Table of Contents

 

 

 

**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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| **(Mark One)**                                        | ** **                                                                                               |
|-------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                            | ** **                                                                                               |
| **x**                                                 | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
| ** **                                            | ** **                                                                                               |
| **for the quarterly period ended June 30, 2008** |
| ** **                                            | ** **                                                                                               |
| **OR**                                                |
| ** **                                            | ** **                                                                                               |
| **o**                                                 | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition period from                to               **

 

**Commission File Number 001-33993**

 

**CardioNet, Inc.**

(Exact name of Registrant as specified in its Charter)

 

| **Delaware**                                                   | ** ** | **33-0604557**                          |
|----------------------------------------------------------------|------------|-----------------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer Identification Number) |

 

**1010 Second AvenueSan Diego, California 92101**(Address of Principal Executive Offices, including Zip Code)

 

**(619) 243-7500**(Registrant’s Telephone Number, Including Area Code)

 

**N/A**(Former name, former address and former fiscal year if changed sincelast report)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90days.    Yes  o  No  x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer x                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicateby check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Securities Exchange Act of 1934). Yes  o  No  x

 

Asof August 11, 2008, 23,136,415 shares of the registrant’s common stock,$0.001 par value per share, were outstanding.

 

 

 

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Table ofContents

 

**CARDIONET, INC.QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2008TABLE OF CONTENTS**

 
| ** **        | ** **                                                                                  | **P****age  No.** |
|-------------------|---------------------------------------------------------------------------------------------|-------------------|
| **PART I.**  | **FINANCIAL INFORMATION**                                                                   |              |
| Item 1.           | Financial  Statements                                                                       | 3                 |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 11                |
| Item 3.           | Quantitative  and Qualitative Disclosures about Market Risk                                 | 17                |
| Item 4T.          | Controls and  Procedures                                                                    | 18                |
|              |                                                                                        |              |
| **PART II.** | **OTHER INFORMATION**                                                                       |              |
| Item 1.           | Legal Proceedings                                                                           | 18                |
| Item 1A.          | Risk Factors                                                                                | 18                |
| Item 2.           | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 30                |
| Item  6.          | Exhibits                                                                                    | 31                |
|              |                                                                                        |              |
| SIGNATURES        | 32                                                                                          |

 

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Table of Contents

 

**PART I — FINANCIAL INFORMATION**

**Item 1. Financial Statements.**

 

**CARDIONET, INC. CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                                                                               | ** ** | **June 30, 2008**                                                          | ** ** | ** **                      | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                               | ** ** | **(Unaudited)**                                                                      | ** ** | **December 31, 2007** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                               | ** ** | **(In thousands except share and  per share amounts)** | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                                               |       |                                                                                 |       |                            |       |
| Current assets:                                                                                                                                                                                                                                                                                                          |       |                                                                                 |       |                            |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                |       | $                                                                                    | 54,572     |                            | $          | 18,091 |   |
| Accounts receivable, net of allowance for doubtful accounts of  $12,935, and $7,909 at June 30, 2008 and December 31, 2007,  respectively                                                                                                                                                                      |       | 29,203                                                                               |       | 22,854                          |       |
| Due from related parties                                                                                                                                                                                                                                                                                                 |       | 98                                                                                   |       | 143                             |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                |       | 1,850                                                                                |       | 287                             |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Total current assets                                                                                                                                                                                                                                                                                                     |       | 85,723                                                                               |       | 41,375                          |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Property and equipment, net                                                                                                                                                                                                                                                                                              |       | 15,412                                                                               |       | 15,094                          |       |
| Intangible assets, net                                                                                                                                                                                                                                                                                                   |       | 2,315                                                                                |       | 2,807                           |       |
| Goodwill                                                                                                                                                                                                                                                                                                                 |       | 45,999                                                                               |       | 41,163                          |       |
| Other assets                                                                                                                                                                                                                                                                                                             |       | 3,394                                                                                |       | 2,601                           |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Total assets                                                                                                                                                                                                                                                                                                             |       | $                                                                                    | 152,843    |                            | $          | 103,040 |   |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| **Liabilities and shareholders’ equity (deficit)**                                                                                                                                                                                                                                                                  |       |                                                                                 |       |                            |       |
| Current liabilities:                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Accounts payable                                                                                                                                                                                                                                                                                                         |       | $                                                                                    | 1,829      |                            | $          | 3,972 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                                      |       | 11,930                                                                               |       | 6,425                           |       |
| Current portion of debt                                                                                                                                                                                                                                                                                                  |       | 321                                                                                  |       | 1,088                           |       |
| Current portion of capital leases                                                                                                                                                                                                                                                                                        |       | 49                                                                                   |       | 49                              |       |
| Deferred revenue                                                                                                                                                                                                                                                                                                         |       | 563                                                                                  |       | 466                             |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Total current liabilities                                                                                                                                                                                                                                                                                                |       | 14,692                                                                               |       | 12,000                          |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Long-term debt, net of current portion                                                                                                                                                                                                                                                                                   |       | 25                                                                                   |       | 1,655                           |       |
| Deferred rent                                                                                                                                                                                                                                                                                                            |       | 818                                                                                  |       | 879                             |       |
| Other noncurrent liabilities                                                                                                                                                                                                                                                                                             |       | 53                                                                                   |       | 69                              |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Total liabilities                                                                                                                                                                                                                                                                                                        |       | 15,588                                                                               |       | 14,603                          |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| **Redeemable convertible preferred stock**                                                                                                                                                                                                                                                                               |       |                                                                                 |       |                            |       |
| Mandatorily redeemable convertible preferred stock — 0 and  114,883 shares authorized , 0 and 114,839 issued and outstanding at  June 30, 2008 and December 31, 2007, respectively                                                                                                                   |       | —                                                                               |       | 115,302                         |       |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| **Shareholders’ equity (deficit)**                                                                                                                                                                                                                                                                                  |       |                                                                                 |       |                            |       |
| Series A — 0 and 1,563,248 shares authorized, issued and  outstanding at June 30, 2008 and December 31, 2007, respectively                                                                                                                                                                           |       | —                                                                               |       | 391                             |       |
| Series B — 0 and 4,720,347 shares authorized, issued and  outstanding at June 30, 2008 and December 31, 2007, respectively                                                                                                                                                                           |       | —                                                                               |       | 6,904                           |       |
| Series C — 0 and 10,399,011 shares authorized, issued and  outstanding at June 30, 2008 and December 31, 2007, respectively                                                                                                                                                                          |       | —                                                                               |       | 36,196                          |       |
| Series D — 0 and 1,000,000 shares authorized, issued and  outstanding at June 30, 2008 and December 31, 2007, respectively                                                                                                                                                                           |       | —                                                                               |       | 9,965                           |       |
| Preferred stock, $.001 par value and no par value at June 30,  2008 and December 31, 2007, respectively; 10,000,000 and 0 shares  authorized at June 30, 3008 and December 31, 2007, respectively, 0  shares issued and outstanding at June 30, 2008, and December 31,  2007, respectively |       | —                                                                               |       | —                          |       |
| Common stock, $.001 par value and no par value at June 30, 2008  and December 31, 2007, respectively; 200,000,000 and 50,000,000 shares  authorized, 23,065,240 and 3,130,054 shares issued, outstanding and vested at  June 30, 2008, and December 31, 2007, respectively                           |       | 23                                                                                   |       | 1,399                           |       |
| Paid-in capital                                                                                                                                                                                                                                                                                                          |       | 217,660                                                                              |       | —                          |       |
| Accumulated deficit                                                                                                                                                                                                                                                                                                      |       | (80,428                                                                              | )          | (81,720                         | )          |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Total shareholders’ equity (deficit)                                                                                                                                                                                                                                                                                |       | 137,255                                                                              |       | (26,865                         | )          |
|                                                                                                                                                                                                                                                                                                                     |       |                                                                                 |       |                            |       |
| Total liabilities and shareholders’ equity (deficit)                                                                                                                                                                                                                                                                |       | $                                                                                    | 152,843    |                            | $          | 103,040 |   |

 

See accompanying notes.

 

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**CARDIONET, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                                                        | ** ** | **Three Months Ended**                                 | ** ** | **Six Months Ended**                                   | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **June 30, 2008**                                      | ** ** | **June 30, 2007**                                      | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
| ** **                                                                        | ** ** | **(In thousands except per share  amounts)** | ** ** | **(In thousands except per share  amounts)** | ** ** |
| Revenues:                                                                         |       |                                                             |       |                                                             |       |   |   |   |   |
| Net patient service revenues                                                      |       | $                                                                | 29,189     |                                                             | $          | 17,263 |   | $ | 54,437 |   | $ | 28,220 |   |
| Other revenues                                                                    |       | 151                                                              |       | 156                                                              |       | 366 |   | 299 |   |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Total revenues                                                                    |       | 29,340                                                           |       | 17,419                                                           |       | 54,803 |   | 28,519 |   |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Cost of revenues                                                                  |       | 9,834                                                            |       | 5,953                                                            |       | 19,353 |   | 9,743 |   |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Gross profit                                                                      |       | 19,506                                                           |       | 11,466                                                           |       | 35,450 |   | 18,776 |   |
| Operating expenses:                                                               |       |                                                             |       |                                                             |       |   |   |   |   |
| Research and development                                                          |       | 931                                                              |       | 1,019                                                            |       | 2,073 |   | 2,010 |   |
| General and administrative                                                        |       | 10,016                                                           |       | 7,080                                                            |       | 19,081 |   | 12,281 |   |
| Sales and marketing                                                               |       | 5,412                                                            |       | 4,377                                                            |       | 10,527 |   | 7,696 |   |
| Integration, restructuring and other nonrecurring charges                         |       | 610                                                              |       | —                                                           |       | 1,916 |   | — |   |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Total expenses                                                                    |       | 16,969                                                           |       | 12,476                                                           |       | 33,597 |   | 21,987 |   |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Income (loss) from operations                                                     |       | 2,537                                                            |       | (1,010                                                           | )          | 1,853 |   | (3,211 | ) |
| Other income (expense):                                                           |       |                                                             |       |                                                             |       |   |   |   |   |
| Interest income                                                                   |       | 353                                                              |       | 681                                                              |       | 531 |   | 904 |   |
| Interest expense                                                                  |       | (86                                                              | )          | (775                                                             | )          | (152 | ) | (1,951 | ) |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Total other income (expense)                                                      |       | 267                                                              |       | (94                                                              | )          | 379 |   | (1,047 | ) |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Income (loss) before income taxes                                                 |       | 2,804                                                            |       | (1,104                                                           | )          | 2,232 |   | (4,258 | ) |
| Income tax (expense) benefit                                                      |       | (1,172                                                           | )          | —                                                           |       | (940 | ) | — |   |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Net income (loss)                                                                 |       | 1,632                                                            |       | (1,104                                                           | )          | 1,292 |   | (4,258 | ) |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Dividends on and accretion of mandatorily redeemable convertible  preferred stock |       | —                                                           |       | (2,362                                                           | )          | (2,597 | ) | (2,845 | ) |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Net income (loss) attributable to common stockholders                             |       | $                                                                | 1,632      |                                                             | $          | (3,466 | ) | $ | (1,305 | ) | $ | (7,103 | ) |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Net income (loss) per common share:                                               |       |                                                             |       |                                                             |       |   |   |   |   |
| Basic                                                                             |       | $                                                                | 0.07       |                                                             | $          | (1.13 | ) | $ | (0.10 | ) | $ | (2.35 | ) |
| Diluted                                                                           |       | $                                                                | 0.07       |                                                             | $          | (1.13 | ) | $ | (0.10 | ) | $ | (2.35 | ) |
|                                                                              |       |                                                             |       |                                                             |       |   |   |   |   |
| Weighted average number of common shares outstanding:                             |       |                                                             |       |                                                             |       |   |   |   |   |
| Basic                                                                             |       | 23,098                                                           |       | 3,054                                                            |       | 13,368 |   | 3,024 |   |
| Diluted                                                                           |       | 24,191                                                           |       | 3,054                                                            |       | 13,368 |   | 3,024 |   |

 

See accompanying notes.

 

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**CARDIONET, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                                                | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                | ** ** | **June 30, 2008**    | ** ** | **June 30, 2007** | ** ** |
| **Operating activities**                                                                                  |       |                           |       |   |   |
| Net income (loss)                                                                                         |       | $                              | 1,292      |   | $ | (4,258 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities:                 |       |                           |       |   |   |
| Depreciation                                                                                              |       | 3,346                          |       | 1,267 |   |
| Amortization of intangibles                                                                               |       | 492                            |       | 307 |   |
| Loss on disposal of property and equipment                                                                |       | 116                            |       | 21 |   |
| (Decrease) increase in deferred rent                                                                      |       | (61                            | )          | 210 |   |
| Provision for doubtful accounts                                                                           |       | 5,089                          |       | 3,762 |   |
| Common stock and stock options issued for services                                                        |       | —                         |       | 123 |   |
| Amortization of debt discount, including recognition of contingent  beneficial conversion                 |       | —                         |       | 638 |   |
| Stock-based compensation                                                                                  |       | 751                            |       | 201 |   |
| Changes in operating assets and liabilities:                                                              |       |                           |       |   |   |
| Accounts receivable                                                                                       |       | (11,581                        | )          | (4,864 | ) |
| Due from related parties                                                                                  |       | 45                             |       | (17 | ) |
| Prepaid expenses and other current assets                                                                 |       | (1,419                         | )          | (102 | ) |
| Other assets                                                                                              |       | (793                           | )          | 328 |   |
| Accounts payable                                                                                          |       | (2,143                         | )          | 720 |   |
| Accrued liabilities                                                                                       |       | 5,815                          |       | 2,973 |   |
| Other noncurrent liabilities                                                                              |       | —                         |       | (90 | ) |
|                                                                                                      |       |                           |       |   |   |
| Net cash provided by operating activities                                                                 |       | 949                            |       | 1,219 |   |
|                                                                                                      |       |                           |       |   |   |
| **Investing activities**                                                                                  |       |                           |       |   |   |
| Purchases of property and equipment                                                                       |       | (3,779                         | )          | (4,611 | ) |
| Investment in subsidiary, net of cash acquired                                                            |       | (5,002                         | )          | (46,886 | ) |
|                                                                                                      |       |                           |       |   |   |
| Net cash used in investing activities                                                                     |       | (8,781                         | )          | (51,497 | ) |
|                                                                                                      |       |                           |       |   |   |
| **Financing activities**                                                                                  |       |                           |       |   |   |
| Net proceeds from issuance of mandatorily redeemable convertible  preferred stock                         |       | —                         |       | 102,119 |   |
| Proceeds from issuance of common stock                                                                    |       | 46,728                         |       | 42 |   |
| Proceeds from issuance of debt                                                                            |       | 500                            |       | 373 |   |
| Repayment of debt                                                                                         |       | (2,915                         | )          | (5,831 | ) |
|                                                                                                      |       |                           |       |   |   |
| Net cash provided by financing activities                                                                 |       | 44,313                         |       | 96,703 |   |
|                                                                                                      |       |                           |       |   |   |
| Net increase in cash and cash equivalents                                                                 |       | 36,481                         |       | 46,425 |   |
| Cash and cash equivalents — beginning of period                                                      |       | 18,091                         |       | 3,909 |   |
|                                                                                                      |       |                           |       |   |   |
| Cash and cash equivalents — end of period                                                            |       | $                              | 54,572     |   | $ | 50,334 |   |
|                                                                                                      |       |                           |       |   |   |
| **Supplemental disclosure of cash flow information**                                                      |       |                           |       |   |   |
| Cash paid for interest                                                                                    |       | $                              | 368        |   | $ | 2,256 |   |
|                                                                                                      |       |                           |       |   |   |   |   |
| **Supplemental disclosure of non-cash financing  activities**                                             |       |                           |       |   |   |
| Exercise of stock options under note receivable arrangements                                              |       | $                              | —     |   | $ | 277 |   |
| Mandatorily redeemable convertible preferred stock issued in  connection with bridge loan                 |       | $                              | —     |   | $ | 3,303 |   |
| Mandatorily redeemable convertible preferred stock issued in  consideration for PDSHeart, Inc acquisition |       | $                              | —     |   | $ | 1,456 |   |

 

See accompanying notes.

 

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** **

**CARDIONET, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**1.     Business**

 

CardioNet, Inc.(the Company), a Delaware corporation, provides ambulatory, continuous,real-time outpatient management solutions for monitoring relevant and timelyclinical information regarding an individual’s health. The Company incorporatedin the state of California in March 1994, but did not actively begindeveloping its product platform until April 2000. The Company spent sevenyears developing a proprietary integrated patient management platform thatincorporates a wireless data transmission network, internally developedsoftware, FDA-cleared algorithms and medical devices and a 24-hour digitalmonitoring service center. The initial focus of the Company is on the diagnosisand monitoring of cardiac arrhythmias, or heart rhythm disorders, with asolution that is marketed as the CardioNet System. In September 1999, theCompany was capitalized as CardioNet, a company focused on helping physiciansmore rapidly diagnose and more effectively manage therapy for patients withcardiovascular disease. In February 2002, the Company received FDA 510(k) clearancefor the first and second generation of its core CardioNet System whichautomatically detects cardiac rhythm problems and transmits ECG data to a24/7/365 monitoring center which was opened in Conshohocken, Pennsylvania in July 2002.The CardioNet Monitoring Center provides analysis and response for all incomingECG data. Currently, the Company provides all arrhythmia monitoring servicesfor the CardioNet System at this location. The Company receives reimbursementfor services provided to patients from Medicare and other third-party payors.

 

On March 8,2007, the Company acquired PDSHeart, Inc. (“PDSHeart”), a leading cardiacmonitoring company, for an aggregate of $51.6 million plus the assumptionof $5.2 million in debt.  Inaddition to the $51.6 million consideration, the Company agreed to payPDSHeart shareholders $5.0 million of contingent consideration in theevent of a qualifying liquidation event, including a public offering oracquisition. The Company’s initial public offering was consummated on March 25,2008 and, accordingly, the purchase price for the PDSHeart acquisition has beenadjusted to $56.6 million to reflect this payment. PDSHeart, now a wholly-ownedsubsidiary of CardioNet, provides event monitoring, Holter monitoring andpacemaker monitoring services in 48 states, primarily in the southeast. Theacquisition has broadened the Company’s geographic coverage and expanded theservice offering to include the complete range of cardiac monitoring services.

 

On February 25,2008, the Board of Directors of the Company, subject to stockholder approval,approved a reverse stock split of the Company’s common stock at a ratio of oneshare for every two shares previously held. On March 5, 2008, thestockholders of the Company approved the reverse stock split and the reversestock split became effective. All common stock share and per-share dataincluded in these consolidated financial statements reflect the reverse stocksplit.

 

On March 25,2008, the Company completed its initial public offering generating net proceedsto the Company of approximately $46.7 million, after deducting underwritercommissions and estimated offering expenses. The underwriters of the offering were Citigroup Global Markets Inc.,Lehman Brothers Inc., Leerink Swann LLC and Thomas Weisel Partners LLC.  Upon the closing of the Company’s initialpublic offering, all outstanding shares of the Company’s mandatorily redeemableconvertible preferred stock and convertible preferred stock converted intoshares of common stock.  Therefore, at June 30,2008, the Company had no shares of preferred stock outstanding.

 

OnAugust 6, 2008,an underwritten secondary public offering of shares of common stock held bycertain of the Company’s existing stockholders was completed.  The Company did not issue any shares andreceived no proceeds in connection with such offering.  The Company incurred approximately $0.7million in offering expenses on behalf of the selling stockholders.  The underwriters of the offering wereCitigroup Global Markets Inc., Banc of America Securities LLC, Leerink SwannLLC, Cowen and Company, LLC and Thomas Weisel Partners LLC.

 

**2.     Summary of Significant Accounting Policies**

 

**Unaudited Interim Financial Data**

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with U.S. generally accepted accounting principles for interimfinancial information and the requirements of Form 10-Q and Article 10of Regulation S-X. Accordingly, these consolidated financial statements do notinclude all of the information and footnotes required by U.S. generallyaccepted accounting principles.  In theopinion of management, these consolidated financial statements reflect alladjustments, which are of normal recurring nature and necessary for a fairpresentation of the Company’s financial position as of June 30, 2008 and December 31,2007, the results of operations for the three and six months ended June 30,2008 and 2007 and cash flows for the six months ended June 30, 2008 and2007. The financial data and other information disclosed in these notes to thefinancial statements related to the three month and six month periods areunaudited. The results for the three month and six month periods ended June 30,2008 are not necessarily indicative of the results to be expected for anyfuture period.

 

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**Net Income (Loss) Attributable to Common Shares**

 

TheCompany computes net income (loss) per share in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 128, *Earnings Per Share* (SFAS No. 128).Under SFAS No. 128, basic net loss per share is computed by dividing netloss per share attributable to common stockholders by the weighted averagenumber of common shares outstanding for the period and excludes the effects ofany potentially dilutive securities. Diluted earnings per share, if presented,would include the dilution that would occur upon the exercise or conversion ofall potentially dilutive securities into common stock using the “treasury stock”and/or “if converted” methods, as applicable.

 

Thefollowing summarizes the potential outstanding common stock of the Company at June 30,2008 and June 30, 2007.  Theconvertible preferred stock, the mandatorily redeemable convertible preferredstock and the Series D-1 warrants were converted into shares of theCompany’s common stock immediately prior to the consummation of the Company’sinitial public offering on March 25, 2008. All share amounts have been adjusted for the one-for-two reverse stocksplit effected by the Company on March 5, 2008:

 
| ** **                                          | ** ** | **June 30, 2008** | ** ** | **June 30, 2007** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Convertible preferred stock (A,B,C,D)               |       | —                      |       | 8,835,042                   |       |
| Mandatorily redeemable convertible preferred stock  |       | —                      |       | 4,784,958                   |       |
| Series B warrants                              |       | 6,250                       |       | 6,250                       |       |
| Series D-1 warrants                            |       | —                      |       | 482,090                     |       |
| Common stock options outstanding                    |       | 1,592,744                   |       | 960,895                     |       |
| Common stock options available for grant            |       | 579,460                     |       | 332,563                     |       |
| Common stock held by certain employees and unvested |       | 65,572                      |       | —                      |       |
| Common stock                                        |       | 23,130,812                  |       | 3,196,102                   |       |
|                                                |       |                        |       |                        |       |
| Total                                               |       | 25,374,838                  |       | 18,597,900                  |       |

 

If theoutstanding options, warrants and preferred stock were exercised or convertedinto common stock, the result would be anti-dilutive for the six months ended June 30,2008 and June 30, 2007 and the three months ended June 30, 2007.Accordingly, basic and diluted net loss attributable to common stockholders pershare are identical for those periods presented in the consolidated statementsof operations.

 

**Stock-Based Compensation**

 

SFAS No. 123(R),*Share-Based Payment*, addressesthe accounting for share-based payment transactions in which an enterprisereceives employee services in exchange for (a) equity instruments of theenterprise or (b) liabilities that are based on the fair value of theenterprise’s equity instruments or that may be settled by the issuance of suchequity instruments. SFAS No. 123(R) requires that an entity measurethe cost of equity-based service awards based on the grant-date fair value ofthe award and recognize the cost of such awards over the period during whichthe employee is required to provide service in exchange for the award (thevesting period). SFAS No. 123(R) requires that an entity measure thecost of liability-based service awards based on current fair value that isre-measured subsequently at each reporting date through the settlement date.The Company accounts for equity awards issued to non-employees in accordancewith EITF 96-18, *Accounting for EquityInvestments that are Issued to Other Than Employees for Acquiring, or inConjunction with, Selling Goods or Services*.

 

Priorto 2006, the Company accounted for grants made under its stock option plan inaccordance with APB Opinion No. 25, *Accountingfor Stock Options Issued to Employees*, as permitted under SFAS No. 123.Under APB Opinion No. 25, the Company was only required to recognizecompensation expenses for options granted to employees for the differencebetween the fair value of the underlying common stock and the exercise price ofthe option at the date of grant. The fair value of these options was determinedusing the minimum value option pricing model. Since the exercise price of theCompany’s stock option grants issued prior to 2006 was equal to the estimatedfair value of the underlying stock on the grant date, no compensation expenserelated to options granted to employees was recognized in prior years.

 

TheCompany’s income before income taxes for the six months ended June 30,2008 and 2007 was $0.8 million and $0.2 million lower, respectively, and theCompany’s after-tax net income for the six months ended June 30, 2008 and2007 was $0.4 million and $0.2 million lower, respectively, as a result ofstock-based compensation expense incurred. The impact of stock-based compensationexpense was $(0.03) and $(0.07) on the basic or diluted earnings per share forthe six months ended June 30, 2008 and 2007, respectively.

 

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TheCompany utilized the Black-Scholes valuation model for estimating the fairvalue of the stock options granted after the adoption of SFAS 123R withthe following weighted average assumptions:

 
| ** **              | ** ** | **Six months ended  June 30, 2008** | ** ** | **Six months ended  June 30, 2007** | ** ** |
|-------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Expected dividend yield |       | 0                                                       | %          | 0                                                       | %          |
| Expected volatility     |       | 50                                                      | %          | 50                                                      | %          |
| Risk-free interest rate |       | 2.68                                                    | %          | 5.0                                                     | %          |
| Expected life           |       | 6.25  years                                             |       | 6.25  years                                             |       |

 

Thedividend yield of zero is based on the fact that the Company has never paidcash dividends and has no present intention to pay cash dividends. Since theCompany’s stock was not publicly traded prior to the closing of its initialpublic offering, the expected volatility was calculated for each date of grantbased on an alternative method. The Company identified similar public entitiesfor which share price information was available and considered the historicalvolatility of these entities’ share price in estimated expected volatility. Therisk-free interest rate is derived from the U.S. Federal Reserve rate in effectat the time of grant. The expected life calculation is based on the observedand expected time to the exercise of options by the Company’s employees basedon historical exercise patterns for similar options. Based on the Company’shistorical experience of options that cancel before becoming fully vested, theCompany has assumed an annualized forfeiture rate of 15% for all options. Underthe true-up provision of SFAS 123R, the Company will record additionalexpense if the actual forfeiture rate is lower than estimated, and will recorda recovery of prior expense if the actual forfeiture rate is higher thanestimated.

 

Basedon the above assumptions, the per share weighted average fair value of theoptions granted under the stock option plan for the six months ended June 30,2008 and 2007 was $8.63 and $3.54, respectively.

 

The following tablesummarizes activity under all stock award plans from December 31, 2007through June 30, 2008:

 
| ** **                            | ** ** | ** **         | ** ** | **Options Outstanding** | ** ** |
|---------------------------------------|------------|--------------------|------------|------------------------------|------------|
| ** **                            | ** ** | **Shares**         | ** ** | ** **                   | ** ** | **Weighted** | ** ** |
| ** **                            | ** ** | **Available**      | ** ** | **Number**                   | ** ** | **Average** | ** ** |
| ** **                            | ** ** | **for Grant** | ** ** | **of Shares**           | ** ** | **Exercise Price** | ** ** |
| Balance – December 31, 2007 |       | 617,534            |       | 1,641,616                    |       | $ | 6.38 |   |
| Granted                               |       | (307,875           | )          | 307,875                      |       | $ | 12.19 |   |
| Canceled                              |       | 223,404            |       | (223,404                     | )          | $ | 5.74 |   |
| Exercised                             |       | —             |       | (21,283                      | )          | $ | 1.26 |   |
|                                  |       |               |       |                         |       |   |   |
| Balance — March 31, 2008    |       | 533,063            |       | 1,704,804                    |       | $ | 7.58 |   |
| Granted                               |       | (10,450            | )          | 10,450                       |       | $ | 20.00 |   |
| Canceled                              |       | 56,847             |       | (56,847                      | )          | $ | 15.46 |   |
| Exercised                             |       | —             |       | (65,663                      | )          | $ | 2.21 |   |
|                                  |       |               |       |                         |       |   |   |
| Balance — June 30, 2008     |       | 579,460            |       | 1,592,744                    |       | $ | 7.60 |   |
|                                  |       |               |       |                         |       |   |   |

 

Additional informationregarding options outstanding is as follows:

 
| ** **                                          | ** ** | **June 30,  2008** | ** **     | **December 31,  2007** | ** ** |
|-----------------------------------------------------|------------|-------------------------|----------------|-----------------------------|------------|
| Range of exercise price (per option)                |       | $                       | 0.70  - $20.00 |                        | $          | 0.70  - $9.50 |   |
| Weighted average remaining contractual life (years) |       | 8.99                    |           | 9.28                        |       |
|                                                     |            |                         |                |                             |            |  |  |

 

**New Accounting Pronouncements**

 

In September 2006,the FASB issued SFAS No. 157, *FairValue Measurements*, which defines fair value, establishes aframework for measuring fair value under generally accepted accountingprinciples, and expands disclosures about fair value measurements. SFAS No. 157applies to other accounting pronouncements that require or permit fair valuemeasurements. The new guidance is effective for the Company beginning January 1,2008. The Company adopted SFAS No. 157 on January 1, 2008 and it didnot have a material effect on the consolidated financial statements.

 

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In February 2007,the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities-Including anAmendment of FASB Statement No. 115*. SFAS 159 permitsentities to choose fair value measurement for many financial instruments and certainother items as of specified election dates. Business entities will thereafterreport in earnings the unrealized gains and losses on items for which the fairvalue option has been chosen. The fair value option may be applied instrumentby instrument but may not be applied to portions of instruments and isirrevocable unless a new elections date occurs. The Company did not elect thefair value option of SFAS 159 and thus, the adoption of SFAS No. 159had no impact on the Company.

 

In December 2007,the FASB issued SFAS No. 141(R), *BusinessCombinations* and SFAS No. 160, *NoncontrollingInterests in Consolidated Financial Statements, an Amendment of ARB No. 151*.SFAS 141(R) establishes new principles and requirements foraccounting for business combinations, including recognition and measurement ofidentifiable assets acquired, goodwill acquired, liabilities assumed andnoncontrolling financial interests. SFAS 160 requires all entities toreport noncontrolling (minority) interests in subsidiaries as equity in theconsolidated financial statements. These new standards will significantlychange the accounting for and reporting of business combination transactionsand noncontrolling (minority) interests in consolidated financial statements.SFAS 141(R) and SFAS 160 are required to be adoptedsimultaneously and are effective for fiscal years beginning on or after December 15,2008. Earlier adoption is prohibited. Upon a future acquisition, the Companywill evaluate the potential effect of adoption of SFAS 141(R) andSFAS 160.

 

**3.     Acquisition - PDSHeart, Inc.**

 

On March 8,2007, the Company acquired all of the outstanding capital stock of PDSHeart foran aggregate purchase price of $51.6 million. The $51.6 millionpurchase price was comprised of $44.3 million cash at closing,$5.2 million in assumed debt, $1.4 million of transaction expensesand the assumption of a $0.7 million liability related to payments due tocertain key employees of PDSHeart upon the one year anniversary of the closing.Approximately $1.5 million of the assumed debt was satisfied through theissuance of 1,456 shares of mandatorily redeemable convertible preferred stock(“MRCPS”) at a value of $1,000 per share. In addition to the $51.6 millionconsideration, the Company agreed to pay PDSHeart shareholders$5.0 million of contingent consideration in the event of a qualifyingliquidation event, including a public offering or acquisition. The Company’sinitial public offering was consummated on March 25, 2008 and,accordingly, the purchase price for the PDSHeart acquisition has been adjustedto $56.6 million to reflect this payment.

 

Theacquisition has been included within the consolidated results of operationsfrom March 8, 2007. The Company believes that the acquisition willaccelerate its market expansion strategy by providing immediate access to asales force with existing physician relationships capable of marketing theCardioNet System in areas of the country where it had previously not been sold.A significant portion of the purchase price has been allocated to goodwill. Themost significant reason is that 75% of PDSHeart revenues are received aspatient reimbursement from medical insurers and Medicare; however the patientsare the customers as they determine the economic relationship. There is nolong-term intangible asset associated with these patients so no value has beenassigned to this revenue stream.

 

Underthe purchase method of accounting, the total purchase price is allocated totangible and identifiable intangible assets acquired and liabilities assumedbased on their estimated fair values. The following is a summary of thepurchase price allocation:

 
| Cash and cash equivalents     |   | $          | 509,000    |   |
|-------------------------------|--------|------------|------------|--------|
| Accounts receivable, net      |   | 5,168,000  |       |
| Property, plant and equipment |   | 4,136,000  |       |
| Other assets                  |   | 505,000    |       |
| Goodwill                      |   | 45,999,000 |       |
| Intangible assets:            |   |       |       |
| Trade name                    |   | 1,810,000  |       |
| Customer relationships        |   | 1,551,000  |       |
| Non compete agreements        |   | 245,000    |       |
| Other accruals                |   | (344,000   | )          |
| Other liabilities assumed     |   | (2,984,000 | )          |
|                          |   |       |       |
| Net assets acquired           |   | $          | 56,595,000 |   |

 

Theintangible assets with definite lives are being amortized on a straight-linebasis over lives ranging from two to six years.

 

Inconnection with the acquisition of PDSHeart, the Company initiated exit plansfor acquired activities that are redundant to the Company’s existingoperations. The plan includes the closure of a facility and the elimination of35 positions in the areas of sales, finance, service and management. Inconnection with the plan, the Company established reserves of $0.5 millionincluded in the purchase price allocation. As of June 30, 2008, all of thepositions had been eliminated and the Company commenced making arrangements toclose the facility. The reserve is included in accrued liabilities in theaccompanying consolidated balance sheet.

 

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Asummary of the reserve activity related to the PDSHeart acquisition integrationplan as of June 30, 2008 is as follows:

 
| ** **                           | ** ** | **Initial Reserves  Recorded in  Purchase Accounting** | ** ** | **Payments/Adjustments  through  June 30, 2008** | ** ** | **Balance as of  June 30, 2008** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Severance and employee related costs |       | $                                                                     | 366,000    |                                                       | $          | 280,000                                              |       | $ | 86,000 |   |
| Rent Abandonment                     |       | $                                                                     | 144,000    |                                                       | $          | —                                               |       | $ | 144,000 |   |
| Total:                               |       | $                                                                     | 510,000    |                                                       | $          | 280,000                                              |       | $ | 230,000 |   |

 

Additionally,the Company incurred expenses of $0.6 million in the first six months of 2008and expects to incur an additional $0.2 million of expense through September 2008to integrate these functions.  Thesecosts will be expensed as incurred in accordance with the SFAS No. 146, *Accounting for Exit or Disposal Activities*.

 

**4.     Mandatorily Redeemable ConvertiblePreferred Stock and Shareholders’ Equity (Deficit)**

 

**Mandatorily Redeemable Convertible Preferred Stock**

 

In March 2007,the Company sold 110,000 shares of its mandatorily redeemable convertiblepreferred stock, or MRCPS, which generated net proceeds to the Company of$102.1 million ($110 million less offering costs of $7.9 million). The Companyalso issued 3,383 shares of MRCPS upon conversion of an outstanding bridge loanand 1,456 shares as consideration to a major shareholder of PDSHeart asconsideration in the PDSHeart acquisition. Accrued dividends were$6.1 million at March 25, 2008. The MRCPS original purchase price plus accrued dividends were convertedto common shares on March 25, 2008 in connection with the Company’sinitial public offering.

 

**Series A, B, C and D Convertible PreferredStock**

 

From1999 to 2004, the Company issued convertible preferred stock which generatednet proceeds to the Company of $53.5 million. All Series A, B, C and Dpreferred stock converted to common stock on March 25, 2008 in connectionwith the Company’s initial public offering.

 

**Preferred Stock Warrants**

 

Inconnection with a borrowing arrangement provided by a bank, the Company issueda warrant in August 2000 to purchase 12,500 shares of Series Bpreferred stock at a price of $1.47 per share. The warrant may be exercised atany time on or before August 9, 2010. In connection with the closing of the Company’s initial public offeringon March 25, 2008, this warrant became exercisable for 6,250 shares of theCompany’s common stock at a price of $2.94 per share.

 

In2005 and 2006, the Company issued 964,189 warrants to purchase shares of itspreferred stock at a price of $3.50 per share to the participants in certainbridge financing transactions and to a stockholder in connection with enteringinto the Amended and Restated Subordinated Promissory Note with a stockholder.As a result of the MRCPS financing, the warrants became exercisable for sharesof the Company’s Series D-1 preferred stock. These warrants wereautomatically net exercised for common stock on March 25, 2008 inconnection with the Company’s initial public offering.

 

**5.****             ****San Diego Restructuring**

 

Duringthe first quarter of 2008, the Company initiated plans to consolidate itsFinance and Human Resource functions in Pennsylvania. This plan involves theelimination of 7 positions in San Diego. The Company incurred expenses of $0.3million in the first six months of 2008 and expects also to incur an additional$0.1 million of expenses to consolidate these functions, which it currentlyexpects to be substantially completed by September 30, 2008. These costswill be expensed as incurred in accordance with the SFAS No. 146, *Accounting for Exit or Disposal Activities*.

 

**6.****             ****Income Taxes**

 

TheCompany’s effective tax rate of 42.1% for the first six months of 2008 is basedon its estimated fiscal 2008 pretax income and does not take into account theutilization of the Company’s net operating loss, credit carryforwards or otherdeferred income tax assets because the Company is still in the process ofdetermining the timing and manner in which it can utilize such carryforwardsand deductions due to limitations in the Internal Revenue Code applicable tochanges in ownership of corporations. The Company is currently conducting an analysis to determine the timingand manner of the utilization of the net operating loss carryforwards.Following the completion of its analysis of the availability of suchcarryforwards and future income tax deductions, the Company will adjust its taxrate accordingly in future quarters.

 

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TheCompany has net deferred income tax assets totaling approximately$31.2 million at the end of 2007, consisting primarily of federal andstate net operating loss and credit carryforwards. The federal and state netoperating loss carryforwards, if unused, will begin to expire in 2010. Thefederal and state credit carryforwards, if unused, will expire in 2026. Due touncertainty regarding the ultimate realization of these net operating loss andcredit carryforwards and other deferred income tax assets, the Company hasestablished a valuation allowance for most of these assets and will recognizethe benefits only as reassessment indicates the benefits are realizable.

 

**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations.**

 

**Overview**

 

We arethe leading provider of ambulatory, continuous, real-time outpatient managementsolutions for monitoring relevant and timely clinical information regarding anindividual’s health. We incorporated in the state of California in March 1994,but did not actively begin developing our product platform until April 2000.From 2000 through 2002, we devoted substantially all of our resources todeveloping an integrated patient monitoring platform that incorporates awireless data transmission network, internally developed software, FDA-clearedalgorithms and medical devices, and a 24-hour monitoring service center.

 

In February 2002,we received FDA 510(k) clearance for the first and second generation ofour core CardioNet System (Mobile Cardiac Outpatient Telemetry). We opened theCardioNet Monitoring Center in Conshohocken, Pennsylvania in July 2002 andcurrently provide all of our CardioNet System arrhythmia monitoring at thatlocation. We established our relationship with QUALCOMM Incorporated, whichprovides us its wireless cellular data connectivity solution and data hostingand queuing services, in May 2003. Pursuant to our agreement withQUALCOMM, we have no fixed or minimum financial commitment. However, in theevent that we fail to maintain an agreed-upon number of active cardiacmonitoring devices on the QUALCOMM network, or in the event that we begin toutilize the services of a provider of monitoring and communications servicesother than QUALCOMM, QUALCOMM has the right to terminate this agreement.

 

In November 2006,we received FDA 510(k) clearance for our third generation product, or C3,which we have begun to incorporate as part of our monitoring solution. We hadpreviously received FDA 510(k) clearance for the proprietary algorithmincluded in our C3 system in October 2005.

 

In September 2002,we were approved as an Independent Diagnostic Testing Facility for Medicare.The local Medicare carrier in Pennsylvania sets the terms for reimbursement ofour CardioNet System for approximately 40 million covered lives. We havealso worked to secure contracts with commercial payors. We increased the numberof contracts with commercial payors from six at year-end 2003 to 41 at year-end2004 to 97 at year-end 2005 to 144 at year-end 2006 and to 181 at June 30,2008. Over this period of time, we estimate that the number of coveredcommercial lives increased from six million at year-end 2003 to 32 millionat year-end 2004 to 70 million at year-end 2005 to 102 million atyear-end 2006 and to 177 million at June 30, 2008. The currentestimated total of 177 million Medicare and commercial lives for which wehad reimbursement contracts as of June 30, 2008 represents approximately70% of the total covered lives in the United States. The majority of theremaining covered lives are insured by a relatively small number of largecommercial insurance companies that, beginning in 2003, deemed the CardioNet Systemto be “experimental and investigational” and do not currently reimburse us forservices provided to their beneficiaries. We believe a primary reason for the “experimentaland investigational” designation has been a lack of a published peer reviewedprospective randomized clinical trial that demonstrates the clinical efficacyof the CardioNet System.  As a result, wesignificantly slowed our geographic expansion in 2005 and 2006, as we awaitedresults of a randomized clinical trial comparing the CardioNet System totraditional loop event monitors.

 

On March 8,2007, we acquired all of the outstanding capital stock of PDSHeart for anaggregate purchase price of $51.6 million. The $51.6 million purchaseprice was comprised of $44.3 million in cash at closing, $5.2 millionin assumed debt, $1.4 million of transaction expenses and the assumptionof a $0.7 million liability related to payments due to certain keyemployees of PDSHeart on March 8, 2008. Approximately $1.5 million ofthe assumed debt was satisfied through the issuance of 1,456 shares of ourmandatorily redeemable convertible preferred stock at an original issue priceper share of $1,000. In addition to the $51.6 million of consideration,the Company agreed to pay PDSHeart shareholders $5.0 million of contingentconsideration in the event of a qualifying liquidation event, including apublic offering or acquisition.  TheCompany’s initial public offering was consummated on March 25, 2008 and,accordingly, the purchase price for the PDSHeart acquisition has been adjustedto $56.6 million to reflect this payment. The acquisition has been included inour consolidated results of operations since March 8, 2007.  PDSHeart, now a wholly-owned subsidiary ofCardioNet, provides event, Holter and pacemaker monitoring services to patientsin 48 states, with a concentration of sales in the Southeast. The acquisitionhas broadened our geographic coverage and expanded our service offerings toinclude the complete range of cardiac monitoring services.

 

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Forour event, Holter and pacemaker monitoring services, we have establishedMedicare reimbursement and we have 106 direct contracts with commercial payorsas of June 30, 2008 representing an estimated 135 million coveredlives.

 

In March 2007,we raised $110 million in mandatorily redeemable convertible preferredstock to, in part, fund the acquisition of PDSHeart.

 

Wehave undertaken an initiative to improve our operational efficiency and futureprofitability in connection with our acquisition of PDSHeart in March 2007,mainly through the integration of operational and administrative functions. Theplan, which was approved at the time of the PDSHeart acquisition, includes theclosure of a facility and the elimination of 35 positions in the areas ofsales, finance, service and management. In connection with the plan, theCompany established reserves of $0.5 million included in the purchase priceallocation.  Additionally, we incurredexpenses of $0.6 million of employee-related costs to integrate these functionsin the first six months of 2008 and expect to incur an additional $0.2 million ofexpenses to integrate these functions. These costs will be expensed as incurredin accordance with the SFAS No. 146, *Accountingfor Exit or Disposal Activities*.

 

On February 25,2008, the Board of Directors of the Company, subject to stockholder approval,approved a reverse stock split of the Company’s common stock at a ratio of oneshare for every two shares previously held. On March 5, 2008, thestockholders of the Company approved the reverse stock split and the reversestock split became effective.

 

On March 25,2008, the Company completed its initial public offering generating net proceedsof approximately $46.7 million after deducting underwriter commissions andestimated offering expenses.

 

OnAugust 6, 2008,an underwritten secondary public offering of shares of common stock held by certainof the Company’s existing stockholders was completed.  The Company did not issue any shares andreceived no proceeds in connection with such offering.  The Company incurred approximately $0.7 millionin offering expenses on behalf of the selling stockholders.  The underwriters of the offering wereCitigroup Global Markets Inc., Banc of America Securities LLC, Leerink SwannLLC, Cowen and Company, LLC and Thomas Weisel Partners LLC.

 

**Statements of Operations Overview**

 

***Revenues***

 

Ourprincipal source of revenues is patient revenue from cardiac monitoringservices. The amount of revenue generated is based on the number of patientsenrolled through physician prescriptions and the rates reimbursed to us bycommercial payors, physicians, patients and Medicare. Reimbursement rates areset by the Centers for Medicare and Medicaid Services (“CMS”) on a case ratebasis for the Medicare program and through negotiations with commercial payorswho typically pay a daily monitoring rate. From 2002 through June 2008,our average case rate for monitoring Medicare patients has remained relativelystable. We expect pricing to decline over time in a manner consistent with theintroduction and penetration of a premium priced service due to competition,introduction of new technologies and the potential addition of largercommercial payors. Since our CardioNet System services are relatively new andthe reimbursement status is evolving, our revenues are subject to fluctuationsdue to increases or decreases in rates and decisions by payors regardingreimbursement.

 

Forthe event, Holter and pacemaker monitoring market we expect the price to beflat or declining as the new generation technology gains wider acceptance inthe market. In addition, the established 2007 Medicare rates compared to 2006for our event monitoring services declined by 3% to 8%, depending on the typeof service, and our Holter monitoring services declined 8%. Based on currentproposed Medicare rates for 2008 through 2010, we expect this downwardreimbursement trend to continue for these services.

 

Webelieve the CardioNet System revenues will increase as a percentage of revenuesgoing forward as we emphasize this service, continue our geographic expansionand achieve greater market penetration in existing markets. We expect that theevent, Holter and pacemaker monitoring services revenues will be flat ordeclining in absolute terms as the old technology is replaced and therefore,decrease as a percentage of revenues going forward. Other revenue consistsmainly of web hosting services provided to an affiliate of a stockholder. Webelieve that other revenues will be flat or declining in absolute terms andtherefore, decrease as a percentage of revenues going forward. Our revenues areseasonal, as the volume of prescriptions tends to slow down in the summermonths due to the more limited use of our monitoring solutions as physiciansand patients vacation.

 

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***Gross Profit***

 

Grossprofit consists of revenues less the cost of revenues which includes:

 

·      salaries, benefits and stock-based compensation forpersonnel providing various services and customer support to physicians andpatients including patient enrollment and education, monitoring services,distribution services (scheduling, packaging and delivery of the monitors andsensors to the patients), device repair and maintenance, and quality assurance;

 

·      cost of patient-related services provided bythird-party subcontractors including device transportation to and from thepatient, cellular airtime charges related to transmission of ECGs to theCardioNet Monitoring Center and cost for in-home customer hook-ups whennecessary;

 

·      consumable supplies sent to patients along with thedurable components of the CardioNet System;

 

·      depreciation on our monitors; and

 

·      service cost related to special project revenues.

 

Forthe quarter ended June 30, 2008, our gross profit margin was 66.5%. Ingeneral, we expect gross profit margins on the CardioNet System services toremain flat or increase, assuming no changes in reimbursement rates. For ourevent and Holter monitoring services, we expect gross profit margins to decreaseas reimbursement rates decline as currently proposed by CMS.

 

***Sales and Marketing***

 

Salesand marketing expense consists primarily of salaries, benefits and stock-basedcompensation related to account executives, marketing personnel and contractingpersonnel, account executive commissions, travel and other reimbursableexpenses, and marketing programs such as trade shows and marketing campaigns.

 

Followingthe completion of our randomized clinical trial and the PDSHeart acquisition,we made a significant investment in sales and marketing by increasing thenumber of account executives in new geographies. We had a sales force of 81account executives as of June 30, 2008. We currently have accountexecutives covering 48 states. We also plan to increase our marketingactivities. As a result, we expect that sales and marketing expenses willincrease in absolute terms, but will remain flat as a percentage of revenuesgoing forward.

 

***Research and Development***

 

Researchand development expense consists primarily of salaries, benefits andstock-based compensation of personnel and the cost of subcontractors who workon the development of the hardware and software for our next generationmonitors, enhance the hardware and software of our existing monitors and providequality control and testing. Expenses related to clinical trials are alsoincluded in research and development expenses. We expect that research anddevelopment expenses will increase in absolute terms but decrease as apercentage of revenues going forward.

 

***General and Administrative***

 

Generaland administrative expense consists primarily of salaries, benefits and stockbased compensation related to general and administrative personnel,professional fees primarily related to legal and audit fees, facilitiesexpenses and the related overhead, and bad debt expense. We expect that generaland administrative expenses will increase in absolute terms due to thesignificant planned investment in infrastructure to support our growth and theadditional expenses related to becoming a publicly traded company, includingthe increased cost of compliance and increased audit fees resulting from theSarbanes-Oxley Act. As a percentage of revenues, we expect general andadministrative expenses to decline as we grow.

 

***Income Taxes***

 

Wehave net deferred income tax assets totaling approximately $31.2 millionat the end of 2007, consisting primarily of federal and state net operatingloss and credit carryforwards. The federal and state net operating losscarryforwards, if unused, will begin to expire in 2010. The federal and statecredit carryforwards, if unused, will expire in 2026. Due to uncertaintyregarding the ultimate realization of these net operating loss and creditcarryforwards and other deferred income tax assets, we have established avaluation allowance for most of these assets and will recognize the benefitsonly as reassessment indicates the benefits are realizable. The Company iscurrently conducting an analysis to determine the timing and manner of theutilization of the net operating loss carryforwards and will adjust our taxrate accordingly in future quarters.

 

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**Critical Accounting Policies and Estimates**

 

Thediscussion and analysis of our financial condition and results of operationsare based on our financial statements, which we have prepared in accordancewith generally accepted accounting principles. The preparation of thesefinancial statements requires us to make estimates and assumptions that affectthe reported amount of assets and liabilities, revenues and expenses andrelated disclosures. We base our estimates and judgments on historicalexperience and on various other factors that we believe to be reasonable underthe circumstances; however actual results may differ from these estimates. Wereview our estimates and judgments on an ongoing basis.

 

Webelieve that our accounting policies and estimates are most critical to a fullunderstanding and evaluation of our reported financial results. Our significantaccounting policies are more fully described in “Management’s Discussion andAnalysis of Financial Condition and Results of Operations – Critical AccountingPolicies and Estimates” in our Final Prospectus filed with the United StatesSecurities and Exchange Commission, or SEC, pursuant to Rule 424(b) (FileNo. 333-145547) on March 19, 2008.

 

**Results of Operations**

 

***Quarters Ended June 30, 2008 and 2007***

 

*Revenues.*    Total revenues for the quarterended June 30, 2008 increased to $29.3 million from$17.4 million for the quarter ended June 30, 2007, an increase of$11.9 million, or 68.4%. CardioNet System revenue increased$12.6 million, of which $5.8 million was attributed to increasedpatient revenues from physicians within the geographies that we historicallyserved and $6.8 was due to geographic expansion.

 

*Gross Profit.*    Gross profit increased to$19.5 million for the quarter ended June 30, 2008, or 66.5% ofrevenues, from $11.5 million for the quarter ended June 30, 2007, or65.8% of revenues. The increase of $8.0 million is due to the increased revenuefrom the CardioNet System as well operational efficiencies achieved and costreductions negotiated with some of our largest vendors during the quarter.

 

*Sales and Marketing Expense.*    Sales and marketing expenseswere $5.4 million for the quarter ended June 30, 2008 compared to$4.4 million for the quarter ended June 30, 2007. The increase of$1.0 million is due to the 5% increase in the number of account executivesand the continued building of the sales operations infrastructure.  As a percent of total revenues, sales andmarketing expenses were 18.5% for the quarter ended June 30, 2008 comparedto 25.1% for the quarter ended June 30, 2007, a decline of 6.6% due to thecompletion of the full integration of the sales force.

 

*Research and Development Expense.*    Research anddevelopment expenses decreased to $0.9 million for the quarter ended June 30,2008 compared to $1.0 million for the quarter ended June 30, 2007. Asa percent of total revenues, research and development expenses declined to 3.2%for the quarter ended June 30, 2008 compared to 5.9% for the quarter endedJune 30, 2007, a decline of 2.7% primarily due to the higher revenue.

 

*General and Administrative Expense.*    General andadministrative expenses (including amortization) increased to$10.1 million for the quarter ended June 30, 2008 from$7.1 million for the quarter ended June 30, 2007. This increase of$3.0 million, or 40.9%, was primarily due to an increase in the provisionfor bad debt ($0.7 million), increased bonus accrual ($0.6 million),increased expense relating to the addition of several key management positions($0.4 million), stock based compensation ($0.3 million), increased legalfees ($0.3 million) and increased infrastructure ($0.6 million). As a percentof total revenues, general and administrative expenses declined to 34.1% forthe quarter ended June 30, 2008 compared to 40.7% for the quarter ended June 30,2007, a decrease of 6.6% as the increase in expense was offset by the higherrevenue.

 

*Integration, Restructuring and Other Nonrecurring Charges.*    Integrationcharges relating to the PDSHeart acquisition were $0.4 million for the quarterended June 30, 2008. Restructuring charges relating to consolidating ourFinance and Human Resources functions in Pennsylvania were $0.2 million for thequarter ended June 30, 2008. We incurred no integration, restructuring orother nonrecurring charges in the quarter ended June 30, 2007.

 

Inconnection with the acquisition of PDSHeart, the Company initiated exit plansfor acquired activities that are redundant to the Company’s existingoperations. The plan includes the closure of a facility and the elimination of35 positions in the areas of sales, finance, service and management. Inconnection with the plan, the Company established reserves of $0.5 millionincluded in the purchase price allocation. For the quarter ended June 30,2008, all of the positions have been eliminated and approximately $0.4 millionof employee-related expenses have been incurred.

 

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Inaddition, in March 2008, the Company initiated restructuring plans toconsolidate its Finance and Human Resources functions in Pennsylvania. Thisplan includes the elimination of seven positions in California and is currentlyanticipated to be completed by September 2008. For the quarter ended June 30,2008, no positions have been eliminated and approximately $0.2 million ofemployee-related expenses have been incurred.

 

*Total Interest Income/Expense, Net.*    Net interestincome was $0.3 million for the quarter ended June 30, 2008 compared tonet interest expense of $0.1 million for the quarter ended June 30,2007. This decrease in interest expense on a net basis is due to the payoff ofdebt which occurred as a result of a preferred stock financing completed by theCompany in March 2007.

 

*Income Taxes.*    The Company’s effective taxrate was 41.8% for the quarter ended June 30, 2008.  This compares to no income tax benefit orexpense for the quarter ended June 30, 2007. The effective tax rate is basedon our estimated fiscal 2008 pretax income and does not take into account ournet operating loss carryforwards and other future income tax deductions becausewe are still in the process of determining the timing and manner in which wecan utilize such carryforwards and deductions due to limitations in theInternal Revenue Code applicable to changes in ownership of corporations. TheCompany has approximately $62 million in federal net operating losses as of December 31,2007 to offset future taxable income expiring in various years through2026.  Following the completion of ouranalysis of the availability of such carryforwards and future income taxdeductions we will adjust our tax rate accordingly in future quarters.

 

*Net Income (Loss).*    Net income was $1.6 millionfor the quarter ended June 30, 2008 compared to a net loss of$1.1 million for the quarter ended June 30, 2007. As a percent oftotal revenues, net income was 5.6% for the quarter ended June 30, 2008compared to a net loss of 6.3% for the quarter ended June 30, 2007.

 

***Six Months Ended June 30, 2008 and 2007***

 

*Revenues.*    Total revenues for the sixmonths ended June 30, 2008 increased to $54.8 million from$28.5 million for the six months ended June 30, 2007, an increase of$26.3 million, or 92.2%. CardioNet System revenue increased$23.4 million, of which $9.4 million was attributed to increasedpatient revenues from physicians within the geographies that we historicallyserved and $14.0 million was due to geographic expansion. Additionally, revenuefrom the event and Holter monitoring business increased $2.8 million versus theprior year due to the full period effect in 2008 of the PDSHeart acquisitionthat was consummated on March 8, 2007.

 

*Gross Profit.*    Gross profit increased to$35.4 million for the six months ended June 30, 2008, or 64.7% ofrevenues, from $18.8 million for the six months ended June 30, 2007,or 65.8% of revenues. The increase of $16.6 million is primarily due toincreased CardioNet System revenue compared to our lower margin event andHolter business. Gross profit as a percent of revenues decreased by 1.1% duemainly to the full period effect of the lower margin PDSHeart products in 2008.

 

*Sales and Marketing Expense.*    Sales and marketing expenseswere $10.5 million for the six months ended June 30, 2008 compared to$7.7 million for the six months ended June 30, 2007. The increase of$2.8 million is due primarily to the full period effect of the PDSHeartacquisition of $1.8 million and the increased sales force infrastructurebuildup of $1.0 million. As a percent of total revenues, sales and marketingexpenses were 19.2% for the six months ended June 30, 2008 compared to27.0% for the six months ended June 30, 2007, a decline of 7.8% primarilydue to sales force integration efforts.

 

*Research and Development Expense.*    Research anddevelopment expenses increased to $2.1 million for the six months ended June 30,2008 compared to $2.0 million for the six months ended June 30, 2007.As a percent of total revenues, research and development expenses declined to3.8% for the six months ended June 30, 2008 compared to 7.0% for the sixmonths ended June 30, 2007, a decline of 3.2% primarily due to higherrevenue.

 

*General and Administrative Expense.*    General andadministrative expenses (including amortization) increased to$19.1 million for the six months ended June 30, 2008 from$12.3 million for the six months ended June 30, 2007. This increaseof $6.8 million, or 55.3%, was primarily due to an increase in theprovision for bad debt ($1.3 million), increased bonus accrual ($0.9million), increased legal fees ($0.9 million), increased costs related to beinga public company ($0.6 million), stock based compensation ($0.6 million),increased expense relating to the addition of several key management positions($0.4 million), increased amortization due to the PDSHeart acquisition ($0.2million) and increased infrastructure ($1.8 million). As a percent of totalrevenues, general and administrative expenses declined to 34.9% for the sixmonths ended June 30, 2008 compared to 43.2% for the six months ended June 30,2007, a decrease of 8.3% as the increase in expense was offset by the higherrevenue.

 

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*Integration, Restructuring and Other Nonrecurring Charges.*    The Company hasincurred integration and restructuring costs as well as $1.0 million related tothe resolution of intellectual property litigation for the six months ended June 30,2008.  Integration charges relating tothe PDSHeart acquisition were $0.6 million for the six months ended June 30,2008. Restructuring charges relating to consolidating our Finance and HumanResources functions in Pennsylvania were $0.3 million for the six months ended June 30,2008. We incurred no integration, restructuring or other nonrecurring chargesin the quarter ended June 30, 2007.

 

Inconnection with the acquisition of PDSHeart, the Company initiated exit plansfor acquired activities that are redundant to the Company’s existingoperations. The plan includes the closure of a facility and the elimination of35 positions in the areas of sales, finance, service and management. Inconnection with the plan, the Company established reserves of $0.5 millionincluded in the purchase price allocation. As of June 30, 2008, all of thepositions have been eliminated and approximately $0.6 million ofemployee-related expenses have been incurred.

 

Inaddition, in March 2008, the Company initiated restructuring plans toconsolidate its Finance and Human Resources functions in Pennsylvania. Thisplan includes the elimination of 7 positions in California and is currentlyanticipated to be completed by September 2008. As of June 30, 2008,no positions have been eliminated and approximately $0.3 million ofemployee-related expenses have been incurred.

 

*Total Interest Income/Expense, Net.*    Net interestincome was $0.4 million for the six months ended June 30, 2008 compared tonet interest expense of $1.0 million for the six months ended June 30,2007. This decrease in interest expense on a net basis is due to the payoff ofdebt which occurred as a result of a preferred stock financing completed by theCompany in March 2007.

 

*Income Taxes.*    The Company’s effective taxrate was 42.1% for the six months ended June 30, 2008.  This compares to no income tax benefit orexpense for the quarter ended June 30, 2007. The effective tax rate isbased on our estimated fiscal 2008 pretax income and does not take into accountour net operating loss carryforwards and other future income tax deductionsbecause we are still in the process of determining the timing and manner inwhich we can utilize such carryforwards and deductions due to limitations inthe Internal Revenue Code applicable to changes in ownership of corporations.The Company has approximately $62 million in federal net operating losses as ofDecember 31, 2007 to offset future taxable income expiring in variousyears through 2026.  Following thecompletion of our analysis of the availability of such carryforwards and futureincome tax deductions we will adjust our tax rate accordingly in futurequarters.

 

*Net Income (Loss).*    Net income was $1.3 millionfor the six months ended June 30, 2008 compared to a net loss of$4.3 million for the six months ended June 30, 2007. As a percent oftotal revenues, net income was 2.3% for the six months ended June 30, 2008compared to a net loss of 15.1% for the six months ended June 30, 2007.

 

**Liquidity and Capital Resources**

 

Fromour inception in 1999 through June 30, 2008, we did not generatesufficient cash flows to fund our operations and the growth of our business. Asa result, prior to the completion of our initial public offering, our operationswere financed primarily through the private placement of equity securities andboth long-term and short-term debt financings. Notably, we completed a financing involving shares of our mandatorilyredeemable convertible preferred stock in March 2007, in which we receivednet proceeds of approximately $102.1 million, and completed our initial publicoffering in March 2008, in which we received net proceeds, afterunderwriting discounts and offering expenses, of approximately $46.7 million.Through June 30, 2008, we funded our business primarily through thefollowing:

 

·      initial public offering that provided net proceedsof approximately $46.7 million, after deducting underwriting commissions andestimated offering expenses;

 

·      issuance of mandatorily redeemable convertiblepreferred stock that provided gross proceeds of $110 million, of which$45.9 million was used to acquire PDSHeart;

 

·      issuance of preferred stock that provided grossproceeds of $53.7 million;

 

·      a term loan of $23.3 million from GuidantInvestment Corporation, which was repaid on August 15, 2007; and

 

·      bank debt from Silicon Valley Bank consisting of aterm loan of $3.0 million, which was repaid on April 1, 2008, and aworking capital line secured by accounts receivable of $1.9 million, whichwas repaid from the proceeds of the mandatorily redeemable convertiblepreferred stock.

 

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As of June 30,2008, our principal source of liquidity was cash totaling $54.6 millionand net accounts receivable of $29.2 million.

 

Ourcash flow from operations decreased by $0.3 million to $0.9 million in thefirst six months of 2008 from $1.2 million in the first six months of 2007. Thedecrease is primarily due to changes in accounts receivable, accounts payableand accrued liabilities as a result of our growth, partially offset byfavorable net income growth as adjusted to exclude non-cash depreciation andamortization.

 

Weused net cash in investing activities of $8.8 million in the first six monthsof 2008, compared to $51.5 million in the first six months of 2007, a decreaseof $42.7 million. The decrease is primarily due to the consummation of thePDSHeart acquisition in March 2007 for a net cash effect of $46.9 million,partially offset by additional cash payments to PDSHeart shareholders in 2008of $5.0 million as a result of the contingent note payment due as a result ofour initial public offering combined with lower capital expenditures in 2008.

 

Wegenerated net cash from financing activities of $44.3 million in the first sixmonths of 2008, compared to $96.7 million in the first six months of 2007, adecrease of $52.4 million. The decrease is primarily due to the mandatorilyredeemable convertible preferred financing in the first quarter of 2007 whichgenerated net proceeds of $102.1 million, partially offset by the retirement ofthe PDSHeart debt of $5.8 million in 2007 compared to the initial publicoffering net cash proceeds in 2008 of $46.7 million, excluding offering expenses,partially offset by $2.9 million in debt repayment mainly attributable to theretirement of Silicon Valley Bank debt.

 

Webelieve that our existing cash and cash equivalent balances and revenues fromour operations will be sufficient to meet our anticipated cash requirements forthe foreseeable future.

 

Ourfuture funding requirements will depend on many factors, including:

 

·      the costs associated with developing, manufacturingand building our inventory of our future monitoring solutions;

 

·      the costs of hiring additional personnel andinvesting in infrastructure to support future growth;

 

·      the reimbursement rates associated with our productsand services;

 

·      actions taken by the FDA and other regulatoryauthorities affecting the CardioNet System and competitive products;

 

·      our ability to secure contracts with additionalcommercial payors providing for the reimbursement of our services;

 

·      the emergence of competing technologies and productsand other adverse market developments;

 

·      the costs of preparing, filing, prosecuting,maintaining and enforcing patent claims and other intellectual property rightsor defending against claims of infringement by others; and

 

·      the costs of investing in additional lines ofbusiness outside of arrhythmia monitoring solutions.

 

To theextent that we raise additional capital by issuing equity securities, ourstockholders’ ownership will be diluted. In addition, if we determine that weneed to raise additional capital, such capital may not be available onreasonable terms, or at all. If we raise additional funds by issuing equitysecurities, substantial dilution to existing stockholders would likely result.If we raise additional funds by incurring additional debt financing, the termsof the debt may involve significant cash payment obligations as well ascovenants and specific financial ratios that may restrict our ability tooperate our business.

 

**Item 3.Quantitative and Qualitative Disclosures about Market Risk.**

 

Ourcash and cash equivalents as of June 30, 2008 consisted primarily of cashand money market funds with maturities of less than 90 days.  The primary objective of our investmentactivities is to preserve our capital for the purpose of funding operationswhile, at the same time, maximizing the income we receive from our investmentswithout significantly increasing risk. To achieve this objective, ourinvestment policy allows us to maintain a portfolio of cash equivalents andshort term investments in a variety of securities including money market funds andcorporate debt securities. Due to the short term nature of our investments, webelieve we have no material exposure to interest rate risk.

 

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**Item 4T.Controls and Procedures.**

 

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our periodic reports filed with the SECis recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms and that such information isaccumulated and communicated to our management, including our chief executiveofficer and chief financial officer, as appropriate, to allow for timelydecisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and noevaluation of controls and procedures can provide absolute assurance that allcontrol issues and instances of fraud, if any, within a company have beendetected. Management is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

Asrequired by Rule 13a-15(b) of the Securities Exchange Act of 1934, asamended, or Exchange Act, prior to the filing of this report we carried out anevaluation, under the supervision and with the participation of our management,including our chief executive officer and chief financial officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) of theExchange Act) as of the end of the period covered by this report. Based ontheir evaluation, our chief executive officer and chief financial officerconcluded that our disclosure controls and procedures were effective as of theend of the period covered by this report.

 

Inaddition, management, including our chief executive officer and chief financialofficer, did not identify any change in our internal control over financialreporting that occurred during our latest fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II - OTHER INFORMATION.**

 

**Item 1.  Legal Proceedings.**

 

OnNovember 26, 2007, we filed a lawsuit against LifeWatch Corp. andcertain of its employees in the United States District Court for the NorthernDistrict of Illinois, Eastern Division. In the action, we allege several causesof action including trade secret misappropriation, breach of contract, fraud,and unfair competition arising from actions of LifeWatch and its employees tounlawfully obtain, use, inspect and test two of our CardioNet System kits. On January 4,2008, LifeWatch responded by filing counterclaims in the action against us. Inits counterclaims, LifeWatch alleged that we misappropriated trade secrets ofLifeWatch through inspection of a LifeWatch device, and that we have mademisleading advertising and marketing statements relating to LifeWatch. In May 2008,the parties entered into a settlement agreement pursuant to which the partiesamicably agreed to resolve the lawsuit with dismissal by both sides of allclaims pending in the lawsuit.

 

**Item 1A.  Risk Factors.**

 

*You should consider carefully the followinginformation about the risks described below, together with the other informationcontained in this Quarterly Report and in our other public filings inevaluating our business. We have marked with an asterisk (*) those risk factorsthat reflect substantive changes from the risk factors included in our finalprospectus filed by the Company with the Securities and Exchange Commission on March 19,2008 relating to the Company’s Registration Statement on Form S-1/A (File No. 333-145547)for the Company’s initial public offering. If any of the following risksactually occurs, our business, financial condition, results of operations andfuture growth prospects would likely be materially and adversely affected. Inthese circumstances, the market price of our common stock would likely decline.*

 

**Risks related to our business and industry**

 

****We have a history of net losses and maynot be able to sustain profitability.***

 

Weincurred net losses from our inception through March 31, 2008.  For the quarter ending June 30, 2008, werealized net income of $1.6 million.  Asof June 30, 2008, we had total stockholders’ deficit of approximately$80.4 million. We expect our operating expenses to increase as we, among otherthings:

 

·      expand our sales and marketing activities;

 

·      invest in designing, manufacturing and building ourinventory of future generations of the CardioNet System;

 

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·      hire additional personnel;

 

·      invest in infrastructure; and

 

·      incur the additional expenses associated with beinga public company.

 

Withincreasing expenses, we will need to continue to increase our revenues toremain profitable.  Because of the risksand uncertainties associated with further developing and marketing theCardioNet System, we are unable to predict the extent of any future income orlosses.

 

***Our business is dependent upon physiciansprescribing our services; if we fail to obtain those prescriptions, ourrevenues could fail to grow and could decrease.***

 

Thesuccess of our business is dependent upon physicians prescribing our servicesfor patients and cross-selling the respective CardioNet and PDSHeart customerbases. Our success in obtaining prescriptions and cross-selling will bedirectly influenced by a number of factors, including:

 

·      the ability of the physicians with whom we work toobtain sufficient reimbursement and be paid in a timely manner for theprofessional services they provide in connection with the use of our arrhythmiamonitoring solutions, particularly the CardioNet System;

 

·      our ability to educate physicians regarding, andconvince them of, the benefits of the CardioNet System over existing treatmentmethods such as Holter monitors and event monitors; and

 

·      the perceived clinical efficacy of the CardioNetSystem.

 

Ifwe are unable to educate physicians regarding the benefits of the CardioNetSystem, obtain sufficient prescriptions and cross-sell our respective customerbases, revenues from the provision of our arrhythmia monitoring solutions couldfail to grow and could decrease.

 

***We and the physicians with whom we work aredependent upon reimbursement for the fees associated with our services; theabsence or inadequacy of reimbursement would cause our revenues to fail to growor decrease.***

 

Wereceive reimbursement for our services from commercial payors and from MedicarePart B carriers where the services are performed on behalf of the Centersfor Medicare and Medicaid Services, or CMS. The Medicare Part B carriersin each state change from time to time, which may result in changes to ourreimbursement rates, increased administrative burden and reimbursement delays.

 

Inaddition, our prescribing physicians receive reimbursement for professionalinterpretation of the information provided by our products and services fromcommercial payors or Medicare carriers within the state where they practice.The efficacy, safety, performance and cost-effectiveness of our products andservices, on a stand-alone basis and relative to competing services, willdetermine the availability and level of reimbursement we and our prescribingphysicians receive. Our ability to successfully contract with payors iscritical to our business because physicians and their patients will selectarrhythmia monitoring solutions other than ours in the event that payors refuseto adequately reimburse our technical fees and physicians’ professional fees.

 

Manycommercial payors refuse to enter into contracts to reimburse the feesassociated with medical devices or services that such payors determine to be “experimentaland investigational”. Commercial payors typically label medical devices orservices as “experimental and investigational” until such devices or serviceshave demonstrated product superiority evidenced by a randomized clinical trial.We completed a clinical trial in which the CardioNet System provided higherdiagnostic yield than traditional loop event monitoring. Prior to our clinicaltrial, the CardioNet System was labeled “experimental and investigational” by21 targeted commercial payors, representing approximately 95 millioncovered lives. Subsequent to our trial, three commercial payors, representing over26 million covered lives, removed the designation of the CardioNet Systemas “experimental and investigational”. Several of the remaining payors,however, have informed us that they do not believe the data from this trialjustifies the removal of this designation. Other commercial payors may alsofind the data from our clinical trial not compelling. Additional commercialpayors may also label the CardioNet System as “experimental and investigational”and, as a result, refuse to reimburse the technical and professional feesassociated with the CardioNet System.

 

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Administrationof the claims process for the many commercial payors is complex. As a result wesometimes bill payors for services for which we have no reimbursement contract.These payors may require that we return any funds that they pay in respect ofthese claims.

 

Ifcommercial payors or Medicare decide not to reimburse our services or therelated services provided by physicians, or the rates of such reimbursementchange, or if we fail to properly administer claims, our revenues could fail togrow and could decrease.

 

****Reimbursement by Medicare is highlyregulated and subject to change; our failure to comply with applicableregulations, could decrease our revenues and may subject us to penalties orhave an adverse impact on our business.***

 

Wereceive approximately 33% of our revenues as reimbursement from Medicare. TheMedicare program is administered by Centers for Medicare & MedicaidServices, or CMS, which imposes extensive and detailed requirements on medicalservices providers, including, but not limited to, rules that govern howwe structure our relationships with physicians, how and when we submitreimbursement claims, how we operate our monitoring facilities and how andwhere we provide our arrhythmia monitoring solutions. Our failure to complywith applicable Medicare rules could result in discontinuing ourreimbursement under the Medicare payment program, our being required to returnfunds already paid to us, civil monetary penalties, criminal penalties and/orexclusion from the Medicare program.

 

Inaddition, reimbursement from Medicare is subject to statutory and regulatorychanges, local and national coverage decisions, rate adjustments andadministrative rulings, all of which could materially affect the range ofservices covered or the reimbursement rates paid by Medicare for use of ourarrhythmia monitoring solutions. For example, CMS adopted a new payment policyin January 2007 that reduced the rate of reimbursement for a number ofservices reimbursed by Medicare. Although this modification to Medicare’sreimbursement rates did not affect the amount paid by Medicare forreimbursement of the fees associated with the CardioNet System, it resulted inthe reduction of reimbursement rates for event services by 3% to 8%, dependingon the type of service, and Holter services by 8% as compared to the correspondingrates in effect in 2006. Based on current proposed Medicare rates for 2008through 2010, we expect that reimbursement for event and Holter services willcontinue to decline at an annual rate similar to 2007. In addition, we cannotpredict whether future modifications to Medicare’s reimbursement policies couldreduce or eliminate the amounts we receive from Medicare for the solutions weprovide. In addition, Medicare’s reimbursement rates can affect the rate thatcommercial payors are willing to pay for our products and services.Consequently, any future elimination, limitation or reduction in thereimbursement rates provided by Medicare for our arrhythmia monitoringsolutions could result in a reduction in the rates we receive from commercialpayors.

 

***Reimbursement for the CardioNet System byMedicare and other commercial payors is complicated by the lack of a specificCurrent Procedural Terminology, or CPT, code, which may result in lowerprescription rates or varying reimbursement rates.***

 

Whenwe bill Medicare and certain other commercial payors for the service we providein connection with the CardioNet System, we submit the bill using thenonspecific billing, or CPT, code “93799”. Unlike dedicated CPT codes approvedby the American Medical Association, or AMA, and CMS, claims using non-specificcodes may require semi-automated or manual processing, as well as additionalreview by payors. The claims processing requirements associated with anonspecific code can make our services less attractive to physicians becauseadded time and effort is often required in order to receive payment for theirservices. Furthermore, the Medicare reimbursement rate for non-specific codesis determined by local Medicare carriers. As a result, the reimbursement ratesrelating to our CardioNet System are subject to change without notice.

 

Arequest to the AMA for a specific CPT code that describes our CardioNet Systemhas been made. The request was discussed and voted upon by the CPT EditorialPanel at its public October 2007 meeting. The results of the vote areconfidential. We have been informally advised that the CPT Editorial Panelvoted in favor of the request. However, the results of the vote are subject tochange until such results are published in the fall of 2008. If the request isofficially approved by the AMA CPT Editorial Panel, the specific CPT code wouldbe published in the fall of 2008 and would be available for use in 2009.However, we cannot guarantee that we will receive a specific CPT code for theCardioNet System in that timeframe, or ever. Moreover, if we do receive a CPTcode, the reimbursement rate associated with that code, which would be subjectto change on an annual basis through a public notice and comment process, maybe lower than our current reimbursement rates.

 

****A reduction in sales of our services or aloss of one or more of our key commercial payors would adversely affect ourbusiness and operating results.***

 

Asmall number of commercial payors represent a significant percentage of ourrevenues. In the quarter ended June 30, 2008, our top 10 commercial payorsby revenues accounted for approximately 32.5% of our total revenues. Ouragreements with these commercial payors typically allow either party to thecontract to terminate the contract by providing between 60 and 120 daysprior written notice to the other party at any time following the end of theinitial term of the contract. Our commercial payors may elect to

 

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terminateor not to renew their contracts with us for any reason and, in some instancescan unilaterally change the reimbursement rates they pay. In the event any ofour key commercial payors terminate their agreements with us, elect not torenew their agreements with us or elect not to enter into new agreements withus upon expiration of their agreements with us on terms as favorable as ourcurrent agreements, our business, operating results and prospects would beadversely affected.

 

***Consolidation of commercial payors couldresult in payors eliminating coverage of our CardioNet System or reducedreimbursement rates for our CardioNet System.***

 

Thecommercial payor industry is undergoing significant consolidation. When payorscombine their operations, the combined company may elect to reimburse ourCardioNet System at the lowest rate paid by any of the participants in theconsolidation. If one of the payors participating in the consolidation does notreimburse for the CardioNet System at all, the combined company may elect notto reimburse for the CardioNet System. Our reimbursement rates tend to be lowerfor larger payors. As a result, as payors consolidate, our averagereimbursement rate may decline.

 

***Our acquisition of PDSHeart, as well as anyother companies or technologies we may acquire in the future, could provedifficult to integrate and may disrupt our business and harm our operatingresults and prospects.***

 

Ouracquisition of PDSHeart involves numerous risks, including the risk that wewill not take advantage of the cross-selling opportunities brought about by theacquisition. In addition, our acquisition of PDSHeart, as well as acquisitionsin which we may engage in the future, involve risks associated with ourassumption of the liabilities of an acquired company, which may be liabilitiesthat we were or are unaware of at the time of the acquisition, potentialwrite-offs of acquired assets and potential loss of the acquired company’s keyemployees or customers.

 

Wemay encounter difficulties in successfully integrating our operations,technologies, services and personnel with that of the acquired company, and ourfinancial and management resources may be diverted from our existingoperations. For example, following our acquisition of PDSHeart, we have officesin Pennsylvania, California, Florida, Georgia and Minnesota. Our offices inmultiple states create a strain on our ability to effectively manage our operationsand key personnel. If we elect to consolidate our facilities we may lose keypersonnel unwilling to relocate to the consolidated facility, may havedifficulty hiring appropriate personnel at the consolidated facility and mayhave difficulty providing continuity of service through the consolidation.

 

Physicianand patient satisfaction or performance problems with an acquired business,technology, service or device could also have a material adverse effect on ourreputation. Additionally, potential disputes with the seller of an acquiredbusiness or its employees, suppliers or customers and amortization expensesrelated to goodwill and other intangible assets could adversely affect ourbusiness, operating results and financial condition.

 

Wemay not be able to realize the anticipated benefits of the PDSHeart acquisitionor any other acquisition we may pursue or to profitably deploy acquired assets.If we fail to properly evaluate and execute acquisitions, our business may bedisrupted and our operating results and prospects may be harmed.

 

****If we are unable to manage our expectedgrowth, our revenues and operating results may be adversely affected.***

 

Ourbusiness plans call for rapid expansion of our sales and marketing operationsand growth of our research and development, product development andadministrative operations. We had a sales force of 81 account executives at June 30,2008. We intend to further expand our sales force by December 31, 2008. Weexpect this expansion will place a significant strain on our management andoperational and financial resources. Our current and planned personnel,systems, procedures and controls may not be adequate to support our anticipatedgrowth. To manage our growth we will be required to improve existing andimplement new operational and financial systems, procedures and controls andexpand, train and manage our growing employee base. If we are unable to manageour growth effectively, revenue growth may not be realized or may not besustainable, may not result in improved operating results or earnings, and ourbusiness, financial condition and results of operations could be harmed.

 

***Our business is dependent upon havingsufficient monitors and sensors. If we do not have enough monitors or sensorsor experience delays in manufacturing, we may be unable to fill prescriptionsin a timely manner, physicians may elect not to prescribe the CardioNet System,and our revenues and growth prospects could be harmed.***

 

Whena physician prescribes the CardioNet System to a patient, our customer servicedepartment begins the patient hook-up process, which includes procuring amonitor and sensors from our distribution department and sending them to thepatient. While our goal is to provide each patient with a monitor and sensorsin a timely manner, we have experienced and may in the future experience delaysdue to the availability of monitors, primarily when converting to a newgeneration of monitor or, more recently, in connection with the increase inprescriptions following our acquisition of PDSHeart.

 

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Wemay also experience shortages of monitors or sensors due to manufacturingdifficulties. Multiple suppliers provide the components used in the CardioNetSystem, but our facilities in San Diego, California are registered and approvedby the United States Food and Drug Administration, or FDA, as the ultimatemanufacturer of the CardioNet System. Our manufacturing operations could bedisrupted by fire, earthquake or other natural disaster, a work stoppage orother labor-related disruption, failure in supply or other logistical channels,electrical outages or other reasons. If there was a disruption to ourfacilities in San Diego, we would be unable to manufacture the CardioNet Systemuntil we have restored and re-qualified our manufacturing capability ordeveloped alternative manufacturing facilities.

 

Oursuccess in obtaining future prescriptions from physicians is dependent upon ourability to promptly deliver monitors and sensors to our patients, and a failurein this regard would have an adverse effect on our revenues and growthprospects.

 

****Interruptions or delays intelecommunications systems or in the data services provided to us by QUALCOMMor the loss of our wireless or data services could impair the delivery of ourCardioNet System services.***

 

Thesuccess of the CardioNet System is dependent upon our ability to store,retrieve, process and manage data and to maintain and upgrade our dataprocessing and communication capabilities. The monitors we use in connectionwith the CardioNet System rely on a third party wireless carrier to transmitdata over its data network during times that the monitor is removed from itsbase. All data sent by our monitors via this wireless data network or vialandline is routed directly to QUALCOMM data centers and subsequently routed toour monitoring center. We are dependent upon these third parties to providedata transmission and data hosting services to us. We do not have an agreementdirectly with this third party wireless carrier. Although we do have anagreement with QUALCOMM that has a termination date in September 2012,QUALCOMM may terminate its agreement with us if certain conditions occur,including if QUALCOMM’s agreement with the third party wireless carrierterminates, in theevent we fail to maintain an agreed-upon number of active cardiac monitoringdevices on the QUALCOMM network or in the event that we begin to utilize theservices of a provider of monitoring and communication services other thanQUALCOMM. We have no control over the status of the agreement between QUALCOMMand the wireless carrier. If we fail to maintain our relationships withQUALCOMM or if we lose wireless carrier services, we would be forced to seekalternative providers of data transmission and data hosting services, whichmight not be available on commercially reasonable terms or at all.

 

Aswe expand our commercial activities, an increased burden will be placed uponour data processing systems and the equipment upon which they rely.Interruptions of our data networks or the data networks of QUALCOMM for anyextended length of time, loss of stored data or other computer problems couldhave a material adverse effect on our business, financial condition and resultsof operations. Frequent or persistent interruptions in our arrhythmiamonitoring services could cause permanent harm to our reputation and couldcause current or potential users of the CardioNet System or prescribingphysicians to believe that our systems are unreliable, leading them to switchto our competitors. Such interruptions could result in liability, claims andlitigation against us for damages or injuries resulting from the disruption inservice.

 

Oursystems are vulnerable to damage or interruption from earthquakes, floods,fires, power loss, telecommunication failures, terrorist attacks, computerviruses, break-ins, sabotage, and acts of vandalism. Despite any precautionsthat we may take, the occurrence of a natural disaster or other unanticipatedproblems could result in lengthy interruptions in these services. We do notcarry business interruption insurance to protect against losses that may resultfrom interruptions in service as a result of system failures. Moreover, thecommunications and information technology industries are subject to rapid andsignificant changes, and our ability to operate and compete is dependent insignificant part on our ability to update and enhance the communicationtechnologies used in our systems and services.

 

***The market for arrhythmia monitoringsolutions is highly competitive. If our competitors are able to develop ormarket monitoring solutions that are more effective, or gain greater acceptancein the marketplace, than any solutions we develop, our commercial opportunitieswill be reduced or eliminated.***

 

Themarket for arrhythmia monitoring solutions is evolving rapidly and becomingincreasingly competitive. Our industry is highly fragmented and characterizedby a small number of large providers and a large number of smaller regionalservice providers. These third parties compete with us in marketing to payorsand prescribing physicians, recruiting and retaining qualified personnel,acquiring technology and developing solutions complementary to our programs. Inaddition, as companies with substantially greater resources than ours enter ourmarket, we will face increased competition. If our competitors are better ableto develop and patent arrhythmia monitoring solutions than us, or develop moreeffective and/or less expensive arrhythmia monitoring solutions that render oursolutions obsolete or non-competitive or deploy larger or more effectivemarketing and sales resources than ours, our business will be harmed and ourcommercial opportunities will be reduced or eliminated.

 

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****If we need to raise additional funding inthe future, we may be unable to raise such capital when needed, or at all, andthe terms of such capital may be adverse to our stockholders.***

 

Webelieve that the net proceeds from our initial public offering, together withour existing cash and cash equivalent balances, will be sufficient to meet ouranticipated cash requirements for the foreseeable future. However, our futurefunding requirements will depend on many factors, including:

 

·      the costs associated with manufacturing and buildingour inventory of our C3 monitor;

 

·      the costs of hiring additional personnel andinvesting in infrastructure to support future growth;

 

·      the reimbursement rates associated with our productsand services;

 

·      actions taken by the FDA, CMS and other regulatoryauthorities affecting the CardioNet System and competitive products;

 

·      our ability to secure contracts with additionalcommercial payors providing for the reimbursement of our services;

 

·      the emergence of competing technologies and productsand other adverse market developments;

 

·      the costs of preparing, filing, prosecuting,maintaining and enforcing patent claims and other intellectual property rightsor defending against claims of infringement by others; and

 

·      the costs of investing in additional lines ofbusiness outside of arrhythmia monitoring solutions.

 

Ifwe need to, or choose to, raise additional capital in the future, such capitalmay not be available on reasonable terms, or at all. If we raise additionalfunds by issuing equity securities, substantial dilution to existingstockholders would likely result. If we raise additional funds by incurringdebt financing, the terms of the debt may involve significant cash paymentobligations as well as covenants and financial ratios that may restrict ourability to operate our business.

 

***Our manufacturing facilities and themanufacturing facilities of our suppliers must comply with applicableregulatory requirements. If we or our suppliers fail to achieve or maintainregulatory approval of these manufacturing facilities, our growth could belimited and our business could be harmed.***

 

Wecurrently manufacture the monitors and sensors for the CardioNet System in SanDiego, California. Monitors used in the provision of services by PDSHeart arepurchased from several third parties. In order to maintain compliance with FDAand other regulatory requirements, our manufacturing facilities must beperiodically re-evaluated and qualified under a quality system to ensure theymeet production and quality standards. Suppliers of components of and productsused to manufacture the CardioNet System and the manufacturers of the monitorsused in the provision of services by PDSHeart must also comply with FDA andforeign regulatory requirements, which often require significant resources andsubject us and our suppliers to potential regulatory inspections and stoppages.We or our suppliers may not satisfy these requirements. If we or our suppliersdo not maintain regulatory approval for our manufacturing operations, ourbusiness would be harmed.

 

***Our dependence on a limited number ofsuppliers may prevent us from delivering our devices on a timely basis.***

 

Wecurrently rely on a limited number of suppliers of components for the CardioNetSystem. If these suppliers became unable to provide components in the volumesneeded or at an acceptable price, we would have to identify and qualifyacceptable replacements from alternative sources of supply. Qualifyingsuppliers is a lengthy process. Delays or interruptions in the supply of ourrequirements could limit or stop our ability to provide sufficient quantitiesof devices on a timely basis, meet demand for our services, which could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

***We could be subject to medical liability orproduct liability claims which may not be covered by insurance and which wouldadversely affect our business and results of operations.***

 

Thedesign, manufacture and marketing of services of the types we provide entail aninherent risk of product liability claims. Any such claims against us mayrequire us to incur significant defense costs, irrespective of whether suchclaims have merit. In addition, we provide information to health care providersand payors upon which determinations affecting medical care are made, andclaims may be made against us resulting from adverse medical consequences topatients resulting from the information we provide. In addition, we may becomesubject to liability in the event that the monitors and sensors we use fail tocorrectly record or transfer 

 

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patientinformation or if we provide incorrect information to patients or health careproviders using our services. We have also agreed to indemnify QUALCOMM for anyclaims resulting from the provision of our services. If we incur one or moresignificant claims against us, if we are required to indemnify QUALCOMM as aresult of the provision of our services, or if we are required to undertakeremedial actions in response to any such claims, such claims or actions wouldadversely affect our business and results of operations.

 

Ourliability insurance is subject to deductibles and coverage limitations. Inaddition, our current insurance may not continue to be available to us onacceptable terms, if at all, and, if available, the coverages may not beadequate to protect us against any future claims. If we are unable to obtaininsurance at an acceptable cost or on acceptable terms with adequate coverageor otherwise protect against any claims against us, we will be exposed tosignificant liabilities, which may harm our business.

 

****If we do not obtain and maintain adequateprotection for our intellectual property, the value of our technology anddevices may be adversely affected.***

 

Ourbusiness and competitive positions are dependent in part upon our ability to protectour proprietary technology. To protect our proprietary rights, we rely on acombination of trademark, copyright, patent, trade secret and otherintellectual property laws, employment, confidentiality and inventionassignment agreements with our employees and contractors, and confidentialityagreements and protective contractual provisions with other third parties. Weattempt to protect our intellectual property position by filing trademarkapplications and U.S., foreign and international patent applications related toour proprietary technology, inventions and improvements that are important tothe development of our business.

 

As of July 21, 2008,we had 14 issued U.S. patents, eight foreign patents and 41 pending U.S.,foreign and international patent applications relating to various aspects ofthe CardioNet System. As of July 21, 2008, we also had 10 trademarkregistrations and one pending trademark application in the United States for avariety of word marks and slogans. We do not believe that any single patent,trademark or other intellectual property right of ours, or combination of ourintellectual property rights, is likely to prevent others from competing withus using a similar business model. There are many issued patents and patentapplications held by others in our industry and the electronics field. Ourcompetitors may independently develop technologies that are substantiallysimilar or superior to our technologies, or design around our patents or otherintellectual property to avoid infringement. In addition, we may not apply fora patent relating to products or processes that are patentable, we may fail toreceive any patent for which we apply or have applied, and any patent owned byus or issued to us could be circumvented, challenged, invalidated, or held tobe unenforceable, or rights granted thereunder may not adequately protect ourtechnology or provide a competitive advantage to us. For example, with respectto one of our U.S. patents, we have a corresponding foreign patent, the claimsof which were amended substantially more so than in the United States, toovercome art that was of record in the U.S. patent. If a third-party challengesthe validity of any patents or proprietary rights of ours, we may becomeinvolved in intellectual property disputes and litigation that would be costlyand time-consuming.

 

Although third partiesmay infringe our patents and other intellectual property rights, we may not beaware of any such infringement, or we may be aware of potential infringementbut elect not to seek to prevent such infringement or pursue any claim ofinfringement, and the third party may continue its potentially infringingactivities. For example, we believe that LifeWatch Corp. may be infringing ourintellectual property rights. Any decision whether or not to take furtheraction in response to potential infringement of our patent or otherintellectual property rights may be based on any one or more of a variety offactors, such as the potential costs and benefits of taking such action, andbusiness and legal issues and circumstances. Litigation of claims ofinfringement of a patent or other intellectual property rights may be costlyand time-consuming and divert the attention of key company personnel, and maynot be successful or result in any significant recovery of compensation for anyinfringement or enjoining of any infringing activity. Litigation or licensingdiscussions may also involve or lead to counterclaims that could be brought bya potential infringer to challenge the validity or enforceability of ourpatents and other intellectual property.

 

Toprotect our trade secrets and other proprietary information, we generallyrequire our employees, consultants, contractors and outside collaborators toenter into written nondisclosure agreements. These agreements, however, may notprovide adequate protection to prevent any unauthorized use, misappropriationor disclosure of our trade secrets, know-how or other proprietary information.These agreements may be breached, and we may not become aware of, or haveadequate remedies in the event of, any such breach. Also, others mayindependently develop the same or substantially equivalent proprietaryinformation and techniques or otherwise gain access to our trade secrets.

 

****Our ability to market our services may beimpaired by the intellectual property rights of third parties.***

 

Oursuccess is dependent in part upon our ability to avoid infringing the patentsor proprietary rights of others. Our industry and the electronics field arecharacterized by a large number of patents, patent filings and frequentlitigation based on allegations of patent infringement. Competitors may havefiled applications for or have been issued patents and may obtain additionalpatents and proprietary rights related to devices, services or processes thatwe compete with or are similar to ours. We may not be aware of all of thepatents or patent applications potentially adverse to our interests that mayhave been or may later be issued to or filed by others. 

 

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U.S.patent applications may be kept confidential while pending in the Patent andTrademark Office. If other companies have or obtain patents relating to ourproducts or services, we may be required to obtain licenses to those patents orto develop or obtain alternative technology. We may not be able to obtain anysuch licenses on acceptable terms, or at all. Any failure to obtain suchlicenses could impair or foreclose our ability to make, use, market or sell ourproducts and services.

 

Based on the litigiousnature of our industry and the electronics field and the fact that we may posea competitive threat to some companies who own or control various patents, itis always possible that one or more third parties may assert a patentinfringement claim seeking damages and to enjoin the manufacture, use, sale andmarketing of our products and services. If a third-party asserts that we haveinfringed its patent or proprietary rights, we may become involved inintellectual property disputes and litigation that would be costly andtime-consuming and could impair or foreclose our ability to make, use, marketor sell our products and services. For example, a competitor initiated a patentinfringement lawsuit against us in November 2004, which we defended andultimately settled in March 2006. Other lawsuits may have already beenfiled against us without our knowledge. LifeWatch Corp. has asserted or madestatements suggesting that it believes we are infringing its intellectualproperty rights. Additionally, we have received and expect to continue toreceive notices from other third parties suggesting or asserting that we areinfringing their patents and inviting us to license such patents. We do notbelieve, however, that we are infringing LifeWatch’s or any other party’spatents or that a license to any such patents is necessary. Should litigationover such patents arise, which could occur if, for example, a third party filesa lawsuit alleging infringement of such patents or if we file a lawsuitchallenging such patents as being invalid or unenforceable, we intend tovigorously defend against any allegation of infringement. If we are found toinfringe the patent or intellectual property rights of others, we may berequired to pay damages, stop the infringing activity or obtain licenses orrights to the patents or other intellectual property in order to use,manufacture, market or sell our products and services. Any required license maynot be available to us on acceptable terms or at all. If we succeed inobtaining such licenses, payments under such licenses would reduce any earningsfrom our products. In addition, licenses may be non-exclusive and, accordingly,our competitors may have access to the same technology as that which may belicensed to us. If we fail to obtain a required license or are unable to alterthe design of our product candidates to make a license unnecessary, we may beunable to manufacture, use, market or sell our products and services, whichcould significantly affect our ability to achieve, sustain or grow ourcommercial business. Moreover, regardless of the outcome, patent litigationagainst or by us could significantly disrupt our business, divert ourmanagement’s attention and consume our financial resources. We cannot predictif or when any third party will file suit for patent or other intellectualproperty infringement.

 

****We are highly dependent on our Presidentand Chief Executive Officer, Chief Financial Officer and other key employees,and if we are not able to retain them or to recruit and retain additionalqualified personnel, our business may suffer.***

 

We are highly dependentupon our President and Chief Executive Officer, Chief Financial Officer andother key employees. The loss of their services could have a material adverseeffect on our business, financial condition and results of operations. Theemployment of our executive officers and key employees with us is “at will”,and each employee can terminate his or her relationship with us at any time .

 

Wewill need to hire additional senior executives and qualified scientific,commercial, regulatory, sales, quality assurance and control and administrativepersonnel as we continue to expand our commercial activities. We may not beable to attract and retain qualified personnel on acceptable terms given thecompetition for such personnel among companies that provide arrhythmiamonitoring solutions. We have offices in Pennsylvania, California, Florida,Georgia and Minnesota. Competition for personnel with arrhythmia monitoringexperience in each of those areas is intense. If we fail to identify, attract,retain and motivate these highly skilled personnel, or if we lose currentemployees, we may be unable to continue our business operations.

 

***Our business operations could besignificantly disrupted if we fail to properly integrate our management team.***

 

OurChief Executive Officer and Chief Financial Officer recently joined CardioNetand are being integrated into our management team. Each of these officers willhave significant responsibility for our operations and success, but have onlylimited experience with our business. If they do not smoothly and rapidly developknowledge of our business and integrate with our existing management, ourbusiness operations could be significantly disrupted.

 

***If we fail to obtain and maintain necessaryFDA clearances, our business would be harmed.***

 

Themonitors and sensors that we manufacture and sell as part of the CardioNetSystem are classified as medical devices and are subject to extensiveregulation by the FDA. Further, we maintain establishment registration with theFDA as a distributor of medical devices. FDA regulations govern manufacturing,labeling, promotion, distribution, importing, exporting, shipping and sale ofthese devices.

 

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TheCardioNet System, including our C3 monitor, and our arrhythmia detectionalgorithms have “510(k) clearance” status from the FDA. Modifications tothe CardioNet System or our algorithms that could significantly affect safetyor effectiveness, or that could constitute a significant change in intendeduse, would require a new clearance from the FDA. If in the future we makechanges to the CardioNet System or our algorithms, the FDA could determine thatsuch modifications require new FDA clearance, and we may not be able to obtainsuch FDA clearances in a timely fashion or at all.

 

Weare subject to continuing regulation by the FDA, including quality regulationsapplicable to the manufacture of the CardioNet System and various reportingregulations and regulations that govern the promotion and advertising ofmedical devices. The FDA could find that we have failed to comply with one ofthese requirements, which could result in a wide variety of enforcementactions, ranging from a warning letter to one or more severe sanctions,including the following:

 

·      fines, injunctions and civil penalties;

 

·      recall or seizure of the CardioNet System;

 

·      operating restrictions, partial suspension or totalshutdown of production;

 

·      refusal to grant 510(k) clearance of newcomponents or algorithms;

 

·      withdrawing 510(k) clearance already granted toone or more of our existing components or algorithms; and

 

·      criminal prosecution.

 

Anyof these enforcement actions could be costly and significantly harm ourbusiness, financial condition and results of operations.

 

***Enforcement of federal and state lawsregarding privacy and security of patient information may adversely affect ourbusiness, financial condition or operations.***

 

Theuse and disclosure of certain health care information by health care providersand their business associates have come under increasing public scrutiny.Recent federal standards under the Health Insurance Portability andAccountability Act of 1996, or HIPAA, establish rules concerning howindividually-identifiable health information may be used, disclosed andprotected. Historically, state law has governed confidentiality issues, andHIPAA preserves these laws to the extent they are more protective of a patient’sprivacy or provide the patient with more access to his or her healthinformation. As a result of the implementation of the HIPAA regulations, manystates are considering revisions to their existing laws and regulations thatmay or may not be more stringent or burdensome than the federal HIPAA provisions.We must operate our business in a manner that complies with all applicablelaws, both federal and state, and that does not jeopardize the ability of ourcustomers to comply with all applicable laws. We believe that our operationsare consistent with these legal standards. Nevertheless, these laws andregulations present risks for health care providers and their businessassociates that provide services to patients in multiple states. Because theselaws and regulations are recent, and few have been interpreted by governmentregulators or courts, our interpretations of these laws and regulations may beincorrect. If a challenge to our activities is successful, it could have anadverse effect on our operations, may require us to forego relationships withcustomers in certain states and may restrict the territory available to us toexpand our business. In addition, even if our interpretations of HIPAA andother federal and state laws and regulations are correct, we could be heldliable for unauthorized uses or disclosures of patient information as a resultof inadequate systems and controls to protect this information or as a resultof the theft of information by unauthorized computer programmers who penetrateour network security. Enforcement of these laws against us could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

***We may be subject, directly or indirectly,to federal and state health care fraud and abuse laws and regulations and, ifwe are unable to fully comply with such laws, could face substantial penalties.***

 

Ouroperations may be directly or indirectly affected by various broad state andfederal health care fraud and abuse laws, including the Federal HealthcarePrograms’ Anti-Kickback Statute, which prohibits any person from knowingly andwillfully offering, paying, soliciting or receiving remuneration, directly orindirectly, to induce or reward either the referral of an individual for anitem or service, or the ordering, furnishing or arranging for an item orservice, for which payment may be made under federal health care programs, suchas the Medicare and Medicaid programs. For some of our services, we directlybill physicians for our services, who in turn bill payors. Although we believesuch payments to be proper and in compliance with laws and regulations, we maybe subject to claims that we are in violation of these laws and regulations. Ifour past or present operations are found to be in violation of these laws, weor our officers may be subject to civil or criminal penalties, including largemonetary penalties, damages, fines, imprisonment and exclusion from Medicareand Medicaid program participation. If enforcement action were to occur, ourbusiness and results of operations could be adversely affected.

 

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****The operation of our call centers andmonitoring facilities is subject to rules and regulations governingIndependent Diagnostic Testing Facilities and state licensure requirements;failure to comply with these rules could prevent us from receivingreimbursement from Medicare and some commercial payors.***

 

Wehave call centers and monitoring facilities in Pennsylvania, Georgia, Florida,and Minnesota that analyze the data obtained from arrhythmia monitors andreport the results to physicians. In order for us to receive reimbursement fromMedicare and some commercial payors, we must have a call center certified as anIndependent Diagnostic Testing Facility, or IDTF. Certification as an IDTFrequires that we follow strict regulations governing how the center operates,such as requirements regarding the experience and certifications of thetechnicians who review data transmitted from our monitors. These rules andregulations vary from location to location and are subject to change. If theychange, we may have to change the operating procedures at our monitoringfacilities and call centers, which could increase our costs significantly. Ifwe fail to obtain and maintain IDTF certification, our services may no longerbe reimbursed by Medicare and some commercial payors, which could have amaterial adverse impact on our business.

 

In order to maintain theIDTF certification of our call centers we are also required to comply withcertain state requirements. The state of Florida has advised us that we mustobtain a license to operate our call center in that state. If we fail to obtaina license, we would be required to cease the operations of our Florida callcenter, we may be subject to fines and penalties, and we may be required torefund amounts previously received in connection with our operation of theFlorida call center during the period that we did not have a license. We haveapplied for and expect to receive the license, but there can be no assurancethat the license will be received. If we fail to obtain and maintain a licenseto operate our call center in Florida or to comply with any other staterequirements to which we are subject, our business and results of operationscould be adversely impacted.

 

***We may be subject to federal and statefalse claims laws which impose substantial penalties.***

 

Manyof the physicians and patients who use our services file claims forreimbursement with government programs such as Medicare and Medicaid. As aresult, we may be subject to the federal False Claims Act if we knowingly “cause”the filing of false claims. Violations may result in substantial civilpenalties, including treble damages. The federal False Claims Act also contains“whistleblower” or “qui tam” provisions that allow private individuals to bringactions on behalf of the government alleging that the defendant has defraudedthe government. In recent years, the number of suits brought in the medicalindustry by private individuals has increased dramatically. Various states haveenacted laws modeled after the federal False Claims Act, including “qui tam”provisions, and some of these laws apply to claims filed with commercialinsurers.

 

Weare unable to predict whether we could be subject to actions under the federalFalse Claims Act, or the impact of such actions. However, the costs ofdefending claims under the False Claims Act, as well as sanctions imposed underthe False Claims Act, could significantly affect our financial performance.

 

****Changes in the regulatory environment mayconstrain or require us to restructure our operations, which may harm ourrevenues and operating results.***

 

Healthcare laws and regulations change frequently and may change significantly in thefuture. We may not be able to adapt our operations to address every newregulation, and new regulations may adversely affect our business. We cannotprovide assurance that a review of our business by courts or regulatoryauthorities would not result in a determination that adversely affects ourrevenues and operating results, or that the health care regulatory environmentwill not change in a way that restricts our operations. In addition, as a resultof the focus on health care reform in connection with the 2008 presidentialelection, there is risk that Congress may implement changes in laws andregulations governing health care service providers, including measures tocontrol costs, or reductions in reimbursement levels, which may adverselyaffect our business and results of operations.

 

***Changes in the health care industry or tortreform could reduce the number of arrhythmia monitoring solutions ordered byphysicians, which could result in a decline in the demand for our solutions,pricing pressure and decreased revenues.***

 

Changesin the health care industry directed at controlling health care costs orperceived over-utilization of arrhythmia monitoring solutions could reduce thevolume of solutions ordered by physicians. If more health care cost controlsare broadly instituted throughout the health care industry, the volume ofcardiac monitoring solutions could decrease, resulting in pricing pressure anddeclining demand for our services, which could harm our operating results. Inaddition, it has been suggested that some physicians order arrhythmiamonitoring solutions even when the services may have limited clinical utilityin large part to establish a record for defense in the event of a claim of medicalmalpractice against the physician. Legal changes making it more difficult tobring medical malpractice cases, known as tort reform, could reduce the amountof our services prescribed as physicians respond to reduced risks oflitigation, which could harm our operating results.

 

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****A write-off of the value of our goodwillor intangible assets could adversely affect our results of operations.***

 

Asof June 30, 2008, we had $46.0 million of goodwill and $2.3 million ofintangible assets, most of which resulted from acquisition of PDSHeart. Currentaccounting rules require that goodwill and certain intangible assets beassessed for impairment using fair value measurement techniques. If thecarrying amount of a reporting unit exceeds its fair value, then a goodwillimpairment test is performed to measure the amount of the impairment loss, ifany. The goodwill impairment test compares the implied fair value of thereporting unit’s goodwill with the carrying amount of that goodwill.Determining the fair value of the implied goodwill is judgmental in nature andoften involves the use of significant estimates and assumptions. Anydetermination requiring the write-off of a significant portion of goodwill orintangible assets could have a material adverse effect on the market price ofour common stock, and our business, financial condition and results ofoperations.

 

**Risks related to the securities market and investment in ourcommon stock**

 

****Our quarterly operating results and stockprice may be volatile or may decline regardless of our operating performance.***

 

Themarket price for our common stock has been and is likely to continue to bevolatile and may fluctuate significantly in response to a number of factors,most of which we cannot control, including:

 

·      changes in reimbursement rates or policies bypayors;

 

·      adoption of the CardioNet System by physicians;

 

·      changes in Medicare rules or regulations;

 

·      the development of increased compensation forarrhythmia monitoring solutions;

 

·      price and volume fluctuations in the overall stockmarket;

 

·      changes in operating performance and stock marketvaluations of other early stage companies generally;

 

·      the seasonal nature of our revenues, which havetypically been moderately lower during summer months, which we believe may bedue to physician and patient vacation schedules and patient reluctance toinitiate cardiac monitoring during months when patients are more likely to bemore active;

 

·      the financial projections we may provide to thepublic, any changes in these projections or our failure to meet theseprojections;

 

·      changes in financial estimates by any securitiesanalysts who follow our common stock, our failure to meet these estimates orfailure of those analysts to initiate or maintain coverage of our common stock;

 

·      ratings downgrades by any securities analysts whofollow our common stock;

 

·      the public’s response to press releases or otherpublic announcements by us or third parties, including our filings with the SECand announcements relating to payor reimbursement decisions, productdevelopment, litigation and intellectual property impacting us or our business;

 

·      market conditions or trends in our industry or theeconomy as a whole;

 

·      the development and sustainability of an activetrading market for our common stock;

 

·      future sales of our common stock by our officers,directors and significant stockholders;

 

·      other events or factors, including those resultingfrom war, incidents of terrorism, natural disasters or responses to theseevents; and

 

·      changes in accounting principles.

 

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Inaddition, the stock markets, and in particular the Nasdaq Global Market, haveexperienced extreme price and volume fluctuations that have affected andcontinue to affect the market prices of equity securities of many health carecompanies. Stock prices of many health care companies have fluctuated in amanner unrelated or disproportionate to the operating performance of thosecompanies. In the past, stockholders have instituted securities class actionlitigation following periods of market volatility. If we were involved insecurities litigation, we could incur substantial costs, and our resources andthe attention of management could be diverted from our business.

 

****Future sales of our common stock orsecurities convertible into our common stock may depress our stock price.***

 

Sales of a substantialnumber of shares of our common stock or securities convertible into our commonstock in the public market could occur at any time. These sales, or the perceptionin the market that the holders of a large number of shares intend to sellshares, could reduce the market price of our common stock. As of June 30,2008, we had 23,065,240 outstanding shares of common stock. Of these,approximately 7,278,258 shares of common stock are subject to lock-upagreements that are in force through and including September 14, 2008 andapproximately 5,319,384 shares of our common stock are subject to lock-upagreements that are in force through and including October 29, 2008.Substantially all of the shares of our common stock subject to lock-upagreements may be sold upon expiration of such agreements. In addition, we haveoutstanding warrants to purchase up to 6,250 shares of our common stock that,if exercised, would result in these additional shares becoming available forsale upon expiration of the lock-up agreements.

 

EffectiveFebruary 15, 2008, the SEC adopted revisions to Rule 144. Under thenewly adopted revisions:

 

·      the holding period for restricted shares of ourcommon stock has been reduced to six months under specified circumstances;

 

·      the restrictions on the sale of restricted shares ofour common stock held by affiliates and non-affiliates of ours has been reduced;and

 

·      certain other restrictions on resale of the sharesof our common stock under Rule 144 were modified, and these modificationsmake it easier for our stockholders under specified circumstances to sell theirshares upon the expiration of the lock-up agreements beginning 180 daysafter the date of the final prospectus relating to our initial public offering.

 

Werecently filed a registration statement on Form S-1 registering 11,964,196shares of our common stock for resale, of which 5,750,000 shares were soldpursuant to an underwritten public offering and of which 6,214,196 shares arefreely tradable, subject to lock-up agreements as described above.  If a large number of our shares of our commonstock or securities convertible into our common stock are sold in the publicmarket after they become eligible for sale, the sales could reduce the tradingprice of our common stock and impede our ability to raise future capital.

 

****Anti-takeover provisions in our charterdocuments and Delaware law might deter acquisition bids for us that ourstockholders might consider favorable.***

 

Ouramended and restated certificate of incorporation and bylaws contain provisionsthat may make the acquisition of our company more difficult without theapproval of our board of directors. These provisions:

 

·      establish a classified board of directors so thatnot all members of our board are elected at one time;

 

·      authorize the issuance of undesignated preferredstock, the terms of which may be established and shares of which may be issuedwithout stockholder approval, and which may include rights superior to therights of the holders of common stock;

 

·      prohibit stockholder action by written consent,which requires all stockholder actions to be taken at a meeting of our stockholders;

 

·      provide that the board of directors is expresslyauthorized to make, alter, or repeal our bylaws; and

 

·      establish advance notice requirements fornominations for elections to our board or for proposing matters that can beacted upon by stockholders at stockholder meetings.

 

Inaddition, because we are incorporated in Delaware, we are subject to Section 203of the Delaware General Corporation Law which, subject to certain exceptions,prohibits stockholders owning in excess of 15% of our outstanding voting stockfrom merging or combining with us. These anti-takeover provisions and otherprovisions under Delaware law could discourage, delay or prevent a transactioninvolving a change of control of our company, even if doing so would benefitour stockholders. These provisions could also discourage proxy contests andmake it more difficult for our stockholders to elect directors of theirchoosing and cause us to take other corporate actions such stockholders desire.

 

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****Our existing principal stockholders,executive officers and directors have substantial control over us, which mayprevent our stockholders from influencing significant corporate decisions andmay harm the market price of our common stock.***

 

Includingstock options that are exercisable within 60 days of June 30, 2008,our existing principal stockholders, executive officers and directors, togetherwith their affiliates, beneficially owned, in the aggregate, approximately 21%of our outstanding common stock. These stockholders may have interests thatconflict with other stockholders and, if acting together, have the ability todetermine the outcome of matters submitted to our stockholders for approval,including the election and removal of directors and any merger, consolidationor sale of all or substantially all of our assets. In addition, thesestockholders, acting together, may have the ability to control our managementand affairs. Accordingly, this concentration of ownership may harm the marketprice of our common stock by:

 

·      delaying, deferring or preventing a change ofcontrol;

 

·      impeding a merger, consolidation, takeover or otherbusiness combination involving us; or

 

·      discouraging a potential acquirer from making atender offer or otherwise attempting to obtain control of us.

 

****If securities or industry analysts publish inaccurate orunfavorable research about our business, our stock price and trading volumecould decline.***

 

The trading market forour common stock will depend in part on the research and reports that securitiesor industry analysts publish about us or our business. If one or more of theanalysts who covers us downgrades our stock or publishes inaccurate orunfavorable research about our business, our stock price would likely decline.If one or more of these analysts ceases coverage of us or fails to publishreports on us regularly, demand for our stock could decrease, which could causeour stock price and trading volume to decline.

 

****We do not expect to pay any cash dividendsfor the foreseeable future.***

 

Thecontinued expansion of our business may require substantial funding.Accordingly, we do not anticipate that we will pay any cash dividends on sharesof our common stock for the foreseeable future. Even if we were not prohibitedfrom paying dividends, any determination to do so in the future would be at thediscretion of our board of directors and will depend upon our results ofoperations, financial condition, contractual restrictions, restrictions imposedby applicable law and other factors our board of directors deems relevant.Accordingly, realization of a gain on your investment will depend on theappreciation of the price of our common stock, which may never occur. Investorsseeking cash dividends in the foreseeable future should not purchase our commonstock.

 

**Item 2.  Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

**RecentSales of Unregistered Securities**

 

From March 31,2008 to June 30, 2008, we granted stock options topurchase 10,450 shares of our common stock at a weighted average exerciseprice of $20.00 per share to our employees and directors under our 2008equity incentive plan. From March 31, 2008 to June 30, 2008, weissued an aggregate of 65,663 shares of our common stock to our employees,directors and consultants at a weighted average price of $2.21 per sharefor an aggregate of $144,800 pursuant to exercises of options granted under our2003 equity incentive plan.

 

Thesales and issuances of securities in the transactions described above weredeemed to be exempt from registration under the Securities Act of 1933, asamended, in reliance upon Rule 701 promulgated under Section 3(b) ofthe Securities Act of 1933, as amended, as transactions pursuant tocompensatory benefit plans and contracts relating to compensation as provided underRule 701. The recipients of securities in each transaction representedtheir intentions to acquire the securities for investment only and not with aview to or for sale in connection with any distribution thereof and appropriatelegends were affixed to the securities issued in these transactions. Allrecipients had adequate access, through employment or other relationships, toinformation about us. All certificates representing the securities issued inthese transactions included appropriate legends setting forth that thesecurities had not been offered or sold pursuant to a registration statementand describing the applicable restrictions on transfer of the securities. Therewere no underwriters employed in connection with any of the transactions set forthabove.

 

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**Use ofProceeds**

 

Ourinitial public offering of common stock was effected through a Registration Statementon Form S-1 (File No. 333-145547) that was declared effective by theSecurities and Exchange Commission on March 18, 2008, which registered anaggregate of 5,175,000 shares of our common stock, including 675,000 sharesthat the underwriters had the option to purchase to cover over-allotments. On March 25,2008, 3,000,000 shares of common stock were sold on our behalf and1,500,000 shares of common stock were sold on behalf of a selling stockholderat an initial public offering price of $18.00 per share, for an aggregategross offering price of $54.0 million to us, and $27.0 million to theselling stockholders. On April 8, 2008, 1,014,286 shares of common stockwere sold on behalf of the selling stockholder upon a partial exercise of theunderwriters’ over-allotment option, at an initial public offering price of$18.00 per share, for an aggregate gross offering price of $1.8 million tothe selling stockholder. The underwriters of the offering were Citigroup GlobalMarkets Inc., Lehman Brothers Inc., Leerink Swann LLC and Thomas WeiselPartners LLC. Following the sale of the shares in connection with theover-allotment closing of our initial public offering, the offering terminated.

 

Wepaid to the underwriters underwriting discounts and commissions totalingapproximately $3.8 million in connection with the offering. In addition,we incurred additional costs of approximately $3.2 million in connectionwith the offering, which when added to the underwriting discounts andcommissions paid by us, amounts to total fees and costs of approximately$7.0 million. Thus, the net offering proceeds to us, after deductingunderwriting discounts and commissions and offering costs, were approximately$46.9 million. No offering costs were paid directly or indirectly to any of ourdirectors or officers (or their associates) or persons owning ten percent ormore of any class of our equity securities or to any other affiliates.

 

As of June 30,2008, we had invested $46.7 million of net proceeds from the offering in moneymarket funds. Through June 30, 2008, we have not used the net proceedsfrom the offering, other than to repay our outstanding long-term debt balanceof $2.4 million and to pay a success fee of $0.2 million in connection with theoffering to the lender of such long-term debt, and to pay $5.0 million owed toformer stockholders of PDSHeart holding certificates of subordinated contingentpayment interest to fully extinguish our obligations under such certificates.We intend to use the remaining proceeds for research and development, to buildour inventory of future generations of our CardioNet System, to increase oursales and marketing capabilities for our CardioNet System, to hire additionalpersonnel, to invest in infrastructure, to pursue new markets and geographiesand to acquire or license products, technologies or businesses, although wecurrently have no agreements or commitments relating to material acquisitionsor licenses. We cannot specify with certainty all of the particular uses forthe net proceeds from our initial public offering.  Accordingly, our management will have broaddiscretion in the application of the net proceeds.

 

**Item 6.  Exhibits.**

 

**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | ** ** |
|---------------------|------------|------------|
|                |       |       |
| 3.1                 |       |       | Amended  and Restated Certificate of Incorporation.(1) |
| 3.2                 |       |       | Amended  and Restated Bylaws.(1) |
| 4.1                 |       |       | Form of  Common Stock Certificate.(1) |
| 4.2                 |       |       | Warrant  issued by Registrant on August 9, 2000 to Silicon Valley Bank.(1) |
| 10.1                |       |       | Amendment No. 6  dated June 26, 2008 to Communications Voice and Data Services Provider  Agreement dated May 12, 2003 between the Company and QUALCOMM,  Incorporated, as amended. (2)* |
| 31.1                |       |       | Certification  of Chief Executive Officer pursuant to Rules 13a-14(a) and  15d-14(a) promulgated under the Securities and Exchange Act of 1934, as  amended. |
| 31.2                |       |       | Certification  of Chief Financial Officer pursuant to Rules 13a-14(a) and  15d-14(a) promulgated under the Securities and Exchange Act of 1934, as  amended. |
| 32.1                |       |       | Certification  of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002. |

 

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(1)      Filed as an exhibit to the Company’s RegistrationStatement on Form S-1 (File No. 333-145547) originally filed with theSecurities and Exchange Commission on August 17, 2007, as amended, andincorporated herein by reference.

 

(2)      Filed as an exhibit to the Company’s RegistrationStatement on Form S-1 (File No. 333-151829) originally filed with theSecurities and Exchange Commission on June 23, 2008, as amended, andincorporated herein by reference.

 

*         Confidential treatment has been granted with respectto certain portions of this exhibit. Omitted portions have been filedseparately with the Securities and Exchange Commission.

 

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**CardioNet, Inc.**

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                       | **CARDIONET, INC.** |
|----------------------------|--------------------------|
|                       |                     |
|                       |                     |
| Date: August 13, 2008 | By:                      | /s/ Martin P. Galvan |
|                       |                     | Martin P. Galvan |
|                       |                     | *Chief Financial Officer and Chief  Operating  Officer, PDSHeart*(Duly  Authorized Officer and Principal  Financial Officer) |

 

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