Table of Contents

 

 

 

**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM 10-Q**

 

----

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

** **

**227 Washington StreetConshohocken, Pennsylvania 19428**

(Address of Principal Executive Offices, including Zip Code)

 

**(610) 729-7000**

(Registrant’s Telephone Number, including Area Code)

 

**N/A**

(Former name, former address and former fiscal year if changed sincelast report)

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90days.    Yes  x  No   ̈

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

 

As of September 30, 2008, 23,380,371 shares of the registrant’scommon stock, $0.001 par value per share, were outstanding.

 

 

 

----

Table of Contents

 

**CARDIONET, INC.**

**QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDEDSEPTEMBER 30, 2008**

**TABLE OFCONTENTS**

 
| ** **        | ** **                                                                                  | **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 | 12                |
| Item 3.           | Quantitative  and Qualitative Disclosures about Market Risk                                 | 19                |
| Item 4T.          | Controls and  Procedures                                                                    | 19                |
|              |                                                                                        |              |
| **PART II.** | **OTHER  INFORMATION**                                                                      | ** **        |
| Item 1.           | Legal Proceedings                                                                           | 20                |
| Item 1A.          | Risk Factors                                                                                | 20                |
| Item 2.           | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 32                |
| Item 6.           | Exhibits                                                                                    | 33                |
|              |                                                                                        |              |
| SIGNATURES        | 34                                                                                          |

 

2

----

Table of Contents

 

**PART I — FINANCIAL INFORMATION**

**Item 1. Financial Statements.**

 

**CARDIONET, INC.**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                                                                                              | ** ** | **September 30, 2008**                                                     | ** ** | **December 31, 2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                              | ** ** | **(Unaudited)**                                                                      | ** ** | ** **                      | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                              | ** ** | **(In thousands except share and  per share amounts)** | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                                                              |       |                                                                                 |       |                            |       |
| Current assets:                                                                                                                                                                                                                                                                                                                         |       |                                                                                 |       |                            |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                               |       | $                                                                                    | 56,292     |                            | $          | 18,091 |   |
| Accounts receivable, net of allowance for  doubtful accounts of $16,678, and $7,909 at September 30, 2008 and  December 31, 2007, respectively                                                                                                                                                                                |       | 35,851                                                                               |       | 22,854                          |       |
| Due from related parties                                                                                                                                                                                                                                                                                                                |       | 91                                                                                   |       | 143                             |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                                               |       | 2,711                                                                                |       | 287                             |       |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Total current assets                                                                                                                                                                                                                                                                                                                    |       | 94,945                                                                               |       | 41,375                          |       |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Property and equipment, net                                                                                                                                                                                                                                                                                                             |       | 16,302                                                                               |       | 15,094                          |       |
| Intangible assets, net                                                                                                                                                                                                                                                                                                                  |       | 2,069                                                                                |       | 2,807                           |       |
| Goodwill                                                                                                                                                                                                                                                                                                                                |       | 45,999                                                                               |       | 41,163                          |       |
| Other assets                                                                                                                                                                                                                                                                                                                            |       | 5,124                                                                                |       | 2,601                           |       |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Total assets                                                                                                                                                                                                                                                                                                                            |       | $                                                                                    | 164,439    |                            | $          | 103,040 |   |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| **Liabilities and shareholders’ equity  (deficit)**                                                                                                                                                                                                                                                                                |       |                                                                                 |       |                            |       |
| Current liabilities:                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Accounts payable                                                                                                                                                                                                                                                                                                                        |       | $                                                                                    | 4,045      |                            | $          | 3,972 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                                                     |       | 17,214                                                                               |       | 6,425                           |       |
| Current portion of debt                                                                                                                                                                                                                                                                                                                 |       | 152                                                                                  |       | 1,088                           |       |
| Current portion of capital leases                                                                                                                                                                                                                                                                                                       |       | 49                                                                                   |       | 49                              |       |
| Deferred revenue                                                                                                                                                                                                                                                                                                                        |       | 575                                                                                  |       | 466                             |       |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Total current liabilities                                                                                                                                                                                                                                                                                                               |       | 22,035                                                                               |       | 12,000                          |       |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Long-term debt, net of current portion                                                                                                                                                                                                                                                                                                  |       | —                                                                               |       | 1,655                           |       |
| Deferred rent                                                                                                                                                                                                                                                                                                                           |       | 786                                                                                  |       | 879                             |       |
| Other noncurrent liabilities                                                                                                                                                                                                                                                                                                            |       | 44                                                                                   |       | 69                              |       |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Total liabilities                                                                                                                                                                                                                                                                                                                       |       | 22,865                                                                               |       | 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 September 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 September 30, 2008 and  December 31, 2007, respectively                                                                                                                                                                                    |       | —                                                                               |       | 391                             |       |
| Series B — 0 and 4,720,347 shares  authorized, issued and outstanding at September 30, 2008 and  December 31, 2007, respectively                                                                                                                                                                                    |       | —                                                                               |       | 6,904                           |       |
| Series C — 0 and 10,399,011 shares  authorized, issued and outstanding at September 30, 2008 and  December 31, 2007, respectively                                                                                                                                                                                   |       | —                                                                               |       | 36,196                          |       |
| Series D — 0 and 1,000,000 shares  authorized, issued and outstanding at September 30, 2008 and  December 31, 2007, respectively                                                                                                                                                                                    |       | —                                                                               |       | 9,965                           |       |
| Preferred stock, $.001 par value and no par  value at September 30, 2008 and December 31, 2007, respectively; 10,000,000  and 0 shares authorized at September 30, 3008 and December 31,  2007, respectively, 0 shares issued and outstanding at September 30,  2008, and December 31, 2007, respectively |       | —                                                                               |       | —                          |       |
| Common stock, $.001 par value and no par  value at September 30, 2008 and December 31, 2007, respectively;  200,000,000 and 50,000,000 shares authorized, 23,328,028 and 3,130,054 shares  issued, outstanding and vested at September 30, 2008, and  December 31, 2007, respectively                               |       | 23                                                                                   |       | 1,399                           |       |
| Paid-in capital                                                                                                                                                                                                                                                                                                                         |       | 220,992                                                                              |       | —                          |       |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                     |       | (79,441                                                                              | )          | (81,720                         | )          |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Total shareholders’ equity (deficit)                                                                                                                                                                                                                                                                                               |       | 141,574                                                                              |       | (26,865                         | )          |
|                                                                                                                                                                                                                                                                                                                                    |       |                                                                                 |       |                            |       |
| Total liabilities and shareholders’ equity  (deficit)                                                                                                                                                                                                                                                                              |       | $                                                                                    | 164,439    |                            | $          | 103,040 |   |

 

See accompanying notes.

 

3

----

Table of Contents

 

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

**(Unaudited)**

 
| ** **                                                                        | ** ** | **Three Months Ended  September 30,**             | ** ** | **Nine Months Ended  September 30,**          | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2008**                                                         | ** ** | **2007**                                                     | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                        | ** ** | **(In thousands except per share  amounts)** | ** ** | **(In thousands except per  share  amounts)** | ** ** |
| Revenues:                                                                         |       |                                                             |       |                                                         |       |   |   |   |   |
| Net patient service revenues                                                      |       | $                                                                | 31,073     |                                                         | $          | 20,362 |   | $ | 85,510 |   | $ | 48,582 |   |
| Other revenues                                                                    |       | 150                                                              |       | 168                                                          |       | 516 |   | 467 |   |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Total revenues                                                                    |       | 31,223                                                           |       | 20,530                                                       |       | 86,026 |   | 49,049 |   |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Cost of revenues                                                                  |       | 10,014                                                           |       | 7,100                                                        |       | 29,367 |   | 16,843 |   |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Gross profit                                                                      |       | 21,209                                                           |       | 13,430                                                       |       | 56,659 |   | 32,206 |   |
| Operating expenses:                                                               |       |                                                             |       |                                                         |       |   |   |   |   |
| Research and development                                                          |       | 943                                                              |       | 810                                                          |       | 3,015 |   | 2,820 |   |
| General and administrative                                                        |       | 10,757                                                           |       | 7,148                                                        |       | 29,839 |   | 19,429 |   |
| Sales and marketing                                                               |       | 5,216                                                            |       | 3,937                                                        |       | 15,743 |   | 11,633 |   |
| Integration, restructuring and other  nonrecurring charges                        |       | 2,859                                                            |       | —                                                       |       | 4,775 |   | — |   |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Total expenses                                                                    |       | 19,775                                                           |       | 11,895                                                       |       | 53,372 |   | 33,882 |   |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Income (loss) from operations                                                     |       | 1,434                                                            |       | 1,535                                                        |       | 3,287 |   | (1,676 | ) |
| Other income (expense):                                                           |       |                                                             |       |                                                         |       |   |   |   |   |
| Interest income                                                                   |       | 332                                                              |       | 470                                                          |       | 863 |   | 1,374 |   |
| Interest expense                                                                  |       | (9                                                               | )          | (197                                                         | )          | (161 | ) | (2,148 | ) |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Total other income (expense)                                                      |       | 323                                                              |       | 273                                                          |       | 702 |   | (774 | ) |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Income (loss) before income taxes                                                 |       | 1,757                                                            |       | 1,808                                                        |       | 3,989 |   | (2,450 | ) |
| Income tax (expense) benefit                                                      |       | (770                                                             | )          | —                                                       |       | (1,710 | ) | — |   |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Net income (loss)                                                                 |       | 987                                                              |       | 1,808                                                        |       | 2,279 |   | (2,450 | ) |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Dividends on and accretion of mandatorily  redeemable convertible preferred stock |       | —                                                           |       | (2,743                                                       | )          | (2,597 | ) | (5,587 | ) |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Net income (loss) attributable to common  stockholders                            |       | $                                                                | 987        |                                                         | $          | (935 | ) | $ | (318 | ) | $ | (8,037 | ) |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Net income (loss) per common share:                                               |       |                                                             |       |                                                         |       |   |   |   |   |
| Basic                                                                             |       | $                                                                | 0.04       |                                                         | $          | (0.30 | ) | $ | (0.02 | ) | $ | (2.70 | ) |
| Diluted                                                                           |       | $                                                                | 0.04       |                                                         | $          | (0.30 | ) | $ | (0.02 | ) | $ | (2.70 | ) |
|                                                                              |       |                                                             |       |                                                         |       |   |   |   |   |
| Weighted average number of common shares  outstanding:                            |       |                                                             |       |                                                         |       |   |   |   |   |
| Basic                                                                             |       | 23,171                                                           |       | 3,072                                                        |       | 16,644 |   | 2,982 |   |
| Diluted                                                                           |       | 24,039                                                           |       | 3,072                                                        |       | 16,644 |   | 2,982 |   |

 

See accompanying notes.

 

4

----

Table of Contents

 

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

**(Unaudited)**

 
| ** **                                                                                                      | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                      | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Operating activities**                                                                                        |       |                                                |       |   |   |
| Net income (loss)                                                                                               |       | $                                                   | 2,279      |   | $ | (2,450 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities:                       |       |                                                |       |   |   |
| Depreciation                                                                                                    |       | 5,384                                               |       | 2,385 |   |
| Amortization of intangibles                                                                                     |       | 738                                                 |       | 553 |   |
| Loss on disposal of property and equipment                                                                      |       | 281                                                 |       | 37 |   |
| (Decrease) increase in deferred rent                                                                            |       | (93                                                 | )          | 315 |   |
| Provision for doubtful accounts                                                                                 |       | 8,849                                               |       | 5,631 |   |
| Common stock and stock options issued for  services                                                             |       | —                                              |       | 193 |   |
| Amortization of debt discount, including  recognition of contingent beneficial conversion                       |       | —                                              |       | 658 |   |
| Stock-based compensation                                                                                        |       | 2,434                                               |       | 320 |   |
| Changes in operating assets and  liabilities:                                                                   |       |                                                |       |   |   |
| Accounts receivable                                                                                             |       | (22,078                                             | )          | (9,501 | ) |
| Due from related parties                                                                                        |       | 141                                                 |       | (17 | ) |
| Prepaid expenses and other current assets                                                                       |       | (2,280                                              | )          | 44 |   |
| Other assets                                                                                                    |       | (2,522                                              | )          | (983 | ) |
| Accounts payable                                                                                                |       | 73                                                  |       | 2,003 |   |
| Accrued liabilities                                                                                             |       | 11,124                                              |       | 1,811 |   |
| Other noncurrent liabilities                                                                                    |       | —                                              |       | (134 | ) |
|                                                                                                            |       |                                                |       |   |   |
| Net cash provided by operating activities                                                                       |       | 4,330                                               |       | 865 |   |
|                                                                                                            |       |                                                |       |   |   |
| **Investing activities**                                                                                        |       |                                                |       |   |   |
| Purchases of property and equipment                                                                             |       | (6,874                                              | )          | (9,108 | ) |
| Investment in subsidiary, net of cash  acquired                                                                 |       | (5,002                                              | )          | (46,886 | ) |
|                                                                                                            |       |                                                |       |   |   |
| Net cash used in investing activities                                                                           |       | (11,876                                             | )          | (55,994 | ) |
|                                                                                                            |       |                                                |       |   |   |
| **Financing activities**                                                                                        |       |                                                |       |   |   |
| Net proceeds from issuance of mandatorily  redeemable convertible preferred stock                               |       | —                                              |       | 102,117 |   |
| Proceeds from issuance of common stock                                                                          |       | 48,364                                              |       | 557 |   |
| Proceeds from issuance of debt                                                                                  |       | 500                                                 |       | 373 |   |
| Repayment of debt                                                                                               |       | (3,117                                              | )          | (29,272 | ) |
|                                                                                                            |       |                                                |       |   |   |
| Net cash provided by financing activities                                                                       |       | 45,747                                              |       | 73,775 |   |
|                                                                                                            |       |                                                |       |   |   |
| Net increase in cash and cash equivalents                                                                       |       | 38,201                                              |       | 18,646 |   |
| Cash and cash equivalents — beginning of  period                                                           |       | 18,091                                              |       | 3,909 |   |
|                                                                                                            |       |                                                |       |   |   |
| Cash and cash equivalents — end of period                                                                  |       | $                                                   | 56,292     |   | $ | 22,555 |   |
|                                                                                                            |       |                                                |       |   |   |
| **Supplemental disclosure of cash flow  information**                                                           |       |                                                |       |   |   |
| Cash paid for interest                                                                                          |       | $                                                   | 378        |   | $ | 3,544 |   |
|                                                                                                            |       |                                                |       |   |   |
| **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.

 

5

----

Table of Contents

 

**CARDIONET, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.****    ****Business**

 

CardioNet, Inc. (the Company), a Delawarecorporation, provides ambulatory, continuous, real-time outpatient managementsolutions for monitoring relevant and timely clinical information regarding anindividual’s health. The Company incorporated in the state of California in March 1994,but did not actively begin developing its product platform until April 2000.The Company spent seven years developing a proprietary integrated patientmanagement platform that incorporates a wireless data transmission network,internally developed software, FDA-cleared algorithms and medical devices and a24-hour digital monitoring service center. The initial focus of the Company ison the diagnosis and monitoring of cardiac arrhythmias, or heart rhythmdisorders, with a solution that is marketed as the CardioNet System. In September 1999,the Company was capitalized as CardioNet, a company focused on helpingphysicians more rapidly diagnose and more effectively manage therapy forpatients with cardiovascular disease. In February 2002, the Companyreceived FDA 510(k) clearance for the first and second generation of itscore CardioNet System which automatically detects cardiac rhythm problems andtransmits ECG data to a 24/7/365 monitoring center which was opened inConshohocken, Pennsylvania in July 2002. The Company re-incorporated inDelaware in 2008. The CardioNet Monitoring Center provides analysis andresponse for all incoming ECG data. Currently, the Company provides allarrhythmia monitoring services for the CardioNet System at this location. TheCompany receives reimbursement for services provided to patients from Medicareand other third-party payors.

 

On March 8, 2007, the Company acquired PDSHeart, Inc.(“PDSHeart”), a leading cardiac monitoring company, for an aggregate of$51.6 million plus the assumption of $5.2 million in debt.  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. 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.See Note 3.

 

On February 25, 2008, the Board of Directors ofthe Company, subject to stockholder approval, approved a reverse stock split ofthe Company’s common stock at a ratio of one share for every two sharespreviously held. On March 5, 2008, the stockholders of the Companyapproved the reverse stock split and the reverse stock split became effective.All common stock share and per-share data included in these consolidatedfinancial statements reflect the reverse stock split.

 

On March 25, 2008, the Company completed itsinitial public offering generating net proceeds to the Company of approximately$46.7 million, after deducting underwriter commissions and estimated offeringexpenses.  Upon the closing of theCompany’s initial public offering, all outstanding shares of the Company’smandatorily redeemable convertible preferred stock and convertible preferredstock converted into shares of common stock. Therefore, at September 30, 2008, the Company had no shares ofpreferred stock outstanding.

 

On August 6, 2008, an underwritten secondary publicoffering of shares of common stock held by certain of the Company’s existingstockholders was completed.  The Companydid not issue any shares and received no proceeds in connection with suchoffering.  The Company incurred approximately$0.9 million in offering expenses on behalf of the selling stockholders.  These expenses were incurred in accordancewith the Company’s obligations under a registration rights agreement with theselling stockholders.

 

**2.****    ****Summary of Significant AccountingPolicies**

 

**Unaudited Interim Financial Data**

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial information and the requirements ofForm 10-Q and Article 10 of Regulation S-X. Accordingly, theseconsolidated financial statements do not include all of the information andfootnotes 

 

6

----

Table of Contents

 

requiredby U.S. generally accepted accounting principles.  In the opinion of management, theseconsolidated financial statements reflect all adjustments, which are of normalrecurring nature and necessary for a fair presentation of the Company’sfinancial position as of September 30, 2008 and December 31, 2007,the results of operations for the three and nine months ended September 30,2008 and 2007 and cash flows for the nine months ended September 30, 2008and 2007. The financial data and other information disclosed in these notes tothe financial statements related to the three month and nine month periods areunaudited. The results for the three month and nine month periods ended September 30,2008 are not necessarily indicative of the results to be expected for anyfuture period.

 

**Net Income (Loss) Attributable toCommon Shares**

 

The Company computes net income (loss) per share inaccordance with Statement of Financial Accounting Standards (SFAS) No. 128,*Earnings Per Share*. Under SFAS No. 128,basic net loss per share is computed by dividing net loss per shareattributable to common stockholders by the weighted average number of commonshares outstanding for the period and excludes the effects of any potentiallydilutive securities. Diluted earnings per share, if presented, would includethe dilution that would occur upon the exercise or conversion of allpotentially dilutive securities into common stock using the “treasury stock”and/or “if converted” methods, as applicable.

 

The following summarizes the potential outstandingcommon stock of the Company at September 30, 2008 and September 30,2007.  The convertible preferred stock,the mandatorily redeemable convertible preferred stock and the Series D-1warrants were converted into shares of the Company’s common stock immediatelyprior to the consummation of the Company’s initial public offering on March 25,2008.  All share amounts have beenadjusted for the one-for-two reverse stock split effected by the Company on March 5,2008:

 
| ** **                                           | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Convertible preferred stock (A,B,C,D)                |       | —                       |       | 8,835,053                    |       |
| Mandatorily redeemable convertible  preferred stock  |       | —                       |       | 4,784,959                    |       |
| Series B warrants                               |       | 6,250                        |       | 6,250                        |       |
| Series D-1 warrants                             |       | —                       |       | 482,038                      |       |
| Common stock options outstanding                     |       | 1,740,885                    |       | 1,208,604                    |       |
| Common stock options available for grant             |       | 373,757                      |       | 68,205                       |       |
| Common stock held by certain employees and  unvested |       | 52,343                       |       | —                       |       |
| Common stock                                         |       | 23,328,028                   |       | 3,212,752                    |       |
|                                                 |       |                         |       |                         |       |
| Total                                                |       | 25,501,263                   |       | 18,597,861                   |       |

 

If the outstanding options, warrants and preferredstock were exercised or converted into common stock, the result would beanti-dilutive for the nine months ended September 30, 2008 and September 30,2007 and the three months ended September 30, 2007. Accordingly, basic anddiluted net loss attributable to common stockholders per share are identicalfor those periods presented in the consolidated statements of operations.

 

**Stock-Based Compensation**

 

SFAS No. 123(R), *Share-Based Payment*, addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or (b) liabilitiesthat are based on the fair value of the enterprise’s equity instruments or thatmay be settled by the issuance of such equity instruments. SFAS No. 123(R) requiresthat an entity measure the cost of equity-based service awards based on thegrant-date fair value of the award and recognize the cost of such awards overthe period during which the employee is required to provide service in exchangefor the award (the vesting period). SFAS No. 123(R) requires that anentity measure the cost of liability-based service awards based on current fairvalue that is re-measured subsequently at each reporting date through thesettlement date. The Company accounts for equity awards issued to non-employeesin accordance with EITF 96-18, *Accountingfor Equity Investments that are Issued to Other Than Employees for Acquiring,or in Conjunction with, Selling Goods or Services*.

 

Prior to 2006, the Company accounted for grants madeunder its stock option plan in accordance with APB Opinion No. 25, *Accounting for Stock Options Issued to Employees*,as permitted under SFAS No. 123. Under APB Opinion No. 25, theCompany was only required to recognize compensation expenses for optionsgranted to employees for the difference between the fair value of theunderlying common stock and the exercise price of the option at the date ofgrant. The fair value of these options was determined using the minimum valueoption pricing model. Since the exercise price of the Company’s 

 

7

----

Table of Contents

 

stockoption grants issued prior to 2006 was equal to the estimated fair value of theunderlying stock on the grant date, no compensation expense related to optionsgranted to employees was recognized in prior years.

 

The Company’s income before income taxes for thenine months ended September 30, 2008 and 2007 was $2.5 million and $0.3million lower, respectively, and the Company’s after-tax net income for thenine months ended September 30, 2008 and 2007 was $1.4 million and $0.3million lower, respectively, as a result of stock-based compensation expenseincurred. The impact of stock-based compensation expense was $(0.08) and$(0.10) on the basic and diluted earnings per share for the nine months ended September 30,2008 and 2007, respectively.

 

The Company utilized the Black-Scholes valuationmodel for estimating the fair value of the stock options granted after theadoption of SFAS No. 123R with the following weighted averageassumptions:

 
| ** **              | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------|------------|-----------------------------------------------------|------------|
| ** **              | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Expected dividend yield |       | 0                                                   | %          | 0 | % |
| Expected volatility     |       | 50                                                  | %          | 50 | % |
| Risk-free interest rate |       | 2.52                                                | %          | 5.0 | % |
| Expected life           |       | 6.25 years                                          |       | 6.25 years |   |

 

The dividend yield of zero is based on the fact thatthe Company has never paid cash dividends and has no present intention to paycash dividends. Since the Company’s stock was not publicly traded prior to theclosing of its initial public offering, the expected volatility was calculatedfor each date of grant based on an alternative method. The Company identifiedsimilar public entities for which share price information was available andconsidered the historical volatility of these entities’ share price inestimated expected volatility. The risk-free interest rate is derived from theU.S. Federal Reserve rate in effect at the time of grant. The expected lifecalculation is based on the observed and expected time to the exercise ofoptions by the Company’s employees based on historical exercise patterns forsimilar options. Based on the Company’s historical experience of options thatcancel before becoming fully vested, the Company has assumed an annualizedforfeiture rate of 15% for all options. Under the true-up provision ofSFAS No. 123R, the Company will record additional expense if theactual forfeiture rate is lower than estimated, and will record a recovery ofprior expense if the actual forfeiture rate is higher than estimated.

 

Based on the above assumptions, the per shareweighted average fair value of the options granted under the stock option planfor the nine months ended September 30, 2008 and 2007 was $12.20 and$3.44, respectively.

 

Thefollowing table summarizes activity under all stock award plans from December 31,2007 through September 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 shares available for grant  |       | 142,500            |       | —                       |       | — |   |
| Granted                                |       | (473,177           | )          | 473,177                      |       | $ | 27.28 |   |
| Canceled                               |       | 124,974            |       | (124,974                     | )          | $ | 5.82 |   |
| Exercised                              |       | —             |       | (200,062                     | )          | $ | 4.87 |   |
|                                   |       |               |       |                         |       |   |   |
| Balance — September 30, 2008 |       | 373,757            |       | 1,740,885                    |       | $ | 13.39 |   |

 

8

----

Table of Contents

 

In the third quarter of 2008, the Company authorized the cancellationof all existing option grants held by certain employees related to integration,restructuring and other nonrecurring activities with exercise prices rangingfrom $0.70 to $18.30 in exchange for the reissuance of a like amount of optionswith similar exercise prices, These cancellations and reissuances resulted inadditional compensation expense of $0.8 million during the nine months ended September 30,2008, included within integration, restructuring and other nonrecurringcharges.

 

A total of 38,177 of the options included as canceled and grantedduring the three months ended September 30, 2008 in the table above relateto options that were cancelled in exchange for a like amount of options withsimilar exercise prices.

 

Additionalinformation regarding options outstanding is as follows:

 
| ** **                                           | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Range of exercise price (per option)                 |       | $0.70 - $31.18               |       | $0.70 - $9.50               |       |
| Weighted average remaining contractual life  (years) |       | 9.09                         |       | 9.28                        |       |

 

*Employee Stock Purchase Plan*

 

In July 2008 the Company made available an employee stock purchaseplan in which substantially all of the Company’s full-time employees becameeligible to participate effective March 18, 2008. Under the plan,employees may contribute up to 15% of their compensation toward the purchase ofthe Company’s common stock at the lower of 85% of the fair market price on thefirst day of the offering period, or 85% of the fair market price on the day ofpurchase. Proceeds received from the issuance of shares are credited tostockholders’ equity in the period that the shares are issued. Under the termsof the plan, a total of 238,000 shares of common stock have been reserved forissuance to employees. At September 30, 2008, approximately 188,503 sharesremain available for purchase under the plan. Net proceeds to the Company fromthe issuance of shares of common stock under the Plan for the three and ninemonths ended September 30, 2008 were $0.8 million.

 

**New Accounting Pronouncements**

 

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*, whichdefines fair value, establishes a framework for measuring fair value undergenerally accepted accounting principles, and expands disclosures about fairvalue measurements. SFAS No. 157 applies to other accountingpronouncements that require or permit fair value measurements. The new guidanceis effective for the Company beginning January 1, 2008. The Companyadopted SFAS No. 157 on January 1, 2008 and it did not have amaterial effect on the consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159,*The Fair Value Option for Financial Assetsand Financial Liabilities-Including an Amendment of FASB Statement No. 115*.SFAS No. 159 permits entities to choose fair value measurement formany financial instruments and certain other items as of specified election dates.Business entities will thereafter report in earnings the unrealized gains andlosses on items for which the fair value option has been chosen. The fair valueoption may be applied instrument by instrument but may not be applied toportions of instruments and is irrevocable unless a new elections date occurs.The Company did not elect the fair value option of SFAS No. 159 andthus, the adoption of SFAS No. 159 had no impact on the Company.

 

In December 2007, the FASB issued SFAS No. 141(R),*Business Combinations* and SFAS No. 160,*Noncontrolling Interests in ConsolidatedFinancial Statements, an Amendment of ARB No. 151*. SFAS No. 141(R) establishesnew principles and requirements for accounting for business combinations,including recognition and measurement of identifiable assets acquired, goodwillacquired, liabilities assumed and noncontrolling financial interests.SFAS No. 160 requires all entities to report noncontrolling(minority) interests in subsidiaries as equity in the consolidated financialstatements. These new standards will significantly change the accounting forand reporting of business combination transactions and noncontrolling(minority) interests in consolidated financial statements. SFAS No. 141(R) andSFAS No. 160 are required to be adopted simultaneously and areeffective for fiscal years beginning on or after December 15, 2008.Earlier adoption is prohibited. Upon a future acquisition, the Company willevaluate the potential effect of adoption of SFAS No. 141(R) andSFAS No. 160.

 

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

 

On March 8, 2007, the Company acquired all ofthe outstanding capital stock of PDSHeart for an aggregate purchase price of$51.6 million. The $51.6 million purchase price was comprised of$44.3 million cash at closing, $5.2 million in assumed debt,$1.4 million of transaction expenses and the assumption of a$0.7 million liability related to payments due to 

 

9

----

Table of Contents

 

certainkey 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.

 

The acquisition has been included within theconsolidated results of operations from March 8, 2007. The Companybelieves that the acquisition will accelerate its market expansion strategy byproviding immediate access to a sales force with existing physicianrelationships capable of marketing the CardioNet System in areas of the countrywhere it had previously not been sold. A significant portion of the purchaseprice has been allocated to goodwill. The most significant reason is that 75%of PDSHeart revenues are received as patient reimbursement from medicalinsurers and Medicare; however the patients are the customers as they determinethe economic relationship. There is no long-term intangible asset associatedwith these patients so no value has been assigned to this revenue stream.

 

Under the purchase method of accounting, the totalpurchase price is allocated to tangible and identifiable intangible assetsacquired and liabilities assumed based on their estimated fair values. Thefollowing is a summary of the purchase 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 |   |

 

The intangible assets with definite lives are beingamortized on a straight-line basis over lives ranging from two to six years.

 

In connection with the acquisition of PDSHeart, theCompany initiated exit plans for acquired activities that are redundant to theCompany’s existing operations. The plan includes the closure of a facility andthe elimination of 35 positions in the areas of sales, finance, serviceand management. In connection with the plan, the Company established reservesof $0.5 million included in the purchase price allocation. As of September 30,2008, all of the positions had been eliminated and the Company vacated thefacility. The reserve is included in accrued liabilities in the accompanyingconsolidated balance sheet.

 

A summary of the reserve activity related to thePDSHeart acquisition integration plan as of September 30, 2008 is asfollows:

 
| ** **                           | ** ** | **Initial Reserves  Recorded in  Purchase Accounting** | ** ** | **Payments/Adjustments  through  September 30, 2008** | ** ** | **Balance as of  September 30, 2008** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Severance and employee related costs |       | $                                                                     | 366,000    |                                                            | $          | 366,000                                                   |       | $ | — |   |
| Rent abandonment                     |       | $                                                                     | 144,000    |                                                            | $          | 42,610                                                    |       | $ | 101,390 |   |
| Total:                               |       | $                                                                     | 510,000    |                                                            | $          | 408,610                                                   |       | $ | 101,390 |   |

 

Additionally, the Company incurred expenses of $0.8million through September 2008 to integrate these functions, and expectsto incur no additional cost. There is no reserve remaining for post-acquisitionintegration costs as of September 30, 2008. Post-acquisition integrationcosts included severance and employee related costs, IT costs, and otheradministrative costs to complete the integration activities. These costs wereexpensed as incurred in accordance with the SFAS No. 146, *Accounting for Exit or Disposal Activities*, and are included in Integration,restructuring, and other nonrecurring charges.

 

10

----

Table of Contents

 

**4.****    ****Mandatorily RedeemableConvertible Preferred Stock and Shareholders’ Equity (Deficit)**

 

**Mandatorily Redeemable ConvertiblePreferred Stock**

 

In March 2007, the Company sold 110,000 sharesof its mandatorily redeemable convertible preferred stock, or MRCPS, whichgenerated net proceeds to the Company of $102.1 million ($110 million lessoffering costs of $7.9 million). The Company also issued 3,383 shares of MRCPS uponconversion of an outstanding bridge loan and 1,456 shares as consideration to amajor shareholder of PDSHeart as consideration in the PDSHeart acquisition.Accrued dividends were $6.1 million at March 25, 2008.  The MRCPS original purchase price plus accrueddividends were converted to common shares on March 25, 2008 in connectionwith the Company’s initial public offering.

 

**Series A, B, C and DConvertible Preferred Stock**

 

From 1999 to 2004, the Company issued convertiblepreferred stock which generated net proceeds to the Company of $53.5 million.All Series A, B, C and D preferred stock converted to common stock on March 25,2008 in connection with the Company’s initial public offering.

 

**Preferred Stock Warrants**

 

In connection with a borrowing arrangement providedby a bank, the Company issued a warrant in August 2000 to purchase 12,500shares of Series B preferred stock at a price of $1.47 per share. Thewarrant may be exercised at any time on or before August 9, 2010.  In connection with the closing of the Company’sinitial public offering on March 25, 2008, this warrant became exercisablefor 6,250 shares of the Company’s common stock at a price of $2.94 per share.

 

In 2005 and 2006, the Company issued 964,189warrants to purchase shares of its preferred stock at a price of $3.50 pershare to the participants in certain bridge financing transactions and to astockholder in connection with entering into the Amended and RestatedSubordinated Promissory Note with a stockholder. As a result of the MRCPS financing,the warrants became exercisable for shares of the Company’s Series D-1preferred stock. These warrants were automatically net exercised for commonstock on March 25, 2008 in connection with the Company’s initial publicoffering.

 

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

 

During the first quarter of 2008, the Companyinitiated plans to consolidate its Finance and Human Resource functions inPennsylvania. This plan involves the elimination of 7 positions in San Diego.The Company incurred expenses of $1.0 million through September 2008 toconsolidate these functions. The integration was substantially completed as of September 30,2008. These costs were expensed as incurred in accordance with the SFAS No. 146,*Accounting for Exit or Disposal Activities*, and are included in Integration,restructuring and other nonrecurring charges.

 

A summary of the reserve activity related to the SanDiego restructuring plan as of September 30, 2008 is as follows:

 
| ** **                           | ** ** | **Initial Reserve  Recorded** | ** ** | **Payments through  September 30, 2008** | ** ** | **Balance as of  September 30, 2008** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Severance and employee related costs |       | $                                  | 662,000    |                                                    | $          | 335,256                                                   |       | $ | 326,744 |   |
|                                      |            |                                    |            |                                                         |            |                                                           |            |  |  |  |

 

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

 

The Company’s effective tax rate of 42.9% for thenine months ended September 30, 2008 is based on its estimated fiscal 2008pretax income and does not take into account the utilization of the Company’snet operating loss, credit carryforwards or other deferred income tax assetsbecause the Company is still in the process of determining the timing andmanner in which it can utilize such carryforwards and deductions due tolimitations in the Internal Revenue Code applicable to changes in ownership ofcorporations.  The Company is currentlyconducting an analysis to determine the timing and manner of the utilization ofthe net operating loss carryforwards. Following the completion of its analysisof the availability of such carryforwards and future income tax deductions, theCompany will adjust its tax rate accordingly in future quarters.

 

The Company has net deferred income tax assets totalingapproximately $31.2 million at the end of 2007, consisting primarily offederal and state net operating loss and credit carryforwards. The federal andstate net operating loss carryforwards, if unused, will begin to expire in2010. The federal and state credit carryforwards, if unused, will expire in2026. Due to uncertainty regarding the ultimate realization of these netoperating loss and credit carryforwards and other 

 

11

----

Table of Contents

 

deferredincome tax assets, the Company has established a valuation allowance for mostof these assets and will recognize the benefits only as reassessment indicatesthe benefits are realizable.

 

**7.****    ****Recent Events**

 

**Conshohocken Fire**

 

In August 2008, theCompany’s corporate headquarters were affected by a fire at an adjacentconstruction site. The fire caused water and electrical damage in one corner ofthe Company’s building. The Company’s patient monitoring services were notinterrupted. Costs of $0.4 million were incurred through September 30,2008, including $0.2 million of newly acquired fixed assets that have beencapitalized as of the balance sheet date, $0.1 million of fixed asset impairments,and $0.1 million of out of pocket costs.

 

The Company’s insurancepolicy covers all out of pocket costs and damaged fixed assets at replacementvalue, and as such, the Company does not expect to incur a loss as a result ofthe fire damage. As of September 30, 2008, the Company could not estimatethe amount of gain or loss that would be associated with the insurancesettlement. The Company has established an insurance receivable for an amountequal to the out of pocket costs and fixed assets incurred to date. There wasno impact to earnings for the three or nine months ended September 30,2008.

 

**Establishment of a CPT Code for the CardioNet System**

 

The Centers for Medicare and MedicaidServices (CMS) have established Category I Current Procedural Terminology (CPT)codes and reimbursement rates that cover the CardioNet System. The 2009national payment rate for technical support related to use of the CardioNetSystem (CPT 93229) has been carrier priced, meaning similar to today, HighmarkMedicare Service is responsible for setting the reimbursement rate for this newcode. The current technical reimbursement rate established by Highmark MedicareServices is $1,123.  The reimbursementrates assigned to the new codes are consistent with current reimbursementrates. A Category I CPT Code, along with reimbursement, provides strongvalidation of our system for commercial payors that do not currently coverCardioNet in their plans, while also creating a simplified and stablereimbursement environment for the physicians. The new billing codes will allow for automated claims adjudication,substantially simplifying the reimbursement process for physicians and payorscompared to the current process. Reimbursement is currently obtained throughnon-specific billing codes which require various narratives that, in mostcases, involve semi-automated or manual processing, as well as additionalreview by payors.

 

The new Category I CPT codes, which wereestablished by the AMA for the professional and technical components associatedwith the CardioNet System, are:

 

·CPT code 93228 –– Wearable mobile cardiovascular telemetry withelectrocardiographic recording, concurrent computerized real time data analysisand greater than 24 hours of accessible ECG data storage (retrievable withquery) with ECG triggered and patient selected events transmitted to a remoteattended surveillance center for up to 30 days; physician review andinterpretation with report.

 

·CPT code 93229 –– Technical support for connection and patient instructions foruse, attended surveillance, analysis and physician prescribed transmission ofdaily and emergent data reports.

 

**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations.**

 

**Overview**

 

We are the leading provider of ambulatory,continuous, real-time outpatient management solutions for monitoring relevantand timely clinical information regarding an individual’s health. Weincorporated in the state of California in March 1994, but did notactively begin developing our product platform until April 2000. From 2000through 2002, we devoted substantially all of our resources to developing anintegrated patient monitoring platform that incorporates a wireless datatransmission network, internally developed software, FDA-cleared algorithms andmedical devices, and a 24-hour monitoring service center.

 

In February 2002, we received FDA 510(k) clearancefor the first and second generation of our core CardioNet System (MobileCardiac Outpatient Telemetry). We opened the CardioNet Monitoring Center inConshohocken, Pennsylvania in July 2002 and currently provide all of ourCardioNet System arrhythmia monitoring at that location. We established ourrelationship with QUALCOMM Incorporated in May 2003, which provides uswith wireless cellular data connectivity and data hosting and queuing services.Pursuant to our agreement with QUALCOMM, we have no fixed or minimum financialcommitments. However, in the event that we fail to maintain an agreed-uponnumber of active cardiac monitoring devices on 

 

12

----

Table of Contents

 

theQUALCOMM network, or in the event that we begin to utilize the services of aprovider of monitoring and communications services other than QUALCOMM,QUALCOMM has the right to terminate this agreement.

 

In November 2006, we received FDA 510(k) clearancefor our third generation product, or C3, which we have begun to incorporate aspart of our monitoring solution. We had previously received FDA 510(k) clearancefor the proprietary algorithm included in our C3 system in October 2005.

 

In September 2002, we were approved as anIndependent Diagnostic Testing Facility for Medicare. The local Medicarecarrier in Pennsylvania sets the terms for reimbursement of our CardioNetSystem for approximately 40 million covered lives. We have also worked tosecure contracts with commercial payors. We increased the number of contractswith commercial payors from six at year-end 2003 to 41 at year-end 2004, 97 atyear-end 2005, 144 at year-end 2006, 169 at year-end 2007 and 194 at September 30,2008. Over this period of time, we estimate that the number of coveredcommercial lives increased from six million at year-end 2003 to32 million at year-end 2004, 70 million at year-end 2005,102 million at year-end 2006, 120 million at year-end 2007 and150 million at September 30, 2008. The current estimated total of190 million Medicare and commercial lives for which we had reimbursementcontracts as of September 30, 2008 represents approximately 75% of thetotal covered lives in the United States. The majority of the remaining coveredlives are insured by a relatively small number of large commercial insurancecompanies that, beginning in 2003, deemed the CardioNet System to be “experimentaland investigational” and do not currently reimburse us for services provided totheir beneficiaries. We believe a primary reason for the “experimental andinvestigational” designation had 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 which was subsequently published in March 2007.

 

On March 8, 2007, we acquired all of theoutstanding capital stock of PDSHeart for an aggregate purchase price of $51.6 million.The $51.6 million purchase price was comprised of $44.3 million incash at closing, $5.2 million in assumed debt, $1.4 million oftransaction expenses and the assumption of a $0.7 million liabilityrelated to payments due to certain key employees of PDSHeart on March 8,2008. Approximately $1.5 million of the assumed debt was satisfied throughthe issuance of 1,456 shares of our mandatorily redeemable convertiblepreferred stock at an original issue price per share of $1,000. In addition tothe $51.6 million of consideration, the Company agreed to pay PDSHeartshareholders $5.0 million of contingent consideration in the event of aqualifying liquidation event, including a public offering or acquisition.  The Company’s initial public offering wasconsummated on March 25, 2008 and, accordingly, the purchase price for thePDSHeart acquisition has been adjusted to $56.6 million to reflect thispayment. The acquisition has been included in our consolidated results ofoperations 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.

 

For our event, Holter and pacemaker monitoringservices, we have established Medicare reimbursement and we have 106 directcontracts with commercial payors as of September 30, 2008 representing anestimated 135 million covered lives.

 

In March 2007, we raised $110 millionthrough the issuance of mandatorily redeemable convertible preferred stock to,in part, fund the acquisition of PDSHeart.

 

We have undertaken an initiative to improve ouroperational efficiency and future profitability in connection with ouracquisition of PDSHeart in March 2007, mainly through the integration ofoperational and administrative functions. The plan, which was approved at thetime of the PDSHeart acquisition, includes the closure of a facility and theelimination of 35 positions in the areas of sales, finance, service andmanagement. In connection with the plan, the Company established reserves of$0.5 million included in the purchase price allocation.  Additionally, we incurred expenses of $0.8million of employee-related costs to integrate these functions through September 2008.These costs will be expensed as incurred in accordance with the SFAS No. 146,*Accounting for Exit or Disposal Activities*.

 

On February 25, 2008, the Board of Directors ofthe Company, subject to stockholder approval, approved a reverse stock split ofthe Company’s common stock at a ratio of one share for every two sharespreviously held. On March 5, 2008, the stockholders of the Companyapproved the reverse stock split and the reverse stock split became effective.

 

On March 25, 2008, the Company completed itsinitial public offering generating net proceeds of approximately $46.7 millionafter deducting underwriter commissions and estimated offering expenses.

 

13

----

Table of Contents

 

On August 6, 2008, an underwritten secondary publicoffering of shares of common stock held by certain of the Company’s existingstockholders was completed.  The Companydid not issue any shares and received no proceeds in connection with suchoffering.  The Company incurredapproximately $0.9 million in offering expenses on behalf of the sellingstockholders.  These expenses wereincurred in accordance with the Company’s obligations under a registrationrights agreement with the selling stockholders.

 

**Statements of Operations Overview**

 

***Revenues***

 

Our principal source of revenues is patient revenuefrom cardiac monitoring services. The amount of revenue generated is based onthe number of patients enrolled through physician prescriptions and the ratesreimbursed to us by commercial payors, physicians, patients and Medicare. Reimbursementrates are set by the Centers for Medicare and Medicaid Services (“CMS”) on acase rate basis for the Medicare program and through negotiations withcommercial payors who typically pay a daily monitoring rate. From 2002 through September 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.

 

For the event, Holter and pacemaker monitoringmarket we expect the price to be flat or declining as the new generationtechnology gains wider acceptance in the market. In addition, the established2007 Medicare rates compared to 2006 for our event monitoring services declinedby 3% to 8%, depending on the type of service, and our Holter monitoringservices declined 8%. Reimbursement rates for 2008 were flat compared to 2007,and we expect 2009 and 2010 rates to remain consistent with 2008.

 

We believe the CardioNet System revenues willincrease as a percentage of revenues going forward as we emphasize thisservice, continue our geographic expansion and achieve greater marketpenetration in existing markets. We expect that the event, Holter and pacemakermonitoring services revenues will be flat or declining in absolute terms as theold technology is replaced and therefore, decrease as a percentage of revenuesgoing forward. Other revenue consists mainly of web hosting services providedto an affiliate of a stockholder. We believe that other revenues will be flator declining in absolute terms and therefore, decrease as a percentage ofrevenues going forward. Our revenues are seasonal, as the volume ofprescriptions tends to slow down in the summer months due to the more limiteduse of our monitoring solutions as physicians and patients vacation.

 

***Gross Profit***

 

Gross profit consists of revenues less the cost ofrevenues. Cost of revenues includes:

 

·**                 **salaries,benefits and stock-based compensation for personnel providing various servicesand customer support to physicians and patients including patient enrollmentand education, monitoring services, distribution services (scheduling,packaging and delivery of the monitors and sensors to the patients), devicerepair and maintenance, and quality assurance;

 

·**                 **cost ofpatient-related services provided by third-party subcontractors includingdevice transportation to and from the patient, cellular airtime charges relatedto transmission of ECGs to the CardioNet Monitoring Center and cost for in-homecustomer hook-ups when necessary;

 

·**                 **consumablesupplies sent to patients along with the durable components of the CardioNetSystem;

 

·**                 **depreciationon our monitors; and

 

·**                 **service costrelated to special project revenues.

 

Forthe quarter ended September 30, 2008, our gross profit margin was 67.9%.In general, 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 remainflat as we expect reimbursement rates to remain unchanged.

 

14

----

Table of Contents

 

***Sales and Marketing***

 

Sales and marketing expense consists primarily ofsalaries, benefits and stock-based compensation related to account executives,marketing personnel and contracting personnel, account executive commissions,travel and other reimbursable expenses, and marketing programs such as tradeshows and marketing campaigns.

 

Following the completion of our randomized clinicaltrial and the PDSHeart acquisition, we made a significant investment in salesand marketing by increasing the number of account executives in newgeographies. We had a sales force of 81 account executives as of September 30,2008. We currently have account executives covering 48 states. We also plan toincrease our marketing activities. As a result, we expect that sales andmarketing expenses will increase in absolute terms, but will remain flat as apercentage of revenues going forward.

 

***Research and Development***

 

Research and development expense consists primarilyof salaries, benefits and stock-based compensation of personnel and the cost ofsubcontractors who work on the development of the hardware and software for ournext generation monitors, enhance the hardware and software of our existingmonitors and provide quality control and testing. Expenses related to clinicaltrials are also included in research and development expenses. We expect thatresearch and development expenses will increase in absolute terms but decreaseas a percentage of revenues going forward.

 

***General and Administrative***

 

General and administrative expense consistsprimarily of salaries, benefits and stock based compensation related to generaland administrative personnel, professional fees primarily related to legal andaudit fees, facilities expenses and the related overhead, and bad debt expense.We expect that general and administrative expenses will increase in absoluteterms due to the significant planned investment in infrastructure to supportour growth and the additional expenses related to becoming a publicly tradedcompany, including the increased cost of compliance and increased audit feesresulting from the Sarbanes-Oxley Act. As a percentage of revenues, we expectgeneral and administrative expenses to decline as we grow.

 

***Income Taxes***

 

We have net deferred income tax assets totalingapproximately $31.2 million at the end of 2007, consisting primarily offederal and state net operating loss and credit carryforwards. The federal andstate net operating loss carryforwards, if unused, will begin to expire in2010. The federal and state credit carryforwards, if unused, will expire in2026. Due to uncertainty regarding the ultimate realization of these netoperating loss and credit carryforwards and other deferred income tax assets,we have established a valuation allowance for most of these assets and willrecognize the benefits only as reassessment indicates the benefits arerealizable. The Company is currently conducting an analysis to determine thetiming and manner of the utilization of the net operating loss carryforwardsand will adjust our tax rate accordingly in future quarters, beginning thefourth quarter of 2008.

 

**Critical Accounting Policies andEstimates**

 

The discussion and analysis of our financialcondition and results of operations are based on our financial statements,which we have prepared in accordance with US generally accepted accountingprinciples. The preparation of these financial statements requires us to makeestimates and assumptions that affect the reported amount of assets andliabilities, revenues and expenses and related disclosures. We base ourestimates and judgments on historical experience and on various other factorsthat we believe to be reasonable under the circumstances; however actualresults may differ from these estimates. We review our estimates and judgmentson an ongoing basis.

 

We believe that our accounting policies andestimates are most critical to a full understanding and evaluation of ourreported financial results. Our significant accounting policies are more fullydescribed in “Management’s Discussion and Analysis of Financial Condition andResults of Operations – Critical Accounting Policies and Estimates” in ourFinal Prospectus filed with the United States Securities and Exchange Commission,or SEC, pursuant to Rule 424(b) (File No. 333-145547) on March 19,2008.

 

15

----

Table of Contents

 

**Results of Operations**

 

***Quarters Ended September 30, 2008 and2007***

 

*Revenues.*    Total revenues forthe quarter ended September 30, 2008 increased to $31.2 million from$20.5 million for the quarter ended September 30, 2007, an increaseof $10.7 million, or 52.1%. CardioNet System revenue increased$11.1 million, offset by a decrease in PDS revenue of $0.4 million.

 

*Gross Profit.*    Gross profitincreased to $21.2 million for the quarter ended September 30, 2008,or 67.9% of revenues, from $13.4 million for the quarter ended September 30,2007, or 65.4% of revenues. The increase of $7.8 million is due to theincreased revenue from the CardioNet System as well as operational efficienciesachieved and cost reductions negotiated with vendors during 2008.

 

*Sales and Marketing Expense.*    Sales and marketingexpenses were $5.2 million for the quarter ended September 30, 2008compared to $3.9 million for the quarter ended September 30, 2007.The increase of $1.3 million is due to the continued building of the salesoperations infrastructure.  As a percentof total revenues, sales and marketing expenses were 16.7% for the quarterended September 30, 2008 compared to 19.2% for the quarter ended September 30,2007, a decline of 2.5% as the increase in expense was offset by higherrevenue.

 

*Research and Development Expense.*    Research anddevelopment expenses increased to $0.9 million for the quarter ended September 30,2008 compared to $0.8 million for the quarter ended September 30,2007. As a percent of total revenues, research and development expensesdeclined to 2.9% for the quarter ended September 30, 2008 compared to 3.9%for the quarter ended September 30, 2007, a decline of 1.0% primarily dueto the higher revenue.

 

*General and AdministrativeExpense.*    Generaland administrative expenses (including amortization) increased to$10.8 million for the quarter ended September 30, 2008 from$7.1 million for the quarter ended September 30, 2007. This increaseof $3.7 million, or 52.1%, was primarily due to an increase in theprovision for bad debt of $1.9 million, increase in stock compensationexpense of $0.7 million, increase in the bonus accrual of $0.2 million, andincreased insurance, audit and tax fees of $0.6 million that were higher due tothe organization becoming a public entity.

 

*Integration, Restructuring andOther Nonrecurring Charges.*    Integration charges relating to the PDSHeartacquisition were $0.2 million for the quarter ended September 30, 2008.Restructuring charges relating to consolidating our Finance and Human Resourcesfunctions in Pennsylvania were $0.7 million for the quarter ended September 30,2008. Secondary offering costs were $0.9 million, and other nonrecurringcharges were $1.1 million for the quarter ended September 30, 2008. Weincurred no integration, restructuring or other nonrecurring charges in thequarter ended September 30, 2007.

 

In connection with the acquisition of PDSHeart, theCompany initiated exit plans for acquired activities that are redundant to theCompany’s existing operations. The plan includes the closure of a facility andthe elimination of 35 positions in the areas of sales, finance, service andmanagement. In connection with the plan, the Company established reserves of$0.5 million included in the purchase price allocation. For the quarter ended September 30,2008, all of the positions have been eliminated and approximately $0.2 millionof employee-related expenses have been incurred.

 

In addition, in March 2008, the Companyinitiated restructuring plans to consolidate its Finance and Human Resourcesfunctions in Pennsylvania. This plan includes the elimination of sevenpositions in California was substantially completed as of September 30,2008. For the quarter ended September 30, 2008, no positions have beeneliminated and approximately $0.7 million of employee-related expenses havebeen incurred.

 

*Total Interest Income/Expense,Net.*    Netinterest income was $0.3 million for the quarter ended September 30, 2008 and2007.

 

*Income Taxes.*    The Company’seffective tax rate was 43.8% for the quarter ended September 30,2008.  This compares to no income taxbenefit or expense for the quarter ended September 30, 2007. The effectivetax rate is based on our estimated fiscal 2008 pretax income and does not takeinto account our net operating loss carryforwards and other future income taxdeductions because we are still in the process of determining the timing andmanner in which we can utilize such carryforwards and deductions due tolimitations in the Internal Revenue Code applicable to changes in ownership ofcorporations. The Company has approximately $62 million in federal netoperating losses as of December 31, 2007 to offset future taxable incomeexpiring in various years through 2026. Following the completion of our analysis of the availability of suchcarryforwards and future income tax deductions we will adjust our tax rateaccordingly in future quarters, beginning in the fourth quarter of 2008.

 

16

----

Table of Contents

 

*Net Income (Loss).*    Net income was $1.0million for the quarter ended September 30, 2008 compared to net income of$1.8 million for the quarter ended September 30, 2007. As a percentof total revenues, net income was 3.2% for the quarter ended September 30,2008 compared to net income of 8.8% for the quarter ended September 30,2007.

 

***Nine Months Ended September 30, 2008and 2007***

 

*Revenues.*    Total revenues for thenine months ended September 30, 2008 increased to $86.0 million from$49.0 million for the nine months ended September 30, 2007, anincrease of $37.0 million, or 75.5%. CardioNet System revenue increased$34.5 million. Revenue from the event and Holter monitoring businessincreased $2.5 million versus the prior year due to the full period effect in2008 of the PDSHeart acquisition that was consummated on March 8, 2007.

 

*Gross Profit.*    Gross profitincreased to $56.7 million for the nine months ended September 30,2008, or 65.9% of revenues, from $32.2 million for the nine months ended September 30,2007, or 65.7% of revenues. The increase of $24.5 million is primarily due toincreased CardioNet System revenue compared to our lower margin event and Holterbusiness.

 

*Sales and Marketing Expense.*    Sales and marketingexpenses were $15.7 million for the nine months ended September 30,2008 compared to $11.6 million for the nine months ended September 30,2007. The increase of $4.1 million is due primarily to the full periodeffect of the PDSHeart acquisition of $1.1 million and the increased salesoperations infrastructure buildup of $3.0 million. As a percent of totalrevenues, sales and marketing expenses were 18.3% for the nine months ended September 30,2008 compared to 23.7% for the nine months ended September 30, 2007, adecline of 5.4% as the increase in expense was offset by higher revenue.

 

*Research and Development Expense.*    Research anddevelopment expenses increased to $3.0 million for the nine months ended September 30,2008 compared to $2.8 million for the nine months ended September 30,2007. As a percent of total revenues, research and development expensesdeclined to 3.5% for the nine months ended September 30, 2008 compared to5.7% for the nine months ended September 30, 2007, a decline of 2.2%primarily due to higher revenue.

 

*General and AdministrativeExpense.*    Generaland administrative expenses (including amortization) increased to$29.8 million for the nine months ended September 30, 2008 from$19.4 million for the nine months ended September 30, 2007. Thisincrease of $10.4 million, or 53.6%, was primarily due to an increase inthe provision for bad debt of $3.2 million, increased infrastructure dueto Company growth, increased bonus accrual of $1.2 million, increased insurancecosts, audit and tax fees of $1.4 million that were higher due to theorganization becoming a public entity, stock based compensation of $0.9million, increased legal fees of $0.8 million, and increased amortization dueto the PDSHeart acquisition of $0.2 million. As a percent of total revenues,general and administrative expenses declined to 34.7% for the nine months endedSeptember 30, 2008 compared to 39.6% for the nine months ended September 30,2007, a decrease of 4.9% as the increase in expense was offset by the higherrevenue.

 

*Integration, Restructuring andOther Nonrecurring Charges.*    The Company has incurred integration andrestructuring costs as well as $1.0 million related to the resolution of intellectualproperty litigation for the nine months ended September 30, 2008.  Integration charges relating to the PDSHeartacquisition were $0.8 million for the nine months ended September 30,2008. Restructuring charges relating to consolidating our Finance and HumanResources functions in Pennsylvania were $1.0 million for the nine months endedSeptember 30, 2008. Secondary offering costs were $0.9 million, and othernonrecurring charges related to the departure of certain directors were $1.1million for the nine months ended September 30, 2008. We incurred nointegration, restructuring or other nonrecurring charges in the quarter ended September 30,2007.

 

In connection with the acquisition of PDSHeart, theCompany initiated exit plans for acquired activities that are redundant to theCompany’s existing operations. The plan includes the closure of a facility andthe elimination of 35 positions in the areas of sales, finance, service andmanagement. In connection with the plan, the Company established reserves of$0.5 million included in the purchase price allocation. As of September 30,2008, all of the positions have been eliminated and approximately $0.8 millionof employee-related expenses have been incurred.

 

In addition, in March 2008, the Company initiatedrestructuring plans to consolidate its Finance and Human Resources functions inPennsylvania. This plan includes the elimination of 7 positions in Californiaand is substantially complete as of September 30, 2008. As of September 30,2008, five positions have been eliminated and approximately $1.0 million ofemployee-related expenses have been incurred.

 

17

----

Table of Contents

 

*Total Interest Income/Expense,Net.*    Netinterest income was $0.7 million for the nine months ended September 30,2008 compared to net interest expense of $0.8 million for the nine monthsended September 30, 2007. This decrease in interest expense on a net basisis due to the payoff of debt which occurred in 2007.

 

*Income Taxes.*    The Company’seffective tax rate was 42.9% for the nine months ended September 30,2008.  This compares to no income taxbenefit or expense for the quarter ended September 30, 2007. The effectivetax rate is based on our estimated fiscal 2008 pretax income and does not takeinto account our net operating loss carryforwards and other future income taxdeductions because we are still in the process of determining the timing and mannerin which 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, beginning in the fourth quarter of 2008.

 

*Net Income (Loss).*    Net income was $2.3million for the nine months ended September 30, 2008 compared to a netloss of $2.5 million for the nine months ended September 30, 2007. Asa percent of total revenues, net income was 2.6% for the nine months ended September 30,2008 compared to a net loss of 5.0% for the nine months ended September 30,2007.

 

**Liquidity and Capital Resources**

 

From our inception in 1999 through September 30,2008, we did not generate sufficient cash flows to fund our operations and thegrowth of our business. As a result, prior to the completion of our initialpublic offering, our operations were financed primarily through the privateplacement of equity securities and both long-term and short-term debtfinancings.  Notably, we completed afinancing involving shares of our mandatorily redeemable convertible preferredstock in March 2007, in which we received net proceeds of approximately$102.1 million, and completed our initial public offering in March 2008,in which we received net proceeds, after underwriting discounts and offeringexpenses, of approximately $46.7 million. Through September 30, 2008, wefunded our business primarily through the following:

 

·                  initial publicoffering that provided net proceeds of approximately $46.7 million, afterdeducting underwriting commissions and offering expenses;

 

·                  issuance ofmandatorily redeemable convertible preferred stock that provided gross proceedsof $110 million, of which $45.9 million was used to acquire PDSHeart;

 

·                  issuance ofpreferred stock that provided gross proceeds of $53.7 million;

 

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

 

·                  bank debt fromSilicon Valley Bank consisting of a term loan of $3.0 million, which wasrepaid on April 1, 2008, and a working capital line secured by accountsreceivable of $1.9 million, which was repaid from the proceeds of themandatorily redeemable convertible preferred stock.

 

As of September 30, 2008, our principal sourceof liquidity was cash and cash equivalents totaling $56.3 million and netaccounts receivable of $35.9 million.

 

Our cash flow from operations increased by $3.4million to $4.3 million in the first nine months of 2008 from $0.9 million inthe first nine months of 2007. The increase is due primarily to taxable netincome growth as adjusted to exclude non cash depreciation and amortization andstock compensation expense, and favorable changes in accrued liabilities. Theincreases in cash from operations were offset by changes in accountsreceivable, prepaid expenses, and other assets.

 

We used net cash in investing activities of $11.9million in the first nine months of 2008, compared to $56.0 million in thefirst nine months of 2007, a decrease of $44.1 million. The decrease isprimarily due to the consummation of the PDSHeart acquisition in March 2007for a net cash effect of $46.9 million, partially offset by additional cashpayments to PDSHeart shareholders in 2008 of $5.0 million as a result of thecontingent note payment due as a result of our initial public offering combinedwith lower capital expenditures in 2008.

 

We generated net cash from financing activities of$45.7 million in the first nine months of 2008, compared to $73.8 million inthe first nine months of 2007, a decrease of $28.1 million. The decrease isprimarily due to the mandatorily redeemable convertible preferred stockfinancing in the first quarter of 2007 which generated net proceeds of $102.1million, 

 

18

----

Table of Contents

 

partiallyoffset by the retirement of debt of $29.3 million in 2007 compared to the netcash proceeds from common stock issuance in 2008 of $48.3 million, excludingoffering expenses, partially offset by $3.1 million in debt repayment mainlyattributable to the retirement of Silicon Valley Bank debt.

 

We believe that our existing cash and cashequivalent balances and revenues from our operations will be sufficient to meetour anticipated cash requirements for the foreseeable future.

 

Our future funding requirements will depend on manyfactors, including:

 

·                  the costsassociated with developing, manufacturing and building our inventory of ourfuture monitoring solutions;

 

·                  the costs ofhiring additional personnel and investing in infrastructure to support futuregrowth;

 

·                  thereimbursement rates associated with our products and services;

 

·                  actions taken bythe FDA and other regulatory authorities affecting the CardioNet System andcompetitive products;

 

·                  our ability tosecure contracts with additional commercial payors providing for thereimbursement of our services;

 

·                  the emergence ofcompeting technologies and products and other adverse market developments;

 

·                  the costs ofpreparing, filing, prosecuting, maintaining and enforcing patent claims andother intellectual property rights or defending against claims of infringementby others; and

 

·                  the costs ofinvesting in additional lines of business outside of arrhythmia monitoringsolutions.

 

To the extent that we raise additional capital byissuing equity securities, our stockholders’ ownership will be diluted. Inaddition, if we determine that we need to raise additional capital, suchcapital may not be available on reasonable terms, or at all. If we raiseadditional funds by issuing equity securities, substantial dilution to existingstockholders would likely result. If we raise additional funds by incurringadditional debt financing, the terms of the debt may involve significant cashpayment obligations as well as covenants and specific financial ratios that mayrestrict our ability to operate our business.

 

**Item3. Quantitative and Qualitative Disclosures about Market Risk.**

 

Our cash and cash equivalents as of September 30, 2008 consistedprimarily of cash and money market funds with maturities of less than 90days.  The primary objective of ourinvestment activities is to preserve our capital for the purpose of fundingoperations while, at the same time, maximizing the income we receive from ourinvestments without significantly increasing risk. To achieve this objective,our investment policy allows us to maintain a portfolio of cash equivalents andshort term investments in a variety of securities including money market fundsand corporate debt securities. Due to the short term nature of our investments,we believe we have no material exposure to interest rate risk.

 

**Item4T. Controls and Procedures.**

 

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourperiodic reports filed with the SEC is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and formsand that such information is accumulated and communicated to our management,including our chief executive officer and chief financial officer, asappropriate, to allow for timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and no evaluation of controls and procedures can provideabsolute assurance that all control issues and instances of fraud, if any,within a company have been detected. Management is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

 

As required by Rule 13a-15(b) of theSecurities Exchange Act of 1934, as amended, or Exchange Act, prior to thefiling of this report we carried out an evaluation, under the supervision andwith the participation of our management, including our chief executive officerand chief financial officer, of the effectiveness of the design and operationof our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act) as of the end of the period covered by this

 

19

----

Table of Contents

 

report.Based on their evaluation, our chief executive officer and chief financialofficer concluded that our disclosure controls and procedures were effective asof the end of the period covered by this report.

 

In addition, management, including our chiefexecutive officer and chief financial officer, did not identify any change inour internal control over financial reporting that occurred during our latestfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II - OTHER INFORMATION.**

 

**Item 1.  Legal Proceedings.**

 

On November 26, 2007, we filed a lawsuit againstLifeWatch Corp. and certain of its employees in the United States DistrictCourt for the Northern District of Illinois, Eastern Division. In the action,we allege several causes of action including trade secret misappropriation,breach of contract, fraud, and unfair competition arising from actions ofLifeWatch and its employees to unlawfully obtain, use, inspect and test two ofour CardioNet System kits. On January 4, 2008, LifeWatch responded byfiling counterclaims in the action against us. In its counterclaims, LifeWatchalleged that we misappropriated trade secrets of LifeWatch through inspectionof a LifeWatch device, and that we have made misleading advertising andmarketing statements relating to LifeWatch. In May 2008, the partiesentered into a settlement agreement pursuant to which the parties amicablyagreed to resolve the lawsuit with dismissal by both sides of all claimspending in the lawsuit.

 

**Item 1A.  Risk Factors.**

 

*You should consider carefully the followinginformation about the risks described below, together with the otherinformation contained in this Quarterly Report and in our other public filingsin evaluating our business. We have marked with an asterisk (*) those riskfactors that reflect substantive changes from the risk factors included in ourfinal prospectus filed by the Company with the Securities and ExchangeCommission on March 19, 2008 relating to the Company’s RegistrationStatement on Form S-1/A (File No. 333-145547) for the Company’sinitial public offering. If any of the following risks actually occurs, ourbusiness, financial condition, results of operations and future growthprospects would likely be materially and adversely affected. In thesecircumstances, the market price of our common stock would likely decline.*

 

**Risks related to our business and industry**

 

****We have a historyof net losses and may not be able to sustain profitability.***

 

We incurred net losses from our inception through March 31,2008.  For the quarter ending September 30,2008, we realized net income of $1.0 million. As of September 30, 2008, we had total stockholders’ deficit ofapproximately $79.4 million. We expect our operating expenses to increase aswe, among other things:

 

·                  expand our salesand marketing activities;

 

·                  invest indesigning, manufacturing and building our inventory of future generations ofthe CardioNet System;

 

·                  hire additionalpersonnel;

 

·                  invest ininfrastructure; and

 

·                  incur theadditional expenses associated with being a public company.

 

With increasing expenses, we will need to continue to increase ourrevenues to remain profitable.  Becauseof the risks and uncertainties associated with further developing and marketingthe CardioNet System, we are unable to predict the extent of any future incomeor losses.

 

20

----

Table of Contents

 

***Our business isdependent upon physicians prescribing our services; if we fail to obtain thoseprescriptions, our revenues could fail to grow and could decrease.***

 

The success of our business is dependent upon physicians prescribingour services for patients and cross-selling the respective CardioNet and PDSHeartcustomer bases. Our success in obtaining prescriptions and cross-selling willbe directly influenced by a number of factors, including:

 

·                  the ability ofthe physicians with whom we work to obtain sufficient reimbursement and be paidin a timely manner for the professional services they provide in connectionwith the use of our arrhythmia monitoring solutions, particularly the CardioNetSystem;

 

·                  our ability toeducate physicians regarding, and convince them of, the benefits of theCardioNet System over existing treatment methods such as Holter monitors andevent monitors; and

 

·                  the perceivedclinical efficacy of the CardioNet System.

 

If we are unable to educate physicians regarding the benefits of theCardioNet System, obtain sufficient prescriptions and cross-sell our respectivecustomer bases, revenues from the provision of our arrhythmia monitoringsolutions could fail to grow and could decrease.

 

***We and thephysicians with whom we work are dependent upon reimbursement for the feesassociated with our services; the absence or inadequacy of reimbursement wouldcause our revenues to fail to grow or decrease.***

 

We receive reimbursement for our services from commercial payors andfrom Medicare Part B carriers where the services are performed on behalfof the Centers for Medicare and Medicaid Services, or CMS. The Medicare Part Bcarriers in each state change from time to time, which may result in changes toour reimbursement rates, increased administrative burden and reimbursementdelays.

 

In addition, our prescribing physicians receive reimbursement forprofessional interpretation of the information provided by our products andservices from commercial payors or Medicare carriers within the state wherethey practice. The efficacy, safety, performance and cost-effectiveness of ourproducts and services, on a stand-alone basis and relative to competingservices, will determine the availability and level of reimbursement we and ourprescribing physicians receive. Our ability to successfully contract withpayors is critical to our business because physicians and their patients willselect arrhythmia monitoring solutions other than ours in the event that payorsrefuse to adequately reimburse our technical fees and physicians’ professionalfees.

 

Many commercial payors refuse to enter into contracts to reimburse thefees associated with medical devices or services that such payors determine tobe “experimental and investigational”. Commercial payors typically labelmedical devices or services as “experimental and investigational” until suchdevices or services have demonstrated product superiority evidenced by arandomized clinical trial. We completed a clinical trial in which the CardioNetSystem provided higher diagnostic yield than traditional loop event monitoring.Prior to our clinical trial, the CardioNet System was labeled “experimental andinvestigational” by 21 targeted commercial payors, representing approximately95 million covered lives. Subsequent to our trial, four commercial payors,representing over 37 million covered lives, removed the designation of theCardioNet System as “experimental and investigational”. Several of theremaining payors, however, have informed us that they do not believe the datafrom this trial justifies the removal of this designation. Other commercialpayors may also find the data from our clinical trial not compelling.Additional commercial payors may also label the CardioNet System as “experimentaland investigational” and, as a result, refuse to reimburse the technical andprofessional fees associated with the CardioNet System.

 

Administration of the claims process for the many commercial payors iscomplex. As a result we sometimes bill payors for services for which we have noreimbursement contract. These payors may require that we return any funds thatthey pay in respect of these claims.

 

If commercial payors or Medicare decide not to reimburse our servicesor the related services provided by physicians, or the rates of suchreimbursement change, or if we fail to properly administer claims, our revenuescould fail to grow and could decrease.

 

****Reimbursement byMedicare is highly regulated and subject to change; our failure to comply withapplicable regulations, could decrease our revenues and may subject us topenalties or have an adverse impact on our business.***

 

We receive approximately 33% of our revenues as reimbursement fromMedicare. The Medicare program is administered by Centers for Medicare & MedicaidServices, or CMS, which imposes extensive and detailed requirements on 

 

21

----

Table of Contents

 

medical services providers, including, but not limited to, rules thatgovern how we structure our relationships with physicians, how and when wesubmit reimbursement claims, how we operate our monitoring facilities and howand where 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.

 

In addition, reimbursement from Medicare is subject to statutory andregulatory changes, 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 of servicesreimbursed by Medicare. Although this modification to Medicare’s reimbursementrates did not affect the amount paid by Medicare for reimbursement of the feesassociated with the CardioNet System, it resulted in the reduction ofreimbursement rates for event services by 3% to 8%, depending on the type ofservice, and Holter services by 8% as compared to the corresponding rates ineffect in 2006. Reimbursement rates for 2008 were flat compared to 2007,and we expect 2009 and 2010 rates to remain consistent with 2008. Inaddition, we cannot predict whether future modifications to Medicare’sreimbursement policies could reduce or eliminate the amounts we receive fromMedicare for the solutions we provide. In addition, Medicare’s reimbursementrates can affect the rate that commercial payors are willing to pay for ourproducts and services. Consequently, any future elimination, limitation orreduction in the reimbursement rates provided by Medicare for our arrhythmiamonitoring solutions could result in a reduction in the rates we receive fromcommercial payors.

 

****A reduction in thepublished reimbursement rates could negatively impact our business and ouroperating results.***

 

Carrier pricing for our services is established by Highmark MedicareServices for 2009 and beyond. We have no reason to believe the reimbursementrate to be reduced in the foreseeable future. However, it is possible that therate could decline. A decrease in the reimbursement rate for our services wouldadversely affect our business and operating results.

 

****A reduction insales of our services or a loss of one or more of our key commercial payorswould adversely affect our business and operating results.***

 

A small number of commercial payors represent a significant percentageof our revenues. In the quarter ended September 30, 2008, our top 10commercial payors by revenues accounted for approximately 32.0% of our totalrevenues. Our agreements with these commercial payors typically allow eitherparty to the contract to terminate the contract by providing between 60 and120 days prior written notice to the other party at any time following theend of the initial term of the contract. Our commercial payors may elect toterminate or not to renew their contracts with us for any reason and, in someinstances can unilaterally change the reimbursement rates they pay. In theevent any of our key commercial payors terminate their agreements with us,elect not to renew their agreements with us or elect not to enter into newagreements with us upon expiration of their agreements with us on terms asfavorable as our current agreements, our business, operating results andprospects would be adversely affected.

 

***Consolidation ofcommercial payors could result in payors eliminating coverage of our CardioNet Systemor reduced reimbursement rates for our CardioNet System.***

 

The commercial payor industry is undergoing significant consolidation.When payors combine their operations, the combined company may elect toreimburse our CardioNet System at the lowest rate paid by any of theparticipants in the consolidation. If one of the payors participating in theconsolidation does not reimburse for the CardioNet System at all, the combinedcompany may elect not to reimburse for the CardioNet System. Our reimbursement ratestend to be lower for larger payors. As a result, as payors consolidate, ouraverage reimbursement rate may decline.

 

***Our acquisition ofPDSHeart, as well as any other companies or technologies we may acquire in thefuture, could prove difficult to integrate and may disrupt our business andharm our operating results and prospects.***

 

Our acquisition of PDSHeart involves numerous risks, including the riskthat we will not take advantage of the cross-selling opportunities broughtabout by the acquisition. In addition, our acquisition of PDSHeart, as well asacquisitions in which we may engage in the future, involve risks associatedwith our assumption of the liabilities of an acquired company, which may beliabilities that we were or are unaware of at the time of the acquisition,potential write-offs of acquired assets and potential loss of the acquiredcompany’s key employees or customers.

 

We may encounter difficulties in successfully integrating ouroperations, technologies, services and personnel with that of the acquiredcompany, and our financial and management resources may be diverted from ourexisting operations. For 

 

22

----

Table of Contents

 

example, following our acquisition of PDSHeart, we have offices inPennsylvania, California, Florida, Georgia and Minnesota. Our offices inmultiple states create a strain on our ability to effectively manage ouroperations and key personnel. If we elect to consolidate our facilities we maylose key personnel 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.

 

Physician and patient satisfaction or performance problems with anacquired business, technology, service or device could also have a materialadverse effect on our reputation. Additionally, potential disputes with theseller of an acquired business or its employees, suppliers or customers andamortization expenses related to goodwill and other intangible assets couldadversely affect our business, operating results and financial condition.

 

We may not be able to realize the anticipated benefits of the PDSHeartacquisition or any other acquisition we may pursue or to profitably deployacquired assets. If we fail to properly evaluate and execute acquisitions, ourbusiness may be disrupted and our operating results and prospects may beharmed.

 

****If we are unable tomanage our expected growth, our revenues and operating results may be adverselyaffected.***

 

Our business plans call for rapid expansion of our sales and marketingoperations and growth of our research and development, product development andadministrative operations. We had a sales force of 81 account executives at September 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 isdependent upon having sufficient monitors and sensors. If we do not have enoughmonitors or sensors or experience delays in manufacturing, we may be unable tofill prescriptions in a timely manner, physicians may elect not to prescribethe CardioNet System, and our revenues and growth prospects could be harmed.***

 

When a physician prescribes the CardioNet System to a patient, ourcustomer service department begins the patient hook-up process, which includesprocuring a monitor and sensors from our distribution department and sendingthem to the patient. While our goal is to provide each patient with a monitorand sensors in a timely manner, we have experienced and may in the futureexperience delays due to the availability of monitors, primarily whenconverting to a new generation of monitor or, more recently, in connection withthe increase in prescriptions following our acquisition of PDSHeart.

 

We may also experience shortages of monitors or sensors due tomanufacturing difficulties. Multiple suppliers provide the components used inthe CardioNet System, but our facilities in San Diego, California areregistered and approved by the United States Food and Drug Administration, orFDA, as the ultimate manufacturer of the CardioNet System. Our manufacturingoperations could be disrupted by fire, earthquake or other natural disaster, awork stoppage or other labor-related disruption, failure in supply orother logistical channels, electrical outages or other reasons. If there was adisruption to our facilities in San Diego, we would be unable to manufacturethe CardioNet System until we have restored and re-qualified our manufacturingcapability or developed alternative manufacturing facilities.

 

Our success in obtaining future prescriptions from physicians isdependent upon our ability to promptly deliver monitors and sensors to ourpatients, and a failure in this regard would have an adverse effect on ourrevenues and growth prospects.

 

****Interruptions ordelays in telecommunications systems or in the data services provided to us byQUALCOMM or the loss of our wireless or data services could impair the deliveryof our CardioNet System services.***

 

The success of the CardioNet System is dependent upon our ability tostore, 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 

 

23

----

Table of Contents

 

the third party wireless carrier terminates, in the event wefail to maintain an agreed-upon number of active cardiac monitoring devices onthe QUALCOMM network or in the event that we begin to utilize the services of aprovider of monitoring and communication services other than QUALCOMM.We have no control over the status of the agreement between QUALCOMM and thewireless carrier. If we fail to maintain our relationships with QUALCOMM or ifwe lose wireless carrier services, we would be forced to seek alternativeproviders of data transmission and data hosting services, which might not beavailable on commercially reasonable terms or at all.

 

As we expand our commercial activities, an increased burden will beplaced upon our 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.

 

Our systems are vulnerable to damage or interruption from earthquakes,floods, fires, power loss, telecommunication failures, terrorist attacks,computer viruses, break-ins, sabotage, and acts of vandalism. Despite anyprecautions that we may take, the occurrence of a natural disaster or otherunanticipated problems could result in lengthy interruptions in these services.We do not carry business interruption insurance to protect against losses thatmay result from interruptions in service as a result of system failures.Moreover, the communications and information technology industries are subjectto rapid and significant changes, and our ability to operate and compete isdependent in significant part on our ability to update and enhance thecommunication technologies used in our systems and services.

 

***The market forarrhythmia monitoring solutions is highly competitive. If our competitors areable to develop or market monitoring solutions that are more effective, or gaingreater acceptance in the marketplace, than any solutions we develop, ourcommercial opportunities will be reduced or eliminated.***

 

The market for arrhythmia monitoring solutions is evolving rapidly andbecoming increasingly 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.

 

****If we need to raiseadditional funding in the future, we may be unable to raise such capital whenneeded, or at all, and the terms of such capital may be adverse to our stockholders.***

 

We believe that the net proceeds from our initial public offering,together with our existing cash and cash equivalent balances, will besufficient to meet our anticipated cash requirements for the foreseeablefuture. However, our future funding requirements will depend on many factors,including:

 

·                  the costsassociated with manufacturing and building our inventory of our C3 monitor;

 

·                  the costs ofhiring additional personnel and investing in infrastructure to support futuregrowth;

 

·                  the reimbursementrates associated with our products and services;

 

·                  actions taken bythe FDA, CMS and other regulatory authorities affecting the CardioNet Systemand competitive products;

 

·                  our ability tosecure contracts with additional commercial payors providing for thereimbursement of our services;

 

·                  the emergence ofcompeting technologies and products and other adverse market developments;

 

·                  the costs ofpreparing, filing, prosecuting, maintaining and enforcing patent claims andother intellectual property rights or defending against claims of infringementby others; and

 

·                  the costs ofinvesting in additional lines of business outside of arrhythmia monitoringsolutions.

 

24

----

Table of Contents

 

If we need to, or choose to, raise additional capital in the future,such capital may not be available on reasonable terms, or at all. If we raiseadditional funds 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 our abilityto operate our business.

 

***Our manufacturingfacilities and the manufacturing facilities of our suppliers must comply withapplicable regulatory requirements. If we or our suppliers fail to achieve ormaintain regulatory approval of these manufacturing facilities, our growthcould be limited and our business could be harmed.***

 

We currently manufacture the monitors and sensors for the CardioNetSystem in San Diego, California. Monitors used in the provision of services byPDSHeart are purchased from several third parties. In order to maintaincompliance with FDA and other regulatory requirements, our manufacturingfacilities must be periodically re-evaluated and qualified under a qualitysystem to ensure they meet production and quality standards. Suppliers ofcomponents of and products used to manufacture the CardioNet System and themanufacturers of the monitors used in the provision of services by PDSHeartmust also comply with FDA and foreign regulatory requirements, which oftenrequire significant resources and subject us and our suppliers to potentialregulatory inspections and stoppages. We or our suppliers may not satisfy theserequirements. If we or our suppliers do not maintain regulatory approval for ourmanufacturing operations, our business would be harmed.

 

***Our dependence on alimited number of suppliers may prevent us from delivering our devices on atimely basis.***

 

We currently rely on a limited number of suppliers of components forthe CardioNet System. If these suppliers became unable to provide components inthe volumes needed or at an acceptable price, we would have to identify andqualify acceptable 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 subjectto medical liability or product liability claims which may not be covered byinsurance and which would adversely affect our business and results ofoperations.***

 

The design, manufacture and marketing of services of the types weprovide entail an inherent risk of product liability claims. Any such claimsagainst us may require us to incur significant defense costs, irrespective ofwhether such claims have merit. In addition, we provide information to healthcare providers and payors upon which determinations affecting medical care aremade, and claims may be made against us resulting from adverse medicalconsequences to patients resulting from the information we provide. Inaddition, we may become subject to liability in the event that the monitors andsensors we use fail to correctly record or transfer patient information or ifwe provide incorrect information to patients or health care providers using ourservices. We have also agreed to indemnify QUALCOMM for any claims resultingfrom the provision of our services. If we incur one or more significant claimsagainst us, if we are required to indemnify QUALCOMM as a result of theprovision of our services, or if we are required to undertake remedial actionsin response to any such claims, such claims or actions would adversely affectour business and results of operations.

 

Our liability insurance is subject to deductibles and coveragelimitations. In addition, our current insurance may not continue to beavailable to us on acceptable terms, if at all, and, if available, thecoverages may not be adequate to protect us against any future claims. If weare unable to obtain insurance at an acceptable cost or on acceptable termswith adequate coverage or otherwise protect against any claims against us, wewill be exposed to significant liabilities, which may harm our business.

 

****If we do not obtainand maintain adequate protection for our intellectual property, the value ofour technology and devices may be adversely affected.***

 

Our business and competitive positions are dependent in part upon ourability to protect our proprietary technology. To protect our proprietaryrights, we rely on a combination of trademark, copyright, patent, trade secretand other intellectual 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.

 

25

----

Table of Contents

 

Asof July 21, 2008, we had 14 issued U.S. patents, nine foreign patents and40 pending U.S., foreign and international patent applications relating tovarious aspects of the CardioNet System. As of November 3, 2008, we alsohad 11 trademark registrations in the United States for a variety of word marksand slogans. We do not believe that any single patent, trademark or otherintellectual property right of ours, or combination of our intellectualproperty rights, is likely to prevent others from competing with us using asimilar business model. There are many issued patents and patent applicationsheld by others in our industry and the electronics field. Our competitors mayindependently develop technologies that are substantially similar or superiorto our technologies, or design around our patents or other intellectualproperty to avoid infringement. In addition, we may not apply for a patentrelating to products or processes that are patentable, we may fail to receiveany patent for which we apply or have applied, and any patent owned by us orissued to us could be circumvented, challenged, invalidated, or held to beunenforceable, 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.

 

Althoughthird parties may infringe our patents and other intellectual property rights,we may not be aware of any such infringement, or we may be aware of potentialinfringement but elect not to seek to prevent such infringement or pursue anyclaim of infringement, and the third party may continue its potentiallyinfringing activities. For example, we believe that LifeWatch Corp. may beinfringing our intellectual property rights. Any decision whether or not totake further action in response to potential infringement of our patent orother intellectual property rights may be based on any one or more of a varietyof factors, 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.

 

To protect our trade secrets and other proprietary information, wegenerally require our employees, consultants, contractors and outsidecollaborators to enter into written nondisclosure agreements. These agreements,however, may not provide adequate protection to prevent any unauthorized use,misappropriation or disclosure of our trade secrets, know-how or otherproprietary information. These agreements may be breached, and we may notbecome aware of, or have adequate remedies in the event of, any such breach.Also, others may independently develop the same or substantially equivalentproprietary information and techniques or otherwise gain access to our tradesecrets.

 

****Our ability tomarket our services may be impaired by the intellectual property rights ofthird parties.***

 

Our success is dependent in part upon our ability to avoid infringingthe patents or proprietary rights of others. Our industry and the electronicsfield are characterized by a large number of patents, patent filings andfrequent litigation based on allegations of patent infringement. Competitorsmay have filed applications for or have been issued patents and may obtainadditional patents and proprietary rights related to devices, services orprocesses that we compete with or are similar to ours. We may not be aware ofall of the patents or patent applications potentially adverse to our intereststhat may have been or may later be issued to or filed by others.

 

U.S. patent applications may be kept confidential while pending in thePatent and Trademark Office. If other companies have or obtain patents relatingto our products or services, we may be required to obtain licenses to thosepatents or to develop or obtain alternative technology. We may not be able toobtain any such licenses on acceptable terms, or at all. Any failure to obtainsuch licenses could impair or foreclose our ability to make, use, market orsell our products and services.

 

Basedon the litigious nature of our industry and the electronics field and the factthat we may pose a competitive threat to some companies who own or controlvarious patents, it is always possible that one or more third parties mayassert a patent infringement claim seeking damages and to enjoin themanufacture, use, sale and marketing of our products and services. If athird-party asserts that we have infringed its patent or proprietary rights, wemay become involved in intellectual property disputes and litigation that wouldbe costly and time-consuming and could impair or foreclose our ability to make,use, market or sell our products and services. For example, a competitorinitiated a patent infringement lawsuit against us in November 2004, whichwe defended and ultimately settled in March 2006. Other lawsuits may havealready been filed against us without our knowledge. LifeWatch Corp. hasasserted or made statements suggesting that it believes we are infringing itsintellectual property rights. Additionally, we have received and expect tocontinue to receive notices from other third parties suggesting or assertingthat we are infringing their patents and inviting us to license such patents.We do not believe, however, that we are infringing LifeWatch’s or any otherparty’s patents or that a license to any such patents is 

 

26

----

Table of Contents

 

necessary.Should litigation over such patents arise, which could occur if, for example, athird party files a lawsuit alleging infringement of such patents or if we filea lawsuit challenging such patents as being invalid or unenforceable, we intendto vigorously 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 highlydependent on our President and Chief Executive Officer, Chief Financial Officerand other key employees, and if we are not able to retain them or to recruitand retain additional qualified personnel, our business may suffer.***

 

Weare highly dependent upon our President and Chief Executive Officer, ChiefFinancial Officer and other key employees. The loss of their services couldhave a material adverse effect on our business, financial condition and resultsof operations. The employment of our executive officers and key employees withus is “at will”, and each employee can terminate his or her relationship withus at any time .

 

We will need to hire additional senior executives and qualifiedscientific, commercial, regulatory, sales, quality assurance and control andadministrative personnel as we continue to expand our commercial activities. Wemay not be able to attract and retain qualified personnel on acceptable termsgiven the competition for such personnel among companies that providearrhythmia monitoring solutions. We have offices in Pennsylvania, California,Florida, Georgia and Minnesota. Competition for personnel with arrhythmiamonitoring experience in each of those areas is intense. If we fail toidentify, attract, retain and motivate these highly skilled personnel, or if welose current employees, we may be unable to continue our business operations.

 

***Our businessoperations could be significantly disrupted if we fail to properly integrateour management team.***

 

Our Chief Executive Officer and Chief Financial Officer recently joinedCardioNet and are being integrated into our management team. Each of theseofficers will have significant responsibility for our operations and success,but have only limited experience with our business. If they do not smoothly andrapidly develop knowledge of our business and integrate with our existing management,our business operations could be significantly disrupted.

 

***If we fail to obtainand maintain necessary FDA clearances, our business would be harmed.***

 

The monitors and sensors that we manufacture and sell as part of theCardioNet System 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.

 

The CardioNet System, including our C3 monitor, and our arrhythmiadetection algorithms have “510(k) clearance” status from the FDA.Modifications to the CardioNet System or our algorithms that could significantlyaffect safety or effectiveness, or that could constitute a significant changein intended use, would require a new clearance from the FDA. If in the futurewe make changes to the CardioNet System or our algorithms, the FDA coulddetermine that such modifications require new FDA clearance, and we may not beable to obtain such FDA clearances in a timely fashion or at all.

 

We are subject to continuing regulation by the FDA, including qualityregulations applicable to the manufacture of the CardioNet System and variousreporting regulations and regulations that govern the promotion and advertisingof medical devices. The FDA could find that we have failed to comply with oneof these 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 orseizure of the CardioNet System;

 

27

----

Table of Contents

 

·                  operatingrestrictions, partial suspension or total shutdown of production;

 

·                  refusal to grant510(k) clearance of new components or algorithms;

 

·                  withdrawing 510(k) clearancealready granted to one or more of our existing components or algorithms; and

 

·                  criminalprosecution.

 

Any of these enforcement actions could be costly and significantly harmour business, financial condition and results of operations.

 

***Enforcement offederal and state laws regarding privacy and security of patient informationmay adversely affect our business, financial condition or operations.***

 

The use and disclosure of certain health care information by healthcare providers and their business associates have come under increasing publicscrutiny. 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 HIPAAprovisions. We must operate our business in a manner that complies with allapplicable laws, both federal and state, and that does not jeopardize theability of our customers to comply with all applicable laws. We believe thatour operations are consistent with these legal standards. Nevertheless, theselaws and regulations 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 and otherfederal and state laws and regulations are correct, we could be held liable forunauthorized uses or disclosures of patient information as a result ofinadequate systems and controls to protect this information or as a result ofthe theft of information by unauthorized computer programmers who penetrate ournetwork security. Enforcement of these laws against us could have a materialadverse effect on our business, financial condition and results of operations.

 

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

 

Our operations may be directly or indirectly affected by various broadstate and federal health care fraud and abuse laws, including the FederalHealthcare Programs’ Anti-Kickback Statute, which prohibits any person fromknowingly and willfully offering, paying, soliciting or receiving remuneration,directly or indirectly, to induce or reward either the referral of anindividual for an item or service, or the ordering, furnishing or arranging foran item or service, for which payment may be made under federal health careprograms, such as the Medicare and Medicaid programs. For some of our services,we directly bill physicians for our services, who in turn bill payors. Althoughwe believe such payments to be proper and in compliance with laws andregulations, we may be subject to claims that we are in violation of these lawsand regulations. If our past or present operations are found to be in violationof these laws, we or our officers may be subject to civil or criminalpenalties, including large monetary penalties, damages, fines, imprisonment andexclusion from Medicare and Medicaid program participation. If enforcementaction were to occur, our business and results of operations could be adverselyaffected.

 

****The operation ofour call centers and monitoring facilities is subject to rules andregulations governing Independent Diagnostic Testing Facilities and statelicensure requirements; failure to comply with these rules could preventus from receiving reimbursement from Medicare and some commercial payors.***

 

We have call centers and monitoring facilities in Pennsylvania,Georgia, Florida, and Minnesota that analyze the data obtained from arrhythmiamonitors and report the results to physicians. In order for us to receivereimbursement from Medicare and some commercial payors, we must have a callcenter certified as an Independent Diagnostic Testing Facility, or IDTF.Certification as an IDTF requires that we follow strict regulations governinghow the center operates, such as requirements regarding the experience andcertifications of the technicians who review data transmitted from ourmonitors. These rules and regulations vary from location to location andare subject to change. If they change, we may have to change the operatingprocedures at our monitoring facilities and call centers, which could increaseour costs significantly. If we fail 

 

28

----

Table of Contents

 

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.

 

Inorder to maintain the IDTF certification of our call centers we are alsorequired to comply with certain state requirements. The state of Florida hasadvised us that we must obtain a license to operate our call center in thatstate. If we fail to obtain a license, we would be required to cease theoperations of our Florida call center, we may be subject to fines andpenalties, and we may be required to refund amounts previously received inconnection with our operation of the Florida call center during the period thatwe did not have a license. We have applied for and expect to receive thelicense, but there can be no assurance that the license will be received. If wefail to obtain and maintain a license to operate our call center in Florida orto comply with any other state requirements to which we are subject, ourbusiness and results of operations could be adversely impacted.

 

***We may be subject tofederal and state false claims laws which impose substantial penalties.***

 

Many of the physicians and patients who use our services file claimsfor reimbursement 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.

 

We are unable to predict whether we could be subject to actions underthe federal False Claims Act, or the impact of such actions. However, the costsof defending claims under the False Claims Act, as well as sanctions imposedunder the False Claims Act, could significantly affect our financialperformance.

 

****Changes in theregulatory environment may constrain or require us to restructure ouroperations, which may harm our revenues and operating results.***

 

Health care laws and regulations change frequently and may changesignificantly in the future. We may not be able to adapt our operations toaddress every new regulation, and new regulations may adversely affect ourbusiness. We cannot provide assurance that a review of our business by courtsor regulatory authorities would not result in a determination that adverselyaffects our revenues and operating results, or that the health care regulatoryenvironment will not change in a way that restricts our operations. Inaddition, as a result of the focus on health care reform in connection with the2008 presidential election, there is risk that Congress may implement changesin laws and regulations governing health care service providers, includingmeasures to control costs, or reductions in reimbursement levels, which mayadversely affect our business and results of operations.

 

***Changes in thehealth care industry or tort reform could reduce the number of arrhythmiamonitoring solutions ordered by physicians, which could result in a decline inthe demand for our solutions, pricing pressure and decreased revenues.***

 

Changes in the health care industry directed at controlling health carecosts or perceived over-utilization of arrhythmia monitoring solutions couldreduce the volume of solutions ordered by physicians. If more health care costcontrols are broadly instituted throughout the health care industry, the volumeof cardiac monitoring solutions could decrease, resulting in pricing pressureand declining demand for our services, which could harm our operating results.In addition, 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 ofmedical malpractice against the physician. Legal changes making it moredifficult to bring medical malpractice cases, known as tort reform, couldreduce the amount of our services prescribed as physicians respond to reducedrisks of litigation, which could harm our operating results.

 

****A write-off of thevalue of our goodwill or intangible assets could adversely affect our resultsof operations.***

 

As of September 30, 2008, we had $46.0 million of goodwill and$2.1 million of intangible assets, most of which resulted from acquisition ofPDSHeart. Current accounting rules require that goodwill and certainintangible assets be assessed for impairment using fair value measurementtechniques. If the carrying amount of a reporting unit exceeds its fair value,then a goodwill impairment test is performed to measure the amount of theimpairment loss, if any. The goodwill impairment test compares the implied fairvalue of the reporting unit’s goodwill with the carrying amount of thatgoodwill. Determining the fair value of the implied goodwill is judgmental innature and often involves the use of significant estimates 

 

29

----

Table of Contents

 

and assumptions. Any determination requiring the write-off of asignificant portion of goodwill or intangible assets could have a materialadverse effect on the market price of our common stock, and our business,financial condition and results of operations.

 

**Risks related to the securities market andinvestment in our common stock**

 

****Our quarterlyoperating results and stock price may be volatile or may decline regardless ofour operating performance.***

 

The market price for our common stock has been and is likely tocontinue to be volatile and may fluctuate significantly in response to a numberof factors, most of which we cannot control, including:

 

·                  changes in reimbursementrates or policies by payors;

 

·                  adoption of theCardioNet System by physicians;

 

·                  changes inMedicare rules or regulations;

 

·                  the developmentof increased compensation for arrhythmia monitoring solutions;

 

·                  price and volumefluctuations in the overall stock market;

 

·                  changes inoperating performance and stock market valuations of other early stagecompanies generally;

 

·                  the seasonalnature of our revenues, which have typically been moderately lower duringsummer months, which we believe may be due to physician and patient vacationschedules and patient reluctance to initiate cardiac monitoring during monthswhen patients are more likely to be more active;

 

·                  the financialprojections we may provide to the public, any changes in these projections orour failure to meet these projections;

 

·                  changes infinancial estimates by any securities analysts who follow our common stock, ourfailure to meet these estimates or failure of those analysts to initiate ormaintain coverage of our common stock;

 

·                  ratingsdowngrades by any securities analysts who follow our common stock;

 

·                  the public’sresponse to press releases or other public announcements by us or thirdparties, including our filings with the SEC and announcements relating to payorreimbursement decisions, product development, litigation and intellectualproperty impacting us or our business;

 

·                  marketconditions or trends in our industry or the economy as a whole;

 

·                  the developmentand sustainability of an active trading market for our common stock;

 

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

 

·                  other events orfactors, including those resulting from war, incidents of terrorism, naturaldisasters or responses to these events; and

 

·                  changes in accountingprinciples.

 

In addition, the stock markets, and in particular the Nasdaq GlobalMarket, have experienced extreme price and volume fluctuations that haveaffected and continue to affect the market prices of equity securities of manyhealth care companies. Stock prices of many health care companies havefluctuated in a manner unrelated or disproportionate to the operatingperformance of those companies. In the past, stockholders have institutedsecurities class action litigation following periods of market volatility. Ifwe were involved in securities litigation, we could incur substantial costs,and our resources and the attention of management could be diverted from ourbusiness.

 

30

----

Table of Contents

 

****Future sales of ourcommon stock or securities convertible into our common stock may depress ourstock price.***

 

Salesof a substantial number of shares of our common stock or securities convertibleinto our common stock in the public market could occur at any time. Thesesales, or the perception in the market that the holders of a large number ofshares intend to sell shares, could reduce the market price of our commonstock. As of September 30, 2008, we had 23,328,028 outstanding shares ofvested common stock. Of these, approximately 5,341,887 shares of our commonstock are subject to lock-up agreements that are in force through and includingNovember 16, 2008. Substantially all of the shares of our common stocksubject to lock-up agreements may be sold upon expiration of such agreements.In addition, we have outstanding warrants to purchase up to 6,250 shares of ourcommon stock that, if exercised, would result in these additional sharesbecoming available for sale upon expiration of the lock-up agreements.

 

We recently filed a registration statement on Form S-1 registering11,964,196 shares of our common stock for resale, of which 5,750,000 shareswere sold pursuant to an underwritten public offering and of which 6,214,196shares are freely tradable, subject to lock-up agreements as describedabove.  If a large number of our sharesof our common stock or securities convertible into our common stock are sold inthe public market after they become eligible for sale, the sales could reducethe trading price of our common stock and impede our ability to raise futurecapital.

 

****Anti-takeoverprovisions in our charter documents and Delaware law might deter acquisitionbids for us that our stockholders might consider favorable.***

 

Our amended and restated certificate of incorporation and bylawscontain provisions that may make the acquisition of our company more difficultwithout the approval of our board of directors. These provisions:

 

·                  establish aclassified board of directors so that not all members of our board are electedat one time;

 

·                  authorize theissuance of undesignated preferred stock, the terms of which may be establishedand shares of which may be issued without stockholder approval, and which mayinclude rights superior to the rights of the holders of common stock;

 

·                  prohibitstockholder action by written consent, which requires all stockholder actionsto be taken at a meeting of our stockholders;

 

·                  provide that theboard of directors is expressly authorized to make, alter, or repeal ourbylaws; and

 

·                  establishadvance notice requirements for nominations for elections to our board or forproposing matters that can be acted upon by stockholders at stockholdermeetings.

 

In addition, because we are incorporated in Delaware, we are subject toSection 203 of the Delaware General Corporation Law which, subject tocertain exceptions, prohibits stockholders owning in excess of 15% of ouroutstanding voting stock from merging or combining with us. These anti-takeoverprovisions and other provisions under Delaware law could discourage, delay orprevent a transaction involving a change of control of our company, even ifdoing so would benefit our stockholders. These provisions could also discourageproxy contests and make it more difficult for our stockholders to electdirectors of their choosing and cause us to take other corporate actions suchstockholders desire.

 

****Our existingprincipal stockholders, executive officers and directors have substantialcontrol over us, which may prevent our stockholders from influencingsignificant corporate decisions and may harm the market price of our commonstock.***

 

Including stock options that are exercisable within 60 days of September 30,2008, our existing principal stockholders, executive officers and directors,together with their affiliates, beneficially owned, in the aggregate,approximately 25% of our outstanding common stock. These stockholders may haveinterests that conflict with other stockholders and, if acting together, havethe ability to determine the outcome of matters submitted to our stockholdersfor approval, including the election and removal of directors and any merger,consolidation or sale of all or substantially all of our assets. In addition,these stockholders, acting together, may have the ability to control ourmanagement and affairs. Accordingly, this concentration of ownership may harmthe market price of our common stock by:

 

·                  delaying,deferring or preventing a change of control;

 

·                  impeding amerger, consolidation, takeover or other business combination involving us; or

 

·                  discouraging apotential acquirer from making a tender offer or otherwise attempting to obtaincontrol of us.

 

31

----

Table of Contents

 

****If securities or industry analysts publishinaccurate or unfavorable research about our business, our stock price andtrading volume could decline.***

 

Thetrading market for our common stock will depend in part on the research andreports that securities or industry analysts publish about us or our business.If one or more of the analysts who covers us downgrades our stock or publishesinaccurate or unfavorable research about our business, our stock price wouldlikely decline. If one or more of these analysts ceases coverage of us or failsto publish reports on us regularly, demand for our stock could decrease, whichcould cause our stock price and trading volume to decline.

 

****We do not expect topay any cash dividends for the foreseeable future.***

 

The continued expansion of our business may require substantialfunding. Accordingly, we do not anticipate that we will pay any cash dividendson shares of our common stock for the foreseeable future. Even if we were notprohibited from paying dividends, any determination to do so in the futurewould be at the discretion of our board of directors and will depend upon ourresults of operations, financial condition, contractual restrictions,restrictions imposed by applicable law and other factors our board of directorsdeems relevant. Accordingly, realization of a gain on your investment willdepend on the appreciation of the price of our common stock, which may neveroccur. Investors seeking cash dividends in the foreseeable future should notpurchase our common stock.

 

****The global financial crisis may have animpact on our business and financial condition in ways that we currently cannotpredict.***

 

The continued credit crisis, reduction in confidence and relatedturmoil in the global financial system may have an impact on our business andour financial condition. Due to the recent tightening of credit markets andconcerns regarding the availability of credit, patients and payors may not haveaccess to sufficient cash or short-term credit to obtain the CardioNet Systemor other services provided by the Company. Delays of this nature wouldadversely affect our service revenues, and therefore harm our business andresults of operations.

 

**Item 2.  Unregistered Sales ofEquity Securities and Use of Proceeds.**

 

**Use of Proceeds**

 

Our initial public offering of common stock waseffected through a Registration Statement on Form S-1 (File No. 333-145547)that was declared effective by the Securities and Exchange Commission on March 18,2008, which registered an aggregate of 5,175,000 shares of our common stock,including 675,000 shares that the underwriters had the option to purchase tocover over-allotments. On March 25, 2008, 3,000,000 shares of commonstock were sold on our behalf and 1,500,000 shares of common stock were sold onbehalf of a selling stockholder at an initial public offering price of$18.00 per share, for an aggregate gross offering price of $54.0 million tous, and $27.0 million to the selling stockholders. On April 8, 2008,1,014,286 shares of common stock were sold on behalf of the selling stockholderupon a partial exercise of the underwriters’ over-allotment option, at aninitial public offering price of $18.00 per share, for an aggregate grossoffering price of $1.8 million to the selling stockholder. Following the saleof the shares in connection with the over-allotment closing of our initialpublic offering, the offering terminated.

 

We paid to the underwriters underwriting discountsand commissions totaling approximately $3.8 million in connection with theoffering. In addition, we incurred additional costs of approximately$3.2 million in connection with the offering, which when added to the underwritingdiscounts and commissions paid by us, amounts to total fees and costs ofapproximately $7.0 million. Thus, the net offering proceeds to us, afterdeducting underwriting discounts and commissions and offering costs, wereapproximately $46.9 million. No offering costs were paid directly or indirectlyto any of our directors or officers (or their associates) or persons owning tenpercent or more of any class of our equity securities or to any otheraffiliates.

 

As of September 30, 2008, we had invested $46.7million of net proceeds from the offering in money market funds. Through September 30,2008, we have not used the net proceeds from the offering, other than to repayour outstanding long-term debt balance of $2.4 million and to pay a success feeof $0.2 million in connection with the offering to the lender of such long-termdebt, and to pay $5.0 million owed to former stockholders of PDSHeart holdingcertificates of subordinated contingent payment interest to fully extinguishour obligations under such certificates. We intend to use the remainingproceeds for research and development, to build our inventory of futuregenerations of our CardioNet System, to increase our sales and marketingcapabilities for our CardioNet System, to hire additional personnel, to investin infrastructure, to pursue 

 

32

----

Table of Contents

 

newmarkets and geographies and to acquire or license products, technologies orbusinesses, although we currently have no agreements or commitments relating tomaterial acquisitions or licenses. We cannot specify with certainty all of theparticular uses for the 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** | ** ** | ** **                                                                                                                                                                                                  |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                        |
| 10.1                |       | Amendment  No. 6 dated September 26, 2008 to Communications Voice and Data  Services Provider Agreement dated May 12, 2003 between the Company and  QUALCOMM, Incorporated, as amended. (1)* |
| 10.2                |       | Letter Agreement dated July 7, 2008, between the Company and  Randy H. Thurman. (2)                                                                                                                    |
| 10.3                |       | Indemnification Agreement between the Company and Randy H. Thurman,  relating to service on the Board of Directors, effective July 11, 2008.                                                           |
| 10.4                |       | Separation Agreement dated July 14, 2008 between the Company and  James M. Sweeney. (3)                                                                                                                |
| 10.5                |       | Indemnification Agreement of Ronald A. Ahrens, relating to service on  the Board of Directors, effective August 19, 2008.                                                                              |
| 10.6                |       | Indemnification Agreement of Kirk E. Gorman, relating to service on  the Board of Directors, effective August 19, 2008.                                                                                |
| 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.                  |

 

----

| (1)    |   | Filed  as an exhibit to the Company’s Registration Statement on Form S-1 (File  No. 333-151829) originally filed with the Securities and Exchange  Commission on June 23, 2008, as amended, and incorporated herein by  reference. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                   |
| (2)    |   | Filed  as an exhibit to the Company’s filing of Current Report on Form 8-K  (File No. 001-33993) originally filed with the Securities and Exchange  Commission on July 11, 2008, and incorporated herein by reference.             |
|   |   |                                                                                                                                                                                                                                                   |
| (3)    |   | Filed  as an exhibit to the Company’s filing of Current Report on Form 8-K  (File No. 001-33993) originally filed with the Securities and Exchange  Commission on July 18, 2008, and incorporated herein by reference.             |
|   |   |                                                                                                                                                                                                                                                   |
| *      |   | Confidential  treatment has been granted with respect to certain portions of this exhibit.  Omitted portions have been filed separately with the Securities and Exchange  Commission.                                                                  |

 

33

----

Table of Contents

 

**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:  November 7, 2008 |       | By:                      | /s/  Martin P. Galvan |
|                         |       |                     | Martin  P. Galvan, CPA |
| * *                     | * *   | * *                 | *Chief Financial Officer*(Principal  Financial Officer) |

 

34

----