##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
 OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
 OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Number 000-51512
 Cardiac Science Corporation
  Delaware
    
    94-3300396(State of Incorporation)
    
    (IRS Employer Identification No.)
 3303 Monte Villa Parkway
Bothell, Washington 98021
 (425) 402-2000
 
  þ o
  o þ o
  o þ




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##### 



TABLE OF CONTENTS
 PagePART I  FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited)
    
    
    3Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    30Item 4.
    
    Controls and Procedures
    
    
    30PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    31Item 1A.
    
    Risk Factors
    
    
    31Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    31Item 3.
    
    Defaults Upon Senior Securities
    
    
    31Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    31Item 5.
    
    Other Information
    
    
    32Item 6.
    
    Exhibits
    
    
    32SIGNATURE
    
    
    
    
    33EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  Page 2 of 33




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 September 30,
    
    
    December 31,(In thousands)
    
    2006
    
    
    2005ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    10,699
    
    
    $
    3,546Accounts receivable, net of allowance for doubtful accounts of $802 and
$3,455, respectively
    
    
    22,646
    
    
    
    25,738Inventories
    
    
    19,873
    
    
    
    22,052Deferred income taxes
    
    
    7,372
    
    
    
    12,115Prepaid expenses and other current assets
    
    
    1,946
    
    
    
    2,511Total current assets
    
    
    62,536
    
    
    
    65,962Other assets
    
    
    228
    
    
    
    100Machinery and equipment, net of accumulated depreciation and amortization of
$9,574 and $7,565, respectively
    
    
    6,429
    
    
    
    7,631Deferred income taxes
    
    
    36,311
    
    
    
    27,849Intangible assets, net of accumulated amortization of $5,244 and $2,642,
respectively
    
    
    32,736
    
    
    
    35,338Investment in unconsolidated entities
    
    
    458
    
    
    
    462Goodwill
    
    
    107,762
    
    
    
    111,215Total assets
    
    $
    246,460
    
    
    $
    248,557LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    12,295
    
    
    $
    11,642Accrued liabilities
    
    
    8,285
    
    
    
    11,918Warranty liability
    
    
    2,666
    
    
    
    2,348Deferred revenue
    
    
    7,109
    
    
    
    7,924Total current liabilities
    
    
    30,355
    
    
    
    33,832Other liabilities
    
    
    937
    
    
    
    1,806Total liabilities
    
    
    31,292
    
    
    
    35,638Minority interest in consolidated entity
    
    
    90
    
    
    
    128Commitments and contingenciesShareholders Equity:Preferred stock (10,000,000 shares authorized), $0.001 par value, no shares
issued or outstanding as of September 30, 2006 and December 31, 2005
    
    
    
    
    
    
    Common stock (65,000,000 shares authorized), $0.001 par value, 22,540,062
and 22,410,344 shares issued and outstanding at September 30, 2006 and
December 31, 2005, respectively
    
    
    220,547
    
    
    
    218,335Accumulated other comprehensive income (loss)
    
    
    (4
    )
    
    
    5Accumulated deficit
    
    
    (5,465
    )
    
    
    (5,549
    )Total shareholders equity
    
    
    215,078
    
    
    
    212,791Total liabilities and shareholders equity
    
    $
    246,460
    
    
    $
    248,557
  Page 3 of 33




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CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,(In thousands, except share and per share data)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:Products
    
    $
    33,890
    
    
    $
    24,033
    
    
    $
    103,466
    
    
    $
    61,450Service
    
    
    4,226
    
    
    
    3,413
    
    
    
    12,986
    
    
    
    9,294Total revenues
    
    
    38,116
    
    
    
    27,446
    
    
    
    116,452
    
    
    
    70,744Cost of Revenues:Products
    
    
    16,910
    
    
    
    13,029
    
    
    
    52,101
    
    
    
    32,909Service
    
    
    3,138
    
    
    
    2,139
    
    
    
    9,300
    
    
    
    5,916Total cost of revenues
    
    
    20,048
    
    
    
    15,168
    
    
    
    61,401
    
    
    
    38,825Gross profit
    
    
    18,068
    
    
    
    12,278
    
    
    
    55,051
    
    
    
    31,919Operating Expenses:Research and development
    
    
    2,792
    
    
    
    2,262
    
    
    
    8,637
    
    
    
    5,979Sales and marketing
    
    
    10,045
    
    
    
    6,601
    
    
    
    29,342
    
    
    
    15,850General and administrative
    
    
    5,863
    
    
    
    4,697
    
    
    
    17,590
    
    
    
    9,008Total operating expenses
    
    
    18,700
    
    
    
    13,560
    
    
    
    55,569
    
    
    
    30,837Operating income (loss)
    
    
    (632
    )
    
    
    (1,282
    )
    
    
    (518
    )
    
    
    1,082Other Income (Expense):Interest income (expense), net
    
    
    18
    
    
    
    123
    
    
    
    (37
    )
    
    
    381Other income, net
    
    
    94
    
    
    
    34
    
    
    
    599
    
    
    
    148Total other income
    
    
    112
    
    
    
    157
    
    
    
    562
    
    
    
    529Income (loss) before income taxes and minority
interest in consolidated entity
    
    
    (520
    )
    
    
    (1,125
    )
    
    
    44
    
    
    
    1,611Income tax benefit (expense)
    
    
    209
    
    
    
    558
    
    
    
    1
    
    
    
    (346
    )Income (loss) before minority interest in
consolidated entity
    
    
    (311
    )
    
    
    (567
    )
    
    
    45
    
    
    
    1,265Minority interest in (income) loss of consolidated
entity
    
    
    13
    
    
    
    (2
    )
    
    
    39
    
    
    
    24Net income (loss)
    
    $
    (298
    )
    
    $
    (569
    )
    
    $
    84
    
    
    $
    1,289Net income (loss) per share  basic
    
    $
    (0.01
    )
    
    $
    (0.04
    )
    
    $
    0.00
    
    
    $
    0.11Net income (loss) per share  diluted
    
    $
    (0.01
    )
    
    $
    (0.04
    )
    
    $
    0.00
    
    
    $
    0.10Weighted average shares outstanding  basic
    
    
    22,523,266
    
    
    
    14,523,096
    
    
    
    22,480,553
    
    
    
    12,099,187Weighted average shares outstanding  diluted
    
    
    22,523,266
    
    
    
    14,523,096
    
    
    
    22,551,600
    
    
    
    12,429,725
  Page 4 of 33




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CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,(In thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Operating Activities:Net income (loss)
    
    $
    (298
    )
    
    $
    (569
    )
    
    $
    84
    
    
    $
    1,289Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:Depreciation and amortization
    
    
    1,561
    
    
    
    792
    
    
    
    4,661
    
    
    
    1,606Deferred income taxes
    
    
    (345
    )
    
    
    (541
    )
    
    
    (233
    )
    
    
    291Stock-based compensation
    
    
    522
    
    
    
    
    
    
    
    1,538
    
    
    
    39Minority interest in income (loss) of consolidated entity
    
    
    (13
    )
    
    
    2
    
    
    
    (39
    )
    
    
    (24
    )Gain on sale of marketable equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (15
    )Changes in operating assets and liabilities, net of
business acquired:Accounts receivable
    
    
    2,238
    
    
    
    (481
    )
    
    
    3,136
    
    
    
    160Inventories
    
    
    (1,077
    )
    
    
    1,081
    
    
    
    697
    
    
    
    696Prepaid expenses and other current assets
    
    
    348
    
    
    
    117
    
    
    
    1,334
    
    
    
    (18
    )Accounts payable
    
    
    67
    
    
    
    (1,864
    )
    
    
    945
    
    
    
    (1,967
    )Accrued liabilities
    
    
    (611
    )
    
    
    626
    
    
    
    (2,959
    )
    
    
    (791
    )Warranty liability
    
    
    (24
    )
    
    
    (188
    )
    
    
    39
    
    
    
    (222
    )Deferred revenue
    
    
    (376
    )
    
    
    190
    
    
    
    (467
    )
    
    
    498Net cash flows provided by (used in) operating activities
    
    
    1,992
    
    
    
    (835
    )
    
    
    8,736
    
    
    
    1,542Investing Activities:Purchases of machinery and equipment
    
    
    (137
    )
    
    
    (164
    )
    
    
    (933
    )
    
    
    (491
    )Payments related to the purchase of Cardiac Science, Inc.
    
    
    (316
    )
    
    
    (14,806
    )
    
    
    (1,530
    )
    
    
    (15,903
    )Proceeds from sales of marketable equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    625Proceeds from collection of note
    
    
    238
    
    
    
    
    
    
    
    238
    
    
    
    Net cash flows used in investing activities
    
    
    (215
    )
    
    
    (14,970
    )
    
    
    (2,225
    )
    
    
    (15,769
    )Financing Activities:Proceeds from exercise of stock options and issuance of
shares under employee purchase plan
    
    
    176
    
    
    
    234
    
    
    
    642
    
    
    
    584Proceeds from issuance of stock, net of issuance costs
    
    
    
    
    
    
    (140
    )
    
    
    
    
    
    
    (140
    )Net cash flows provided by financing activities
    
    
    176
    
    
    
    94
    
    
    
    642
    
    
    
    444Net change in cash and cash equivalents
    
    
    1,953
    
    
    
    (15,711
    )
    
    
    7,153
    
    
    
    (13,783
    )Cash and cash equivalents, beginning of period
    
    
    8,746
    
    
    
    23,830
    
    
    
    3,546
    
    
    
    21,902Cash and cash equivalents, end of period
    
    $
    10,699
    
    
    $
    8,119
    
    
    $
    10,699
    
    
    $
    8,119
  Page 5 of 33




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CARDIAC SCIENCE CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. Summary of Significant Accounting Policies
 Organization and Description of Business
   Basis of Presentation
  Use of Estimates
  Net Income Per Share
  Page 6 of 33




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Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,(in thousands, except share data)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator:Net income (loss)
    
    $
    (298
    )
    
    $
    (569
    )
    
    $
    84
    
    
    $
    1,289Denominator:Weighted average shares for basic calculation
    
    
    22,523,266
    
    
    
    14,523,096
    
    
    
    22,480,553
    
    
    
    12,099,187Incremental shares from employee stock options
    
    
    
    
    
    
    
    
    
    
    71,047
    
    
    
    330,538Weighted average shares for diluted calculation
    
    
    22,523,266
    
    
    
    14,523,096
    
    
    
    22,551,600
    
    
    
    12,429,725
  Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Antidilutive shares issuable upon exercise of stock options
    
    
    3,049,224
    
    
    2,051,836
    
    
    2,219,438
    
    
    956,593Antidilutive shares issuable upon exercise of warrants
    
    
    330,909
    
    
    110,313
    
    
    330,909
    
    
    36,768Total
    
    
    3,380,133
    
    
    2,162,149
    
    
    2,550,347
    
    
    993,361
 Customer and Vendor Concentrations
  Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,Customer
    
    2006
    
    2005
    
    2006
    
    2005Customer 1
    
    
    13.6
    %
    
    
    *
    
    
    
    12.4
    %
    
    
    *Customer 2
    
    
    *
    
    
    
    10.7
    %
    
    
    *
    
    
    
    13.9
    %
 
 *
    
    Did not exceed 10%.  Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,Vendor
    
    2006
    
    2005
    
    2006
    
    2005Vendor 1
    
    
    23.2
    %
    
    
    *
    
    
    
    14.4
    %
    
    
    *Vendor 2
    
    
    *
    
    
    
    17.8
    %
    
    
    11.8
    %
    
    
    19.0
    %Vendor 3
    
    
    *
    
    
    
    10.7
    %
    
    
    *
    
    
    
    *
 
 *
    
    Did not exceed 10%.  Taxes Collected from Customers and Remitted to Governmental Authorities
  Recent Accounting Pronouncements
  Page 7 of 33




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2. Merger Transaction with Cardiac Science, Inc.
    
    
    11,467,753 shares of common stock valued at approximately $146,911,000 issued to CSI
stockholders and senior note holders. The fair value of common stock issued is based on a
per share value of $12.81, which is equal to Quintons average closing price per share as
reported on The Nasdaq National Market for a five trading day period (two days before and
after February 28, 2005), the announcement date of the merger transaction, adjusted by the
Quinton exchange ratio.
    
    Cash payment of $20,000,000 to the CSI senior note holders.
    
    1,229,881 vested options to purchase shares of common stock issued to CSI option
holders, valued at $7,402,000 calculated using the Black-Scholes option-pricing model.
    
    330,909 exercisable warrants to purchase shares of common stock issued to certain CSI
warrant holders, valued at $1,320,000 calculated using the Black-Scholes option-pricing
model.
    
    $3,198,000 in accrued liabilities related to estimated exit and severance costs.
    
    $2,244,000 in estimated transaction related costs of Quinton.
 Page 8 of 33




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(in thousands)Cash
    
    $
    20,000Shares
    
    
    146,911Options
    
    
    7,402Warrants
    
    
    1,320Accrued liabilities
    
    
    3,198Transaction costs
    
    
    2,244Total
    
    $
    181,075
   (in thousands)Cash and cash equivalents
    
    $
    6,295Accounts receivable, net of allowance for doubtful accounts
    
    
    7,098Inventories
    
    
    11,826Net deferred tax assets, current
    
    
    2,957Prepaid expenses and other current assets
    
    
    2,548Machinery and equipment
    
    
    3,979Net deferred tax assets, non-current
    
    
    29,725Other long-term assets
    
    
    661Intangible assets
    
    
    31,360Goodwill
    
    
    99,139Total assets acquired
    
    
    195,588Liabilities assumed
    
    
    (14,513
    )Net assets acquired
    
    $
    181,075
  Nine months ended(in thousands)
    
    September 30, 2006Goodwill, beginning of period
    
    $
    102,592Increase in accounts receivable, net of allowance for doubtful accounts
    
    
    (44
    )Decrease in inventories
    
    
    1,513Decrease in net deferred tax assets, current
    
    
    4,742Increase in prepaid expenses and other current assets
    
    
    (1,135
    )Increase in net deferred tax assets, non-current
    
    
    (8,225
    )Decrease in liabilities assumed
    
    
    (304
    )Goodwill, end of period
    
    $
    99,139
  Page 9 of 33




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Three months ended
    
    Nine months ended(in thousands, except per share data)
    
    September 30, 2005
    
    September 30, 2005Revenues
    
    $
    

    32,907
    

    $
    

    106,091Net loss
    

    $
    

    (4,716
    )

    $
    

    (59,007
    )Basic net loss per share
    

    $
    

    (0.21
    )
    $
    

    (2.64
    )
   3. Segment Reporting
   Page 10 of 33




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Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,(in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Cardiac monitoring products
    
    $
    16,697
    
    
    $
    18,597
    
    
    $
    54,230
    
    
    $
    55,487Defibrillation products
    
    
    17,193
    
    
    
    5,436
    
    
    
    49,236
    
    
    
    5,963Service
    
    
    4,226
    
    
    
    3,413
    
    
    
    12,986
    
    
    
    9,294Total
    
    $
    38,116
    
    
    $
    27,446
    
    
    $
    116,452
    
    
    $
    70,744
  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,(in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Domestic
    
    $
    27,816
    
    
    $
    24,188
    
    
    $
    87,416
    
    
    $
    64,174Foreign
    
    
    10,300
    
    
    
    3,258
    
    
    
    29,036
    
    
    
    6,570Total
    
    $
    38,116
    
    
    $
    27,446
    
    
    $
    116,452
    
    
    $
    70,744
  4. Restructuring Costs
      Balance at
    
    Accrued as Part
    
    
    
    
    
    
    
    
    
    Balance atDecember 31,
    
    of the Merger
    
    
    
    
    
    Cash
    
    December 31,(in thousands)
    
    2004
    
    Transaction
    
    Additions
    
    Expenditures
    
    2005Vacated facilities
    
    $
    

    
    $
    2,709

    
    $
    56

    
    $
(514
    )

    $
2,251Employee severance and retention costs
    
    
    

    
    
    1,702

    
    
    1,589

    
    
    (1,478
    )

    
    1,813
 Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atDecember 31,
    
    
    
    
    
    Cash
    
    
    
    
    
    September 30,(in thousands)
    
    2005
    
    Additions
    
    Expenditures
    
    Adjustments
    
    2006Vacated facilities
    
    $
    2,251

    
    $
93

    
    $
(680
    )

    $
    (152
    )

    $
1,512Employee severance and retention costs
    
    
1,813
    
    
    
    233
    
    
    
    (1,696
    )
    
    
    
    
    
    
    350
 Page 11 of 33




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5. Inventories
  September 30,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005Raw materials
    
    $
    16,046
    
    
    $
    18,746Finished goods
    
    
    3,827
    
    
    
    3,306Total inventories
    
    $
    19,873
    
    
    $
    22,052
 6. Credit Facility
   7. Warranty Liability
  Nine months ended(in thousands)
    
    September 30, 2006Warranty liability, beginning of the period
    
    $
    2,348Charged to cost of revenues
    
    
    1,546Adjustment to estimated fair value of acquired warranty
    
    
    279Warranty expenditures
    
    
    (1,507
    )Warranty liability, end of the period
    
    $
    2,666
 8. Stock-Based Compensation Plans
   Page 12 of 33




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Three months ended
    
    Nine months endedSeptember 30, 2006
    
    September 30, 2006As Reported
    
    If Reported
    
    As Reported
    
    If ReportedFollowing
    
    Following
    
    Following
    
    Following(in thousands, except per share data)
    
    SFAS 123R
    
    APB 25
    
    SFAS 123R
    
    APB 25Condensed Consolidated Statement of Operations:Operating income (loss)
    
    $
    (632
    )

    $
    (203
    )

    $
(518
    )

    $
788Income
(loss) before income taxes and minority interest in consolidated entity
    
    $
(520
    )

    $
(91
    )

    $
44

    
    $
1,350Net income (loss)
    
    $
(298
    )

    $
72

    
    $
84

    
    $
1,206Net income (loss) per share:Basic
    
    $
(0.01
    )

    $


    
    $

    
    $
0.05Diluted
    
    $
(0.01
    )

    $


    
    $


    
    $
0.05Condensed Consolidated Statement of Cash Flows:Net cash provided by operating activities
    
    $
1,992

    
    $
1,992

    
    $
8,736

    
    $
8,736Net cash provided by financing activities
    
    $
176

    
    $
176

    
    $
642

    
    $
642
  Page 13 of 33




---



##### Table of Contents



Three months
    
    
    Nine monthsended
    
    
    endedSeptember 30,
    
    
    September 30,(in thousands, except per share data)
    
    2005
    
    
    2005Net income (loss)  as reported
    
    $
    (569
    )
    
    $
    1,289Add back: Stock-based employee compensation expense included in
reported income, net of related tax effects
    
    
    
    
    
    
    39Deduct: Total stock-based employee compensation expense determined
under fair value based method for all awards, net of related tax effect of
$39 and $150, respectively
    
    
    (550
    )
    
    
    (1,645
    )Net loss  pro forma
    
    $
    (1,119
    )
    
    $
    (317
    )Net income (loss) per share as reported  basic
    
    $
    (0.04
    )
    
    $
    0.11Net income (loss) per share as reported  diluted
    
    $
    (0.04
    )
    
    $
    0.10Net loss per share pro forma  basic
    
    $
    (0.08
    )
    
    $
    (0.03
    )Net loss per share pro forma  diluted
    
    $
    (0.08
    )
    
    $
    (0.03
    )
  Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005(pro forma)
    
    
    
    
    
    (pro forma)Stock options plans:*Volatility
    
    
    54.3
    %

    


    
    
55.6
    %

    
62.0
    %Expected term (years)
    
    
6.25

    
    


    
    
6.25

    
    
6.25Risk-free interest rate
    
    
5.1
    %

    


    
    
4.7
    %

    
4.5
    %Expected dividend yield
    
    
    

    
    


    
    


    
    
Fair value of options granted
    
    $
4.74

    
    $


    
    $
6.12

    
    $
8.05Employee stock purchase plan:Volatility
    
    
34.0
    %

    
64.6
    %

    
34.0
    %

    
64.6
    %Expected term (years)
    
    
0.5

    
    
0.5

    
    
0.5

    
    
0.5Risk-free interest rate
    
    
4.4
    %

    
2.7
    %

    
4.4
    %

    
   2.7
    %Expected dividend yield
    
    


    
    


    
    


    
    
Fair value of employee stock purchase rights
    
    $
2.37

    
    $
4.44

    
    $
2.37

    
    $
4.44Non-vested stock:Fair value of non-vested stock awards granted
    
    $
8.14

    
    $


    
    $
8.24

    
    $

 
 *
    
    Stock options were not issued in the three months ended June 30, 2006 or 2005 or the three
months ended September 30, 2005.   Page 14 of 33




---



##### Table of Contents



Stock Option Plans
     Outstanding shares  2002 Plan
    
    
    1,891,915Outstanding shares  1997 Plan
    
    
    1,157,309Stock options available for grant
    
    
    576,637Outstanding restricted stock grants
    
    
    183,300Employee stock purchase plan shares available for issuance
    
    
    589,615Total common shares reserved for future issuance
    
    
    4,398,776
 2002 Plan 
  Page 15 of 33




---



##### Table of Contents



Shares
    
    
    Weighted Average
    
    
    Weighted Average
    
    
    Aggregate IntrinsicSubject to
    
    
    Exercise Price
    
    
    Remaining
    
    
    ValueOptions
    
    
    per Share
    
    
    Contractual Life
    
    
    (in thousands)Outstanding, January 1, 2006
    
    
    1,960,525
    
    
    $
    7.67
    
    
    6.8 yearsGranted
    
    
    75,000
    
    
    
    11.13
    
    
    9.8 yearsExercised
    
    
    (41,124
    )
    
    
    0.84
    
    
    2.9 yearsCancelled
    
    
    (66,023
    )
    
    
    10.26
    
    
    7.7 yearsOutstanding, March 31, 2006
    
    
    1,928,378
    
    
    
    7.86
    
    
    6.9 years
    
    
    $
    4,297Granted
    
    
    
    
    
    
    
    
    
    
    Exercised
    
    
    (7,796
    )
    
    
    8.80
    
    
    6.2 yearsCancelled
    
    
    (5,285
    )
    
    
    10.21
    
    
    7.7 yearsOutstanding, June 30, 2006
    
    
    1,915,297
    
    
    
    7.86
    
    
    6.6 years
    
    
    
    3,222Granted
    
    
    20,000
    
    
    
    8.18
    
    
    9.8 yearsExercised
    
    
    (8,871
    )
    
    
    4.56
    
    
    5.0 yearsCancelled
    
    
    (34,511
    )
    
    
    9.18
    
    
    9.3 yearsOutstanding, September 30, 2006
    
    
    1,891,915
    
    
    $
    7.83
    
    
    6.6 years
    
    
    $
    2,861Exercisable, September 30, 2006
    
    
    1,620,474
    
    
    $
    7.27
    
    
    5.3 years
    
    
    $
    2,861
  OutstandingWeighted-
    
    
    ExercisableWeighted-
    
    
    Average
    
    
    
    
    
    
    Weighted-Average
    
    
    Remaining
    
    
    
    
    
    
    AverageNumber of
    
    
    Exercise
    
    
    Contractual
    
    
    Number of
    
    
    ExerciseRange of Exercise Prices
    
    Options
    
    
    Price
    
    
    Life
    
    
    Options
    
    
    Price$0.00  $1.08
    
    
    32,335
    
    
    $
    0.29
    
    
    2.4 years
    
    
    32,335
    
    
    $
    0.29$1.09  $2.42
    
    
    6,138
    
    
    
    1.31
    
    
    3.0 years
    
    
    6,138
    
    
    
    1.31$2.43  $3.25
    
    
    559,044
    
    
    
    2.85
    
    
    4.3 years
    
    
    559,044
    
    
    
    2.85$3.26  $4.51
    
    
    13,091
    
    
    
    4.28
    
    
    5.5 years
    
    
    13,091
    
    
    
    4.28$4.52  $7.59
    
    
    7,718
    
    
    
    6.99
    
    
    6.8 years
    
    
    7,718
    
    
    
    7.00$7.60  $8.79
    
    
    215,345
    
    
    
    7.81
    
    
    6.6 years
    
    
    175,655
    
    
    
    7.77$8.80  $10.84
    
    
    599,567
    
    
    
    9.83
    
    
    8.0 years
    
    
    581,593
    
    
    
    9.81$10.85  $12.95
    
    
    450,189
    
    
    
    12.01
    
    
    8.1 years
    
    
    236,876
    
    
    
    12.14$12.96  $14.25
    
    
    8,488
    
    
    
    13.46
    
    
    8.1 years
    
    
    8,024
    
    
    
    13.36$0.00  $14.25
    
    
    1,891,915
    
    
    $
    7.83
    
    
    6.6 years
    
    
    1,620,474
    
    
    $
    7.27
 1997 Plan 
  Page 16 of 33




---



##### Table of Contents



Shares
    
    
    Weighted Average
    
    
    Weighted Average
    
    
    Aggregate IntrinsicSubject to
    
    
    Exercise Price
    
    
    Remaining
    
    
    ValueOptions
    
    
    per Share
    
    
    Contractual Life
    
    
    (in thousands)Outstanding, January 1, 2006
    
    
    1,274,748
    
    
    $
    25.04
    
    
    6.8 yearsCancelled
    
    
    (18,350
    )
    
    
    23.35
    
    
    7.5 yearsOutstanding, March 31, 2006
    
    
    1,256,398
    
    
    
    25.07
    
    
    6.6 years
    
    
    $
    6Cancelled
    
    
    (6,750
    )
    
    
    26.29
    
    
    7.7 yearsOutstanding, June 30, 2006
    
    
    1,249,648
    
    
    
    25.06
    
    
    6.3 years
    
    
    
    Cancelled
    
    
    (92,339
    )
    
    
    22.86
    
    
    7.5 yearsOutstanding and exercisable, September 30, 2006
    
    
    1,157,309
    
    
    $
    25.21
    
    
    6.0 years
    
    
    $
    
  Weighted-
    
    
    AverageAverage
    
    
    RemainingNumber of
    
    
    Exercise
    
    
    ContractualRange of Exercise Prices
    
    Options
    
    
    Price
    
    
    Life$9.05
    
    
    60,000
    
    
    $
    9.05
    
    
    9.1 years$10.20  $11.10
    
    
    16,825
    
    
    
    10.84
    
    
    8.6 years$16.00  $17.50
    
    
    122,475
    
    
    
    17.36
    
    
    6.1 years$19.30  $20.60
    
    
    555,375
    
    
    
    20.29
    
    
    5.4 years$21.20  $22.40
    
    
    16,464
    
    
    
    22.07
    
    
    7.0 years$24.00  $24.60
    
    
    59,595
    
    
    
    24.19
    
    
    5.9 years$26.00  $26.00
    
    
    32,000
    
    
    
    26.00
    
    
    6.7 years$35.20  $36.50
    
    
    25,340
    
    
    
    35.21
    
    
    7.1 years$38.30  $41.50
    
    
    207,842
    
    
    
    39.99
    
    
    6.4 years$45.30  $50.70
    
    
    29,500
    
    
    
    46.05
    
    
    6.4 years$54.40  $60.00
    
    
    31,893
    
    
    
    58.37
    
    
    3.9 years$9.05  $60.00
    
    
    1,157,309
    
    
    $
    25.21
    
    
    6.0 years
 Non-vested Stock Awards 
   Page 17 of 33




---



##### Table of Contents



Weighted AverageShares
    
    
    Grant-Date Fair ValueNon-vested balance, January 1, 2006
    
    
    104,350
    
    
    $
    9.38Granted
    
    
    3,700
    
    
    
    10.12Non-vested balance, March 31, 2006
    
    
    108,050
    
    
    
    9.41Granted
    
    
    1,450
    
    
    
    9.62Vested
    
    
    (1,450
    )
    
    
    9.62Cancelled
    
    
    (9,300
    )
    
    
    9.40Non-vested balance, June 30, 2006
    
    
    98,750
    
    
    
    9.41Granted
    
    
    88,900
    
    
    
    8.14Cancelled
    
    
    (4,350
    )
    
    
    9.18Non-vested balance, September 30, 2006
    
    
    183,300
    
    
    $
    8.80
 Employee Stock Purchase Plan 
  9. Comprehensive Income
  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,(in thousands)
    
    2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)
    
    $
    (298
    )
    
    $
    (569
    )
    
    $
    84
    
    
    $
    1,289Other comprehensive income
(loss), net of related tax
effects of $1, $0, $5 and $13
respectively
    
    
    (2
    )
    
    
    
    
    
    
    (9
    )
    
    
    (22
    )Total comprehensive income (loss)
    
    $
    (300
    )
    
    $
    (569
    )
    
    $
    75
    
    
    $
    1,267
 10. Commitments and Contingencies
   Page 18 of 33




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 This Quarterly Report on Form 10-Q contains forward-looking statements relating to Cardiac
Science Corporation. Except for historical information, the following discussion contains
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of
1995. All statements other than statements of historical fact, including future results of
operations or financial position, made in this Quarterly Report on Form 10-Q are forward looking.
The words believe, expect, intend, anticipate, will, may, variations of such words, and
similar expressions identify forward-looking statements, but their absence does not mean that the
statement is not forward-looking. These forward-looking statements reflect managements current
expectations and involve risks and uncertainties. Our actual results could differ materially from
results that may be anticipated by such forward-looking statements due to uncertainties, including
the risk that:
 
    
    The unpredictability of our quarterly revenue and operating results may cause
volatility in the trading price of our common stock;
    
    We may fail to successfully develop and commercialize new versions of our products or
maintain our relationships with our distributors, strategic partners or suppliers;
 Page 19 of 33




---



##### Table of Contents




    
    Our products face intense competition, which may result in pricing pressure that
could negatively impact our revenue;
    
    We may fail to maintain or obtain regulatory clearances or approvals for our products;
    
    We face potential liability claims related to infringement of intellectual property rights and product warranties;
    
    Application of accounting rules related to stock option expensing, utilization of
deferred tax assets, asset impairment and purchase accounting could cause fluctuations
in our operating results and affect our reported results of operations; and
 The principal factors that could cause or contribute to such differences include, but are not
limited to, those listed above and the other factors discussed in the section entitled Risk
Factors in Part 1  Item 1A of our Annual Report on Form 10-K for the year ended December 31,
2005 and those discussed elsewhere in this report. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date of this report. We
undertake no obligation to revise any forward-looking statements to reflect events or circumstances
that may subsequently arise. Readers are urged to review and consider carefully the various
disclosures made in this report and in our other filings made with the SEC that attempt to advise
interested parties of the risks and factors that may affect our business, prospects and results of
operations.
  Business Overview
     Page 20 of 33




---



##### Table of Contents



Critical Accounting Estimates and Policies
  Critical Accounting Estimates
 and
 Stock-based Compensation
  Purchase Price Allocations
   Accounts Receivable
  Inventories
  Goodwill
  Page 21 of 33




---



##### Table of Contents



Intangible Assets
    Valuation of Long-Lived Assets
  Warranty
  Page 22 of 33




---



##### Table of Contents



Deferred Tax Assets and Income Taxes
  Litigation and Other Contingencies
  Restructuring Costs
  Software Revenue Recognition
  Sales Returns
  Critical Accounting Policies
 Segment Reporting
  Revenue Recognition
  Page 23 of 33




---



##### Table of Contents



Accounting for Stock-Based Compensation
   Page 24 of 33




---



##### Table of Contents



Results of Operations
 Overview of Results for the Three and Nine Months Ended September 30, 2006
 
    
    Revenue of $38.1 million for the three months ended September 30, 2006 and $116.5
million for the nine months then ended increased by 39% and 65%, respectively, over the
reported amounts for the comparable periods in the prior year.
    
    Gross margin improved to approximately 47% for both the three and nine month periods
ended September 30, 2006 from approximately 45% for both of the comparable respective
periods in the prior year.
    
    In the three and nine months ended September 30, 2006, the Company generated cash from
operations of $2.0 million and $8.7 million, respectively.
 Looking Forward
    Revenues
  Page 25 of 33




---



##### Table of Contents



Three months ended
    
    
    
    
    
    
    Three months ended
    
    
    Nine months ended
    
    
    
    
    
    
    Nine months endedSeptember 30,
    
    
    % Change
    
    
    September 30,
    
    
    September 30,
    
    
    % Change
    
    
    September 30,(dollars in thousands)
    
    2006
    
    
    2005 to 2006
    
    
    2005
    
    
    2006
    
    
    2005 to 2006
    
    
    2005Cardiac monitoring products
    
    $
    16,697
    
    
    
    (10.2
    %)
    
    $
    18,597
    
    
    $
    54,230
    
    
    
    (2.3
    %)
    
    $
    55,487% of revenue
    
    
    43.8
    %
    
    
    
    
    
    
    67.8
    %
    
    
    46.6
    %
    
    
    
    
    
    
    78.5
    %Defibrillation products
    
    
    17,193
    
    
    
    216.3
    %
    
    
    5,436
    
    
    
    49,236
    
    
    
    725.7
    %
    
    
    5,963% of revenue
    
    
    45.1
    %
    
    
    
    
    
    
    19.8
    %
    
    
    42.3
    %
    
    
    
    
    
    
    8.4
    %Service
    
    
    4,226
    
    
    
    23.8
    %
    
    
    3,413
    
    
    
    12,986
    
    
    
    39.7
    %
    
    
    9,294% of revenue
    
    
    11.1
    %
    
    
    
    
    
    
    12.4
    %
    
    
    11.2
    %
    
    
    
    
    
    
    13.1
    %Total revenues
    
    $
    38,116
    
    
    
    38.9
    %
    
    $
    27,446
    
    
    $
    116,452
    
    
    
    64.6
    %
    
    $
    70,744
 Three Months Ended September 30, 2006 Compared to the Three Months Ended September 30,
2005
    Nine Months Ended September 30, 2006 Compared to the Nine Months Ended September 30, 2005
    Gross Profit
  Page 26 of 33




---



##### Table of Contents



Three months ended
    
    
    
    
    
    
    Three months ended
    
    
    Nine months ended
    
    
    
    
    
    
    Nine months endedSeptember 30,
    
    
    % Change
    
    
    September 30,
    
    
    September 30,
    
    
    % Change
    
    
    September 30,(dollars in thousands)
    
    2006
    
    
    2005 to 2006
    
    
    2005
    
    
    2006
    
    
    2005 to 2006

    
    
    2005Products
    
    $
    16,980
    
    
    
    54.3
    %
    
    $
    11,004
    
    
    $
    51,365
    
    
    
    80.0
    %
    
    $
    28,541% of products revenue
    
    
    50.1
    %
    
    
    
    
    
    
    45.8
    %
    
    
    49.6
    %
    
    
    
    
    
    
    46.4
    %Service
    
    
    1,088
    
    
    
    (14.6
    %)
    
    
    1,274
    
    
    
    3,686
    
    
    
    9.1
    %
    
    
    3,378% of service revenue
    
    
    25.7
    %
    
    
    
    
    
    
    37.3
    %
    
    
    28.4
    %
    
    
    
    
    
    
    36.3
    %Total gross profit
    
    $
    18,068
    
    
    
    47.2
    %
    
    $
    12,278
    
    
    $
    55,051
    
    
    
    72.5
    %
    
    $
    31,919% of total revenue
    
    
    47.4
    %
    
    
    
    
    
    
    44.7
    %
    
    
    47.3
    %
    
    
    
    
    
    
    45.1
    %
 Three Months Ended September 30, 2006 Compared to the Three Months Ended September 30,
2005
   Nine Months Ended September 30, 2006 Compared to the Nine Months Ended September 30, 2005
   Operating Expenses
     Page 27 of 33




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##### Table of Contents



Three months
    
    
    
    
    
    
    Three months
    
    
    Nine months
    
    
    
    
    
    
    Nine monthsended
    
    
    
    
    
    
    ended
    
    
    ended
    
    
    
    
    
    
    endedSeptember
    
    
    % Change
    
    
    September
    
    
    September
    
    
    % Change
    
    
    September(dollars in thousands)
    
    30, 2006
    
    
    2005 to 2006
    
    
    30, 2005
    
    
    30, 2006
    
    
    2005 to 2006
    
    
    30, 2005Research and development (including
stock based compensation expense of
$84 and $250 in 2006)
    
    $
    2,792
    
    
    
    23.4
    %
    
    $
    2,262
    
    
    $
    8,637
    
    
    
    44.5
    %
    
    $
    5,979% of total revenue
    
    
    7.3
    %
    
    
    
    
    
    
    8.2
    %
    
    
    7.4
    %
    
    
    
    
    
    
    8.5
    %Sales and marketing (including
stock based compensation expense of
$183 and $555 in 2006)
    
    
    10,045
    
    
    
    52.2
    %
    
    
    6,601
    
    
    
    29,342
    
    
    
    85.1
    %
    
    
    15,850% of total revenue
    
    
    26.4
    %
    
    
    
    
    
    
    24.1
    %
    
    
    25.2
    %
    
    
    
    
    
    
    22.4
    %General and administrative
(including stock based compensation
expense of $164, $0, $495 and $39)
    
    
    5,863
    
    
    
    24.8
    %
    
    
    4,697
    
    
    
    17,590
    
    
    
    95.3
    %
    
    
    9,008% of total revenue
    
    
    15.4
    %
    
    
    
    
    
    
    17.1
    %
    
    
    15.1
    %
    
    
    
    
    
    
    12.7
    %Total operating expenses
    
    $
    18,700
    
    
    
    37.9
    %
    
    $
    13,560
    
    
    $
    55,569
    
    
    
    80.2
    %
    
    $
    30,837% of total revenue
    
    
    49.1
    %
    
    
    
    
    
    
    49.4
    %
    
    
    47.7
    %
    
    
    
    
    
    
    43.6
    %
    Other Income and Expense
  Income Taxes
  Consolidation of Operations
  Page 28 of 33




---



##### Table of Contents



Liquidity and Capital Resources
  Three months
    
    
    
    
    
    
    Three months
    
    
    Nine months
    
    
    
    
    
    
    Nine monthsended
    
    
    
    
    
    
    ended
    
    
    ended
    
    
    
    
    
    
    endedSeptember
    
    
    % Change
    
    
    September
    
    
    September
    
    
    % Change
    
    
    September(dollars in thousands)
    
    30, 2006
    
    
    2005 to 2006
    
    
    30, 2005
    
    
    30, 2006
    
    
    2005 to 2006
    
    
    30, 2005Cash flow provided by (used in) operating activities
    
    $
    1,992
    
    
    
    338.6
    %
    
    $
    (835
    )
    
    $
    8,736
    
    
    
    466.5
    %
    
    $
    1,542Cash flow used in investing activities
    
    
    (215
    )
    
    
    98.6
    %
    
    
    (14,970
    )
    
    
    (2,225
    )
    
    
    (85.9
    %)
    
    
    (15,769
    )Cash flow provided by financing activities
    
    
    176
    
    
    
    87.2
    %
    
    
    94
    
    
    
    642
    
    
    
    44.6
    %
    
    
    444Total change in cash
    
    $
    1,953
    
    
    
    112.4
    %
    
    $
    (15,711
    )
    
    $
    7,153
    
    
    
    151.9
    %
    
    $
    (13,783
    )
     Page 29 of 33




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
   Page 30 of 33




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##### Table of Contents



PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
     
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
   For
    
    WithheldJeffrey F. ODonnell, Sr.
    
    
    20,844,846
    
    
    
    203,245
  Page 31 of 33




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##### Table of Contents



Item 5. Other Information
  
 Item 6. Exhibits
 Exhibits
    
    Description10.57*
    
    Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and John R. Hinson10.58*
    
    Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and Michael K. Matysik10.59*
    
    Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and Kurt B. Lemvigh10.60*
    
    Amended and Restated Employment Agreement dated as of September 20, 2006 between Cardiac Science Corporation and Darryl R. Lustig10.61*
    
    2006 Compensation Incentive Plan for Darryl R. Lustig31.1
    
    Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Incorporated by reference to the Registrants Current Report on Form 8-K (File No.
000-51512) filed on September 22, 2006. Page 32 of 33




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##### Table of Contents



SIGNATURE
  CARDIAC SCIENCE CORPORATIONBy:
    
    /s/ Michael K. Matysik

Michael K. MatysikSenior Vice President and Chief Financial Officer(Principal Financial and Accounting Officer)Date: November 9, 2006
 Page 33 of 33