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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF

THE SECURITIES EXCHANGE ACT OF 1934

LIFELINE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

(508) 988-1000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (i) 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 (ii) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer    Yes  x    No  ¨

Number of shares outstanding of the issuer’s class of common stock, $0.02 par value per share, as of April 30, 2005:  13,951,653

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LIFELINE SYSTEMS, INC.

INDEX

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LIFELINE SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except par value)

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

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LIFELINE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

(In thousands except for per share data)

(Unaudited)

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

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LIFELINE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

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

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LIFELINE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

These statements should be read in conjunction with the consolidated financial statements and the related notes included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, commonly referred to as the SEC, on March 11, 2005, for the year ended December 31, 2004.

The results of operations for the three-month period ended March 31, 2005 are not necessarily indicative of the results expected for the full year.

Reclassification

Certain 2004 amounts have been reclassified to conform to 2005 presentation.

The Company considers all securities purchased with a maturity of three months or less at the date of acquisition to be cash equivalents. The Company’s investments are deemed to be available for sale. They are carried at fair value, which approximates cost. Short-term investments consist solely of certificates of deposit with maturity dates of less than one year. The Company maintained approximately $41.3 million and $45.0 million at March 31, 2005 and December 31, 2004, respectively, of its cash and cash equivalents and short term investments with a single institution. The Company has not experienced any losses associated with deposits at this institution. In accordance with its investment policy, the Company may from time to time invest in long-term investments with terms greater than one year in order to increase the return on its cash balance.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

3. Details of certain balance sheet captions are as follows (in thousands):

4. STOCKHOLDERS’ EQUITY

The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS 148”). SFAS 148 amends Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation and also amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the methods of accounting for stock-based employee compensation and the effect of the method used on reported results. As permitted by SFAS 148 and SFAS 123, the Company continues to apply the accounting provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and related interpretations, with respect to the measurement of compensation cost for options granted under the Company’s stock-based employee compensation plans. No employee compensation expense has been recorded, as all options granted had an exercise price equal to the fair market value of the underlying common stock on the date of grant.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment” (“SFAS 123R”). SFAS 123R is a revision of SFAS 123, supersedes APB 25, and amends FASB Statement No. 95, “Statement of Cash Flows.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS 123R must be adopted by the first fiscal year beginning after June 15, 2005. In March 2005, the U.S. Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107, “Share-Based Payments” (“SAB 107”). SAB 107 expresses views of the SEC regarding the interaction between SFAS 123R and certain SEC rules and regulations and provides the SEC’s views

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

4. STOCKHOLDERS’ EQUITY (continued)

regarding the valuation of share-based compensation arrangements for public companies. The Company is currently completing its evaluation of the adoption of SFAS 123R and the impact that this statement will have on its results of operations. The Company will apply the principles of SAB 107 in conjunction with its adoption of SFAS 123R.

The following table illustrates the effect on net income and earnings per share for the three months ended March 31, 2005 and 2004 as if the fair value based method had been applied to all outstanding and unvested awards in each period.

For the three months ended March 31, 2005, there were no options excluded from the computation of diluted net income per share. For the three months ended March 31, 2004, options to purchase 278,900 shares at an average exercise price of $20.23 were not included in the computation of diluted net income per share, as their effect would have been anti-dilutive.

Restricted Stock

In accordance with the terms of an employment agreement between the Company and its Chief Executive Officer, the Company issued 72,000 shares of restricted stock to its Chief Executive Officer, effective February 13, 2003, in consideration of future services. The shares are subject to vesting at the rate of one-third of such shares at the end of the 36^th month following the date of grant, one third at the end of the 48^th month following the date of grant, and one-third at the end of the 60^th month following the date of grant. The fair market value of these shares was recorded as unearned compensation expense within Stockholders’ Equity and is being expensed as part of selling, general and administrative expenses from the date of issuance over the vesting period.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

4. STOCKHOLDERS’ EQUITY (continued)

Stock Appreciation Rights

On February 2, 2005, the Company granted its Chief Executive Officer a stock appreciation right based on 25,000 shares of the Company’s common stock at an exercise price of $26.46 per share, which will be settled in the Company’s common stock. The stock appreciation right vests in 16 equal quarterly installments, commencing on May 2, 2005 and will expire on February 2, 2012.

5. SEGMENT INFORMATION

The Company operates in one industry segment. Its operations consist of providing personal response services associated with its products. The Company maintains sales and marketing operations in both the United States and Canada.

Geographic Segment Data

Net revenues from customers are based on the location of the customer. Geographic information related to the results of operations for the periods ended March 31, 2005 and 2004 and the financial position as of March 31, 2005 and December 31, 2004 is presented as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

6. GOODWILL AND INTANGIBLES

The Company generates intangible assets generally through two types of transactions - preferred provider agreements and business combinations.

In a preferred provider agreement, the Company pays a fee to a customer in return for preferred provider status. These fees are amortized either as a reduction of services revenue (when payment is made in cash or receivables are forgiven) or as part of cost of services (when free product is given) over the term of the agreement, which is typically five years.

For transactions that qualify as business combinations, there are several intangible assets typically recorded. One of the intangible assets recorded relates to the existing subscribers of the acquired business, which is amortized over the estimated term of the subscribers’ remaining service. Other intangible assets relate to non-competition agreements and employment agreements, which are typically amortized over the term of the respective agreement.

The Company also records intangible assets related to the business’ referral sources and other business relationships, which are amortized over the estimated useful life. Any excess of the purchase price over the fair value of identifiable assets acquired, net of liabilities assumed, is recorded as goodwill.

The Company acts as its only reporting unit of its business. As a result, all acquisitions are fully integrated and absorbed into the Company. In accordance with the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), the Company is required to assess the impairment of goodwill on an annual basis or, along with other amortizable intangible assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Step one of the goodwill and other intangible assets impairment test is to compare the fair value of the reporting unit with its carrying amount. The fair value of a reporting unit is the amount that a willing party would pay to buy or sell the unit, other than in a forced or liquidation sale. The carrying amount of a reporting unit is total assets, including goodwill and other intangible assets, minus total liabilities. If the fair value is below the carrying value, the Company would proceed to the next step, which is to measure the amount of the impairment loss. Any such impairment loss would be recognized in the Company’s results of operations in the period in which the impairment loss arose.

In measuring whether goodwill or other intangible assets are impaired, the Company uses an estimate of its future undiscounted net cash flows of the business over the estimated remaining life. If the Company’s expectation of future undiscounted net cash flows indicates an impairment, the Company would write down the appropriate assets to their estimated realizable values based on discounted cash flows. In estimating expected future cash flows for determining whether an asset is impaired, assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows of other groups of assets. Under this approach, the Company specifically tests the Goodwill and the Other Intangible Assets asset groups when testing for impairment.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

6. GOODWILL AND INTANGIBLES (continued)

The following table represents the type and value of the Company’s intangible assets at March 31, 2005 and December 31, 2004:

All of the Company’s acquired intangible assets, other than goodwill, are subject to amortization. Amortization expense for acquired intangible assets for the three months ended March 31, 2005 and 2004 was approximately $634,000 and $698,000, respectively.

In accordance with the Company’s assessment of the fair value of assets acquired from its July 2003 senior living acquisition, the Company recorded approximately $0.2 million of additional goodwill during the first quarter of 2005 as a result of a payment for certain earnout provisions associated with the agreement.

Estimated amortization expense for intangible assets over the next five years is as follows (dollars in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (continued)

7. PRODUCT WARRANTY

The Company’s products are generally under warranty against defects in material and workmanship.

Changes in product warranty obligations for the three months ended March 31, 2005 and for the year ended December 31, 2004 are as follows:

8. NEWLY ISSUED ACCOUNTING STANDARDS

In December 2004, the FASB issued SFAS 123R. SFAS 123R is a revision of SFAS 123, supersedes APB 25 and amends FASB Statement No. 95. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS 123R must be adopted by the first fiscal year beginning after June 15, 2005. In March 2005, the SEC issued SAB 107. SAB 107 expresses views of the SEC regarding the interaction between SFAS123R and certain SEC rules and regulations and provides the SEC’s views regarding the valuation of share-based compensation arrangements for public companies. The Company is currently completing its evaluation of the adoption of SFAS 123R and the impact that this statement will have on its results of operations. The Company will apply the principles of SAB 107 in conjunction with its adoption of SFAS 123R.

In November 2004, the FASB issued FASB Statement No. 151, “Inventory Costs, an Amendment of ARB No. 43 Chapter 4” (“SFAS 151”). SFAS 151 is applicable for inventory costs incurred during fiscal years beginning after June 15, 2005. SFAS 151 requires that items such as idle facility expense, excessive spoilage, double freight and rehandling be recognized as current-period charges rather than being included in inventory regardless of whether the costs meet the criterion of abnormal as defined in ARB 43. The Company is in the process of evaluating the impact of SFAS 151 and does not believe the adoption of the standard will have a material impact on the Company upon adoption in fiscal 2006.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with respect to, among other things, our future revenues, operating income or earnings per share. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. There are a number of factors that may cause our actual results to vary materially from those forecast or projected in any such forward-looking statement. These factors include, without limitation, those set forth below under the caption “Certain Factors That May Affect Future Results.” Our failure to successfully address any of these factors could have a material adverse effect on our future results of operations.

Executive Overview

We provide 24-hour personal emergency response monitoring services and related products to subscribers, primarily elderly individuals with medical or age-related conditions, who wish to continue to live independently in their home. We were instrumental in pioneering the PERS industry with our inception in 1974 and have been the leading provider of PERS products and services for the past 30 years. Initially, we were primarily an equipment business predicated on selling PERS products to community hospitals and other health care providers seeking to operate local PERS programs for their patients. Due to industry trends primarily relating to economic pressures on these hospitals to reduce costs, our business evolved into primarily a services-based business, providing packaged PERS products and monitoring services.

Our PERS products and services consist principally of a home communicator connected to the telephone and a wireless personal help button which, when activated, initiates an automated digital telephone signal to one of our centralized monitoring facilities. Our monitoring technology platform retrieves the subscriber’s record from our centralized database and routes the call to one of our highly-trained monitoring professionals. Our monitoring professionals follow a prescribed response protocol to quickly assess the nature of the call through immediate two-way, voice-to-voice communication and provide a prompt, appropriate response in a respectful and compassionate manner. This response may consist of contacting local ambulance, police or fire services or family, friends and neighbors. As of March 31, 2005, we monitored approximately 433,000 PERS subscribers in the United States and Canada. Approximately 75,000 additional individuals are monitored independently by hospitals and other health care providers on monitoring platforms purchased from us.

In 2003, we formed our senior living division to provide complementary PERS products to assisted living and other senior living facilities as a replacement for, or upgrade from, existing emergency call systems. We believe our senior living products are superior to existing call systems in these facilities, which are typically operated by a pull-cord and do not allow for immediate two-way, voice-to-voice communication. Our senior living products include a personal help button, home communicator and monitoring platform with preloaded, customized monitoring software for use by the facility. As of March 31, 2005 our senior living products were installed in approximately 1,200 senior living facilities in 40 states, which monitored approximately 100,000 residents.

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We generate revenue through recurring monthly fees by billing subscribers or their families who receive our Lifeline OneSource offering, or by billing customers that outsource their monitoring activities to us. In addition, we generate revenue from product sales in connection with our other PERS offerings, as well as product sales to senior living facilities. We typically receive payment for our products and services from our health care provider customers or, in some instances, directly from the subscriber or state Medicaid programs. Our PERS offerings are generally “private pay” offerings and are not covered by private insurance or federal Medicare programs.

Historically, we have grown our PERS business through sales and marketing efforts focused on educating health care professionals about the benefits of PERS programs to their organizations and the patients they serve. In addition, we have grown our subscriber base by acquiring other PERS providers, some of which were former customers. We are growing our senior living division through direct sales and marketing efforts and strategic acquisitions of products and technology. In July 2003, we acquired the emergency response systems business unit of March Networks Corporation and, in June 2004, we acquired Protect Emergency Response Systems. We plan to continually evaluate potential acquisition candidates that fit within our growth strategy.

RESULTS OF OPERATIONS

Total revenues for the three months ended March 31, 2005 increased 13% to $35.0 million from $31.0 million for the three months ended March 31, 2004.

Services Revenue

Services revenue increased approximately 15% for the three months ended March 31, 2005 to $28.4 million from $24.7 million for the same period in 2004. The increase in our services revenues is mainly a result of the growth of our monitored subscriber base by 9% to approximately 433,000 subscribers as of March 31, 2005 from approximately 396,000 subscribers as of March 31, 2004 and our continued improvement in the lifetime revenue per subscriber we generate.

Our ability to sustain this level of services revenue growth depends on our ability to continue with enhancements in service delivery, retain subscribers for longer periods of time, develop and implement strategies to increase the revenue each subscriber generates, expand the market for our personal response services and focus on health care channel initiatives to help our customers grow their subscriber base. We believe that the high quality of our services, quality of our equipment and our commitment to providing caring and rapid response to the at-risk elderly will be factors in meeting our growth objectives.

Net Product Sales

Net product sales for the first quarter of 2005 increased 8% to $6.5 million from $6.0 million for the first quarter of 2004. The increase is primarily attributable to the contribution from sales of wireless emergency call systems for the senior living industry following our acquisition of a supplier of these systems in June 2004. We were also successful in encouraging our hospital programs to grow their Lifeline programs as well as upgrade their subscribers’ PERS products.

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Cost of Services

We believe that service gross margin (services revenue less cost of services) is a key factor of our profitability. We have focused on continued improvement in our service gross margin in part by undertaking cost reduction initiatives. These initiatives include improved productivity in our monitoring facilities, greater efficiency of subscriber enrollment and leveraging the capabilities of our CareSystem monitoring platform.

Cost of services, as a percentage of service revenues, decreased 5% to 46% for the three months ended March 31, 2005 as compared to 51% for the three months ended March 31, 2004 mainly as a result of us leveraging our fixed cost base as services revenue grows. On a dollar basis, cost of services increased $0.6 million for the first quarter of 2005 as compared to the same period in 2004 mainly as a result of growth in the number of subscribers serviced under our OneSource offering. This resulted in an increase in related expenses such as depreciation of Company-owned home communicators provided to OneSource subscribers as part of that service, certain operational costs including data entry, customer service, sales and support and increased costs for our government services division as we continue to grow this portion of our business. We expect to continue with our service gross margin initiatives for the remainder of 2005.

Cost of Product Sales

Cost of product sales as a percentage of net product sales was consistent at 36% for the quarters ended March 31, 2005 and 2004. The consistency we experienced was related, in part, to increased sales of our PERS products at higher average selling prices in the first quarter of 2005 as compared the first quarter of 2004. Also, sales of our standard wireless emergency call systems to our senior living customers which we generated in the first quarter of 2005 as a result of our June 2004 senior living acquisition favorably impacted cost of sales as a percentage of revenue on a comparative basis. The products associated with this solution maintain lower costs as a percentage of product sales than our non-wireless emergency call system senior living solution. These positive factors were offset by less efficiencies realized in manufacturing our product for the three months ended March 31, 2005 as compared to the same period in 2004 as the three months ended March 31, 2004 was favorably impacted by the efficiencies created from the high production of our new communicator which was introduced in the second quarter of 2004.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses, as a percentage of total revenues, was 41% for the three months ended March 31, 2005 as compared to 39% for the three months ended March 31, 2004 and represented a $2.3 million increase. We continued to experience increased expenses for our senior living initiative, including approximately $0.6 million of incremental operational costs associated with our June 2004 acquisition. We incurred approximately $1.2 million of increased expenditures associated with our business and marketing initiatives, including the ongoing investment in our health care direct marketing campaign and related information technology costs related to these business and marketing initiatives. We expect that SG&A expenses as a percentage of total revenues will range between 39% and 41% of total revenues for the year ending December 31, 2005 as we continue with our business initiatives.

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Research and Development

Research and development expenses were approximately 2% of total revenues for each of the three months ended March 31, 2005 and 2004. Research and development efforts are focused on ongoing product improvements and developments. We expect to maintain these expenses, as a percentage of total revenues, at a relatively consistent level for the remainder of 2005.

Taxes

Our effective tax rate was 30% for the three months ended March 31, 2005 compared to 41% for the same period in 2004. The lower effective tax rate was primarily due the receipt of a favorable tax settlement of a recent state income tax audit as well as our holding company reorganization, which we completed in December 2004. We expect our normalized effective tax rate to be approximately 39% in 2005.

We are currently under state income tax audit or inquiries for prior tax years. We believe that we have provided sufficiently for all tax exposures. A favorable settlement from audits or the expiration of the statute of limitations may result in a future tax benefit, which could be significant. Any such benefit would be recorded upon final resolution with the related taxing authorities, or closing of a statute of limitation.

LIQUIDITY AND CAPITAL RESOURCES

During the three months ended March 31, 2005, our portfolio of cash and cash equivalents decreased approximately $1.4 million to $41.0 million from $42.4 million at December 31, 2004. We experienced an increase in cash provided by operating activities of approximately $1.9 million, which reflected the growth in our profitability and the impact of continued improvements in collections of our accounts receivable portfolio, generating approximately $1.3 million and resulting in a reduction in days sales outstanding (DSO) from 31 days for the three months ended March 31, 2004 to 29 days for the three months ended March 31, 2005. This increase, however, was offset by net payroll related payments of $2.4 million, primarily as a result of the payout of management and sales bonuses relating to our fiscal 2004, net payments of $2.3 million for income tax obligations and $1.2 million of payments primarily as a result of the timing of expenditures related to our business and marketing initiatives.

During the three months ended March 31, 2005, we incurred expenditures of approximately $2.0 million for purchases of property and equipment in the ordinary course of business, including approximately $0.9 million for Company–owned equipment provided to customers and subscribers under our OneSource and Product and Service Fee (“PSF”) offerings. We also spent a total of approximately $2.1 million for provider agreements for Lifeline Monitoring Services (“LMS”) and PSF offerings and for business acquisitions during the first three months of 2005, including the acquisition of a small regional service provider and acquisitions of OneSource businesses.

We have a $30.0 million credit facility with Citizens Bank of Massachusetts that expires in July 2007. As of March 31, 2005, we did not have any debt outstanding under this facility.

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The following table summarizes our contractual obligations as of March 31, 2005 and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

(Dollars in thousands)

We expect that funding requirements for operations and future growth are expected to be met primarily from operating cash flow, existing cash and short-term investment balances and, if necessary, our line of credit. We expect these sources will be sufficient to finance our operating cash needs through the next twelve months. These needs include continued investments in our response center platform and our back-up U.S. monitoring facility and other investments in support of our current business and potential acquisitions. We may also consider alternative financing vehicles, including potential equity issuances.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. We have identified the following accounting policies as critical to understanding the preparation of our consolidated financial statements and results of operations.

Revenue Recognition

We record monitoring service revenue in the month service is provided under our OneSource, Product and Service Fee (“PSF”) and Lifeline Monitoring Services (“LMS”) service offerings. Under our OneSource and PSF offerings, the monitoring service can be cancelled without penalty at any time by the subscriber and no product revenue is recognized because the subscriber does not acquire title to any product. However, customers who choose our LMS service offering purchase the home communicators from us which the customer then provides to its subscribers. In this instance, we record product revenue upon shipment, as title to the equipment passes to the customer at that time.

Under our LMS and PSF offerings, we charge the customer a nominal fee for one-time administrative set up and data entry of new subscribers. Under our OneSource offering, we charge

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subscribers a nominal fee for installation of the personal response devices, including a one-time administrative set-up fee for data entry of the new subscribers. Since incremental direct costs related to the installation and administrative tasks associated with new subscribers exceed installation and one-time administrative set-up revenue, we expense these costs in the period incurred. We review our installation and one-time administrative set-up revenue quarterly and have not experienced situations where this revenue exceeds incremental direct costs.

We also record deferred revenue. A portion of our deferred revenue relates to situations where we contract with our customers to install our personal response products in their facilities (i.e., senior living customers). Rather than record product revenue upon shipment, we defer our product revenue until the installation of the equipment is complete. We also record deferred revenue related to billings to customers for annual service contracts for which revenue has not been recognized because the service has not yet been provided. Service contract revenues are recognized ratably over the contractual period.

While we do not have a specific right of return policy, we do record a provision for an estimated amount of future returns based on historical experience. Such returns have historically been immaterial to our total product revenue, and we do not foresee any change that would have a material adverse impact on our operating results.

Goodwill and intangible assets

Acquisition accounting requires extensive use of estimates and judgments to allocate the purchase price to the fair market value of the assets and liabilities purchased. The cost of acquisitions is allocated first to their identifiable tangible assets based on estimated fair values at the date of acquisition. Costs are then allocated to identifiable intangible assets and are amortized on a straight-line basis over the estimated useful lives of the assets. The excess of the purchase price over the fair value of identifiable assets acquired, net of liabilities assumed, is recorded as goodwill.

During the three months ended March 31, 2005, we entered into a variety of LMS and PSF provider agreements and purchased several OneSource businesses. We used accounting estimates and judgments to determine the fair value of assets and liabilities, if any. We did not record any cost in excess of net asset value (i.e., goodwill) as a result of the acquisition accounting for these arrangements; however, we did record intangible assets related to the specific arrangements and we are amortizing these costs over the expected lives of the identified intangible assets, which range from five to 15 years. Any change in assumptions could either result in a decrease or increase in the estimated life. A decrease in estimated life would reduce our net income and an increase in estimated life would increase our net income.

During the three months ended March 31, 2005, we acquired a regional service provider and are currently in the process of finalizing the purchase accounting associated with this acquisition.

In measuring whether goodwill or other intangible assets are impaired, we use an estimate of our future undiscounted net cash flows of the business over the estimated remaining life. If our expectation of future undiscounted net cash flows indicates an impairment, we would write down the appropriate assets to their estimated realizable values, based on discounted cash flows.

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Allowance for doubtful accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. We estimate the allowance based upon historical collection experience, analysis of accounts receivable by aging categories, customer credit quality and analytics. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Based on our experience, we have historically maintained reasonable estimates of our allowance for doubtful accounts.

Inventories

We value our inventories at the lower of cost or market, as determined by the first-in, first-out method. We regularly review inventory quantities on hand and record a provision for excess or obsolete inventory based upon our estimated forecast of product demand. If actual future demand is less than the projections made by management, then additional provisions may be required. Based on our experience, we have historically maintained reasonable provisions for our inventory.

Warranty

Our products are generally under warranty against defects in material and workmanship. We provide an accrual for estimated warranty costs at the time of sale of the related products based upon historical return rates and repair costs at the time of the sale. A significant increase in product return rates could have a material adverse effect on our results of operations. Based on our experience, we have historically adequately provided for our warranty accrual.

Net investment in sales-type leases

We considered the requirements of Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS 140”) when considering the accounting treatment associated with the assignment of approximately $4.0 million of our lease-portfolio net investment to a third party in December 2004. Paragraph 9 of SFAS 140 outlines the conditions that are required to be met for specific accounting treatment to be applied to this assignment. Similar to the assignment of $1.5 million of our lease-portfolio net investment in December 2003, we concluded that the appropriate accounting treatment was for the net investment of the assigned portfolio to remain on our books with an offsetting liability which will be amortized over the remaining terms of the leases. We also recorded deferred finance income on the assignment that will be recognized as part of finance income as the leases expire.

Taxes

We record liabilities for income tax contingencies based on our best estimate of the underlying exposures. We are currently under state income tax audit or inquiries for prior tax years. We believe that we have provided sufficiently for all tax exposures. A favorable settlement from audits or the expiration of the statute of limitations may result in a future tax benefit, which could be significant. Any such benefit would be recorded upon final resolution with the related taxing authorities, or closing of a statute of limitation.

NEWLY ISSUED ACCOUNTING STANDARDS

In December 2004, the FASB issued SFAS 123R. SFAS 123R is a revision of SFAS 123, supersedes APB 25 and amends FASB Statement No. 95. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements

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based on their fair values. SFAS 123R must be adopted by the first fiscal year beginning after June 15, 2005. In March 2005, the SEC issued SAB 107. SAB 107 expresses views of the SEC regarding the interaction between SFAS 123R and certain SEC rules and regulations and provides the SEC’s views regarding the valuation of share-based compensation arrangements for public companies. We are currently completing our evaluation of the adoption of SFAS 123R and the impact that this statement will have on our results of operations. We will apply the principles of SAB 107 in conjunction with our adoption of SFAS 123R.

In November 2004, the FASB issued FASB Statement No. 151, “Inventory Costs, an Amendment of ARB No. 43 Chapter 4” (“SFAS 151”). SFAS 151 is applicable for inventory costs incurred during fiscal years beginning after June 15, 2005. SFAS 151 requires that items such as idle facility expense, excessive spoilage, double freight and rehandling be recognized as current-period charges rather than being included in inventory regardless of whether the costs meet the criterion of abnormal as defined in ARB 43. We are in the process of evaluating the impact of SFAS 151 and do not believe the adoption of the standard will have a material impact on us upon adoption in fiscal 2006.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

The following important factors, among others, could cause actual results to differ materially from those indicated by forward-looking statements made in this Quarterly Report on Form 10-Q and presented elsewhere by management from time to time.

If our recent marketing initiatives are not effective, we may not grow as we anticipate.

We have recently launched a number of marketing initiatives to increase our service and other revenue, including a direct marketing campaign directed at health care providers likely to refer our services to their patients, a direct-to-subscriber campaign to target caregivers as purchasers of our service on behalf of their parents and other relatives, and a recent initiative focused on the senior living industry. We have allocated, and expect to continue to allocate, significant resources and capital expenditures to support these efforts and anticipate that our future growth will depend, in part, on the success of these initiatives. If these marketing efforts are unsuccessful, we may not grow as anticipated, or at all, and our results of operations may be harmed.

If our customers do not successfully manage and grow their local Lifeline programs, or if we are unable to maintain and build these customer relationships, the distribution of our products and services will be materially and adversely affected and we could experience decreased sales or slower than expected growth in revenues.

We rely primarily on community hospitals and other health care providers to sell and distribute our products and services to subscribers. These customers may not seek to grow their Lifeline subscriber bases as actively as we might if we were selling our service directly to subscribers due to their limited resources or because our customers, which are often non-profit institutions, may have reasons for implementing a Lifeline program that could be different from ours. Limited or ineffective marketing of our products and services by our customers could lead to decreased sales or slower than expected growth in revenues.

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If we fail to maintain our leadership position in the PERS industry, our sales and competitive position will suffer and our results of operations will be harmed.

Our future success will depend in large part on our ability to maintain our leadership position in the PERS industry. We must continue to enhance our current product and service offerings, achieve greater market penetration among our target subscribers and expand into complementary businesses such as the senior living industry. If we fail in these endeavors, our revenues may not grow as we anticipate or may decline.

Our future growth is dependent, in part, on acquiring other PERS providers and businesses strategic to us. If we are unable to identify and acquire suitable acquisition candidates, our future growth may be curtailed.

One of our principal growth strategies is to expand our business through acquisitions of PERS providers and other complementary businesses that we believe are strategic, such as businesses providing products and services to the senior living industry. If we are unable to continue to identify, attract and close future acquisitions, our growth may slow, and our subscriber base and revenues may decline. In addition, negotiations for acquisitions could result in significant diversion of management time, as well as substantial out-of-pocket costs.

If we acquire other businesses, we may be unable to effectively integrate them with our business, or we may not realize the anticipated financial and strategic goals for any such transactions.

Even if we are successful in identifying and acquiring businesses strategic to us, these activities involve a number of risks, including:

These and other factors could have a material adverse effect on our results of operations, particularly in the case of a larger acquisition or multiple acquisitions in a short period of time. Acquisitions

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may also have a negative effect on our earnings per share. If we were to proceed with one or more significant acquisitions or investments in which the consideration included cash, we could be required to use a substantial portion of our available cash to consummate any acquisition or investment. To the extent we issue shares of capital stock or other rights to purchase capital stock, including options, stock appreciation rights and warrants, existing shareholders may be diluted and earnings per share may decrease. In addition, acquisitions and investments may result in the incurrence of debt, large one-time write-offs, such as of acquired in-process research and development costs, and restructuring charges. They may also result in goodwill and other intangible assets that are subject to impairment tests, which could result in future impairment charges.

Our Canadian operations subject us to risks that could harm our business.

Our Canadian operations, which represented approximately 12% of our total revenues for the three-months ended March 31, 2005, subject us to risks, including:

Failure to adequately address any of these risks could adversely affect our ability to operate our Canadian facilities.

If we fail to adapt our products and services to changes in technology or in the marketplace, we could lose existing customers and subscribers and be unable to attract new business.

Our business depends, in part, on our ability to enhance our current products and to develop new services and products that keep pace with continuing technological changes, evolving industry standards, changing customer and subscriber preferences and new service and product introductions by our competitors. Although we believe the introduction of products utilizing new, non-telephony-based communications may be limited by the availability of such communications technologies in the homes of our target market, others may be successful in introducing monitoring services through other communications technologies. If we are not successful in developing, marketing and selling new services and products that meet changing demands, our business may be harmed.

We currently face and expect to continue to face competition in our industry.

Although we believe we are the leader in the PERS industry, there are a large number of smaller providers, primarily at the local or regional level, who we compete with for customers and subscribers. In addition, there are a number of other companies providing non-PERS monitoring and other related services to their customers. If these or other companies enter the PERS industry, they may have a competitive advantage by having greater financial, sales and marketing, engineering and manufacturing resources, a larger installed based of existing customers and economies of scale not available to us.

We derive a portion of our revenue from government-funded health care programs such as Medicaid. If these programs tighten eligibility standards or coverage policies or if current reimbursement rates are reduced, we may lose subscribers and our revenues may decline.

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As of March 31, 2005, less than 10% of our centrally-monitored subscribers were billed under state Medicaid contracts, representing less than 10% of our total revenue for the quarter then ended. As we pursue our acquisition strategy, we anticipate that the proportion of our revenues from Medicaid programs may increase due to the large number of Medicaid subscribers associated with the smaller locally-operated PERS providers that are acquisition prospects. If government-funded health care programs tighten their program eligibility standards, impose new coverage restrictions or reduce or eliminate payments for our services, these subscribers may not have the financial resources to continue our service. In addition, it is typically more difficult to collect accounts receivable from sales to Medicaid programs than from private payors.

Our business is subject to U.S. state and federal government regulation, as well as Canadian regulation, and may be subject to additional regulations in the future. If we fail to comply with applicable regulations, our revenue, operating margin and profitability could suffer.

Our monitoring equipment is registered with the Federal Communication Commission, or FCC, and the Food and Drug Administration, or FDA, in the United States and certified by Industry Canada in Canada. Our revenue, operating margin and profitability could be adversely affected by new laws and/or regulations, changes in the interpretation of existing laws and/or regulations, reductions in funding or imposition of additional limits on reimbursements. Furthermore, as a provider of services under government-funded health care programs, we are subject to fraud and abuse, anti-referral and anti-kickback laws and regulations that impose stringent limitations on our compensation, consulting, marketing and other business relationships with health care providers and other businesses.

In addition, our business is affected by the Health Insurance Portability and Accountability Act of 1996, or HIPAA, which imposed comprehensive national standards for privacy, security and electronic transactions involving individually identifiable health information. Since our government services business conducts electronic health claim transactions relating to the coordination of health care treatment for individual persons, it may be covered by the HIPAA privacy, security and transaction standards. Much of our business is conducted under contractual service arrangements with hospitals and other health care providers that are, in turn, required by HIPAA to impose certain privacy, security and transaction requirements through their contracts with us. The HIPAA regulations define minimum national standards, but individual states are permitted to adopt and enforce more stringent health data privacy and security rules.

Because we are engaged in commercial activities in Canada, our business is subject to Canadian privacy legislation. In addition, we must comply with provincial health information legislation as a result of the individually identifiable health information of our subscribers that we maintain. These federal and provincial laws require us to obtain consent to collect, use and disclose personal information and to implement procedures to keep this information secure.

Variation in regulatory requirements among different jurisdictions may cause us to incur significant compliance costs. Violations of these laws by us could have a material and adverse impact on our business and may subject us to substantial fines and penalties.

If we lose the services of one or more members of our executive management team or other key employees, we may not be able to execute our business strategy.

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Our future success depends to a significant extent upon the continued service of our executive management team and other key employees. The loss of the services of one or more of these individuals could harm our business and our ability to execute on our business strategy.

If we are unable to attract, train and retain qualified monitoring personnel, our ability to provide high quality monitoring services and continue to develop and successfully market our service could be harmed.

We believe our business depends, in part, on the talents and efforts of our monitoring personnel, who are key to delivering high quality, caring monitoring services. As a result, our future growth is dependent on our ability to identify, attract, train, retain and motivate these persons. Any of our current employees may terminate their employment with us at any time. We may not be able to hire or retain the personnel necessary to fulfill our monitoring function. The loss of a significant portion of our monitoring personnel would materially and adversely affect our business and ability to deliver high-quality monitoring services to our subscribers.

If our monitoring products fail or contain design or other defects, or if our monitoring personnel do not appropriately respond to a call, our reputation may be damaged, we may lose subscribers and we may have significant damage claims against us.

Subscribers rely on our monitoring equipment and services in emergency situations. Our monitoring products may contain design defects or fail to operate or transmit in an emergency situation. In addition, after a subscriber pushes their personal help button, we rely on wireless signals to initiate the call from the home communicator attached to the subscriber’s telephone. The wireless signals that we use may be subject to interference and the frequencies may become congested over time. Additionally, although our monitoring professionals are highly trained in emergency response and are required to follow a response protocol established by us, these employees must exercise judgment about how best to respond to each particular emergency. In the event our products fail to operate or transmit properly, or if our monitoring personnel do not appropriately respond to a call, such as by failing to send an appropriate responder to the subscriber’s home, especially in an emergency situation, we may suffer significant adverse consequences, including:

If we experience interruptions or failures in our centralized monitoring facilities, we may lose subscribers or have significant damage claims against us.

We have two monitoring centers located in Framingham, Massachusetts to service U.S. subscribers, as well as two additional monitoring centers, in Toronto, Ontario and Montreal, Quebec, to service Canadian subscribers. We believe that our fully-redundant second U.S. monitoring facility adds significantly to our disaster recovery capabilities as it equips us with the stability, redundancy and

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scalability to maintain a high level of fault tolerance. Although we chose to locate our two U.S. monitoring centers close to one another after analysis as to the likely causes of center failure, the close proximity of these two centers may mean that failures caused by regional emergencies, such as an earthquake, storm or electrical outage, may cause both of our U.S. monitoring facilities to fail. In the event that one or more of these monitoring centers fails, we may not be able to respond to subscriber emergencies, possibly for an extended period of time. Failure of our ability to answer subscribers’ calls during an emergency could expose us to significant liability claims, negative publicity and loss of subscribers.

We have from time to time been named as a defendant in lawsuits alleging damages based on our response to subscriber calls. We seek to manage our product liability risk through contractual limits on liability and damages, and by carrying comprehensive liability insurance. However, the contractual limits may not be enforceable in all jurisdictions or circumstances. A successful claim may be made for damages which exceeds the coverage under any insurance policy. In the future, our insurance costs may become more expensive and, as a result, additional insurance may not be available on acceptable terms, or at all.

If there is an unauthorized disclosure of customer data, whether through a breach of our computer systems or otherwise, we could be exposed to costly litigation or we could lose customers.

We store sensitive subscriber data on our computer networks, including names, addresses and health information. If our network security is compromised by a third party, or such data are otherwise misappropriated, we could be subject to civil liability claims, regulatory enforcement actions under laws such as HIPAA or similar state laws, loss of reputation and loss of customers.

Our holding company structure may adversely affect our ability to meet future obligations.

Substantially all of our consolidated assets are held through direct or indirect wholly-owned subsidiaries. Accordingly, our cash flow depends on the results of operations of our subsidiaries and upon the ability of our subsidiaries to provide us with cash, whether in the form of dividends, loans or otherwise, and on our ability to pay amounts due on any future obligations, including under our credit facility. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to make payments on our future obligations or to make any funds available for such purpose. In addition, dividends, loans or other distributions from our subsidiaries to us may be subject to contractual and other restrictions and are subject to other business considerations.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have considered the provisions of Financial Reporting Release No. 48, “Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments.” We have no holdings of derivative financial or commodity-based instruments or other market risk sensitive instruments entered into for trading purposes at March 31, 2005. We believe that we currently have no material exposure to interest rate and foreign currency exchange rate risks in our instruments entered into for other than trading purposes.

Interest rates

Our balance sheet may from time to time include an outstanding balance associated with a revolving credit facility that is subject to interest rate risk. We have the ability to obtain a revolving credit loan with an interest rate based on LIBOR or a revolving credit loan with an interest rate based on the lender’s prime interest rate. As a result of these factors, at any given time, a change in interest rates could result in either an increase or decrease in our interest expense. As of March 31, 2005, we did not have any outstanding balances associated with our credit facility and, therefore, our consolidated financial position, results of operations and cash flows would not be affected by near-term changes in interest rates.

Foreign currency exchange rates

Our earnings are affected by fluctuations in the value of the U.S. dollar as compared to the Canadian dollar as a result of the sale of our products and services in Canada and translation adjustments associated with the conversion of our Canadian subsidiary’s currency into the reporting currency (U.S. dollar). As such, our exposure to changes in Canadian exchange rates could impact our consolidated financial position, results of operations and cash flows. We performed a sensitivity analysis as of March 31, 2005 to assess the potential effect of a 10% increase or decrease in Canadian foreign exchange rates and concluded that short-term changes in Canadian exchange rates would not materially affect our consolidated financial position, results of operations or cash flows. Our sensitivity analysis of the effects of changes in foreign currency exchange rates in such magnitude did not factor in a potential change in sales levels or local prices for our services/products as a result of the currency fluctuations or otherwise.

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ITEM 4. CONTROLS AND PROCEDURES

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2005. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2005, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

No change in our internal control over financial reporting occurred during the fiscal quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS

The Exhibits that are filed with this Report are set forth in the Exhibit Index, which appears on page 29 hereof.

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LIFELINE SYSTEMS, INC.

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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EXHIBIT INDEX

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