to primary care physicians and cardiologists; (3) our North American defibrillation sales force, which consists of an integrated network of direct sales representatives and third party distributors who work together to optimize our sales of AEDs in this market; and (4) our international sales team, which consists of direct presences in countries such as China, Denmark, France, Germany and the United Kingdom, with a network of distributors that provide sales and service relating to all of our products in nearly 100 countries.

 

Our U.S. acute care sales team principally sells cardiac monitoring products to hospitals. Each sales representative is responsible for a region and a sales quota for that region. Our sales efforts in the acute care market increasingly target system sales opportunities. Our sales efforts have historically promoted stand-alone product sales and were most successful in small and midsize hospitals, and rehabilitation clinics.

 

Our U.S. primary care sales force principally sells cardiac monitoring and defibrillation products outside of hospitals. Each sales specialists within this channel is responsible for a specific geographic territory and has a sales quota in supporting our independent distributor network in making sales to primary care physicians, cardiology offices, and all other alternate care facilities in that territory. We provide our distributors with discounts and promotional marketing support, based on a variety of factors including the annual volume of orders.

 

Our North American defibrillation sales force sells our defibrillation products, primarily AEDs and training services to corporate and government workplace markets, as well as through school, military, and first responder (police/fire) markets. Our sales representatives in this channel are responsible for territories that are defined by a combination of geographic and market segment characteristics. Each sales representative, selling directly and working with distributors in their territories, is responsible for a sales quota in that territory.

 

Internationally, we sell both our cardiac monitoring and defibrillation products primarily through country specific distributors, except in areas where we have direct sales operations or where we have a strategic selling alliance, such as Japan. Our international distribution network is managed by a team of employees and agents living abroad.

 

In addition to these sales channels, we have distribution arrangements with various partners such as GE, whereby we sell our AEDs and in-hospital defibrillation products in the North American hospital market and in all international markets.

 

We support all of our sales efforts with a variety of targeted marketing activities, including direct mail, telemarketing, publications, trade shows, training, and other promotional activities.

 

We do not have significant sales backlog. At both December 31, 2009 and 2008, our total sales backlog represented less than 30 days of anticipated sales volume.

 

Customer Service and Support

 

We believe that our comprehensive training and services capabilities differentiate us from our competitors. Our extensive capabilities to provide AED and CPR training, medical direction, and information management relating to the deployment and maintenance of AEDs allows us to provide a unique, single source, turnkey AED solution to our customers. In addition, we believe our focused, dedicated cardiology customer and field service capabilities distinguish us from our competitors in competing for advanced cardiac monitoring product sales.

 

Our large installed base facilitates the sale of service contracts and post — warranty support and presents a cross-selling opportunity for products that are complementary to our customers’ existing installations. In international markets, our distributors provide support and other services.

Research and Development

 

We believe that strong product development capabilities are essential to our strategy of enhancing, developing, and incorporating improved functionality into our products and maintaining the competitiveness of our products in our core markets. We believe our team of experienced engineers is on the leading edge of software and other technologies in our core markets. Our research and development process is dependent on assessment of customer needs, identification, and evaluation of new technologies, and monitoring market acceptance and demand. We have a structured process for undertaking product development projects that involves functional groups at all levels within our company. This process is designed to provide a framework for defining and addressing the steps, tasks, and activities required to bring product concepts and development projects to market.

 

Our research and development expenses were $15.0 million in 2009, $16.4 million in 2008 and $13.0 million in 2007. This represents approximately 8.1% of our revenues over that three-year period. From 2007 to 2009, our research and development efforts focused on enhancing and expanding the proven capabilities of our existing product lines, introducing new versions of our products and reducing costs relating to our existing products. We use a blend of internal employees, independent contractors and outsourced partners to optimize our spending and the effectiveness of our development efforts.

 

Technology

 

Our engineering teams have specific expertise in ECG algorithms, signal processing, artifact filtering, electrical systems, software development, high voltage waveforms, and data management. Software algorithms for analyzing the electrical activity of the heart are the basis for both our cardiac monitoring and our defibrillation product lines. Almost all of our products include hardware components that connect to the patient and digitize ECG waveform signals.

 

In our cardiac monitoring systems we generally use object-oriented design based on Microsoft technologies to create the software. We develop our systems’ user interfaces for many of our products using Microsoft tools. Many of our systems have been designed for network operation and many of our software modules have also been developed as objects that can be reused in our other products as needed. In addition, we have designed many of our cardiac monitoring systems to meet emerging industry standards, from reports rendered in PDF or XML format, to the use of Health Level 7 (“HL7”) and Serial Communication Protocol format for communications and ECG waveform data.

 

All of our defibrillation products incorporate our proprietary RHYTHMx technology. This platform technology is designed to detect and discriminate life-threatening arrhythmias. Our STAR biphasic technology is designed to optimize the delivery of a potentially life-saving electric shock to victims of SCA. We integrated our core technology, along with other proprietary technology, into our AED and hospital defibrillation product lines. We license certain components of our core technology to third-parties for integration into other products.

 

Manufacturing and Supply

 

Our manufacturing process consists primarily of assembly and testing of AEDs, electrocardiograph devices, stress test systems, Holter monitoring systems, cardiac rehabilitation telemetry systems, medical treadmills, electrodes, and various other products. During 2009, we performed these manufacturing activities at our Deerfield, Wisconsin facility and, to a lesser extent, at the facilities of our majority-owned joint venture operation in Shanghai, China.

 

We also rely upon other third-party suppliers to provide us with various materials used in the production and assembly of our devices and systems. We have long-standing supply relationships for essentially all of our outsourced product components. We purchase a portion of our products from third parties on an original equipment manufacturer (“OEM”) basis.

 

We maintain a comprehensive quality assurance and quality control program that includes documentation of all material specifications, operating procedures, equipment maintenance, and quality control methods. Our quality systems are based on and are in compliance with the requirements of the Quality Management Standards for

Medical Devices and Related Services (ISO 13485:2003) and the applicable U.S. laws and regulations governing medical device manufacturers.

 

Our Competition

 

The following chart indicates who we believe are the most significant competitors for each of our major product lines:

 

 

We believe that, depending on the products and situation, our customers consider some or all of the following factors in determining which products to purchase:

 

 

We believe our products compete favorably on these factors. We believe that our Rescue Ready, RHYTHMx, and STAR biphasic technologies set our AEDs apart from the competition. We believe our investment in connected data informatics and corresponding new EMR system alliances will also benefit us. We believe our service capabilities, comprehensive program management services, warranties, service plans, and technical support distinguish us and provide us with a competitive advantage over some of our competitors. However, products and services offered by some of our competitors offer features that may compete favorably on these factors as well. Our markets are highly competitive and competition may intensify. Some competitors enjoy advantages, including greater resources that can be devoted to the development, promotion, and sale of their products; more established sales channels; deeper product development experience; and/or greater name recognition.

 

Third-Party Reimbursement

 

In the U.S., as well as in foreign countries, government-funded or private insurance programs, commonly known as third-party payers, pay a significant portion of the cost of a patient’s medical expenses. A uniform policy of reimbursement does not exist among all these payers. We believe that reimbursement is an important factor in the success of many medical devices.

All U.S. and foreign third-party reimbursement programs, whether government funded or commercially insured, are developing increasingly sophisticated methods of controlling healthcare costs through prospective reimbursement and capitation programs, group purchasing, redesign of benefits, second opinions required prior to major surgery, careful review of bills, encouraging healthier lifestyles, and exploring more cost-effective methods of delivering healthcare. These types of programs can potentially limit the amount which healthcare providers may be willing to pay for medical devices.

 

Government Regulation of Medical Devices

 

Our products are medical devices subject to extensive regulation by the FDA, as well as other global regulatory agencies. FDA regulations govern, among other things, the following activities we perform and will continue to perform in connection with medical devices:

 

 

FDA’s Pre-market Clearance and Approval Requirements.  Each medical device we seek to commercially distribute in the U.S. must first receive 510(k) clearance or pre-market approval from the FDA, unless specifically exempted by the agency. The FDA classifies all medical devices into one of three classes. Devices deemed to pose lower risk are categorized as either Class I or II, which requires the manufacturer to submit to the FDA a 510(k) pre-market notification requesting clearance of the device for commercial distribution in the U.S. Some low risk devices are exempted from this requirement. Devices deemed by the FDA to pose the greatest risk, such as life sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a previously 510(k) cleared device are categorized as Class III, requiring pre-market approval. In rare cases, as with our AEDs, the devices are categorized as Class III and still cleared under the 510(k) pre-market notification process. Class III devices which can be marketed with a pre-market notification 510(k) are those that are post-amendment (i.e., introduced to the U.S. market after May 28, 1976), Class III devices which are substantially equivalent to pre-amendment (i.e., introduced to the U.S. market before May 28, 1976) Class III devices and for which the regulation calling for the pre-market approval application has not been published in 21 CFR.

 

510(k) Clearance Process.  The 510(k) clearance process is the process applicable to our current products. To obtain 510(k) clearance, we must submit a pre-market notification to the FDA demonstrating the proposed device to be substantially equivalent to a previously cleared 510(k) device, a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of pre-market approval applications, or is a device that has been reclassified from Class III to either Class II or I. In rare cases, as described in the prior paragraph, Class III devices, including our AEDs, are cleared through the 510(k) process. The FDA’s 510(k) clearance process usually takes at least three months from the date the application is submitted and filed with the FDA, but may take significantly longer.

 

After a device receives 510(k) clearance, any subsequent modification of the device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, will require a new 510(k) clearance or could require pre-market approval. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA may require the manufacturer

to cease marketing and/or recall the modified device until 510(k) clearance or pre-market approval is obtained. We have modified aspects of some of our devices since receiving regulatory clearance. Some of those modifications we believe are not significant, and therefore, new 510(k) clearances or pre-market approvals are not required. Other modifications we believe are significant and we have obtained new 510(k) clearances from the FDA for these modifications. In the future, we may make additional modifications to our products after they have received FDA clearance or approval, and in appropriate circumstances, determine if new clearance or approval is unnecessary. However, the FDA may disagree with our determination and if the FDA requires us to seek 510(k) clearance or pre-market approval for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain the required clearance or approval. Under these circumstances, we may also be subject to significant regulatory fines or other penalties.

 

Pre-market Approval Process.  A pre-market approval application must be submitted if the medical device is in Class III (although the FDA has the discretion to continue to allow certain pre-amendment Class III devices to use the 510(k) process) or cannot be cleared through the 510(k) process. A pre-market approval application must be supported by, among other things, extensive technical, preclinical, clinical trials, manufacturing and labeling data to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device.

 

After a pre-market approval application is submitted and filed, the FDA begins an in-depth review of the submitted information, which typically takes between one and three years, but may take significantly longer. During this review period, the FDA may request additional information or clarification of information already provided. Also during the review period, an advisory panel of experts from outside the FDA will usually be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a pre-approval inspection of the manufacturing facility to ensure compliance with Quality System regulations. New pre-market approval applications or pre-market approval application supplements are required for significant modifications to the manufacturing process, labeling of the product and design of a device that is approved through the pre-market approval process. Pre-market approval supplements often require submission of the same type of information as a pre-market approval application, except that the supplement is limited to information needed to support any changes from the device covered by the original pre-market approval application, and may not require as extensive clinical data or the convening of an advisory panel.

 

As described previously, certain of our devices have been classified as Class III pre-amendment devices. These devices include our AED product line. Although we currently have 510(k) clearance for these devices, the FDA has the discretion at any time to request pre-market approval applications from us and all manufacturers of similar devices. If the FDA calls for pre-market approval applications, we will be required to submit and obtain approvals for such devices within a specified period of time. If we fail to do so, we will not be allowed to continue marketing these products.

 

Clinical or Market Trials.  A clinical or market trial is typically required to support a pre-market approval application and is sometimes required for a 510(k) pre-market notification. Clinical and market trials generally require submission of an application for an Investigational Device Exemption (“IDE”) to the FDA. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the investigational protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of patients, unless the product is deemed a non-significant risk device and eligible for more abbreviated investigational device exemption requirements. Clinical and market trials for a significant risk device may begin once the investigational device exemption application is approved by the FDA as well as the appropriate institutional review boards at the clinical or market trial sites, and the informed consent of the patients participating in the clinical trial is obtained.

 

Pervasive and Continuing FDA Regulation.  After a medical device is placed on the market, numerous FDA regulatory requirements apply, including, but not limited to the following:

 

 

 

Failure to comply with applicable regulatory requirements may result in enforcement action by the FDA, which may include one or more of the following sanctions:

 

 

In late June 2009, we voluntarily ceased shipments of certain of our AED products due to two instances we became aware of involving the failure of our AEDs to deliver therapy, apparently as a consequence of a malfunction of one of the components used in the manufacture of the affected AED. On August 10, 2009, we resumed production and shipments of the affected AED products after implementing a more stringent process to test for defects in the component at issue. As a result of a thorough review and analysis performed during the third quarter of 2009, we determined that the component at issue has the potential to fail and that routine self-tests performed by the AED may not detect a malfunctioning component. We also determined that approximately 300,000 AEDs shipped between June 2003 and June 2009 are potentially impacted by the component issue. Although we determined that the probability that an AED would fail to deliver therapy as a result of a malfunction of the component issue was low, we decided to implement a field corrective action to enhance the reliability of the affected AED units in the field. We publicly announced our proposed corrective action to address this component issue in November 2009.

 

In February 2010, we received a warning letter from the FDA noting, among other things, that the proposed field corrective action is inadequate since it is intended to improve the products’ ability to detect the potential component problem, but is not designed to prevent component failure. The FDA letter also asserts other inadequacies, including our procedures relating to the evaluation, investigation and follow up of complaints, procedures to verify the effectiveness of corrective and preventative actions and procedures relating to certain design requirements. We are in ongoing discussions with the FDA regarding these issues. If we are unable to correct the inadequacies asserted in the FDA’s letter or otherwise satisfy the FDA’s concerns, we may be subject to regulatory action by the FDA, including seizure, injunction and/or civil monetary penalties. Any such actions could significantly disrupt our ongoing business and operations and have a material adverse impact on our financial position and results of operations. See Note 2 — Corrective Action Liabilities to the Consolidated Financial Statements in Item 8 of this report for further discussion on this matter.

 

International Regulation.  Sales of medical devices outside the United States are subject to foreign government regulations, which vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ significantly.

 

European Union.  The European Union has adopted legislation, in the form of directives to be implemented in each member state, concerning the regulation of medical devices within the European Union. The directives include, among others, the Medical Device Directive that establishes standards for regulating the design, manufacture, clinical trials, labeling, and vigilance reporting for medical devices. Under the European Union Medical

Device Directive, medical devices are classified into four Classes, I, IIa, IIb, and III, with Class I being the lowest risk and Class III being the highest risk. Under the Medical Device Directive, a competent authority is nominated by the government of each member state to monitor and ensure compliance with the Directive. The competent authority of each member state then designates a notified body to oversee the conformity assessment procedures set forth in the Directive, whereby manufacturers demonstrate that their devices comply with the requirements of the Directive and are entitled to bear the CE mark. CE is an abbreviation for Conformité Européene (or European Conformity) and the CE mark, when placed on a product, indicates compliance with the requirements of the applicable directive. Medical devices properly bearing the CE mark may be commercially distributed throughout the European Union. We have received CE certification from the British Standards Institute for conformity with the European Union Medical Device Directive allowing us to place the CE mark on our product lines. This quality system has been developed by the International Organization for Standardization to ensure companies are aware of the standards of quality to which their products will be held worldwide. Additional pre-market approvals in individual European Union countries are sometimes required prior to marketing of a product. Failure to maintain the CE mark would preclude us from selling our products in the European Union, as could failure to comply with the specific requirements of member states.

 

Canada.  Under the Canadian Medical Devices Regulations, all medical devices are classified into four classes, Class I being the lowest risk class and Class IV being the highest risk. Class I devices include among others, devices that make only non-invasive contact with the patient. Classes II, III and IV include devices of increasingly higher risk as determined by such factors as degree of invasiveness and the potential consequences to the patient if the device fails or malfunctions. Our current products sold in Canada generally fall into Classes II and III. All Class II, III and IV medical devices must have a valid Medical Device License issued by the Therapeutic Products Directorate of Health Canada before they may be sold in Canada (Class I devices do not require such a license). We have obtained applicable Medical Device Licenses for many of our products. Failure to maintain required Medical Device Licenses in Canada or to meet other requirements of the Canadian Medical Devices Regulations (such as quality system standards and labeling requirements) for our products will preclude us from selling our products in Canada. We may not be successful in continuing to meet the medical device licensing requirements necessary for distribution of our products in Canada.

 

Other Countries.  Many other countries have specific requirements for classification, registration, and post-marketing surveillance that are independent of the countries already listed. We obtain what we believe is the appropriate clearances and conduct business in accordance with the applicable laws of each country. This landscape is constantly changing, and, we could be found in violation if we interpret the laws incorrectly or fail to keep pace with changes. In the event of either of these occurrences, we could be instructed to recall products, cease distribution, and/or be subject to civil or criminal penalties.

 

Intellectual Property

 

We believe that our intellectual property assets, including trademarks, patents, trade secrets and proprietary technology, are extremely valuable and constitute a cornerstone of our business. As of December 31, 2009, we held 142 U.S. and foreign patents, which expire at various times between 2010 and 2026. We also have 37 patent applications pending before U.S. and foreign governmental bodies. We believe our patents and proprietary technology provide us with a competitive advantage over our competitors. We intend to continue to aggressively defend our inventions and also look for opportunities to license our technology to generate royalty income.

 

Our wide range of patents and patent applications cover much of the technology found in our defibrillation products, including our Rescue Ready technology, which features one button operation, pre-connected disposable therapy electrode pads, and self-test capabilities. Other patents relating to our defibrillation products include our proprietary RHYTHMx arrhythmia detection software technology, our STAR biphasic defibrillation waveform technology, and our disposable therapy electrode pads. Our patents protect many features of our cardiac monitoring products, including filters for ECG signals, monitoring electrodes and methods of interfacing the monitoring electrodes to a patient, and devices and methods for obtaining, analyzing, and presenting certain physiological data. We also have perpetual rights to certain patented technology relating to our medical treadmills. In addition, we have registered or applied to register certain trademarks with domestic and certain foreign trademark authorities.

Our business also depends, in part, on licenses to use third parties’ software in our product offerings. We believe the agreements we have in place with third parties generally provides for such software at fair market value and that, if any such agreements expire or terminate, we would be able to obtain alternative software at comparable prices.

 

Customers

 

In the U.S. and abroad, we sell many of our products through distributors and other third party organizations. One of these distributors is located in Japan, Nihon Kohden Corporation (“Nihon Kohden”), and accounted for approximately 7%, 19% and 11% of the Company’s revenues in 2009, 2008 and 2007, respectively. On June 15, 2009, we notified Nihon Kohden, our distributor of AEDs in Japan, that our OEM Supply and Purchase Agreement dated effective as of January 1, 2008 will terminate June 15, 2010.

 

Employees

 

As of December 31, 2009, we had 556 full time employees plus 61 contract employees. This combined total of 617 full time positions includes 71 in research and development, 225 in sales and marketing, 99 in technical and support services, 110 in manufacturing and supplies operations, 26 in regulatory affairs and 86 in finance and administration. These employee totals include 26 employees in our majority owned Cardiac Science Shanghai joint venture. In addition, we had approximately 121 part-time employees, most of whom provide training to our customers on an as-needed basis. None of our employees are represented by a labor union, except in China, where substantially all employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good.

 

Foreign Operations

 

Sales to customers located outside the United States were approximately $51.0 million, $81.0 million and $46.5 million for the years ended December 31, 2009, 2008 and 2007, respectively. Additional financial information is provided in Item 8, Note 3 to the Consolidated Financial Statements, “Segment Reporting.” Also, for a discussion of risks associated with our foreign operations see Item 1A Risk Factors — “Our international business is subject to risk that could adversely affect our profitability and operating results.”

 

Available Information

 

We maintain an Internet site at http://www.cardiacscience.com. We make available free of charge on or through our Internet site, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. We will voluntarily provide electronic or paper copies of our filings free of charge upon request. Our web site and the information contained therein or connected thereto are not incorporated by reference into this report. These reports may also be obtained at the SEC’s public reference room at 100 F Street, NE Washington, DC 20549. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including the Company.

 

 

We are subject to many laws and governmental regulations and any adverse regulatory action may materially adversely affect our business operations and financial results.

 

Our medical devices are subject to regulation by numerous government agencies, including the FDA and comparable foreign agencies. To varying degrees, each of these agencies requires us to comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing and distribution of our medical

devices. We cannot guarantee that we will be able to obtain marketing clearance from the FDA for our new products, or enhancements or modifications to existing products, and if we do, such approval may:

 

 

Both before and after a product is commercially released, we have ongoing responsibilities under FDA regulations. If the FDA were to conclude that we are not in compliance with applicable laws or regulations, or that any of our medical devices are ineffective or pose an unreasonable health risk, the FDA could ban such medical devices, detain or seize adulterated or misbranded medical devices, order a recall, repair, replacement, or refund of such devices and require us to notify health professionals and others that the devices present unreasonable risks of substantial harm to the public health. The FDA may also impose operating restrictions, enjoin and restrain certain violations of applicable law pertaining to medical devices and assess civil or criminal penalties against our officers, employees, or us. The FDA may also recommend prosecution to the Department of Justice. Any adverse regulatory action, depending on its magnitude, may restrict us from effectively marketing and selling our products.

 

Foreign governmental regulations have become increasingly stringent, and we may become subject to more rigorous regulation by foreign governmental authorities in the future. Penalties for a company’s noncompliance with foreign governmental regulation could be severe, including revocation or suspension of a company’s business license and criminal sanctions. Any domestic or foreign governmental law or regulation imposed in the future may have a material adverse effect on us.

 

We face numerous challenges in implementing a field initiative to address the component issue that led to our AED ship-hold in late June 2009 and our business, financial position and results of operations may be negatively impacted by the costs and other commitments needed to carry out the initiative.

 

In late June 2009, we voluntarily ceased shipments of certain of our AED products due to two instances we became aware of involving the failure of our AEDs to deliver therapy, apparently as a consequence of a malfunction of one of the components used in the manufacture of the affected AED. On August 10, 2009, we resumed production and shipments of the affected AED products after implementing a more stringent process to test for defects in the component at issue. As a result of a thorough review and analysis performed during the third quarter of 2009, we determined that the component at issue has the potential to fail and that routine self-tests performed by the AED may not detect a malfunctioning component. We also determined that approximately 300,000 AEDs shipped between June 2003 and June 2009 are potentially impacted by the component issue. Although we determined that the probability that an AED would fail to deliver therapy as a result of a malfunction of the component issue was low, we decided to implement a field corrective action to enhance the reliability of the affected AED units in the field. We publicly announced our proposed corrective action to address this component issue in November 2009.

 

Our proposed voluntary corrective action is subject to numerous risks and uncertainties, including the following:

 

 

 

Moreover, in February 2010, we received a warning letter from the FDA noting, among other things, that the proposed field corrective action is inadequate since it is intended to improve the products’ ability to detect the potential component problem, but is not designed to prevent component failure. The FDA letter also asserts other inadequacies, including our procedures relating to the evaluation, investigation and follow up of complaints, procedures to verify the effectiveness of corrective and preventative actions and procedures relating to certain design requirements. We are in ongoing discussions with the FDA regarding these issues. If we are unable to correct the inadequacies asserted in the FDA’s letter or otherwise satisfy the FDA’s concerns, we may be subject to regulatory action by the FDA, including seizure, injunction and/or civil monetary penalties. Any such actions could significantly disrupt our ongoing business and operations and have a material adverse effect on our financial position and operating results.

 

We face numerous challenges in implementing a recall announced on February 3, 2010, and our business, financial position and results of operations may be negatively impacted by the costs and other commitments needed to carry out the recall and correct the product issue.

 

On February 3, 2010, we announced a worldwide voluntary recall after determining that approximately 12,200 automated external defibrillators (AEDs) manufactured or serviced between October 19, 2009 and January 15, 2010 may not be able to deliver therapy during a resuscitation attempt, which may lead to serious adverse events or death. These AEDs were manufactured in a way that makes them potentially susceptible to failure under certain conditions. In connection with the corrective action, we intend to replace all affected AEDs at no charge to the customer. We recorded a charge of $2.5 million in the fourth quarter of 2009, reflecting our current estimate of the expected costs relating to this action. Actual costs may vary based on a variety of factors. Cash expenditures relating to replacement of the affected AEDs will occur primarily in the first half of 2010. See Note 2 — Corrective Action Liabilities to the Consolidated Financial Statements in Item 8 of this report for further discussion on this matter.

 

This recall, and the estimated costs, are subject to numerous risks and uncertainties, including the following:

 

 

 

Our cash and cash equivalents may not be sufficient to fund future operations and we may not be able to secure additional sources of financing or obtain financing on acceptable terms.

 

Our cash and cash equivalents as of December 31, 2009, totaled $26.9 million. We expect to incur operating losses in 2010 and to use cash in operations. Additionally, we have recently initiated two voluntary corrective actions relating to our AED products, the costs of which have been estimated at $21.0 million, of which $15.2 million remains as an accrued liability as of December 31, 2009. We expect to spend substantially all of the remained accrued costs associated with these corrective actions during 2010 which will negatively impact our cash position. We believe our existing cash and cash equivalents will be sufficient to fund our anticipated operating losses, meet working capital requirements and fund anticipated capital expenditures needs and other obligations, including the remaining estimated costs of the ongoing corrective actions, through at least December 31, 2010.

 

However, we cannot be certain our cash and cash equivalents will be sufficient to meet our operating needs in 2010 as we may be affected by economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. Accordingly, we may be required to reduce costs, which could adversely impact our forecasts for revenue growth in future periods which in turn could also adversely impact our forecasts for cash and cash equivalents throughout the year. Additionally, we may be forced to borrow or obtain additional sources of financing in order to sustain our operations. Our current line of credit agreement with Silicon Valley Bank will expire in March 2010. There can be no assurance that we will be successful in securing a renewed line of credit with Silicon Valley Bank and, if not, we may be required to seek alternative sources of financing that may be more expensive and have more restrictive covenants and conditions. As such, we may not be able to obtain any additional financing, or may not be able to obtain additional financing on acceptable terms.

 

We may be required to implement other costly product recalls or corrective actions.

 

In the event that any of our products prove to be defective or deficient, we can voluntarily recall or otherwise take corrective action, or the FDA could require us to redesign or implement a recall of or take other action regarding, any of our products. Should we be required or choose to implement any additional recalls or corrective actions in future periods, we could incur substantial costs as well as face significant adverse publicity or regulatory consequences, which could harm our business, including our ability to market our products in the future. The financial impact of a recall could have a material adverse effect on our business, financial position and results of operations.

Quality problems with our processes, goods and services could harm our reputation for producing high quality products and erode our competitive advantage.

 

Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our quality certifications are critical to the marketing success of our goods and services. If we fail to meet these standards our reputation could be damaged, we could lose customers and our revenue could decline. Aside from specific customer standards, our success depends generally on our ability to manufacture to exact tolerances, precision engineered components, subassemblies and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high quality components will be harmed, our competitive advantage could be damaged, and we could lose customers and market share. For example, the component issues that led to the field corrective action we announced in November, 2009 and the recall we announced in February, 2010 may lead to reduced demand for our AED products.

 

Warranty and product liability claims could adversely impact our earnings and reputation.

 

The manufacturing, marketing and sale of medical devices expose us to the risk of warranty claims, product liability claims or product recalls. We are, from time to time, subject to warranty claims with regard to product performance, which expose us to unexpected repair and replacement costs. In addition, component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information with respect to products we manufacture or sell could result in an unsafe condition or injury to, or death of, a patient. The occurrence of such a problem could result in product liability claims, product recalls or a safety alert relating to one or more of our products. Although we maintain product liability insurance, the coverage may not be adequate or may not be available at affordable rates. Warranty claims, product liability claims or product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers for our products.

 

Our business may be adversely affected by deteriorating economic conditions.

 

Economic conditions in both the United States and other countries in which we sell our products have deteriorated significantly in recent years and may continue to deteriorate in the foreseeable future. If economic conditions in the markets in which we operate continue to deteriorate, it may result in declining demand for our products and services, longer sales cycles, increased order cancellations and declining pricing due to customers’ reduced capital budgets, difficulties encountered in securing financing needed to purchase our products, or other factors. Moreover, such conditions may result in increased excess or obsolete inventories and difficulties collecting customer receivables. All of these factors could materially adversely affect our future operating results and financial condition.

 

We rely significantly on our distributors and strategic selling alliances to generate sales of our products; if we do not maintain our relationships with these parties or they fail to successfully distribute our products, our sales and operating results will likely suffer.

 

In the U.S. and abroad, we sell many of our products through distributors, strategic selling alliances and other third party organizations. Generally, we have little or no control over these sales processes, and in many cases our contracts are short-term or may be terminated on little or no notice. If any of our key distributor agreements or selling alliance agreements are cancelled or if we are unable to renew them as they expire, or if our distributors or selling alliances fail to develop relationships with important target customers, our sales and operating results may suffer materially.

 

On June 15, 2009, we notified Nihon Kohden Corporation, our distributor of AEDs in Japan, that our OEM Supply and Purchase Agreement dated effective as of January 1, 2008 will terminate effective June 15, 2010. Under our agreement with Nihon Kohden, Nihon Kohden has had the exclusive right in Japan to distribute a Nihon Kohden-branded version of our AED product (model “9231”) designed for the Japanese market, as well as certain related consumables. Because Nihon Kohden has decided to build and market its own AED products, we elected to terminate the agreement in order to explore alternative means of distributing our AED products in Japan. In 2009, the percentage of our net sales from the Japanese market decreased from 19% in 2008 to 7%. If our efforts to

establish alternative distribution arrangements for our AED products in Japan, our operating results may be adversely affected. Moreover, the introduction of Nihon Kohden’s own AED products may further erode sales of our products in Japan.

 

We are dependent upon licensed and purchased technology for some of our products, and we may not be able to renew these licenses or purchase agreements in the future.

 

We license and purchase technology from third parties for features in some of our products. We anticipate that we will need to license and purchase additional technology to remain competitive. We may not be able to renew existing licenses and purchase agreements or to license and purchase other technologies on commercially reasonable terms or at all. If we are unable to renew existing licenses and purchase agreements or to license or purchase new technologies, we may not be able to offer competitive products, which could negatively impact our revenues.

 

Our international business is subject to risks that could adversely affect our profitability and operating results.

 

Our international operations, which accounted for 33% of our revenues in 2009, are accompanied by certain financial and other risks. In recent years, we have pursued growth opportunities internationally and intend to continue pursuing such opportunities in the future, which could expose us to greater risks associated with international sales and operations. Our international operations are, and will continue to be, subject to a number of risks and potential costs, including:

 

 

Also, like the U.S., economic conditions in the foreign countries in which we operate have deteriorated significantly in recent years and may continue declining for the foreseeable future. For example, in 2009, sales of our products in Japan accounted for 7% of our net sales, down from 19% in 2008. This reduction in sales in Japan can be attributed in part to weak economic conditions in that market. Economic conditions in Japan are expected to remain weak for the foreseeable future. As a result, our sales in this market may decline, perhaps significantly, during 2010 and beyond. We may also experience declining sales in other international markets due to deteriorating economic conditions.

 

Our business is subject to intense competition, which may reduce the demand for our products.

 

The cardiac monitoring and defibrillation markets are highly competitive, and we expect competition to intensify in the future. Some of our competitors are larger companies, such as General Electric Company, Medtronic

Emergency Response Systems, a unit of Medtronic, Inc., and Philips Medical Systems, a unit of Koninklijke Philips Electronics N.V., who may have:

 

 

In addition, the timing of the introduction of competing products into the market could affect the market acceptance and market share of our products. If we are unable to develop competitive products that obtain market acceptance, our revenues and financial results may suffer.

 

We may be unable to increase sales of our cardiac monitoring products and services, which could cause our stock price to decrease.

 

The market for cardiac monitoring products and services is generally mature and stable. However, our 2009 revenues from products and services in this market decreased 15.3% from 2008. Our ability to revitalize this line of products and services depends on our restructuring efforts, the development and commercialization of competitive new products and service offerings, and our success in increasing sales and gaining market share from our competitors. Current economic conditions may provide particular challenges to our efforts to revitalize this line. If we are unsuccessful in these efforts, our sales revenues from this line of products and services may decrease, our financial results may suffer, and our stock price may decline.

 

Our financial results could be impacted by the credit risk of our customers.

 

We have exposure to the credit risks of some of our customers. Although we have programs in place that are designed to monitor and mitigate the associated risk, there can be no assurance that such programs will be effective in reducing our credit risks adequately. We monitor individual payment capability in granting credit arrangements, seek to limit the total credit to amounts we believe our customers can pay, and maintain reserves we believe are adequate to cover exposure for potential losses. If there is a deterioration of a major customer’s creditworthiness or actual defaults are higher than expected, future resulting losses, if incurred, could harm our business and have a material adverse effect on our operating results. These risks may become more pronounced if economic conditions continue to deteriorate.

 

Our stock price is volatile, and you may not be able to sell your shares for a profit.

 

The trading price of our common stock is volatile. Our common stock price could be subject to fluctuations in response to a number of factors, including:

 

 

 

In the past, companies that have experienced volatility in the market price of their stock have been the target of securities class action litigation. We may become the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert management attention, which could seriously harm our business.

 

We were not profitable in 2008 or 2009 and we may be unable to return to profitability in the future, which could result in a decline in our stock price.

 

We had a net loss of $77.0 million in 2009 due largely to a non cash charge of approximately $42.2 million related to a valuation allowance on our deferred tax assets as well as costs totaling $21.0 million related to two separate voluntary corrective actions which we announced between November 2009 and February 2010. In 2008, we had a net loss $98.4 million due to a pre tax, non cash impairment charge related to goodwill of $107.7 million. We had net income of $8.5 million in 2007. Although we expect to become profitable again in future periods, our ability to return to profitability will depend on our ability to increase our revenues and manage our expenses. In order to generate additional revenues, we will need to continue developing and offering competitive products and services, maintain our sales and distribution network and expand our customer base. Our ability to increase revenues may be impacted by current economic conditions and other factors, such as the impact on customer demand from product quality issues and related corrective actions that we have announced in the last several months. Also, we will need to manage costs associated product development and marketing, protecting our intellectual property, and handling product quality issues and related corrective actions. We may be unable to accomplish some, or any, of these goals because of the risks identified in this report or for other unforeseen reasons. If we are unable to attain profitability in the future, our stock price could decline.

 

Our business may be adversely affected by restructurings.

 

On January 14, 2009, we announced a restructuring involving a 12% reduction in our staff, and have had subsequent restructurings and reductions. The reductions primarily affected customer service, product development and manufacturing. Implementation of past restructurings and reductions, as well as any future restructurings or reductions, may adversely affect the effectiveness of the functional areas impacted by the staff reductions, as well as adversely impact our relationships with customers and suppliers. The costs of implementing past and future restructurings and reductions may adversely affect our results of operations. Finally, past or future restructuring may not result in all of the cost savings and operational and strategic benefits that we anticipate.

 

Our quarterly revenues and operating results are unpredictable and may vary significantly.

 

Our quarterly revenues and operating results have varied in the past and our quarterly revenues and operating results may continue to vary in the future due to a number of factors, many of which are outside of our control. Factors contributing to these fluctuations may include:

 

 

 

Historically, our quarterly financial results have often been impacted by the receipt of a large number of customer orders in the last weeks of a quarter. If these orders are delayed to the following quarter or canceled, our sales could fall short of our targets and our stock price could decline. Due to the factors summarized above, we believe that period-to-period comparisons of our operating results are not a good indication of future performance and should not be relied upon to predict future operating results.

 

If we are unsuccessful in developing and commercializing new versions of our products, our operating results will suffer.

 

To be successful, we must develop and commercialize new versions of our products for both domestic and international markets. Our products must keep pace with rapid industry change, comply with rapidly evolving industry standards and government regulations and compete effectively with new product introductions of our competitors. Because our products are technologically complex, developing new products requires extensive design, development and testing at the technological, product and manufacturing stages. To successfully develop and commercialize new versions of our products, we need to:

 

 

 

Our failure to accomplish any of these items, or others involved in developing and commercializing new products, could delay or prevent the release of new products. These difficulties and delays could cause our development expenses to increase and harm our financial and operating results.

 

Interruption or cancellation of supply, and our inability to secure alternative suppliers on a timely basis, would likely harm our ability to ship products to our customers, decrease our revenues and increase our costs.

 

If our suppliers reduce, delay or discontinue production of component parts for our products, we will be forced to seek replacement parts from alternative sources. We purchase many of the components and raw materials used in manufacturing our products from numerous suppliers in various countries. Generally we have been able to obtain adequate supplies of such raw materials and components. In some cases, for reasons of quality assurance, cost effectiveness or availability, we procure certain components and raw materials only from a sole supplier. While we work closely with our suppliers to try to ensure continuity of supply while maintaining high quality and reliability, we cannot guarantee that our supplies will be uninterrupted. In addition, due to the stringent regulations and requirements of the FDA regarding the manufacture of our products, we may not be able to quickly establish additional or replacement sources for certain components or materials. A reduction or interruption in supply, and an inability to develop alternative sources for such supply, could result in significant delays or cancellations of product shipments and the need to modify our products to utilize available components. This could result in reduced revenues, higher costs or both.

 

Inadequate levels of reimbursement from governmental or other third-party payers for procedures using our products may cause revenues to decrease.

 

Healthcare costs have risen significantly over the past decade. Federal, state and local governments have adopted a number of healthcare policies intended to curb rising healthcare costs. There have been and may continue to be proposals by legislators, regulators and third-party payers to keep these costs down. Certain proposals, if passed, could impose limitations on the prices we will be able to charge for our products, or the amounts of reimbursement available for our products from governmental agencies or third-party payers. These limitations could have a material adverse effect on our financial position and results of operations.

 

In the U.S., healthcare providers that purchase certain of our products often rely on governmental and other third-party payers, such as federal Medicare, state Medicaid, and private health insurance plans to pay for all or a portion of the cost of the procedures that utilize those products. The availability of this reimbursement affects customers’ decisions to purchase capital equipment. Denial of coverage or reductions in levels of reimbursement for procedures performed using our products by governmental or other third-party payers would cause our revenues to decrease.

 

If we do not maintain or grow revenues from our support services or consumables, our operating and financial results may be negatively impacted.

 

A significant portion of our revenues is generated from post-sale support services we provide for our products and from the sale of ancillary cardiology products and consumables related to our products, such as patented electrodes, pads, cables, leads, and thermal chart paper. As hospitals expand their in-house capabilities to service diagnostic equipment and systems, they may be able to service our products without additional support from us. In addition, our customers may express an increasing preference for ancillary cardiology products and consumables that are manufactured or provided by other vendors. Any of these events could result in a decline in our revenues and adversely affect our financial and operating results.

Our lack of customer purchase contracts and our limited order backlog make it difficult to predict sales and plan manufacturing requirements, which can lead to lower revenues, higher expenses and reduced margins.

 

Our customers typically order products on a purchase order basis, and we do not generally have long-term purchase contracts. In limited circumstances, customer orders may be cancelled, changed or delayed on short notice. Lack of significant order backlog makes it difficult for us to forecast future sales with certainty. Long and varying sales cycles with our customers make it difficult to accurately forecast component and product requirements. These factors expose us to a number of risks:

 

 

If market conditions cause us to reduce the selling price of our products, or our market share is negatively affected by the activities of our competitors, our margins and operating results will decrease.

 

The selling price of our products and our market share are subject to market conditions. Major shifts in industry market share have occurred in connection with product problems, physician advisories and safety alerts, reflecting the importance of product quality in the medical device industry. Many healthcare industry companies, including medical device companies, are consolidating to create new companies with greater market power. As the healthcare industry consolidates, competition to provide goods and services to industry participants will become more intense. These industry participants may try to use their market power to negotiate price concessions or reductions for medical devices that incorporate components produced by us. We may experience decreasing prices for the goods and services we offer due to pricing pressure experienced by our customers from managed care organizations and other third-party payers; increased market power of our customers as the medical device industry consolidates; and increased competition among medical engineering and manufacturing services providers. If the prices for our goods and services decrease and we are unable to reduce our expenses, we may lose market share and our results of operations will be adversely affected.

 

If we are unable to retain our executive officers and hire and retain other key personnel, we may not be able to sustain or grow our business.

 

Our success is dependent in large part on the continued employment and performance of key executive, managerial, sales and technical personnel and our ability to attract and retain additional highly qualified personnel. We compete for key personnel with other companies, academic institutions, government entities and other organizations. Our ability to maintain and expand our business may be impaired if we are unable to retain our key personnel, hire or retain other qualified personnel in the future, or if our key personnel decide to join a competitor or otherwise compete with us.

 

Failure to adequately protect our intellectual property rights may cause our expenses to increase and our business to suffer.

 

Our success depends in part on obtaining, maintaining, and enforcing our patents, trademarks and other proprietary rights, and our ability to avoid infringing the proprietary rights of others. We take precautionary steps to protect our technological advantages and intellectual property rights and rely, in part, on patent, trade secret, copyright, know-how, trademark laws, license agreements and contractual provisions to establish our intellectual property rights and protect our products. We require our new employees, consultants, and corporate partners to execute confidentiality agreements at the commencement of their employment or consulting relationship with us.

However, these agreements may be breached or, in the event of unauthorized use or disclosure, they may not provide adequate remedies. While we intend to defend against any threats to our intellectual property, there can be no assurance that these patents, trade secrets or other agreements will adequately protect our intellectual property.

 

In addition, the validity and breadth of claims covered in medical technology patents involve complex legal and factual questions and are often highly uncertain. There can also be no assurance that pending patent applications owned by us will result in patents to be issued to us, that patents issued to or licensed by us in the past or in the future will not be challenged or circumvented by competitors or that such patents will be found to be valid or sufficiently broad to protect our technology or to provide us with any competitive advantage. Third parties could also obtain patents that may require us to negotiate licenses to conduct our business, and there can be no assurance that the required licenses would be available on reasonable terms or at all. In some cases, we rely upon trade secrets instead of patents to protect our proprietary technology. Others may independently develop or otherwise acquire substantially equivalent know-how, or gain access to and disclose our proprietary technology. If we are not able to adequately protect our intellectual property and other proprietary rights, our product offerings may lose their competitive edge, which would negatively impact our revenues.

 

Additionally, third parties may assert intellectual property claims and related claims against the Company, whether through civil litigation, administrative proceedings, or otherwise, in the United States or abroad, which may result in a narrowing or invalidation of our intellectual property rights or freedom to operate, significant damage awards and costs of litigation or other legal proceedings, injunctive relief against us, the necessity of costly or disadvantageous licenses, and may be disruptive to our business operations.

 

Our technology may become obsolete, which would negatively impact our ability to sell our products.

 

The medical equipment and healthcare industries are characterized by extensive research and rapid technological change. The development by others of new or improved products, processes, or technologies may make our products obsolete or less competitive. Accordingly, we plan to devote continued resources, to the extent available, to further develop and enhance existing products and to develop new products. If these efforts are not successful, we may not be able to meet our financial goals and our stock price may suffer.

 

Our reliance on a principal manufacturing facility may impair our ability to respond to natural disasters or other unforeseen catastrophic events.

 

We manufacture substantially all of our products in one principal manufacturing facility, located in a single building in Deerfield, Wisconsin. Despite precautions taken by us, a natural disaster or other unanticipated catastrophic events at this building could significantly impair our ability to manufacture our products and operate our business. Our facility and certain manufacturing equipment located in that facility would be difficult to replace and could require substantial replacement lead-time. Catastrophic events may also destroy any inventory of product or components located in our facility. While we carry insurance for natural disasters and business interruption, the occurrence of such an event could result in losses that exceed the amount of this insurance coverage, which would impair our financial results.

 

We may make future acquisitions, which involve numerous risks that could impact our business and results of operations.

 

As part of our growth strategy, we intend to selectively acquire other businesses, product lines, assets, or technologies, which are complementary to our product offerings. Successful execution of our acquisition strategy depends upon our ability to identify, negotiate, complete and integrate suitable acquisitions. Acquisitions involve numerous risks, including:

 

 

 

Future acquisitions may not be successful and, if we are unable to effectively manage the risks described above, our business, operating results or financial condition may be negatively affected.

 

We may need additional capital to continue our acquisition growth strategy.

 

Successful continued execution of our acquisition strategy may also depend upon our ability to obtain satisfactory debt or equity financing. We likely would require additional debt or equity financing to make any further significant acquisitions. Such financing may not be available on terms that are acceptable to us or at all, particularly in light of current adverse conditions in the capital markets. If we are required to incur additional indebtedness to fund acquisitions in the future, our cash flow may be negatively affected by additional debt servicing requirements and the terms of such indebtedness may impose covenants and restrictions that provide us less flexibility in how we operate our business. Fluctuations in our stock price may make it difficult to make acquisitions using our stock as consideration. Moreover, use of our stock to fund acquisitions may have a significant dilutive effect on existing shareholders.

 

Our internal research and product development activities are complemented by acquisitions, investments and alliances. We cannot guarantee that any previous or future acquisitions, investments or alliances will be successful for the purpose of complementing our internal research and product development activities.

 

A component of our growth strategy is to enter into strategic alliances in order to complement and expand our current product and service offerings and distribution. The rapid pace of technological development in the medical industry and the specialized expertise required in different areas of medicine make it difficult for one company alone to develop a broad portfolio of technological solutions. In addition to internally generated growth through our research and development efforts, historically we have relied, and expect to continue to rely, upon acquisitions, investments and alliances to provide us access to new technologies both in areas served by our existing businesses as well as in new areas. We may make future investments where we believe that we can stimulate the development of, or acquire, new technologies and products to further our strategic objectives and strengthen our existing businesses. Investments and alliances in and with medical technology companies are inherently risky, and we cannot guarantee that any of our previous or future acquisitions, investments or alliances will be successful or will not materially adversely affect our consolidated earnings, financial condition or cash flows.

 

Future issuances of our common stock could dilute existing stockholders and cause our stock price to decline.

 

As of December 31, 2009 we have reserved 5,054,144 shares of common stock for issuance under our stock-based compensation plans and arrangements, including pursuant to options that are outstanding or may be granted in the future. Future stock awards under our plans and the issuance of stock upon exercise of options would have a dilutive effect on our stockholders and may adversely affect the market price of our common stock.

 

Our charter documents and Delaware law contain provisions that could make it more difficult for a third party to acquire us.

 

Certain provisions of our certificate of incorporation and bylaws could make it harder for a third party to acquire us without the consent of our board of directors. Our certificate of incorporation authorizes the issuance of preferred stock with the designations, rights, and preferences as may be determined from time to time by our board of directors, without any further vote or action by our stockholders. In addition, our board of directors is divided into

three classes with staggered terms, which makes it difficult for stockholders to change the control of our board. Lastly, Section 203 of the Delaware General Corporation Law limits business combination transactions with interested stockholders that have not been previously approved by the issuer’s board of directors. Our board of directors could choose not to negotiate with an acquirer that it did not feel was in our strategic interest. If the acquirer was discouraged from offering to acquire us or prevented from successfully completing a hostile acquisition by the anti-takeover measures described above, our stockholders could lose the opportunity to sell their shares at a favorable price.

 

Realization of our deferred tax assets is uncertain.

 

During 2009, we evaluated our ability to realize our net deferred tax assets, primarily our net operating losses and tax credit carryforwards and determined that the realization of these deferred tax assets is uncertain as of the year ended December 31, 2009. We assessed both positive and negative evidence as well as objective and subjective evidence, including but not limited to such factors as past performance, recent history of operating results on a GAAP basis, recent history of generating taxable income, history of recovering net operating loss carryforwards for tax purposes, and expectations of future taxable income as well as current conditions and issues facing our industry and its customers. Based on our evaluation, we determined it was not more likely than not that we would be able to realize all or a portion of its deferred tax assets and as such, we recorded a valuation allowance against deferred tax assets resulting in a non cash charge to income tax expense of approximately $42.2 million. Our ability to realize these deferred tax assets in the future is dependent upon our ability to generate taxable income. If in future periods we generate taxable income, then the valuation allowance may be released in part, or in total, when it becomes more likely than not that the deferred tax assets will be realized.

 

Changes in tax laws and unanticipated tax liabilities could adversely affect our effective income tax rate and profitability.

 

President Obama’s administration has announced several proposals for to reform U.S. tax laws that would fundamentally change how U.S. multinational corporations are taxed on their global income. These proposals have been carried forward from proposals which did not pass Congress. Although adjusted since the original proposals, the new proposals include a proposal to defer tax deductions for interest expense allocable to non-U.S. earnings until earnings are repatriated and a proposal to further limit foreign tax credits. In addition, the latest proposals also include taxing currently any excess returns as Subpart F income associated with transfers of intangible assets offshore to a related controlled foreign corporation. These proposals, if passed, would be effective for tax years beginning after 2010. It is unclear whether these proposed tax reforms will be enacted, or, if enacted, what the scope of the reforms will be. Depending on their content, such reforms may have an adverse impact to our worldwide tax expense in future periods.

 

Our future financial results could be adversely impacted by asset impairments.

 

We are required not to amortize goodwill and other intangible assets determined to have indefinite lives, and have established a method of testing these assets for impairment on an annual or on an interim basis if certain events occur or circumstances change that would reduce the fair value of a reporting unit below its carrying value or if the fair value of intangible assets with indefinite lives falls below their carrying value. We also need to evaluate intangible assets determined to have finite lives for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of the business, or other factors such as a decline in our market value below its book value for an extended period of time. A significant decline in our stock price could require us to evaluate intangible assets for recoverability during the quarter in which the decline occurred. In the case of intangible assets with indefinite lives, we will need to evaluate whether events or circumstances continue to support an indefinite useful life. We will need to evaluate the estimated lives of all intangible assets on an annual basis, including those with indefinite lives, to determine if events and circumstances continue to support an indefinite useful life or the remaining useful life, as applicable, or if a revision in the remaining period of amortization is required. The amount

of any such annual or interim impairment charge could be significant, and could have a material adverse effect on our reported financial results for the period in which the charge is taken.

 

 

None.

 

 

We lease a facility in Bothell, Washington, which houses our corporate offices and certain of our research and development and customer support services, as well as marketing, finance and administrative functions. This facility occupies approximately 56,000 square feet and is under lease through 2013.

 

We also lease a facility in Deerfield, Wisconsin, which houses our manufacturing operations and certain of our research and development, customer support services, marketing, finance and administrative functions. This facility is approximately 100,000 square feet. The lease expires in 2018 with two five-year renewal options.

 

We have other facilities under lease in Laguna Hills, California, which houses certain of our research and development operations, as well as in other locations such as Manchester, United Kingdom, Shanghai, China, Copenhagen, Denmark, Cologne, Germany and Paris, France.

 

 

We are subject to various legal proceedings arising in the normal course of business. In the opinion of management, the ultimate resolution of these proceedings is not expected to have a material effect on our consolidated financial position, results of operations or cash flows.

 

 

 

Our common stock is traded on the NASDAQ Global Market (symbol “CSCX”). The number of shareholders of record of our common stock at March 8, 2010, was 944.

 

Quarterly high and low bid closing prices for our common stock as reported on NASDAQ for the periods indicated are set forth in the table below.

 

 

We have never declared or paid any cash dividends on our common stock. We currently anticipate that we will retain any future earnings for use in the expansion and operations of our business and do not anticipate paying cash dividends in the foreseeable future.

Recent Sales of Unregistered Securities

 

In November 2009, we issued 100,000 shares of our common stock, par value $0.001 per share, to Gust H. Bardy, M.D. in exchange for an undivided 20% ownership interest in certain patents and patent applications and rights thereto. The shares of our common stock issued to Dr. Bardy were not registered under the Securities Act of 1933, as amended (the “Securities Act”), and were issued in reliance on an exemption from registration under Section 4(2) of the Securities Act.

 

Performance Comparison Graph

 

The following graph depicts the Company’s total return to stockholders from August 31, 2005 through December 31, 2009, relative to the performance of the NASDAQ Composite Index and the Standard & Poor’s Health Care Equipment Index. All indices shown in the graph have been reset to a base of 100 as of September 1, 2005 (the date of the merger of Quinton and CSI), and assume an investment of $100 on that date and the reinvestment of dividends paid since that date. We have never paid a dividend on our common stock. The stock price performance shown in the graph is not necessarily indicative of future price performance.

 

COMPARISON OF 52 MONTH CUMULATIVE TOTAL RETURN*
Among Cardiac Science Corporation, The NASDAQ Composite Index
And The S&P Health Care Equipment Index

 

 

 

 

Copyright^© 2010 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto and the information contained herein in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historical results are not necessarily indicative of future results. Our company is the result of the combination of Quinton and CSI pursuant to a merger transaction that was completed on September 1, 2005. Since we are deemed to be the successor to Quinton for accounting purposes, our selected consolidated financial data in the table below represents the historical financial data of Quinton through September 1, 2005 the results of operations of the combined company since September 1, 2005.

 

 

 

 

 

 

You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this report. Except for historical information, the following discussion contains forward-looking statements within the meaning of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including future results of operations or financial position, made in this Annual Report on Form 10-K are forward looking. The words “believe,” “expect,” “intend,” “anticipate,” “will,” “may,” variations of such words, and similar expressions identify forward-looking statements, but their absence does not mean that the statement is not forward-looking. These forward-looking statements reflect management’s current expectations and involve risks and uncertainties. Our actual results could differ materially from results that may be anticipated by such forward-looking statements due to various uncertainties. The principal factors that could cause or contribute to such differences include, but are not limited to, the factors discussed in the section entitled “Risk Factors” and those discussed elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements to reflect events or circumstances that may subsequently arise. Readers are urged to review and consider carefully the various disclosures made in this report and in our other filings made with the SEC that disclose and describe the risks and factors that may affect our business, prospects and results of operations. The terms “the Company,” “us,” “we” and “our” refer to Cardiac Science Corporation and our majority-owned subsidiaries.

 

Business Overview

 

We develop, manufacture, and market a family of advanced diagnostic and therapeutic cardiology devices and systems, including automated external defibrillators (“AEDs”), electrocardiograph devices (“ECG/EKG”), cardiac stress testing treadmills and systems, Holter monitoring systems, hospital defibrillators, cardiac rehabilitation telemetry systems, vital signs and spot check monitors and cardiology data management systems (“Informatics”) that connect with hospital information (“HIS”), electronic medical record (“EMR”), and other information systems. We sell a variety of related products and consumables, and provide a portfolio of training, maintenance, and support services. We are the successor to the cardiac businesses that established the trusted Burdick^®, Quinton^® and Powerheart^® brands and are headquartered in Bothell, Washington. With customers in more than 100 countries worldwide, we have operations in North America, Europe, and Asia.

Critical Accounting Estimates and Policies

 

To prepare financial statements that conform with U.S. generally accepted accounting principles, we must select and apply accounting policies and make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our accounting estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

There are certain critical accounting estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if it requires us to make assumptions because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate, and changes in the estimate or different estimates that we reasonably could have selected would have had a material impact on our financial condition or results of operations.

 

Deferred Tax Assets and Income Taxes.  We account for income taxes under the asset and liability method under which deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities and operating losses and tax credit carryforwards. This process involves calculating our current tax obligation or refund and assessing the nature and measurements of temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. In each period, we assess the likelihood that our deferred tax assets will be recovered from existing deferred tax liabilities or future taxable income. If required, we will recognize a valuation allowance to reduce such deferred tax assets to amounts that are more likely than not to be ultimately realized. To the extent that we establish a valuation allowance or change this allowance in a period, we adjust our tax provision or tax benefit in the consolidated statements of operations. We use our judgment to determine estimates associated with the calculation of our provision or benefit for income taxes, and in our evaluation of the need for a valuation allowance recorded against our net deferred tax assets.

 

During 2009, we evaluated the expected realization of our deferred tax assets and determined an increase to our valuation allowance of $54.6 million was required of which $42.2 million was included in the consolidated statements of operations as deferred tax expense. Factors we considered in making such an assessment included, but were not limited to past performance, including our recent history of operating results on a U.S. GAAP basis, our recent history of generating taxable income, our history of recovering net operating loss carryforwards for tax purposes and our expectation of future taxable income, both considering our past history in predicting future results and considering current macroeconomic conditions and issues facing our industry and customers.

 

Stock-Based Compensation.  We account for stock-based compensation based on fair value of the options or restricted stock units at the date of grant. Share-based compensation cost is measured at the grant date and is recognized as expense over the related vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating future volatility, expected term and the amount of share-based awards that are expected to be forfeited during the vesting period. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

 

Indefinite Lived Intangible Assets.  Our indefinite lived intangible assets are comprised primarily of trade names, which were acquired in our acquisition of Burdick in 2003 and the merger transaction with CSI in 2005. We use our judgment to estimate the fair value of each of these indefinite lived intangible assets. Our judgment about fair value is based on our expectation of future cash flows and an appropriate discount rate.

 

We believe the Burdick and Cardiac Science trade names have indefinite lives and, accordingly, we do not amortize the trade names. We evaluate this conclusion annually or more frequently if events and circumstances indicate that the asset(s) might be impaired and make a judgment about whether there are factors that would limit our ability to benefit from the trade name in the future. If there were such factors, we would start amortizing the trade name over the expected remaining period in which we believed it would continue to provide benefit.

Additionally, we periodically evaluate whether the carrying value of our intangible assets might be impaired. For our trade names, this evaluation is performed annually, or more frequently if events occur that suggest there may be an impairment loss, and involves comparing the carrying amount to our estimate of fair value.

 

We evaluated our indefinite lived intangible assets for impairment during 2009 and 2008 and we determined no impairment was necessary for our indefinite lived intangible assets and therefore, we did not record an impairment charge in either period.

 

Valuation of Long-Lived Assets.  We review long-lived assets, such as machinery and equipment, and intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of asset groups to be held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If the carrying amount of an asset group exceeds its estimated future cash flows, an impairment charge is recognized on our consolidated statements of operations and as a reduction to value of the asset group on our consolidated balance sheets. We use our judgment to estimate the useful lives of our intangible assets subject to amortization and evaluate the remaining useful lives annually.

 

Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

 

We evaluated our long-lived assets for impairment during 2009 and 2008 and we determined no impairment was necessary for our long-lived assets and therefore, we did not record an impairment charge in either period.

 

Accounts Receivable.  Accounts receivable represent a significant portion of our assets. We make estimates of the collectability of accounts receivable, including analyzing historical write-offs, changes in our internal credit policies and customer concentrations when evaluating the adequacy of our allowance for doubtful accounts. Different estimates regarding the collectability of accounts receivable may have a material impact on the timing and amount of reported bad debt expense and on the carrying value of accounts receivable.

 

Inventories.  Inventories represent a significant portion of our assets. We value inventories at the lower of cost, on an average cost basis, or market. We regularly perform a detailed analysis of our inventories to determine whether adjustments are necessary to reduce inventory values to estimated net realizable value. We consider various factors in making this determination, including the salability of individual items or classes of items, recent sales history and predicted trends, industry market conditions and general economic conditions. Different estimates regarding the net realizable value of inventories could have a material impact on our reported net inventory and cost of revenues, and thus could have a material impact on the consolidated financial statements as a whole.

 

Warranty.  We provide warranty service covering many of the products and systems we sell. We estimate and accrue for future costs of providing warranty service, which relate principally to the hardware components of the systems, when the systems are sold. Our estimates are based, in part, on our warranty claims history and our cost to perform warranty service. Differences could result in the amount of the recorded warranty liability and cost of revenues if we made different judgments or used different estimates.

 

Corrective Action Costs.  We provide for additional warranty costs associated with field corrective actions and recalls when the likelihood of incurring costs associated with these matters becomes probable and estimable. We record estimated warranty costs associated with field corrective actions and recalls as part of cost of revenues on the consolidated statements of operations and within corrective action liabilities on the consolidated balance sheets.

 

During 2009, we recorded expenses of $21.0 million related to two separate voluntary corrective actions associated with our AEDs. The costs of these voluntary corrective actions are estimates. The actual costs incurred to implement the voluntary corrective actions could vary significantly based on a number of factors, including the number of impacted devices, the customer and geographical segments related to the impacted devices, the logistical processes we employ to address the issues, the customer response rate in implementing the corrective action plans, the level of required follow up with customers, the extent to which we rely on third party assistance to carry out the corrective actions, and the length of time and other resources required to complete the corrective actions, among others.

In February 2010, we received a warning letter from the FDA noting, among other things, that the voluntary field corrective action we announced in November 2009 is inadequate since it is intended to improve the products’ ability to detect the potential component problem, but is not designed to prevent component failure. The FDA letter also asserts other inadequacies, including our procedures relating to the evaluation, investigation and follow up of complaints, procedures to verify the effectiveness of corrective and preventative actions and procedures relating to certain design requirements. We are in ongoing discussions with the FDA regarding these issues. We may need to take different or additional actions than anticipated depending on the outcome of those discussions, in which case the amounts we record in connection with these initiatives may need to be adjusted. We evaluate the adequacy of our accruals for these initiatives on a regular basis and will make adjustments to our estimates if facts and circumstances indicate that changes to our initial estimates would be appropriate.

 

Goodwill.  We performed a test for goodwill impairment at November 30, 2008 in accordance with our policy for performing this test annually. During the fourth quarter of 2008, we recorded a pre-tax impairment charge of $107.7 million, equivalent to the full amount of previously acquired goodwill resulting primarily from our acquisitions of Burdick and CSI. See Note 9 — Goodwill to the Consolidated Financial Statements in Item 8 of this report for further discussion of the impairment charge. We did not enter into any business combinations during the year ended December 31, 2009 and thus no new goodwill has been recorded since this impairment charge was recorded.

 

Application of the goodwill impairment test applied at November 30, 2008 required judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit and ultimately impact the results of our goodwill impairment test.

 

Software Revenue Recognition.  We account for the licensing of software and arrangements where software is considered more than incidental to the product as software revenue arrangements. We use judgment when determining the appropriate accounting for our software revenue arrangements, including whether an arrangement includes multiple elements, and if so, whether vendor-specific objective evidence (“VSOE”) of fair value exists for those elements. A portion of software revenue is recorded as unearned due to undelivered elements including, in some cases, software implementation and post-delivery support. The amount of revenue allocated to undelivered elements is based on the sales price of each element when sold seperately (VSOE) using the residual method.

 

Revenue from post-delivery support is recognized over the service period, which is typically a year and revenue from software implementation services is recognized as the services are provided (based on VSOE of fair value). When significant implementation activities are required, we recognize revenue from software and services upon installation. Changes to the elements in a software arrangement and the ability to identify VSOE of fair value for those elements could materially impact the amount of earned and unearned revenue.

 

Revenue Recognition.  Revenue from sales of hardware products is generally recognized when title transfers to the customer, typically upon shipment. Some of our customers are distributors that sell goods to third party end users. Except for certain identified distributors where collection may be contingent on distributor resale, we recognize revenue on sales of products made to distributors when title transfers to the distributor and all significant obligations have been satisfied. In making a determination of whether significant obligations have been met, we evaluate any installation or integration obligations to determine whether those obligations are inconsequential or perfunctory. In cases where the remaining installation or integration obligation is not determined to be inconsequential or perfunctory, we defer the portion of revenue associated with the fair value of the installation and integration obligation until these services have been completed.

 

Distributors do not have price protection and generally do not have product return rights, except if the product is defective upon shipment or shipped in error, and in some cases upon termination of the distributor agreement. For certain identified distributors where collection may be contingent on the distributor’s resale, revenue recognition is deferred and recognized on a “sell through” or cash basis. The determination of whether sales to distributors are contingent on resale is subjective because we must assess the financial wherewithal of the distributor to pay regardless of resale. For sales to distributors, we consider several factors, including past payment history, where available, trade references, bank account balances, Dun & Bradstreet reports and any other financial information

provided by the distributor, in assessing whether the distributor has the financial wherewithal to pay regardless of, or prior to, resale of the product and that collection of the receivable is not contingent on resale.

 

We offer limited volume price discounts and rebates to certain distributors. Volume price discounts are on a per order basis based on the size of the order and are netted against the revenue recorded at the time of shipment. We have some arrangements with key distributors that provide for volume discounts based on meeting certain quarterly or annual purchase levels or based on sales volumes of certain of our products during a defined period in which we offer a promotion. Rebates are paid quarterly or annually and are accrued for as incurred.

 

We consider program management packages and training and other services as separate units of accounting when sold with an AED based on the fact that the items have value to the customer on a stand alone basis and could be acquired from another vendor. Fair value is determined to be the price at which they are sold to customers on a stand alone basis. Training revenue is deferred and recognized at the time the training occurs. AED program management services revenue, pursuant to annual or multi-year agreements that exist with some customers, is deferred and amortized on a straight-line basis over the related contract period.

 

We offer optional extended service contracts to customers. Fair value is determined to be the price at which they are sold to customers on a stand alone basis. Service contract revenues are recognized on a straight-line basis over the term of the extended service contracts, which generally begin after the expiration of the original warranty period. For services performed, other than pursuant to warranty and extended service contract obligations, revenue is recognized when the service is performed and collection of the resulting receivable is reasonably assured.

 

Recent Accounting Pronouncements

 

In January 2010, the FASB issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance will become effective for us with the reporting period beginning January 1, 2010, except for the disclosure on the roll forward activities for Level 3 fair value measurements, which will become effective for us with the reporting period beginning January 1, 2011. Other than requiring additional disclosures, adoption of this new guidance will not have a material impact on our consolidated financial statements.

 

In September 2009, the Emerging Issues Task Force (EITF) reached a consensus related to revenue arrangements with multiple deliverables, which the FASB then issued as an Accounting Standards Update (“ASU”), 2009-13. The ASU amends Accounting Standards Codification (“ASC”) Subtopic 605-25, “Revenue Recognition — Multiple Element Arrangements” and provides application guidance on whether multiple deliverables exist in a revenue arrangement, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This ASU establishes a selling price hierarchy for determining the selling price of a deliverable based on vendor-specific objective evidence, if available, third-party evidence, or estimated selling price if neither vendor-specific nor third-party evidence is available. The ASU can be applied on a prospective basis or in certain circumstances on a retrospective basis. We plan to adopt this ASU on a prospective basis beginning January 1, 2011. We believe the adoption of this ASU may have an impact on our financial position and results of operations, however we are uncertain whether the impact will be material. We are continuing to evaluate this ASU as of December 31, 2009.

 

In September 2009, the EITF reached a consensus related to revenue arrangements that include software elements, which the FASB issued as ASU, 2009-14. The ASU amends ASC Subtopic 985-605, “Software — Revenue Recognition”. Previously, companies that sold tangible products with “more than incidental” software were required to apply software revenue recognition guidance. This guidance often delayed revenue recognition for the delivery of the tangible product. Under the new guidance, tangible products that have software components that are “essential to the functionality” of the tangible product will be excluded from the software revenue recognition guidance. The new guidance will include factors to help companies determine what is “essential to the functionality.” Software-enabled products will now be subject to other revenue guidance and will likely follow the guidance

for multiple deliverable arrangements issued by the FASB in September 2009 in ASU 2009-13. The new guidance is to be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. We plan to adopt this ASU on a prospective basis beginning January 1, 2011. We believe the adoption of this ASU may have an impact on our financial position and results of operations, however we are uncertain whether the impact will be material. We are continuing to evaluate this ASU as of December 31, 2009.

 

Results of Operations

 

Overview of 2009 Results

 

During 2009, we:

 

 

Looking Forward

 

We expect flat-to-modest overall revenue growth in 2010, with growth in our cardiac monitoring revenue likely offset by decreases in defibrillation revenue; service revenue will likely be flat.

 

After several years of decline, we expect our cardiac monitoring revenues to grow in 2010 as a result of planned new product introductions and as a result of improved marketing and demand generation capabilities which we put into place in 2009. We expect continued growth after 2010, as we continue to develop and introduce new products, either internally or in partnership with third parties. If we are unable to successfully execute on our new product development plans or if the market is not receptive to our new products, our cardiac monitoring revenues could be adversely affected in future periods.

 

Our AED revenues in 2010 may be adversely affected by recent events and, as a result, we may experience a further decline in defibrillation revenue. Factors that may negatively affect AED revenue in 2010 include the potential for loss of market share as a result of the recent voluntary corrective actions associated with our AEDs, a warning letter that we received from the FDA in February 2010 and the recent re-entry into the market of the former AED market leader, Physio Control. Further, if we are unable to address to the satisfaction of the FDA the issues raised in the warning letter, we could be required to implement a more costly corrective action plan or recall,

temporarily cease shipments of our products, which could ultimately impact our ability to fulfill customer orders and maintain market share, or we may be subject to regulatory action by the FDA, including seizure, injunction and/or civil monetary penalties. Any such regulatory actions could significantly disrupt our ongoing business and operations and have a material adverse effect on our financial position and results of operations.

 

Additionally, we continue to face challenges in the global economy. However, we expect the global market for AEDs to grow over time, as awareness of the benefits of AEDs continues to increase and as the prevalence of mandates requiring deployment of AEDs in public venues continues to rise. As the market continues to grow and as we overcome what we believe to be temporary challenges associated with our quality and regulatory issues, we believe that we will be able to grow our AED revenues over time, both domestically and overseas. We believe our direct presence in several countries in Europe will result in continued growth in sales in these markets over time, though again we may experience softness in the near term due to the quality and regulatory issues, the return of a competitor to the market and continued general economic factors.

 

We expect our revenues in Japan to decline further in 2010, as we continue to explore and hopefully finalize alternative distribution. On June 15, 2009, we notified Nihon Kohden, our current exclusive distributor of AEDs in Japan, that our OEM Supply and Purchase Agreement dated as of January 1, 2008 (the “OEM Agreement”) will terminate effective June 15, 2010. We elected to terminate the OEM Agreement in order to explore alternative means of distributing AED products in that market, largely in response to Nihon Kohden’s release of a competing AED. At this point, it is unclear whether we will continue to distribute through Nihon Kohden after termination of our existing agreement. If we do not continue our relationship with Nihon Kohden, we expect to begin selling products in Japan via an alternative partner sometime in 2010. We do not expect to realize significant revenue in Japan until such time as this transition occurs or we define a more advantageous relationship with Nihon Kohden.

 

Our future gross profits and gross margins will be dependent upon our overall revenue volume (by product mix), market pricing and our costs. Increasing volumes provide economies of scale and tend to enhance our gross margin. AEDs generally have a higher gross margin than our monitoring products. Accordingly, if our product mix shifts toward a relatively higher proportion of AEDs, our overall gross margin increases and if the mix shifts toward a relatively higher proportion of monitoring products, our overall gross margin is likely to decline. Market pricing for our products has declined slightly in recent years. As we face challenges in retaining our AED market share in the face of circumstances discussed elsewhere in this report, we may experience additional pricing pressure, which may, in turn, result in a reduction of our gross margins. Finally, any increases in costs, including any unexpected additional costs associated with the ongoing or new corrective actions or recalls relating to our AEDs, or any other quality issues related to our products that may arise in the future, would also negatively affect our gross margins. Our actual gross profit and margins will be dependent on the aggregation of these and other factors.

 

We expect our operating expenses to increase in 2010 due to increased expenses associated with regulatory and quality assurance as we continue to upgrade our internal capabilities in these areas. We also expect to incur higher research and development and marketing expenses associated with new product development initiatives. Further, we expect to see operating expenses increase over time due to our estimates for modest revenue growth in future periods. We will continue to monitor our operating expenses in light of our actual and anticipated future revenues and gross profit and we may need to take steps to reduce operating expenses in the future if our revenues and gross profit do not grow over time.

 

We expect to realize an operating loss in 2010, as we continue to invest in new product development, new product launches and as we improve our quality systems.

Revenues

 

We derive our revenues primarily from the sale of our non-invasive cardiology products and related consumables, and to a lesser extent, from services related to these products, including training. We categorize our revenues as (1) defibrillation products, which include our AEDs, hospital defibrillators and related accessories; (2) cardiac monitoring products, which include capital equipment, software products and related accessories and supplies; and (3) service, which includes service contracts, CPR/AED training services, AED program management services, equipment maintenance and repair, replacement part sales and other services. We derive a portion of our service revenue from sales of separate extended maintenance arrangements. We defer and recognize these revenues over the applicable maintenance period.

 

Revenues for the years ended December 31, 2009, 2008 and 2007 were as follows:

 

 

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

Revenue from defibrillation products declined by $36.1 million, or 30%, for 2009 compared to 2008. Approximately $27.8 million of this decrease was due to reduced AED shipments to Nihon Kohden, our exclusive Japanese distribution partner, due to our relationship with that partner beginning to wind down, their introduction of competing AED products in the Japanese market and overall weakened demand in Japan. The remainder of the decrease in defibrillation products revenue was due primarily to the impact of the weak economy on demand for our AEDs in North America. Our AED sales increased slightly outside of North America and Japan, as the overall market continued to grow somewhat, despite a weak global economy.

 

Revenue from cardiac monitoring products decreased by $12.2 million or 19% for, 2009 as compared to 2008. The decrease in cardiac monitoring revenue in 2009 compared to the prior year was primarily due to weakness in the worldwide medical products markets as a result of the weakened global economy.

 

Service revenue for 2009 decreased 6%, as compared to 2008 due primarily to lower AED training and program management services related to declines in AED product sales during these same periods.

 

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

Defibrillation products revenue increased significantly for 2008 as compared to 2007 due to strong growth throughout Europe and Asia (particularly in Japan), which increased by 86% during the period. This increase was partially offset by decreases in domestic defibrillation products revenue of 18% during 2008, as compared to 2007. This decrease was due in part to exceptionally high revenue in the prior year that included multi-million dollar school and corporate AED deployments, which did not recur at the same levels in 2008. The weak U.S. economy negatively impacted defibrillation product sales, especially in the latter part of 2008.

 

Cardiac monitoring products revenue decreased by 4.5% for 2008 from the comparable period in 2007. We believe this was due, in part, to weakening of general economic conditions, resulting in longer buying cycles and deferred purchasing decisions for customers in this portion of our business.

Service revenue increased for 2008 as compared to 2007 due primarily to the success of our continued focus on, and promotion of, our AED training and program management services, and to a lesser extent on growth in our cardiac monitoring service contract sales.

 

Gross Profit

 

Gross profit is revenues less the cost of revenues. Cost of revenues consists primarily of the costs associated with manufacturing, assembling and testing our products, amortization of certain intangibles, overhead costs, compensation, including stock-based compensation and other costs related to manufacturing support and logistics. Cost of revenues also includes costs associated with voluntary corrective actions related to field initiatives and recalls. We rely on third parties to manufacture certain of our product components. Accordingly, a significant portion of our cost of revenues consists of payments to these manufacturers. Cost of service revenue consists of customer support costs, training and professional service expenses, parts and compensation. Our hardware products include a warranty period that includes factory repair services or replacement parts. We accrue estimated expenses for warranty obligations at the time products are shipped.

 

Gross profit for the years ended December 31, 2009, 2008 and 2007 was as follows:

 

 

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

Total gross profit from defibrillation products in 2009 decreased significantly compared to 2008 due primarily to: (1) significant declines in revenue and gross profit from the Japanese market compared to the prior year, and (2) the impact of the charges for our voluntary corrective actions related to AEDs in the field, totaling $21.0 million. To a lesser extent, gross profit from defibrillation products also declined due to lower overall AED sales, resulting from the weakened global economy. However, gross margin on defibrillation products in 2009 increased by 2.6% compared to 2008, due largely to lower sales volumes in the Japanese market, for which our gross margins are typically lower than for other geographic markets.

 

Charges associated with corrective action costs of $21.0 million incurred in 2009 represent estimated costs associated with two separate voluntary corrective actions associated with our AEDs. During the third quarter of 2009, we recorded a charge of $18.5 million related to estimated costs associated with a voluntary field corrective action intended to enhance the reliability of approximately 300,000 AEDs shipped to customers between June 2003 and June 2009. Additionally, during the fourth quarter of 2009, we recorded a charge of $2.5 million related to a voluntary recall of approximately 12,200 AEDs manufactured between October 2009 and January 2010. The estimated costs associated with these corrective actions include development expenses as well as materials, shipping and other logistical costs required to manage the corrective actions. There were no similar charges during the years ended December 31, 2008 or 2007. See the “Looking Forward” section above for additional information regarding the impact of possible corrective actions on gross profit in future periods.

Gross profit from cardiac monitoring products decreased for 2009 as compared to 2008 due principally to lower sales volumes resulting from weakened conditions in the global economy. Gross margins on cardiac monitoring products decreased for 2009 as compared to 2008 due primarily to changes in product mix toward an increased proportion of lower margin products and, to a lesser extent, to increased component parts in certain products.

 

Gross profit from service decreased for 2009 as compared to 2008 due principally to lower service revenues associated with our AED training and program management services related to declines in AED product sales during these same periods.

 

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

Gross profit from defibrillation products increased for 2008 as compared to 2007 due principally to higher sales to Nihon Kohden during the period, and to a lesser extent to cost efficiencies associated with increased volumes of production related to our defibrillation products.

 

Gross profit and gross margin from cardiac monitoring products decreased for 2008 as compared to 2007 due principally to changes in product mix as well as challenges resulting from deteriorating economic conditions during 2008.

 

Gross profit from service in 2008 increased as a percentage of service revenue for 2008 as compared to 2007 due in part to increased sales of higher value-added offerings and general growth in service revenue while costs remained relatively fixed.

 

Operating Expenses

 

Operating expenses include expenses related to research and development, sales, marketing and other general and administrative expenses required to run our business, including stock-based compensation.

 

Research and development expenses consist primarily of salaries and related expenses for development and engineering personnel, fees paid to consultants, and prototype costs related to the design, development, testing and enhancement of products. Several components of our research and development activities require significant funding, the timing of which can cause significant quarterly variability in our expenses.

 

Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in sales, marketing and sales support functions as well as costs associated with corporate and product branding, promotional and other marketing activities.

 

General and administrative expenses consist primarily of employee salaries and related expenses for executive, finance, accounting, information technology, regulatory and human resources personnel as well as bad debt expense, professional fees, legal fees, excluding fees associated with significant litigation matters, and other corporate expenses.

 

Impairment of goodwill consists of pre-tax charges of $107.7 million taken in 2008, representing a write-off of the entire amount of our previously acquired goodwill, primarily resulting from our merger transaction with CSI in 2005. See Note 9 — Goodwill to the Consolidated Financial Statements in Item 8 of this report for further discussion of the impairment charge.

 

Litigation and related expenses include settlement costs and legal fees related primarily to three cases which were settled in the first half of 2007.

 

Licensing income and litigation settlement consists of non cash income of $5.5 million for the license rights given to Philips as part of the litigation settlement and a non cash gain on the transaction of $0.5 million. See Note 1 — Summary of Significant Accounting Policies to the Consolidated Financial Statements in Item 8 of this report for further discussion.

Operating expenses for the years ended December 31, 2009, 2008 and 2007 were as follows:

 

 

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

The decrease in research and development expenses in 2009 as compared to 2008 was due primarily to decreased labor costs resulting from restructuring programs we implemented during the first quarter of 2009 for which estimated costs were recorded in the fourth quarter of 2008. These restructuring programs resulted in lower cost structures during 2009, partially offset by increased consulting, outsourcing and severance costs during the last six months of 2009.

 

The decrease in sales and marketing expenses for 2009 as compared to 2008 was due in part to lower commissions related to lower total revenues, which decreased 24%. In addition, employee related labor and other costs decreased for the year ended December 31, 2009 as a result of efforts to reduce costs and prioritize spending during 2009.

 

The increase in general and administrative expenses for 2009 as compared to 2008 was due primarily to increases in staffing and professional services in our regulatory affairs and quality assurance functions and transition and separation costs associated with turnover of our President and Chief Executive Officer and two members of our Board of Directors during 2009.

 

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

The increase in research and development expenses for 2008 compared to 2007 was due primarily to higher labor and outside contractor costs related to increased investment in future versions of our products. Additionally, research and development expenses included significant costs resulting from a planned reduction in the number of research and development personnel in order to reduce internal staffing in favor of external resources for certain products.

 

The increase in sales and marketing expenses for 2008 compared to 2007 was due primarily to higher commissions related to higher total revenues and higher selling expenses from foreign subsidiaries where we have added a direct presence. In addition, payroll and benefit related costs increased due to higher staffing.

 

The increase in general and administrative expenses for 2008 compared to 2007 was due primarily to increases in payroll and benefit related costs, including temporary labor as well as increased bad debt expense and legal expenses, partially offset by lower professional service fees related to audit, tax and consulting fees.

Impairment of goodwill during 2008 totaled $107.7 million and represented a pre-tax full write-off of previously acquired goodwill related primarily to the merger transaction with CSI in 2005. The impairment was a result of a number of factors that existed during the fourth quarter of 2008, and primarily driven by the significant downtown in global economic conditions during this period and the related impact on our market capitalization. See Note 9 — Goodwill to the Consolidated Financial Statements in Item 8 of this report for further discussion. We had no similar expense related to impairment of goodwill or other intangible assets in 2009 or in 2007.

 

Litigation and related expenses for 2007 totaled $3.8 million which were comprised of settlement costs and legal fees related primarily to three cases which were settled between April and July. We had no expenses related to these same cases for the years ended December 31, 2009 or 2008.

 

We had no licensing income and litigation settlement benefit in 2009 or 2008. Licensing income and litigation settlement for 2007 included non cash income of $5.5 million for the license rights granted to Philips as part of the litigation settlement and a non cash gain on the transaction of $0.5 million.

 

Other Income and Expense

 

Other income, net for 2009 was $0.1 million and consisted primarily of $0.5 million income from royalty agreements and $0.1 million income associated with the implementation of a new purchase card program, substantially offset by $0.5 million in net foreign currency exchange losses.

 

Other income, net for 2008 was $0.6 million and consisted primarily of income from royalty agreements of $0.5 million and interest income on invested cash of $0.5 million. Additionally, other income included realized foreign currency gains related to forward exchange contracts associated with cash and accounts receivable that are denominated in currencies other than the U.S. Dollar. These realized gains were substantially offset by foreign currency losses on intercompany payables denominated in U.S. dollars owed by foreign subsidiaries.

 

Other income, net for 2007 was $0.8 million and consisted primarily of income from sub-lease agreements at facilities, royalty income, and foreign currency transaction gains. Interest income on invested cash was $0.5 million in 2007.

 

Income Taxes

 

During 2009 we recorded income tax expense of $42.5 million. Our worldwide effective tax rate for 2009 was 125.8% which was substantially affected by an increase to our valuation allowance against our net deferred tax assets of $54.6 million for the year ended December 31, 2009 of which $42.2 million was included in the statement of operations as deferred tax expense. We evaluated both the positive and negative evidence which existed during 2009 in making our determination to increase our valuation allowance against our deferred tax assets. Based on our evaluation of recent cumulative book losses, including the unfavorable impact of the voluntary corrective actions described above, as well as giving consideration to uncertainty regarding estimates of future profitability, we concluded that an increase to our valuation allowance was required during 2009 to reduce gross deferred tax assets to an amount that is more likely than not to be realized. As of December 31, 2009, after consideration of the valuation allowance recorded against gross deferred tax assets, the consolidated balance sheet includes a noncurrent deferred tax liability of $5.4 million relating primarily to indefinite-lived intangible assets acquired from Quinton and CSI that are not expected to reverse unless the related assets become amortizable or are impaired in future periods.

 

As a result of recording the valuation allowance, we effectively have not recognized a deferred tax benefit for domestic losses incurred during 2009. If in future periods we generate taxable income, we will evaluate the positive and negative evidence available at the time in order to support our analysis of the need for a valuation allowance, and as a result we may release our valuation allowance in part, or in total, when it becomes more likely than not that the deferred tax assets will be realized. Until this occurs, we will continue to record a deferred tax benefit for any domestic losses that might be incurred in the future and will increase the recorded valuation allowance for any such additional losses. We expect to record additional tax expense in future periods related primarily to profits generated in our foreign jurisdictions in which we operate, which generally are forecasted to be marginally profitable on a financial reporting and taxable basis. Tax expense related to foreign jurisdictions was $1.0 million for the year ended December 31, 2009.

During 2008 we recorded income tax expense of $4.1 million compared to income tax expense of $4.9 million in 2007. Our worldwide effective tax rate for 2008 was 4% and was materially affected by the pre-tax goodwill impairment charge of $107.7 million, of which substantially all was nondeductible for federal and state income tax purposes. Accordingly, substantially all of our 2008 income tax expense was based on income excluding this impairment charge. Our worldwide effective tax rate applicable to income excluding the goodwill impairment charge was approximately 31%. This worldwide effective tax rate was down from our 2007 worldwide effective tax rate of 37% due in part to a shift in income from the U.S. to foreign jurisdictions with lower income tax rates, an increase in federal and state research and development credits as well as a slight decrease in our 2008 state effective tax rate.

 

The worldwide effective tax rate for 2007 was 37% and resulted from our federal and state effective tax rates, partially offset by research and development credits earned during the same period.

 

Liquidity and Capital Resources

 

Cash flows for the years ended December 31, 2009, 2008 and 2007 were as follows:

 

 

Cash used in operating activities of $4.9 million in 2009 resulted from our net loss of $77.0 million, substantially offset by non cash items included in net income, excluding cash, of $51.2 million, a decrease in accounts receivable of $8.9 million, and an increase in current liabilities, most notably the $15.2 million estimate for the corrective action liabilities, for which cash will be expended in future periods. Cash provided by operating activities of $17.7 million for 2008 resulted from our net loss of $98.4 million plus net non cash items included in net loss of $119.3 million (including the pre-tax goodwill impairment charge of $107.7 million) and a net increase in working capital, excluding cash, of $3.6 million. Cash provided by operating activities of $13.3 million for 2007 resulted from our net income of $8.5 million plus net non cash items included in net income of $7.5 million, reduced by a net increase in working capital of $2.7 million.

 

We anticipate that we will continue to use cash in operations during 2010 due in part to our anticipation of operating losses for the year and also due to the cash requirements associated with satisfying our obligations under the two previously mentioned voluntary corrective actions associated with our AEDs. Our use of cash to fund operations may be further impacted by other general business factors such as our ability to successfully sell our products and deliver our services, collect our accounts receivables, optimize lead times and inventory levels, and manage our expenses. Our ability to grow the business through possible acquisitions funded by cash or other borrowing has been reduced substantially in the foreseeable future as we plan to use a significant amount of our existing cash and cash equivalents during 2010.

 

Net cash used in investing activities of $4.2 million and $4.3 million for 2009 and 2008, respectively, consisted primarily of payments for capital expenditures related to investments in information technology and new manufacturing equipment and tooling for products under development, and to a lesser extent, expenditures related to leasehold improvements at our facility in Laguna Hills, CA during 2008.

 

Net cash used in investing activities in 2007 consisted of payments for capital expenditures of $2.0 million, purchases of short-term investments of $1.2 million, payments of acquisition related costs associated with the

merger transaction of $1.0 million, and payment of $1.0 million in consideration of certain patent rights received as part of the Philips settlement agreement. These investing outflows were partially offset by proceeds from maturities of short-term investments of $1.4 million.

 

Net cash provided by financing activities for 2009, 2008 and 2007 consisted primarily of proceeds from exercises of stock options and sales of common stock under our Employee Stock Purchase Plan less minimum tax withholdings on restricted stock awards remitted to taxing authorities.

 

As of December 31, 2009, we had cash and cash equivalents totaled $26,9 million. We expect to incur operating losses in 2010 and to use cash in operations. We have recently initiated two voluntary corrective actions relating to its AED products, the costs of which have been estimated at $21.0 million. The costs recorded are estimates and actual costs that the company will incur to carry out the corrective actions could be more or less than the $15.2 million that is remaining in our accrued corrective action liabilities on the consolidated balance sheets as of December 31, 2009. However, we expect to spend substantially all of the required costs associated with these two voluntary corrective actions during 2010 which will negatively impact our cash position. We believe our existing cash and cash equivalents will be sufficient to fund our anticipated operating losses, meet working capital requirements and fund anticipated capital expenditures and other obligations, including the estimated remaining costs of the ongoing corrective actions, through at least December 31, 2010.

 

However, we may be affected by economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. As discussed in Note 2, in February 2010, we received a warning letter from the FDA noting, among other things, that the voluntary field corrective action undertaken in November 2009 is inadequate. While we are in ongoing discussions with the FDA regarding this issue, we may need to take different or additional actions than anticipated depending on the outcome of those discussions. If we are unable to satisfy the FDA’s concerns, we may be subject to regulatory action by the FDA, including but not limited to seizure, injunction, halting shipment of our products and/or civil monetary penalties. Any such actions could significantly disrupt its ongoing business and operations and have a material adverse effect on its financial position and results of operations. Additionally, the above issues and other matters, such as the recent re entry into the market of the former AED market leader, may adversely impact our projected revenues in the near term. Accordingly, we may be required to reduce costs, which could adversely impact our forecasts for revenue growth in future periods.

 

At December 31, 2009, we did not have any borrowings under our existing $10.0 million line of credit agreement with Silicon Valley Bank. This line of credit agreement, which originally expired in January 2010, has been extended through March 2010 and we are currently negotiating for a renewed line of credit that would extend for a year or more. There can be no assurance that we will be successful in securing a renewed line of credit and, if not, we may be required to seek alternative sources of financing that may be more expensive and have more restrictive covenants and conditions.

 

Given the above factors, we plan to closely monitor our projected operating results and cash balances during 2010. If we are not successful in obtaining additional financing and, to the extent our operating results are not in line with our projected results, we would have the intent to reduce costs, to the extent necessary, to enable us to continue operations through at least December 31, 2010. While such cost reductions might negatively impact future growth opportunities, we believe we have the ability to make such reductions, should they be necessary.

 

In addition, we may be affected by economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. For more information on the factors that may impact our financial results, please see Part I, Item 1A Risk Factors included in this Annual Report on Form 10-K. In addition, we are continually considering other acquisitions that would complement or expand our existing business or that may enable us to expand into new markets. Future acquisitions may require additional debt, equity financing, or both. We may not be able to obtain any additional financing, or may not be able to obtain additional financing on acceptable terms.

Contractual Obligations

 

The table below summarizes our contractual obligations and other commercial commitments as of December 31, 2009 (amounts in thousands):

 

 

Purchase obligations consist of outstanding purchase orders issued in the normal course of business.

 

At December 31, 2009 we had performance bonds of $0.1 million outstanding which were collateralized by letters of credit issued by Silicon Valley Bank in connection with various sales contracts or financing arrangements.

 

 

We develop products in the U.S. and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since the majority of our revenues are currently priced in U.S. dollars and are translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets.

 

CARDIAC SCIENCE CORPORATION
AND SUBSIDIARIES

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework as of December 31, 2009 in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2009.

 

KPMG LLP, an independent registered public accounting firm, has issued an attestation report on the Company’s internal control over financial reporting as of December 31, 2009, which is included on page 52.

 

The Board of Directors and Shareholders

Cardiac Science Corporation:

 

We have audited the accompanying consolidated balance sheets of Cardiac Science Corporation and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2009. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule II. We also have audited Cardiac Science Corporation’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Cardiac Science Corporation’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting on page 51. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule and an opinion on the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated 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.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cardiac Science Corporation and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, the Company changed its accounting for minority interests as required by Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (included in FASB ASC Topic 810, “Consolidation”), effective January 1, 2009. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, Cardiac Science Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

 

Seattle, Washington

March 15, 2010

CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES

 

 

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

CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES

 

 

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