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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-Q
---------
(MARK ONE)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
COMMISSION FILE NUMBER 0-19567
CARDIAC SCIENCE, INC.
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0465681
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1900 MAIN STREET, SUITE 700, IRVINE, CA 92614
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 797-3800
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark if the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes |X| No |_|
The number of shares of the Common Stock of the registrant outstanding as
of August 5, 2004 was 86,148,048.
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CARDIAC SCIENCE, INC.
INDEX TO FORM 10-Q
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Unaudited Financial Statements:
Consolidated Condensed Balance Sheets as of June 30, 2004 and
December 31, 2003 3
Consolidated Condensed Statements of Operations for the three
and six months ended June 30, 2004 and 2003 4
Consolidated Condensed Statements of Comprehensive Loss for the
three and six months ended June 30, 2004 and 2003 5
Consolidated Condensed Statements of Cash Flows for the six
months ended June 30, 2004 and 2003 6
Consolidated Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
--------------------------
Item 1. Legal Proceedings 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CARDIAC SCIENCE, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(UNAUDITED)
IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
JUNE 30, DECEMBER 31,
2004 2003
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,411 $ 8,871
Accounts receivable, net of allowance for
doubtful accounts of $2,235 at June 30,
2004 and $1,626 at December 31, 2003 16,939 20,410
Inventories 10,346 9,575
Prepaid expenses 4,118 2,154
------------ ------------
Total current assets 35,814 41,010
Property and equipment, net 5,630 7,003
Goodwill 140,466 139,859
Intangible assets, net 10,656 11,626
Other assets 3,164 3,503
------------ ------------
Total assets $ 195,730 $ 203,001
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,819 $ 8,955
Accrued expenses 7,631 6,542
Deferred revenue 2,003 2,479
Current portion of long term obligations 30 53
------------ ------------
Total current liabilities 17,483 18,029
Senior notes payable 48,178 46,481
Deferred revenue 783 859
Other long term obligations 32 41
------------ ------------
Total liabilities 66,476 65,410
------------ ------------
Commitments and contingencies (Note 7)
Stockholders' equity:
Common stock - $.001 par value; 160,000,000
shares authorized, 80,740,539 and
80,465,585 shares issued and outstanding
at June 30, 2004 and December 31, 2003,
respectively 81 80
Additional paid-in capital 245,042 243,219
Accumulated other comprehensive income (28) (20)
Accumulated deficit (115,841) (105,688)
------------ ------------
Total stockholders' equity 129,254 137,591
------------ ------------
Total liabilities and stockholders' equity $ 195,730 $ 203,001
============ ============
The accompanying notes are an integral part of the financial statements.
3
CARDIAC SCIENCE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net revenue $ 17,509 $ 14,527 $ 33,113 $ 28,551
Cost of goods sold 7,823 6,221 14,331 12,310
------------ ------------ ------------ ------------
Gross profit 9,686 8,306 18,782 16,241
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing 6,947 3,946 12,950 8,363
Research and development 1,456 1,393 3,125 2,495
General and administrative 4,317 3,207 8,483 6,414
Amortization of intangible assets 504 381 1,007 830
------------ ------------ ------------ ------------
Total operating expenses 13,224 8,927 25,565 18,102
------------ ------------ ------------ ------------
Loss from operations (3,538) (621) (6,783) (1,861)
Interest and other non-operating expense, net (1,783) (1,483) (3,370) (2,884)
------------ ------------ ------------ ------------
Loss before minority interest (5,321) (2,104) (10,153) (4,745)
Minority interest in consolidated subsidiary -- -- -- (48)
------------ ------------ ------------ ------------
Loss from continuing operations (5,321) (2,104) (10,153) (4,793)
Income from discontinued operations -- 130 -- 237
------------ ------------ ------------ ------------
Net loss $ (5,321) $ (1,974) $ (10,153) $ (4,556)
============ ============ ============ ============
Net loss per share (basic and diluted) $ (0.07) $ (0.03) $ (0.13) $ (0.07)
============ ============ ============ ============
Weighted average number of shares used in the computation of net loss
per share (basic and diluted) 80,674,736 67,039,034 80,603,773 66,917,471
============ ============ ============ ============
The accompanying notes are an integral part of the financial statements.
4
CARDIAC SCIENCE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)
IN THOUSANDS
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------- ---------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net loss $ (5,321) $ (1,974) $ (10,153) $ (4,556)
Other comprehensive income (loss):
Foreign currency translation adjustments -- 142 (8) 262
------------ ------------ ------------ ------------
Comprehensive loss $ (5,321) $ (1,832) $ (10,161) $ (4,294)
============ ============ ============ ============
The accompanying notes are an integral part of the financial statements
5
CARDIAC SCIENCE, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
IN THOUSANDS
SIX MONTHS ENDED
----------------
JUNE 30, 2004 JUNE 30, 2003
------------- -------------
Cash flows from operating activities:
Net loss $ (10,153) $ (4,556)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 1,334 1,267
Amortization of intangible assets 1,007 830
Provision for doubtful accounts 624 199
Accrued interest and amortization of debt discount/issuance costs 3,334 2,901
Minority interest -- 48
Gain on sale of assets (280) --
Changes in operating assets and liabilities:
Accounts receivable 2,611 (3,796)
Inventories (892) (343)
Placement of Powerheart CRMs at customer locations -- (525)
Prepaid expenses and other current assets (1,807) 413
Other assets 218 (120)
Accounts payable and accrued expenses (90) (2,515)
Assets and liabilities held-for-sale -- (511)
Deferred revenue (423) --
------------- -------------
Net cash used in operating activities (4,517) (6,708)
------------- -------------
Cash flows from investing activities:
Purchase of property and equipment (916) (1,860)
Proceeds from sale of property and equipment 23 --
Acquisition of Lifetec, net of cash acquired -- (294)
Acquisition costs paid (50) (26)
Funds in escrow to buy minority interest -- (1,299)
Refund of investment in MRL -- 3,001
Proceeds from sale of assets of subsidiary, net of costs 672 767
Purchase of intangible assets (37) (15)
Proceeds (payments) related to acquisitions (25) 163
------------- -------------
Net cash (used in) provided by investing activities (333) 437
------------- -------------
Cash flows from financing activities:
Payments on long term obligations (32) (114)
Proceeds from exercise of common stock options and warrants 460 405
Costs of equity issuances (30) --
------------- -------------
Net cash provided by financing activities 398 291
------------- -------------
Effect of exchange rates on cash and cash equivalents (8) 276
------------- -------------
Net decrease in cash and cash equivalents (4,460) (5,704)
Cash and cash equivalents at beginning of period 8,871 15,598
------------- -------------
Cash and cash equivalents at end of period $ 4,411 $ 9,894
============= =============
The accompanying notes are an integral part of the financial statements
6
CARDIAC SCIENCE, INC.
CONSOLIDATED CONDENSED NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND DESCRIPTION OF THE BUSINESS
Cardiac Science, Inc. (the "Company") was incorporated in May 1991 and
develops, manufactures and markets portable automated public access
defibrillators and a fully-automatic in-hospital bedside defibrillator-monitor
that continuously monitors cardiac patients, instantly detects the onset of
life-threatening abnormal heart rhythms, and, when appropriate, delivers
defibrillation shocks within seconds and without human intervention to convert
the heart back to its normal rhythm. The Company's core technology platform
consists of its proprietary arrhythmia detection and discrimination software
("RHYTHMx(R)"), which is combined with its proprietary STAR(R) Biphasic
defibrillation hardware and electrode technology to create the only fully
automatic in-hospital cardioverter defibrillator (the "Powerheart(R) CRM(R)" or
"CRM") and a unique semi-automatic, or automated defibrillator, (the "Powerheart
AED" or "G3 AED") for use in out-of-hospital settings. The Company's
Powerheart(R) Cardiac Rhythm Module(TM) and Powerheart(R) brand AEDs are
marketed by its direct sales force and distribution network in the United States
and around the world.
On July 1, 2000, the Company acquired Cadent Medical Corporation, a
privately held company, for an aggregate of 4,500,000 shares of the Company's
common stock.
On September 26, 2001, the Company acquired Survivalink Corporation, a
privately held company, for $10,500 in cash, $25,800 in senior secured
promissory notes, and 18,150,000 shares of the Company's common stock.
On November 30, 2001, the Company acquired 94.7% of Artema Medical AB and
Subsidiaries ("Artema") for 4,150,976 shares of common stock and approximately
$215 in cash. During 2003, the Company acquired the remaining minority interest
for $843 in cash. On September 1, 2003, the Company transferred ownership of the
shares in Cardiac Science International A/S, its Danish operations and a
subsidiary of Artema, from Artema to Cardiac Science, Inc. in exchange for
forgiveness of intercompany debt. Then on September 21, 2003, the Company sold
100% of its shares in Artema to an outside party for $600 in cash.
On May 29, 2003, the Company acquired Lifetec Medical Limited, its U.K.
distributor, for $383 in cash.
On October 21, 2003, the Company acquired substantially all of the assets
and liabilities of Complient Corporation, a privately held company, for
10,250,000 shares of the Company's common stock.
2. CONTINUED EXISTENCE
Based on achieving its internal revenue growth targets, the Company
believes its current cash balances, combined with proceeds from its private
placement in July 2004, net cash that it expects to generate from operations,
and proceeds from the sale of a product line expected to close before the end of
the year, will sustain its ongoing operations for at least the next twelve
months. In the event that the Company requires additional cash to support its
operations during the next twelve months or thereafter, it would attempt to
raise the required capital through either debt or equity arrangements. The
Company cannot provide any assurance that the required capital would be
available on acceptable terms, if at all, or that any financing activity would
not be dilutive to current stockholders of the Company. If the Company were not
able to raise additional funds, it might be required to significantly curtail
its operations and this would have an adverse effect on its financial position,
results of operations and cash flows.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
In the opinion of the Company's management, the accompanying consolidated
condensed unaudited financial statements include all adjustments (which consist
only of normal recurring adjustments) necessary for a fair presentation of its
financial position at June 30, 2004 and results of operations and cash flows for
the periods presented. Although the Company believes that the disclosures in
these financial statements are adequate to make the information presented not
misleading, certain information and disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted and should be read in conjunction with the
Company's audited financial statements included in the Company's 2003 Annual
Report on Form 10-K. Results of operations for the six months ended June 30,
2004 are not necessarily indicative of results for the full year.
7
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventories consist of the following as of:
JUNE 30, DECEMBER 31,
2004 2003
---------- ------------
Raw materials $ 3,512 $ 3,728
Work in process 257 157
Finished goods 6,577 5,690
---------- ------------
$ 10,346 $ 9,575
========== ============
Goodwill and Intangibles
In accordance with Statement of Financial Accounting Standards ("SFAS")
142, Goodwill and Other Intangible Assets, which became effective January 1,
2002, goodwill and other intangible assets with indefinite lives are no longer
subject to amortization but are tested for impairment annually or whenever
events or changes in circumstances indicate that the asset might be impaired.
Other intangible assets with finite lives continue to be subject to
amortization, and any impairment is determined in accordance with SFAS 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. Estimated
intangible asset amortization expense for the years ending December 31, 2004,
2005, 2006, 2007 and 2008 is $2,029, $2,029, $1,982, $1,744, and $1,697,
respectively.
Goodwill and other intangible assets consist of the following as of:
JUNE 30, 2004 DECEMBER 31, 2003
------------- -----------------
ACCUMULATED ACCUMULATED
COST AMORTIZATION NET COST AMORTIZATION NET
---------- ------------ ---------- ---------- ------------ ----------
Goodwill $ 140,466 $ -- $ 140,466 $ 139,859 $ -- $ 139,859
========== ============ ========== ========== ============ ==========
Intangible assets subject to amortization:
Patents and patent applications 10,417 (3,849) 6,568 10,396 (3,372) 7,024
Customer base 4,082 (1,216) 2,866 4,082 (894) 3,188
Covenants not to compete 726 (162) 564 726 (41) 685
URL website address 656 (97) 559 640 (32) 608
Trade name 378 (378) -- 378 (378) --
Purchased software 128 (29) 99 128 (7) 121
---------- ------------ ---------- ---------- ------------ ----------
$ 16,387 $ (5,731) $ 10,656 $ 16,350 $ (4,724) $ 11,626
========== ============ ========== ========== ============ ==========
The increase in goodwill during the six months ended June 30, 2004 was due
to purchase price allocation adjustments related to the Complient acquisition to
the net realizable value of certain fixed assets under leases ($532) and certain
accruals ($75).
The following unaudited pro forma data summarizes the results of
operations for the periods indicated as if the Complient acquisition had been
completed as of the beginning of the periods presented. The pro forma data gives
effect to actual operating results prior to the acquisition, adjusted to include
the pro forma effect of amortization of identified intangible assets and the
elimination of sales to Complient prior to the acquisition.
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
2003 2003
------------ ------------
Pro forma net revenue $ 16,914 $ 33,614
Pro forma net loss $ (3,228) $ (7,056)
Pro forma net loss per share (basic and diluted) $ (0.04) $ (0.09)
Pro forma weighted-averaged shares 77,289,034 77,167,471
Product Warranty
Our products are generally under warranty against defects in material and
workmanship for a period of one to seven years. We estimate warranty costs at
the time of sale based on historical experience. Estimated warranty expenses are
recorded as an accrued expense, with a corresponding provision to cost of sales.
8
Changes in the product warranty accrual for the six months ended June 30
were as follows:
2004 2003
------------ ------------
Warranty accrual, beginning of period $ 836 $ 1,604
Accruals for warranties issued during the period 1,372 150
Warranty expenditures during the period (705) (427)
Currency translation adjustments -- 28
------------ ------------
Warranty accrual, end of period $ 1,503 $ 1,355
============ ============
In early April 2004, the Company received a Warning Letter from the U.S.
Food and Drug Administration (FDA) following a routine inspection of its
manufacturing facility in Minneapolis. The letter specified certain procedural
and documentation items in the Company's quality system. The Company took
corrective and preventive action to bring its quality system into compliance. In
addition, during May 2004, the Company initiated a limited, voluntary recall of
approximately 5,800 units of its older model Powerheart AEDs in order to replace
a potentially faulty capacitor component. The decision to replace the suspect
capacitors was made by the Company following a detailed analysis performed as
part of the corrective and preventive actions implemented by the Company in
response to the Warning Letter issued by the FDA. The Company has received
written notification from the FDA that its voluntary recall plan has been
accepted. The Company believes that only a small number of devices may contain
faulty capacitors, however, as a precaution, it will recall all the units and
replace the capacitors as necessary. No adverse effects or patient injuries have
occurred as a result of the suspect capacitors.
Also in May 2004, the Company initiated a limited, voluntary recall of
approximately 4,800 AED batteries due to an error made by the Company's battery
supplier whereby an incorrect fuse was used in the manufacture of a certain lot
of batteries. As of June 30, 2004, the recall has been substantially completed
and customers have received replacement batteries.
The Company estimates the cost of these voluntary recall actions could
range from $1,000 to $1,200, however, the Company has received from its
suppliers credits against existing and future amounts due to these suppliers
totaling $1,240, which have been recorded to accrued expenses to establish a
warranty accrual for these recall matters. Actual recall related costs incurred
have been charged against this accrual and totaled approximately $400 to date as
of June 30, 2004.
Stock Based Compensation
On December 31, 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS 148, Accounting for Stock-Based Compensation--Transition and
Disclosure, which amends SFAS 123, Accounting for Stock-Based Compensation. SFAS
148 allows for three methods of transition for those companies that adopt SFAS
123's provisions for fair value recognition. SFAS 148's transition guidance and
provisions for annual and interim disclosures are effective for fiscal periods
ending after December 15, 2002. The Company has not adopted fair value
accounting for employee stock options under SFAS 123 and SFAS 148.
The Company has adopted the disclosure-only provisions of SFAS 123,
Accounting for Stock-Based Compensation. SFAS 123 defines a fair value based
method of accounting for an employee stock option. Fair value of the stock
option is determined considering factors such as the exercise price, the
expected life of the option, the current price of the underlying stock, expected
dividends on the stock, and the risk-free interest rate for the expected term of
the option. Under the fair value based method, compensation cost is measured at
the grant date based on the fair value of the award and is recognized over the
service period. Pro forma disclosures are required for entities that elect to
continue to measure compensation cost under the intrinsic method provided by
Accounting Principles Board Opinion ("APB") 25.
Additionally, in accordance with SFAS 123 and Emerging Issues Task Force
("EITF") 96-18, Accounting for Equity Instruments That are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling Goods or Services, the
Company measures stock based non-employee compensation at fair value.
Under SFAS 123, stock based compensation expense related to stock options
granted to consultants is recognized as the stock options are earned. The fair
value of the stock options granted is calculated at each reporting date using
the Black-Scholes option pricing model. As a result, the stock based
compensation expense will fluctuate as the fair market value of the Company's
stock fluctuates.
9
Pro forma Effect of Stock-Based Compensation
Had compensation costs been determined based upon the fair value at the
grant date, consistent with the methodology prescribed under SFAS 123, the
Company's total stock-based compensation cost, pro forma net loss, and pro forma
net loss per share, basic and diluted, would have been as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net loss, as reported $ (5,321) $ (1,974) $ (10,153) $ (4,556)
Add: Compensation expense included in reported loss -- -- -- --
Deduct: Compensation expense determined under fair value
based method (834) (918) (1,842) (1,899)
---------- ---------- ---------- ----------
Pro forma net loss $ (6,155) $ (2,892) $ (11,995) $ (6,455)
========== ========== ========== ==========
Net loss per share, as reported (basic and diluted) $ (0.07) $ (0.03) $ (0.13) $ (0.07)
========== ========== ========== ==========
Pro forma net loss per share (basic and diluted) $ (0.08) $ (0.04) $ (0.15) $ (0.10)
========== ========== ========== ==========
Recent Pronouncements
In December 2003, the FASB issued Interpretation No. 46R, Consolidation of
Variable Interest Entities (FIN 46R). FIN 46R requires the application of either
FIN 46 or FIN 46R by public entities to all Special Purpose Entities (SPE)
created prior to February 1, 2003 as of December 31, 2003 for calendar year-end
companies. FIN 46R is applicable to all non-SPEs created prior to February 1,
2003 at the end of the first interim or annual period ending after March 15,
2004. For all entities created subsequent to January 31, 2003, Public Entities
were required to apply the provisions of FIN 46. The adoption of FIN 46 and FIN
46R did not have a material impact on the Company's consolidated financial
position, results of operations or cash flows.
4. SEGMENT REPORTING
The Company follows the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS No. 131 established
standards for reporting information about operating segments in annual financial
statements and requires selected information about operating segments in interim
financial reports issued to stockholders. It also established standards for
related disclosures about products and services, geographic areas and major
customers. An operating segment is defined as a component of an enterprise that
engages in business activities from which it may earn revenues and incur
expenses whose separate financial information is available and is evaluated
regularly by the Company's chief operating decision makers, or decision making
group, to perform resource allocations and performance assessments.
The Company's chief operating decision makers are the Executive Management
Team which is comprised of the Chief Executive Officer and senior executive
officers of the Company. Based on evaluation of the Company's financial
information, management believes that the Company operates in one reportable
segment with its various product lines that service the external defibrillation
and cardiac monitoring industry. The product lines include AEDs and related
training, services, and accessories; Powerhearts, electrodes and related
accessories; and emergency defibrillators, monitors, CPR products and related
accessories.
The Company's chief operating decision makers evaluate revenue performance
of product lines, both domestically and internationally, however, operating,
strategic and resource allocation decisions are not based on product line
performance, but rather on the Company's overall performance in its operating
segment.
The following is a breakdown of net revenue by product line:
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
AEDs and related accessories $ 13,835 $ 13,276 $ 25,887 $ 25,690
AED/CPR training and program management services 2,043 -- 3,782 --
-------- -------- -------- --------
Total AED related revenue 15,878 13,276 29,669 25,690
Powerheart CRMs, electrodes and related accessories 254 325 587 725
Emergency defibrillators, monitors, training products and accessories 1,377 926 2,857 2,136
-------- -------- -------- --------
$ 17,509 $ 14,527 $ 33,113 $ 28,551
======== ======== ======== ========
The following is a breakdown of net sales by geographic location:
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2004 2003 2004 2003
---- ---- ---- ----
United States $ 12,494 $ 10,670 $ 23,705 $ 21,151
Foreign 5,015 3,857 9,408 7,400
-------- -------- -------- --------
$ 17,509 $ 14,527 $ 33,113 $ 28,551
======== ======== ======== ========
10
The following is a breakdown of the Company's long-lived assets by
geographic location as of:
JUNE 30, DECEMBER 31,
2004 2003
---- ----
United States $ 5,357 $ 6,758
Foreign 273 245
-------- ------------
$ 5,630 $ 7,003
======== ============
5. CORPORATE RELOCATION AND RESTRUCTURING
During the first quarter of 2003, the Company commenced its plan to
relocate its corporate headquarters, expanded its manufacturing capacity, and
consolidated its accounting and finance functions in Irvine, California. All
expansion, relocation, and restructuring activities were completed in the second
quarter of 2003.
Costs related to severance, moving, lease termination and accelerated
depreciation of leaseholds and other assets of $718 were incurred and included
in general and administrative expenses in the accompanying consolidated
statement of operations for the six months ended June 30, 2003.
The accrual represented costs recognized pursuant to SFAS 146, Accounting
for Costs Associated with Exit or Disposal Activities and SEC Staff Accounting
Bulletin ("SAB") 100, Restructuring and Impairment Charges. The Company
committed to a sufficiently detailed plan that identified significant actions to
be taken and the activities that would not be continued. The plan was completed
during the quarter ended June 30, 2003 and there were no significant changes to
the original plan. The involuntary one-time employee-termination arrangement
established the benefits to be paid to employees and specifically identified the
classifications or functions of those employees, their locations, and their
expected completion date. All employees were informed about the terms of the
benefit arrangement, including the benefits that employees would receive upon
termination (including but not limited to cash payments), in sufficient detail
to enable employees to determine the type and amount of benefits they would
receive. The Company reviewed the net book value of leasehold improvements to be
abandoned in certain facilities in accordance with SFAS 144, and appropriately
recorded an adjustment to accelerate the related depreciation over the revised
useful life through their cease-use dates.
6. LONG-TERM DEBT
During February 2004, the Company secured a $5,000 line of credit from its
bank. The line of credit will be used to provide additional working capital, as
needed, to fund the Company's growth. The 24-month facility is collateralized by
accounts receivable, inventory, cash, and marketable securities, bears interest
at the bank's prime rate plus .75% (floor of 5%) with interest payable monthly,
and requires the Company to maintain certain financial covenants. In August
2004, the Company obtained a waiver from the bank for the quarter ended June 30,
2004, consistent with the waiver obtained for the quarter ended March 31, 2004,
for non-compliance with the net profit covenant required by the agreement. There
was no balance outstanding on the line as of June 30, 2004, or through the date
of this filing.
On March 15, 2004, the Company amended its Senior Note and Warrant
Agreement (the "Agreement") in order to ease certain financial covenants into
2005 to reflect the Company's actual and expected financial results. In exchange
for modifying these covenants, the Company issued warrants to the holders of the
Senior Notes to purchase 500,000 shares of common stock at $3.95 per share. The
warrants were valued at $1,301 using a Black-Scholes model and were recorded as
additional discount to the Senior Notes and will be amortized over the remaining
term of the Senior Notes using the effective interest method. This modification
was not considered to be a significant modification of the Agreement.
7. LITIGATION AND OTHER CONTINGENCIES
On December 3, 2002, the Company filed a Complaint in Orange County
Superior Court against Medical Research Laboratories, Inc. ("MRL") alleging
declaratory relief and breach of contract arising out of a July 29, 2002 letter
of intent entered into between the parties. The Company alleged that MRL failed
to comply with certain conditions of closing set forth in the letter of intent
whereby the Company would acquire all of MRL's stock. MRL filed a
cross-complaint, also seeking breach of contract and declaratory relief arising
out of the same letter of intent. On February 25, 2003, the Company filed suit
against MRL for patent infringement in the United States District Court for the
District of Minnesota. The Company alleged that MRL's LifeQuest JumpStart AED
infringed the Company's patented disposable electrode pre-connect technology.
The Company settled both law suits with MRL on June 24, 2003. Under the terms of
the confidential settlement agreement, the Company received a settlement amount
from MRL and MRL received the right to license two of the Company's patents for
additional royalties.
11
In February 2003, the Company filed a patent infringement action against
Philips Medical Systems North America, Inc., Philips Electronics North America
Corporation and Koninklijke Philips Electronics N.V. ("Philips") in the United
States District Court for the District of Minnesota. The suit now charges that
Philips' automated external defibrillators sold under the names "HeartStart
OnSite Defibrillator", "HeartStart", "HeartStart FR2" and the "HeartStart Home
Defibrillator," infringed at least ten of the Company's United States patents.
In the same action, the Company also sought a declaration from the Court that
the Company's products do not infringe several of Philips' patents and Philips
counterclaimed for infringement of the same patents. Many of the Philips
Defibrillators' are promoted by Philips as including, among other things,
pre-connected disposable defibrillation electrodes and daily self-testing of
electrodes and battery, features that the suit alleges are key competitive
advantages of the Company's Powerheart and Survivalink AEDs and are covered
under the Company's patents. At this stage, the Company is unable to predict the
outcome of this litigation. The Company has not established an accrual for this
matter because a loss is not determined to be probable.
On April 30, 2003, the Company filed a Complaint against Defibtech, LLC
for patent infringement in the United States District Court for the District of
Minnesota. The Complaint alleged that Defibtech's Sentry and Reviver AEDs
infringe the Company's patented disposable electrode pre-connect technology as
well as other patents. Defibtech answered the Complaint and asserted
counterclaims alleging that the Company has engaged in activities that
constitute tortious interference with present and prospective contractual
relations, common law business disparagement and statutory business
disparagement. The Company responded to the counterclaims with a complete and
general denial of the allegations. At this stage, the Company is unable to
predict the outcome of this litigation. The Company has not established an
accrual for this matter because a loss is not determined to be probable.
On March 19, 2004, William S. Parker filed suit against the Company for
patent infringement in Michigan Federal Court. The Parker patent generally
covers the use of a synthesized voice to instruct a person to perform certain
tasks. The Complaint alleges that certain of the Company's AEDs infringe the
Patent. The patent is now expired. The Company has filed an Answer to the
Complaint stating the patent is not infringed and is otherwise invalid and
unenforceable. At this stage of the litigation, the Company is unable to predict
the outcome of this litigation. The Company has not established an accrual for
this matter because a loss is not determined to be probable.
In the ordinary course of business, various lawsuits and claims are filed
against the Company. While the outcome of these matters is currently not
determinable, management believes that the ultimate resolution of these matters
will not have a material adverse effect on the Company's operations or financial
position.
8. SUBSEQUENT EVENT
In July 2004, the Company completed a private placement of common stock
and warrants raising $12,370 in gross proceeds. The financing was led by the
holders of the Senior Notes. New shares of the Company's common stock of
5,219,409 were issued at a price of $2.37 per share. In addition, five year
warrants to purchase 2,087,763 shares of common stock at an exercise price of
$2.84 per share were issued. Proceeds of the offering will provide additional
working capital and fund product development initiatives.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto appearing elsewhere in this
report.
A WARNING ABOUT FORWARD-LOOKING INFORMATION AND THE SAFE HARBOR UNDER THE
SECURITIES LITIGATION REFORM ACT OF 1995
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and
we intend that such forward looking statements be subject to the safe harbors
created thereby. These forward-looking statements relate to, among other things,
(i) future expenditures and results, (ii) business strategies, and (iii) the
need for, and availability of, additional financing.
The forward-looking statements included herein are based on current
expectations, which involve a number of risks and uncertainties and assumptions
regarding our business and technology. These assumptions involve judgments with
respect to, among other things, future economic and competitive conditions, and
future business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond our control. Although we believe that
the assumptions underlying the forward-looking statements are reasonable, any of
the assumptions could prove inaccurate and, therefore, there can be no assurance
that the results contemplated in forward-looking statements will be realized and
actual results may differ materially. In light of the significant uncertainties
inherent in the forward-looking information included herein, the inclusion of
such information should not be regarded as a representation by us or any other
person that our objectives or plans will be achieved. We undertake no obligation
to publicly release the result of any revisions to these forward-looking
statements that may be made to reflect events or circumstances after the date
hereof, or to reflect the occurrence of unanticipated events. Readers should
carefully review the risk factors described in the documents that we file from
time to time with the Securities and Exchange Commission, including Quarterly
Reports on Form 10-Q, Annual Reports on Form 10-K and subsequent current reports
on Form 8-K.
RESULTS OF OPERATIONS
QUARTER ENDED JUNE 30, 2004 COMPARED TO THE QUARTER ENDED JUNE 30, 2003
Revenue
The following is a summary of net revenue by product line for the quarters
ended June 30:
2004 2003 CHANGE
--------------- -------------- -----------------
AEDs and related accessories and services $15,878 90.7% $13,276 91.4% $ 2,602 19.6%
Powerheart in-hospital defibrillators and accessories 254 1.4 325 2.2 (71) (21.8)
Patient monitors, training products and accessories 1,377 7.9 926 6.4 451 48.7
---------------- --------------- --------
Total net revenue $17,509 100.0% $14,527 100.0% $ 2,982 20.5%
================= =============== =======
Net revenue for the quarter ended June 30, 2004 increased $2,982 or 20.5%
compared to the quarter ended June 30, 2003. This increase was primarily
attributable to AED/CPR training and program management services of $2,043
resulting from the acquisition of this business from Complient Corporation in
October 2003. In addition, sales of AED products and related accessories
increased to $13,835 compared to $13,276 for the same quarter in 2003. This
increase was the result of year-over-year growth in international AED revenue of
49%, which was largely offset by continued weakness in the domestic municipal
and medical markets, attributable to budgetary constraints and competitive
pressures. The remainder of the increase in net revenue was due to $1,377 of
patient monitors, training equipment and accessories sold in the quarter ended
June 30, 2004 compared to $926 in the same quarter in 2003. We anticipate sales
of these products to decrease to approximately $100 next quarter due to the
discontinuation and sale of these product lines. We expect that these decreases
will be somewhat or completely offset by an increase in AED revenue for the
second half of the year.
Gross Margin
Cost of goods sold for the quarter ended June 30, 2004 was $7,823 compared
to $6,221 for the same quarter in 2003. Gross margins as a percentage of revenue
decreased to 55.3% for the quarter ended June 30, 2004 from 57.2% in the same
quarter in 2003. The decrease was primarily the result of costs associated with
a deadline to fulfill certain installation services and AED training for New
York City Schools resulting in lower margins on our service revenue, as well as
higher overhead costs per AED unit resulting from lower than planned production
levels during the quarter. We expect our gross margin to return to previous
levels for the second half of the year.
13
Operating Expenses
The following is a summary of operating expenses as a percentage of net
revenue for the quarters ended June 30:
2004 2003 CHANGE
---------------- ---------------- ----------------
Sales and marketing $ 6,947 39.7% $ 3,946 27.2% $ 3,001 76.1%
Research and development 1,456 8.3 1,393 9.6 63 4.5
General and administrative 4,317 24.6 3,207 22.1 1,110 34.6
Amortization 504 2.9 381 2.6 123 32.3
---------------- ---------------- -------
Total operating expenses $13,224 75.5% $ 8,927 61.5% $ 4,297 48.1%
================ ================ =======
Sales and marketing expenses increased by 76.1% to $6,947 for the quarter
ended June 30, 2004. The increase is primarily attributable to higher direct
marketing programs in the U.S. ($1,072), expanded international direct sales
operations, primarily in the U.K and Germany ($819), new sales and marketing
expenses related to program management and training services pursuant to the
business acquired from Complient in October 2003 ($634), and the establishment
of a new inside sales team ($229). We expect to realize some decrease in sales
and marketing expense as a percent of revenue for the second half of 2004.
Research and development expenses for the quarter ended June 30, 2004
increased by $63 or 4.5% compared to the same quarter in 2003. In the quarter
ended June 30, 2004, research and development expenses were 8.3% of revenue,
down from 9.6% of revenue in the same quarter in 2003. Although resources such
as headcount and project costs were allocated to different projects in 2004
compared to 2003, the overall impact on research and development expense was
neutral for the quarter ended June 30, 2004 compared to the quarter ended June
30, 2003. We expect research and development expenses to decrease somewhat in
the second half of the year.
General and administrative expenses increased $1,110 or 34.6% during the
quarter ended June 30, 2004 compared with the same quarter in 2003. As a
percentage of revenue, general and administrative expenses increased to 24.7% in
the quarter ended June 30, 2004 from 22.1% in the same quarter in 2003. The
absolute dollar increase was primarily comprised of new expenses, primarily
headcount and facilities, related to the Complient acquisition ($453), increased
legal, accounting, consulting and corporate governance costs ($546), and higher
bad debt expense ($253). These increases were partially offset by a decrease in
costs related to our relocation and expansion of facilities in 2003 ($178) and a
net gain on sales of assets in the quarter ended June 30, 2004 ($280). We expect
to realize some decrease in general and administrative expenses during the
second half of 2004.
Amortization of intangibles was $504 for the quarter ended June 30, 2004,
an increase of $123 or 32.3% from the $381 for the same quarter in 2003. The
increase is the result of additional amortization expense of certain
identifiable intangible assets related to the Complient acquisition in October
2003. We expect amortization expense to remain constant for the balance of 2004.
Interest and Other Expense
Net interest and other expenses increased by $300 for the quarter ended
June 30, 2004 compared to the same quarter in 2003. This increase was primarily
due to higher interest expense based on the average outstanding note balance and
amortization of warrants using the effective interest rate method, both of which
are associated with the senior notes payable issued in May 2002.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED JUNE 30, 2003
Revenue
The following is a summary of net revenue by product line for the six
months ended June 30:
2004 2003 CHANGE
--------------- ---------------- ----------------
AEDs and related accessories and services $29,669 89.6% $25,690 90.0% $ 3,979 15.5%
Powerheart in-hospital defibrillators and accessories 587 1.8 725 2.5 (138) (19.0)
Patient monitors, training products and accessories 2,857 8.6 2,136 7.5 721 33.8
---------------- --------------- -------
Total net revenue $33,113 100.0% $28,551 100.0% $ 4,562 16.0%
================ =============== =======
Net revenue for the six months ended June 30, 2004 increased $4,562 or
16.0% compared to the six months ended June 30, 2003. This increase was
primarily attributable to AED/CPR training and program management services of
$3,782 resulting from the acquisition of this business from Complient
14
Corporation in October 2003. Sales of AED products and related accessories for
the six months ended June 30, 2004 were relatively flat at $25,887 compared to
$25,690 for the same period in 2003. In addition, we sold $2,857 of patient
monitors, training equipment and accessories in the six months ended June 30,
2004 compared to $2,136 for the six months ended June 30, 2003.
Gross Margin
Cost of goods sold for the six months ended June 30, 2004 was $14,331
compared to $12,310 for the six months ended June 30, 2003. Gross margins as a
percentage of revenue were 56.7% for the six months ended June 30, 2004
compared to 56.9% in the six months ended June 30, 2003. Although we introduced
our new lower material cost version Powerheart AED G3 in August 2003, these cost
savings were offset by lower service revenue margins and higher overhead costs
on a per unit basis in the second quarter of 2004.
Operating Expenses
The following is a summary of operating expenses as a percentage of net
revenue for the six months ended June 30:
2004 2003 CHANGE
---------------- ----------------- ---------------
Sales and marketing $12,950 39.1% $ 8,363 29.3% $ 4,587 54.8%
Research and development 3,125 9.4 2,495 8.7 630 25.3
General and administrative 8,483 25.6 6,414 22.5 2,069 32.3
Amortization 1,007 3.1 830 2.9 177 21.3
---------------- ---------------- -------
Total operating expenses $25,565 77.2% $18,102 63.4% $ 7,463 41.2%
================ ================ =======
Sales and marketing expenses increased by 54.8% to $12,950 for the six
months ended June 30, 2004. The increase is primarily attributable to expanded
international sales operations ($1,594), primarily our direct sales operations
in the U.K and Germany, new sales and marketing expenses related to program
management and training services related to the business acquired from Complient
in October 2003 ($1,267), increased U.S. marketing activities ($1,149), and the
establishment of a new inside sales team ($393).
Research and development expenses for the six months ended June 30, 2004
increased by $630 or 25.3% compared to the six months ended June 30, 2003. The
increase is primarily attributable to increased headcount and project costs
associated with the development of a standard hospital defibrillator for GE
Healthcare pursuant to a development agreement signed in July 2003 ($564), as
well as the addition of research and development personnel and activities in
connection with the business acquired from Complient Corporation in October 2003
($107).
General and administrative expenses increased $2,069 or 32.3% during the
six months ended June 30, 2004 compared with the six months ended June 30, 2003.
The increase was primarily comprised of new expenses, primarily headcount and
facilities, related to the Complient acquisition ($941), increased legal,
accounting and corporate governance costs ($1,091), higher commercial and health
insurance costs ($367), and higher bad debt expense ($416). These increases were
partially offset by a decrease in costs related to our relocation and expansion
of facilities in the first quarter of 2003 ($718).
Amortization of intangibles was $1,007 for the six months ended June 30,
2004, an increase of $177 or 21.3% from the $830 for the six months ended June
30, 2003. The increase is primarily the result of additional amortization
expense of certain identifiable intangible assets related to the Complient
acquisition in October 2003.
Interest and Other Expense
Net interest and other expenses increased by $486 for the six months ended
June 30, 2004 compared to the six months ended June 30, 2003. This increase was
primarily due to higher interest expense based on the average outstanding note
balance and amortization of warrants using the effective interest rate method,
both of which are associated with the senior notes payable issued in May 2002.
LIQUIDITY AND CAPITAL RESOURCES
JUNE 30, DECEMBER 31,
2004 2003
---- ----
Working capital $ 18,331 $ 22,981
Current ratio (current assets to current liabilities) 2.0 : 1.0 2.3 : 1.0
Cash and cash equivalents 4,411 8,871
Accounts receivable, net 16,939 20,410
Inventories 10,346 9,575
Short-term and long-term borrowings 48,240 46,575
15
The decrease in our current ratio, working capital and cash and cash
equivalents is primarily due to our operating loss.
At June 30, 2004, our days sales outstanding on accounts receivable
("DSO") was approximately 88 days compared to approximately 99 days at March 31,
2004 and 105 days at December 31, 2003.
In February 2004, we secured a $5,000 line of credit with Silicon Valley
Bank. The line of credit will be used to provide additional working capital, as
needed, to fund our continued growth. This 24-month facility is collateralized
by accounts receivable, inventory and cash and cash equivalents, has an interest
rate of the bank's prime rate plus .75% (with a floor of 5%) payable monthly,
and requires us to maintain certain financial covenants. In August 2004, the
Company obtained a waiver from the bank for the quarter ended June 30, 2004 for
non-compliance with the net profit covenant required by the line of credit
agreement. There was no outstanding balance on the line at June 30, 2004 or
through the date of this filing.
From inception, our sources of funding for operations and mergers and
acquisition activity were derived from placements of debt and equity securities.
In 2001, we raised approximately $37,000 in a series of private equity
placements and through the exercise of outstanding options and warrants. In May
2002, we entered into a Senior Note and Warrant Purchase Agreement with
investors pursuant to which the investors loaned us $50,000. We in turn repaid
the $26,468 plus accrued interest in senior promissory notes relating to the
Survivalink acquisition. In September 2003, we raised $8,375 in a private equity
placement of 2,233,334 shares of our common stock at $3.75 per share to a small
group of institutional and accredited investors. In connection with this
offering, we also issued 223,333 five-year warrants with an exercise price of
$5.00 per share. In July 2004, we raised gross proceeds of $12,370 in a private
equity placement of 5,219,409 shares of our common stock at $2.37 per share. In
connection with this offering, we issued five-year warrants to purchase
2,087,763 shares of common stock at a price of $2.84 per share.
In March 2004, we amended the Senior Note and Warrant Agreement in order
to ease certain financial covenants into 2005 to reflect our actual and expected
financial results. In exchange for these modifications, we issued the note
holders 500,000 additional warrants to purchase shares of common stock at $3.95
per share.
From inception through June 30, 2004, we have incurred losses of
approximately $116,000. Recovery of our assets is dependent upon future events,
the outcome of which is indeterminable. Additionally, transition to profitable
operations is dependent upon achieving a level of revenues adequate to support
our cost structure. The accompanying financial statements have been prepared
assuming that we will continue as a going concern.
Cash used in operating activities for the six months ended June 30, 2004
decreased by $2,191 or 32.7%, to $4,517 from $6,708 for the same period in 2003.
This decrease was primarily attributable to a $6,407 reduction in cash used in
accounts receivable and a $2,425 reduction in cash used in accounts payable
offset by an increase in our net loss for the period of $5,597 and an increase
in cash used in prepaid expenses of $2,220.
Cash used in investing activities for the six months ended June 30, 2004
of $333 changed by $770 or 176.2% compared to cash provided by investing
activities of $437 for the same period in 2003. This change was primarily
attributable to the refund of the MRL investment of $3,001 in the six months
ended June 2003, offset by the funds placed in escrow to buy the minority
interest in Artema of $1,299 in the six months ended June 30, 2003 and a
decrease in purchases of property and equipment of $944 period over period.
Cash provided by financing activities for the six months ended June 30,
2004 increased by $107 or 36.8%. This increase was primarily due to an increase
in proceeds from the exercise of stock options and warrants and decreased
payments on long-term obligations.
Based on meeting our internal sales growth targets, we believe that our
current cash balances, including the proceeds from the private placement in July
2004, combined with net cash that we expect to generate from operations, and
proceeds from the sale of a product line expected to close before the end of the
year, will sustain our ongoing operations for at least the next twelve months.
In the event that we require additional cash to support our operations
thereafter, we would attempt to raise the required capital through either debt
or equity arrangements. We cannot provide any assurance that the required
capital would be available on acceptable terms, if at all, or that any financing
activity would not be dilutive to our current stockholders. If we were not able
to raise additional funds, we might be required to significantly curtail our
operations and this would have an adverse effect on our financial position,
results of operations and cash flows.
16
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any material off-balance sheet arrangements other than
non-cancelable operating leases entered into in the ordinary course of business.
For liquidity purposes, we choose to lease our facilities, automobiles, and
certain equipment instead of purchasing them.
CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
We had no material commitments for capital expenditures as of June 30,
2004.
The following table presents our expected cash requirements for
contractual obligations outstanding as of June 30, 2004:
LESS THAN AFTER
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
--------- --------- --------- --------- ---------
Senior secured promissory notes $ 69,945 $ 353 $ 8,128 $ 61,463 --
Other long-term obligations 62 30 24 8 --
Non-cancelable operating leases 6,898 1,628 3,343 1,927 --
--------- --------- --------- --------- ---------
$ 76,905 $ 2,011 $ 11,495 $ 63,398 $ --
========= ========= ========= ========= =========
INCOME TAXES
As of December 31, 2003, we have research and experimentation credit carry
forwards for federal and state purposes of approximately $3,000 and $1,000,
respectively. These credits begin to expire in 2006 for federal purposes and
carry forward indefinitely for California state purposes. We have capital loss
carry forwards of approximately $1,000 for both federal and state purposes which
begin to expire in 2004 for federal purposes and carry forward indefinitely for
state purposes. We also have approximately $134,000 and $74,000, respectively,
of federal and state net operating loss carry forwards which will begin to
expire in 2006 and 2005, respectively. The utilization of net operating loss and
tax credit carry forwards will be limited under the provisions of Internal
Revenue Code Sections 382 and 1503 and similar state provisions. The limitations
could result in the expiration of our net operating loss carry forwards and
research and experimentation credit carry forwards before full utilization.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenue and expenses for
each period.
The following represents a summary of our critical accounting policies,
defined as those policies that we believe are: (a) the most important to the
portrayal of our financial condition and results of operations, and (b) that
require our most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effects of matters that are inherently
uncertain.
VALUATION OF ACCOUNTS RECEIVABLE
We maintain an allowance for uncollectible accounts receivable to estimate
the risk of extending credit to customers. The allowance is estimated based on
customer compliance with credit terms, the financial condition of the customer,
and collection history, where applicable. Additional allowances could be
required if the financial condition of our customers were to be impaired beyond
our estimates.
VALUATION OF INVENTORY
Inventory is valued at the lower of cost (estimated using the first-in,
first-out method) or market. We periodically evaluate the carrying value of
inventories and maintain an allowance for obsolescence to adjust the carrying
value, as necessary, to the lower of cost or market. The allowance is based on
physical and technical functionality as well as other factors affecting the
recoverability of the asset through future sales. Unfavorable changes in
estimates of obsolete inventory would result in an increase in the allowance and
a decrease in gross profit.
GOODWILL AND OTHER INTANGIBLES
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
which became effective January 1, 2002, goodwill and other intangible assets
with indefinite lives are no longer subject to amortization but are tested for
impairment annually or whenever events or changes in circumstances indicate that
the asset might be impaired. Other intangible assets with finite lives continue
to be subject to amortization, and any impairment is determined in accordance
with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets."
17
Should an impairment in goodwill be determined, it could result in a
material charge to operations.
VALUATION OF LONG-LIVED ASSETS
In accordance with SFAS No. 144, long-lived assets and intangible assets
with determinate lives are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. We evaluate potential impairment by comparing the carrying amount
of the asset with the estimated undiscounted future cash flows associated with
the use of the asset and its eventual disposition. Should the review indicate
that the asset is not recoverable, our carrying value of the asset would be
reduced to its estimated fair value, which is generally measured by future
discounted cash flows. In our estimate, no provision for impairment is currently
required on any of our long-lived assets.
REVENUE RECOGNITION
We record revenue in accordance with Securities and Exchange Commission
("SEC") Staff Accounting Bulletin No. 104, Revenue Recognition in Financial
Statements (SAB 104). SAB 104 requires that product sales be recognized when
there is persuasive evidence of an arrangement which states a fixed and
determinable price and terms, delivery of the product has occurred in accordance
with the terms of the sale, and collectibility of the sale is reasonably
assured. We record product sales when we have received a valid customer purchase
order for product at a stated price, the customer's credit is approved, and we
have shipped the product to the customer whereby title and risk have passed to
the customer. Some of our customers are distributors that sell goods to third
party end users. We are not contractually obligated to repurchase any inventory
from distributors or end user customers. For certain identified distributors
where collection may be contingent on the distributor's resale, revenue
recognition is deferred and recognized on a "sell through" basis. Training and
AED service revenue is deferred and recognized at the time the training occurs.
AED program management services pursuant to agreements that existed with
Complient customers are deferred and amortized straight-line over the related
contract period. License fees are deferred and recognized straight-line over the
term of the license agreement.
PRODUCT WARRANTY
Products sold are generally covered by a warranty against defects in
material and workmanship for a period of one to five years. We accrue a warranty
reserve to estimate the risk of incurring costs to provide warranty services.
The accrual is based on our historical experience and our expectation of future
conditions. An increase in warranty claims or in the costs associated with
servicing those claims would result in an increase in the accrual and a decrease
in gross profit.
LITIGATION AND OTHERS CONTINGENCIES
We regularly evaluate our exposure to threatened or pending litigation and
other business contingencies. Because of the uncertainties related to the amount
of loss from litigation and other business contingencies, the recording of
losses relating to such exposures requires significant judgment about the
potential range of outcomes. We have had ongoing legal expenses related to the
Philips matter which have been material and are expected to continue to be
material to our results of operations. At this stage of the litigation, as well
as for the other cases pending, we have not established an accrual because a
loss is not determined to be probable. As additional information about current
or future litigation or other contingencies becomes available, we will assess
whether such information warrants the recording of additional expense relating
to these contingencies. To be recorded as expense, a loss contingency must
generally be both probable and measurable. If a loss contingency is material but
is not both probable and estimable, we will disclose it in notes to the
financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2003, the FASB issued Interpretation No. 46R, Consolidation of
Variable Interest Entities (FIN 46R). FIN 46R requires the application of either
FIN 46 or FIN 46R by public entities to all Special Purpose Entities (SPE)
created prior to February 1, 2003 as of December 31, 2003 for calendar year-end
companies. FIN 46R is applicable to all non-SPEs created prior to February 1,
2003 at the end of the first interim or annual period ending after March 15,
2004. For all entities created subsequent to January 31, 2003, Public Entities
were required to apply the provisions of FIN 46. The adoption of FIN 46 and FIN
46R did not have a material impact on our consolidated financial position,
results of operations or cash flows.
18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate and Market Risk. We do not use derivative financial
instruments in our investment portfolio. We are averse to principal loss and try
to ensure the safety and preservation of our invested funds by limiting default
risk, market risk, and reinvestment risk. We attempt to mitigate default risk by
investing in only the safest and highest credit quality securities. At June 30,
2004, we invested our available cash in money market securities of high credit
quality financial institutions.
Interest expense on our existing long-term debt commitments is based on a
fixed interest rate and therefore it is unaffected by fluctuations in interest
rates.
Foreign Currency Exchange Rate Risk. The majority of our international
sales are made through our international sales office in Copenhagen primarily in
U.S. dollars, however, some sales to the U.K. are in pounds and to Germany in
Euros, and thus may be adversely affected by fluctuations in currency exchange
rates. Additionally, fluctuations in currency exchange rates may adversely
affect foreign demand for our products by increasing the price of our products
in the currency of the countries in which the products are sold. The majority of
inventory purchases, both components and finished goods, in our foreign
operations are made in U.S. dollars. The functional currency of our foreign
operations in Denmark, the U.K. and Germany is the U.S. dollar and therefore,
the financial statements of these operations are maintained in U.S. dollars. Any
assets and liabilities in foreign currencies, such as bank accounts and certain
payables, are remeasured in U.S. dollars at period-end exchange rates in effect.
Any transactions in foreign currencies, such as wages paid in local currencies,
are remeasured in U.S. dollars using an average monthly exchange rate. Any
resulting gains and losses are included in operations and were not material in
any period.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation as of the end of the period covered by this report was
carried out, under the supervision and participation of management, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures. Based upon
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be included in our periodic
SEC filings. There has been no change in our internal control over financial
reporting during the period covered by this report that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In February 2003, we filed a patent infringement action against Philips
Medical Systems North America, Inc., Philips Electronics North America
Corporation and Koninklijke Philips Electronics N.V. ("Philips") in the
United States District Court for the District of Minnesota. The suit
now charges that Philips' automated external defibrillators sold under
the names "HeartStart OnSite Defibrillator", "HeartStart", "HeartStart
FR2" and the "HeartStart Home Defibrillator," infringed at least ten of
our United States patents. In the same action, we also sought a
declaration from the Court that our products do not infringe several of
Philips' patents and Philips counterclaimed for infringement of the
same patents. Many of the Philips Defibrillators' are promoted by
Philips as including, among other things, pre-connected disposable
defibrillation electrodes and daily self-testing of electrodes and
battery, features that the suit alleges are key competitive advantages
of our Powerheart and Survivalink AEDs and are covered under our
patents. At this stage, we are unable to predict the outcome of this
litigation. We have not established an accrual for this matter because
a loss is not determined to be probable.
On April 30, 2003, we filed a Complaint against Defibtech, LLC for
patent infringement in the United States District Court for the
District of Minnesota. The Complaint alleged that Defibtech's Sentry
and Reviver AEDs infringe our patented disposable electrode pre-connect
technology as well as other patents. Defibtech answered the Complaint
and asserted counterclaims alleging that we have engaged in activities
that constitute tortious interference with present and prospective
contractual relations, common law business disparagement and statutory
business disparagement. We responded to the counterclaims with a
complete and general denial of the allegations. At this stage, we are
unable to predict the outcome of this litigation. We have not
established an accrual for this matter because a loss is not determined
to be probable.
On March 19, 2004, William S. Parker filed suit against us for patent
infringement in Michigan Federal Court. The Parker patent generally
covers the use of a synthesized voice to instruct a person to perform
certain tasks. The Complaint alleges that certain of our AEDs infringe
the Patent. The patent is now expired. We have filed an Answer to the
Complaint stating the patent is not infringed and is otherwise invalid
and unenforceable. At this stage of the litigation, we are unable to
predict the outcome of this litigation. We have not established an
accrual for this matter because a loss is not determined to be
probable.
ITEM 5. OTHER INFORMATION
In early April, we received a Warning Letter from the U.S. Food and
Drug Administration (FDA) following a routine inspection of our
manufacturing facility in Minneapolis. The letter specified certain
procedural and documentation items in our quality system. We took
corrective and preventive action to bring our quality system into
compliance. In addition, during May 2004, we initiated a limited
voluntary recall of approximately 5,800 units of our older model
Powerheart AEDs in order to replace a potentially faulty capacitor
component. The decision to replace the suspect capacitors was made by
us following a detailed analysis performed as part of the corrective
and preventive actions implemented by us in response to the Warning
Letter issued by the FDA. We have has received written notification
from the FDA that our voluntary recall plan has been accepted.
We believe that only a small number of devices may contain faulty
capacitors, however, as a precaution, we will recall all the units and
replace the capacitors as necessary. No adverse effects or patient
injuries have occurred as a result of the suspect capacitors.
Also in May 2004, we initiated a limited, voluntary recall of 4,800 AED
batteries due to an error made by our battery supplier whereby an
incorrect fuse was used in the manufacture of a certain lot of
batteries. As of June 30, 2004, the recall has been substantially
completed and customers have received replacement batteries.
We estimate the cost of these voluntary recall actions could range from
$1,000,000 to $1,200,000, however, we have received from our suppliers
credits against existing and future amounts due to these suppliers
totaling $1,240,000, which have been recorded to accrued expenses to
establish a warranty accrual for these recall matters. Actual recall
related costs incurred to date have been charged to this accrual and
total approximately $400,000 as of June 30, 2004.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
Exhibit 31.1 Chief Executive Officer's Certification as required by
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Chief Financial Officer's Certification as required by
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Chief Executive Officer's Certification as required by
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Chief Financial Officer's Certification as required by
Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K:
Form 8-K filed on April 9, 2004, furnishing the press release
announcing the preliminary revenue results for the quarter ended
March 31, 2004.
Form 8-K filed on May 9, 2004, furnishing the press release
announcing the Company's financial results for the quarter ended
March 31, 2004.
Form 8-K filed on June 1, 2004, disclosing certain voluntary recall
actions by the Company related to AED products.
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this 10-Q report to be signed on its behalf by the
undersigned thereunto duly authorized.
CARDIAC SCIENCE, INC.
---------------------------------------------
(Registrant)
Date: August 9, 2004 /s/ RODERICK DE GREEF
----------------------------------------------------------
Roderick de Greef
(Duly Authorized Officer and Principal Financial Officer)
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