10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

x Annual Report Under Section 13 or 15(d) of The Securities Exchange Act of 1934

 

For the fiscal Year Ended December 31, 2003

 

OR

 

¨ Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                  to                 

 

Commission File Number 0-19567

 


 

CARDIAC SCIENCE, INC.

(Exact Name of registrant as specified in its Charter)

 

Delaware   33-0465681

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

1900 Main Street, Suite 700, Irvine, CA 92614

(Address of Principal Executive Offices) (Zip Code)

 

Issuer’s telephone number (949) 797-3800

 

Securities registered under Section 12(b) of the Exchange Act:

 

None.

 

Securities registered under Section 12(g) of the Exchange Act:

 

Common Stock, $0.001 Par Value

(Title of Class)

 


 

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

 

Indicate by check mark if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K:  x

 

Indicate by check mark if the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes  x    No  ¨

 

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price of Common Stock on June 30, 2003, as reported by the Nasdaq National Market System, was approximately $160,381,000. Shares of voting stock held by each officer and director and by each person who owns 10% or more of the outstanding voting stock have been excluded in that such persons may be deemed to be affiliates. This assumption regarding affiliate status is not necessarily a conclusive determination for other purposes.

 

There were 80,576,128 shares of the registrant’s Common Stock outstanding as of March 11, 2004.

 



Table of Contents

TABLE OF CONTENTS

 

Item Number and Caption


   Page
Number


PART I     

Item 1.

  

Description of Business

   1

Item 2.

  

Description of Property

   19

Item 3.

  

Legal Proceedings

   20

Item 4.

  

Submission of Matters to a Vote of Security Holders

   21
PART II     

Item 5.

  

Market for Common Equity and Related Stockholder Matters

   22

Item 6.

  

Selected Financial Data

   23

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   25

Item 7A.

  

Quantitative and Qualitative Disclosures about Market Risk

   32

Item 8.

  

Financial Statements and Supplementary Data

   32

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   60

Item 9A.

  

Controls and Procedures

   60
PART III     

Item 10.

  

Directors and Executive Officers of the Registrant

   61

Item 11.

  

Executive Compensation

   65

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management

   69

Item 13.

  

Certain Relationships and Related Transactions

   71

Item 14.

  

Principal Accountant Fees and Services

   71

Item 15.

  

Exhibits, Financial Statement Schedules and Reports on Form 8-K

   72

 

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PART I

 

ITEM 1. DESCRIPTION OF BUSINESS.

 

Overview

 

Cardiac Science is a leading developer, manufacturer and marketer of life-saving public access defibrillators, or automated external defibrillators (“AEDs”), and the largest corporate provider of comprehensive AED/CPR training services. We also manufacture and market a unique therapeutic in-hospital patient monitor-defibrillator that instantly and automatically treats cardiac patients with life-threatening heart rhythms and those that suffer sudden cardiac arrest (“SCA”). More than 450,000 people in the United States die each year from SCA. SCA is the leading cause of death in both the United States and Europe. Approximately two thirds of SCA deaths occur outside a hospital, and according to the American Heart Association (“AHA”) survival rates for victims of SCA average 5% outside the hospital. For victims of SCA, survival is directly linked to the amount of time between the onset of SCA and receiving a defibrillation shock, so that for every minute that goes by without a defibrillation shock, a victim’s chance of survival is reduced by approximately 10%. Additionally, the average survival rate for patients suffering an in-hospital SCA-event, is estimated to be less than 25%—a rate that has not improved since the 1960s.

 

Our proprietary RHYTHMx® software technology, and STAR® Biphasic energy delivery system, form the technology platform for our line of AED products, the Powerheart AED®, and our unique therapeutic monitor-defibrillator, the Powerheart® Cardiac Rhythm Module®, or Powerheart® CRM®. Our products and technology are designed to easily and effectively treat victims of SCA whether outside or inside a hospital in the shortest time frame possible, thereby significantly increasing a victim’s chance of survival. Once the electrodes of our Powerheart AED are placed on a patient, our device instantly and accurately detects the presence of any life-threatening arrhythmias and will advise the user to deliver a shock if required. In the case of our in-hospital Powerheart CRM, which continuously monitors a patient’s heart rhythms in the event of a life-threatening arrhythmia, can automatically deliver a potentially life-saving shock to the patient, with no human intervention.

 

We are active in new product development initiatives, including expanding and enhancing our existing Powerheart AED product line, as well as integrating our RHYTHMx and STAR Biphasic technology into new cardiac resuscitation product platforms for our strategic Original Equipment Manufacturer (“OEM”) partner General Electric Medical Systems (“GEMS”). We have a portfolio of 82 issued patents relating to our core technology and products.

 

In September 2001, we acquired Survivalink Corporation (“Survivalink”), a privately held Minneapolis, Minnesota-based manufacturer of AEDs. The acquisition of Survivalink enabled us to enter the rapidly growing AED marketplace, which we estimated to have worldwide sales of $200 million in 2003 and, according to Frost & Sullivan and our estimates, is expected to grow to approximately $650 million in sales in 2006.

 

In November 2001, we acquired approximately 95% of the outstanding shares of Artema Medical AB, (“Artema”) a Swedish based developer, manufacturer and marketer of standard hospital-based emergency defibrillators and patient monitoring equipment, which also had operations in Denmark. This acquisition provided us with a network of international distributors and the infrastructure required to establish our international headquarters in Copenhagen, Denmark.

 

In May 2002, we placed $50 million in 6.9% senior notes due May 2007 with Perseus, LLC, a merchant bank and private equity fund management company. We used the proceeds from this financing to retire $27 million in short term notes issued in connection with our acquisition of Survivalink and for working capital purposes. The interest on the notes accrues, but is not payable until May 2005. As part of the placement, the investors also received warrants to purchase 10 million shares of our common stock at $3.00 per share and warrants to purchase 3 million shares of our common stock at $4.00 per share.

 

In October 2003, we purchased substantially all the assets and certain liabilities of Complient Corporation (“Complient”), a Cleveland, Ohio based, privately held provider of comprehensive AED/CPR training and program management services designed to ensure successful AED deployments. The addition of these services means we are the only AED manufacturer offering a single source, turnkey AED deployment solution, which we believe provides us with a competitive advantage at point of sale, particularly with larger, multi-facility purchasers.

 

Our corporate headquarters is located in Irvine, California, and our research and development facility is located in Lake Forest, California. Our manufacturing facility is located in Minneapolis, Minnesota, and our international headquarters are located in Copenhagen, Denmark. We also have a facility related to the delivery of AED/CPR training and program management services located in Cleveland, Ohio. Our corporate headquarters is located at 1900 Main Street, Suite 700, Irvine, CA 92614 and the telephone number is (949) 797-3800.

 

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Business Strategy

 

Our primary business objective is to become the market leader in the rapidly growing global AED marketplace, which according to Frost & Sullivan and our estimates should reach $650 million in 2006. Our secondary objective is to increase the rate of adoption of our in-hospital Powerheart CRM product, and to enter the traditional hospital “crash-cart” defibrillation market, estimated to total $300 million per year. We believe that achieving these objectives will result in consistent and significant revenue growth and profitability. We expect to achieve our objectives by focusing on the following core strategies:

 

  Continuing AED market share growth—We estimate that the market for AEDs in the U.S. is growing at approximately 30% per year, with some international markets growing even faster, and that the worldwide AED market totaled $200 million in 2003. In 2003, our AED related revenue increased 47% over 2002, and we estimate that we increased our market share to 28% at year end, compared to approximately 15% at the end of 2001. In order for us to continue to increase our market share and become the AED market leader we intend to focus on the following:

 

  Increasing our AED distribution channels—We currently sell our AEDs through direct, indirect and original equipment manufacturer (“OEM”) channels in the U.S. and internationally. In 2002 our efforts were focused on expanding our direct sales force which increased from 17 to 55 during that year, and totaled 62 people at the end of 2003. In addition to maintaining our direct sales channel during 2003, our focus centered on expanding our indirect distributor and OEM channel relationships. During the year, we increased the number of U.S. distributors purchasing AEDs from 30 to 53. In addition to the OEM relationship we established with Nihon Khoden in 2002, we signed AED OEM agreements with Criticare Systems, Inc. for the dental market and Quinton Cardiology Systems, Inc. for the physician’s office market. In August, 2003 we entered into a multi-dimensional agreement with GEMS, the healthcare business of General Electric Company, which included providing a GE branded AED for sale by GEMS outside the U.S. Internationally, we continue to sell primarily through country specific distributors, however, in 2003 we established direct operations in the United Kingdom and Germany, the two largest AED markets outside of Japan. We believe that in order to gain AED market leadership we must continue to expand and broaden our direct and indirect distribution channels. In 2004 and beyond, in addition to continued expansion and optimization of our existing direct and indirect distribution channels, we expect to increase the size of our 9 person inside sales department which was established in late 2003 as a compliment to our direct selling efforts.

 

  Enhancing our AED product line—We plan to continue to expand and enhance our core Powerheart AED product line as we did in 2003 with the second half launch of the Powerheart G3 and FirstSave G3 products. In the first half of 2004, we expect to introduce a fully automatic version of the Powerheart G3, and a more sophisticated Powerheart G3 Pro, which will have among other new features, real time electrocardiogram (“EKG”) viewing and manual override capability. The G3 Pro is targeted at those medical and first responder customers in the U.S. and internationally who demand a certain feature set which we do not currently offer. We believe that by continuing to expand and enhance our core product offering to include niche-specific feature sets, we will broaden the base of potential customers.

 

  Leveraging our AED services—Our October 2003 purchase of Complient’s assets allows us to provide a unique, single source, turnkey AED deployment solution to purchasers of AEDs. Through our nationwide network of 150 certified employee-educators, we can now provide the AED/CPR training required by most states to deploy AEDs. In addition, our AED program management services provide the medical direction and information management necessary for AED users to be in compliance with various state laws and regulations. We believe that the ability to offer a turnkey solution differentiates us from other AED manufacturers and provides us with a competitive advantage at point of sale, particularly with larger, multi-unit, multi-facility institutional customers such as schools, government and corporate purchasers.

 

 

Continuing to reduce our cost of goods—We were able to decrease the cost of goods on our Powerheart AED by 14% during 2002, and in 2003, primarily due to the introduction of our redesigned AED G3, we reduced our manufacturing costs an additional 31%. In 2004 and beyond, we plan to

 

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continue to focus on and expect to realize cost of goods reductions which will provide us with maximum flexibility with respect to competitive pricing pressures that may arise in the AED market.

 

  Increasing the rate of adoption of our Powerheart CRM—Our therapeutic monitoring product, the Powerheart CRM, is the only hospital bedside monitor defibrillator cleared by the FDA for attachment and continuous monitoring of patients at risk of life-threatening arrhythmias that can deliver a potentially lifesaving shock without human intervention. It has the potential to become a new “standard of care” in the treatment of in-hospital SCA. However, despite clinical evidence which clearly demonstrates the positive impact the CRM can have on the survival rate of SCA victims, adoption of the technology has been slower than our expectations. We believe that the adoption of the product has been hindered by a lack of (a) peer reviewed clinical evidence demonstrating the cost/benefit of the technology; and (b) distribution capability. We intend to address these issues by:

 

  Funding a multi-center and several single site clinical studies at recognized hospitals, for publication in peer-reviewed medical journals, to further support, improved patient outcomes and cost effectiveness of our Powerheart CRM.

 

  Expanding our distribution network in the U.S. by signing additional regional distribution partners, and focus on marketing to Premier, Inc., a group buying organization consisting of more than 200 of the nation’s leading hospital and healthcare systems purchasing more than $17 billion annually in supplies and equipment, which included the Powerheart CRM on their purchasing list under the category of breakthrough technology.

 

  Supporting GEMS in its efforts to market the Powerheart CRM internationally. This distribution relationship was a part of the GEMS agreement we signed in 2003.

 

  Developing new product embodiments for our existing technology—In 2003, we entered into a strategic relationship with GEMS. In addition to OEM distribution of our Powerheart AED and CRM products, we agreed to develop and manufacture for GEMS a standard “crash cart” hospital defibrillator utilizing our core RHYTHMx and STAR Biphasic technology. We anticipate that this development project, which has minimum take or pay quantities associated with it, will be completed in the fourth quarter of 2004. This development arrangement allows us to enter the $300 million per year traditional hospital defibrillator market using the distribution strength of GEMS. We have identified other product development projects where GEMS technology and our RHYTHMx and STAR Biphasic core technology could be brought together to create a new line of hospital based patient monitor and defibrillation products. We are currently in discussions with GEMS with respect to the timing and funding of these projects. We believe that continued collaboration with GEMS will allow us to develop additional hospital based products which incorporate our core technology, ultimately allowing increased adoption of our technology through the marketing strength and hospital presence of GEMS.

 

Sudden Cardiac Arrest

 

The Prevalence of SCA

 

Sudden Cardiac Arrest (“SCA”) is the leading cause of death of Americans. Each year, more than 450,000 people in the U.S. die from SCA. Death can occur in minutes if the SCA victim receives no treatment. External defibrillation is the only known treatment, but it must occur as soon as possible after the onset of SCA in order for it to be effective.

 

The Heart

 

The heart has four chambers, the two upper, smaller chambers are called the left and right atria and the two lower, larger and stronger chambers are referred to as the left and right ventricles. Blood is pumped throughout the circulatory system by a series of highly coordinated contractions of the heart’s four chambers. If these contractions do not occur in a synchronized manner, then the transportation of blood throughout the body is diminished. Under normal conditions, an electrical impulse is initiated in a bundle of highly specialized cells located in the right atrium. This bundle of cells, referred to as the sinus node, is also appropriately known as the heart’s natural pacemaker. From the sinus node, this electrical current moves across a specific

 

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path in the atria, and to the ventricles, causing the chambers to contract and pump blood. If the heart is to beat properly, then the electrical current, beginning in the atria, must follow a precise path so that the heart’s chambers beat in a synchronized and coordinated fashion.

 

Arrhythmias

 

If the heart deviates from this normal series of electrical impulses, then abnormal heart rhythms result, and the ability of the heart to effectively pump blood throughout the circulatory system is diminished. Although some arrhythmias are short in duration and have little effect on the heart’s normal rhythm, arrhythmias that last for some time may cause the heart to beat too fast—tachycardia—or too slow—bradycardia. If tachycardia originates in the ventricles, it is referred to as ventricular tachycardia (“VT”), otherwise it is known as supraventricular tachycardia (“SVT”). Tachycardia in the ventricles requires prompt treatment. VT may result from serious heart disease and can be treated with medicines and by treating the cause.

 

While atrial fibrillation and bradycardia, as described below, are serious conditions affecting heart rhythm and effectiveness, it is the first type of arrhythmia described below, ventricular fibrillation, that is immediately life threatening and must be corrected by defibrillation to prevent sudden cardiac death. Our products are capable of diagnosing all of these cardiac conditions and applying therapy to reestablish regular heart rhythm. Our technology and devices are designed to detect and treat the three types of arrhythmia.

 

Ventricular Fibrillation and SCA

 

Ventricular fibrillation (“VF”) is a lethal form of arrhythmia in which disordered electrical activity in the heart causes the ventricles to contract in a rapid, unsynchronized, uncoordinated fashion. With the onset of VF, little or no blood is pumped from the heart to the brain and vital organs, resulting in collapse and sudden death unless medical help is provided immediately. This loss of heart function is known as sudden cardiac arrest and to prevent death, the only treatment remains defibrillation—the application of an electric shock to resynchronize the heart’s disordered electrical activity to a normal rhythm.

 

Atrial Fibrillation

 

Atrial fibrillation occurs when the atria emit uncoordinated electrical signals, causing the atrial chambers to contract too fast, pumping blood unevenly. Although the heart beat will be irregular, these electrical signals will not always be transmitted to the ventricles, still allowing the ventricles to continue to pump blood throughout the circulatory system. Although AF is not life threatening, it can eventually lead to SCA and to other problems, including chronic fatigue, congestive heart failure and stroke. According to the AHA, patients with AF are five times more likely to suffer a stroke and 15% of all strokes occur in people with AF. More than two million Americans currently suffer from AF.

 

Cardioversion and drug therapy are the common treatment modalities for AF. Cardioversion therapy is applied by a defibrillator which delivers an electric shock that is synchronized with a patient’s heartbeat, returning the atria to its normal rhythm. Our Powerheart CRM and Powerheart AEDs both have cardioversion capability.

 

Bradycardia

 

Bradycardia occurs when the heart beats too slowly, generally less than 60 beats per minute, depending on age. Bradycardia can cause fatigue, dizziness, lightheadedness and fainting. It is treated on an emergency basis through the administration of drugs or invasive temporary pacing, in which a wire is inserted into the heart to deliver a current, or noninvasive temporary pacing, where external electrodes are attached to a patient deliver an electrical stimulus. Our Powerheart CRM is noninvasive pacing capable.

 

Where Does SCA Strike?

 

Factors contributing to the onset of SCA include coronary heart disease, drug abuse, respiratory arrest, electrocution, drowning, choking and trauma. Death from SCA is sudden and unexpected, occurring without warning or immediately after the onset of symptoms. The AHA estimates that 50% of SCA victims have no prior indication of heart disease—their first symptom is SCA. And for those with a known history of heart attacks, the chance of sudden cardiac death is four to six times greater than the that of the general population.

 

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According to the AHA, almost 60% of SCA incidents are witnessed. It is estimated that 95% of SCA victims die before reaching the hospital. Survival is directly linked to the amount of time between the onset of SCA and defibrillation: a victim’s chances of survival are reduced by approximately 10% with every minute of delay.

 

Average response time for emergency personnel to arrive on scene in the U.S. is approximately 8-12 minutes after calling 911. The average time from collapse to providing defibrillation varies widely across the country. Communities with public access defibrillation (“PAD”) programs in place, where AEDs are placed in public buildings, at sporting events and in emergency vehicles, response times are significantly reduced. In some venues, when the first shock is delivered within 3-5 minutes, the reported survival rates from SCA are as high as 48% to 74%. Other studies show that police equipped with AEDs can cut response times to SCA victims by about three minutes when compared to historical response times, significantly improving a victim’s chance of survival.

 

Our Core Technology

 

All of our products incorporate our proprietary RHYTHMx technology. This platform technology is designed to detect and discriminate life-threatening arrhythmias. Our STAR Biphasic technology is designed to optimize the delivery of a potentially life-saving electric shock to victims of SCA. We have integrated our core technology, along with other proprietary technology that we have developed into our Powerheart AED and CRM product lines. We also sell accessories and disposable products, including our proprietary disposable defibrillator electrodes, and are actively licensing certain components of our core technology to third-parties for integration into other products.

 

Our RHYTHMx Technology

 

Our proprietary RHYTHMx technology allows for the detection and identification of life-threatening arrhythmias and, in the case of our CRM, automatic delivery of the appropriate measured therapy, or in the case of our Powerheart AED, instructions to deliver the appropriate shock. Our patented RHYTHMx software algorithm offers the unique ability of filtering noise and artifact from a patient’s EKG signal without compromising its ability to correctly identify heart rhythms that are life-threatening—shockable, or non-life-threatening—non-shockable.

 

RHYTHMx begins by filtering the patient’s EKG signal to reduce noise artifact and then detects the heart’s QRS complexes in conjunction with the patient’s heart rate. The heart’s ECG signals contain wave shapes that are referred to as P-QRS-T waves. While a normal heartbeat contains each of these wave shapes, in the case of the chaotic and disorganized rhythm of ventricular fibrillation, these wave shapes—or QRS complexes—are absent or indistinguishable. If the heart rhythm is considered shockable by RHYTHMx, and it persists, then a shock is indicated. Further analysis by RHYTHMx, which occurs in a fraction of a second, classifies the shockable rhythm as requiring a synchronous shock—in the case of a life-threatening VT—or an asynchronous shock—in the case of life-threatening VF.

 

Clinical results with our RHYTHMx technology demonstrated 100% sensitivity (correct identification of shockable rhythms) and 99.4% specificity (correct identification of non-shockable rhythms). The average time to first shock was 21 seconds and normal rhythm was restored by the device’s first shock in 96.2% of the cases. These results were based on data from a multi-center clinical trial conducted between February 1993 and May 1997 using early versions of our original Powerheart device. The trial was divided into two phases, with 155 patients enrolled and 104 patients tested, at Arizona Heart Institute, University of California Irvine Medical Center and University of Southern California Medical Center. We received FDA clearance to market RHYTHMx technology as a stand-alone device in August 1998.

 

Another study, the European Powerheart Trial, was presented during the “late breaking” clinical trial session of the North American Society of Pacing and Electrophysiology at San Diego in May 2002, and was subsequently published in the Journal of the American College of Cardiology. In the study, 117 patients in 10 European medical centers in Germany, Spain, Italy and Finland were monitored. The patients included 51 at risk of cardiac arrest located in special monitoring wards (intensive or coronary care units or in the emergency room), and 66 who were undergoing electrophysiological testing or implantation of cardioverter-defibrillators because of suspected or documented ventricular tachyarrhythmias. During a total of 1,240 hours of testing, there were no adverse events, with 1,988 heart rhythm events documented and 115 of those requiring treatment through defibrillation. The mean response time of our Powerheart device was 14.4 seconds. The trial’s investigators concluded that our Powerheart device is safe and effective in detecting, monitoring and treating spontaneous arrhythmias and that the use of the device will shorten response times and significantly improve the outcome of patients with in-hospital cardiac arrest.

 

Our platform RHYTHMx technology is integral to our Powerheart AED and CRM products. We also license our RHYTHMx technology for use in certain other wearable defibrillators.

 

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Our STAR Biphasic Technology

 

Our Self-Tracking Active Response (“STAR”) Biphasic waveform technology allows our Powerheart AED and CRM defibrillator devices to deliver the most effective therapy possible by delivering an optimized amount of energy in response to SCA. STAR Biphasic quickly assesses the unique characteristics of a patient and customizes the defibrillation energy he or she receives.

 

The STAR Biphasic waveform treats cardiac patients individually, based on three important characteristics: impedance, defibrillation threshold and cellular response.

 

Impedance is the number one difficulty in delivering current to the heart in external defibrillation. Tissue such as skin, fat, muscle and bone, surround the heart and impede the flow of energy delivered by a defibrillator. Impedance varies from person to person and in order to optimize energy delivery, adjustments must be made for a patient’s impedance. Our STAR Biphasic waveform technology provides optimized energy delivery by measuring a patient’s impedance and customizing a waveform to deliver the most effective defibrillation energy. This customization occurs for even the most difficult high-impedance patients. STAR Biphasic technology delivers optimal therapy for every patient.

 

Defibrillation threshold (“DFT”) is defined as the minimum current required to defibrillate the heart and establish normal rhythm. DFT varies from person to person, based primarily on a person’s anatomy, disease condition and metabolic state of the heart. Failure to exceed a patient’s DFT means failure to defibrillate a patient’s heart. STAR Biphasic technology automatically escalates defibrillation energy to ensure that a patient’s DFT is exceeded as rapidly as possible.

 

During the delivery of any defibrillation shock, the cell membranes of the heart are charged, until the cells depolarize. This allows normal electrical pathways to reestablish control and produce a coordinated rhythm. If any residual charge remains on the cells, i.e., they do not fully depolarize, then refibrillation may occur. The STAR Biphasic waveform has been uniquely designed to neutralize any residual charge through a process of charge balancing. STAR Biphasic precisely controls the energy delivered in the first phase of defibrillation and balances any residual cellular charge during the second phase of defibrillation. By neutralizing the residual charge, STAR Biphasic minimizes the likelihood of refibrillation and provides the optimal environment to defibrillate the heart.

 

The STAR Biphasic waveform was validated in a clinical trial led by researchers at the Cleveland Clinic and Cedars-Sinai Medical Center. This multi-center study, designed according to FDA guidelines, determined that the STAR Biphasic waveform was safe and effective. The study’s high success rates resulted in statistically significant results with a smaller sample size than initially expected.

 

In addition to the use of STAR Biphasic waveform technology in our defibrillator devices, we also license this technology to selected partners internationally.

 

Our Products

 

The Powerheart AED

 

Our Powerheart AED product line is powered by our RHYTHMx and STAR Biphasic technology, and is the only AED that can provide continuous monitoring capabilities before, during and after SCA, protecting the victim against delays in therapy and the reoccurrence of another life-threatening arrhythmia following resuscitation.

 

Reflecting the merger of Survivalink and Cardiac Science in September 2001, our Powerheart AED combines industry-leading AED expertise with advanced arrhythmia detection technology. In 2003, our Powerheart AED and related services and accessories represented 91% of our company-wide revenue and our devices have been deployed by such companies as Harrah’s Entertainment, Coca Cola, General Electric, Procter & Gamble, Exxon, Pepsi, Anheuser Busch and Merrill Lynch. Our Powerheart AED has also been chosen by many local governments and municipalities for use in respective community Public Access Defibrillation (“PAD”) programs, the United States Navy, Army and Air Force, as well as by numerous schools and educational facilities throughout the U.S.

 

We believe that our Powerheart AED offers the following competitive advantages:

 

  Our patented RescueReady® technology tests not only the battery and system components, but also verifies that the pre-connected disposable electrodes are properly functioning.

 

  Clear, concise voice prompts guide the user through the rescue process and our exclusive one-button operation eliminates confusion and uncertainty.

 

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  Our innovative RHYTHMx technology provides continuous monitoring capability and our STAR Biphasic waveform technology allows for customized defibrillation and escalating variable energy delivery.

 

  Pre-connected electrodes save time and ensure the AED is ready at time of rescue.

 

Our proprietary self-testing AED defibrillator electrodes are interchangeable for body placement and are supplied pre-gelled with a self-adhesive. We have also developed and are marketing our proprietary FDA-cleared pediatric defibrillation electrode system, designed for use with our AED, to deliver reduced defibrillation energy to infants and children up to 8-years old, or up to 55 lbs. These innovative pediatric electrodes are suitably sized for a child’s smaller torso, and are less than half the size of our adult AED electrodes.

 

The Powerheart CRM

 

The chances of survival for a patient suffering SCA in a hospital remains at less than 25%. Because of the time it takes to defibrillate patients, even under monitored conditions, this survival rate has not changed in the last 40 years. And those that do survive are typically faced with a longer and more expensive hospital stay.

 

The Powerheart CRM, attached to patients via our disposable defibrillator electrodes, continuously monitors a patient’s cardiac rhythm, and if a life-threatening arrhythmia is detected, automatically delivers a life-saving defibrillation shock within seconds and with no human intervention.

 

Therapeutic monitoring with the Powerheart CRM offers cardiac patients the best chance of survival from SCA and represents a potential new standard of care for medical facilities worldwide. In December 2001, we received clearance from the FDA to market the Powerheart CRM to medically supervised environments such as hospitals, medical and dental surgery centers, physician offices, clinics and nursing homes in the United States. We have also received the necessary approvals to market the Powerheart CRM in Europe, Canada, Australia and other regions around the world. Our Powerheart CRM is in numerous hospitals worldwide.

 

Our Powerheart CRM is a unique therapeutic monitor incorporating state-of-the-art technology that offers medical facilities the following features and benefits:

 

  Powerheart CRM provides reliable, continuous monitoring, detection and treatment of life-threatening arrhythmias;

 

  Biphasic waveform technology customizes defibrillation energy to deliver optimal therapy for each patient;

 

  Non invasive external pacing;

 

  The Powerheart CRM’s compact design and battery operation allows for use in transporting patients and also provides for multiple mounting options at the bedside and uninterrupted operation in any hospital setting. The Powerheart CRM’s footprint measures 11 inches x 4 inches x 8.25 inches and weighs only 11.5 pounds; and

 

  User friendly programmable interface software and control buttons permit simple operation and a color LCD provides exceptional viewing and resolution. The Powerheart CRM can operate in manual, advisory or fully automatic modes.

 

We also market our proprietary disposable defibrillator electrodes for use with the Powerheart CRM. These disposable defibrillator electrodes provide reliable ECG monitoring, defibrillation and external pacing performance and offer reduced motion artifact caused by patient movement. The compact design and radiotransluscence of the Powerheart CRM disposable defibrillator electrodes also allows clearer views of the chest under x-ray and fluoroscopy and a new hydrogel adhesive reduces the potential for skin irritation.

 

Miscellaneous Products

 

As part of the Artema acquisition, we marketed a low-end line of patient monitors. The Diascope G2 is a compact, transportable vital signs monitor designed for use in hospitals and day surgery units and has been marketed in certain international markets. In 2003 we sold approximately $2.5 million of this product, compared to $3.9 million in 2002.

 

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In connection with the Complient acquisition, we marketed a line of CPR related resuscitation products and accessories, including training mannequins and an audible CPR prompt device. These products, which accounted for $730,000 in revenue in the quarter ended December 31, 2003 are sold primarily through distributors in the U.S.

 

In February 2004, we made a strategic decision to discontinue the Diascope patient monitor product line and sell the CPR training related product line, both of which had below average gross margins and used disproportionate manufacturing, sales and administrative resources. We believe that exiting these product lines will allow us to focus our resources on our core AED products and services and our in-hospital CRM technology.

 

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Our Markets

 

We segment the market for our devices and technology into two principal categories: AEDs and related accessories and AED/CPR services, and in-hospital therapeutic monitoring-defibrillation (Powerheart CRM).

 

AED Market Segments

 

We estimate the worldwide AED market in 2003 was approximately $200 million, with the U.S. AED market, comprising 85% of the worldwide market, growing at approximately 30% with faster growth recorded in certain international markets. We expect the worldwide market for AEDs in 2004 to be between $260 million to $270 million, and believe international markets will become a larger proportion of the overall market for AEDs.

 

We estimate that we now hold approximately 28% of the worldwide market share in AEDs, up from 15% at the end of 2001. We believe that we are the leader in two of our market segments, the U.S. government agency workplace segment and the U.S. corporate workplace market. The following are our market segment highlights:

 

  In the U.S. corporate workplace market segment, we estimate that only 5% of U.S. corporations have AEDs. In 2003, 47% of our U.S. AED sales were from this segment and we estimate our market share to be in excess of 35% in the corporate AED market segment.

 

  Only 1%-3% of schools in the United States have AEDs and to date only New York has mandated deployment of AEDs in public schools. In 2003, we generated 9% of our U.S. AED sales from schools and colleges.

 

  In the fire, police and EMS market segment, only 15% of the estimated 210,000 police, Sheriff and Highway Patrol vehicles carry AEDs and approximately 25% of an estimated 75,000 fire vehicles are equipped with AEDs. Sales in this segment represented 12% of our U.S. 2003 AED sales.

 

  The PAD market segment includes the U.S. government, municipalities, and community PAD programs. Despite legislation mandating deployment in all 17,000 Federal government buildings, it is estimated less than 3% have installed AEDs. Moreover, we estimate only 5% of U.S. cities have implemented PAD programs. This segment accounted for 19% of our 2003 U.S. AED sales.

 

  The medical segment includes physician and dental offices and hospitals. We estimate less than 5% of an estimated 200,000 physician and dental offices have AEDs and only a small percentage of the 6,600 hospitals have AEDs available. About 13% of our U.S. AED sales in 2003 were to the medical market segment.

 

  We believe we are the market leader in the Japanese AED market due to our strategic partnership with Nihon Kohden. We also have more than 50 distributors in all major world markets, and we continue to focus our sales and marketing efforts on growing our market share in the three largest and fastest growing global markets, Japan, Germany and the U.K. We estimate the international market for AEDs accounts for 15% of worldwide AED sales. International sales represented 19% of our total 2003 AED sales.

 

In-Hospital Therapeutic Monitoring-Defibrillation (Powerheart CRM)

 

Traditionally, hospitals have deployed manual or semi-automatic defibrillators to treat SCA victims. Standard defibrillators require supervision by highly skilled medical personnel to analyze and interpret the patient’s electrocardiogram and to manually deliver a shock using handheld paddles. Standard defibrillators are typically positioned in the hospital at locations such as critical care and cardiac care units, emergency and operating rooms and electrophysiology labs. We estimate that there are 6,600 hospitals in the United States.

 

Despite the availability of standard defibrillators to treat SCA in hospitals, numerous hospital studies have documented delays of five minutes or more between the onset of cardiac arrest to the arrival of the first medical team member. Clinical studies show that the average survival rate of patients who have an in-hospital SCA is estimated at less than 25%, a rate of survival that has not improved since the 1960s. We believe that our Powerheart CRM is well positioned to provide hospitals with a therapeutic monitoring alternative which will result in an increase in survival rates and a reduction in patient care costs.

 

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Technology Licensing

 

We are seeking strategic relationships with third parties to license our RHYTHMx and STAR Biphasic proprietary technologies for use in patient monitoring type devices.

 

During 2002, we entered into three separate licensing agreements with Zoll Medical, Inc., Lifecor, Inc., and Innomed Medical Co. We licensed our STAR Biphasic technology for use into standard emergency defibrillators for sales internationally and licensed certain patents relating to wearable defibrillators and other proprietary features of our AEDs, as well as licensing of our platform RHYTHMx technology. In consideration for these licenses we received cash and ongoing royalty payments.

 

AED Market Drivers

 

SCA kills approximately 450,000 people in the United States each year. A few minutes after the onset of SCA, brain damage can start to occur and death will result unless the victim’s heart is shocked back into rhythm by a defibrillator. According to the AHA almost 60% of all SCAs are witnessed by a bystander. Moreover, the AHA currently estimates that 95% of SCA victims die before reaching the hospital. Communities that strategically place AEDs in public buildings, arenas, airports and emergency vehicles can significantly reduce response times. In venues where bystanders or first responders can defibrillate a victim within three to five minutes, the reported survival rates from SCA are as high as 48% to 74%.

 

There is now widespread acknowledgement and increasing awareness that AEDs save lives and can be safely used by lay people. The AHA has publicly encouraged widespread deployment of AEDs through community AED programs.

 

Legislation is a key market driver, and numerous AED-related bills have been introduced at the Federal level and in State governments in the past two years, which we believe will facilitate the growth of new and existing markets for AEDs:

 

  In 2000, the 106th Congress of the United States passed the Cardiac Arrest Survival Act, which directs placement of AEDs in all Federal buildings in order to improve survival rates of SCA victims in those buildings and establishes protections from civil liability arising from the emergency use of AEDs.

 

  The Rural Access to Emergency Devices Act, signed into law in 2000, authorized the spending of $25 million in federal funds over three years to help rural communities purchase AEDs and to provide training on how to use them.

 

  In 2001, the Office of Management and Budget directed the Occupational Safety and Health Administration (“OSHA”) to consider whether promotion of AEDs should be elevated to a priority. In response, OSHA issued a technical bulletin encouraging all employers to consider making AEDs available in the workplace. According to OSHA, 13% of all workplace fatalities are attributable to SCA

 

  The Community Access Emergency Defibrillation Act of 2001 was added to the Public Health Security and Bioterrorism Preparedness and Response Act of 2002, and was signed into law in June 2002. The Act provided federal funding for implementation of PAD programs.

 

  In 2002, the New York State Legislature passed laws requiring public school facilities, regardless of size, to retain at least one AED on school premises. Currently, seven other states are considering legislative alternatives to either recommend or mandate the use of AEDs in schools and certain other facilities and public places.

 

  State of Illinois House Bill 43, was passed on March 5, 2003 creating the Physical Fitness Facility Medical Emergency Preparedness Act which requires various physical fitness facilities, including (i) facilities owned or operated by a unit of local government or by a school, college, or university, (ii) golf courses, and (iii) health or fitness clubs, to have on its premises at least one AED and a trained AED user.

 

Sales and Marketing

 

In 2003, we expanded our indirect and OEM AED distribution channels. Our marketing efforts were focused on the U.S. corporate workplace and the U.S. government agency workplace market segments. As a result of this effort, we believe that we are the market leaders in those segments. We currently have 61 direct AED sales people in the United States and also have over 50 distributors focusing on certain domestic market segments.

 

Outside the U.S., we distribute the Powerheart AED through 50 international distributors and have a presence in all major foreign markets. In 2003, we established direct sales operations in the United Kingdom and Germany. Our international

 

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distribution channel is managed from our Copenhagen office by a group of 9 sales managers who each have sales responsibility for certain regions of the world.

 

We currently have 3 specialists supporting our CRM sales and marketing effort, and also utilize distributors in certain regions in the United States and internationally. In addition, in 2003 we signed an OEM agreement with GEMS whereby it distributes the CRM through its distribution channels. We are also focused on the collection of clinical data supporting the cost-effectiveness and improved patient outcomes of our Powerheart CRM.

 

Competition

 

Our principal competitors in the AED market are Philips Medical’s Heartstream division, Medtronic Physio-Control and ZOLL Medical Corporation. We believe that Philips Medical is currently the market leader with an estimated 33% market share.

 

Our experience indicates that the key criteria that buyers of AEDs exhibit in their purchasing decision is:

 

  ease of use,

 

  reliability and self testing,

 

  overall value—a combination of features and price, and

 

  capability to assist in deployment and training.

 

We believe that our Powerheart AED compares favorably with our competitors’ products in the AED market based on these factors as well as on other competitive determinants. We also believe that our ability to provide a complete turnkey AED deployment solution provides us with a competitive advantage over other manufacturers, particularly in the government and corporate workplace segments.

 

The Powerheart CRM is the only FDA-cleared external defibrillator that provides fully automatic detection and treatment for patients suffering from life-threatening arrhythmias. We compete against numerous companies in the hospital marketplace where we sell our Powerheart CRM.

 

Manufacturing

 

We manufacture our Powerheart AEDs and Powerheart CRMs at our 25,000 square foot manufacturing facility in Minnetonka, Minnesota. Our current in-place assembly and manufacturing capacity will allow us to build approximately 80,000 AEDs annually. In 2003, we manufactured approximately 30,000 AEDs, compared with 18,000 in 2002. We outsource the manufacture of major subassembly components such as printed circuit boards primarily for the benefit of reduced cost, and perform final assembly and testing in our facility.

 

Our FDA-registered Minnetonka facility is ISO certified for the design and manufacture of medical products. Our certifications allow us to design and manufacture medical products with the CE mark for shipment to Europe and to ship FDA-cleared products in the United States.

 

The manufacturing processes used to produce our products are required to comply with FDA enforced Good Manufacturing Practices (”GMP”) regulations which cover the design, testing, production, control and documentation of our products. In those foreign jurisdictions where we market our products, we are also required to comply with and obtain regulatory approvals and clearances. These regulatory requirements also apply to our third party contract manufacturers, as well as to some of our suppliers. The FDA and foreign counterparts conduct periodic inspections of manufacturing facilities to ensure compliance with “Quality System Regulation,” GMP, and other regulations, such as those promulgated by the International Standards Association. Any concern raised by such inspections could result in regulatory action, delays or termination of production.

 

Intellectual Property

 

We believe that our intellectual assets, including trademarks, patents, trade secrets and proprietary technology, are extremely valuable and constitute a cornerstone of our business. We own 82 U.S. and foreign patents relating to our automatic defibrillation technology platform and its various applications. We intend to file additional patent applications relating to each of our products and our underlying proprietary technology, as well as around new technological inventions that we are developing. We believe that our patents and proprietary technology provide us with a competitive advantage over our competitors. We will

 

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aggressively defend our inventions and also look for opportunities to generate royalty fees from licensing our intellectual property.

 

We have a wide range of patents covering the technology found in our AEDs, including our RescueReady technology, which features one button operation, pre-connected disposable electrode pads and self-test capabilities. Other patents we have been issued cover our proprietary RHYTHMx arrhythmia detection software technology, our STAR Biphasic defibrillation waveform technology and our disposable therapy electrodes.

 

During 2003, we were granted six additional U.S. patents and one European patent relating to our core technology and key aspects of our RHYTHMx analysis algorithm software.

 

Clinical Studies

 

We are actively engaged in, and are pursuing the sponsorship of, clinical studies at hospital medical centers both in the U.S. and Europe, relating to our Powerheart CRM product. These studies are primarily focused on demonstrating clinical efficacy, along with improved survival rates and the economic benefits associated with deployment of our Powerheart technology for hospitalized at-risk cardiac patients. We anticipate that the results of these studies will be presented in abstract form at conferences, and if accepted, as manuscripts published in peer reviewed medical journals. Various studies are either ongoing, planned or proposed, at luminary medical centers in the U.S. and Europe.

 

A 117-patient, 10-center study, published February, 2003 in the Journal of the American College of Cardiology, demonstrates that our Powerheart CRM is not only safe and effective, but significantly shortens hospital response time to SCA. Because time to defibrillation is critical to patient survival, the study investigators concluded that our Powerheart CRM has the potential to significantly improve the outcome of patients with SCA.

 

Government Regulation

 

In the United States, clinical testing, manufacturing, packaging, labeling, promotion, marketing, distribution, registration, record keeping and reporting, clearance or approval of medical devices generally are subject to regulation by the FDA. Medical devices intended for human use are classified into three categories, subject to varying degrees of regulatory control. Class III devices, which we believe cover certain of our products, are subject to the most stringent controls.

 

In October 1997, we received 510(k) clearance from the FDA to market the clinical version of the original Powerheart in the United States. In August 1998, we received 510(k) clearance from the FDA to market RHYTHMx and to integrate it into other stand-alone defibrillator monitors. In January 2000, we received clearance from the FDA to market the commercial version of the original Powerheart in the United States. In February 2001, we received notification from the FDA that allows our original Powerheart to be used in outpatient surgery centers, nursing homes and at home when prescribed by a physician. In December 2001, the FDA granted us 510(k) clearance to market our Powerheart CRM in medically supervised environments such as hospitals, medical and dental surgery centers, physician offices, clinics and nursing homes. In October 2001, the FDA granted us 510(k) clearance to market a new advanced version of our monitoring-defibrillation-pacing electrodes.

 

In February, 2002, the FDA granted us 510(k) clearance to market our Powerheart AED for the emergency treatment of victims of sudden cardiac arrest and in January 2003, the FDA granted us 510(k) clearance to market our Powerheart AED for use on children under eight-years of age.

 

We have also received the necessary approvals to market the Powerheart CRM, Powerheart AED and related product accessories within Europe, Canada, Australia and other regions of the world.

 

Our products are subject to FDA review of labeling, advertising and promotional materials, as well as record keeping and reporting requirements. Failure to comply with any of the FDA’s requirements, or the discovery of a problem with any of the products, could result in FDA regulatory or enforcement action. Further, any changes to the products or their labeling may require additional FDA submissions, review, clearance or approval.

 

Research and Development

 

We are committed to improving and expanding our product line through the application of our existing patented and proprietary technology, and through the research and development of new technology. Our core RHYTHMx and STAR Biphasic

 

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technologies have multiple patient monitoring and therapeutic applications, and we continue to seek out new device embodiments integrating our proprietary technology, enhancing or expanding our own product line, or by licensing to a third-party.

 

Research and development expenses for the years ended December 31, 2003, 2002 and 2001 were $5.5 million, $6.1 million, and $8.6 million, respectively. We intend to continue to devote resources and capital to research and development so we can improve and refine our existing products and technology, develop and commercialize our products currently under development, and develop new applications for our technology.

 

Backlog

 

As of December 31, 2003, we had a backlog of $700,000 in training related orders, as compared to a backlog of $877,900 as of December 31, 2002. The backlog of orders in 2003 was related to AED/CPR training services which were ordered but yet not delivered. Revenue on AED/CPR training services is recognized when the services are delivered.

 

Employees

 

As of December 31, 2003, we had 284 full-time employees, of which 97 employees were involved in worldwide sales and marketing functions, 29 were involved in supporting our research and development activities, 104 were in manufacturing and 54 were general and administrative personnel. None of our employees are represented by a collective bargaining arrangement and we believe our relationship with our employees is satisfactory. We may add additional personnel as we grow.

 

General Information

 

We maintain an Internet website at www.cardiacscience.com where our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are available without charge, as reasonably practicable following the date they are filed with or furnished to the SEC.

 

A Warning About Forward-Looking Information and the Safe Harbor Under the Securities Litigation Reform Act of 1995

 

This Annual Report on Form 10-K and the other reports, releases, and statements (both written and oral) issued by us and our officers from time to time may contain statements concerning our future results, future performance, intentions, objectives, plans, and expectations that are deemed to be “forward-looking statements.” These statements, including statements regarding:

 

  products under development;

 

  technological and competitive advantages;

 

  timetable for commercial introduction of our products;

 

  our ability to improve patient care, increase survival rates, decrease recovery time, lessen patient debilitation, and reduce patient care costs;

 

  markets, demand for our services, purchase orders and commitments;

 

  strategic alliances;

 

  the competitive and regulatory environment;

 

  planned integration of technologies with products; and

 

  business strategies.

 

Such statements are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our actual results, performance, and achievements may differ significantly from those discussed or implied in the forward-looking statements as a result of a number of known and unknown risks and uncertainties including, without limitation, those

 

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discussed below and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Although we believe that our assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, we cannot assure you that the results discussed or implied in such forward-looking statements will prove to be accurate. In light of the significant uncertainties inherent in such forward-looking statements, the inclusion of such statements should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Words such as “believes,” “anticipates,” “expects,” “intends,” “may,” “plans,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. We undertake no obligation to revise any of these forward-looking statements.

 

Sometimes we communicate with securities analysts. It is against our policy to disclose to analysts any material non-public information or other confidential commercial information. You should not assume that we agree with any statement or report issued by any analyst regardless of the content of the statement or report. We have a policy against issuing financial forecasts or projections or confirming the accuracy of forecasts or projections issued by others. If reports issued by securities analysts contain projections, forecasts or opinions, those reports are not our responsibility.

 

Availability of SEC Filings

 

We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. You can read our SEC filings over the Internet at the SEC’s website at http://www.sec.gov. We also make our SEC filings available free of charge through our Internet website as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. Our website address is www.cardiacscience.com. The reference to our website address does not constitute incorporation by reference into this report of the information contained at that site.

 

Risk Factors

 

The risks set forth below are not intended to be exhaustive. These are the factors that we believe could cause actual results to be different from expected and historical results. Our industry is very competitive and changes rapidly. Sometimes new risks emerge and we may not be able to predict all of them, or be able to predict how they may cause actual results to be different from those contained in any forward-looking statements. You should not rely upon forward-looking statements as a prediction of future results.

 

If the worldwide AED market does not grow as projected, our sales and results may suffer.

 

According to Frost & Sullivan and our estimates, the worldwide AED market is expected to grow from $155 million in annual sales in 2002 to $650 million in 2006. Our current level of operations is based on assumptions concerning the future expected growth of AED markets, and if such assumptions are significantly different from actual AED market growth rates, then we may not be able to successfully grow our revenue and, as a result, our level of revenue may not be able to support our current or future level of operations.

 

If we fail to successfully compete against new or existing competitors, our operating results may suffer.

 

Our principal competitors relating to our AED product line are Medtronic Physio-Control and Philips Heartstream. Due to their dominant market position and well established customer relationships, it may be difficult for us to increase our market share and penetrate new markets. In addition, these competitors are part of much larger organizations, and thus have significantly greater resources than we do. Accordingly, Medtronic Physio-Control and Philips Heartstream may increase the resources they devote to the development and marketing of AEDs, which could materially impact our results.

 

We also compete against other companies that manufacture and sell external defibrillator devices to hospitals, where we sell our Powerheart CRM. These companies include Medtronic Physio-Control, Philips Heartstream and ZOLL Medical Corporation. Many of the manufacturers of these competing external devices are well established in the medical device field, have substantially greater experience than us in research and development, obtaining regulatory clearances, manufacturing, and sales and marketing, and have significantly greater financial, research, manufacturing, and marketing resources than us.

 

Other companies may develop invasive or non-invasive products capable of delivering comparable or greater therapeutic benefits than our products, or which offer greater safety or cost effectiveness than our products. Furthermore, future technologies or therapies developed by others may render our products obsolete or uneconomical, and we may not be successful in marketing our products against such competitors.

 

The markets for our products, in particular our Powerheart AED, are subject to price competition, which could be detrimental to our profitability.

 

The market for AEDs is highly competitive and is subject to significant price competition because price is an important purchase decision criteria for many customers. Average selling prices for AEDs have eroded during recent years and are projected to continue declining, and principal competitors have substantially greater resources and experience than we do, which may provide them with a competitive advantage as price erosion continues or if it accelerates. If this occurs, our level of sales and profitability may suffer.

 

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We recently acquired Complient Corporation, and we may acquire other businesses, the integration of which may prove difficult.

 

We recently acquired Complient Corporation, and we may acquire other companies or make strategic purchases of interests in other companies related to our business in order to grow, add product lines, acquire customers or otherwise attempt to gain a competitive advantage in new or existing markets. Such acquisitions and investments may involve the following risks:

 

  our management may be distracted by these acquisitions and may be forced to divert a significant amount of time and energy into integrating and running the acquired businesses,

 

  we may face difficulties associated with financing the acquisitions,

 

  we may face the inability to achieve the desired outcomes justifying the acquisition, and

 

  we may face difficulties integrating the acquired business’ operations and personnel.

 

General economic conditions and geopolitical uncertainty may affect the purchasing decisions of our customers, which may result in lower revenues.

 

Many of our customers face challenges in their respective markets due to general economic conditions relating to fluctuating demand for their services and budgetary or financing constraints. As a result, an economic downturn in any of the markets in which we compete may affect the purchase decisions of our customers, which may in turn negatively impact our revenue and sales growth. In addition, global geopolitical uncertainty and war may also negatively impact a customer’s decision making process or timing.

 

We have a history of losses.

 

We have a history of losses, and expect to incur some losses in the future. We were formed in 1991 and have been engaged primarily in organizational activities, research and development, pre-clinical testing, human clinical trials, and capital raising activities, until the introduction of our first commercial product in December 1999.

 

We are a relatively new entrant without a significant presence in the hospital market. If we are not successful in this market, our operating results may suffer.

 

Our Powerheart CRM is designed for bedside use in hospitals and clinics and competes against other external defibrillator products. We are relatively new to this market, and as such, face a number of challenges, including acceptance by hospital administrative and medical staff, long purchasing decision processes, and competitors’ pre-existing relationships with customers. If we are not successful in gaining market acceptance of our Powerheart CRM, our operating results may suffer.

 

Recurring sales of our disposable defibrillator electrodes may not grow.

 

Our business strategy within the in-hospital marketplace, where we market our Powerheart CRM, is to generate recurring revenue from the sale of our disposable defibrillator electrode pads, which for sanitary, performance and safety reasons, must be replaced every 24-hours. Although we have developed proprietary smart chip technology to ensure that only our electrodes will be used with the Powerheart CRM, there can be no assurance that other companies will not develop electrode adapters that will allow generic electrodes to be used with our devices. If we are not successful in preventing the use of generic electrodes with our products, or if customers do not follow the recommended protocol of regularly changing electrodes, we may not experience future sales growth of our proprietary disposable electrode pads.

 

Uncertain customer decision processes and long sales cycles may cause fluctuations in our operating results.

 

Many of our AED customers are municipalities and other quasi-governmental groups, such as schools and law enforcement agencies. As a result, these customers have numerous decision makers, as well as varying levels of procedures that must be adhered to before a purchase of our products can be made. The same is true regarding our in-hospital Powerheart CRM product, which faces several levels of purchase decision makers, at the departmental and hospital-wide level. Accordingly, the purchasing decisions of many of our customers are characterized by a protracted decision making process, which may result in period-to-period fluctuations in our operating results.

 

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Supply shortages can cause delays in manufacturing and delivering products.

 

We rely upon unaffiliated suppliers for the material components and parts used to assemble our products. Most parts and components purchased from suppliers are available from multiple sources. We believe that we will be able to continue to obtain most required components and parts from a number of different suppliers, although there can be no assurance of continued availability. The lack of availability of certain components could require a major redesign of our products and could result in production and delivery delays.

 

During 2002, we issued $50 million in 6.9% senior notes, which are collateralized by all of our assets.

 

In May 2002, we placed $50 million in 6.9% senior notes due May 2007 with an investor group. Interest on the senior notes accrues, but is not payable until May 2005. The senior notes are collateralized by a senior blanket security interest in our assets. If we default on these senior notes, we may become subject to claims by note holders seeking to enforce their security interest in our assets. Such claims, if they arise, may substantially restrict or even eliminate our ability to utilize our assets in conducting our business, and may cause us to incur substantial legal and administrative costs.

 

Our auditors have expressed doubt about our ability to continue as a going concern.

 

We received a report on our consolidated financial statements from our independent auditors for the years ended December 31, 2003 and 2002 that includes an explanatory paragraph expressing substantial doubt as to our ability to continue as a going concern without, among other things, obtaining additional financing to support expansion plans, manufacturing, research and development activities, or achieving a level of revenues adequate to support our cost structure.

 

Our operating results may fluctuate from quarter to quarter, which could cause our stock price to be volatile.

 

The market prices of many publicly traded companies, including emerging companies in the healthcare industry, have been and can be expected to be highly volatile. The future market price of our common stock could be significantly impacted by:

 

  future sales of our common stock,

 

  general stock market conditions,

 

  announcements of technological innovations for new commercial products by our present or potential competitors,

 

  developments concerning proprietary rights,

 

  adverse results in our field or with clinical tests,

 

  adverse litigation,

 

  unfavorable legislation or regulatory decisions,

 

  public concerns regarding our products,

 

  variations in quarterly operating results;

 

  general trends in the health care industry, and

 

  other factors outside of our control.

 

Our quarterly financial results are often impacted by the receipt of a large number of customer orders in the last weeks of a quarter. Absent these orders, our sales could fall short of our targets, thus causing our stock price to decline.

 

We must comply with governmental regulations and industry standards.

 

We are subject to significant regulation by authorities in the United States and foreign jurisdictions regarding the clearance of our products and the subsequent manufacture, marketing, and distribution of our products once approved. The design, efficacy, and safety of our products are subject to extensive and rigorous testing before receiving marketing clearance from the U.S. Food and Drug Administration (“FDA”). The FDA also regulates the registration, listing, labeling, manufacturing, packaging, marketing, promotion, distribution, record keeping and reporting for medical devices. The process of obtaining FDA clearances is lengthy and expensive, and we cannot assure you that we will be able to obtain the necessary clearances for marketing our

 

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products on a timely basis, if at all. Failure to receive, or delays in receiving, regulatory clearances would limit our ability to commercialize our products, which would have a material adverse effect on our business, financial condition, and results of operations. Even if such clearances are granted by the FDA, our products will be subject to continual regulatory review. Later discovery of previously undetected problems or failure to comply with regulatory standards may result in product labeling restrictions, costly and time-consuming product recalls, withdrawals of clearances, or other regulatory or enforcement actions. Moreover, future governmental statutes, regulations, or policies, or changes in existing statutes, regulations, or policies, may have an adverse effect on the development, production, or distribution of our products.

 

Any regulatory clearance, if granted, may include significant limitations on the uses for which our products may be marketed. FDA enforcement policy strictly prohibits the marketing of cleared medical devices for unapproved uses. In addition, the manufacturing processes used to produce our products will be required to comply with the Good Manufacturing Practices or “GMP” regulations of the FDA. These regulations cover design, testing, production, control, documentation, and other requirements. Enforcement of GMP regulations has increased significantly in the last several years, and the FDA has publicly stated that compliance will be more strictly scrutinized. Our facilities and manufacturing processes and those of certain of our third party contract manufacturers and suppliers, if any, will be subject to periodic inspection by the FDA and other agencies. Failure to comply with applicable regulatory requirements could result in, among other things:

 

  warning letters;

 

  fines;

 

  injunctions;

 

  civil penalties;

 

  recalls or seizures of products;

 

  total or partial suspension of production;

 

  refusal of the government to grant pre-market clearance or pre-market approval for devices;

 

  withdrawal of clearances; and/or

 

  criminal prosecution.

 

To market our products in certain foreign jurisdictions, we must obtain required regulatory clearances and approvals and otherwise comply with extensive regulations regarding safety and quality. Compliance with these regulations and the time required for regulatory reviews vary from country to country. We cannot assure you that we will obtain regulatory clearances and approvals in foreign countries, and we may be required to incur significant costs in applying for, obtaining, or maintaining foreign regulatory clearances and approvals.

 

We are exposed to numerous risks associated with international operations.

 

We market our products in international markets. International operations entail various risks, including:

 

  political instability;

 

  economic instability and recessions;

 

  exposure to currency fluctuations;

 

  difficulties of administering foreign operations generally;

 

  reduced protection for intellectual property rights;

 

  potentially adverse tax consequences; and

 

  obligations to comply with a wide variety of foreign laws and other regulatory requirements.

 

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Our business is dependent upon our executive officers, and our ability to attract and retain other key personnel.

 

Our success is dependent in large part on the continued employment and performance of our Chairman and Chief Executive Officer, Raymond W. Cohen, as well as other key management and operating personnel. The loss of any of these persons could have a material adverse effect on our business. We do not have key person life insurance on any of our employees other than Mr. Cohen.

 

Our future success will also depend upon our ability to retain existing key personnel, and to hire and to retain additional qualified technical, engineering, scientific, managerial, marketing, and sales personnel. The failure to recruit such personnel, the loss of such existing personnel, or failure to otherwise obtain such expertise would have a material adverse effect on our business and financial condition.

 

We may face product liability claims.

 

The testing, manufacturing, marketing and sale of medical devices subjects us to the risk of liability claims or product recalls. For example, it is possible that our products will fail to deliver an energy charge when needed by the patient, or that they will deliver an energy charge when it is not needed. As a result, we may be subject to liability claims or product recalls for products to be distributed in the future or products that have already been distributed. Although we maintain product liability insurance in the countries in which we conduct business, we cannot assure you that such coverage is adequate or will continue to be available at affordable rates. Product liability insurance is expensive and may not be available in the future on acceptable terms, if at all. A successful product liability claim could inhibit or prevent commercialization of our products, impose a significant financial burden on us, or both, and could have a material adverse effect on our business and financial condition.

 

Our technology may become obsolete.

 

The medical equipment and healthcare industries are characterized by extensive research and rapid technological change. The development by others of new or improved products, processes, or technologies may make our products obsolete or less competitive. Accordingly, we plan to devote continued resources, to the extent available, to further develop and enhance our existing products and to develop new products. We cannot assure you that these efforts will be successful.

 

We depend on patents and other intellectual property rights that we may not be able to protect.

 

Our success will depend, in part, on our ability to obtain and maintain patent rights, preserve our trade secrets, and operate without infringing on the proprietary rights of third parties. The validity and breadth of claims covered in medical technology patents involve complex legal and factual questions and therefore may be highly uncertain. We cannot assure you that:

 

  any additional patents will be issued to us;

 

  the scope of any existing or future patents will exclude competitors or provide us with competitive advantages;

 

  any of our patents will be held valid and enforceable if challenged; or

 

  others will not claim rights in or ownership to our patents and other proprietary rights held by us.

 

Furthermore, others may have developed or could develop similar products or patent rights, may duplicate our products, or design around our current or future patents. In addition, others may hold or receive patents which contain claims having a scope that covers products developed by us. We also rely upon trade secrets to protect our proprietary technology. Others may independently develop or otherwise acquire substantially equivalent know-how, or gain access to and disclose our proprietary technology. We cannot assure you that we can ultimately protect meaningful rights to our proprietary technology. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Such litigation, if it occurs, could result in substantial expense to us and a diversion of our efforts, but may be necessary to enforce our patents;

 

  protect our trade secrets and know-how;

 

  defend us against claimed infringement of the rights of others; or

 

  determine the enforceability, scope, and validity of the proprietary rights of others.

 

An adverse determination in any such litigation could subject us to significant liability to third parties or require us to seek licenses from third parties. Although patent and intellectual property disputes in the medical device industry have often been

 

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settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. Moreover, we cannot assure you that necessary licenses would be available to us on satisfactory terms, if at all. If such licenses cannot be obtained on acceptable terms, we could be prevented from marketing our products. Accordingly, an adverse determination in such litigation could have a material adverse effect on our business and financial condition.

 

In February 2003, we announced we had filed a patent infringement action against Philips Medical Systems North America, Inc., Philips Electronics North America Corporation and Koninklijke Philips Electronics N.V. (“Philips”) in the United States District Court for the District of Minnesota. The suit charged that Philips’ automated external defibrillators sold under the names “HeartStart OnSite Defibrillator” and “HeartStart Home Defibrillator” infringed at least seven of our United States patents. In the same action, we also sought a declaration from the Court that our products do not infringe several of Philips’ patents. In June 2003, we filed our First Amended Complaint further accusing Philips’ “HeartStart FR2” automated external defibrillator of infringing our U.S. Patents and removing four of the Philips’ patents from suit pursuant to an agreement between the parties. The Philips “HeartStart Home Defibrillator,” which was recently cleared by the FDA for marketing in the United States, is promoted by Philips as including, among other things, pre-connected disposable defibrillation electrodes and daily self-testing of electrodes and battery, features that the suit alleges are key competitive advantages of our Powerheart and Survivalink AEDs and are covered under our patents. On June 19, 2003, Philips filed a Complaint against us in the United States District Court for the Western District of Washington. Philips’ Complaint alleged patent infringement of ten of Philips’ U.S. Patents by our Powerheart and Survivalink AEDs. Five of the asserted patents were already contained in our Minnesota case against Philips. We made a motion to dismiss the Washington case as duplicative and the motion was granted. Philips made a motion in the Minnesota case to have its patents severed from that action, but the motion was denied. At this stage, we are unable to predict the outcome of this litigation or its ultimate effect, if any, on our financial condition.

 

Our ability to issue preferred stock could adversely affect common stockholders.

 

Our certificate of incorporation authorizes the issuance of preferred stock with such designations, rights, and preferences as may be determined from time to time by our board of directors, without any further vote or action by our stockholders. Therefore, our board of directors is empowered, without stockholder approval, to issue a class of stock with dividend, liquidation, conversion, voting, or other rights, which could adversely affect the voting power or other rights of the holders of our common stock.

 

Anti-takeover provisions may discourage takeover attempts.

 

Provisions of the Delaware General Corporation Law and our certificate of incorporation may discourage potential acquisition proposals, or delay or prevent a change of control.

 

Future issuances of our common stock could cause our stock price to decline.

 

We currently have reserved 14,000,000 shares of common stock for issuance upon the exercise of options that may be granted under our 1997 Stock Option/Stock Issuance Plan, as amended, and 14,286,735 shares for issuance upon the exercise of currently outstanding warrants. The holders of these options or warrants may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us. The exercise of these options or warrants and the sale of the common stock obtained upon exercise would have a dilutive effect on our stockholders and may have a material adverse effect on the market price of our common stock.

 

Significant decreases in our stock price could result in our having to record an impairment charge related to our goodwill.

 

Applicable accounting standards require that goodwill be tested for impairment at least annually or whenever evidence of potential impairment exists. If, in any period, our stock price decreases to the point where the fair value of our goodwill, as determined by our market capitalization, is less than the book value of our goodwill, we would be required to record an impairment charge in that period.

 

ITEM 2. DESCRIPTION OF PROPERTY.

 

Our corporate headquarters is located in Irvine, California, and encompass approximately 22,000 square feet. Our lease for this property expires in 2008 and our annual net rent expense for this facility is approximately $458,000. Our R&D facility, located in Lake Forest, California comprises approximately 10,000 square feet. This lease expires in 2008 and our annual net rent expense is approximately $120,000. We also have a manufacturing facility located in Minnetonka, Minnesota, totaling approximately 31,000 square feet. The lease on this facility expires in 2007 and our annual net rent expense for this facility is approximately $335,000. We also have international sales and marketing offices in Copenhagen, Denmark, Manchester, England and Dresden, Germany.

 

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ITEM 3. LEGAL PROCEEDINGS.

 

In February 2003, we announced that we had filed a patent infringement action against Philips Medical Systems North America, Inc., Philips Electronics North America Corporation and Koninklijke Philips Electronics N.V. (“Philips”) in the United States District Court for the District of Minnesota. The suit charged that Philips’ automated external defibrillators sold under the names “HeartStart OnSite Defibrillator” and “HeartStart Home Defibrillator” infringed at least seven of our United States patents. In the same action, we also sought a declaration from the Court that our products do not infringe several of Philips’ patents. In June 2003, we filed our First Amended Complaint further accusing Philips’ “HeartStart FR2” automated external defibrillator of infringing our U.S. Patents and removing four of the Philips’ patents from suit pursuant to an agreement between the parties. The Philips “HeartStart Home Defibrillator,” which was recently cleared by the U.S. Food and Drug Administration (“FDA”) for marketing in the United States, is promoted by Philips as including, among other things, pre-connected disposable defibrillation electrodes and daily self-testing of electrodes and battery, features that the suit alleges are key competitive advantages of our Powerheart and Survivalink AEDs and are covered under our patents. On June 19, 2003, Philips filed a Complaint against us in the United States District Court for the Western District of Washington. Philips’ Complaint alleged patent infringement of ten of Philips’ U.S. Patents by our Powerheart and Survivalink AEDs. Five of the asserted patents were already contained in our Minnesota case against Philips. We made a motion to dismiss the Washington case as duplicative and the court granted our motion. Philips made a motion in the Minnesota case to have its patents severed from that action, but the motion was denied. At this stage, we are unable to predict the outcome of this litigation or its ultimate effect, if any, on our financial condition.

 

On April 30, 2003, we filed a Complaint against Defibtech, LLC for patent infringement in the United States District Court for the District of Minnesota. The Complaint alleged that Defibtech’s Sentry and Reviver AEDs infringe our patented disposable electrode pre-connect technology. Defibtech answered the Complaint with no counterclaims. At this stage, we are unable to predict the outcome of this litigation or its ultimate effect, if any, on our financial condition.

 

In the ordinary course of business, various lawsuits and claims are filed against us. While the outcome of these matters is currently not determinable, we believe that the ultimate resolution of these matters will not have a material adverse effect on our operations or financial position.

 

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

On November 17, 2003, the Company held an annual meeting of the stockholders. Seven persons, five of whom were existing members of the Board of Directors, were nominees for election at the annual meeting. All of the following persons were elected as directors at the annual meeting:

 

Name


   Votes For

   Votes
Against


   Abstentions

   Broker
Non-votes


Raymond W. Cohen

   48,929,761    —      8,624,041    —  

Howard L. Evers

   57,265,758    —      288,044    —  

Peter Crosby

   56,973,528    —      580,396    —  

Raymond E. Newton III

   57,237,525    —      316,277    —  

Jeffrey F. O’Donnell Sr.

   56,960,141    —      593,661    —  

Brian H. Dovey

   56,973,528    —      580,274    —  

Bruce J. Barclay

   56,965,406    —      588,396    —  

 

Proposals voted on at the annual meeting were:

 

  1. To elect seven members to the board of directors to serve until the next Annual Meeting of Stockholders and until their successors are duly elected and qualified.

 

  2. To approve an amendment to our 1997 Stock Option/Stock Issuance Plan to increase the number of shares of Common Stock reserved for issuance thereunder from 11,000,000 shares to 14,000,000 shares in order to provide an adequate pool of stock options for existing and future employees.

 

  3. To ratify the selection of the Board of Directors of PricewaterhouseCoopers LLP as independent accountants of the Company for the year ending December 31, 2003.

 

The following table shows the matters voted upon except election of the Directors which is detailed above, votes cast for, against or withheld as the number of abstentions and broker non-votes.

 

Matter


   Votes For

   Votes
Against


   Abstentions

   Broker
Non-votes


Proposal 2

   23,847,511    4,855,677    172,112    28,678,502

Proposal 3

   56,907,015    588,988    57,799    —  

 

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PART II

 

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

 

Market Information

 

In September 2000, our common stock was accepted for trading on the NASDAQ National Market under the symbol “DFIB”. The following table sets forth for the periods indicated the high and low closing prices for our common stock as reported on NASDAQ National Market.

 

     High

   Low

4th Quarter 2003, ended 12/31/03

   $ 4.65    $ 3.40

3rd Quarter 2003, ended 9/30/03

   $ 4.99    $ 2.54

2nd Quarter 2003, ended 6/30/03

   $ 3.19    $ 2.22

1st Quarter 2003, ended 3/31/03

   $ 2.94    $ 1.98

4th Quarter 2002, ended 12/31/02

   $ 2.64    $ 1.36

3rd Quarter 2002, ended 9/30/02

   $ 3.80    $ 1.20

2nd Quarter 2002, ended 6/30/02

   $ 3.98    $ 2.54

1st Quarter 2002, ended 3/31/02

   $ 4.89    $ 2.52

 

Holders

 

As of March 11, 2004, there were approximately 938 holders of record of our common stock.

 

Dividends

 

We have never paid any cash dividends on our common stock. We presently intend to retain earnings, if any, to finance our operations and therefore do not anticipate paying any cash dividends in the foreseeable future. The payment of any dividends will depend upon, among other things, our earnings, assets and general financial condition.

 

Recent Sales of Unregistered Securities

 

In July 2003, we signed multi-year strategic OEM, distribution and development agreements with GE Medical Systems Information Technologies pursuant to which GE will market AEDs and CRMs under the GE name in Europe, Asia, the Middle East and other international markets. In connection with the development agreement, we issued GE a warrant to purchase 750,000 shares of our common stock with an exercise price of $3.00 per share. In September 2003, we completed a private placement of 2,233,334 shares of common stock at $3.75 per share. We also issued warrants to purchase 223,333 shares of our common stock with an exercise price of $5.00 per share in connection with the transaction. In October 2003, we acquired substantially all of the assets of Complient Corporation for 10,250,000 shares of our common stock, subject to a lock-up agreement and general indemnification escrow. All of the shares issued in these recent sales of unregistered securities were registered for resale on Form S-3 (333-110898).

 

The sale and issuance of these securities were deemed to be exempt from registration under the Securities Act of 1933, as amended in reliance upon Section 4(2) of the Securities Act of 1933, as amended. The recipient of securities represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the securities issued in such transactions these sales were made without general solicitation or advertising. Each recipient was an accredited investor. All recipients had adequate access, through their relationship with us, to information about us.

 

To the extent we received proceeds from the above referenced recent sales of unregistered securities, we expect to use the net proceeds for working capital and other general corporate purposes, which may include commercial activities relating to existing product sales and anticipated product launches and acquisitions of companies, products or technology, although there are no current agreements with respect to any such acquisitions. If we engage in such acquisitions of companies, products, rights or technology in order to execute our business strategy, we may need to raise additional capital. Pending such uses, we intend to invest the net proceeds from the offering in short-term, interest-bearing, investment grade securities.

 

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ITEM 6. SELECTED FINANCIAL DATA.

 

The following selected financial information is derived from our consolidated financial statements. You should read this summary financial information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related notes.

 

Statement of Operations Data:

(In thousands, except share and per share data)

 

     For the Year Ended December 31,

 
     2003

    2002

    2001

    2000

    1999

 

Net revenue

   $ 61,982     $ 50,043     $ 10,651     $ 4,242     $ 103  
    


 


 


 


 


Gross profit

     33,439       25,306       2,676       417       5  
    


 


 


 


 


Gross profit %

     54 %     51 %     25 %     10 %     5 %

Operating expenses:

                                        

Sales and marketing

     18,616       17,325       8,972       4,371       1,370  

Research and development

     5,538       6,053       8,575       8,248       4,406  

General and administrative

     14,720       11,474       6,935       5,159       1,853  

Acquired in-process research and development

     —         —         —         13,587       —    

Amortization of goodwill and intangibles

     1,656       2,111       1,740       1,063       —    

Amortization of restricted stock

     —         —         —         1,551       —    

Impairment of assets

     —         —         1,438       —         —    

Gain on Settlement

     —         (832 )     —         —         —    
    


 


 


 


 


Total Operating Expenses

     40,530       36,131       27,660       33,979       7,629  
    


 


 


 


 


Loss from operations

     (7,091 )     (10,825 )     (24,984 )     (33,562 )     (7,624 )
    


 


 


 


 


Interest income (expense), net

     (5,891 )     (4,142 )     (538 )     618       21  

Loss on sale of marketable securities

     —         —         (707 )     —         —    

Minority interest in (income) loss of subsidiary

     (48 )     (33 )     16       —         —    

Loss in unconsolidated affiliate

     —         —         —         —         (115 )

Provision for income taxes

     —         —         (2 )     (2 )     (2 )
    


 


 


 


 


       (5,939 )     (4,175 )     (1,231 )     616       (96 )
    


 


 


 


 


Loss from continuing operations

     (13,030 )     (15,000 )     (26,215 )     (32,946 )     (7,720 )

Income (loss) from discontinued operations

     493       (52 )     —         —         —    
    


 


 


 


 


Net loss

   $ (12,537 )   $ (15,052 )   $ (26,215 )   $ (32,946 )   $ (7,720 )
    


 


 


 


 


Basic and diluted loss per share:

                                        

Continuing operations

   $ (0.19 )   $ (0.22 )   $ (0.78 )   $ (1.82 )   $ (0.85 )

Discontinued operations

     0.01       —         —         —         —    
    


 


 


 


 


Net loss per share

   $ (0.18 )   $ (0.22 )   $ (0.78 )   $ (1.82 )   $ (0.85 )
    


 


 


 


 


Weighted average shares used in computing net loss per share

     69,848       67,199       33,507       18,080       9,113  

 

Selected Balance Sheet Data:

(In thousands, except share and per share data)

 

     December 31,

     2003

   2002

   2001

   2000

   1999

Cash and cash equivalents

   $ 8,871    $ 15,598    $ 15,830    $ 13,537    $ 5,902

Working capital

     22,981      19,177      12,388      18,022      4,384

Total assets

     203,001      153,920      145,469      33,336      7,044

Long term debt, net of current portion

     46,522      41,145      27,780      192      104

Total stockholders’ equity

     137,591      94,270      98,344      28,985      4,822

 

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Summarized Quarterly Data:

(In thousands, except share and per share data)

 

     Quarter Ended

 
     March 31

    June 30

    September 30

    December 31

 

2003

                                

Net revenue

   $ 14,024     $ 14,527     $ 15,728     $ 17,703  

Gross profit

   $ 7,935     $ 8,306     $ 9,511     $ 7,687  (3)

Gross profit %

     57 %     57 %     61 %     43 %

Operating loss

   $ (1,240 )   $ (621 )   $ (264 )   $ (4,966 )

Net loss

   $ (2,582 )   $ (1,974 )   $ (1,490 )   $ (6,491 )

Basic and diluted loss per share

   $ (0.04 )   $ (0.03 )   $ (0.02 )   $ (0.09 )

2002

                                

Net revenue

   $ 9,361     $ 12,841     $ 13,588     $ 14,253  

Gross profit

   $ 4,451     $ 6,174     $ 6,800     $ 7,881  

Gross profit %

     48 %     48 %     50  %     55 %

Operating loss

   $ (2,839 )   $ (2,926 )   $ (2,789 )   $ (2,271 )

Net loss

   $ (3,482 )(2)   $ (3,753 )   $ (4,136 )   $ (3,681 )

Basic and diluted loss per share

   $ (0.05 )   $ (0.06 )   $ (0.06 )   $ (0.05 )

2001

                                

Net revenue

   $ 1,758     $ 491     $ 644     $ 7,758  

Gross profit

   $ 141     $ 89     $ (1,142 )(1)   $ 3,588  

Gross profit %

     8 %     18 %     (177 )%     46 %

Operating loss

   $ (5,397 )   $ (6,453 )   $ (8,031 )   $ (5,103 )

Net loss

   $ (5,267 )   $ (7,120 )   $ (8,016 )   $ (5,812 )

Basic and diluted loss per share

   $ (0.21 )   $ (0.29 )   $ (0.31 )   $ (0.10 )

(1) The gross profit for the quarter ended September 30, 2001, includes a write-down of $1,454 of inventories as a result of the discontinuation of the original Powerheart model and the introduction of the new Powerheart CRM and reflects management’s estimate of the cost of component inventory on-hand that will not be transformed into finished goods.
(2) Loss from operations includes a gain of $832 related to a Settlement Agreement and Mutual Release with Medtronic Physio-Control Corp.
(3) The gross profit for the quarter ended December 31, 2003 includes an impairment change of $2,917 related to the Company’s in-hospital defibrillators as a result of a strategic decision to terminate the “no cap” placement business model in U.S. hospitals.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

(In thousands, except share and per share data)

 

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto set forth herein.

 

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

 

Results of Operations

 

On October 21, 2003, in a move to capture additional revenue related to the sale of our AEDs, we acquired substantially all the assets and liabilities of Complient Corporation, the nation’s leading independent provider of AED and CPR training and comprehensive AED program management. Corporations, municipalities, schools, government agencies and others who purchase and deploy AEDs are required by certain federal and state laws to obtain a medical prescription and have designated personnel trained annually in AED use and CPR by a certified trainer. Traditionally, buyers of AEDs have had to arrange for their own training with non-profit organizations or off-duty paramedics, coordinate their own site assessment and deployment, and assure ongoing compliance with recertification and other regulations. Complient was the first organization of its kind to offer a comprehensive training program that included the management and coordination of all aspects of AED deployment including site surveys, medical direction, web-based software for record-keeping and AED/CPR training with 150 certified trainers on staff covering all 50 states nationwide. Strategically, Complient fits well with us and was a logical extension of our core business. The acquisition provides additional point-of-sale revenue as well as a recurring revenue opportunity linked to AED sales. Moreover, we believe this will provide us with a significant competitive advantage over our competitors who do not offer comparable programs. We reduced Complient’s non-trainer staff by approximately one third and have substantially completed the integration of its operations into ours as of December 31, 2003. In 2002, Complient generated revenue of approximately $12.6 million from sales of AEDs and related services.

 

At the end of 2003, we made a strategic decision to discontinue the “no cap” Powerheart CRM placement business model in U.S. hospitals in favor of a capital sale model focused on key distribution relationships such as those we entered into in 2003 with General Electric Medical Systems and the Premier, Inc. buying group. In 2001, we adopted the “no cap” model, whereby we marketed the Powerheart to U.S. hospitals directly, and agreed to place Powerheart units in a customer’s facility, while retaining ownership of the unit, with no upfront capital equipment charge to the customer in exchange for an agreement to purchase our proprietary, disposable defibrillation electrodes monthly or quarterly. We believed this “no cap” model would increase the rate of adoption of our AECD/CRM technology by addressing the capital budget constraints many U.S. hospitals face and would ultimately result in higher levels of recurring revenue from disposable electrodes. While this model did initially increase adoption of the technology, it has failed to produce the expected levels of revenue required to continue with this business model going forward. As a result of this strategic change, we incurred a $2.9 million inventory impairment charge to write down the value of first generation Powerheart and Powerheart CRM in-hospital defibrillators in inventory and at certain customer sites. However, there are a number of customer sites where the technology has been successfully deployed and that are generating sufficient revenue on disposable electrode sales to justify the continuation of this program for those specific customers.

 

Revenue

 

The following is a summary of net revenue by product line:

 

     2003

    2002

    Change

 

AEDs and related accessories and services

   $ 56,529    91.2 %   $ 38,572    77.1 %   $ 17,957     46.6  %

Powerheart in-hospital defibrillators and accessories

     1,259    2.0 %     1,278    2.5 %     (19 )   (1.5 )%

Emergency defibrillators, monitors, training products and accessories

     4,194    6.8 %     10,193    20.4 %     (5,999 )   (58.9 )%
    

  

 

  

 


     

Total net revenue

   $ 61,982    100.0 %   $ 50,043    100.0 %   $ 11,939     23.9  %
    

  

 

  

 


     

 

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Net revenue for the year ended December 31, 2003 increased $11.9 million or 23.9% compared to the year ended December 31, 2002. This increase was primarily attributable to our expanding share of the growing worldwide market for AEDs. Sales of AED products and related accessories and services, which represented 91.2% of our total revenue, increased by $18 million, or 46.6%. The AED product line, led by the Powerheart AED G3, continued to be the principal growth driver and was fueled and complemented by the acquisition of Complient and the addition of AED/CPR training and program management services, which accounted for $1.5 million of sales in 2003, primarily in the period following the acquisition of Complient on October 21, 2003. In addition, we sold $4.2 million of emergency defibrillators, monitors, training equipment and accessories in 2003 compared to $10.2 million in 2002. This decrease of $6 million, or 58.9%, is due to the fact that we dedicated less resources to our patient monitoring line, which is not part of our core AED and hospital defibrillation markets, and has resulted in a strategic change for 2004 to exit the patient monitoring line, along with the training related equipment and supplies product line we acquired from Complient. Sales of Powerheart CRMs and related accessories were $431 for 2003 compared to $240 in 2002, which represents less than 1% of total revenue in both years. Sales of our Powerheart proprietary disposable defibrillation electrodes related to the first generation Powerheart and the Powerheart CRM were $828 for 2003 and $1,038 for 2002. The lack of growth in these in-hospital products contributed to the business model change in late 2003 discussed earlier under “Results of Operations.”

 

Gross Margin

 

Cost of goods sold for the year ended December 31, 2003 was $28,543, including an impairment charge of $2,917, compared to $24,737 for the year ended December 31, 2002. Gross margins as a percentage of revenue, including the impairment charge, improved to 53.9% in 2003 from 50.6% in 2002. The improvement was a result of increased sales of higher margin AEDs as a percentage of total revenue from 77.1% in 2002 to 91.2% in 2003, as well as the reduced cost of the AED product line due to significant cost reduction initiatives taken in 2003 and the introduction of our new lower cost version Powerheart AED G3 in August 2003.

 

Operating Expenses

 

The following is a summary of operating expenses as a percentage of net revenue:

 

     2003

    2002

    Change

 

Sales and marketing

   $ 18,616    30.0 %   $ 17,325     34.6 %   $ 1,291     7.5 %

Research and development

     5,538    8.9 %     6,053     12.1 %     (515 )   (8.5 %)

General and administrative

     14,720    23.8 %     11,474     22.9 %     3,246     28.3 %

Amortization

     1,656    2.7 %     2,111     4.2 %     (455 )   (21.6 %)

Gain on settlement

     —      —         (832 )   (1.6 )%     832     100.0 %
    

  

 


 

 


     

Total operating expenses

   $ 40,530    65.4 %   $ 36,131     72.2 %   $ 4,399     12.2 %
    

  

 


 

 


     

 

Sales and marketing expenses increased by 7.5% to $18.6 million for the year ended December 31, 2003, but decreased as a percentage of revenue to 30.0% in 2003 from 34.6% in 2002. The absolute dollar increase is primarily attributable to increased sales and marketing activities related to international sales operations ($1,228), including the establishment of direct sales operations in the U.K and Germany, and increased U.S. sales activities related to the growth of AED related sales ($1,073), including new sales and marketing expenses related to program management and training services pursuant to the acquisition of Complient. This increase is offset by a decrease in the sales and clinical efforts associated with the Powerheart CRM in-hospital product line ($1,129). The decrease in expenses as a percentage of revenue reflects our operating leverage and an increasing mix of revenue flowing through lower-cost indirect distribution channels.

 

Research and development expenses for the year ended December 31, 2003 decreased 8.5% compared to 2002. In 2003, research and development expenses were 8.9% of revenue, down from 12.1% of revenue in 2002. The absolute dollar decrease is primarily attributable to: (i) the development and completion of the Powerheart CRM project in 2002 which resulted in higher salaries, bonuses and benefits as well as project design, consulting and materials expenses during 2002 and (ii) the fact that we reallocated resources previously focused on preproduction activities included in research and development expenses in 2002, but now focused on Company-wide operations which are included in general and administrative in 2003. The second half of 2003

 

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compared with the first half of 2003 shows an increase in research and development expenses directly related to more headcount and project costs associated with the development of a standard crash-cart biphasic defibrillator for GEMS pursuant to a development agreement signed in July 2003. An increase in research and development expenditures is expected to continue into 2004 based on the anticipated completion date of this project in the fourth quarter of 2004.

 

General and administrative expenses increased $3.2 million or 28.3% during the year ended December 31, 2003 compared with 2002. As a percentage of revenue, general and administrative expenses increased to 23.8% in 2003 from 22.9% in 2002. This increase was primarily comprised of new expenses, primarily headcount and facilities, related to the Complient acquisition ($435), our relocation of corporate headquarters and expansion of corporate, manufacturing and R&D facilities in 2003 ($936), increased salaries and benefits ($675), depreciation expense ($449) and the fact that we reallocated resources previously focused on preproduction activities included in research and development expenses in 2002, but now focused on Company-wide operations which are included in general and administrative in 2003 ($585).

 

Amortization of intangibles was $1,656 for the year ended December 31, 2003, a decrease of $455 or 21.6% from the $2,111 for the year ended December 31, 2002. The decrease is primarily the result of certain identifiable intangible assets becoming fully amortized during 2003 offset by approximately two months of amortization of intangibles related to the Complient acquisition.

 

Interest

 

Interest expense for the year ended December 31, 2003 was $6,031 compared to interest expense of $4,452 for 2002. The increase was a result of a full year of interest expense and warrant and debt issuance cost amortization in 2003 associated with the senior secured promissory notes issued in May 2002.

 

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

 

Results of Operations

 

On September 26, 2001, we acquired Survivalink which enabled us to enter the rapidly growing public access defibrillation market and has contributed significantly and positively to the results of our operations. On November 30, 2001 we acquired a 94.7% ownership interest in Artema which allowed us to gain access to a line of manual emergency defibrillators and patient monitors. In addition to the new product line, we significantly expanded our international distribution channel through which we were able to sell additional Powerheart AEDs and CRMs during 2002. We also established our international sales and marketing headquarters in Copenhagen, Denmark where Artema had certain operations.

 

In 2001, we also made a fundamental shift in the way we market the Powerheart CRM in the U.S. away from a capital equipment model, where sales of the Powerheart were made to a large distributor Medtronic Physio-Control, to a recurring revenue business model. Under this model, we market the Powerheart directly to U.S. hospitals, and agree to place Powerheart units in a customer’s facility, while retaining ownership of the unit, with no upfront capital equipment charge, in exchange for an agreement to purchase a specific number of our proprietary, disposable defibrillation electrodes monthly or quarterly. We believe this model will increase the rate of adoption of our AECD technology by addressing the capital budget constraints many U.S. hospitals face and will ultimately result in higher levels of recurring revenue from disposable electrodes.

 

Revenue

 

Net revenue for the year ended December 31, 2002 increased $39,392 or 369.8% to $50,043 as compared to $10,651 for the year ended December 31, 2001. This increase was primarily attributable to our acquisition of Survivalink which generated $38,572 in Powerheart AED and related accessory sales in 2002 as compared to $6,519 in 2001. This increase in AED revenue was largely due to the timing of the Survivalink acquisition which we owned for approximately 90 days in 2001. In addition, based on our acquisition of Artema, we sold approximately $10.2 million of emergency defibrillators and monitors and related accessories in 2002, as compared to $1.4 million for the one month we owned the company in 2001. Sales of Powerheart CRMs and accessories were $240 for the year ended December 31, 2002, a decrease of $1,122 or 82.4% compared to $1,362 for the comparable period in 2001, as a result of transitioning from a traditional capital equipment distribution model to our strategy of placing Powerheart units at customer locations. Sales of our Powerheart proprietary disposable defibrillation electrodes increased $551 or 113.1% to

 

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$1,038 for the year ended December 31, 2002, compared to $487 for the comparable period in 2001, as a result of a greater number of Powerheart units in the field generating electrode utilization.

 

Gross Margin

 

Cost of goods sold for the year ended December 31, 2002 was $24,737 as compared to $7,975 for the year ended December 31, 2001. Gross margins as a percentage of revenue improved to 50.6% in 2002 from 25.1% in 2001 (including the write-down of first generation Powerheart inventory). The improvement was primarily a result of the increase, as a percentage of total revenue, of the higher margin AEDs and accessories. In addition, the cost of goods sold of the Powerheart AED decreased approximately 19% throughout the year of 2002.

 

Operating Expenses

 

Sales and marketing expenses were $17,325 or 34.6% of revenue for the year ended December 31, 2002, as compared to $8,972 or 84.2% of sales in 2001. This increase is attributable to absorbing a full year of sales expenses (as compared to three months in 2001) including wages, commissions, travel and related expenses ($8,701), associated with our U.S. direct AED sales force, and the expansion of this sales force from 17 representatives at the end of 2001 to 55 at the end of 2002.

 

Research and development expenses for the year ended December 31, 2002 were $6,053, a decrease of $2,522 or 29.4% compared to $8,575 for 2001. This decrease is attributable to the completion of the Powerheart CRM project which resulted in lower salaries, bonuses and benefits ($458) associated with headcount reductions and reductions in project design, consulting and materials expenses ($1,861). In addition, we recorded the recovery of a previously written off note receivable from HeartSine Technologies, a privately held research and development firm ($236).

 

General and administrative expenses were $11,474 for the year ended December 31, 2002, an increase of $4,539 or 65.5% over the $6,935 for the year ended December 31, 2001. This increase was primarily comprised of increased patent related legal expenses ($1,702), and increased salaries and benefits ($698), travel ($263), insurance ($574) and depreciation expense ($539) associated with the full year integration of the Survivalink and Artema acquisitions.

 

Amortization of goodwill and other intangibles was $2,111 for the year ended December 31, 2002, an increase of $371 or 21.3% from the $1,740 for the year ended December 31, 2001. The increase resulted primarily from a full year of amortization of intangibles from the Survivalink ($1,570) and Artema ($185) acquisitions. These increases were offset by the discontinuation of goodwill amortization as of December 31, 2001 in accordance with SFAS No. 142.

 

Interest

 

Interest expense for the year ended December 31, 2002 was $4,452 compared to interest expense of $594 for the same period in 2001. The increase was primarily attributable to interest expense relating to the Survivalink notes ($1,134) and interest expense and warrant and debt issuance cost amortization associated with the Senior Debt issued in May of 2002 ($3,207).

 

Liquidity and Capital Resources

 

     December 31

     2003

   2002

Working capital

   $ 22,981    $ 19,177

Current ratio (current assets to current liabilities)

     2.3 : 1.0      2.2 : 1.0

Cash and cash equivalents

   $ 8,871    $ 15,598

Accounts receivable, net

   $ 20,410    $ 10,986

Inventories

   $ 9,575    $ 5,918

Short-term and long-term borrowings

   $ 46,575    $ 41,391

 

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The increase in our current ratio and working capital and the decrease in our cash and cash equivalents are primarily due to the increase in accounts receivable and inventories resulting from our market share and revenue growth in 2003.

 

At December 31, 2003, our days sales outstanding on accounts receivable (“DSO”) was approximately 105 days compared to approximately 70 days at December 31, 2002. The increase in our DSO is primarily attributable to an increasing mix of revenue flowing through indirect distribution channels which typically have longer payment terms. We expect our DSO in 2004 to average around 90 days and expect to move towards that level in the first two quarters of 2004.

 

In February 2004, we secured a $5 million line of credit with Silicon Valley Bank. The line of credit will be used to provide additional working capital, as needed, to fund our continued growth. This 24-month facility is collateralized by accounts receivable, inventory and cash and cash equivalents, has an interest rate of the bank’s prime rate plus .75% (with a floor of 5%) payable monthly, and requires us to maintain certain financial covenants.

 

From inception, our sources of funding for operations and mergers and acquisition activity were derived from placements of debt and equity securities. In 2001, we raised approximately $37 million in a series of private equity placements and through the exercise of outstanding options and warrants. In May 2002, we entered into a Senior Note and Warrant Purchase Agreement with investors pursuant to which the investors loaned us $50 million. We in turn repaid the $26,468 plus accrued interest in senior promissory notes relating to the Survivalink acquisition. In September 2003, we raised $8.4 million in a private equity placement of 2,233,334 shares of our common stock at $3.75 per share to a small group of institutional and accredited investors. In connection with this offering, we also issued 223,333 five-year warrants with an exercise price of $5.00 per share. The proceeds from this offering will fund the acceleration of current product development projects associated with the recently announced partnership with GEMS and for working capital for future strategic initiatives.

 

In March 2004, we amended the Senior Note and Warrant Agreement in order to ease certain financial covenants into 2005 to reflect our actual and expected financial results. In exchange for these modifications, we issued the note holders 500,000 additional warrants to purchase shares of common stock at $3.95 per share.

 

From inception through December 31, 2003, we have incurred losses of approximately $106 million. Recovery of the Company’s assets is dependent upon future events, the outcome of which is indeterminable. Additionally, transition to profitable operations is dependent upon achieving a level of revenues adequate to support the Company’s cost structure. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.

 

Cash used by operating activities for the year ended December 31, 2003 decreased by $4,434 or 21.3%, to $16,347 from $20,781 for the year ended December 31, 2002. This decrease was primarily attributable to a $3,734 or 34.5% decrease in our operating loss year to year including the non-cash impairment charge in 2003.

 

Cash provided by investing activities for the year ended December 31, 2003 increased by $312 to $219 in 2003 compared to cash used by investing activities in 2002 of $93. This increase was primarily attributable to the refund of cash invested in MRL of $3,001 offset by higher property and equipment expenditures and the Lifetec and Complient acquisitions and related costs in 2003. Property and equipment purchases increased in 2003 primarily due to additional leasehold improvements for our new corporate headquarters in Irvine, CA, our new R&D facility in Lake Forest, CA and our expanded manufacturing facility in Minnetonka, MN. Some of these leasehold improvements have been reimbursed to us by our landlords and will be accounted for as credits to rent expense over the life of the related leases.

 

Cash provided by financing activities for the year ended December 31, 2003 decreased by $10,960 or 53.5% to $9,509 in 2003 from $20,469 in 2002. This decrease was primarily due to the net proceeds of $20,746 from the senior secured promissory notes issued, after repayment of the Survivalink notes, in 2002 offset by the net proceeds received in 2003 for the private equity placement of $8,331 and an increase in proceeds from the exercises of stock options year to year of $1,338.

 

Based on meeting our internal sales growth targets, we believe that our current cash balances, combined with net cash that we expect to generate from operations and our unused line of credit of $5 million, will sustain our ongoing operations for at least the next twelve months. In the event that we require additional cash to support our operations during the next twelve months, we will attempt to raise the required capital through either debt or equity arrangements. We cannot provide any assurance that the required capital will be available on acceptable terms, if at all, or that any financing activity will not be dilutive to our current stockholders. If we are not able to raise additional funds, we may be required to significantly curtail our operations and this would have an adverse effect on our financial position, results of operations and cash flows.

 

Off-Balance Sheet Arrangements

 

We do not have any material off-balance sheet arrangements other than non-cancelable operating leases entered into in the ordinary course of business. For liquidity purposes, we choose to lease our facilities, automobiles, and certain equipment instead of purchasing them.

 

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Contractual Obligations and Other Commercial Commitments

 

We had no material commitments for capital expenditures as of December 31, 2003.

 

The following table presents our expected cash requirements for contractual obligations outstanding as of December 31, 2003:

 

     Total

   Less than
1 Year


   1-3 Years

   4-5 Years

   After
5 Years


Senior secured promissory notes

   $ 69,945      —      $ 69,945      —        —  

Other long-term obligations

     94      53      30      11      —  

Non-cancelable operating leases

     7,632      1,609      3,327      2,662      34
    

  

  

  

  

     $ 77,671    $ 1,662    $ 73,302    $ 2,673    $ 34
    

  

  

  

  

 

Income Taxes

 

As of December 31, 2003, the Company has research and experimentation credit carry forwards for federal and state purposes of approximately $3 million and $1 million, respectively. These credits begin to expire in 2006 for federal purposes and carry forward indefinety for California state purposes. The Company has capital loss carry forwards of approximately $1 million for both federal and state purposes which begin to expire in 2004 for federal purposes and carry forward indefinately for state purposes. The Company also has approximately $134 million and $74 million, respectively, of federal and state net operating loss carry forwards which will begin to expire in 2006 and 2005, respectively. The utilization of net operating loss and tax credit carry forwards may be limited under the provisions of Internal Revenue Code Sections 382 and 1503 and similar state provisions. The limitations could result in the expiration of our net operating loss carry forwards and research and experimentation credit carry forwards before full utilization.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses for each period.

 

The following represents a summary of our critical accounting policies, defined as those policies that we believe are: (a) the most important to the portrayal of our financial condition and results of operations, and (b) that require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

 

Valuation of Accounts Receivable

 

We maintain an allowance for uncollectible accounts receivable to estimate the risk of extending credit to customers. The allowance is estimated based on customer compliance with credit terms, the financial condition of the customer, and collection history, where applicable. Additional allowances could be required if the financial condition of our customers were to be impaired beyond our estimates.

 

Valuation of Inventory

 

Inventory is valued at the lower of cost (estimated using the first-in, first-out method) or market. We periodically evaluate the carrying value of inventories and maintain an allowance for obsolescence to adjust the carrying value, as necessary, to the lower of cost or market. The allowance is based on physical and technical functionality as well as other factors affecting the recoverability of the asset through future sales. Unfavorable changes in estimates of obsolete inventory would result in an increase in the allowance and a decrease in gross profit.

 

Goodwill and Other Intangibles

 

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which became effective January 1, 2002, goodwill and other intangible assets with indeterminate lives are no longer subject to amortization but are tested for impairment

 

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annually or whenever events or changes in circumstances indicate that the asset might be impaired. Other intangible assets with finite lives continue to be subject to amortization, and any impairment is determined in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

Should an impairment in goodwill be determined, it could result in a material charge to operations (see Note 6 and Note 9 of the consolidated financial statements for further discussion on intangibles and amortization periods).

 

Valuation of Long-Lived Assets

 

In accordance with SFAS No. 144, long-lived assets and intangible assets with determinate lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the asset with the estimated undiscounted future cash flows associated with the use of the asset and its eventual disposition. Should the review indicate that the asset is not recoverable, the Company’s carrying value of the asset would be reduced to its estimated fair value, which is generally measured by future discounted cash flows. In our estimate, no provision for impairment is currently required on any of our long-lived assets.

 

Revenue Recognition

 

We record revenue in accordance with Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), as amended. SAB 101 requires that product sales be recognized when there is persuasive evidence of an arrangement which states a fixed and determinable price and terms, delivery of the product has occurred in accordance with the terms of the sale, and collectibility of the sale is reasonably assured. We generally record product sales when we have received a valid customer purchase order for product at a stated price, the customer’s credit is approved, and we have shipped the product to the customer whereby title and risk have passed to the customer. Some of our customers are distributors which sell goods to third party end users. We are not contractually obligated to repurchase any inventory from distributors or end user customers. For certain identified distributors where collection may be contingent on the distributor’s resale, revenue recognition is deferred and recognized on a “sell through” basis. Training and AED service revenue is deferred and recognized at the time the training occurs. AED program management services pursuant to agreements that existed with Complient customers are deferred and amortized straight-line over the related contract period. License fees are generally deferred and recognized systematically over the term of the license agreement.

 

Product Warranty

 

Products sold are generally covered by a warranty against defects in material and workmanship for a period of one to five year. We accrue a warranty reserve to estimate the risk of incurring costs to provide warranty services. The accrual is based on our historical experience and our expectation of future conditions. An increase in warranty claims or in the costs associated with servicing those claims would result in an increase in the accrual and a decrease in gross profit.

 

Litigation and Others Contingencies

 

We regularly evaluate our exposure to threatened or pending litigation and other business contingencies. Because of the uncertainties related to the amount of loss from litigation and other business contingencies, the recording of losses relating to such exposures requires significant judgment about the potential range of outcomes. We are not presently affected by any litigation or other contingencies that have had, or are currently anticipated to have, a material impact on our results of operations or financial position. As additional information about current or future litigation or other contingencies becomes available, we will assess whether such information warrants the recording of additional expense relating to these contingencies. To be recorded as expense, a loss contingency must generally be both probable and measurable. If a loss contingency is material but is not both probable and estimable, we will disclose it in notes to the financial statements.

 

Recent Accounting Pronouncements

 

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities-an interpretation of ARB No. 51. This Interpretation addresses consolidation by business enterprises of variable interest entities, which have one or both of the following characteristics: (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity, and (ii) the equity investors lack an essential characteristic of a controlling

 

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financial interest. It applies to all variable interest entities established after January 31, 2003 and is effective July 1, 2003 for any variable interest entity acquired prior to February 1, 2003. The application of FIN 46 did not have a significant impact on the Company’s consolidated financial statements.

 

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. It amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. SFAS 149 amends SFAS 133 for decisions made as part of the Derivatives Implementation Group process that effectively required amendments to SFAS 133, in connection with other FASB projects dealing with financial instruments and in connection with implementation issues raised in relation to the application of the definition of a derivative. The application of this statement did not have an impact on the Company’s consolidated financial statements.

 

In May 2003, the FASB issued SFAS No. 150, Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for how a company clarifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires a company to classify such instruments as liabilities, whereas they previously may have been classified as equity. SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise was effective July 1, 2003. The application of this statement did not have an impact on the Company’s consolidated financial statements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate and Market Risk. We do not use derivative financial instruments in our investment portfolio. We are averse to principal loss and try to ensure the safety and preservation of our invested funds by limiting default risk, market risk, and reinvestment risk. We attempt to mitigate default risk by investing in only the safest and highest credit quality securities. At December 31, 2003, we invested our available cash in money market securities of high credit quality financial institutions.

 

Interest expense on our existing long-term debt commitments is based on a fixed interest rate and therefore it is unaffected by fluctuations in interest rates.

 

Foreign Currency Exchange Rate Risk. The majority of our international sales are made through our international sales office in Copenhagen primarily in U.S. dollars. Some sales to the U.K. are in pounds and to Germany in Euros, and thus may be adversely affected by fluctuations in currency exchange rates. Additionally, fluctuations in currency exchange rates may adversely affect foreign demand for our products by increasing the price of our products in the currency of the countries in which the products are sold. Our operations outside of the United States are maintained in their local currency. All assets and liabilities of our international subsidiaries are translated to U.S. dollars at year-end exchange rates in effect during the year. Translation adjustments arising from the use of differing exchange rates are included in accumulated other comprehensive income in stockholders equity. Gains and losses on foreign currency transactions are included in operations and were not material in any period.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

For an index to the financial statements and supplementary data, see Item 15(a).

 

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REPORT OF INDEPENDENT AUDITOR

 

The Board of Directors and Stockholders

Cardiac Science, Inc.

Irvine, California

 

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Cardiac Science, Inc. and Subsidiaries (the “Company”) at December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note 3 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets.” Accordingly effective January 1, 2002, the Company ceased amortization of its goodwill.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2, the Company has suffered recurring losses from operations which raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with regard to this matter are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

/s/    PRICEWATERHOUSECOOPERS LLP

 

PricewaterhouseCoopers LLP

Orange County, California

February 27, 2004 (except for Note 23, as to which the date is March 15, 2004)

 

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CARDIAC SCIENCE, INC.

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

     December 31,
2003


    December 31,
2002


 
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 8,871     $ 15,598  

Accounts receivable, net of allowance for doubtful accounts of $1,626 in 2003 and $1,042 in 2002

     20,410       10,986  

Inventories, net

     9,575       5,918  

Assets held-for-sale

     —         1,161  

Prepaid expenses and other current assets

     2,154       2,098  
    


 


Total current assets

     41,010       35,761  

Property and equipment, net

     7,003       5,206  

Goodwill, net

     139,859       97,850  

Intangibles, net

     11,626       8,696  

Other assets

     3,503       6,407  
    


 


     $ 203,001     $ 153,920  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 8,955     $ 6,921  

Accrued expenses

     6,542       7,188  

Liabilities held-for-sale

     —         2,067  

Deferred revenue

     2,479       162  

Current portion of long term obligations

     53       246  
    


 


Total current liabilities

     18,029       16,584  

Deferred revenue

     859       1,021  

Senior secured promissory notes

     46,481       41,054  

Other long term obligations

     41       91  
    


 


Total liabilities

     65,410       58,750  
    


 


Commitments and contingencies (Note 16)

                

Minority interest

     —         900  
    


 


Stockholders’ equity:

                

Preferred stock—$.001 par value; 1,000,000 shares authorized, none issued or outstanding

     —         —    

Common stock—$.001 par value; 160,000,000 shares authorized, 80,465,585 and 66,827,170 shares issued and outstanding in 2003 and 2002, respectively

     80       67  

Additional paid-in capital

     243,219       187,239  

Accumulated other comprehensive income (loss)

     (20 )     115  

Accumulated deficit

     (105,688 )     (93,151 )
    


 


Total stockholders’ equity

     137,591       94,270  
    


 


     $ 203,001     $ 153,920  
    


 


 

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

 

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CARDIAC SCIENCE, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share data)

 

     For the Years Ended December 31,

 
     2003

    2002

    2001

 

Net revenue

   $ 61,982     $ 50,043     $ 10,651  

Cost of goods sold

     25,626       24,737       6,521  

Write down of inventories

     2,917       —         1,454  
    


 


 


Gross profit

     33,439       25,306       2,676  
    


 


 


Operating expenses:

                        

Sales and marketing

     18,616       17,325       8,972  

Research and development

     5,538       6,053       8,575  

General and administrative

     14,720       11,474       6,935  

Amortization of intangibles

     1,656       2,111       1,740  

Gain on settlement

     —         (832 )     —    

Impairment of assets

     —         —         1,438  
    


 


 


       40,530       36,131       27,660  
    


 


 


Loss from operations

     (7,091 )     (10,825 )     (24,984 )

Interest income

     106       402       269  

Interest expense

     (6,031 )     (4,452 )     (594 )

Other non-operating income (expense)

     34       (92 )     (213 )

Loss on sale of marketable securities

     —         —         (707 )
    


 


 


Loss before income taxes

     (12,982 )     (14,967 )     (26,229 )

Provision for income taxes

     —         —         2  
    


 


 


Loss before minority interest

     (12,982 )     (14,967 )     (26,231 )

Minority interest in consolidated subsidiary

     (48 )     (33 )     16  
    


 


 


Loss from continuing operations

     (13,030 )     (15,000 )     (26,215 )

Income (loss) from discontinued operations

     493       (52 )     —    
    


 


 


Net loss

   $ (12,537 )   $ (15,052 )   $ (26,215 )
    


 


 


Basic and diluted loss per share:

                        

Continuing operations

     (0.19 )     (0.22 )     (0.78 )

Discontinued operations

     .01       —         —    
    


 


 


Net loss per share (basic and diluted)

   $ (0.18 )   $ (0.22 )   $ (0.78 )
    


 


 


Weighted average number of shares used in the computation of net loss per share (basic and diluted)

     69,848,014       67,199,419       33,507,322  
    


 


 


 

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

 

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CARDIAC SCIENCE, INC.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands, except share and per share data)

 

     For the Years Ended December 31,

 
     2003

    2002

    2001

 

Net loss

   $ (12,537 )   $ (15,052 )   $ (26,215 )

Other comprehensive income (loss):

                        

Unrealized gain on investments

     —         —         (504 )

Foreign currency translation adjustments

     (135 )     37       78  
    


 


 


Comprehensive loss

   $ (12,672 )   $ (15,015 )   $ (26,641 )
    


 


 


 

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

 

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CARDIAC SCIENCE, INC.

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(In thousands, except share and per share data)

 

     Common Stock

  

Common Stock

Subscribed


    Additional
Paid-In
Capital


   

Accumulated

Other

Comprehensive

Income (Loss)


   

Accumulated

Deficit


    Total

 
     Number of
Shares


    Amount

   Number of
Shares


    Amount

         

Balances at December 31, 2000

   24,382,228     $ 24    300,000     $ 1,551     $ 78,789     $ 504     $ (51,884 )   $ 28,984  

Issuance of common stock for acquisition of Survivalink at $2.31 per share

   18,150,000       18                    41,909                       41,927  

Issuance of common stock for acquisition of Artema Medical AB at $3.75 per share

   4,150,976       4                    15,562                       15,566  

Stock subscribed at $5.17 per share

   300,000       1    (300,000 )     (1,551 )     1,550                       —    

Common stock warrants exercised at $2.00 to $5.00 per share

   140,835                            486                       486  

Common stock options exercised at $1.88 to $4.63 per share

   325,492                            755                       755  

Issuance of common stock for cash at $2.00 per share (net of cost of issuances of $976)

   14,204,000       14                    27,418                       27,432  

Issuance of common stock for finders fees at $2.00 per share

   375,000                            750                       750  

Issuance of common stock for cash at $2.03 per share (net of cost of issuances of $1,702)

   4,750,000       5                    7,936                       7,941  

Issuance of common stock for services at an average of $2.03 per share

   380,000       1                    769                       770  

Compensation related to fair value of options granted non-employees

                                374                       374  

Unrealized loss on marketable securities

                                        (504 )             (504 )

Foreign currency translation

                                        78               78  

Net loss

                                                (26,215 )     (26,215 )
    

 

  

 


 


 


 


 


Balances at December 31, 2001

   67,158,531       67    —         —         176,298       78       (78,099 )     98,344  

Ascribed value of warrants issued at $3.00 and $4.00 per share in connection with debt offering

                                11,815                       11,815  

Common stock options exercised at $2.00 to $2.06 per share

   39,537                            83                       83  

Issuance of common stock for cash at $3.00 per share

   78,333                            235                       235  

Issuance of common stock for finders fees at $2.00 per share

   25,000                                                    —    

Equity issuance costs related to 2001

                                (97 )                     (97 )

Return and cancellation of shares in escrow related to the Survivalink acquisition

   (474,231 )                          (1,095 )                     (1,095 )

Foreign currency translation

                                        37               37  

Net loss

                                                (15,052 )     (15,052 )
    

 

  

 


 


 


 


 


Balances at December 31, 2002

   66,827,170       67    —         —         187,239       115       (93,151 )     94,270  

Ascribed value of warrants issued at $3.00 and $3.27 per share

                                936                       936  

Common stock options exercised at $1.60 to $3.83 per share

   658,552       1                    1,415                       1,416  

Common stock warrants exercised at $0.01 to $2.00 per share

   496,529                            5                       5  

Issuance of common stock for cash at $3.75 per share

   2,233,334       2                    8,373                       8,375  

Issuance of common stock for acquisition of Complient at $4.42 per share

   10,250,000       10                    45,295                       45,305  

Equity issuance costs

                                (44 )                     (44 )

Foreign currency translation

                                        (135 )             (135 )

Net loss

                                                (12,537 )     (12,537 )
    

 

  

 


 


 


 


 


Balance at December 31, 2003

   80,465,585     $ 80    —       $ —       $ 243,219     $ (20 )   $ (105,688 )   $ 137,591  
    

 

  

 


 


 


 


 


 

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

 

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Table of Contents

CARDIAC SCIENCE, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, except share and per share data)

 

    

For the Years Ended

December 31,


 
     2003

    2002

    2001

 

Cash flows from operating activities:

                        

Net loss

   $ (12,537 )   $ (15,052 )   $ (26,215 )

Adjustments to reconcile net loss to net cash used in operating activities:

                        

Depreciation

     2,623       1,935       751  

Amortization of intangibles

     1,656       2,111       1,740  

Minority interest

     48       33       (16 )

Fair value of options granted to non-employees

     —         —         374  

Expenses paid with common stock

     —         —         770  

Loss on sale of marketable securities

     —         —         707  

Provision for doubtful accounts

     725       463       659  

Write down of inventories

     2,917       —         1,454  

Impairment of assets

     —         —         1,438  

Gain on contractual settlement

     —         (832 )     —    

Gain on collection of note receivable previously written off

     —         (236 )     —    

Accrued paid in kind interest and amortization of debt discount/issuance costs

     5,983       3,207       —    

Changes in operating assets and liabilities, net of acquisitions:

                        

Accounts receivable

     (8,365 )     (2,840 )     (2,255 )

Inventories

     (4,398 )     (3,926 )     1,064  

Placement of Powerhearts at customer locations

     (531 )     (1,397 )     (1,998 )

Prepaid expenses and other current assets

     (562 )     (687 )     63  

Other assets

     254       54       170  

Accounts payable and accrued expenses

     (1,840 )     (4,640 )     (1,742 )

Assets and liabilities held for sale

     (1,460 )     543       —    

Deferred revenue

     (860 )     483       —    
    


 


 


Net cash used in operating activities

     (16,347 )     (20,781 )     (23,036 )
    


 


 


Cash flows from investing activities:

                        

Purchase of property and equipment

     (2,744 )     (1,499 )     (1,125 )

Purchase of Artema minority interest

     (843 )     —         —    

Reduction in Artema goodwill

     1,050       —         —    

Sale of Artema subsidiary, net of costs of $111

     489       —         —    

Advances to Inovise Medical, Inc., Medical Resource Management, Inc., and Survivalink

     —         —         (760 )

Sales of marketable securities

     —         —         3,793  

Refund of (investment in) MRL transactions

     3,001       (3,001 )     —    

Proceeds from the sale of assets at subsidiary, net of costs

     767       470       —    

Proceeds from note receivable previously written off

     —         236       —    

Advance to related party

     —         —         (500 )

Cash acquired in Artema AB acquisition, net of cash paid of $215

     —         —         862  

Cash acquired in Complient acquisition

     308       —         —    

Increase in intangible assets

     (560 )     —         —    

Acquisition of Survivalink, net of cash acquired of $1,397

     —         —         (9,103 )

Acquisition costs paid

     (955 )     (308 )     (2,923 )

Cash refund from (advance to) Survivalink shareholders tax escrow

     —         2,108       (2,108 )

Refund of Survivalink purchase price escrow

     —         1,901       —    

Acquisition of Lifetec, net of cash acquired of $89

     (294 )     —         —    
    


 


 


Net cash provided by (used) in investing activities

     219       (93 )     (11,864 )
    


 


 


Cash flows from financing activities:

                        

Proceeds from issuance of common stock

     8,375       235       38,051  

Payment of Survivalink promissory notes

     —         (26,468 )     —    

Proceeds from Senior secured promissory notes, net of issuance costs of $2,786

     —         47,214       —    

Proceeds from capital lease refinancings

     —         —         73  

Payments on long term obligations

     (243 )     (498 )     (322 )

Proceeds from exercise of common stock options and warrants

     1,421       83       1,241  

Costs of equity issuances

     (44 )     (97 )     (1,928 )
    


 


 


Net cash provided by financing activities

     9,509       20,469       37,115  
    


 


 


Effect of exchange rates on cash and cash equivalents

     (108 )     173       78  
    


 


 


Net increase (decrease) in cash and cash equivalents

     (6,727 )     (232 )     2,293  

Cash and cash equivalents at beginning of year

     15,598       15,830       13,537  
    


 


 


Cash and cash equivalents at end of year

   $ 8,871     $ 15,598     $ 15,830  
    


 


 


 

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

 

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Table of Contents

CARDIAC SCIENCE, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

 

1. Organization and Description of the Business

 

Cardiac Science, Inc. (the “Company”) was incorporated in May 1991 and develops, manufactures and markets portable public access defibrillators and a fully-automatic in-hospital bedside defibrillator-monitor that continuously monitors cardiac patients, instantly detects the onset of life-threatening abnormal heart rhythms, and, when appropriate, delivers defibrillation shocks within seconds and without human intervention to convert the heart back to its normal rhythm. The Company’s core technology platform consists of its proprietary arrhythmia detection and discrimination software (“RHYTHMx®”), which is combined with its proprietary STAR® Biphasic defibrillation hardware and electrode technology to create the only fully automatic in-hospital cardioverter defibrillator (the “Powerheart® CRM®” or “CRM”) and a unique semi-automatic, or automated defibrillator, (the “Powerheart AED” or “AED”) for use in out-of-hospital settings. The Company’s Powerheart® Cardiac Rhythm Module and Powerheart® brand AEDs along with Diascope G2® patient monitoring products are marketed by its direct sales force and distribution network in the United States and by international distributors around the world.

 

On July 1, 2000, the Company acquired Cadent Medical Corporation, a privately held company, for an aggregate of 4,500,000 shares of the Company’s common stock.

 

On September 26, 2001, the Company acquired Survivalink Corporation, a privately held company, for $10,500 in cash, $25,800 in senior secured promissory notes, and 18,150,000 shares of the Company’s common stock.

 

On November 30, 2001, the Company acquired 94.7% of Artema Medical AB and Subsidiaries (“Artema”) for 4,150,976 shares of common stock and approximately $215 in cash. During 2003, the Company acquired the remaining minority interest for $843 in cash. On September 1, 2003, the Company transferred ownership of the shares in Cardiac Science International A/S, its Danish operations and a subsidiary of Artema, from Artema to Cardiac Science, Inc. in exchange for forgiveness of intercompany debt. Then on September 21, 2003, the Company sold 100% of its shares in Artema to an outside party for $600 in cash.

 

On May 29, 2003, the Company acquired Lifetec Medical Limited, its U.K. distributor, for $383 in cash.

 

On October 21, 2003, the Company acquired substantially all of the assets and liabilities of Complient Corporation, a privately held company, for 10,250,000 shares of the Company’s common stock.

 

2. Continued Existence

 

Based on achieving its internal revenue growth targets, the Company believes its current cash balances, combined with net cash that it expects to generate from operations, will sustain its ongoing operations for at least twelve months. In the event that the Company requires additional cash to support its operations during the next twelve months, it will attempt to raise the required capital through either debt or equity arrangements. The Company cannot provide any assurance that the required capital will be available on acceptable terms, if at all, or that any financing activity will not be dilutive to current stockholders of the Company. If the Company is not able to raise additional funds, it may be required to significantly curtail its operations and this would have an adverse effect on its financial position, results of operations and cash flows.

 

3. Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements

 

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Table of Contents

and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents.

 

Marketable Securities

 

The Company has classified its marketable securities as “available-for-sale” as defined under Statement of Financial Accounting Standard (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Fair value is measured using quoted market prices. The unrealized gains or losses, if any, are recorded as a separate component of stockholders’ equity until realized. The cost of securities sold is based on the specific identification method. At December 31, 2003 and 2002, the Company did not have any marketable securities.

 

Allowance for Doubtful Accounts

 

The Company maintains an allowance for uncollectible accounts receivable to estimate the risk of extending credit to customers. The allowance is based on customer compliance with credit terms, the financial condition of the customer, and collection history, where applicable.

 

Inventories

 

Inventories are stated at the lower of cost (first-in, first-out) or market value. Inventory consists of the following at December 31:

 

     2003

   2002

Raw materials

   $ 3,728    $ 1,784

Work in process

     157      874

Finished goods

     5,690      3,260
    

  

     $ 9,575    $ 5,918
    

  

 

The Company placed $531, $1,397 and $1,998 during 2003, 2002 and 2001, respectively, of completed Powerheart units at customer locations. The Company retains title to these units and such amounts were transferred to property and equipment where they are being depreciated through cost of goods sold over a five year period.

 

During the year ended December 31, 2003, the Company wrote down $2,917 of inventory related to its first generation Powerheart and CRM in-hospital defibrillators as a result of a strategic decision to terminate the “no cap” placement business model in U.S. hospitals, in favor of a capital sale model.

 

During the year ended December 31, 2001, the Company wrote down $1,454 of inventories as a result of discontinuation of the original Powerheart model and the introduction of the new Powerheart CRM and reflected management’s estimate of the cost of component inventory on-hand that would not be transformed into finished goods.

 

Property and Equipment

 

Property, plant and equipment is stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the related assets, which range from three to fifteen years, or over the lesser of the term of the lease or the estimated useful life of the asset for assets under capital lease. Leasehold improvements are amortized over the lesser of the term of the lease or the estimated useful life of the improvements. Normal repairs and maintenance are expensed as incurred whereas significant improvements that materially increase values or extend useful lives are capitalized and depreciated over the remaining estimated useful lives of the related assets. Upon sale or retirement of depreciable assets, the related cost and accumulated depreciation or amortization are removed from the accounts. Any gain or loss on the sale or retirement is recognized in current operations.

 

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Table of Contents

Goodwill and Other Intangibles

 

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which became effective January 1, 2002, goodwill and other intangible assets with indeterminate lives are no longer subject to amortization but are tested for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. The Company has also reclassified the balance of acquired workforce to goodwill. Other intangible assets with finite lives continue to be subject to amortization, and any impairment is determined in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

Goodwill and other intangible assets consist of the following at December 31:

 

     2003

    2002

 

Goodwill

   $ 141,668     $ 99,659  

Intangible assets subject to amortization:

                

Patents and patent applications

     10,396       10,211  

Customer base

     4,082       1,175  

Covenants not to compete

     726       —    

URL website address

     640       —    

Trade name

     378       378  

Purchased software

     128       —    
    


 


       158,018       111,423  

Less: accumulated amortization

     (6,533 )     (4,877 )
    


 


     $ 151,485     $ 106,546  
    


 


 

Patents and patent applications are being amortized over three to twenty years. Customer base is being amortized over two to seven years while the trade name was amortized over one year. The covenants not to compete and software are being amortized over 3 years. The URL website address (aed.com) is being amortized over 5 years.

 

In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS Nos. 141 and 142. SFAS No. 141, Business Combinations, is effective for all business combinations for which the date of acquisition is after June 30, 2001, and requires that the purchase method of accounting be used for all business combinations, and establishes specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 142, Goodwill and Other Intangible Assets, requires that goodwill and indefinite long-lived intangible assets will no longer be amortized, goodwill will be tested for impairment at least annually at the reporting unit level, other intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and the amortization period of intangible assets with finite lives will no longer be limited to forty years.

 

The Company adopted these statements effective January 1, 2002 and determined that the identifiable intangibles assets of customer base, trade name and patents were appropriately valued and would continue to be amortized. In adopting SFAS No. 142, the Company discontinued amortizing goodwill associated with the acquisition of Cadent, which occurred in July 2000. The net book value of the Cadent goodwill at January 1, 2002 was $5,434. The acquisitions of Survivalink and Artema, which occurred on September 26, 2001 and November 30, 2001, respectively, were accounted for using SFAS Nos. 141 and 142 at the time of acquisition and therefore no goodwill has been amortized. The Company has determined that it has a single reporting unit for the purpose of performing an annual impairment analysis of these assets. The Company had amortization expense for identifiable intangibles with finite lives of $1,656, $2,111, and $752 for the years ended December 31, 2003, 2002 and 2001, respectively, and amortization expense for goodwill of $988 for the year ended December 31, 2001.

 

Future amortization expense on existing identifiable intangibles for the years ending December 31 is as follows:

 

2004

   $ 2,029

2005

     2,029

2006

     1,982

2007

     1,744

2008

     1,697

Thereafter

     2,145
    

     $ 11,626
    

 

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If the Company had adopted SFAS No. 142 effective January 1, 2001, net loss and basic and diluted loss per share for the years ended December 31 would have been as follows:

 

     2003

    2002

    2001

 

Reported net loss

   $ (12,537 )   $ (15,052 )   $ (26,215 )

Add back: Goodwill amortization

     —         —         988  
    


 


 


Pro forma net loss

   $ (12,537 )   $ (15,052 )   $ (25,227 )
    


 


 


Basic and diluted loss per share:

                        

Reported net loss

   $ (0.18 )   $ (0.22 )   $ (0.78 )

Goodwill amortization

     —         —         0.03  
    


 


 


Adjusted net loss

   $ (0.18 )   $ (0.22 )   $ (0.75 )
    


 


 


 

Long-Lived Assets

 

In accordance with SFAS No. 144, long-lived assets and intangible assets with determinate lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company evaluates potential impairment by comparing the carrying amount of the asset with the estimated undiscounted future cash flows associated with the use of the asset and its eventual disposition. Should the review indicate that the asset is not recoverable, the Company’s carrying value of the asset would be reduced to its estimated fair value, which is generally measured by future discounted cash flows.

 

Per Share Information

 

The Company has adopted SFAS No. 128, Earnings Per Share. This statement requires the presentation of basic and diluted earnings per share, as defined, on the statement of operations for companies whose capital structure includes convertible securities and options.

 

Net loss per share as presented in the accompanying statements of operations is computed based on the weighted average number of common shares outstanding and subscribed. Shares issuable upon exercise of outstanding stock options and warrants are not included since the effects would be anti-dilutive.

 

Revenue Recognition

 

Revenue is recognized in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101), as amended. Product sales are recognized when there is persuasive evidence of an arrangement which states a fixed and determinable price and terms, delivery of the product has occurred in accordance with the terms of the sale, and collectibility of the sale is reasonably assured. Some of the Company’s customers are distributors which sell goods to third party end users. The Company is not contractually obligated to repurchase any inventory from distributors or end user customers. For certain identified distributors where collection may be contingent on the distributor’s resale, revenue recognition is deferred and recognized on a “sell through” basis. Training and AED service revenue is deferred and recognized at the time the training occurs. AED program management services pursuant to agreements that existed with Complient customers are deferred and amortized straight-line over the related contract period. License fees are generally deferred and recognized systematically over the term of the license agreement.

 

Deferred Revenue

 

Deferred revenue consists of license fees received in connection with certain licensing agreements. License fees are amortized over the term of the respective agreements using the straight-line method.

 

Product Warranty

 

The Company’s products are generally under warranty against defects in material and workmanship for a period of one to five years. Warranty costs are estimated at the time of sale based on historical experience. Estimated warranty expenses are recorded as an accrued liability, with a corresponding provision to cost of sales.

 

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Changes in the product warranty accrual for the years ended December 31, 2003 and 2002 was as follows:

 

     2003

    2002

 

Warranty accrual, Beginning of period

   $ 1,604     $ 1,945  

Change in liability for warranties issued during the period

     204       803  

Warranty expenditures

     (1,005 )     (1,144 )

Currency translation adjustments

     33       —    
    


 


Warranty accrual, End of period

   $ 836     $ 1,604  
    


 


 

Foreign Currency

 

The financial statements of the Company’s foreign subsidiaries are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and a weighted average exchange rate for each period for revenues, expenses, gains and losses.

 

Research and Development Costs

 

Research and development costs are expensed as incurred.

 

Advertising Costs

 

The Company expenses advertising costs as incurred. Advertising expenses were $925, $1,280, and $393, for the years ended December 31, 2003, 2002, and 2001, respectively.

 

Software Development Costs

 

The Company expenses all costs incurred, prior to the achievement of technological feasibility of a working model, related to the development of the proprietary software used in its products. Such costs incurred subsequent to the attainment of technological feasibility have been nominal.

 

Discontinued Operations

 

The Company has classified certain facilities operations related to its MCS gas business (see Note 9) as discontinued operations in accordance with SFAS No. 144. SFAS No. 144 established accounting and reporting standards requiring that long-lived assets to be disposed of be reported as discontinued operations if management has committed to a plan to dispose of the asset under usual and customary terms within one year of establishing the plan. Subsequent to the initial one year period, the Company follows the guidance of EITF 90-6, Accounting for Certain Events Not Addressed in Issue No. 87-11 Relating to an Acquired Operating Unit to Be Sold.

 

Fair Value of Financial Instruments

 

The fair value of the Company’s financial instruments, which include cash equivalents, accounts receivable, accounts payable, and notes payable, are based on assumptions concerning the amount and timing of estimated future cash flows. The carrying value of these financial instruments approximated their fair value at December 31, 2003 and 2002.

 

Stock-Based Compensation

 

On December 31, 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS 148, Accounting for Stock-Based Compensation—Transition and Disclosure, which amends SFAS 123, Accounting for Stock-Based Compensation. SFAS 148 allows for three methods of transition for those companies that adopt SFAS 123’s provisions for fair value recognition. SFAS 148’s transition guidance and provisions for annual and interim disclosures are effective for fiscal periods ending after December 15, 2002. The Company has not adopted fair value accounting for employee stock options under SFAS 123 and SFAS 148.

 

The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 defines a fair value based method of accounting for an employee stock option. Fair value of the stock option is determined considering factors such as the exercise price, the expected life of the option, the current price of the underlying stock, expected dividends on the stock, volatility of the expected market prices, and the risk-free interest rate for the expected term of the option. Under the fair value based

 

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method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period. Pro forma disclosures are required for entities that elect to continue to measure compensation cost under the intrinsic method provided by Accounting Principles Board Opinion (“APB”) No. 25.

 

Additionally, in accordance with SFAS 123 and EITF Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services, the Company measures stock based non-employee compensation at fair value.

 

Under SFAS No. 123, stock based compensation expense related to stock options granted to consultants is recognized as the stock options are earned. The fair value of the stock options granted is calculated at each reporting date using the Black-Scholes option pricing model. As a result, the stock based compensation expense will fluctuate as the fair market value of the Company’s stock fluctuates.

 

Pro Forma Effect of Stock-Based Compensation

 

In calculating pro forma information as required by SFAS No. 123, the fair value was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions for the options on the Company’s common stock for the years ended December 31, 2003, 2002, and 2001: risk free weighted average rate with a range of 1.9% to 6.85%; dividend yield of 0%; volatility of the expected market prices of the Company’s common stock of 63.0%, 63.0%, and 97.4%, respectively; and expected life of the options of four years.

 

Had compensation costs been determined based upon the fair value at the grant date, consistent with the methodology prescribed under SFAS 123, the Company’s total stock-based compensation cost, proforma net loss, and proforma net loss per share, basic and diluted, would have been as follows:

 

     2003

    2002

    2001

 

Net loss, as reported

   $ (12,537 )   $ (15,052 )   $ (26,215 )

Add: Compensation expense included in reported net loss

     —         —         —    

Deduct: Compensation expense determined under fair value based method

     (3,669 )     (3,825 )     (3,575 )
    


 


 


Pro forma net loss

   $ (16,206 )   $ (18,877 )   $ (29,790 )
    


 


 


Net loss per share, as reported (basic and diluted)

   $ (0.18 )   $ (0.22 )   $ (0.78 )
    


 


 


Pro forma net loss per share (basic and diluted)

   $ (0.23 )   $ (0.28 )   $ (0.89 )
    


 


 


 

Income Taxes

 

The Company follows SFAS No. 109, Accounting for Income Taxes, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets when it is more likely than not that a portion of such assets will not be recoverable through future operations. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

 

Comprehensive Income

 

In June 1997, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 130 “Reporting Comprehensive Income.” SFAS No. 130 requires disclosure of all components of comprehensive income on an annual and interim basis. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources.

 

Reclassifications

 

Certain reclassifications have been made in the 2002 and 2001 statements to conform to the 2003 presentation.

 

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4. Segment Reporting

 

The Company follows the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also established standards for related disclosures about products and services, geographic areas and major customers. An operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses whose separate financial information is available and is evaluated regularly by the Company’s chief operating decision makers, or decision making group, to perform resource allocations and performance assessments.

 

The Company’s chief operating decision makers are the Executive Management Team which is comprised of the Chief Executive Officer and senior executive officers of the Company. Based on evaluation of the Company’s financial information, management believes that the Company operates in one reportable segment with its various product lines that service the external defibrillation and cardiac monitoring industry. The product lines include AEDs and related training, services, and accessories; Powerhearts, electrodes and related accessories; and emergency defibrillators, monitors, CPR products and related accessories.

 

The Company’s chief operating decision makers evaluate revenue performance of product lines, both domestically and internationally, however, operating, strategic and resource allocation decisions are not based on product line performance, but rather on the Company’s overall performance in its operating segment.

 

The following is a breakdown of net revenue by product line for the years ended December 31:

 

     2003

   2002

   2001

AEDs and related accessories

   $ 55,010    $ 38,572    $ 6,519

AED/CPR training and program management services

     1,519      —        —  
    

  

  

AED related revenue

     56,529      38,572      6,519

Powerhearts, electrodes and related accessories

     1,259      1,278      1,849

Emergency defibrillators, monitors, CPR products and related accessories

     4,194      10,193      2,283
    

  

  

     $ 61,982    $ 50,043    $ 10,651
    

  

  

 

The following is a breakdown of net sales by geographic location for the years ended December 31:

 

     2003

   2002

   2001

United States

   $ 47,778    $ 34,091    $ 6,127

Foreign

     14,204      15,952      4,524
    

  

  

     $ 61,982    $ 50,043    $ 10,651
    

  

  

 

The following is a breakdown of the Company’s long-lived assets by geographic location at December 31:

 

     2003

   2002

United States

   $ 141,370    $ 97,286

Foreign

     20,621      20,873
    

  

     $ 161,991    $ 118,159
    

  

 

5. Property, Plant and Equipment

 

Property, plant and equipment consist of the following at December 31:

 

     2003

    2002

 

Equipment and furniture

   $ 6,643     $ 4,763  

Equipment on lease to customers

     1,633       —    

Leasehold improvements

     764       526  

Tooling

     316       —    

Vehicles

     66       66  

Powerhearts on loan to hospitals

     1,263       2,835  
    


 


       10,685       8,190  

Less: accumulated depreciation

     (3,682 )     (2,984 )
    


 


     $ 7,003     $ 5,206  
    


 


 

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6. Other Assets

 

In July 2002, the Company entered into preliminary negotiations regarding a possible transaction with Medical Research Laboratories, Inc. (“MRL”), a privately-held medical device manufacturer. The Company made an initial investment in the common stock of the manufacturer in the amount of $1,000 and placed $2,001 into an escrow account pending the outcome of further negotiations. On December 3, 2002, the Company filed a Complaint in Orange County Superior Court against Medical Research Laboratories, Inc. (“MRL”) alleging declaratory relief and breach of contract arising out of a July 29, 2002 letter of intent entered into between the parties. The Company alleged that MRL failed to comply with certain conditions of closing set forth in the letter of intent whereby the Company would acquire all of MRL’s stock. MRL filed a cross-complaint, also seeking breach of contract and declaratory relief arising out of the same letter of intent. On February 25, 2003, the Company filed suit against MRL for patent infringement in the United States District Court for the District of Minnesota. The Company alleged that MRL’s LifeQuest JumpStart AED infringed the Company’s patented disposable electrode pre-connect technology. The Company settled both law suits with MRL on June 24, 2003. Under the terms of the confidential settlement agreement, the Company received a settlement amount from MRL and MRL received the right to license two of the Company’s patents for additional royalties.

 

On December 18, 2000, the Company entered into a non-binding letter of intent to acquire Inovise Medical, Inc., a privately held Oregon based corporation, which potential acquisition was terminated in February 2001. In connection with this proposed transaction, the Company advanced funds for a bridge loan to support working capital requirements. The bridge loan was collateralized by all assets of Inovise, excluding certain receivables from royalty payments, accrued interest at 6% and was convertible into equity of Inovise. The total amount advanced to Inovise was $1,038. In February 2002, the Company’s convertible bridge loan was converted into 13,000,000 shares of Inovise’s Series D convertible preferred stock. As there is currently no market for these shares and there is no foreseeable recovery of the initial investment, the Company has determined that these shares have no value. Accordingly, the Company was fully reserved for this investment at December 31, 2003 and 2002.

 

7. Accrued Expenses

 

Accrued expenses consist of the following as of December 31:

 

     2003

   2002

Accrued warranty

   $ 836    $ 1,604

Accrued commissions

     961      694

Accrued lease obligations and deferred rent

     1,895      —  

Accrued plant closure cost and severances

     209      2,122

Accrued accounts receivable factoring costs

     —        366

Accrued bonus

     315      360

Accrued vacation and payroll tax

     965      716

Accrued other expenses

     1,361      1,326
    

  

     $ 6,542    $ 7,188
    

  

 

8. Business Combinations

 

Complient Corporation

 

On October 21, 2003, the Company acquired substantially all of the assets and certain liabilities of Cleveland-based Complient Corporation, a privately-held company that is the nation’s leading independent provider of AED and CPR training and comprehensive AED program management. As consideration, the Company issued to Complient 10,250,000 shares of its

 

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common stock. The common stock is subject to a lock-up agreement and a general indemnification escrow. The resale of the shares will be registered with the Securities and Exchange Commission and 1,325,000 shares will become available for resale on the effective date of the registration statement. The balance of the shares issued are subject to a lock-up agreement pursuant to which they will be released from the “lock-up” in 12 equal monthly installments of 743,750 shares, beginning on the effective date of the registration statement.

 

The acquisition was accounted for as a purchase under SFAS No. 141, Business Combinations. In accordance with SFAS No. 141, the Company allocated the purchase price based on the fair value of the assets acquired and liabilities assumed. Portions of the purchase price, including intangible assets, were identified by an independent appraiser. These intangible assets include approximately $42.5 million for goodwill, $2.9 million in customer relationships, $726 for covenants not to compete, and $128 for custom-developed software. The customer relationships are being amortized over 7 years, and the covenants not to compete and the software are being amortized over 3 years.

 

The components of the purchase price allocation are as follows:

 

Purchase Price:

        

Stock consideration (10,250,000 shares @ $4.42/share)

   $ 45,305  

Acquisition costs

     894  
    


Total

   $ 46,199  
    


Allocation of Purchase Price:

        

Current assets

   $ 2,569  

Property and equipment, net

     2,685  

Current liabilities

     (3,053 )

Deferred revenue

     (2,257 )

Customer relationships

     2,907  

Covenants not to compete

     726  

Software

     128  

Goodwill

     42,494  
    


Total

   $ 46,199  
    


 

The following unaudited pro forma data summarizes the results of operations for the periods indicated as if the Complient acquisition had been completed as of the beginning of the periods presented. The pro forma data gives effect to actual operating results prior to the acquisition, adjusted to include the pro forma effect of amortization of identified intangible assets and the elimination of sales to Complient prior to the acquisition.

 

     2003

    2002

 
     (unaudited)  

Net sales

   $ 70,069     $ 62,629  

Net loss

   $ (15,493 )   $ (20,061 )

Pro forma net loss per share (basic and diluted)

   $ (0.20 )   $ (0.26 )

Pro forma weighted-averaged shares

     78,104,179       77,449,419  

 

Lifetec Medical Limited

 

On May 29, 2003, the Company acquired Lifetec Medical Limited, its U.K. distributor. The purchase price was $383 in cash and $61 in acquisition costs. The acquisition was accounted for as a purchase under SFAS No. 141. The Company allocated the purchase price based on the fair value of the assets and liabilities assumed. Current assets acquired were valued at $418, including cash of $89, and current liabilities assumed were valued at $557, and goodwill was valued at $583.

 

Artema Medical AB

 

On November 30, 2001, the Company acquired a 94.7% ownership interest in Artema Medical AB (“Artema”), a Swedish based manufacturer of patient monitors and external defibrillator devices. As consideration, the Company paid approximately $215 in cash and issued 4,150,976 shares of common stock to Artema shareholders.

 

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The components of the purchase price and original allocation were as follows:

 

Purchase Price:

        

Stock consideration (4,150,976 shares @ $3.75/share)

   $ 15,566  

Cash

     215  

Acquisition costs

     1,586  
    


Total

   $ 17,367  
    


Allocation of Purchase Price:

        

Current assets

   $ 7,741  

Property, plant and equipment, net

     1,819  

Current liabilities

     (9,578 )

Long term liabilities

     (519 )

Minority interest

     (883 )

Developed technology

     796  

Customer base

     499  

MCS Gas intangible assets

     1,426  

Goodwill

     16,066  
    


Total

   $ 17,367  
    


 

During 2002, goodwill related to the Artema acquisition was adjusted for the following:

 

Original Artema goodwill

   $ 16,066  

Artema restructuring (see note 9):

        

Building and other impairments

     544  

Inventory reserve

     922  

Accounts receivable reserve

     11  

Loss on closure of Copenhagen facility

     664  

Copenhagen facility severance and other miscellaneous costs

     123  

Disposal of MCS gas business (see note 9):

        

Asset impairments

     1,868  

Warranty reserve

     50  

Losses from MCS gas business

     (711 )

MCS gas business severance and other miscellaneous costs

     1,280  
    


Adjusted Artema goodwill at December 31, 2002

   $ 20,817  
    


 

During 2003, final adjustments to Artema goodwill were made related to acquiring the minority interest and subsequent sale of the MCS gas business.

 

Artema goodwill at December 31, 2002

   $ 20,817  

Change in minority interest value when purchased, net of costs

     (83 )

VAT refund

     (163 )

Cash sales price of MCS gas business

     (600 )

Legal and travel expenses related to the sale

     111  

Change in estimate of MCS gas business assets and liabilities sold

     (334 )
    


Artema goodwill at December 31, 2003

   $ 19,748  
    


 

Survivalink Corporation

 

On September 26, 2001, the Company acquired Survivalink Corporation (“Survivalink”), a privately held Minneapolis-based company that is a leading provider of Automated External Defibrillators (“AEDs”). As consideration, the Company paid $10.5 million in cash, issued $25.8 million in senior secured promissory notes (see Note 11) and tendered 18,150,000 shares of common stock to Survivalink shareholders.

 

The shares and cash were released after a settlement was reached on certain breaches of representation on November 6, 2002. On November 6, 2002, the Company received $1,901 in cash and 474,231 shares of Cardiac Science common stock valued at $1,095. The remaining balance of the escrow was 430,227 shares of Cardiac Science common stock which has been transferred

 

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to the original Survivalink shareholders. These settlement proceeds from the escrow account were recorded against goodwill associated with the Survivalink acquisition.

 

As partial consideration for the acquisition of Survivalink, the Company issued senior promissory notes to Survivalink shareholders in the principal amount of $25.8 million with simple interest payable upon maturity at the rate of 10% per annum. In addition, the Company assumed $1.5 million plus accrued interest of bridge notes from certain shareholders of Survivalink. The Company and the bridge note holders agreed to convert the bridge notes into a senior note payable with terms and conditions similar to the notes issued as merger consideration. During 2002, the Company issued $50 million of Senior Notes to a third party (see Note 11) and the proceeds of the Notes were used to redeem the senior promissory notes issued to the Survivalink shareholders and held in escrow, the assumed bridge loan and all accrued interest.

 

The Company entered into an agreement with Survivalink shareholders to establish a tax escrow fund to make loans to employees of Survivalink who owned options to purchase Survivalink common stock to help them meet their tax obligations arising from the exercise of their employee stock options. The Company deposited $2,108 of cash into this fund as of December 31, 2001. Each loan from the fund was documented by an individual secured tax note. The tax notes were collateralized by any amounts payable to the Survivalink employee under the senior secured promissory notes issued to the employee as consideration in the acquisition of Survivalink. During 2002, upon repayment of the senior secured promissory notes, all loans to employees were paid back to the Company and the tax escrow account was refunded to the Company.

 

The acquisition was accounted for as a purchase under SFAS No. 141, Business Combinations. In accordance with SFAS No. 141, the Company allocated the purchase price based on the fair value of the assets acquired and liabilities assumed. Portions of the purchase price, including intangible assets were identified by an independent appraiser. These intangible assets include approximately $73.8 million for goodwill, $7.6 million for patents, $676 for customer base, and $378 for the Survivalink tradename. The patents are being amortized over seven years, the customer base over two years, and the Survivalink tradename over one year.

 

The components of the purchase price allocation are as follows:

 

Purchase Price:

        

Stock consideration (18,150,000 shares @ $2.31/share)

   $ 41,927  

Cash

     10,500  

Senior secured promissory notes

     25,800  

Acquisition costs

     2,184  
    


Total

   $ 80,411  
    


Allocation of Purchase Price:

        

Current assets

   $ 5,369  

Property, plant and equipment, net

     390  

Other assets

     21  

Current liabilities

     (6,299 )

Bridge notes

     (1,500 )

Long term liabilities

     (11 )

Patents

     7,584  

Customer base

     676  

Tradename

     378  

Goodwill

     73,803  
    


Total

   $ 80,411  
    


 

During 2002, goodwill related to the Survivalink acquisition was adjusted for the following:

 

Original goodwill

   $ 73,803  

Cash received from escrow

     (1,901 )

Value of shares received from escrow

     (1,095 )

Bad debt reserve

     (56 )

Warranty reserve

     847  
    


Adjusted goodwill

   $ 71,598  
    


 

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9. Artema Restructuring and Disposition of the MCS Gas Business

 

As part of the Artema acquisition, the Company developed a plan to restructure the operations of the manufacturing facility in Denmark (“the plan”). Originally, the Company recorded certain purchase price adjustments in connection with the plan totaling $3,064. The plan included plant and facility closure costs that were either contractually obligated or were incremental in nature, adjustments to fair market value for owned facilities to be disposed of based on market assessments, adjustments to fair value for raw materials that would not be converted into finished goods and certain severance related costs for employees in closed facilities that the Company was obligated to pay upon execution of the plan.

 

The plan, which included closing the manufacturing facility in Denmark, relocating from the then current facility in Copenhagen, as well as discontinuing or subcontracting the manufacturing of certain product lines, was completed in the quarter ended September 30, 2002. Additionally, an existing defibrillator product line and the accompanying future service obligations were sold to a European company as part of the plan. The Company sold related inventories, manufacturing assets and the right to manufacture and sell the existing products for consideration of cash and future royalty payments based on future units produced. No gain or loss was recognized on the transaction as the disposal of these assets was contemplated as a part of the plan. Upon execution of the plan, the Company recorded an additional $905 of purchase price adjustments to reflect the fair value of the assets disposed.

 

The Company also entered into a licensing agreement with the European company granting them the right to use Cardiac Science’s proprietary bi-phasic defibrillation technology. In consideration, the Company received an upfront payment of $487 and will receive eight quarterly installments over the next 2 years totaling $500. The total licensing revenue of $987 will be recognized on a pro-rata basis over the next seven years, which is the term of the agreement and, accordingly, the Company recognized $141 of licensing revenue in the year ended December 31, 2003.

 

Also as part of the Artema acquisition, the Company identified the MCS gas business, located in Stockholm, Sweden, as a business segment acquired in a business combination accounted for as a purchase, to be disposed of. The MCS gas business designs, develops and manufactures gas analyzers, which are sold to OEM patient monitoring customers. The MCS gas business is a distinct and separate business unit. The Company was, for the period from acquisition through November 30, 2002 accounting for this in accordance with EITF 87-11, Allocation of Purchase Price to Assets to be Sold, which requires that the operations of the MCS gas business be excluded from the consolidated operating results of the Company. The Company had initially estimated that the operating loss of the MCS gas business from the acquisition date until disposition would be approximately $1,017 and had included this as a liability assumed in the acquisition and included it in the purchase price allocation. This estimated loss was subsequently revised to an estimated operating loss of $306. The Company sold the MCS gas business to an outside party for $600 in cash excluding selling costs of $111, on September 21, 2003. The operating loss of $306 has been excluded from the statements of operations for the one year period from acquisition through November 30, 2002 (i.e. included in the purchase price allocation) and the MCS operating loss of $52 in December 2002 and the net operating income of $493 for the period from January 1, 2003 through the sale on September 21, 2003, has been recorded as discontinued operations in accordance with EITF 90-6, Accounting for Certain Events not Addressed in Issue No. 87-11 Relating to Acquired Operating Unit to be Sold.

 

The following is a breakdown of the restructuring accruals recorded related to the Danish facilities shutdown and relocation and the MCS gas business disposal:

 

     Original
Adjustment


   Balance at
December 31,
2001


    Cash
Payments


   

Non-Cash

Adjustments


    Adjustments
to Goodwill


    Balance at
December 31,
2002


Restructuring accruals:

                                             

Loss on closure of Danish facilities

   $ 648    $ 648     $ (692 )   $ 108     $ 664     $ 728

Danish facilities severance and other miscellaneous costs

     520      520       (607 )     —         123       36

Losses from MCS gas business

     1,017      872       (161 )     —         (711 )     —  

MCS gas business severance and other miscellaneous costs

     —        —         —         —         1,280       1,280
    

  


 


 


 


 

     $ 2,185    $ 2,040     $ (1,460 )   $ 108     $ 1,356     $ 2,044
    

  


 


 


 


 

     Balance at
December 31,
2002


   Cash
Payments


    Currency
Fluctuations


    Adjustment
to Goodwill


    Balance
Sold


    Balance at
December 31,
2003


Restructuring accruals:

                                             

Loss on closure of Danish facilities

   $ 728    $ (652 )   $ 29     $ —       $ —       $ 105

Danish facilities severance and other miscellaneous costs

     36      (40 )     4       —         —         —  

Losses from MCS gas business

     —        —         —         —         —         —  

MCS gas business severance and other miscellaneous costs

     1,280      (514 )     —         (332 )     (434 )     —  
    

  


 


 


 


 

     $ 2,044    $ (1,206 )   $ 33     $ (332 )   $ (434 )   $ 105
    

  


 


 


 


 

 

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10. Corporate Relocation and Restructuring

 

During the first quarter of 2003, the Company commenced its plan to relocate its corporate headquarters, expanded its manufacturing capacity, and consolidate its accounting and finance functions in Irvine, California.

 

The costs which were incurred are included in general and administrative expenses in the accompanying consolidated statement of operations for the year ended December 31, 2003. All expansion, relocation, and restructuring activities were completed in the second quarter of 2003 and there are no future expected costs.

 

The following is a breakdown of the accrual recorded related to the expansion, relocation and restructuring activities:

 

     Original
Estimate


   Costs
Incurred


   Cash
Payments


    Non-cash
Adjustment


    Balance at
December 31,
2003


Severance costs

   $ 199    $ 199    $ (199 )   $ —       $ —  

Moving and travel costs

     68      92      (92 )     —         —  

Lease termination costs

     139      139      (139 )     —         —  

Accelerated depreciation of leaseholds and other assets

     288      288      —         (288 )     —  
    

  

  


 


 

     $ 694    $ 718    $ (430 )   $ (288 )   $ —  
    

  

  


 


 

 

The accrual represented costs recognized pursuant to SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities and SEC Staff Accounting Bulletin (“SAB”) 100, Restructuring and Impairment Charges. The Company committed to a sufficiently detailed plan that identified significant actions to be taken and the activities that would not be continued. The plan was completed during the quarter ended June 30, 2003 and there were no significant changes to the original plan. The involuntary one-time employee-termination arrangement established the benefits to be paid to employees and specifically identified the classifications or functions of those employees, their locations, and their expected completion date. All employees were informed about the terms of the benefit arrangement, including the benefits that employees would receive upon termination (including but not limited to cash payments), in sufficient detail to enable employees to determine the type and amount of benefits they would receive. The Company reviewed the net book value of leasehold improvements to be abandoned in certain facilities in accordance with SFAS 144, and appropriately recorded an adjustment to accelerate the related depreciation over the revised useful life through their cease-use dates.

 

11. Senior Secured Promissory Notes

 

As partial consideration for the acquisition of Survivalink (see Note 8), the Company issued senior secured promissory notes to Survivalink shareholders during 2001 in the principal amount of $25.8 million, with simple interest payable upon maturity at the rate of 10% per annum. In addition, the Company assumed $1.5 million of bridge notes from certain shareholders of Survivalink. The Company and the bridge note holders agreed to convert the bridge notes into a senior secured promissory note with terms and conditions similar to the notes issued as merger consideration. The notes issued to Survivalink shareholders were subsequently redeemed pursuant to the note and warrant financing described in the immediately following paragraph.

 

On May 29, 2002, the Company entered into a Senior Note and Warrant Purchase Agreement (“the Agreement”) with investors, pursuant to which the investors loaned the Company $50 million. The Senior Notes (the “Notes”) are due and payable in cash on May 30, 2007, unless accelerated pursuant to the terms of the Agreement. The Notes accrue interest at 6.9% per annum. During the first three years of the term of the Notes, accrued and unpaid interest on the Notes will, at the option of the Company, a) be due and payable in cash, or b) accrue and be paid in kind, in each case quarterly in arrears, and then due on the termination date of the Notes. After the end of the third year of the term of the Notes, any additional accrued and unpaid interest on the Notes will be due and payable in cash quarterly in arrears, and on the termination date of the Notes. Interest expense and amortization of the discount and issuance costs related to these notes was $5,983 and $3,207 for 2003 and 2002, respectively. As of December 31, 2003, the Company is in compliance with all such covenants, as amended (see Note 23).

 

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The Notes are collateralized by all the assets of the Company and its subsidiaries, to the extent permitted by law. Proceeds from the Notes were used by the Company to repay $26,468 of senior promissory notes plus accrued interest issued in connection with the acquisition of Survivalink Corporation (see Note 8). The remaining proceeds were available for working capital purposes.

 

In connection with the Notes, the investors were issued warrants (the “Warrants”) for the purchase of an aggregate of 10,000,000 shares of the Company’s common stock at an exercise price of $3.00 per share, and an aggregate of 3,000,000 shares of common stock at an exercise price of $4.00 per share. The Warrants are immediately exercisable, expire by their terms on May 30, 2009 and are subject to certain limited antidilution adjustments. After two years, the Company has the right to force the exercise of the warrants pursuant to the terms of the Agreement. The proceeds of the Notes were allocated between the Notes and the Warrants based on their relative fair values at the date of issuance, which allocation was determined by a third party valuation. Such allocation resulted in a discount being recorded on the Notes in the amount of $11,815, which will be amortized over the five-year term of the Notes using the effective interest method. In addition, the Company paid approximately $2,760 in debt issuance costs which will be amortized over the five-year term of the Notes using the effective interest method.

 

12. Promissory Note and Security Agreement

 

In July 1999, the Company terminated its agreement to acquire HeartSine Technologies, Inc. (“HeartSine”). In December 1999, the Company entered into an exclusive license and development agreement with HeartSine Technologies, Inc. to utilize HeartSine’s biphasic defibrillation waveform technology in the Company’s in-hospital defibrillation products. HeartSine Technologies is a privately held research and development firm with its primary operations in Northern Ireland. Pursuant to the agreement, the Company could have paid to HeartSine a total of $650 upon the attainment of agreed upon milestones. During 2000 the Company terminated the development portion of the agreement and therefore there are no additional development fees to be earned by HeartSine. Included in the amount of $650 was a one time license fee of $250 which was paid in December 1999 and included in research and development expense for the year ended December 31, 1999. Also, during 1999, the Company advanced cash to HeartSine in the amount of $189. The Company obtained a promissory note and security agreement with regard to these advances. The principal amount plus interest at 10% was due and payable on December 31, 2001.

 

In prior periods, the Company wrote-off to research and development expense this $189, as the Company believed that the note receivable was permanently impaired and uncollectible. In February 2002, the Company received from HeartSine $236, which represented full repayment of the original promissory note plus accrued interest and late fees. The Company has included this recovery of $236 as an offset to research and development expense in the statement of operations for the year ended December 31, 2002. In November 2002, the Company agreed to terminate its development and license agreement with HeartSine in exchange for $100. The Company also included this $100 as an offset to research and development expense in the statement of operations for the year ended December 31, 2002.

 

13. Related Party Transaction

 

In November 2001, the Company advanced $500 to its President and CEO. The principal amount plus interest of 6% is due and payable in November 2004. In the event that his employment is terminated, whether voluntarily or involuntarily, the principal and interest on this note shall become due and payable within 180 days from such termination of employment. The note is not collateralized and is included in other current assets on the consolidated balance sheet at December 31, 2003.

 

14. Notes Payable

 

In July 1998, Cadent entered into an equipment loan agreement under which Cadent borrowed $300 to finance previously purchased property and equipment. The Company assumed the outstanding loan balance as part of the acquisition of Cadent. The loan was repaid over a 48-month period commencing on July 10, 1998 with interest at a rate of 9.8%. The balance of the loan was $45 at December 31, 2001. This loan was paid off in full during 2002.

 

Between 1983 and 1986, Artema entered into four mortgage agreements to borrow approximately $806 to finance the purchase of the manufacturing facilities in Aabybro, Denmark. The Company has assumed these outstanding loan balances as part of the acquisition of Artema. At December 31, 2001, the outstanding loan balances were $255 bearing interest of 7%. These loans were paid off in full during 2002.

 

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During 2002, the Company purchased two vehicles which were financed through the auto dealers. Both loan agreements are to be repaid over 60 months. At December 31, 2003, and 2002, the outstanding loan balances totaled $51 and $62, respectively.

 

15. Common Stock Issuance

 

During September 2003, the Company completed a private placement of its common stock to a small group of institutional and accredited investors, raising $8,375 in gross proceeds. The transaction involved the sale of 2,233,334 newly issued shares of Cardiac Science common stock at a price of $3.75 per share. In addition to the common stock, 223,333 five-year warrants with an exercise price of $5.00 per share were issued in connection with the transaction.

 

16. Commitments and Contingencies

 

Concentrations of Risk

 

The Company is exposed to credit loss for the amount of cash deposits with financial institutions in excess of federally-insured limits. The Company invests its excess cash deposits in government securities and money market cash portfolios with major financial institutions.

 

Litigation

 

In November 2002, the Company settled a patent infringement suit with ZOLL Medical Corporation (“ZOLL”), which it originally initiated in March 2002. The terms of the settlement included the cross licensing of a number of patents between the two parties. Under the terms of the confidential settlement agreement, the Company received a settlement amount and will be entitled to royalties under a licensing agreement based on ZOLL’s AED sales. The Company recorded the settlement as an offset to legal expense included in general and administrative expenses in the quarter ended December 31, 2002.

 

On December 3, 2002, the Company filed a Complaint in Orange County Superior Court against Medical Research Laboratories, Inc. (“MRL”) alleging declaratory relief and breach of contract arising out of a July 29, 2002 letter of intent entered into between the parties. The Company alleged that MRL failed to comply with certain conditions of closing set forth in the letter of intent whereby the Company would acquire all of MRL’s stock. MRL filed a cross-complaint, also seeking breach of contract and declaratory relief arising out of the same letter of intent. On February 25, 2003, the Company filed suit against MRL for patent infringement in the United States District Court for the District of Minnesota. The Company alleged that MRL’s LifeQuest JumpStart AED infringed the Company’s patented disposable electrode pre-connect technology. The Company settled both law suits with MRL on June 24, 2003. Under the terms of the confidential settlement agreement, the Company received a settlement amount from MRL and MRL received the right to license two of the Company’s patents for additional royalties.

 

In February 2003, the Company announced that it had filed a patent infringement action against Philips Medical Systems North America, Inc., Philips Electronics North America Corporation and Koninklijke Philips Electronics N.V. (“Philips”) in the United States District Court for the District of Minnesota. The suit charged that Philips’ automated external defibrillators sold under the names “HeartStart OnSite Defibrillator” and “HeartStart Home Defibrillator” infringed at least seven of the Company’s United States patents. In the same action, the Company also sought a declaration from the Court that the Company’s products do not infringe several of Philips’ patents. In June 2003, the Company filed its First Amended Complaint further accusing Philips’ “HeartStart FR2” automated external defibrillator of infringing the Company’s U.S. Patents and removing four of the Philips’ patents from suit pursuant to an agreement between the parties. The Philips “HeartStart Home Defibrillator,” which was recently cleared by the U.S. Food and Drug Administration (“FDA”) for marketing in the United States, is promoted by Philips as including, among other things, pre-connected disposable defibrillation electrodes and daily self-testing of electrodes and battery, features that the suit alleges are key competitive advantages of the Company’s Powerheart and Survivalink AEDs and are covered under the Company’s patents. On June 19, 2003, Philips filed a Complaint against the Company in the United States District Court for the Western District of Washington. Philips’ Complaint alleges patent infringement of ten of Philips’ U.S. patents by the Company’s Powerheart and Survivalink AEDs. Five of the asserted patents were already contained in the Company’s Minnesota case against Philips. The Company made a motion to dismiss the Washington case as duplicative and the motion was granted. Philips made a motion in the Minnesota case to have its patents severed from that action, but the motion was denied. At this stage, the Company is unable to predict the outcome of this litigation or its ultimate effect, if any, on its financial condition.

 

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On April 30, 2003, the Company filed a Complaint against Defibtech, LLC for patent infringement in the United States District Court for the District of Minnesota. The Complaint alleged that Defibtech’s Sentry and Reviver AEDs infringe the Company’s patented disposable electrode pre-connect technology. Defibtech answered the Complaint with no counterclaims. At this stage, the Company is unable to predict the outcome of this litigation or its ultimate effect, if any, on its financial condition.

 

In the ordinary course of business, various lawsuits and claims are filed against the Company. While the outcome of these matters is currently not determinable, management believes that the ultimate resolution of these matters will not have a material adverse effect on the Company’s operations or financial position.

 

Employee Benefit Plan

 

In 1995, the Company adopted the Cardiac Science, Inc. 401(k) Profit Sharing Plan (the “Plan”) which is a 401(k) plan covering all of the Company’s full-time employees who meet certain eligibility requirements. The Company may contribute to the Plan on a discretionary basis. As of December 31, 2003, the Company had never contributed to the Plan.

 

Operating Leases

 

The Company leases office space and equipment under various operating lease agreements. Total rent expense for the years ended December 31, 2003, 2002, and 2001 was $1,153, $666, and $381, respectively. The minimum lease payments, net of sublease payments, under the terms of the lease agreements for the years ending December 31 are as follows:

 

2004, net of sublease income of $443

   $ 1,609

2005, net of sublease income of $442

     1,580

2006, net of sublease income of $395

     1,747

2007, net of sublease income of $33

     1,562

2008

     1,100

Thereafter

     34
    

     $ 7,632
    

 

17. Income Taxes

 

The Company’s provision for income tax represents the current state minimum taxes. There is no deferred income tax provision due to the valuation allowance.

 

The temporary differences which give rise to the deferred tax provision (benefit) consist of the following for the years ended December 31:

 

     2003

    2002

    2001

 

Property and equipment

   $ (424 )   $ 341     $ 35  

Capitalized costs

     302       168       530  

Accrued liabilities

     (380 )     366       (2,052 )

Tax credit carry forwards

     (292 )     (903 )     (1,756 )

Stock options

     211       337       (160 )

Deferred revenue

     (437 )     —         —    

Charitable contributions

     (4 )     (139 )     —    

Restricted stock

     —         —         665  

Capital loss carry forwards

     —         (303 )     (171 )

Other

     4       64       (64 )

Net operating loss carry forwards

     (3,171 )     (7,602 )     (21,361 )
    


 


 


       (4,191 )     (7,671 )     (24,334 )

Valuation allowance

     4,191       7,671       24,334  
    


 


 


     $ —       $ —       $ —    
    


 


 


 

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The temporary differences which give rise to deferred income tax assets and liabilities at December 31 are as follows:

 

     2003

    2002

 

Property and equipment

   $ 14     $ (410 )

Capitalized costs

     411       713  

Accrued liabilities/reserves

     2,221       1,841  

Tax credit carry forwards

     4,027       3,735  

Stock options

     —         211  

Deferred revenue

     437       —    

Capital loss carry forwards

     524       524  

Charitable contributions

     143       139  

Other

     1       5  

Net operating loss carry forwards

     52,005       48,834  
    


 


       59,783       55,592  

Valuation allowance

     (59,783 )     (55,592 )
    


 


     $ —       $ —    
    


 


 

In connection with the acquisition of Survivalink in 2001, the Company acquired deferred tax assets of approximately $15.5 million. A full valuation allowance has been applied to these deferred tax assets.

 

The provision for income taxes differs from the amount that would result from applying the federal statutory rate for the years ended December 31 as follows:

 

     2003

    2002

    2001

 

Statutory regular federal income tax rate

   (34.0 )%   (34.0 )%   (34.0 )%

Nondeductible expenses

   0.5     0.7     2.4  

Tax credits

   (2.9 )   (5.1 )   (1.2 )

Other

   0.9     —       —    

Change in valuation allowance

   35.5     38.4     32.8  
    

 

 

     0.0 %   0.0 %   0.0 %
    

 

 

 

As of December 31, 2003, the Company has research and experimentation credit carry forwards for federal and state purposes of approximately $3 million and $1 million, respectively. These credits begin to expire in 2006 for federal purposes and carry forward indefinitely for California state purposes. The Company has capital loss carry forwards of approximately $1 million for both federal and state purposes which begin to expire in 2004 for federal purposes and carry forward indefinitely for state purposes. The Company also has approximately $134 million and $74 million of federal and state net operating loss carry forwards which will begin to expire in 2006 and 2004, respectively. The utilization of net operating loss and tax credit carry forwards may be limited under the provisions of Internal Revenue Code Sections 382 and 1503 and similar state provisions. The limitations could result in the expiration of the Company’s net operating loss carry forwards and research and experimentation credit carry forwards before full utilization.

 

18. Stock Options

 

1997 Stock Option/Stock Issuance Plan

 

In May 1998, the Company’s 1997 Stock Option/Stock Issuance Plan (the “1997 Plan”) was approved by stockholders at the Annual Meeting of Stockholders. All outstanding stock options under the Company’s 1991 Stock Option Plan and 1993 Stock Option Plan were exchanged for stock options in the 1997 Plan. The 1997 Plan provides for the granting of stock options intended to qualify as incentive stock options and stock options not intended to qualify as incentive stock options (“non-statutory options”) to employees of the Company, including officers, and non-statutory stock options to employees, including officers and directors of the Company, as well as to certain consultants and advisors.

 

The 1997 Plan is administered by a Compensation Committee (the “Committee”) which is comprised of three members appointed by the Company’s Board of Directors. The Committee may grant options to any officers, directors or key employees of the Company or its subsidiaries and to any other individuals whose participation in the 1997 Plan the Committee determines is in the Company’s best interest. In 2001, stockholders approved an amendment to the 1997 Plan to increase the number of shares of common stock up to a maximum of 8.8 million shares. In 2002, stockholders approved another amendment to increase the number of shares of common stock up to a maximum of 11 million shares. In 2003, stockholders approved another amendment to increase the number of shares of common stock up to a maximum of 14 million shares. The 1997 Plan is subject to adjustment upon the occurrence of certain events, including, but not limited to, stock dividends, stock splits, combinations, mergers, consolidations, reorganizations, reclassifications, exchanges, or other capital adjustments. The 1997 Plan limits to $100 the fair market value

 

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(determined at the time the option is granted) of the common stock with respect to which incentive stock options are first exercisable by any individual employee during any calendar year.

 

The 1997 Plan incorporates the federal tax law requirements for incentive stock options. Among other such requirements, the per share exercise price of an incentive stock option granted under the 1997 Plan must not be less than 100% of the fair market value of a share of the common stock on the date of grant and the option may not be exercised more than 10 years after its grant date. If an incentive stock option is granted to an employee owning more than 10% of the total combined voting power of all classes of stock of the Company, the exercise price may not be less than 110% of such fair market value and the option may not be exercised more than five years after its grant date. Option grants under the 1997 Plan generally vest over a period of four years.

 

Outstanding options may be terminated or accelerated in the event of certain corporate acquisitions or other change of control events. An option granted under the 1997 Plan will not be assignable or transferable by the grantee other than by will or the laws of inheritance, except that a non-statutory option will be transferable by the grantee pursuant to a qualified domestic relations order as defined in the Code, Title I of the Employee Retirement Income Security Act or the rules thereunder. Other vesting, termination and payment provisions for incentive and non-statutory options may be determined by the Committee.

 

Stock option activity for the years ended December 31 is summarized as follows:

 

     Option Price
Per Share


   Number of
Shares
Outstanding


    Number of
Shares
Exercisable


Outstanding, December 31, 2000

   $ 1.88–$6.00    2,686,045     841,783

Granted

   $ 2.06–$3.00    6,880,400 (1)    

Exercised

   $ 1.88–$4.63    (325,492 )    

Cancelled

   $ 1.88–$6.00    (750,403 )    
    

  

   

Outstanding, December 31, 2001

   $ 1.88–$6.00    8,490,550     1,166,086

Granted

   $ 1.60–$4.55    2,892,000      

Exercised

   $ 2.00–$4.00    (39,537 )    

Cancelled

   $ 1.60–$5.94    (1,121,134 )    
    

  

   

Outstanding, December 31, 2002

   $ 1.60–$6.00    10,221,879     3,343,376

Granted

   $ 2.23–$5.07    4,295,000 (2)    

Exercised

   $ 1.60–$3.83    (658,552 )    

Cancelled

   $ 1.60–$6.00    (1,450,037 )    
    

  

   

Outstanding, December 31, 2003

   $ 1.60–$6.00    12,408,290     4,789,702
    

  

   

(1) Includes 205,500 options to purchase shares of the Company’s common stock granted in 2001 outside the Plan and pursuant to consulting agreements for services rendered to the Company, all of which are still outstanding at December 31, 2003. The stock options issued to these consultants are subject to the same vesting requirements as employee stock options issued pursuant to the Company’s 1997 Stock Option/Stock Issuance Plan. The services contracted for included business sales services and consulting in the areas of operations, business plan implementation and marketing, and such services did not include capital raising activities.
(2) Includes 475,500 options to purchase shares of the Company’s common stock granted in 2003 outside the Plan, 465,000 of which are still outstanding at December 31, 2003. The stock options issued to employees outside the U.S. are subject to the same vesting requirements as employee stock options issued pursuant to the Company’s 1997 Stock Option/Stock Issuance Plan.

 

The following table summarizes information about stock options outstanding at December 31, 2003:

 

Range of Exercise Price


   Options
Outstanding


   Weighted
Average
Remaining
Contractual
Life


   Weighted
Average
Exercise
Price


   Options
Exercisable


   Weighted
Average
Exercise
Price


$1.60–$2.00

   2,534,755    95 months    $ 1.78    1,139,481    $ 1.85

$2.06

   4,218,639    93 months      2.06    2,375,826      2.06

$2.23–$3.99

   3,759,051    112 months      3.34    472,194      2.63

$4.00–$5.81

   1,801,429    99 months      4.41    711,015      4.55

$6.00

   94,416    79 months      6.00    91,186      6.00
    
              
      

$1.60–$6.00

   12,408,290    100 months    $ 2.76    4,789,702    $ 2.51
    
              
      

 

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At December 31, 2003, there were 12,408,290 shares reserved or available for issuance under the 1997 Plan.

 

For stock options granted to non-employees (consultants), the Company recognized compensation cost of $374 for 2001, using a Black-Scholes option pricing model. No stock options were granted to non-employees (consultants) in 2002 or 2003.

 

19. Warrants

 

Historically, the Company has granted warrants in connection with fund raising activities and as consideration for certain services. In 2003, warrants were also issued in connection with a distribution and development agreement (see note 20). The following summarizes warrants to purchase shares of common stock that were outstanding and exercisable at December 31, 2003:

 

Grant Date


   Warrants
Outstanding


   Exercise Price
Per Share


   Warrants
Exercisable


   Expiration
Date


1994

   18,750    $0.01    18,750    2004

1997

   75,000    $2.25    75,000    2007

2002

   35,000    $2.40    35,000    2004

2002

   13,000,000    $3.00–3.96    13,000,000    2009

2002

   25,000    $1.75    —      2012

2003

   18,000    $1.80-2.00    18,000    2006-2007

2003

   765,000    $3.00-3.27    765,000    2007-2008

2003

   323,000    $4.61-5.00    223,333    2008

2003

   26,652    $3.96    26,652    2009
    
       
    

Total

   14,286,735         14,161,735     
    
       
    

 

20. Distribution and License Agreements

 

In December 1998, the Company entered into a five-year exclusive distribution and licensing agreement with Medtronic Physio-Control (“MPC”), a subsidiary of Medtronic, Inc. (“Medtronic”). Under the original agreement, MPC had the exclusive right to market the Powerheart in the United States and Canada. In May 1999, the agreement was expanded to include the United Kingdom, Germany, France, and certain Scandinavian countries. Subsequent to December 31, 2000, MPC provided the Company with notice that, among other things, the acquisition of Survivalink (see Note 8), a significant competitor of MPC, placed MPC at substantial risk of violating restrictions placed on Medtronic by the Federal Trade Commission in connection with Medtronic’s acquisition of Physio-Control. MPC believed these restrictions, among other things, directly impacted MPC’s ability to continue its relationship with Cardiac Science. MPC had stated that in light of such fact, it believed it to be in the best interests of the parties to terminate the agreement. The Company entered into a settlement agreement and mutual release with MPC in February 2002. The terms of this settlement agreement provided that MPC return to the Company, at no charge, approximately 220 Powerheart units, which MPC had previously purchased and paid for, in substantially the same condition in which the units were originally sold to MPC. Additionally, the Company owed MPC $1.1 million pursuant to a senior secured promissory note issued by the Company to MPC in the merger transaction between the Company and Survivalink. This $1.1 million is part of the $25.8 million of senior secured promissory notes issued in the Survivalink merger. Pursuant to this settlement agreement, MPC agreed to forgive and release payment of $832 of the amount owing under the promissory note to MPC.

 

In July 2003, the Company signed multi-year strategic OEM, distribution, and development agreements with GE Medical Systems Information Technologies (“GEMS”), under which GEMS will market the Company’s AED and CRM products under the GE name in Europe, Asia, the Middle East, and other international markets. Under the agreements, the Company will also develop and manufacture a line of biphasic external defibrillators for exclusive sale by GEMS, under the GE brand world-wide. The Company began shipping AED and CRM products to GEMS in September 2003. The biphasic external defibrillator is expected to ship in the fourth quarter of 2004. In connection with the development agreement, the Company issued 750,000 warrants to purchase shares of the Company’s common stock at an exercise price of $3.00 per share. The value of the warrants of $907 is included in Other Assets in the accompanying consolidated balance sheet and will be amortized as a reduction of revenue beginning with the first shipment of the biphasic external defibrillator over the term of the agreement.

 

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21. Supplemental Cash Flow Disclosures

 

     2003

    2002

   2001

 

Cash paid during the year for:

                       

Income taxes

   $ —       $ —      $ 2  

Interest

     50       2,213      53  

Supplemental schedule of non-cash investing and financing activities:

                       

Costs of equity issuances paid with common stock

     —         —        770  

Exchange of common stock subscribed for common stock

     —         —        1,551  

Purchases of equipment with a capital lease or note payable

     —         64      73  

Deferred revenue receivable

     758       700      —    

Return of shares in escrow related to Survivalink acquisition

     —         1,095      —    

Costs of equity issuances not yet paid

     —         —        60  

Fair value of warrants issued

     936       11,815      —    

Portion of proceeds from the sale of assets at subsidiary held in escrow at December 31, 2002

     —         767      —    

Acquisition of Complient Corporation:

                       

Fair value of non-cash tangible assets acquired

     4,947                 

Liabilities assumed and incurred

     (6,205 )               

Intangible assets

     46,255                 

Fair value of stock consideration

     (45,305 )               
    


              

Cash acquired

   $ (308 )               
    


              

Acquisition of Lifetec Medical Limited:

                       

Fair value of non-cash tangible assets acquired

     329                 

Liabilities assumed and incurred

     (618 )               

Goodwill

     583                 

Cash consideration

     (383 )               
    


              

Cash acquired

   $ (89 )               
    


              

Acquisition of Survivalink Corporation:

                       

Fair value of non-cash tangible assets acquired

                  $ 4,383  

Liabilities assumed and incurred, net of senior secured promissory notes

                    (8,494 )

Senior secured promissory notes

                    (27,300 )

Intangible assets

                    82,441  

Cash consideration paid

                    (10,500 )

Fair value of stock consideration

       <