Attached files
file | filename |
---|---|
EX-32.2 - EX-32.2 - Cardiac Science CORP | v56550exv32w2.htm |
EX-31.2 - EX-31.2 - Cardiac Science CORP | v56550exv31w2.htm |
EX-32.1 - EX-32.1 - Cardiac Science CORP | v56550exv32w1.htm |
EX-10.4 - EX-10.4 - Cardiac Science CORP | v56550exv10w4.htm |
EX-31.1 - EX-31.1 - Cardiac Science CORP | v56550exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 000-51512
Cardiac Science Corporation
(Exact name of registrant as specified in its charter)
Delaware | 94-3300396 | |
(State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) |
|
3303 Monte Villa Parkway, Bothell, WA | 98021 | |
(Address of Principal Executive Offices) | (Zip Code) |
(425) 402-2000
(Registrants Telephone Number, Including Area Code)
(Registrants Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant
to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for
such shorter period that the registrant was required to submit and post such files). o Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See definition of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act.
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The number of shares of the registrants Common Stock outstanding at August 2, 2010 was
23,815,781.
TABLE OF CONTENTS
Page | ||||||||
PART I FINANCIAL INFORMATION | ||||||||
Item 1. | 3 | |||||||
Item 2. | 19 | |||||||
Item 3. | 31 | |||||||
Item 4. | 31 | |||||||
PART II OTHER INFORMATION | ||||||||
Item 1. | 32 | |||||||
Item 1A. | 32 | |||||||
Item 2. | 33 | |||||||
Item 3. | 33 | |||||||
Item 4. | 33 | |||||||
Item 5. | 34 | |||||||
Item 6. | 34 | |||||||
SIGNATURE | 35 | |||||||
EX-10.4 | ||||||||
EX-31.1 | ||||||||
EX-31.2 | ||||||||
EX-32.1 | ||||||||
EX-32.2 |
Page 2 of 35
Table of Contents
PART I FINANCIAL INFORMATION
Item 1. | Financial Statements |
CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, | December 31, | |||||||
(in thousands, except share amounts) | 2010 | 2009 | ||||||
ASSETS |
||||||||
Current Assets: |
||||||||
Cash and cash equivalents |
$ | 10,885 | $ | 26,866 | ||||
Accounts receivable, net of allowance for doubtful accounts of $900 and
$1,017, respectively |
23,784 | 24,228 | ||||||
Inventories |
24,476 | 23,581 | ||||||
Prepaid expenses and other current assets |
3,240 | 3,702 | ||||||
Total current assets |
62,385 | 78,377 | ||||||
Other assets |
666 | 872 | ||||||
Machinery and equipment, net of accumulated depreciation and amortization
of $18,749 and $17,490, respectively |
8,418 | 8,406 | ||||||
Deferred income taxes |
31 | 31 | ||||||
Intangible assets, net of accumulated amortization of $19,836 and $17,876,
respectively |
25,999 | 27,988 | ||||||
Investments in unconsolidated entities |
400 | 386 | ||||||
Total assets |
$ | 97,899 | $ | 116,060 | ||||
LIABILITIES AND EQUITY |
||||||||
Current Liabilities: |
||||||||
Accounts payable |
$ | 12,499 | $ | 11,030 | ||||
Accrued liabilities |
12,619 | 12,216 | ||||||
Warranty liability |
3,981 | 4,028 | ||||||
Deferred revenue |
7,799 | 7,919 | ||||||
Corrective action liabilities |
21,452 | 15,249 | ||||||
Total current liabilities |
58,350 | 50,442 | ||||||
Deferred income taxes |
5,389 | 5,389 | ||||||
Total liabilities |
63,739 | 55,831 | ||||||
Equity: |
||||||||
Cardiac Science Corporation shareholders equity: |
||||||||
Preferred stock (10,000,000 shares authorized), $0.001 par value, no shares
issued or outstanding as of June 30, 2010 and December 31, 2009,
respectively |
| | ||||||
Common stock (65,000,000 shares authorized), $0.001 par value,
23,808,124 and 23,566,320 shares issued and outstanding at
June 30, 2010 and December 31, 2009, respectively |
232,455 | 231,159 | ||||||
Accumulated other comprehensive income |
53 | 304 | ||||||
Accumulated deficit |
(199,624 | ) | (172,527 | ) | ||||
Total Cardiac Science Corporation shareholders equity |
32,884 | 58,936 | ||||||
Noncontrolling interests |
1,276 | 1,293 | ||||||
Total equity |
34,160 | 60,229 | ||||||
Total liabilities and equity |
$ | 97,899 | $ | 116,060 | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.
Page 3 of 35
Table of Contents
CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(In thousands, except share and per share data) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Revenues: |
||||||||||||||||
Products |
$ | 31,672 | $ | 31,653 | $ | 60,439 | $ | 66,918 | ||||||||
Service |
4,431 | 4,461 | 8,771 | 8,860 | ||||||||||||
Total revenues |
36,103 | 36,114 | 69,210 | 75,778 | ||||||||||||
Cost of Revenues: |
||||||||||||||||
Products |
16,047 | 15,433 | 31,075 | 32,067 | ||||||||||||
Corrective action costs |
11,000 | | 11,000 | | ||||||||||||
Service |
3,187 | 3,130 | 6,350 | 6,281 | ||||||||||||
Total cost of revenues |
30,234 | 18,563 | 48,425 | 38,348 | ||||||||||||
Gross profit |
5,869 | 17,551 | 20,785 | 37,430 | ||||||||||||
Operating Expenses: |
||||||||||||||||
Research and development |
4,629 | 3,617 | 8,834 | 7,088 | ||||||||||||
Sales and marketing |
12,412 | 11,271 | 25,214 | 22,469 | ||||||||||||
General and administrative |
7,201 | 6,349 | 13,594 | 11,965 | ||||||||||||
Total operating expenses |
24,242 | 21,237 | 47,642 | 41,522 | ||||||||||||
Operating loss |
(18,373 | ) | (3,686 | ) | (26,857 | ) | (4,092 | ) | ||||||||
Other Income (Loss): |
||||||||||||||||
Interest income |
8 | 19 | 18 | 32 | ||||||||||||
Other income (loss), net |
(37 | ) | 545 | 94 | 397 | |||||||||||
Total other income (loss) |
(29 | ) | 564 | 112 | 429 | |||||||||||
Loss before income tax benefit (expense) |
(18,402 | ) | (3,122 | ) | (26,745 | ) | (3,663 | ) | ||||||||
Income tax benefit (expense) |
(58 | ) | 1,194 | (191 | ) | 1,360 | ||||||||||
Net loss |
(18,460 | ) | (1,928 | ) | (26,936 | ) | (2,303 | ) | ||||||||
Less: Net income attributable to noncontrolling interests |
(50 | ) | (178 | ) | (161 | ) | (341 | ) | ||||||||
Net loss attributable to Cardiac Science Corporation |
$ | (18,510 | ) | $ | (2,106 | ) | $ | (27,097 | ) | $ | (2,644 | ) | ||||
Net loss per share attributable to Cardiac |
||||||||||||||||
Science Corporation: |
||||||||||||||||
Basic |
$ | (0.78 | ) | $ | (0.09 | ) | $ | (1.15 | ) | $ | (0.11 | ) | ||||
Diluted |
$ | (0.78 | ) | $ | (0.09 | ) | $ | (1.15 | ) | $ | (0.11 | ) | ||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
23,723,268 | 23,198,352 | 23,658,886 | 23,127,742 | ||||||||||||
Diluted |
23,723,268 | 23,198,352 | 23,658,886 | 23,127,742 |
The accompanying notes are an integral part of these unaudited condensed consolidated
financial statements.
Page 4 of 35
Table of Contents
CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(In thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Operating Activities: |
||||||||||||||||
Net loss |
$ | (18,460 | ) | $ | (1,928 | ) | $ | (26,936 | ) | $ | (2,303 | ) | ||||
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities: |
||||||||||||||||
Stock-based compensation |
635 | 554 | 1,220 | 1,213 | ||||||||||||
Depreciation and amortization |
1,620 | 1,542 | 3,208 | 3,067 | ||||||||||||
Deferred income taxes |
| (1,398 | ) | | (1,765 | ) | ||||||||||
Changes in operating assets and liabilities, net of
businesses acquired: |
||||||||||||||||
Accounts receivable, net |
(2,662 | ) | 730 | (18 | ) | 8,717 | ||||||||||
Inventories |
1,021 | (89 | ) | (997 | ) | (1,330 | ) | |||||||||
Prepaid expenses and other assets |
86 | (392 | ) | 660 | 36 | |||||||||||
Accounts payable |
1,593 | (118 | ) | 1,726 | (2,457 | ) | ||||||||||
Accrued liabilities |
(390 | ) | 1,045 | 579 | (291 | ) | ||||||||||
Warranty liability |
(72 | ) | 111 | (15 | ) | 9 | ||||||||||
Corrective action liabilities |
7,947 | | 6,203 | | ||||||||||||
Deferred revenue |
(649 | ) | 426 | (120 | ) | (670 | ) | |||||||||
Net cash provided by (used in) operating activities |
(9,331 | ) | 483 | (14,490 | ) | 4,226 | ||||||||||
Investing Activities: |
||||||||||||||||
Purchases of machinery and equipment |
(669 | ) | (769 | ) | (1,345 | ) | (1,654 | ) | ||||||||
Proceeds from repayment of note |
| 10 | 2 | 83 | ||||||||||||
Cash paid for acquisitions |
| | | (54 | ) | |||||||||||
Net cash used in investing activities |
(669 | ) | (759 | ) | (1,343 | ) | (1,625 | ) | ||||||||
Financing Activities: |
||||||||||||||||
Proceeds from exercise of stock options and issuance of
shares under employee stock purchase plan |
57 | 502 | 152 | 736 | ||||||||||||
Minimum tax withholding on restricted stock awards |
(64 | ) | | (94 | ) | (97 | ) | |||||||||
Net cash provided by (used in) financing activities |
(7 | ) | 502 | 58 | 639 | |||||||||||
Effect of exchange rate changes on cash and cash equivalents |
(113 | ) | 79 | (206 | ) | (27 | ) | |||||||||
Net change in cash and cash equivalents |
(10,120 | ) | 305 | (15,981 | ) | 3,213 | ||||||||||
Cash and cash equivalents, beginning of period |
21,005 | 37,563 | 26,866 | 34,655 | ||||||||||||
Cash and cash equivalents, end of period |
$ | 10,885 | $ | 37,868 | $ | 10,885 | $ | 37,868 | ||||||||
Supplemental disclosures of noncash investing and financing activities: |
||||||||||||||||
Increase (decrease) in accrued machinery and equipment purchases |
$ | (69 | ) | $ | 153 | $ | (85 | ) | $ | (243 | ) |
The accompanying notes are an integral part of these unaudited condensed consolidated
financial statements.
Page 5 of 35
Table of Contents
CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Organization and Description of Business
Cardiac Science develops, manufactures, and markets a family of advanced diagnostic and
therapeutic cardiology devices and systems, including automated external defibrillators (AED),
electrocardiograph devices (ECG/EKG), cardiac stress treadmills and systems, PC-based diagnostic
workstations, Holter monitoring systems, hospital defibrillators, vital signs monitors, cardiac
rehabilitation telemetry systems and cardiology data management systems (informatics) that connect
with hospital information (HIS), electronic medical record (EMR), and other information systems.
The Company sells a variety of related products and consumables and provides a portfolio of
training, maintenance, and support services. Cardiac Science, the successor to the cardiac
businesses that established the trusted Burdick®, Quinton® and
Powerheart® brands, is headquartered in Bothell, Washington. With customers in more than
100 countries worldwide, the Company has operations in North America, Europe, and Asia.
The Company is the result of the combination of Quinton Cardiology Systems, Inc. (Quinton)
and Cardiac Science, Inc. (CSI) pursuant to a merger transaction (the Merger) that was
completed on September 1, 2005.
Basis of Presentation
The Company follows accounting standards set by the Financial Accounting Standards Board,
commonly referred to as the FASB. The FASB sets U.S. generally accepted accounting principles
(U.S. GAAP) that the Company follows to ensure it consistently reports its financial position,
results of operations, and cash flows. References to U.S. GAAP issued by the FASB in the Companys
notes to its unaudited condensed consolidated financial statements are to the FASB Accounting
Standards Codification, sometimes referred to as the Codification or ASC.
The condensed consolidated balance sheet dated June 30, 2010, the condensed consolidated
statements of operations for the three and six month periods ended June 30, 2010 and 2009, and the
condensed consolidated statements of cash flows for the three and six month periods ended June 30,
2010 and 2009 have been prepared by the Company and are unaudited. The condensed consolidated
balance sheet dated December 31, 2009 was derived from the Companys audited financial statements.
Certain information and note disclosures normally included in annual financial statements prepared
in accordance with U.S. GAAP have been omitted pursuant to the rules and regulations of the
Securities and Exchange Commission (the SEC). The notes to the audited consolidated financial
statements included in the Companys annual report on Form 10-K for the fiscal year ended December
31, 2009 provide a summary of significant accounting policies and additional financial information
that should be read in conjunction with this report.
The accompanying unaudited condensed consolidated financial statements present
the Company on a consolidated basis, including the Companys wholly owned subsidiaries and its
majority owned joint ventures. All intercompany accounts and transactions have been eliminated.
Liquidity
As of June 30, 2010, the Companys cash and cash equivalents totaled $10,885,000. The Company
is currently in the process of addressing two separate voluntary corrective actions relating to its
AED products, the first of which was initially announced in November 2009 and the second of which
was initially announced in February 2010. See Note 2.
The Company has recorded charges totaling $32,000,000 related to these two voluntary
corrective actions, of which $21,000,000 was recorded during 2009 and an additional $11,000,000 was
recorded during the second quarter of 2010. This additional $11,000,000 charge is associated with
the Companys plan, first announced in July 2010, to replace or repair approximately 24,000 AEDs
used by certain first responders and medical facilities in the United States and includes an
estimate for devices located outside of the United States which the Company believes that it is
probable that it would be required to repair or replace in the future. Through June 30, 2010, the
Company had used cash of $10,548,000 in carrying out these corrective actions, with remaining
accrued corrective action liabilities of $21,452,000 at June 30, 2010. See Note 2.
The costs recorded are estimates and actual costs that the Company incurs to complete the
corrective actions could be more or less than the remaining $21,452,000 accrual as of June 30,
2010. The Company expects that it will satisfy substantially all of the requirements under its
ongoing corrective actions during 2011 and expects to spend a significant amount of the remaining
accrued corrective action liability costs during this same period, which will negatively impact the
Companys cash position. The Company expects to operate at a loss and to use cash in its operations
for the remainder of 2010. However the Company currently believes that it will return to profitability at some
point during 2011 and that it will begin to generate cash from its operations during 2011.
Page 6 of 35
Table of Contents
On July 16, 2010, the Company entered into an amended and restated line of credit agreement
with Silicon Valley Bank which, among other things, increased the amount available for borrowing
from $5,000,000 to $15,000,000. The Company did not have any borrowings under its line of credit
agreement at June 30, 2010. The Companys ability to borrow under this agreement is primarily based
on outstanding accounts receivable and, to a lesser extent, on its inventory holdings.
The Company believes it has addressed
the issues raised by the Food and Drug Administration
(FDA) in connection with the voluntary field
corrective action first announced in November 2009. See Note 2. However, the Company is in ongoing
discussions with the FDA regarding the remaining issues raised by the FDA in its warning letter
from February 2010 which asserted inadequacies relating to the Companys procedures associated with
the evaluation, investigation and follow up of complaints, procedures to verify the effectiveness
of corrective and preventative actions and procedures relating to certain design requirements. If
the Company is unable to satisfy the FDAs concerns, the Company may be subject to regulatory
action by the FDA, including but not limited to seizure, injunction, halting shipment of the
Companys products and/or civil monetary penalties. Any such actions could significantly disrupt
the Companys ongoing business and operations and have a material adverse effect on its financial
position and results of operations. Additionally, quality issues and related corrective actions may
adversely impact the Companys projected revenues in the near term. Accordingly, the Company may be
required to reduce costs, which could adversely impact the Companys forecasts for revenue growth
in future periods.
Given the above factors, the Company plans to closely monitor its actual and projected
operating results and cash balances during the remainder of 2010, and beyond. Additionally, the
Company is focused on executing its corrective action plans and reducing operating losses during
the remainder of 2010 and returning to profitability at some point during 2011. The Company intends
to reduce operating losses through both revenue growth and by reducing operating expenses beginning
in the second half of 2010 and during 2011. If the Companys actual operating results are not in
line with its projected results, the Company intends to, and believes it has the ability to, make
such cost reductions should they become necessary. Ultimately, the Company anticipates it will have
sufficient operating profits, and/or cash generated from operations in future periods, to repay any
borrowings under its line of credit. Further, the Company believes its existing cash and cash
equivalents and ability to borrow under its available line of credit will be sufficient to fund its
anticipated operating losses for at least the next twelve months, as well as to meet working
capital requirements and fund anticipated capital expenditures and other obligations, including the
estimated remaining costs of the ongoing corrective actions. Further, the Company believes it will
be able to renew its line of credit agreement with Silicon Valley Bank in July 2011. However, to
the extent the Company is not successful in renewing its line of credit, or if other adverse events
or circumstances arise during the remainder of 2010 or 2011 which could require additional funding
beyond that available under its current line of credit, the Company may need to seek additional or
alternative sources of financing. There can be no assurance that the Company would be able to
obtain financing from alternative sources and, if such financing were to be available, it may be
expensive and/or dilutive to stockholders.
Use of Estimates
The preparation of the unaudited condensed consolidated financial statements and related
disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements and revenues and expenses during the periods
reported. These estimates include the collectibility of accounts receivable, the recoverability of
inventory, the adequacy of warranty liabilities, the adequacy of our liabilities for corrective
actions, the valuation of stock awards, the fair value of patent rights, estimated worldwide
effective tax rates in U.S. and foreign jurisdictions, the realizability of investments, the
realizability of deferred tax assets and valuation and useful lives of tangible and intangible
assets, among others. The market for the Companys products is characterized by intense
competition, rapid technological development and frequent new product introductions, all of which
could affect the future realizability of the Companys assets. Estimates and assumptions are
reviewed periodically, and the effects of revisions are reflected in the unaudited condensed
consolidated financial statements in the period they are determined to be necessary.
Net Loss Per Share
Basic loss per share is computed by dividing net loss attributable to Cardiac Science
Corporation by the weighted average number of shares of common stock outstanding during the period.
Diluted loss per share is computed by dividing net loss attributable to Cardiac Science Corporation
by the weighted average number of common and dilutive common equivalent shares outstanding during
the period. Common equivalent shares consist of shares issuable upon the exercise of stock options,
non-vested stock awards, warrants and issuance of shares under the Companys 2002 Employee Stock
Purchase Plan (ESPP) using the treasury stock method. Common equivalent shares are excluded from
the calculation if their effect is antidilutive.
Page 7 of 35
Table of Contents
The following table sets forth the computation of basic and diluted net loss per share
attributable to Cardiac Science Corporation:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(in thousands, except share data) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Numerator: |
||||||||||||||||
Net loss attributable to Cardiac Science
Corporation |
$ | (18,510 | ) | $ | (2,106 | ) | $ | (27,097 | ) | $ | (2,644 | ) | ||||
Denominator: |
||||||||||||||||
Weighted average shares for basic calculation |
23,723,268 | 23,198,352 | 23,658,886 | 23,127,742 | ||||||||||||
Weighted average shares for diluted calculation |
23,723,268 | 23,198,352 | 23,658,886 | 23,127,742 | ||||||||||||
The following table sets forth the number of antidilutive shares issuable upon exercise of
stock options, non-vested stock awards, ESPP and warrants excluded from the computation of diluted
net loss attributable to Cardiac Science Corporation per share:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Antidilutive shares issuable upon exercise of stock options |
2,907,638 | 3,094,822 | 2,907,638 | 3,094,822 | ||||||||||||
Antidilutive shares issuable upon exercise of warrants |
| 212,776 | | 212,776 | ||||||||||||
Antidilutive shares related to non-vested stock awards and
ESPP |
1,546,725 | 935,039 | 1,546,725 | 935,039 | ||||||||||||
Total |
4,454,363 | 4,242,637 | 4,454,363 | 4,242,637 | ||||||||||||
Customer and Vendor Concentrations
For the three and six month periods ended June 30, 2010 and 2009, we did not have any
customers that accounted for more than 10% of our revenues.
For the three and six month periods ended June 30, 2010, we had one vendor in each period that
accounted for 10% of purchases during these periods. For the three and six month periods ended June
30, 2009, we had one vendor which accounted for 13% of purchases during all of these periods.
Although components are available from other sources, a key vendors inability or unwillingness to
supply components in a timely manner or on terms acceptable to the Company could adversely affect
the Companys ability to meet customers demands.
Subsequent Events
Subsequent events have been evaluated through the date of issuance of these unaudited
condensed consolidated financial statements.
Recent Accounting Pronouncements
In January 2010, the FASB issued guidance to amend the disclosure requirements related to
recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the
transfers of assets and liabilities between Level 1 (quoted prices in active market for identical
assets or liabilities) and Level 2 (significant other observable inputs) of the fair value
measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the
guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of
the assets and liabilities measured using significant unobservable inputs (Level 3 fair value
measurements). The guidance became effective for the Company with the reporting period beginning
January 1, 2010, except for the disclosure on the roll forward activities for Level 3 fair value
measurements,
which will become effective for the Company with the reporting period beginning January 1,
2011. Other than requiring additional disclosures, adoption of this new guidance did not and will
not have a material impact on the Companys financial statements.
In September 2009, the Emerging Issues Task Force (EITF) reached a consensus related to
revenue arrangements with multiple deliverables, which the FASB then issued as an Accounting
Standards Update (ASU), 2009-13. The ASU amends Accounting Standards Codification (ASC)
Subtopic 605-25, Revenue Recognition Multiple Element Arrangements and
Page 8 of 35
Table of Contents
provides application
guidance on whether multiple deliverables exist in a revenue arrangement, how the deliverables
should be separated and how the consideration should be allocated to one or more units of
accounting. This ASU establishes a selling price hierarchy for determining the selling price of a
deliverable based on vendor-specific objective evidence, if available, third-party evidence, or
estimated selling price if neither vendor-specific nor third-party evidence is available. The ASU
can be applied on a prospective basis or in certain circumstances on a retrospective basis. The
Company plans to adopt this ASU on a prospective basis beginning January 1, 2011. The Company
believes the adoption of this ASU may have an impact on its financial position and results of
operations, however it is uncertain whether the impact will be material. The Company is continuing
to evaluate this ASU as of June 30, 2010.
In September 2009, the EITF reached a consensus related to revenue arrangements that include
software elements, which the FASB issued as ASU, 2009-14. The ASU amends ASC Subtopic 985-605,
Software Revenue Recognition. Previously, companies that sold tangible products with more
than incidental software were required to apply software revenue recognition guidance. This
guidance often delayed revenue recognition for the delivery of the tangible product. Under the new
guidance, tangible products that have software components that are essential to the functionality
of the tangible product will be excluded from the software revenue recognition guidance. The new
guidance will include factors to help companies determine what is essential to the functionality.
Software-enabled products will now be subject to other revenue guidance and will likely follow the
guidance for multiple deliverable arrangements issued by the FASB in September 2009 in ASU 2009-13.
The new guidance is to be applied on a prospective basis for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010, with earlier application
permitted. The Company plans to adopt this ASU on a prospective basis beginning January 1, 2011.
The Company believes the adoption of this ASU may have an impact on its financial position and
results of operations, however it is uncertain whether the impact will be material. The Company is
continuing to evaluate this ASU as of June 30, 2010.
2. Corrective Action Liabilities
November 2009 Corrective Actions
At the end of the second quarter of 2009, the Company voluntarily ceased shipments of certain
of its AED products due to two instances the Company became aware of involving the failure of AEDs
to deliver therapy during a resuscitation attempt, apparently as a consequence of a malfunction of
one of the components used in the manufacture of the affected AED products. On August 10, 2009, the
Company resumed production and shipments of the AED products after implementing a more stringent
process to test for defects in the component at issue.
During the third quarter of 2009, the Company conducted a thorough review and analysis of the
potential for certain of its AED products shipped prior to August 10, 2009 to fail to perform a
rescue due to the component issue described above. The Company determined that the component at
issue has the unlikely potential to fail and that routine self-tests performed by the AED may not
detect a component that has malfunctioned. The Company also determined that approximately 300,000
AEDs shipped between June 2003 and June 2009 are potentially impacted by the component issue. In
November 2009 the Company announced it was initiating a voluntary field corrective action to
enhance the reliability of the affected AED units in the field through a software update related to
the AEDs routine self test functionality. The Company recorded a charge of $18,500,000 in the
third quarter of 2009 related to this corrective action. During the first quarter of 2010, the
Company completed development of the initial software update related to certain models of its AEDs
and made this update available to its customers earlier than originally communicated in November
2009. The Company introduced the remaining versions of the software update for all remaining AED
models in June 2010.
In February 2010, the Company received a warning letter from the FDA noting, among other
things, that the voluntary field corrective action it announced in November 2009 is inadequate
since the software update is intended to improve the products ability to detect the potential
component defect, but is not designed to prevent component failure. See Note 1. In April 2010, the
FDA published additional information regarding this corrective action, further clarifying the AED
models impacted by the potential component defect and provided further guidance to users of the
Companys affected AEDs. Additionally, the FDA noted that the Companys software update addresses
some, but not all electrical component defects.
Following discussions with the FDA, in July 2010, the Company announced it will replace
approximately 24,000 AEDs used by certain first responders and medical facilities in the United
States that are included in the customer population covered by the voluntary corrective action first announced in November 2009. The population of
first responders includes police, fire and ambulance services and medical facilities include
hospitals, medical clinics, dialysis centers and assisted living facilities. The Company recorded
an additional $11,000,000 charge during the second quarter of 2010, representing the estimated
costs for repair or replacement of these devices, as well as an estimate of the cost to repair or
replace certain devices located outside of the United States that the Company believes that it is
probable that it would be required to perform in the future. The Company expects that it will
satisfy substantially all of the requirements under this corrective action during 2011.
Page 9 of 35
Table of Contents
Concurrent to the Companys July 2010 announcement, the FDA published a communication
regarding the Companys updated corrective action plan, citing the Companys commitment to repair
or replace approximately 24,000 high risk and/or frequently used AEDs with first responders and
medical facilities within the United States. The FDA recommended that all other impacted customers
follow the process, as outlined by the Company, for implementing the software update which has been
made available to customers through the Companys website or through a software kit shipped
directly to the customer. The Company believes this updated recommendation by the FDA addressed all
outstanding issues with the Companys previously communicated plan to address potential component
defects through a field software update as originally announced in November 2009.
February 2010 Corrective Action
During the first quarter of 2010, the Company announced it was initiating a worldwide
voluntary medical device recall after determining that approximately 12,200 AEDs may not be able to
deliver therapy during a resuscitation attempt, which may lead to serious adverse events or death.
These AEDs were manufactured in a way that makes them potentially susceptible to failure under
certain conditions. The FDA was informed of this situation in February 2010. The Company recorded a
charge of $2,500,000 in the fourth quarter of 2009 related to this voluntary recall. As of June 30,
2010, the Company has replaced substantially all of the devices included in this corrective action
and is currently expecting this matter to be complete by the end of the third quarter of 2010.
Recorded Charges
As of June 30, 2010, the Company has recorded charges totaling $32,000,000 representing
estimated costs related to the two voluntary corrective actions described above. These charges were
included in cost of revenues on the consolidated statements of operations for the year ended
December 31, 2009 and on the unaudited condensed consolidated statement of operations for the three
and six month periods ended June 30, 2010.
The Companys corrective action liabilities are included in corrective action liabilities on
the unaudited condensed consolidated balance sheets and are
summarized as follows:
Charged to | ||||||||||||||||||||
Beginning | product cost | End of | ||||||||||||||||||
(in thousands) | of period | of revenues | Adjustments | Expenditures | period | |||||||||||||||
Six months ended June 30, 2010 |
$ | 15,249 | $ | 11,000 | $ | | $ | (4,797 | ) | $ | 21,452 |
The costs of these voluntary corrective actions are estimates. The actual costs incurred by
the Company to implement the voluntary corrective actions could vary significantly based on a
number of factors, including the outcome of discussions or negotiations with applicable regulatory
bodies in geographies outside the U.S., the number of impacted devices, the customer and
geographical segments related to the impacted devices, the logistical processes employed by the
Company to address the issues, the customer response rate in implementing the corrective action
plans, the level of required follow up with customers, the extent to which the Company relies on
third party assistance to carry out the corrective actions, the extent to which AED units recovered
from affected customers can be repaired and used as replacement units for other customers, and the
length of time and other resources required to complete the corrective actions, among others.
However, as of June 30, 2010, the Company believes its remaining accrued corrective action
liabilities on the unaudited condensed consolidated balance sheet as of June 30, 2010 will be
sufficient to fund the remaining expected costs of these matters.
The Company expects that it will satisfy substantially all of the requirements under its
ongoing corrective actions during the remainder of 2010 and during 2011, which will continue to have a negative impact on cash flows
during this same period, and possibly later periods. Further, as a result of these charges, the
Company also considered the impact the corrective actions could have on the carrying value of
indefinite lived intangible assets or other long lived assets including property and equipment and
intangible
assets subject to amortization, or the realizability of its inventories as of June 30, 2010.
Based on the Companys analysis, it was determined that no adjustments to the carrying value of
these assets were required as of June 30, 2010.
The results of the Companys evaluation of the component issues described herein and any
responsive actions taken by the Company are subject to significant uncertainty. The Companys
policy is to assess the likelihood of any potential corrective actions, voluntary or not,
associated with its products as well as ranges of possible or probable costs associated with such
activities, when appropriate. A determination of the amount of the liability required for this or
other contingencies is made after an analysis of each known issue. A liability is recorded and
charged to cost of revenues if and when the Company determines that a loss is probable and the
amount of the loss can be reasonably estimated. Additionally, the Company discloses contingencies
for which a material loss is reasonably possible, but not probable.
Page 10 of 35
Table of Contents
3. Equity and Comprehensive Income (Loss)
For the Company, components of other comprehensive income (loss) consist of unrealized gains
and losses on available-for-sale securities, net of related income tax effects, if applicable, and
translation gains and losses related to consolidation of financial statements from foreign
subsidiaries and joint ventures. Available for sale securities are classified as investments in
unconsolidated entities on the unaudited condensed consolidated balance sheets.
The Company reports its noncontrolling interests in consolidated joint ventures as a component
of equity in the Companys unaudited condensed consolidated balance sheets separate from the
parents equity. Transactions that do not result in the deconsolidation of the subsidiary are
recorded as equity transactions, while those transactions that do result in a change from
noncontrolling to controlling ownership, or a deconsolidation of the subsidiary, are recorded in
net income (loss) with the gain or loss measured at fair value.
The following tables reflect the changes in equity attributable to both Cardiac Science
Corporation and the noncontrolling interests of the joint ventures in which the Company has a
majority, but not total, ownership interest for the three and six month periods ended June 30, 2010
and 2009, respectively:
Attributable to | ||||||||||||
Cardiac Science | Noncontrolling | Total | ||||||||||
(in thousands) | Corporation | Interests | Equity | |||||||||
Equity at March 31, 2010 |
$ | 51,025 | $ | 1,336 | $ | 52,361 | ||||||
Comprehensive loss: |
||||||||||||
Net income (loss) |
(18,510 | ) | 50 | (18,460 | ) | |||||||
Unrealized gains on available for sale securities |
(92 | ) | | (92 | ) | |||||||
Foreign currency translation adjustments |
(165 | ) | (110 | ) | (275 | ) | ||||||
Comprehensive loss |
(18,767 | ) | (60 | ) | (18,827 | ) | ||||||
Stock-based transactions and compensation expense under
employee benefit plans |
626 | | 626 | |||||||||
Equity at June 30, 2010 |
$ | 32,884 | $ | 1,276 | $ | 34,160 | ||||||
Equity at March 31, 2009 |
$ | 131,880 | $ | 658 | $ | 132,538 | ||||||
Comprehensive income (loss): |
||||||||||||
Net income (loss) |
(2,106 | ) | 178 | (1,928 | ) | |||||||
Unrealized losses on available for sale securities,
net of related tax of ($183) |
402 | | 402 | |||||||||
Foreign currency translation adjustments |
54 | 33 | 87 | |||||||||
Comprehensive income (loss) |
(1,650 | ) | 211 | (1,439 | ) | |||||||
Stock-based transactions and compensation expense under
employee benefit plans |
1,044 | | 1,044 | |||||||||
Equity at June 30, 2009 |
$ | 131,274 | $ | 869 | $ | 132,143 | ||||||
Page 11 of 35
Table of Contents
Attributable to | ||||||||||||
Cardiac Science | Noncontrolling | Total | ||||||||||
(in thousands) | Corporation | Interests | Equity | |||||||||
Equity at December 31, 2009 |
$ | 58,936 | $ | 1,293 | $ | 60,229 | ||||||
Comprehensive loss: |
||||||||||||
Net income (loss) |
(27,097 | ) | 161 | (26,936 | ) | |||||||
Unrealized gains on available for sale securities |
15 | | 15 | |||||||||
Foreign currency translation adjustments |
(266 | ) | (178 | ) | (444 | ) | ||||||
Comprehensive loss |
(27,348 | ) | (17 | ) | (27,365 | ) | ||||||
Stock-based transactions and compensation expense under
employee benefit plans |
1,296 | | 1,296 | |||||||||
Equity at June 30, 2010 |
$ | 32,884 | $ | 1,276 | $ | 34,160 | ||||||
Equity at December 31, 2008 |
$ | 131,703 | $ | 545 | $ | 132,248 | ||||||
Comprehensive income (loss): |
||||||||||||
Net income (loss) |
(2,644 | ) | 341 | (2,303 | ) | |||||||
Unrealized
losses on available for sale securities, net of related tax of ($169) |
374 | | 374 | |||||||||
Foreign currency translation adjustments |
(27 | ) | (17 | ) | (44 | ) | ||||||
Comprehensive income (loss) |
(2,297 | ) | 324 | (1,973 | ) | |||||||
Stock-based transactions and compensation expense under
employee benefit plans |
1,868 | | 1,868 | |||||||||
Equity at June 30, 2009 |
$ | 131,274 | $ | 869 | $ | 132,143 | ||||||
4. Segment Reporting
The Company is required to disclose selected information about operating segments. The Company
also reports 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 Companys chief operating decision makers, or decision
making group, to perform resource allocations and performance assessments.
The Companys chief operating decision makers are the Chief Executive Officer and other senior
executive officers of the Company. Based on evaluation of the Companys financial information,
management believes that the Company operates in one reportable segment with its various cardiology
products and services.
The Companys chief operating decision makers evaluate revenue performance of product lines,
both domestically and internationally. However, operating, strategic and resource allocation
decisions are based primarily on the Companys overall performance in its operating segment.
The following table summarizes revenues by product line:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(in thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Defibrillation products |
$ | 19,051 | $ | 16,853 | $ | 34,913 | $ | 39,791 | ||||||||
Cardiac monitoring products |
12,621 | 14,800 | 25,526 | 27,127 | ||||||||||||
Service |
4,431 | 4,461 | 8,771 | 8,860 | ||||||||||||
Total |
$ | 36,103 | $ | 36,114 | $ | 69,210 | $ | 75,778 | ||||||||
Page 12 of 35
Table of Contents
The following table summarizes revenues, which are attributed based on the geographic location
of the customers:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(in thousands) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Domestic |
$ | 25,915 | $ | 26,227 | $ | 50,404 | $ | 52,090 | ||||||||
Foreign |
10,188 | 9,887 | 18,806 | 23,688 | ||||||||||||
Total |
$ | 36,103 | $ | 36,114 | $ | 69,210 | $ | 75,778 | ||||||||
Substantially all intangible assets are domestic. Long-lived assets located outside of the
United States are not material.
5. Inventories
Inventory is valued at the lower of cost or market. Cost is determined using a standard cost
method, including material, labor and factory overhead. Inventories were comprised of the
following:
June 30, | December 31, | |||||||
(in thousands) | 2010 | 2009 | ||||||
Raw materials |
$ | 16,770 | $ | 18,752 | ||||
Finished goods |
7,706 | 4,829 | ||||||
Total inventories |
$ | 24,476 | $ | 23,581 | ||||
The Company performs a detailed analysis of our inventories on a quarterly basis, or more
frequently should circumstances arise. Such circumstances could include, but would not be limited
to, changes in a product bill of material due to design or quality improvements, product failures
related to faulty or defective materials, decisions regarding product life cycles, and the
Companys ability to sell refurbished products, among others. This analysis is performed
to ensure inventory items are carried at the lower of cost, on a weighted average basis, or market,
and that the Company has adequately reserved any excess and/or obsolete items in inventory.
6. Intangible Assets
The following table sets forth the balances of intangible assets at June 30, 2010 (in
thousands):
Accumulated | ||||||||||||||||
Useful life | Cost | Amortization | Net | |||||||||||||
Intangible assets not subject to amortization: |
||||||||||||||||
Burdick trade name |
$ | 3,400 | $ | | $ | 3,400 | ||||||||||
Cardiac Science trade name |
11,380 | | 11,380 | |||||||||||||
Cardiac Science Deutschland trade name |
163 | | 163 | |||||||||||||
Total intangible assets not subject to
amortization |
14,943 | | 14,943 | |||||||||||||
Intangible assets subject to amortization: |
||||||||||||||||
Cardiac Science customer relationships |
5 years | 8,650 | (8,362 | ) | 288 | |||||||||||
Cardiac Science developed technology |
8 years | 11,330 | (6,845 | ) | 4,485 | |||||||||||
Burdick distributor relationships |
10 years | 1,400 | (1,050 | ) | 350 | |||||||||||
Burdick developed technology |
7 years | 860 | (860 | ) | | |||||||||||
Patents and patent applications |
5-10 years | 960 | (938 | ) | 22 | |||||||||||
Patent rights |
6-13 years | 7,692 | (1,781 | ) | 5,911 | |||||||||||
Total intangible assets subject to amortization |
30,892 | (19,836 | ) | 11,056 | ||||||||||||
Total |
$ | 45,835 | $ | (19,836 | ) | $ | 25,999 | |||||||||
Page 13 of 35
Table of Contents
The Companys estimated expense for the amortization of intangibles for each full year ended
December 31 is summarized as follows (in thousands):
2010 (excluding Q1, Q2 2010) |
$ | 1,383 | ||
2011 |
2,190 | |||
2012 |
2,187 | |||
2013 |
1,567 | |||
2014 |
623 | |||
Thereafter |
3,106 |
7. Credit Facility
On July 16, 2010, the Company entered into an amended and restated line of credit agreement
with Silicon Valley Bank which, among other things, increased the amount available for borrowing in
revolving credit from $5,000,000 to $15,000,000. The Companys ability to borrow under this
agreement is based largely on its accounts receivable outstanding at the time of borrowing and, to
a lesser extent, on its inventory holdings. Interest on borrowings, if any, will be based on the
Wall Street Journal Prime rate plus 2.5%. Interest is payable monthly, on the last day of the
month, and all obligations are due on July 14, 2011. In addition, upon finalizing the agreement in
July 2010, the Company paid Silicon Valley Bank a non-refundable commitment fee of $175,000 and any
unused balances under this facility will bear monthly fees equal to 0.25% per annum on the average
unused portion of the revolving line. The Company granted Silicon Valley Bank a first priority
security interest in substantially all of its assets to secure its obligations under the line of
credit.
At June 30, 2010, the Company did not have any borrowings under this or any other line of
credit.
8. Warranty Liability
Changes in the warranty liability for the six months ended June 30, 2010 were as follows:
Six Months Ended | ||||
(in thousands) | June 30, 2010 | |||
Warranty liability, beginning of the period |
$ | 4,028 | ||
Charged to product cost of revenues, net |
887 | |||
Warranty expenditures |
(934 | ) | ||
Warranty liability, end of the period |
$ | 3,981 | ||
9. Stock-Based Compensation Plans
The Company maintains an ESPP, as well as several equity incentive plans under which it may
grant non-qualified stock options, incentive stock options and non-vested stock awards to
employees, non-employee directors and consultants.
The fair value of each option grant and ESPP purchase is estimated using the Black-Scholes
option-pricing model with the following weighted-average assumptions and the fair value of the
non-vested stock awards is calculated based on the market value of the shares awarded at date of
grant:
Page 14 of 35
Table of Contents
Three months ended | Six months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Stock options plans: |
||||||||||||||||
Volatility |
55.5 | % | 54.0 | % | 55.5 | % | 53.7 | % | ||||||||
Expected term (years) |
6.00 | 6.70 | 6.00 | 6.61 | ||||||||||||
Risk-free interest rate |
3.3 | % | 2.7 | % | 3.3 | % | 2.6 | % | ||||||||
Expected dividend yield |
| | | | ||||||||||||
Fair value of options granted |
$ | 1.03 | $ | 2.30 | $ | 1.03 | $ | 2.16 | ||||||||
Employee stock purchase plan: |
||||||||||||||||
Volatility |
47.0 | % | 40.0 | % | 47.0 | % | 40.0 | % | ||||||||
Expected term (years) |
0.5 | 0.5 | 0.5 | 0.5 | ||||||||||||
Risk-free interest rate |
2.7 | % | 2.1 | % | 2.7 | % | 2.1 | % | ||||||||
Expected dividend yield |
| | | | ||||||||||||
Fair value of employee stock purchase rights |
$ | 0.79 | $ | 1.73 | $ | 0.79 | $ | 1.73 | ||||||||
Non-vested stock: |
||||||||||||||||
Fair value of non-vested stock awards granted |
$ | 1.51 | $ | 4.10 | $ | 2.32 | $ | 4.07 |
In January 2010, the Company granted to certain of its executives 625,000 non-vested stock
awards as part of a long term performance based restricted stock unit award program. These awards
will vest at the end of a three-year performance period, with 50% based on the achievement of a
specified revenue compound annual growth rate with certain adjustments and 50% based on specified
combined operating cash flow (or suitable financing in place to fund operations beyond 2012) with
certain adjustments. The Company has granted an additional 78,500 non-vested stock
awards during 2010. These non-vested stock awards vest ratably over a four-year period in annual
increments beginning one year from the date of grant. Non-vested stock awards require no payment
from the employee, with the exception of employee related federal taxes.
The following table summarizes information about the non-vested stock award activity during
the three and six month periods ended June 30, 2010:
Shares | ||||
Non-vested balance, December 31, 2009 |
1,045,460 | |||
Granted |
675,000 | |||
Vested |
(41,738 | ) | ||
Forfeited |
(89,194 | ) | ||
Non-vested balance, March 31, 2010 |
1,589,528 | |||
Granted |
28,500 | |||
Vested |
(147,288 | ) | ||
Forfeited |
(19,637 | ) | ||
Non-vested balance, June 30, 2010 |
1,451,103 | |||
In April 2010, the Company granted 7,500 shares of non-qualified stock options. Stock options
typically vest 25% after one year from the date of the grant and then monthly thereafter over a
four year period.
The Company issued 57,955 and 36,753 shares of common stock during the three month periods
ended June 30, 2010 and 2009, respectively, and 110,144 and 77,704 shares of common stock during
the six month periods ended June 30, 2010 and 2009, respectively in connection with the ESPP and
received total proceeds of $57,000, $129,000, $152,000 and $256,000, respectively.
Page 15 of 35
Table of Contents
10. Commitments and Contingencies
Other Commitments
As of June 30, 2010, the Company had purchase obligations of approximately $43,032,000
consisting of outstanding purchase orders issued in the normal course of business.
Guarantees and Indemnities
During its normal course of business, the Company has made certain guarantees, indemnities and
commitments under which it may be required to make payments in relation to certain transactions.
These indemnities include intellectual property and other indemnities to the Companys customers
and suppliers in connection with the sales of its products, and indemnities to directors and
officers of the Company to the maximum extent permitted under the laws of the State of Delaware.
Historically, the Company has not incurred any losses or recorded any liabilities related to
performance under these types of indemnities.
Legal Proceedings
The Company is subject to various legal proceedings arising in the normal course of business.
In the opinion of management, the ultimate resolution of these proceedings is not expected to have
a material effect on the Companys consolidated financial position, results of operations or cash
flows.
11. Income Taxes
The Company records its quarterly provision for income taxes based on the estimated worldwide
effective tax rates for the full year, which is determined based on estimates of pre-tax income or
losses for the full year, and applicable tax rates in jurisdictions in which income and losses are
expected to be generated. The Company estimates its worldwide effective tax rate for the year ended
December 31, 2010, excluding the U.S. jurisdictions, will be approximately 31%. This estimate
relates primarily to the Companys foreign operations which generally are forecasted to be
marginally profitable during 2010.
Based on authoritative guidance, the Company has excluded the U.S. jurisdiction from its
worldwide effective tax rate analysis which was calculated separately and estimated to be zero as
of June 30, 2010 and for the full year of 2010. The Company excluded the U.S. jurisdiction based on
guidance that a jurisdiction should be excluded from the worldwide effective tax rate and
calculated separately to the extent such jurisdiction anticipates an ordinary loss for the year or
has generated ordinary losses on a year to date basis for which no tax benefit can be recognized.
The Company has maintained its valuation allowance on domestic deferred tax assets as the positive
and negative evidence which existed as of June 30, 2010 does not warrant a change from its position
as of December 31, 2009. As such, the Company believes it is not more likely than not that it will
be able to realize the benefits of the expected income tax losses generated during the current
year.
For the six month period ended June 30, 2010, the Company recorded a worldwide effective tax
rate of 29% which includes the Companys estimated worldwide effective tax rate, excluding the U.S.
jurisdictions, of 31% adjusted for favorable true-ups related to tax filings in foreign
jurisdictions which had lower pre-tax book income on their filed tax returns than what was
anticipated at December 31, 2009. Based on this, the Company recorded income tax expense of $0.1
million and $0.2 million for the three and six month periods ended June 30, 2010.
The Company recorded a worldwide effective tax benefit of 37% for the six month period ended
June 30, 2009, resulting in income tax benefits of $1.2 million and $1.4 million in the three and
six month periods ended June 30, 2009. The prior year worldwide effective tax rate did not exclude
the U.S. jurisdiction from the analysis as noted above and was based on estimates of pre-tax income
or losses for the full year, applicable tax rates in jurisdictions in which income and losses were
expected to be generated, including the U.S., and expected U.S. federal and state tax credits.
Based on managements review of the Companys tax positions, the Company had no significant
unrecognized tax benefits as of June 30, 2010 and December 31, 2009. The Companys continuing
practice is to recognize interest and/or penalties related to income tax matters in income tax
expense. At June 30, 2010 and December 31, 2009, the Company had no accrued interest related to
uncertain tax positions and no accrued penalties.
The Company is subject to U.S. federal income tax as well as income tax in multiple state and
foreign jurisdictions as well as federal, state and foreign filings related to Quinton and CSI. As
a result of the NOL carryforwards, substantially all tax years are open for U.S. federal and state
income tax matters. Foreign tax filings are open for years 2001 forward.
Page 16 of 35
Table of Contents
12. Derivatives
The Company is exposed to foreign currency exchange-rate fluctuations in the normal course of
its business, which the Company manages from time to time through the use of forward foreign
exchange contracts. Forward foreign exchange contracts are used to hedge the impact of fluctuations
of foreign exchange on certain assets or liabilities denominated in a currency other than the
functional currency of the Company or its subsidiaries. Currently, these forward foreign exchange
contracts do not qualify for derivative hedge accounting. The Company uses forward foreign exchange
contracts to mitigate risk and does not intend to engage in speculative transactions. The forward
foreign exchange contracts are entered into by the Company and its subsidiaries primarily to hedge
foreign denominated accounts receivable and foreign denominated intercompany payables. These
contracts do not contain any credit-risk-related contingent features.
The Company seeks to manage the counterparty risk associated with these forward foreign
exchange contracts by limiting transactions to counterparties with which the Company has an
established banking relationship. In addition, the contracts are limited to a time period of less
than one year, generally three months or less.
During each of the three and six month periods ended June 30, 2010, these forward foreign
exchange contracts resulted in net realized gains of $232,000 and $343,000, respectively. During
each of the three and six month periods ended June 30, 2009, these forward foreign exchange
contracts resulted in insignificant net realized gains and losses. The realized gains were
partially offset by realized and unrealized gains and losses on foreign denominated accounts
receivable and foreign intercompany payables in the same periods. Realized gains and losses related
to forward foreign exchange contracts are recorded in other income (loss), net and the assets and
liabilities for these contracts are recorded in prepaid and other assets and accrued liabilities.
The Company had no outstanding forward foreign exchange contracts as of June 30, 2010 or December
31, 2009.
13. Fair Value Measurement
Fair value measurements are determined under a three-level hierarchy that prioritizes the
inputs to valuation techniques used to measure fair value, distinguishing between market
participant assumptions developed based on market data obtained from sources independent of the
reporting entity (observable inputs) and the reporting entities own assumptions about market
participant assumptions developed based on the best information available in the circumstances
(unobservable inputs). Level 1 inputs consist of quoted prices (unadjusted) in active markets for
identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and
liabilities in active markets or inputs that are observable for the asset or liability, either
directly or indirectly through market corroboration, for substantially the full term of the
financial instrument. Level 3 inputs are unobservable inputs based on the Companys own assumptions
used to measure assets and liabilities at fair value. Classification of a financial asset or
liability within the hierarchy is determined based on the lowest level input that is significant to
the fair value measurement. There were no changes to the valuation techniques during the three and
six month periods ended June 30, 2010.
The Companys investments in unconsolidated entities, which totaled $321,000 at June 30, 2010,
are comprised primarily of investments in equity securities of unconsolidated entities that are
carried at fair value and are included in investments in unconsolidated entities on the Companys
unaudited condensed consolidated balance sheet, using quoted market prices in active markets (level
1 inputs).
The Company has other financial instruments in addition to its investments in unconsolidated
entities noted above which consist primarily of cash, accounts receivable, notes receivable,
accounts payable and other accrued liabilities which are presented in the unaudited condensed
consolidated financial statements at their approximate fair values at June 30, 2010 due to the
short-term nature of their settlements.
14. Restructuring Costs
On January 14, 2009, the Company announced the implementation of a restructuring plan which
included a 12% reduction in work force, primarily impacting the Companys product development,
manufacturing, and customer service organizations. The restructuring was implemented in order to
realign the Companys cost structure and become more flexible and efficient in operations.
Additionally, as the Company has established a historical practice of providing similar termination
benefits, it was determined that the restructuring plan was an ongoing benefit arrangement, rather
than a one time termination benefit. The Company recorded severance charges of approximately
$1,203,000 in the fourth quarter of 2008 as management, having the appropriate authority,
determined the amount of benefits to be provided was probable and estimable as of December 31,
2008.
Page 17 of 35
Table of Contents
During the six month period ended June 30, 2009, the Company made cash severance payments of
$888,000 related to this restructuring and all remaining costs associated with this restructuring
were paid prior to December 31, 2009. While there are periodic departures resulting in severance
payments, there were no broad based restructuring costs incurred during the three and six month
periods ended June 30, 2010 and 2009.
Page 18 of 35
Table of Contents
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements relating to Cardiac
Science Corporation. Except for historical information, the following discussion contains
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995. All statements other than statements of historical fact, including our expectations relating
to future results of operations, liquidity or financial position, completion of corrective action
plans; costs associated with corrective actions, cost reductions, resolution of pending regulatory
issues, and other matters, made in this Quarterly Report on Form 10-Q are forward looking. The
words believe, expect, intend, anticipate, will, may, variations of such words, and
similar expressions identify forward-looking statements, but their absence does not mean that the
statement is not forward-looking. These forward-looking statements reflect managements current
expectations and involve risks and uncertainties. Our actual results could differ materially from
results that may be anticipated by such forward-looking statements due to various uncertainties.
The principal factors that could cause or contribute to such differences include, but are not
limited to, the factors discussed in the section entitled Risk Factors in Part 1 Item 1A of
our Annual Report on Form 10-K for the year ended December 31, 2009, those discussed in Part II
Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 and those
discussed elsewhere in this report. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this report. We undertake no
obligation to revise any forward-looking statements to reflect events or circumstances that may
subsequently arise. Readers are urged to review and consider carefully the various disclosures made
in this report and in our other filings made with the Securities and Exchange Commission (SEC)
that disclose and describe the risks and factors that may affect our business, prospects and
results of operations.
You should read the following discussion and analysis in conjunction with our unaudited
condensed consolidated financial statements and related notes included elsewhere in this report.
Operating results for the three and six month periods ended June 30, 2010 are not necessarily
indicative of future results including the full fiscal year. You should also refer to our Annual
Consolidated Financial Statements, Notes thereto, and Managements Discussion and Analysis of
Financial Condition and Results of Operations and Risk Factors contained in our Annual Report on
Form 10-K for the year ended December 31, 2009, filed with the SEC on March 15, 2010.
Business Overview
We develop, manufacture, and market a family of advanced diagnostic and therapeutic cardiology
devices and systems, including automated external defibrillators (AEDs), electrocardiograph
devices (ECG/EKG), cardiac stress testing treadmills and systems, PC-based diagnostic work
stations, Holter monitoring systems, hospital defibrillators, vital signs monitors, cardiac
rehabilitation telemetry systems, and cardiology data management systems (Informatics) that
connect with hospital information (HIS), electronic medical record (EMR), and other information
systems. We sell a variety of related products and consumables, and provide a portfolio of
training, maintenance, and support services. We are the successor to the cardiac businesses that
established the trusted Burdick®, Quinton® and Powerheart® brands
and are headquartered in Bothell, Washington. With customers in more than 100 countries worldwide,
we have operations in North America, Europe, and Asia.
Page 19 of 35
Table of Contents
Critical Accounting Estimates and Policies
To prepare financial statements that conform with U.S. generally accepted accounting
principles (U.S. GAAP), we must select and apply accounting policies and make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. We base our accounting estimates on
historical experience and on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form our basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
There are certain critical accounting estimates that we believe require significant judgment
in the preparation of our consolidated financial statements. We consider an accounting estimate to
be critical if it requires us to make assumptions because information was not available at the time
or it included matters that were highly uncertain at the time we were making the estimate, and
changes in the estimate or different estimates that we reasonably could have selected would have
had a material impact on our financial condition or results of operations.
Deferred Tax Assets and Income Taxes. We account for income taxes under the asset and
liability method under which deferred income taxes are provided for the temporary differences
between the financial reporting basis and the tax basis of our assets and liabilities and operating
losses and tax credit carryforwards. This process involves calculating our current tax obligation
or refund and assessing the nature and measurements of temporary differences resulting from
differing treatment of items for tax and accounting purposes. These differences result in deferred
tax assets and liabilities. In each period, we assess the likelihood that our deferred tax assets
will be recovered from existing deferred tax liabilities or future taxable income. If required, we
will recognize a valuation allowance to reduce such deferred tax assets to amounts that are more
likely than not to be ultimately realized. To the extent that we establish a valuation allowance or
change this allowance in a period, we adjust our tax provision or tax benefit in the consolidated
statements of operations. We use our judgment to determine estimates associated with the
calculation of our provision or benefit for income taxes, and in our evaluation of the need for a
valuation allowance recorded against our net deferred tax assets.
During the third quarter of 2009, we evaluated the expected realization of our deferred tax
assets and determined an increase to our valuation allowance of $54.6 million was required of which
$42.2 million was included in the consolidated statement of operations as deferred tax expense.
Factors we considered in making such an assessment included, but were not limited to past
performance, including our recent history of operating results on a U.S. GAAP basis, our recent
history of generating taxable income, our history of recovering net operating loss carryforwards
for tax purposes and our expectation of future taxable income, both considering our past history in
predicting future results and considering current macroeconomic conditions and issues facing our
industry and customers.
Stock-Based Compensation. We account for stock-based compensation based on fair value of the
options or restricted stock units at the date of grant. Share-based compensation cost is measured
at the grant date and is recognized as expense over the related vesting period. Determining the
fair value of share-based awards at the grant date requires judgment, including estimating future
volatility and expected term. If actual forfeiture results differ significantly from estimates,
stock-based compensation expense and our results of operations could be materially impacted.
Indefinite Lived Intangible Assets. Our indefinite lived intangible assets are comprised
primarily of trade names, which were acquired in our acquisition of
Spacelabs Burdick, Inc. in 2003 and the merger
transaction
between Quinton Cardiology Systems, Inc. and Cardiac Science, Inc.
in 2005. We use our judgment to estimate the fair value of each of these
indefinite lived intangible assets. Our judgment about fair value is based on our expectation of
future cash flows and an appropriate discount rate.
We believe the Burdick and Cardiac Science trade names have indefinite lives and, accordingly,
we do not amortize the trade names. We evaluate this conclusion annually or more frequently if
events and circumstances indicate that the asset(s) might be impaired and make a judgment about
whether there are factors that would limit our ability to benefit from the trade name in the
future. If there were such factors, we would start amortizing the trade name over the expected
remaining period in which we believed it would continue to provide benefit.
Additionally, we periodically evaluate whether the carrying value of our intangible assets
might be impaired. For our trade names, this evaluation is performed annually, or more frequently
if events occur that suggest there may be an impairment loss, and involves comparing the carrying
amount to our estimate of fair value.
Valuation of Long-Lived Assets. We review long-lived assets, such as machinery and equipment,
and intangible assets subject to amortization, for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset group may not be recoverable.
Recoverability of asset groups to be held and used is measured by a comparison of the carrying
amount of an asset group to estimated undiscounted future cash flows expected to be generated by
the asset group. If
Page 20 of 35
Table of Contents
the carrying amount of an asset group exceeds its estimated future cash flows, an impairment
charge is recognized on our consolidated statements of operations and as a reduction to value of
the asset group on our condensed consolidated balance sheets. We use our judgment to estimate the
useful lives of our intangible assets subject to amortization and evaluate the remaining useful
lives annually.
Assets to be disposed of would be separately presented in the unaudited condensed consolidated
balance sheet and reported at the lower of the carrying amount or fair value less costs to sell,
and are no longer depreciated. The assets and liabilities of a disposal group classified as held
for sale would be presented separately in the appropriate asset and liability sections of the
unaudited condensed consolidated balance sheet.
Accounts Receivable. Accounts receivable represent a significant portion of our assets. We
make estimates of the collectability of accounts receivable, including analyzing historical
write-offs, changes in our internal credit policies and customer concentrations when evaluating the
adequacy of our allowance for doubtful accounts. Different estimates regarding the collectability
of accounts receivable may have a material impact on the timing and amount of reported bad debt
expense and on the carrying value of accounts receivable.
Inventories. Inventories represent a significant portion of our assets. We value inventories
at the lower of cost, on an average cost basis, or market. We regularly perform a detailed analysis
of our inventories to determine whether adjustments are necessary to reduce inventory values to
estimated net realizable value. We consider various factors in making this determination, including
the salability of individual items or classes of items, recent sales history and predicted trends,
industry market conditions and general economic conditions. Different estimates regarding the net
realizable value of inventories could have a material impact on our reported net inventory and cost
of revenues, and thus could have a material impact on the condensed consolidated financial
statements as a whole.
Warranty. We provide warranty service covering many of the products and systems we sell. We
estimate and accrue for future costs of providing warranty service, which relate principally to the
hardware components of the systems, when the systems are sold. Our estimates are based, in part, on
our warranty claims history and our cost to perform warranty service. Differences could result in
the amount of the recorded warranty liability and cost of revenues if we made different judgments
or used different estimates.
Corrective Action Costs. We provide for additional warranty costs associated with field
corrective actions and recalls when the likelihood of incurring costs associated with these matters
becomes probable and estimable. We record estimated warranty costs associated with field corrective
actions and recalls as part of cost of revenues on the unaudited condensed consolidated statements
of operations and within corrective action liabilities on the unaudited condensed consolidated
balance sheets. We evaluate the adequacy of our accruals for these initiatives on a regular basis
and will make adjustments to our estimates if facts and circumstances indicate that changes to our
initial estimates would be appropriate.
As of June 30, 2010, we have recorded charges totaling $32.0 million representing the
estimated costs related to the two voluntary corrective actions. We recorded a charge of $18.5
million in the third quarter of 2009, representing the estimated costs of implementing a software
update relating to the voluntary corrective action first announced in November 2009 covering nearly
300,000 AEDs shipped between June 2003 and June 2009, and a charge of $2.5 million in the fourth
quarter of 2009 representing the estimated costs of replacing approximately 12,200 AEDs that were
the subject of the corrective action announced in February 2010. As further described below, we
recorded an additional charge of $11.0 million during the second quarter of 2010 related to the
updated corrective action plan first announced in July 2010.
The costs of these voluntary corrective actions are estimates. Our actual costs incurred to
implement the voluntary corrective actions could vary significantly based on an number of factors,
including the outcome of discussions or negotiations with applicable regulatory bodies in
geographies outside the United States, the number of impacted devices, the customer and
geographical segments related to the impacted devices, the logistical processes we employ to
address the issues, the customer response rate in implementing the corrective action plans, the
level of required follow up with customers, the extent to which we rely on third party assistance
to carry out the corrective actions, the extent to which AED units recovered from affected
customers can be repaired and used as replacement units for other customers, and the length of time
and other resources required to complete the corrective actions, among others.
In February 2010, we received a warning letter from the Food & Drug Administration (FDA)
noting, among other things, that the voluntary field corrective action we announced in November
2009 is inadequate since it is intended to improve the products ability to detect the potential
component problem, but is not designed to prevent component failure. The FDA letter also asserted
other inadequacies, including our procedures relating to the evaluation, investigation and follow
up of complaints, procedures to verify the effectiveness of corrective and preventative actions and
procedures relating to certain design requirements. In April 2010, the FDA published additional
information regarding our corrective action announced in November 2009, further clarifying the AED
models impacted by the potential component defect and provided further guidance to users of our affected AEDs. Additionally, the FDA noted that our software update
addresses some, but not all electrical component defects.
Page 21 of 35
Table of Contents
Following discussions with the FDA, in July 2010, we announced that we will replace
approximately 24,000 AEDs used by certain first responders and medical facilities in the United
States that are included in the customer population covered by the voluntary corrective action
first announced in November 2009. The population of first responders includes police, fire and
ambulance services and medical facilities include hospitals, medical clinics, dialysis centers and
assisted living facilities. We recorded an additional $11.0 million charge during the second
quarter of 2010, representing the estimated costs for repair or replacement of these devices, as
well as an estimate of the cost to repair or replace certain devices located outside of the United
States that the Company believes that it is probable that it would be required to perform in the
future.
In July 2010, the FDA published a communication regarding our updated corrective action plan,
citing our plan to repair or replace approximately 24,000 AEDs used by certain first responders and
medical facilities within the United States. The FDA recommended that all other impacted customers
follow the process, as outlined by the Company, for implementing the software update which has been
made available to customers through our website or through a software kit shipped directly to the
customer. With this updated recommendation by the FDA, we believe we have addressed all outstanding
issues raised by the FDA with respect to our previously communicated plan to address potential
component defects through a field software update as originally announced in November 2009.
Software Revenue Recognition. We account for the licensing of software and arrangements where
software is considered more than incidental to the product as software revenue arrangements. We use
judgment when determining the appropriate accounting for our software revenue arrangements,
including whether an arrangement includes multiple elements, and if so, whether vendor-specific
objective evidence (VSOE) of fair value exists for those elements. A portion of software revenue
is recorded as unearned due to undelivered elements including, in some cases, software
implementation and post-delivery support. The amount of revenue allocated to undelivered elements
is based on the sales price of each element when sold separately (VSOE) using the residual method.
Revenue from post-delivery support is recognized over the service period, which is typically a
year and revenue from software implementation services is recognized as the services are provided
(based on VSOE of fair value). When significant implementation activities are required, we
recognize revenue from software and services upon installation. Changes to the elements in a
software arrangement and the ability to identify VSOE of fair value for those elements could
materially impact the amount of earned and unearned revenue.
Revenue Recognition. Revenue from sales of hardware products is generally recognized when
title transfers to the customer, typically upon shipment. Some of our customers are distributors
that sell goods to third party end users. Except for certain identified distributors where
collection may be contingent on distributor resale, we recognize revenue on sales of products made
to distributors when title transfers to the distributor and all significant obligations have been
satisfied. In making a determination of whether significant obligations have been met, we evaluate
any installation or integration obligations to determine whether those obligations are
inconsequential or perfunctory. In cases where the remaining installation or integration obligation
is not determined to be inconsequential or perfunctory, we defer the portion of revenue associated
with the fair value of the installation and integration obligation until these services have been
completed.
Distributors do not have price protection and generally do not have product return rights,
except if the product is defective upon shipment or shipped in error, and in some cases upon
termination of the distributor agreement. For certain identified distributors where collection may
be contingent on the distributors resale, revenue recognition is deferred and recognized on a
sell through or cash basis. The determination of whether sales to distributors are contingent on
resale is subjective because we must assess the financial wherewithal of the distributor to pay
regardless of resale. For sales to distributors, we consider several factors, including past
payment history, where available, trade references, bank account balances, Dun & Bradstreet reports
and any other financial information provided by the distributor, in assessing whether the
distributor has the financial wherewithal to pay regardless of, or prior to, resale of the product
and that collection of the receivable is not contingent on resale.
We offer limited volume price discounts and rebates to certain distributors. Volume price
discounts are on a per order basis based on the size of the order and are netted against the
revenue recorded at the time of shipment. We have some arrangements with key distributors that
provide for volume discounts based on meeting certain quarterly or annual purchase
levels or based on sales volumes of certain of our products during a defined period in which
we offer a promotion. Rebates are paid quarterly or annually and are accrued for as incurred.
We consider program management packages and training and other services as separate units of
accounting when sold with an AED based on the fact that the items have value to the customer on a
stand alone basis and could be acquired from another vendor. Fair value is determined to be the
price at which they are sold to customers on a stand alone basis. Training
Page 22 of 35
Table of Contents
revenue is deferred and recognized at the time the training occurs. AED program management
services revenue, pursuant to annual or multi-year agreements that exist with some customers, is
deferred and amortized on a straight-line basis over the related contract period.
We offer optional extended service contracts to customers. Fair value is determined to be the
price at which they are sold to customers on a stand alone basis. Service contract revenues are
recognized on a straight-line basis over the term of the extended service contracts, which
generally begin after the expiration of the original warranty period. For services performed, other
than pursuant to warranty and extended service contract obligations, revenue is recognized when the
service is performed and collection of the resulting receivable is reasonably assured.
Recent Accounting Pronouncements
In January 2010, the FASB issued guidance to amend the disclosure requirements related to
recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the
transfers of assets and liabilities between Level 1 (quoted prices in active market for identical
assets or liabilities) and Level 2 (significant other observable inputs) of the fair value
measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the
guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of
the assets and liabilities measured using significant unobservable inputs (Level 3 fair value
measurements). The guidance became effective for us with the reporting period beginning January 1,
2010, except for the disclosure on the roll forward activities for Level 3 fair value measurements,
which will become effective for us with the reporting period beginning January 1, 2011. Other than
requiring additional disclosures, adoption of this new guidance did not and will not have a
material impact on our consolidated financial statements.
In September 2009, the Emerging Issues Task Force (EITF) reached a consensus related to
revenue arrangements with multiple deliverables, which the FASB then issued as an Accounting
Standards Update (ASU), 2009-13. The ASU amends Accounting Standards Codification (ASC)
Subtopic 605-25, Revenue Recognition Multiple Element Arrangements and provides application
guidance on whether multiple deliverables exist in a revenue arrangement, how the deliverables
should be separated and how the consideration should be allocated to one or more units of
accounting. This ASU establishes a selling price hierarchy for determining the selling price of a
deliverable based on vendor-specific objective evidence, if available, third-party evidence, or
estimated selling price if neither vendor-specific nor third-party evidence is available. The ASU
can be applied on a prospective basis or in certain circumstances on a retrospective basis. We plan
to adopt this ASU on a prospective basis beginning January 1, 2011. We believe the adoption of this
ASU may have an impact on our financial position and results of
operations; however, we are
uncertain whether the impact will be material. We are continuing to evaluate this ASU as of June
30, 2010.
In September 2009, the EITF reached a consensus related to revenue arrangements that include
software elements, which the FASB issued as ASU, 2009-14. The ASU amends ASC Subtopic 985-605,
Software Revenue Recognition. Previously, companies that sold tangible products with more
than incidental software were required to apply software revenue recognition guidance. This
guidance often delayed revenue recognition for the delivery of the tangible product. Under the new
guidance, tangible products that have software components that are essential to the functionality
of the tangible product will be excluded from the software revenue recognition guidance. The new
guidance will include factors to help companies determine what is essential to the functionality.
Software-enabled products will now be subject to other revenue guidance and will likely follow the
guidance for multiple deliverable arrangements issued by the FASB in September 2009 in ASU 2009-13.
The new guidance is to be applied on a prospective basis for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010, with earlier application
permitted. We plan to adopt this ASU on a prospective basis beginning January 1, 2011. We believe
the adoption of this ASU may have an impact on our financial position and results of operations;
however, we are uncertain whether the impact will be material. We are continuing to evaluate this
ASU as of June 30, 2010.
Results of Operations
Summary of Results for the Three and Six Months Ended June 30, 2010
| We generated revenue of $36.1 million for the three month period ended June 30, 2010, which was essentially flat compared to the same period of the prior year, but up $3.0 million from the first quarter of 2010. | ||
| We generated revenue of $69.2 million for the six month period ended June 30, 2010, representing a decrease of approximately 9% over the six month period ended June 30, 2009, including declines in defibrillation and cardiac monitoring revenues of 12% and 6%, respectively, as compared to the same period in 2009. |
Page 23 of 35
Table of Contents
| We recorded a charge of $11.0 million during the three month period ended June 30, 2010 related to an estimate of additional costs associated with our updated plan to repair or replace approximately 24,000 AEDs used by first responders and medical facilities in the United States and an estimate of the cost to repair or replace certain devices located outside of the United States that the Company believes that it is probable that it would be required to perform in the future. | ||
| We incurred a net loss of $18.5 million and $27.1 million for the three and six month periods ended June 30, 2010, respectively, compared a net loss of $2.1 million and $2.6 million for the three and six month periods ended June 30, 2009. | ||
| We used cash from operations of $9.3 million and $14.5 million for the three and six month periods ended June 30, 2010, respectively, compared to cash generated from operations of $0.5 million and $4.2 million for the three and six month periods ended June 30, 2009, respectively. | ||
| We successfully negotiated an amendment to our line of credit agreement with Silicon Valley Bank which was finalized in July, 2010, increasing the amount available for borrowing to $15.0 million. This agreement expires in July 2011. | ||
| We made significant progress in addressing our previously announced voluntary corrective actions associated with our AED products, including the release of our universal software update associated with the field corrective action announced in November 2009, as well as the replacement of substantially all of the devices included in our medical device recall announced in February 2010. | ||
| We continued to make progress toward multiple cardiac monitoring product releases which are expected in upcoming quarters. |
Looking Forward
We expect revenue for the full year 2010 to be down slightly compared to the prior year, with
decreases in defibrillation revenue and with cardiac monitoring and service revenue likely flat or
increasing slightly.
After several years of decline, we expect our cardiac monitoring revenues to grow during the
remaining periods in 2010 as a result of recently announced and planned new product introductions
and as a result of improved marketing and demand generation capabilities which were put into place
during 2009. We expect continued growth in cardiac monitoring revenues beyond 2010 as we continue
to develop and introduce new products, either internally or in partnership with third parties. If
we are unable to successfully execute on our new product development plans or if the market is not
receptive to our new products, our cardiac monitoring revenues could be adversely affected in
future periods.
We expect our defibrillation revenue to grow moderately during the second half of 2010
relative to the first half of 2010, although we expect our full year defibrillation revenue to
decline relative to the prior year. We are continuing to face challenges in the market place
related to regulatory and quality issues associated with our AEDs as well as increased competition
due to the re-entry of a significant competitor into the market earlier in 2010. Additionally, we
continue to face challenges in the global economy, as well as declines in our defibrillation
revenue in Japan, due to the termination of our OEM Supply and Purchase Agreement (the OEM
Agreement) with Nihon Kohden Corporation (Nihon Kohden), our former exclusive distributor of
AEDs in Japan, in June 2010.
However, we have entered into a ten-year agreement with a new distribution partner in Japan
and we expect to launch a co-branded AED with this distribution partner in the first half of 2011.
With this agreement in place, we believe our international defibrillation revenues will grow in
2011 and beyond, as we re-establish our presence in the Japanese market. We believe this
distribution partner will be successful in competing in the Japanese AED market by leveraging their
expertise in home medical devices and also leveraging their existing distribution channels and
relationships with many potential AED customers. Our new distribution agreement calls for modest
product commitment levels for the duration of the agreement. However there is no assurance that our
new distribution partner will be able to satisfy these commitment levels during 2011, or beyond. If
we are not successful in launching a co-branded AED with our new distribution partner or if our new
partner is not successful in recapturing market share in Japan, our international defibrillation
revenue growth could be negatively impacted in future periods.
We expect the global market for AEDs to grow over time, as awareness of the benefits of AEDs
continues to increase and as the prevalence of mandates requiring deployment of AEDs in public
venues continues to rise. As the market continues to grow and as we overcome what we believe to be
temporary challenges associated with our regulatory and quality issues, we
Page 24 of 35
Table of Contents
believe that we will be able to grow our defibrillation revenues over time, both domestically
and overseas. We believe our direct presence in several countries in Europe will result in
continued growth in sales in these markets over time, though again we may experience softness in
the near term due to the quality and regulatory issues, the return of a competitor to the market
and continued general economic factors.
We are in the process of working with the FDA on our recent regulatory and quality matters
which were raised in the FDAs warning letter we received in February 2010. As part of this
process, in July 2010 we announced our plans to repair or replace approximately 24,000 AEDs used by
certain first responders and medical facilities in the United States. This represents a subset of
the customers covered by the voluntary corrective action we originally announced in November 2009,
which affected nearly 300,000 AED devices shipped between June 2003 and June 2009. The FDA also
provided an updated public communication regarding these plans in July 2010. The FDA communication
recommended that all other customers impacted by our voluntary corrective action announced in
November 2009, who are not first responders or medical facilities, follow our instructions for
installing the software update on their AEDs which is available on our website or by ordering a
software kit from us. With this updated recommendation by the FDA, we believe we have
addressed all outstanding issues with our previously communicated plan to address potential
component defects through a field software update as originally announced in November 2009.
We are still addressing the remaining matters noted by the FDA in its February 2010 warning
letter. These include assertions by the FDA that our procedures relating to the evaluation,
investigation and follow up of complaints, procedures to verify the effectiveness of corrective and
preventative actions, and procedures relating to certain design requirements are inadequate. To the
extent we are unable to address these matters to the satisfaction of the FDA, we could be
required to temporarily cease shipments of our products, which could ultimately impact
our ability to fulfill customer orders and maintain market share. Further, to the extent we are not
able to satisfy the FDA, we may be subject to further regulatory action by the FDA, including
seizure, injunction and/or civil monetary penalties. Any such regulatory
actions could significantly disrupt our ongoing business and operations and have a material
adverse effect on our financial position and results of operations. While we are
optimistic that we will be successful in addressing our ongoing regulatory matters with the FDA,
our AED revenues may continue to be adversely affected by these circumstances during 2010, and
potentially beyond.
Our future gross profits and gross margins will be dependent upon our overall revenue volume,
by product mix, market pricing and our costs. Increasing volumes provide economies of scale and
tend to enhance our gross margin. AEDs generally have a higher gross margin than our monitoring
products. Accordingly, if our product mix shifts toward a relatively higher proportion of AEDs, our
overall gross margins will increase and if the mix shifts toward a relatively higher proportion of
monitoring products, our overall gross margins are likely to decline. Market pricing for our
products has declined slightly in recent years. As we face challenges in retaining our AED market
share in the face of circumstances discussed elsewhere in this report, we may experience additional
pricing pressure, which may, in turn, result in a reduction of our gross margins. Finally, any
increases in costs, including any unexpected additional costs associated with the ongoing or new
corrective actions or recalls relating to our AEDs, or any other quality issues related to our
products that may arise in the future, would also negatively affect our gross margins. Our actual
gross profit and margins will be dependent on the aggregation of these and other factors.
We expect our operating expenses to increase slightly during 2010 relative to the prior year
due to increased expenses associated with regulatory affairs and quality assurance as we continue
to upgrade our internal capabilities in these areas. We also expect to incur higher research and
development and marketing expenses associated with new product development initiatives and planned
product launches during the second half of 2010. However, we expect to see operating expenses
decrease somewhat in the second half of 2010 as we complete our planned product launches and other
ongoing initiatives near completion. We will continue to monitor our operating expenses in light of
our actual and anticipated future revenues and gross profit and we may need to take additional
steps to reduce operating expenses in the future if our revenues and gross profit do not grow over
time.
We expect to realize an operating loss in 2010 due to softness in our revenue, our ongoing
investments in new product development and product launches and as we make improvements to our
quality and information systems. In addition, the accrual of $11.0 million related to our updated
corrective action announced in July, 2010, will add significantly to our operating loss for the
year. We expect to return to profitability before the end of 2011 and expect to generate cash from
operations for the full year 2011, excluding cash used to complete the ongoing corrective field
actions for which we have accrued as of June 30, 2010.
Revenues
We derive our revenues primarily from the sale of our non-invasive cardiology products and
related consumables, and to a lesser extent, from services related to these products, including
training. We categorize our revenues as (1) defibrillation
Page 25 of 35
Table of Contents
products, which include our AEDs, hospital defibrillators and related accessories; (2)
cardiac monitoring products, which include capital equipment, software products and related
accessories and supplies; and (3) service, which includes service contracts, CPR/AED training
services, AED program management services, equipment maintenance and repair, replacement part sales
and other services. We derive a portion of our service revenue from sales of separate extended
maintenance arrangements. We defer and recognize these revenues over the applicable maintenance
period.
Revenues for the three and six month periods ended June 30, 2010 and 2009 were as follows:
Three Months | Three Months | |||||||||||||||||||||||
Ended | % Change | Ended | Six Months Ended | % Change | Six Months Ended | |||||||||||||||||||
(dollars in thousands) | June 30, 2010 | 2009 to 2010 | June 30, 2009 | June 30, 2010 | 2009 to 2010 | June 30, 2009 | ||||||||||||||||||
Defibrillation products |
$ | 19,051 | 13.0 | % | $ | 16,853 | $ | 34,913 | (12.3 | %) | $ | 39,791 | ||||||||||||
% of revenue |
52.8 | % | 46.7 | % | 50.4 | % | 52.5 | % | ||||||||||||||||
Cardiac monitoring products |
12,621 | (14.7 | %) | 14,800 | 25,526 | (5.9 | %) | 27,127 | ||||||||||||||||
% of revenue |
35.0 | % | 41.0 | % | 36.9 | % | 35.8 | % | ||||||||||||||||
Service |
4,431 | (0.7 | %) | 4,461 | 8,771 | (1.0 | %) | 8,860 | ||||||||||||||||
% of revenue |
12.3 | % | 12.4 | % | 12.7 | % | 11.7 | % | ||||||||||||||||
Total revenues |
$ | 36,103 | (0.0 | %) | $ | 36,114 | $ | 69,210 | (8.7 | %) | $ | 75,778 | ||||||||||||
Defibrillation products revenue increased 13% for the three month period ended June 30,
2010 from the comparable period in 2009, which included the unfavorable impact of approximately
$3.0 million of defibrillation products which were placed on a voluntary ship-hold prior to June
30, 2009, as management investigated possible quality issues relating to certain components of our
AEDs. Absent this prior year event, defibrillation product revenue
was down approximately 6%, or
$1.0 million, due mostly to a decline in AED shipments to Nihon Kohden as compared to the three
month period ended June 30, 2009.
Defibrillation products revenue decreased 12% for the six month period ended June 30, 2010
from the comparable period in 2009 due primarily to declines in international sales of 23%,
including a decrease of approximately 11%, or $4.5 million, due to a significant decline in AED
shipments to Nihon Kohden during the first half of 2010 as compared to the same period in 2009. The
remainder of the decrease in defibrillation products revenue was due primarily to the adverse
impact and publicity associated with the FDA warning letter we received in February 2010, and to a
lesser extent to the return of a significant competitor to the market. Additionally, the impact of
the weak economy continues to provide challenges for our AED business both domestically and
internationally.
Cardiac monitoring products revenue decreased by 15% for the three month period ended June 30,
2010 from the comparable period in 2009. The decline reflects the fact that our cardiac monitoring
revenue for the second quarter of 2009 benefited to a significant extent from the fulfillment of
backlog resulting from a ship hold of certain products during the first quarter of 2009. Revenue
from cardiac monitoring decreased by 6% for the six month period ended June 30, 2010 from the
comparable period in 2009 due primarily to the weakened economy and as our physician customers
defer purchases of capital equipment in the face of continuing uncertainty about reimbursement
levels for procedures used in providing patient care.
Service revenue remained relatively flat for both the three month and six month periods ended
June 30, 2010 from the comparable periods in 2009.
Gross Profit
Gross profit is revenues less the cost of revenues. Cost of revenues consists primarily of the
costs associated with manufacturing, assembling and testing our products, amortization of certain
intangibles, overhead costs, compensation, including stock-based compensation and other costs
related to manufacturing support and logistics. Cost of revenues also includes costs associated
with corrective actions and recalls associated with our products. We rely on third parties to
manufacture certain of our product components. Accordingly, a significant portion of our cost of
revenues consists of payments to these manufacturers. Cost of service revenue consists of customer
support costs, training and professional service expenses, parts and compensation. Our hardware
products include a warranty period that includes factory repair services or replacement parts. We
accrue estimated expenses for warranty obligations at the time products are shipped.
Page 26 of 35
Table of Contents
Gross profit for the three and six month periods ended June 30, 2010 and 2009 was as follows:
Three Months | Three Months | |||||||||||||||||||||||
Ended | % Change | Ended | Six Months Ended | % Change | Six Months Ended | |||||||||||||||||||
(dollars in thousands) | June 30, 2010 | 2009 to 2010 | June 30, 2009 | June 30, 2010 | 2009 to 2010 | June 30, 2009 | ||||||||||||||||||
Products |
$ | 15,625 | (3.7 | %) | $ | 16,220 | $ | 29,364 | (15.7 | %) | $ | 34,851 | ||||||||||||
% of products
revenue |
49.3 | % | 51.2 | % | 48.6 | % | 52.1 | % | ||||||||||||||||
Corrective action costs |
(11,000 | ) | n/m | | (11,000 | ) | n/m | | ||||||||||||||||
Service |
1,244 | (6.5 | %) | 1,331 | 2,421 | (6.1 | %) | 2,579 | ||||||||||||||||
% of service revenue |
28.1 | % | 29.8 | % | 27.6 | % | 29.1 | % | ||||||||||||||||
Total gross profit |
$ | 5,869 | (66.6 | %) | $ | 17,551 | $ | 20,785 | (44.5 | %) | $ | 37,430 | ||||||||||||
% of total revenue |
16.3 | % | 48.6 | % | 30.0 | % | 49.4 | % |
Gross profit from products decreased for the three and six month periods ended June 30,
2010 from the comparable periods in 2009 due in part to significant declines in both revenue and
gross profit related to lower AED sales to our former exclusive distributor in Japan, Nihon Kohden.
Additionally, gross margins from products decreased during the three and six month periods ended
June 30, 2010 from the comparable periods in 2009 due primarily to changes in product mix, cost
increases in certain product components, and inefficiencies in our factory due to our recent recall
activities.
Charges associated with corrective action costs of $11.0 million incurred in the three and six
month periods ended June 30, 2010 represent estimated additional costs associated with our
voluntary corrective action related to our AEDs which we previously announced in November 2009.
During the second quarter of 2010, we recorded an additional charge of $11.0 million related to our
estimated costs associated with repairing or replacing approximately 24,000 AEDs used by certain
first responders and medical facilities in the United States, and also includes an estimate of
costs to repair or replace certain devices located outside of the United States which we believe
that it is probable that we would be required to perform in the future. This represents a subset of
the customer based affected by the November 2009 corrective action. The estimated costs associated
with repairing or replacing these devices consist primarily of materials, shipping and other
logistical costs required to manage the corrective actions and replace the units with our
customers. There were no similar charges during the three and six month periods ended June 30,
2009. See the Looking Forward section above for additional information regarding the impact of
possible corrective actions on gross profit in future periods.
Gross profit from service decreased for the three and six month periods ended June 30, 2010
from the comparable periods in 2009 due principally to lower service revenues associated with our
AED training and program management services related to declines in AED product sales during the
same periods.
Operating Expenses
Operating expenses include expenses related to research and development, sales, marketing and
other general and administrative expenses required to run our business, including stock-based
compensation.
Research and development expenses consist primarily of salaries and related expenses for
development and engineering personnel, fees paid to consultants, and prototype costs related to the
design, development, testing and enhancement of products. Several components of our research and
development activities require significant funding, the timing of which can cause significant
quarterly variability in our expenses.
Sales and marketing expenses consist primarily of salaries, commissions and related expenses
for personnel engaged in sales, marketing and sales support functions as well as costs associated
with corporate and product branding, promotional and other marketing activities.
General and administrative expenses consist primarily of employee salaries and related
expenses for executive, finance, accounting, information technology, regulatory affairs, quality
assurance and human resources personnel as well as bad debt expense, professional fees, legal fees,
and other corporate expenses.
Operating expenses for the three and six month periods ended June 30, 2010 and 2009 were as
follows:
Page 27 of 35
Table of Contents
Three Months | % Change 2010 | Three Months | Six Months | % Change 2010 | Six Months | |||||||||||||||||||
Ended | to 2009 | Ended | Ended | to 2009 | Ended | |||||||||||||||||||
(dollars in thousands) | June 30, 2010 | (Increase)/Decrease | June 30, 2009 | June 30, 2010 | (Increase)/Decrease | June 30, 2009 | ||||||||||||||||||
Research and development |
$ | 4,629 | (28.0 | %) | $ | 3,617 | $ | 8,834 | (24.6 | %) | $ | 7,088 | ||||||||||||
% of total revenue |
12.8 | % | 10.0 | % | 12.8 | % | 9.4 | % | ||||||||||||||||
Sales and marketing |
12,412 | (10.1 | %) | 11,271 | 25,214 | (12.2 | %) | 22,469 | ||||||||||||||||
% of total revenue |
34.4 | % | 31.2 | % | 36.4 | % | 29.7 | % | ||||||||||||||||
General and administrative |
7,201 | (13.4 | %) | 6,349 | 13,594 | (13.6 | %) | 11,965 | ||||||||||||||||
% of total revenue |
19.9 | % | 17.6 | % | 19.6 | % | 15.8 | % | ||||||||||||||||
Total operating expenses |
$ | 24,242 | (14.1 | %) | $ | 21,237 | $ | 47,642 | (14.7 | %) | $ | 41,522 | ||||||||||||
% of total revenue |
67.1 | % | 58.8 | % | 68.8 | % | 54.8 | % |
The increase in research and development expenses for the three and six month periods
ended June 30, 2010 from the comparable periods in 2009 was due primarily to outside design costs
and other professional services relating to planned new cardiac monitoring product introductions
during the second half of 2010.
The increase in sales and marketing expenses for the three and six month periods ended June
30, 2010 from the comparable periods in 2009 was due primarily to increased consulting and business
development fees for lead generation activities and promotion for the upcoming product launches as
well as increased salaries and benefits associated with headcount increases and changes in staffing
mix. Additionally, sales and marketing expenses increased for the six month period ended June 30,
2010 from the comparable period in 2009 due to increased labor and severance costs incurred during
the first quarter of 2010 related to our former Senior Vice President of Sales and Marketing.
The increase in general and administrative expenses for the three and six month periods ended
June 30, 2010 from the comparable periods in 2009 was due primarily to increased headcount,
consulting and professional fees associated with expanding our internal capabilities in both our
regulatory affairs and quality assurance functions as well as our information technology function
for system upgrades. Additionally, general and administrative expenses increased for the six month
period ended June 30, 2010 from the comparable period in 2009 due to increased salaries and
benefits resulting from general compensation increases as well as increased legal and other
professional fees related to financing and related initiatives.
Other Income and Expense
Other income (loss), net was a loss of less than ($0.1) million for the three month period
ended June 30, 2010 as compared to income of $0.5 million during the same period in 2009. Other
loss, net for the three month period ended June 30, 2010 consisted primarily of net foreign
currency exchange losses of ($0.2) million, partially offset by $0.1 million of income from royalty
agreements. Other income, net for the three month period ended June 30, 2009 consisted primarily of
net foreign currency exchange gains of $0.3 million, income from royalty agreements of $0.1 million
and other miscellaneous income items totaling $0.1 million.
Other income (loss), net was income of $0.1 million for the six month period ended June 30,
2010 as compared to income of $0.4 million during the same period in 2009. Other income, net for
the six month period ended June 30, 2010 consisted primarily of income from royalty agreements of
$0.3 million and other miscellaneous income items totaling $0.1 million, partially offset by net
foreign currency exchange losses of ($0.3) million. Other income, net for the six month period
ended June 30, 2009 consisted primarily of net foreign currency exchange gains of $0.1 million,
income from royalty agreements of $0.2 million and other miscellaneous income items totaling $0.1
million.
Page 28 of 35
Table of Contents
Income Taxes
During the three and six month periods ended June 30, 2010, we recorded income tax expense of
$0.1 million and $0.2 million, respectively, compared to income tax benefits of $1.2 million and
$1.4 million in the three and six month periods ended June 30, 2009, respectively. Our worldwide
effective tax rate, excluding the U.S. jurisdictions, for the six month period ended June 30, 2010
was 29% as compared to a worldwide effective tax benefit of 37.0% for the same period in the prior
year.
The difference in our estimated worldwide effective tax rate for the six month period ended
June 30, 2010 as compared to the same period in the prior year is due largely to the exclusion of
the U.S. jurisdiction from the worldwide effective tax rate for the six month period ended June 30,
2010 and for the full year of 2010. We excluded the U.S. jurisdiction based on authoritative
guidance that a jurisdiction should be excluded from the worldwide effective tax rate and
calculated separately to the extent such jurisdiction anticipates an ordinary loss for the year or
has ordinary losses for the year to date for which no tax benefit can be recognized. The U.S
jurisdiction was not excluded from our estimated worldwide effective tax rate for the same period
in the prior year, and our estimated worldwide effective tax rate was based on estimates of pre-tax
income or losses for the full year, applicable tax rates in jurisdictions in which income and
losses were expected to be generated, including the U.S., and expected U.S. federal and state tax
credits.
The decrease of our worldwide effective tax rate from 31% to 29% between the three month
period ended March 31, 2010 and the six month period ended June 30, 2010 is due primarily to
favorable true-ups related to tax filings in foreign jurisdictions which had lower pre-tax book
income on their tax returns than what was anticipated December 31, 2009.
We have maintained the valuation allowance on our domestic deferred tax assets as the evidence
available at June 30, 2010 does not warrant a change and as such, we believe it is not more likely
than not that we will be able to realize the benefits of the losses anticipated in the current
year. If in future periods we generate taxable income, the valuation allowance may be released in
part, or in total, when it becomes more likely than not that the deferred tax assets will be
realized. Until this occurs, we will continue to record a deferred tax benefit for any domestic
losses that might be incurred in the future and we will record deferred tax expense to increase the
recorded valuation allowance for any such additional losses. The tax expense recorded in the
quarter ended June 30, 2010 relates primarily to our foreign operations, which generally are
forecasted to be marginally profitable during 2010.
Liquidity and Capital Resources
Three Months | Three Months | Six Months | Six Months | |||||||||||||||||||||
Ended | % Change | Ended | Ended | % Change | Ended | |||||||||||||||||||
(dollars in thousands) | June 30, 2010 | 2009 to 2010 | June 30, 2009 | June 30, 2010 | 2009 to 2010 | June 30, 2009 | ||||||||||||||||||
Cash provided by (used in) operating activities |
$ | (9,331 | ) | (2031.9 | %) | $ | 483 | $ | (14,490 | ) | (442.9 | %) | $ | 4,226 | ||||||||||
Cash used in investing activities |
(669 | ) | 11.9 | % | (759 | ) | (1,343 | ) | 17.4 | % | (1,625 | ) | ||||||||||||
Cash provided by (used in) financing activities |
(7 | ) | (101.4 | %) | 502 | 58 | (90.9 | %) | 639 | |||||||||||||||
Effect of
exchange rates on cash and cash equivalents |
(113 | ) | (243.0 | %) | 79 | (206 | ) | (663.0 | %) | (27 | ) | |||||||||||||
Net change in cash and cash equivalents |
$ | (10,120 | ) | (3418.0 | %) | $ | 305 | $ | (15,981 | ) | (597.4 | %) | $ | 3,213 | ||||||||||
Cash used in operating activities of $9.3 million for the three month period ended June 30,
2010 resulted from our net loss of $18.5 million plus adjustments for net non-cash items included
in our net loss of $2.3 million and a net decrease in working capital of $6.9 million. The net
non-cash items included in our net loss related primarily to depreciation and amortization and
stock-based compensation. The net decrease in working capital of $6.9 million was due primarily to
an increase in current liabilities, most notably the $11.0 million estimate for additional
corrective action liabilities, for which cash will be expended in future periods, an increase in
accounts payable of $1.6 million and a decrease in inventory of $1.0 million, substantially offset
by cash used in the amount of $3.1 million used to satisfy our ongoing corrective action
liabilities and an increase in accounts receivables of $2.7 million. Cash provided by operating
activities of $0.5 million for the three month period ended June 30, 2009 resulted from our net
loss of $1.9 million offset by adjustments for net non-cash items included in net income of $0.7
million and a net increase in working capital of $1.7 million. The net increase in working capital
of $1.7 million was due primarily to a decrease in accounts receivable of $0.7 million and a $1.0
million increase in accrued liabilities. The net non-cash items included in net income related
primarily to depreciation and amortization, stock-based compensation and deferred income taxes.
Cash used in operating activities of $14.5 million for the six month period ended June 30,
2010 resulted from our net loss of $26.9 million plus adjustments for net non-cash items included
in our net loss of $4.4 million and a net decrease in working capital of $8.0 million. The net
non-cash items included in our net loss related primarily to depreciation and amortization and
Page 29 of 35
Table of Contents
stock-based compensation. The net decrease in working capital of $8.0 million was due
primarily to an increase in current liabilities, most notably the $11.0 million estimate for
additional corrective action liabilities, for which cash will be expended in future periods and an
increase in accounts payable and accrued liabilities of $2.3 million, substantially offset by cash
in the amount of $4.8 million used to satisfy our ongoing corrective action liabilities and an
increase in inventory of $1.0 million. Cash provided by operating activities of $4.2 million for
the six month period ended June 30, 2009 resulted from our net loss of $2.3 million offset by
adjustments for net non-cash items included in net income of $2.5 million and a net increase in
working capital of $4.0 million. The net increase in working capital of $4.0 million was due
primarily to a decrease in accounts receivable of $8.7 million offset by an increase in inventories
of $1.3 million and a decrease in accounts payable of $2.5 million. The net non-cash items included
in net income related primarily to depreciation and amortization, stock-based compensation and
deferred income taxes.
We anticipate that we will continue to use cash in operations during the remainder of 2010 due
in part to our anticipation of operating losses for the year and also due to the cash requirements
associated with carrying out the two voluntary corrective actions associated with our AEDs
described elsewhere in this report, including the additional estimated costs of $11.0 million
recorded during the second quarter of 2010 related to our plans to repair or replace approximately
24,000 AEDs used by certain first responders and medical facilities in the United States and
potentially outside of the United States. See Note 2 Corrective Action Liabilities to the
unaudited condensed consolidated financial statements. Our use of cash to fund operations may be
further impacted by other general business factors such as our ability to successfully sell our
products and deliver our services, collect our accounts receivables, optimize lead times and
inventory levels, and manage our expenses.
Net cash used in investing activities for the three and six month periods ended June 30, 2010
and June 30, 2009 consisted of payments for capital expenditures related primarily to investments
in information technology and new manufacturing equipment, including tooling for products under
development.
Net cash provided by financing activities for the three and six month periods ended June 30,
2010 and 2009 consisted of proceeds from exercises of stock options and sales of common stock under
our Employee Stock Purchase Plan, less required minimum tax withholdings on restricted stock awards
remitted to taxing authorities.
As of June 30, 2010, we had cash and cash equivalents of $10.9 million. We expect to incur
operating losses for the remainder of 2010 and to use cash in operations. We have initiated two
voluntary corrective actions relating to our AED products, the costs of which were estimated at
$21.0 million and were included in our results of operations for the full year ended December 31,
2009 and an additional $11.0 million has been included in our results of operations for the second
quarter ended June 30, 2010. As of June 30, 2010, we had
used cash of $10.5 million
towards these corrective actions. The costs recorded are estimates and actual costs that we will
incur to complete the corrective actions could be more or less than the $21.5 million that is
remaining in our accrued corrective action liabilities on the unaudited condensed consolidated
balance sheet as of June 30, 2010. We expect to satisfy a significant portion of the requirements
under the ongoing corrective actions during the remainder of 2010 and
during 2011 and we expect to spend a significant amount of the
remaining accrued corrective action liability costs during this period, which will negatively
impact our cash position for the remainder of 2010 and during 2011. In addition, we expect to
operate at a loss and to use cash in operations for the remainder of 2010. However, we are
forecasting a return to profitability before the end of 2011. We believe our existing cash and cash
equivalents, together with borrowings under our line of credit with Silicon Valley Bank discussed
below, will be sufficient to fund our anticipated operating losses, meet working capital
requirements and fund anticipated capital expenditures and other obligations, including the
estimated remaining costs of the ongoing corrective actions, for at least the next twelve months.
However, we may be affected by economic, financial, competitive, legislative, regulatory,
business and other factors beyond our control. As discussed in Note 2 to the unaudited condensed
consolidated financial statements and elsewhere in this report, in February 2010, we received a
warning letter from the FDA noting, among other things, that the voluntary field corrective action
undertaken in November 2009 is inadequate. In April 2010, the FDA published additional information
regarding this corrective action, further clarifying the AED models impacted by the potential
component defect and provided further guidance to users of our affected AEDs. Additionally, the FDA
noted that our software update addresses some, but not all electrical component defects. In July
2010, concurrent with our announcement relating to our updated corrective action plan, the FDA
published a communication regarding our updated corrective action plan, citing our commitment to
repair or replace approximately 24,000 high risk and/or frequently used AEDs with first responders
and medical facilities within the United States. The FDA recommended that all other impacted
customers follow the process, as we outlined, for implementing the software update
which has been made available to customers through our website or through a software kit shipped
directly to the customer. With this updated recommendation by the FDA, we believe we have addressed
all outstanding issues with our previously communicated plan to address potential component defects
through a field software update as originally announced in November 2009.
We are in ongoing discussions with the FDA regarding the remaining matters it raised in its
warning letter. These include assertions by the FDA that our procedures relating to the evaluation,
investigation and follow up of complaints, procedures to
Page 30 of 35
Table of Contents
verify the effectiveness of corrective and preventative actions, and procedures relating to
certain design requirements are inadequate. It is possible that we may need to take additional
actions beyond those incurred to date depending on the outcome of those discussions. If we are
unable to satisfy the FDAs remaining concerns, we may be subject to regulatory action by the FDA,
including but not limited to seizure, injunction, halting shipment of our products and/or civil
monetary penalties. Any such actions could significantly disrupt our ongoing business and
operations and have a material adverse effect on our financial position and results of operations.
Additionally, quality issues and related corrective actions, as well as other matters such as the
recent re entry into the market of the former AED market leader and our ability to identify a new
distribution partner in Japan, may adversely impact our projected revenues in the near term.
Accordingly, we may be required to reduce costs, which could adversely impact our forecasts for
revenue growth in future periods.
On July 16, 2010, we amended our existing line of credit agreement with Silicon Valley Bank to
increase the amount available for borrowing on a revolving credit basis from $5.0 million to $15.0
million. This new agreement expires in July 14, 2011 (the maturity date). Our ability to borrow
under this agreement is based largely on our accounts receivable outstanding at the time of
borrowing and, to a lesser extent, on our inventory holdings. Interest on borrowings, if any, will
be based on the Wall Street Journal Prime rate plus 2.5%. Interest is payable monthly, on the last
day of the month, and all obligations are due on the maturity date.
In addition, upon finalizing our
agreement in July 2010, we paid Silicon Valley Bank a non-refundable commitment fee of $175,000 and
any unused balances under this facility will bear monthly fees equal to 0.25% per annum on the
average unused portion of the revolving line. We granted Silicon Valley Bank a first priority
security interest in substantially all of our assets to secure our obligations under the above line
of credit. At June 30, 2010, we did not have any borrowings under this, or any other, line of
credit.
Given the above factors, we plan to closely monitor our projected operating results and cash
balances during the remainder of 2010, and beyond. To the extent our actual operating results are
not in line with our projected results, we intend to reduce costs, to the extent necessary, to
enable us to continue operations for at least the next twelve months. While such cost reductions
might negatively impact future growth opportunities, we believe we have the ability to make such
reductions, should they become necessary. Our ability to grow the business through possible
acquisitions funded by cash or other borrowing has been reduced substantially for the foreseeable
future, as we plan to use a significant amount of our existing cash and cash equivalents, as well
as borrowings, during the remainder of 2010 and throughout 2011 to fund our ongoing corrective
actions and operating losses. Further, we believe that we will be able to renew our line of credit
agreement with Silicon Valley Bank in July 2011. However, to the extent we are not successful in
renewing our line of credit, or if other adverse events or circumstances arise during the remainder
of 2010 or 2011 which could require additional funding beyond that available under our current line
of credit, we may need to seek additional or alternative sources of financing. There can be no
assurance that we would be able to obtain financing from alternative sources and, if such financing
were to be available, it may be expensive and/or dilutive to stockholders.
For more information on the factors that may impact our financial results, please see the Risk
Factors included in our Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 15, 2010, our Quarterly Report on Form 10-Q for the quarter ended March 31,
2010 and elsewhere in this report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We develop products in the U.S. and sell them worldwide. As a result, our financial results
could be affected by factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. Since the majority of our revenues are currently priced in U.S.
dollars and are translated to local currency amounts, a strengthening of the dollar could make our
products less competitive in foreign markets.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures (as defined under Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended). Management, under the supervision
and with the participation of our chief executive officer and our chief financial officer,
evaluated the effectiveness and design of the Companys disclosure controls and procedures pursuant
to Exchange Act Rule 13a-15(b) as of June 30, 2010. Based on that evaluation, our chief executive
officer and our chief financial officer concluded that the Companys disclosure controls and
procedures were effective as of June 30, 2010.
There were no changes in our internal control over financial reporting that occurred during
our fiscal quarter ended June 30, 2010 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
Page 31 of 35
Table of Contents
PART II OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to various other legal proceedings arising in the normal course of business. In
the opinion of management, the ultimate resolution of these proceedings is not expected to have a
material effect on our consolidated financial position, results of operations or cash flows.
Item 1A. Risk Factors
We face numerous challenges in implementing a field corrective action plan to address the
component issue that led to our AED ship-hold in late June 2009 and our business, financial
position and results of operations may be negatively impacted by the costs and other commitments
needed to carry out the plan.
In late June 2009, we voluntarily ceased shipments of certain of our AED products due to two
instances we became aware of involving the failure of our AEDs to deliver therapy, apparently as a
consequence of a malfunction of one of the components used in the manufacture of the affected AED.
On August 10, 2009, we resumed production and shipments of the affected AED products after
implementing a more stringent process to test for defects in the component at issue. As a result of
a thorough review and analysis performed during the third quarter of 2009, we determined that the
component at issue has the potential to fail and that routine self-tests performed by the AED may
not detect a malfunctioning component. We also determined that approximately 300,000 AEDs shipped
between June 2003 and June 2009 are potentially impacted by the component issue. Although we
determined that the probability that an AED would fail to deliver therapy as a result of a
malfunction of the component issue was low, we decided to implement a field corrective action to
enhance the reliability of the affected AED units in the field. We publicly announced our proposed
corrective action to address this component issue in November 2009 through a field software update.
In July 2010, we further announced our plans to also repair or replace approximately 24,000 high
risk and/or frequently used AEDs with first responders and medical facilities in the United States,
which are included in this overall population of AEDs.
Our proposed voluntary corrective action is subject to numerous risks and uncertainties,
including the following:
| since we have limited history and experience designing and carrying out a field initiative or other corrective action plan of the magnitude under contemplation, we are likely to encounter challenges that could cause a delay in the implementation of the field initiative or negatively impact its effectiveness; | ||
| the actual costs to implement the proposed field initiative could exceed the $29.5 million estimate taken as a charge of $18.5 million in the third quarter of 2009 and an additional $11.0 million charge in the second quarter of 2010. Actual costs could vary due to a variety of factors, including the outcome of discussions or negotiations with applicable regulatory bodies in geographies outside the United States, the number of impacted devices, the customer and geographical segments related to the impacted devices, the logistical processes we employ to address the issues, the customer response rate in implementing the corrective action plans, the level of required follow up with customers, the extent to which we rely on third party assistance to carry out the corrective actions, the extent to which AED units recovered from affected customers can be repaired and used as replacement units for other customers, and the length of time and other resources required to complete the corrective actions, among others | ||
| implementation of the proposed field initiative, as well as attendant publicity, may create a negative perception of our AED products in the market, leading to a decline in sales that could materially adversely impact our financial position and results of operations; | ||
| we will need to devote technical, management, logistics and other resources to the implementation of the proposed field initiative, which could detract from our ability to operate our core business and hinder our ability to carry out initiatives relating to new products or product enhancements; | ||
| despite implementation of the field initiative, some devices may still fail at a time when they are being used to deliver therapy, which could lead to product liability claims against us that, if successful, could adversely impact our financial position and results of operations or negatively impact the markets perception of our products; and | ||
| the plan, including the expanded scope announced in July 2010, will require the expenditure of significant amounts of cash which, in combination with expected operating losses during 2010, may negatively impact our liquidity or at least constrain our ability to pursue strategic initiatives such as acquisitions, new product development, or other growth initiatives. |
Page 32 of 35
Table of Contents
Moreover, in February 2010, we received a warning letter from the FDA noting, among other
things, that the proposed field corrective action is inadequate since it is intended to improve the
products ability to detect the potential component problem, but is not designed to prevent
component failure. The FDA letter also asserted other inadequacies, including our procedures
relating to the evaluation, investigation and follow up of complaints, procedures to verify the
effectiveness of corrective and preventative actions and procedures relating to certain design
requirements. In July 2010, following discussions with the FDA, we announced our plans to repair or
replace approximately 24,000 AEDs used by certain first responders and medical facilities in the
United States. The FDA also updated its public recommendation citing our plan to repair or replace
these AEDs and that all other customers should follow our plans to address the potential
component defects through installation of a software update to the AED. We believe this addressed
all remaining matters with the FDA related to our plans to address the potential component defects
associated with our AEDs which was announced in November 2009. However, we are still addressing the
remaining matters identified by the FDA in its warning letter from February 2010. If we are unable
to satisfy the FDAs concerns regarding these matters, we may be subject to regulatory action by
the FDA, including seizure, injunction and/or civil monetary penalties. Any such actions could
significantly disrupt our ongoing business and operations and have a material adverse effect on our
financial position and operating results.
Our cash and cash equivalents may not be sufficient to fund future operations and we may not be
able to secure additional sources of financing or obtain financing on acceptable terms.
Our cash and cash equivalents as of June 30, 2010, totaled $10.9 million. We expect to incur
operating losses in 2010 and to use cash in operations. Additionally, we have two ongoing voluntary
corrective actions relating to our AED products, the costs of which have been estimated at $32.0
million in the aggregate, of which $21.5 million remains as an accrued liability as of June 30,
2010. We expect to spend a significant portion of the remaining accrued costs associated with these
corrective actions by the end of 2011 which will negatively impact our cash position for the rest
of 2010 and during 2011. We believe our existing cash and cash equivalents will be sufficient to
fund our anticipated operating losses, meet working capital requirements and fund anticipated
capital expenditures needs and other obligations, including the remaining estimated costs of the
ongoing corrective actions, through at least the next twelve months.
However, we cannot be certain our cash and cash equivalents, together with borrowings under
our recently amended line of credit with Silicon Valley Bank, will be sufficient to meet our
operating needs through 2011 as we may be affected by economic, financial, competitive,
legislative, regulatory, business and other factors beyond our control. Accordingly, we may be
required to reduce costs, which could adversely impact our forecasts for revenue growth in future
periods which in turn could also adversely impact our forecasts for cash and cash equivalents
throughout the year. In addition, we may be forced to borrow from our available line of credit or
may need to seek additional or alternative sources of financing.
There can be no assurance that we
would be able to obtain financing from alternative sources and, if such financing were to
be available, it may be expensive and/or dilutive to stockholders.
On July 16, 2010, we amended our existing line of credit agreement with Silicon Valley Bank
which now provides up to $15.0 million of revolving credit. Our ability to borrow under this
agreement is based largely on our accounts receivable outstanding at the time of borrowing and, to
a lesser extent, on our inventory holdings. Interest on borrowings, if any, will be based on the
Wall Street Journal Prime rate plus 2.5%. This new agreement expires in July 2011 and all amounts
outstanding under this facility will be due and payable at that time. We may be unable to extend
this facility when it expires or refinance amounts outstanding at maturity, which could have a
material adverse effect on our liquidity.
With the exception of the risk factors above, there have been no new risk factors or updates
to risk factors that we are aware of from the risk factors set forth in Part I, Item 1A in our
Annual Report on Form 10-K for the year ended December 31, 2009 filed with the Securities and
Exchange Commission (SEC) on March 15, 2010 and in Part II, Item 1A in our Quarterly Report on
Form 10-Q for the quarter ended March 31, 2010 filed with the SEC on May 7, 2010.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Removed and Reserved
Page 33 of 35
Table of Contents
Item 5. Other Information
None.
Item 6. Exhibits
No. | Description | |
31.1
|
Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. | |
31.2
|
Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. | |
32.1
|
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2
|
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
10.1
|
Third Amended and Restated Loan and Security Agreement dated as of July 16, 2010 between Silicon Valley Bank and Cardiac Science Corporation. (1) | |
10.2
|
Loan and Security Agreement (EX IM Loan Facility) dated as of July 16, 2010 between Silicon Valley Bank and Cardiac Science Corporation. (1) | |
10.3
|
Export-Import Bank of the United States Working Capital Guarantee Program Borrower Agreement dated as of July 16, 2010 entered into by Cardiac Science Corporation in favor of the Export-Import Bank of the United States and Silicon Valley bank. (1) | |
10.4
|
Form of Executive Incentive Plan dated as of June 1, 2010 |
(1) | Incorporated by reference to the Registrants Current Report on Form 8-K (File No 000-51512) filed on July 19, 2010. |
Page 34 of 35
Table of Contents
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CARDIAC SCIENCE CORPORATION |
||||
By: | /s/ Michael K. Matysik | |||
Michael K. Matysik | ||||
Senior Vice President and Chief Financial Officer (Principal Financial Officer) | ||||
Date:
August 6, 2010
Page 35 of 35