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

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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| **(Mark  One)** |                                                                                                    |
|-----------------|---------------------------------------------------------------------------------------------------------|
| ** **      |                                                                                                    |
| **x**           | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**forthe quarterly period ended March 31, 2008**

 

**OR**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**Forthe transition period from                to                 **

 

**Commission File Number 001-33993**

 

**CardioNet, Inc.**

(Exact name of Registrant as specified in its Charter)

 

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

 

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

 

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

 

**N/A**(Former name, formeraddress and former fiscal year if changed since last report)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.    Yes  o  No  x

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934).  Yes  o  No  x

 

As of April 30,2008, 23,068,332 shares of the registrant’s common stock, $0.001 par value pershare, were outstanding.

 

 

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**CARDIONET, INC.QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 2008TABLE OF CONTENTS**

 
| ** **        | ** **                                                                                  | **P****age  No.** |
|-------------------|---------------------------------------------------------------------------------------------|-------------------|
| **PART I.**  | **FINANCIAL  INFORMATION**                                                                  |              |
| Item 1.           | Financial  Statements                                                                       | 3                 |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 11                |
| Item 3.           | Quantitative  and Qualitative Disclosures about Market Risk                                 | 16                |
| Item 4.           | Controls and  Procedures                                                                    | 16                |
|              |                                                                                        |              |
| **PART II.** | **OTHER  INFORMATION**                                                                      |              |
| Item 1.           | Legal Proceedings                                                                           | 16                |
| Item 1A.          | Risk Factors                                                                                | 17                |
| Item 2.           | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 28                |
| Item 4.           | Submission  of Matters to a Vote of Security Holders                                        | 29                |
| Item 6.           | Exhibits                                                                                    | 30                |
|              |                                                                                        |              |
| SIGNATURES        | 31                                                                                          |

 

2

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**PART I— FINANCIAL INFORMATION**

 

**Item1. Financial Statements.**

 

**CARDIONET, INC. CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                                                        | ** ** | **March 31, 2008** | ** **  | ** **                      | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|-------------|---------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                        | ** ** | **(Unaudited)**              | ** **  | **December 31, 2007** | ** ** |
| **Assets**                                                                                                                                                                                                                                                                                        |       | ** **                   |        |                            |       |
| Current assets:                                                                                                                                                                                                                                                                                   |       |                         |        |                            |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                        |       | $                            | 61,973,117  |                            | $          | 18,090,636 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $10,227,226, and  $7,909,147 at March 31, 2008 and December 31, 2007, respectively                                                                                                                                                |       | 25,636,175                   |        | 22,853,958                      |       |
| Due from related  parties                                                                                                                                                                                                                                                                         |       | 130,206                      |        | 142,965                         |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                                                        |       | 1,342,018                    |        | 287,284                         |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Total current  assets                                                                                                                                                                                                                                                                             |       | 89,081,516                   |        | 41,374,843                      |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Property and  equipment, net                                                                                                                                                                                                                                                                      |       | 15,138,648                   |        | 15,094,205                      |       |
| Intangible  assets, net                                                                                                                                                                                                                                                                           |       | 2,560,854                    |        | 2,806,950                       |       |
| Goodwill                                                                                                                                                                                                                                                                                          |       | 45,999,403                   |        | 41,162,835                      |       |
| Other assets                                                                                                                                                                                                                                                                                      |       | 1,985,894                    |        | 2,600,695                       |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Total assets                                                                                                                                                                                                                                                                                      |       | $                            | 154,766,315 |                            | $          | 103,039,528 |   |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| **Liabilities  and shareholders’ equity (deficit)**                                                                                                                                                                                                                                          |       |                         |        |                            |       |
| Current  liabilities:                                                                                                                                                                                                                                                                             |       |                         |        |                            |       |
| Accounts payable                                                                                                                                                                                                                                                                                  |       | $                            | 2,929,864   |                            | $          | 3,971,781 |   |
| Accrued  liabilities                                                                                                                                                                                                                                                                              |       | 12,005,951                   |        | 6,424,886                       |       |
| Current portion  of debt                                                                                                                                                                                                                                                                          |       | 1,489,950                    |        | 1,088,528                       |       |
| Current portion  of capital leases                                                                                                                                                                                                                                                                |       | 48,688                       |        | 48,688                          |       |
| Deferred revenue                                                                                                                                                                                                                                                                                  |       | 648,850                      |        | 465,578                         |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Total current  liabilities                                                                                                                                                                                                                                                                        |       | 17,123,303                   |        | 11,999,461                      |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Long-term debt,  net of current portion                                                                                                                                                                                                                                                           |       | 1,381,976                    |        | 1,655,449                       |       |
| Deferred rent                                                                                                                                                                                                                                                                                     |       | 849,502                      |        | 878,886                         |       |
| Other noncurrent  liabilities                                                                                                                                                                                                                                                                     |       | 60,867                       |        | 68,961                          |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Total  liabilities                                                                                                                                                                                                                                                                                |       | 19,415,648                   |        | 14,602,757                      |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| **Redeemable  convertible preferred stock**                                                                                                                                                                                                                                                       |       |                         |        |                            |       |
| Mandatorily  redeemable convertible preferred stock — 0 and 114,883 shares authorized  , 0 and 114,839 issued and outstanding at March 31, 2008 and  December 31, 2007, respectively                                                                                          |       | —                       |        | 115,301,850                     |       |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| **Shareholders’  equity (deficit)**                                                                                                                                                                                                                                                          |       |                         |        |                            |       |
| Series A —  0 and 1,563,248 shares authorized, issued and outstanding at March 31,  2008 and December 31, 2007, respectively                                                                                                                                                  |       | —                       |        | 390,812                         |       |
| Series B —  0 and 4,720,347 shares authorized, issued and outstanding at March 31,  2008 and December 31, 2007, respectively                                                                                                                                                  |       | —                       |        | 6,903,969                       |       |
| Series C —  0 and 10,399,011 shares authorized, issued and outstanding at March 31,  2008 and December 31, 2007, respectively                                                                                                                                                 |       | —                       |        | 36,195,991                      |       |
| Series D —  0 and 1,000,000 shares authorized, issued and outstanding at March 31,  2008 and December 31, 2007, respectively                                                                                                                                                  |       | —                       |        | 9,964,933                       |       |
| Common stock,  $.001 par value and no par value at March 31, 2008 and December 31,  2007, respectively; 200,000,000 and 50,000,000 shares authorized, 22,985,279  and 3,130,054 shares issued, outstanding and vested at March 31, 2008,  and December 31, 2007, respectively |       | 23,067                       |        | 1,399,402                       |       |
| Paid-in capital                                                                                                                                                                                                                                                                                   |       | 217,387,993                  |        | —                          |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                              |       | (82,060,393                  | )           | (81,720,186                     | )          |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Total  shareholders’ equity (deficit)                                                                                                                                                                                                                                                        |       | 135,350,667                  |        | (26,865,079                     | )          |
|                                                                                                                                                                                                                                                                                              |       |                         |        |                            |       |
| Total  liabilities and shareholders’ equity (deficit)                                                                                                                                                                                                                                        |       | $                            | 154,766,315 |                            | $          | 103,039,528 |   |

 

See accompanying notes.

 

3

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

**(Unaudited)**

 
| ** **                                                                        | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **March 31, 2008**          | ** ** | **March 31, 2007** | ** ** |
| Revenues:                                                                         |       |                             |       |   |   |
| Net patient  service revenues                                                     |       | $                                | 25,247,977 |   | $ | 10,957,150 |   |
| Other revenues                                                                    |       | 215,307                          |       | 143,361 |   |
|                                                                              |       |                             |       |   |   |
| Total revenues                                                                    |       | 25,463,284                       |       | 11,100,511 |   |
|                                                                              |       |                             |       |   |   |
| Cost of revenues                                                                  |       | 9,518,996                        |       | 3,790,238 |   |
|                                                                              |       |                             |       |   |   |
| Gross profit                                                                      |       | 15,944,288                       |       | 7,310,273 |   |
| Operating  expenses:                                                              |       |                             |       |   |   |
| Research and  development                                                         |       | 1,141,530                        |       | 990,467 |   |
| General and  administrative                                                       |       | 9,066,407                        |       | 5,200,815 |   |
| Sales and  marketing                                                              |       | 5,114,727                        |       | 3,319,838 |   |
| Integration,  restructuring and other nonrecurring charges                        |       | 1,305,555                        |       | — |   |
|                                                                              |       |                             |       |   |   |
| Total operating  expenses                                                         |       | 16,628,219                       |       | 9,511,120 |   |
|                                                                              |       |                             |       |   |   |
| Loss from  operations                                                             |       | (683,931                         | )          | (2,200,847 | ) |
| Other income  (expense):                                                          |       |                             |       |   |   |
| Interest income                                                                   |       | 178,040                          |       | 223,270 |   |
| Interest expense                                                                  |       | (65,826                          | )          | (1,176,532 | ) |
|                                                                              |       |                             |       |   |   |
| Total other  income (expense)                                                     |       | 112,214                          |       | (953,262 | ) |
|                                                                              |       |                             |       |   |   |
| Loss before benefit  from income taxes                                            |       | (571,717                         | )          | (3,154,109 | ) |
| Benefit from  income taxes                                                        |       | 231,510                          |       | — |   |
|                                                                              |       |                             |       |   |   |
| Net loss                                                                          |       | (340,207                         | )          | (3,154,109 | ) |
|                                                                              |       |                             |       |   |   |
| Dividends on and  accretion of mandatorily redeemable convertible preferred stock |       | (2,596,942                       | )          | (482,448 | ) |
|                                                                              |       |                             |       |   |   |
| Net loss attributable  to common stockholders                                     |       | $                                | (2,937,149 | ) | $ | (3,636,557 | ) |
|                                                                              |       |                             |       |   |   |
| Net loss per  common share:                                                       |       |                             |       |   |   |
| Basic and  diluted                                                                |       | $                                | (0.63      | ) | $ | (1.22 | ) |
|                                                                              |       |                             |       |   |   |
| Weighted average  number of common shares outstanding:                            |       |                             |       |   |   |
| Basic and  diluted                                                                |       | 4,694,561                        |       | 2,993,061 |   |

 

See accompanying notes.

 

4

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

**(Unaudited)**

 
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **March 31, 2008**          | ** ** | **March 31, 2007** | ** ** |
| **Operating  activities**                                                                 |       |                             |       |   |   |
| Net loss                                                                                  |       | $                                | (340,207   | ) | $ | (3,154,109 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities:          |       |                             |       |   |   |
| Depreciation                                                                              |       | 1,647,326                        |       | 416,248 |   |
| Loss on disposal  of property and equipment                                               |       | 46,313                           |       | 10,829 |   |
| (Decrease)  increase in deferred rent                                                     |       | (29,384                          | )          | 105,010 |   |
| Provision for  doubtful accounts                                                          |       | 2,343,544                        |       | 1,717,249 |   |
| Common stock and  stock options issued for services                                       |       | —                           |       | 16,200 |   |
| Amortization of  debt discount, including recognition of contingent beneficial conversion |       | —                           |       | 487,292 |   |
| Stock-based  compensation                                                                 |       | 359,881                          |       | 69,363 |   |
| Amortization of  intangibles                                                              |       | 246,096                          |       | 60,862 |   |
| Changes in  operating assets and liabilities:                                             |       |                             |       |   |   |
| Accounts  receivable                                                                      |       | (5,268,726                       | )          | (1,730,729 | ) |
| Due from related  parties                                                                 |       | 12,759                           |       | (17,026 | ) |
| Prepaid expenses  and other current assets                                                |       | (911,769                         | )          | (132,508 | ) |
| Other assets                                                                              |       | 614,801                          |       | 9,514 |   |
| Accounts payable                                                                          |       | (1,041,918                       | )          | 545,030 |   |
| Accrued  liabilities                                                                      |       | 3,134,542                        |       | 2,946,912 |   |
| Other noncurrent  liabilities                                                             |       | —                           |       | (44,862 | ) |
|                                                                                      |       |                             |       |   |   |
| Net cash  provided by operating activities                                                |       | 813,258                          |       | 1,305,275 |   |
|                                                                                      |       |                             |       |   |   |
| **Investing  activities**                                                                 |       |                             |       |   |   |
| Purchases of  property and equipment                                                      |       | (1,738,083                       | )          | (974,952 | ) |
| Investment in  subsidiary, net of cash acquired                                           |       | (2,608,280                       | )          | (45,906,548 | ) |
|                                                                                      |       |                             |       |   |   |
| Net cash used in  investing activities                                                    |       | (4,346,363                       | )          | (46,881,500 | ) |
|                                                                                      |       |                             |       |   |   |
| **Financing  activities**                                                                 |       |                             |       |   |   |
| Net proceeds  from issuance of mandatorily redeemable convertible preferred stock         |       | —                           |       | 102,195,953 |   |
| Proceeds from issuance  of common stock                                                   |       | 47,294,052                       |       | 2,236 |   |
| Proceeds from  issuance of debt                                                           |       | 500,062                          |       | 372,997 |   |
| Repayment of  debt                                                                        |       | (380,209                         | )          | (5,829,840 | ) |
| Common stock  subject to repurchase                                                       |       | 1,681                            |       | — |   |
|                                                                                      |       |                             |       |   |   |
| Net cash  provided by financing activities                                                |       | 47,415,586                       |       | 96,741,346 |   |
|                                                                                      |       |                             |       |   |   |
| Net increase in  cash and cash equivalents                                                |       | 43,882,481                       |       | 51,165,121 |   |
| Cash and cash  equivalents — beginning of period                                     |       | 18,090,636                       |       | 3,909,150 |   |
|                                                                                      |       |                             |       |   |   |
| Cash and cash  equivalents — end of period                                           |       | $                                | 61,973,117 |   | $ | 55,074,271 |   |
|                                                                                      |       |                             |       |   |   |
| **Supplemental  disclosure of cash flow information**                                     |       |                             |       |   |   |
| Cash paid for  interest                                                                   |       | $                                | 64,010     |   | $ | 2,170,132 |   |

 
| **Supplemental  disclosure of non-cash financing activities**                                             |   |   |   |   |   |
|-----------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|
| Exercise of  stock options under note receivable arrangements                                             |   | $      | — |   | $      | 276,900 |   |
| Mandatorily  redeemable convertible preferred stock issued in connection with bridge loan                 |   | $      | — |   | $      | 3,303,000 |   |
| Mandatorily redeemable convertible preferred stock  issued in consideration for PDSHeart, Inc acquisition |   | $      | — |   | $      | 1,456,000 |   |

 

See accompanying notes.

 

5

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**CARDIONET,INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**1.     Business**

 

CardioNet, Inc.(the Company), a Delaware corporation, provides ambulatory, continuous,real-time outpatient management solutions for monitoring relevant and timelyclinical information regarding an individual’s health. The Company spent sevenyears developing a proprietary integrated patient management platform thatincorporates a wireless data transmission network, internally developedsoftware, FDA-cleared algorithms and medical devices and a 24-hour digitalmonitoring service center. The initial focus of the Company is on the diagnosisand monitoring of cardiac arrhythmias, or heart rhythm disorders, with asolution that is marketed as the CardioNet System. In September 1999, theCompany was capitalized as CardioNet, a company focused on helping physiciansmore rapidly diagnose and more effectively manage therapy for patients withcardiovascular disease. In February 2002, the Company received FDA 510(k) clearancefor the first and second generation of its core CardioNet System whichautomatically detects cardiac rhythm problems and transmits ECG data to a24/7/365 monitoring center which was opened in Conshohocken, Pennsylvania in July 2002.The CardioNet Monitoring Center provides analysis and response for all incomingECG data. Currently, the Company provides all arrhythmia monitoring servicesfor the CardioNet System at this location. The Company receives reimbursementfor services provided to patients from Medicare and other third-party payors.

 

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

 

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

 

On March 25,2008, the Company completed its initial public offering generating net proceedsto the Company of approximately $46.9 million, after deducting underwritercommissions and estimated offering expenses. The underwriters of the offering were Citigroup Global Markets Inc.,Lehman Brothers Inc., Leerink Swann LLC and Thomas Weisel Partners LLC.  Upon the closing of the Company’s initialpublic offering, all outstanding shares of the Company’s mandatorily redeemableconvertible preferred stock and convertible preferred stock converted intoshares of common stock.  Therefore, at March 31,2008, the Company had no shares of preferred stock outstanding.

 

**2.     Summary of Significant Accounting Policies**

 

**Unaudited Interim Financial Data**

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with U.S. generally accepted accounting principles and therequirements of Form 10-Q and Article 10 of Regulation S-X.

 

Theaccompanying consolidated balance sheet as of March 31, 2008, theconsolidated statements of operations for the three months ended March 31,2008 and 2007, and the consolidated statements of cash flows for the threemonths ended March 31, 2008 and 2007 are unaudited. The unaudited interimfinancial statements have been prepared on the same basis as the annualfinancial statements and, in the opinion of management, reflect alladjustments, which only include normal recurring adjustments  necessary to state fairly the Company’sfinancial position as of March 31, 2008, and the results of operations andcash flows for the three months ended March 31, 2008 and 2007. Thefinancial data and other information disclosed in these notes to the financialstatements related to the three month period are unaudited. The results for thethree months ended March 31, 2008 are not necessarily indicative of theresults to be expected for any future period.

 

6

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**Net Loss Attributable to Common Shares**

 

TheCompany computes net loss per share in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 128, *EarningsPer Share* (SFAS No. 128). Under SFAS No. 128, basic netloss per share is computed by dividing net loss per share attributable tocommon stockholders by the weighted average number of common shares outstandingfor the period and excludes the effects of any potentially dilutive securities.Diluted earnings per share, if presented, would include the dilution that wouldoccur upon the exercise or conversion of all potentially dilutive securitiesinto common stock using the “treasury stock” and/or “if converted” methods, asapplicable.

 

Thefollowing summarizes the potential outstanding common stock of the Company at March 31,2008 and March 31, 2007.  Theconvertible preferred stock, the mandatorily redeemable convertible preferredstock and the Series D-1 warrants were converted into shares of theCompany’s common stock immediately prior to the consummation of the Company’sinitial public offering on March 25, 2008. All share amounts have been adjusted for the one-for-two reverse stocksplit effected by the Company on March 5, 2008:

 
| ** **                                           | ** ** | **March 31, 2008** | ** ** | **March 31, 2007** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Convertible  preferred stock (A,B,C,D)               |       | —                       |       | 8,835,042                    |       |
| Mandatorily  redeemable convertible preferred stock  |       | —                       |       | 4,784,958                    |       |
| Series B  warrants                              |       | 6,250                        |       | 6,250                        |       |
| Series D-1  warrants                            |       | —                       |       | 482,090                      |       |
| Common stock  options outstanding                    |       | 1,704,804                    |       | 1,562,739                    |       |
| Common stock  options available for grant            |       | 533,063                      |       | 506,033                      |       |
| Common stock  held by certain employees and unvested |       | 79,866                       |       | —                       |       |
| Common stock                                         |       | 22,985,279                   |       | 3,153,945                    |       |
|                                                 |       |                         |       |                         |       |
| Total                                                |       | 25,309,262                   |       | 19,331,057                   |       |

 

If theoutstanding options, warrants and preferred stock were exercised or convertedinto common stock, the result would be anti-dilutive. Accordingly, basic anddiluted net loss attributable to common stockholders per share are identicalfor both periods presented in the consolidated statements of operations.

 

**Stock-Based Compensation**

 

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

 

7

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Priorto 2006, the Company accounted for grants made under its stock option plan inaccordance with APB Opinion No. 25, *Accountingfor Stock Options Issued to Employees*, as permitted under SFAS No. 123.Under APB Opinion No. 25, the Company was only required to recognize compensationexpenses for options granted to employees for the difference between the fairvalue of the underlying common stock and the exercise price of the option atthe date of grant. The fair value of these options was determined using theminimum value option pricing model. Since the exercise price of the Company’sstock option grants issued prior to 2006 was equal to the estimated fair valueof the underlying stock on the grant date, no compensation expense related tooptions granted to employees was recognized in prior years.

 

TheCompany’s income before income taxes for the quarters ended March 31, 2008and 2007 was $360,000 and $69,000 lower, respectively, and the Company’safter-tax net income for quarters ended March 31, 2008 and 2007 was $211,000and $69,000 lower, respectively, as a result of stock-based compensationexpense incurred. The impact of stock-based compensation expense was $(0.04)and $(0.02) on the basic or diluted earnings per share for the quarters ended March 31,2008 and 2007, respectively.

 

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

 
| ** **               | ** ** | **Quarter ended  March 31, 2008** | ** ** | **Quarter ended  March 31, 2007** | ** ** |
|--------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| Expected  dividend yield |       | 0                                                | %          | 0                                                | %          |
| Expected  volatility     |       | 50                                               | %          | 50                                               | %          |
| Risk-free  interest rate |       | 2.71                                             | %          | 5.0                                              | %          |
| Expected life            |       | 6.25 years                                       |       | 6.25 years                                       |       |

 

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

 

Basedon the above assumptions, the per share weighted average fair value of theoptions granted under the stock option plan for the quarters ended March 31,2008 and 2007 was $12.19 and $5.04, respectively.

 

The following tablesummarizes activity under all stock award plans from December 31, 2007through March 31, 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 |   |

 

Additional informationregarding options outstanding is as follows:

 
| ** **                                           | ** ** | **March 31,  2008** | ** **    | **December 31,  2007** | ** ** |
|------------------------------------------------------|------------|--------------------------|---------------|-----------------------------|------------|
| Range of  exercise price (per option)                |       | $                        | 0.70 - $18.30 |                        | $          | 0.70 - $9.50 |   |
| Weighted average  remaining contractual life (years) |       | 9.22                     |          | 9.28                        |       |
|                                                      |            |                          |               |                             |            |  |  |

 

8

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**New Accounting Pronouncements**

 

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

 

In February 2007,the FASB issued SFAS No. 159, *The FairValue Option for Financial Assets and Financial Liabilities-Including anAmendment of FASB Statement No. 115*. SFAS 159 permitsentities to choose fair value measurement for many financial instruments andcertain other items as of specified election dates. Business entities willthereafter report in earnings the unrealized gains and losses on items forwhich the fair value option has been chosen. The fair value option may beapplied instrument by instrument but may not be applied to portions ofinstruments and is irrevocable unless a new elections date occurs. The Companydid not elect the fair value option of SFAS 159 and thus, the adoption ofSFAS No. 159 had no impact on the Company.

 

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

 

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

 

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

 

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

 

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

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

 

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

 

9

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Inconnection with the acquisition of PDSHeart, the Company initiated exit plansfor acquired activities that are redundant to the Company’s existingoperations. The plan includes the closure of a facility and the elimination of58 positions in the areas of sales, finance, service and management. Inconnection with the plan, the Company established reserves of $510,000 includedin the purchase price allocation. As of March 31, 2008, none of thepositions had been eliminated and the facility has not been closed. The reserveis included in accrued liabilities in the accompanying consolidated balancesheet.

 

Asummary of the reserve activity related to the PDSHeart acquisition integrationplan as of March 31, 2008 is as follows:

 
| ** **                            | ** ** | **Initial Reserves  Recorded in  Purchase Accounting** | ** ** | **Payments/Adjustments  through  March 31, 2008** | ** ** | **Balance as of  March 31, 2008** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| Severance and  employee related costs |       | $                                                                     | 366,000    |                                                        | $          | 166,000                                               |       | $ | 200,000 |   |
| Rent Abandonment                      |       | $                                                                     | 144,000    |                                                        | $          | —                                                |       | $ | 144,000 |   |
| Total:                                |       | $                                                                     | 510,000    |                                                        | $          | 166,000                                               |       | $ | 344,000 |   |

 

Additionally,the Company incurred expenses of $274,000 in the first quarter of 2008 andexpects to incur an additional $625,000 of expense to integrate thesefunctions.  These costs will be expensedas incurred in accordance with the SFAS No. 146, *Accounting for Exit or Disposal Activities*.

 

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

 

**Mandatorily Redeemable Convertible Preferred Stock**

 

In March 2007,the Company sold 110,000 shares of its mandatorily redeemable convertiblepreferred stock, or MRCPS, which generated net proceeds to the Company of$102,119,142 ($110,000,000 less offering costs of $7,880,858). The Company alsoissued 3,383 shares of MRCPS upon conversion of an outstanding bridge loan and1,456 shares as consideration to a major shareholder of PDSHeart asconsideration in the PDSHeart acquisition. Accrued dividends were$6.1 million at March 25, 2008. The MRCPS original purchase price plus accrued dividends were convertedto common shares on March 25, 2008 in connection with the Company’sinitial public offering.

 

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

 

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

 

**Preferred Stock Warrants**

 

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

 

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

 

10

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

 

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

 

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

 

TheCompany’s effective tax rate of 41.4% 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.

 

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

 

**Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations.**

 

**Overview**

 

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

 

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

 

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

 

In September 2002,we were approved as an Independent Diagnostic Testing Facility for Medicare.The local Medicare carrier in Pennsylvania sets the terms for reimbursement ofour CardioNet System for approximately 40 million covered lives. We havealso worked to secure contracts with commercial payors. We increased the numberof contracts with commercial payors from six at year-end 2003 to 41 at year-end2004 to 97 at year-end 2005 to 144 at year-end 2006 and to 170 at March 31,2008. 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 to 70 million at year-end 2005 to102 million at year-end 2006 and to 176 million at March 31,2008. The current estimated total of 176 million Medicare and commerciallives for which we had reimbursement contracts as of March 31, 2008represents approximately 74% of the total covered lives in the United States.The majority of the remaining covered lives are insured by a relatively smallnumber of large commercial insurance companies that, beginning in 2003, deemedthe CardioNet System to be “experimental and investigational” and do notcurrently reimburse us for services provided to their beneficiaries.

 

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

 

Forour event, Holter and pacemaker monitoring services, we have establishedMedicare reimbursement and we have 106 direct contracts with commercial payorsas of March 31, 2008 representing an estimated 135 million coveredlives.

 

In March 2007, weraised $110 million in mandatorily redeemable convertible preferred stockto, in part, fund the acquisition of PDSHeart.

 

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Wehave undertaken an initiative to improve our operational efficiency and futureprofitability in connection with our acquisition of PDSHeart in March 2007,mainly through the integration of operational and administrative functions. Theplan, which was approved at the time of the PDSHeart acquisition, includes theclosure of a facility and the elimination of 58 positions in the areas ofsales, finance, service and management. In connection with the plan, theCompany established reserves of $510,000 included in the purchase priceallocation.  Additionally, we incurredexpenses of $0.3 million of employee-related costs to integrate these functionsin the first quarter of 2008 and expect to incur an additional$0.6 million of expenses to integrate these functions. These costs will beexpensed as incurred in accordance with the SFAS No. 146, *Accounting for Exit or Disposal Activities*.

 

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

 

On March 25,2008, the Company completed its initial public offering generating net proceedsof approximately $46.9 million after deducting underwriter commissions andestimated offering expenses.

 

**Statements of Operations Overview**

 

***Revenues***

 

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

 

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

 

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

 

***Gross Profit***

 

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

 

·                  salaries, benefits and stock-basedcompensation for personnel providing various services and customer support tophysicians and patients including patient enrollment and education, monitoringservices, distribution services (scheduling, packaging and delivery of themonitors and sensors to the patients), device repair and maintenance, andquality assurance;

 

·                  cost of patient-related servicesprovided by third-party subcontractors including device transportation to andfrom the patient, cellular airtime charges related to transmission of ECGs tothe CardioNet Monitoring Center and cost for in-home customer hook-ups whennecessary;

 

·                  consumable supplies sent to patientsalong with the durable components of the CardioNet System;

 

·                  depreciation on our monitors; and

 

·                  service cost related to specialproject revenues.

 

12

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Forthe quarter ended March 31, 2008, our gross profit margin was 62.6%. Ingeneral, we expect gross profit margins on the CardioNet System services toremain flat or increase, assuming no changes in reimbursement rates. For ourevent and Holter monitoring services, we expect gross profit margins todecrease as reimbursement rates decline as currently proposed by CMS.

 

***Sales and Marketing***

 

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

 

Followingthe completion of our randomized clinical trial and the PDSHeart acquisition,we made a significant investment in sales and marketing by increasing thenumber of account executives in new geographies. We had a sales force of 75account executives as of March 31, 2008 and expect to have 89 accountexecutives by December 31, 2008. We currently have account executivescovering 48 states. We also plan to increase our marketing activities. As a result,we expect that sales and marketing expenses will increase in absolute terms,but will remain flat as a percentage of revenues going forward.

 

***Research and Development***

 

Researchand development expense consists primarily of salaries, benefits and stock-basedcompensation of personnel and the cost of subcontractors who work on thedevelopment of the hardware and software for our next generation monitors,enhance the hardware and software of our existing monitors and provide qualitycontrol and testing. The expenses related to the randomized clinical trial arealso included in research and development expenses. We expect that research anddevelopment expenses will increase in absolute terms but decrease as apercentage of revenues going forward.

 

***General and Administrative***

 

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

 

***Income Taxes***

 

We havenet deferred income tax assets totaling approximately $31.2 million at theend of 2007, consisting primarily of federal and state net operating loss andcredit carryforwards. The federal and state net operating loss carryforwards,if unused, will begin to expire in 2010. The federal and state creditcarryforwards, if unused, will expire in 2026. Due to uncertainty regarding theultimate realization of these net operating loss and credit carryforwards andother deferred income tax assets, we have established a valuation allowance formost of these assets and will recognize the benefits only as reassessmentindicates the benefits are realizable. The Company is currently conducting ananalysis to determine the timing and manner of the utilization of the net operatingloss carryforwards and will adjust our tax rate accordingly in future quarters.

 

**Critical Accounting Policies and Estimates**

 

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

 

Webelieve that our accounting policies and estimates are most critical to a fullunderstanding and evaluation of our reported financial results. Our significantaccounting policies are more fully described in “Management’s Discussion andAnalysis of Financial Condition and Results of Operations – Critical AccountingPolicies and Estimates” in our Final Prospectus filed with the United StatesSecurities and Exchange Commission pursuant to Rule 424(b) (File No. 333-145547)on March 19, 2008.

 

**Results of Operations**

 

***Quarters Ended March 31, 2008 and 2007***

 

*Revenues.*    Total revenues for the quarterended March 31, 2008 increased to $25.5 million from$11.1 million for the quarter ended March 31, 2007, an increase of$14.4 million, or 129.4%. This increase of $14.4 million included anincrease of $14.3 million in patient revenues, of which $3.5 millionwas from the event and Holter monitoring business versus the prior year quarter(full 

 

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quarter effect in 2008,as the PDSHeart acquisition was consummated on March 8, 2007) and$10.7 million was from CardioNet System revenues. In addition, specialproject revenue increased by $0.1 million due to increased pass-through costs.Of the $10.7 million increase in CardioNet System revenues,$3.6 million was attributed to increased patient revenues from physicianswithin the geographies that we historically served and $7.1 was due togeographic expansion.

 

*Gross Profit.*    Gross profit increased to$15.9 million for the quarter ended March 31, 2008, or 62.6% ofrevenues, from $7.3 million for the quarter ended March 31, 2007, or65.9% of revenues. The increase of $8.6 million is primarily due to increasedrevenue from the CardioNet System and the full quarter effect of the PDSHeartacquisition. As a percentage of revenues, gross profit decreased by 3.3% in thequarter ended March 31, 2008 versus the same quarter last year, primarilydue to the inclusion of an entire quarter of lower margin PDSHeart event andHolter monitoring products and a fuel surcharge on device shipments to and frompatients.

 

*Sales and Marketing Expense.*    Sales and marketing expenseswere $5.1 million for the quarter ended March 31, 2008 compared to$3.3 million for the quarter ended March 31, 2007. The increase of$1.8 million is due to the full quarter effect of the PDSHeartacquisition.  As a percent of totalrevenues, sales and marketing expenses were 20.1% for the quarter ended March 31,2008 compared to 29.9% for the quarter ended March 31, 2007, a decline of9.8% as the full quarter effect of the PDSHeart acquisition was more thanoffset by higher revenue.

 

*Research and Development Expense.*    Research anddevelopment expenses increased to $1.1 million for the quarter ended March 31,2008 compared to $1.0 million for the quarter ended March 31, 2007.As a percent of total revenues, research and development expenses declined to4.5% for the quarter ended March 31, 2008 compared to 8.9% for the quarterended March 31, 2007, a decline of 4.4% primarily due to higher revenue.

 

*General and Administrative Expense.*    General andadministrative expenses (including amortization) increased to $9.1 millionfor the quarter ended March 31, 2008 from $5.2 million for thequarter ended March 31, 2007. This increase of $3.9 million, or74.3%, was primarily due to an increase in the provision for bad debt($0.6 million), stock based compensation ($0.3 million), increasedlegal fees ($0.7 million), increased infrastructure due to increased growth andin preparation of becoming a public company ($1.5 million), and amortization ofintangible assets in connection with our acquisition of PDSHeart($0.2 million). In addition, $0.7 million of this increase wasrelated to the PDSHeart general and administrative expenses, excluding bad debtexpense, due to the full quarter effect of the PDSHeart acquisition in 2008. Asa percent of total revenues, general and administrative expenses declined to35.6% for the quarter ended March 31, 2008 compared to 46.9% for thequarter ended March 31, 2007, a decrease of 11.3% as the increase inexpense was offset by the higher revenue.

 

*Integration, Restructuring and Other Nonrecurring Charges.*    The Company hasaccrued for integration and restructuring costs as well as $1.0 million relatedto the resolution of a legal matter for the quarter ended March 31, 2008. Integrationcharges relating to the PDSHeart acquisition were $0.3 million for the quarterended March 31, 2008. Restructuring charges relating to consolidating ourFinance and Human Resources functions in Pennsylvania were $0.1 million for thequarter ended March 31, 2008. We incurred no integration, restructuring orother nonrecurring charges in the quarter ended March 31, 2007.

 

Inconnection with the acquisition of PDSHeart, the Company initiated exit plansfor acquired activities that are redundant to the Company’s existingoperations. The plan includes the closure of a facility and the elimination of58 positions in the areas of sales, finance, service and management. Inconnection with the plan, the Company established reserves of $510,000 includedin the purchase price allocation. As of March 31, 2008, no positions havebeen eliminated and approximately $0.3 million of employee-related expenses havebeen incurred.

 

Inaddition, in March of 2008, the Company initiated restructuring plans toconsolidate its Finance and Human Resources functions in Pennsylvania. Thisplan includes the elimination of 7 positions in California and is currentlyanticipated to be completed by September 2008. As of March 31, 2008,no positions have been eliminated and approximately $0.1 million ofemployee-related expenses have been incurred.

 

*Total Interest Income/Expense, Net.*    Net interestincome was $0.1 million for the quarter ended March 31, 2008 compared tonet interest expense of $1.0 million for the quarter ended March 31,2007. This decrease in interest expense on a net basis is due to the payoff ofdebt which occurred as a result of a preferred stock financing completed by usin March 2007.

 

*Income Taxes.*    The Company’s effective taxrate was 41.4% for the quarter ended March 31, 2008.  This compares to no income tax benefit orexpense for the quarter ended March 31, 2007. The effective tax rate isbased on our estimated fiscal 2008 pretax income and does not take into accountour net operating loss carryforwards and other future income tax deductionsbecause we are still in the process of determining the timing and manner inwhich we can utilize such carryforwards and deductions due to limitations inthe Internal Revenue Code applicable to changes in ownership of corporations.The Company has approximately $62 million in federal net operating losses as ofDecember 31, 2007 to offset future taxable income expiring in variousyears through 2026.  Following thecompletion of our analysis of the availability of such carryforwards and futureincome tax deductions we will adjust our tax rate accordingly in futurequarters.

 

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*Net Loss.*    Net loss was $0.3 million forthe quarter ended March 31, 2008 compared to a net loss of$3.2 million for the quarter ended March 31, 2007. As a percent oftotal revenues, net loss was 1.0% for the quarter ended March 31, 2008compared to a net loss of 28.4% for the quarter ended March 31, 2007.

 

**Liquidity and Capital Resources**

 

Fromour inception in 1999 through March 31, 2008, we did not generatesufficient cash flows to fund our operations and the growth of our business. Asa result, prior to the completion of our initial public offering, ouroperations were financed primarily through the private placement of equitysecurities and both long-term and short-term debt financings.  Notably, we completed a financing involvingshares of our mandatorily redeemable convertible preferred stock in March 2007,in which we received net proceeds of approximately $102.1 million, andcompleted our initial public offering in March 2008, in which we receivednet proceeds, after underwriting discounts and offering expenses, ofapproximately $46.9 million. Through March 31, 2008, we funded ourbusiness primarily through the following:

 

·                  initial public offering that providednet proceeds of approximately $46.9 million, after deducting underwritingcommissions and estimated offering expenses;

 

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

 

·                  issuance of preferred stock thatprovided gross proceeds of $53.7 million;

 

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

 

·                  bank debt from Silicon Valley Bankconsisting of a term loan of $3.0 million, which was repaid on April 1,2008, and a working capital line secured by accounts receivable of$1.9 million, which was repaid from the proceeds of the mandatorilyredeemable convertible preferred stock.

 

As of March 31,2008, our principal source of liquidity was cash totaling $62.0 million andnet accounts receivable of $25.6 million.

 

Ourcash flow from operations decreased by $0.5 million to $0.8 million in thefirst quarter of 2008 from $1.3 million in the first quarter of 2007. Thedecrease is primarily due to changes in accounts receivable, accounts payableand accrued liabilities as a result of our growth, partially offset byfavorable net income growth as adjusted to exclude non-cash depreciation andamortization.

 

Weused net cash in investing activities of $4.3 million in the first quarter of2008, compared to $46.9 million in the first quarter of 2007, a decrease of$42.6 million. The decrease is primarily due to the consummation of thePDSHeart acquisition in March 2007 for a net cash effect of $45.9 million,partially offset by additional cash payments to PDSHeart shareholders in 2008of $2.6 million as a result of the contingent note payment due as a result ofour initial public offering and additional expenditures of $0.8 million in 2008to support our growth.

 

Wegenerated net cash from financing activities of $47.4 million in the firstquarter of 2008, compared to $96.7 million in the first quarter of 2007, adecrease of $49.3 million. The decrease is primarily due to the mandatorilyredeemable convertible preferred financing in the first quarter of 2007 whichgenerated net proceeds of $102.1 million, partially offset by the retirement ofthe PDSHeart debt of $5.8 million in 2007 and the initial public offering netcash proceeds of $47.3 million, excluding offering expenses not yet paid,generated in the first quarter of 2008.

 

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

 

Ourfuture funding requirements will depend on many factors, including:

 

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

 

·                  the costs of hiring additionalpersonnel and investing in infrastructure to support future growth;

 

·                  the reimbursement rates associatedwith our products and services;

 

·                  actions taken by the FDA and otherregulatory authorities affecting the CardioNet System and competitive products;

 

·                  our ability to secure contracts withadditional commercial payors providing for the reimbursement of our services;

 

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·                  the emergence of competingtechnologies and products and other adverse market developments;

 

·                  the costs of preparing, filing,prosecuting, maintaining and enforcing patent claims and other intellectualproperty rights or defending against claims of infringement by others; and

 

·                  the costs of investing in additionallines of business outside of arrhythmia monitoring solutions.

 

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

 

**Item 3. Quantitative and QualitativeDisclosures about Market Risk.**

 

Our cash and cashequivalents as of March 31, 2008 consisted primarily of cash and moneymarket funds with maturities of less than 90 days.  The primary objective of our investmentactivities is to preserve our capital for the purpose of funding operationswhile, at the same time, maximizing the income we receive from our investments withoutsignificantly increasing risk. To achieve this objective, our investment policyallows us to maintain a portfolio of cash equivalents and short terminvestments in a variety of securities including money market funds andcorporate debt securities. Due to the short term nature of our investments, webelieve we have no material exposure to interest rate risk.

 

**Item 4. Controls and Procedures.**

 

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our periodic reports filed with theSecurities and Exchange Commission, or SEC, is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andforms and that such information is accumulated and communicated to ourmanagement, including our chief executive officer and chief financial officer,as appropriate, 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.

 

Asrequired by Rule 13a-15(b) of the Securities Exchange Act of 1934, asamended, or Exchange Act, prior to the filing of this report we carried out anevaluation, under the supervision and with the participation of our management,including our chief executive officer and chief financial officer, of the effectivenessof the design and operation of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) asof the end of the period covered by this report. Based on their evaluation, ourchief executive officer and chief financial officer concluded that ourdisclosure controls and procedures were effective as of the end of the periodcovered by this report.

 

**PART II- OTHER INFORMATION.**

 

**Item1.  Legal Proceedings.**

 

On November 26,2007, we filed a lawsuit against LifeWatch Corp. and certain of itsemployees in the United States District Court for the Northern District ofIllinois, Eastern Division. In the action, we allege several causes of actionincluding trade secret misappropriation, breach of contract, fraud, and unfaircompetition arising from actions of LifeWatch and its employees to unlawfullyobtain, use, inspect and test two of our CardioNet System kits. On January 4,2008, LifeWatch responded by filing counterclaims in the action against us. Inits counterclaims, LifeWatch alleged that we misappropriated trade secrets ofLifeWatch through inspection of a LifeWatch device, and that we have mademisleading advertising and marketing statements relating to LifeWatch. InMay 2008, the parties entered into a settlement agreement pursuant towhich the parties amicably agreed to resolve the lawsuit with dismissal by bothsides of all claims pending in the lawsuit.

 

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**Item1A.  Risk Factors.**

 

*Youshould consider carefully the following information about the risks describedbelow, together with the other information contained in this Quarterly Reportand in our other public filings in evaluating our business. We have marked withan asterisk (*) those risk factors that reflect substantive changes from therisk factors included in our final prospectus filed by the Company with theSecurities and Exchange Commission on March 19, 2008 relating to theCompany’s Registration Statement on Form S-1/A (File No. 333-145547)for the Company’s initial public offering. If any of the following risksactually occurs, our business, financial condition, results of operations andfuture growth prospects would likely be materially and adversely affected. Inthese circumstances, the market price of our common stock would likely decline.*

 

**Risksrelated to our business and industry**

 

****We have a history of net losses and may never becomeprofitable.***

 

We have incurrednet losses from our inception through March 31, 2008, including net lossesof $0.3 million for the quarter ended March 31, 2008 and $11.5 million for theyear ended December 31, 2007.  As of March 31,2008, we had total stockholders’ deficit of approximately $82.1 million. Weexpect our operating expenses to increase as we, 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 increasingexpenses, we will need to continue to substantially increase our revenues tobecome profitable. Because of the risks and uncertainties associated withfurther developing and marketing the CardioNet System, we are unable to predictthe extent of any future losses or when we will become profitable, if at all.

 

***Our business is dependent upon physicians prescribing ourservices; if we fail to obtain those prescriptions, our revenues could fail togrow and could decrease.***

 

The success of ourbusiness is dependent upon physicians prescribing our services for patients andcross-selling the respective CardioNet and PDSHeart customer bases. Our successin obtaining prescriptions and cross-selling will be directly influenced by anumber 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 unableto educate physicians regarding the benefits of the CardioNet System, obtainsufficient prescriptions and cross-sell our respective customer bases, revenuesfrom the provision of our arrhythmia monitoring solutions could fail to growand could decrease.

 

***We and the physicians with whom we work are dependent uponreimbursement for the fees associated with our services; the absence orinadequacy of reimbursement would cause our revenues to fail to grow ordecrease.***

 

We receivereimbursement for our services from commercial payors and from Medicare Part Bcarriers where the services are performed on behalf of the Centers for Medicareand Medicaid Services, or CMS. The Medicare Part B carriers in each statechange from time to time, which may result in changes to our reimbursementrates, increased administrative burden and reimbursement delays.

 

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In addition, ourprescribing physicians receive reimbursement for professional interpretation ofthe information provided by our products and services from commercial payors orMedicare carriers within the state where they practice. The efficacy, safety,performance and cost-effectiveness of our products and services, on astand-alone basis and relative to competing services, will determine theavailability and level of reimbursement we and our prescribing physiciansreceive. Our ability to successfully contract with payors is critical to ourbusiness because physicians and their patients will select arrhythmiamonitoring solutions other than ours in the event that payors refuse toadequately reimburse our technical fees and physicians’ professional fees.

 

Many commercialpayors refuse to enter into contracts to reimburse the fees associated withmedical devices or services that such payors determine to be “experimental andinvestigational”. Commercial payors typically label medical devices or servicesas “experimental and investigational” until such devices or services havedemonstrated product superiority evidenced by a randomized clinical trial. Wecompleted a clinical trial in which the CardioNet System provided higherdiagnostic yield than traditional loop event monitoring. Prior to our clinicaltrial, the CardioNet System was labeled “experimental and investigational” by21 targeted commercial payors, representing approximately 95 millioncovered lives. Subsequent to our trial, three commercial payors, representingover 26 million covered lives, removed the designation of the CardioNetSystem as “experimental and investigational”. Several of the remaining payors,however, have informed us that they do not believe the data from this trialjustifies the removal of this designation. Other commercial payors may alsofind the data from our clinical trial not compelling. Additional commercialpayors may also label the CardioNet System as “experimental and investigational”and, as a result, refuse to reimburse the technical and professional feesassociated with the CardioNet System.

 

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

 

If commercialpayors or Medicare decide not to reimburse our services or the related servicesprovided by physicians, or the rates of such reimbursement change, or if wefail to properly administer claims, our revenues could fail to grow and coulddecrease.

 

***Reimbursement by Medicare is highly regulated and subject tochange; our failure to comply with applicable regulations, could decrease ourrevenues and may subject us to penalties or have an adverse impact on ourbusiness.***

 

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

 

In addition,reimbursement from Medicare is subject to statutory and regulatory changes,local and national coverage decisions, rate adjustments and administrativerulings, all of which could materially affect the range of services covered orthe reimbursement rates paid by Medicare for use of our arrhythmia monitoringsolutions. For example, CMS adopted a new payment policy in January 2007that reduced the rate of reimbursement for a number of services reimbursed byMedicare. Although this modification to Medicare’s reimbursement rates did notaffect the amount paid by Medicare for reimbursement of the fees associatedwith the CardioNet System, it resulted in the reduction of reimbursement ratesfor event services by 3% to 8%, depending on the type of service, and Holterservices by 8% as compared to the corresponding rates in effect in 2006. Basedon current proposed Medicare rates for 2008 through 2010, we expect thatreimbursement for event and Holter services will continue to decline at anannual rate similar to 2007. In addition, we cannot predict whether futuremodifications to Medicare’s reimbursement policies could reduce or eliminatethe amounts we receive from Medicare for the solutions we provide. In addition,Medicare’s reimbursement rates can affect the rate that commercial payors arewilling to pay for our products and services. Consequently, any futureelimination, limitation or reduction in the reimbursement rates provided byMedicare for our arrhythmia monitoring solutions could result in a reduction inthe rates we receive from commercial payors.

 

***Reimbursement for the CardioNet System by Medicare and othercommercial payors is complicated by the lack of a specific Current ProceduralTerminology, or CPT, code, which may result in lower prescription rates orvarying reimbursement rates.***

 

When we billMedicare and certain other commercial payors for the service we provide inconnection with the CardioNet System, we submit the bill using the nonspecificbilling, or CPT, code “93799”. Unlike dedicated CPT codes approved by the AmericanMedical Association, or AMA, and CMS, claims using non-specific codes mayrequire semi-automated or manual processing, as well as additional review bypayors. The claims processing requirements associated with a nonspecific codecan make our services less attractive to physicians because added time andeffort is often required in order to receive payment for their services.Furthermore, the Medicare reimbursement rate for non-specific codes isdetermined by local Medicare carriers. As a result, the reimbursement ratesrelating to our CardioNet System are subject to change without notice.

 

A request to theAMA for a specific CPT code that describes our CardioNet System has been made.The request was discussed and voted upon by the CPT Editorial Panel at itspublic October 2007 meeting. The results of the vote are confidential. Wehave been informally advised that the CPT Editorial Panel voted in favor of therequest. However, the results of the vote are subject to change

 

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until such resultsare published in the fall of 2008. If the request is officially approved by theAMA CPT Editorial Panel, the specific CPT code would be published in the fallof 2008 and would be available for use in 2009. However, we cannot guaranteethat we will receive a specific CPT code for the CardioNet System in thattimeframe, or ever. Moreover, if we do receive a CPT code, the reimbursementrate associated with that code, which would be subject to change on an annualbasis through a public notice and comment process, may be lower than ourcurrent reimbursement rates.

 

****A reduction in sales of our services or a loss of one ormore of our key commercial payors would adversely affect our business andoperating results.***

 

A small number ofcommercial payors represent a significant percentage of our revenues. In thequarter ended March 31, 2008, our top 10 commercial payors by revenuesaccounted for approximately 27.8% of our total revenues. Our agreements withthese commercial payors typically allow either party to the contract toterminate the contract by providing between 60 and 120 days prior writtennotice to the other party at any time following the end of the initial term ofthe contract. Our commercial payors may elect to terminate or not to renewtheir contracts with us for any reason and, in some instances can unilaterallychange the reimbursement rates they pay. In the event any of our key commercialpayors terminate their agreements with us, elect not to renew their agreementswith us or elect not to enter into new agreements with us upon expiration oftheir agreements with us on terms as favorable as our current agreements, ourbusiness, operating results and prospects would be adversely affected.

 

***Consolidation of commercial payors could result in payorseliminating coverage of our CardioNet System or reduced reimbursement rates forour CardioNet System.***

 

The commercialpayor industry is undergoing significant consolidation. When payors combinetheir operations, the combined company may elect to reimburse our CardioNetSystem at the lowest rate paid by any of the participants in the consolidation.If one of the payors participating in the consolidation does not reimburse forthe CardioNet System at all, the combined company may elect not to reimbursefor the CardioNet System. Our reimbursement rates tend to be lower for largerpayors. As a result, as payors consolidate, our average reimbursement rate maydecline.

 

***Our acquisition of PDSHeart, as well as any other companiesor technologies we may acquire in the future, could prove difficult tointegrate and may disrupt our business and harm our operating results andprospects.***

 

Our acquisition ofPDSHeart involves numerous risks, including the risk that we will not takeadvantage of the cross-selling opportunities brought about by the acquisition.In addition, our acquisition of PDSHeart, as well as acquisitions in which wemay engage in the future, involve risks associated with our assumption of theliabilities of an acquired company, which may be liabilities that we were orare unaware of at the time of the acquisition, potential write-offs of acquiredassets and potential loss of the acquired company’s key employees or customers.

 

We may encounterdifficulties in successfully integrating our operations, technologies, servicesand personnel with that of the acquired company, and our financial andmanagement resources may be diverted from our existing operations. For example,following our acquisition of PDSHeart we have offices in Pennsylvania,California, Florida, Georgia and Minnesota. Our offices in multiple statescreate a strain on our ability to effectively manage our operations and keypersonnel. If we elect to consolidate our facilities we may lose key personnelunwilling to relocate to the consolidated facility, may have difficulty hiringappropriate personnel at the consolidated facility and may have difficultyproviding continuity of service through the consolidation.

 

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

 

We may not be ableto realize the anticipated benefits of the PDSHeart acquisition or any otheracquisition we may pursue or to profitably deploy acquired assets. If we failto properly evaluate and execute acquisitions, our business may be disruptedand our operating results and prospects may be harmed.

 

****If we are unable to manage our expected growth, ourrevenues and operating results may be adversely affected.***

 

Our business planscall for rapid expansion of our sales and marketing operations and growth ofour research and development, product development and administrativeoperations. We had a sales force of 75 account executives at March 31,2008. We intend to expand our sales force to 89 individuals by December 31,2008. We expect this expansion will place a significant strain on ourmanagement and operational and financial resources. Our current and plannedpersonnel, systems, procedures and controls may not be adequate to support ouranticipated growth. To manage our growth we will be required to improveexisting and implement new operational and financial systems, procedures andcontrols and expand, train and manage our growing employee base. If we areunable to manage our growth effectively, revenue growth may not be realized ormay not be sustainable, may not result in improved operating results orearnings, and our business, financial condition and results of operations couldbe harmed.

 

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***Our business is dependent upon having sufficient monitorsand sensors. If we do not have enough monitors or sensors or experience delaysin manufacturing, we may be unable to fill prescriptions in a timely manner,physicians may elect not to prescribe the CardioNet System, and our revenuesand growth prospects could be harmed.***

 

When a physicianprescribes the CardioNet System to a patient, our customer service departmentbegins the patient hook-up process, which includes procuring a monitor andsensors from our distribution department and sending them to the patient. Whileour goal is to provide each patient with a monitor and sensors in a timelymanner, we have experienced and may in the future experience delays due to theavailability of monitors, primarily when converting to a new generation ofmonitor or, more recently, in connection with the increase in prescriptionsfollowing our acquisition of PDSHeart.

 

We may alsoexperience shortages of monitors or sensors due to manufacturing difficulties.Multiple suppliers provide the components used in the CardioNet System, but ourfacilities in San Diego, California are registered and approved by the UnitedStates Food and Drug Administration, or FDA, as the ultimate manufacturer ofthe CardioNet System. Our manufacturing operations could be disrupted by fire,earthquake or other natural disaster, a work stoppage or otherlabor-related disruption, failure in supply or other logistical channels,electrical outages or other reasons. If there was a disruption to ourfacilities in San Diego, we would be unable to manufacture the CardioNet Systemuntil we have restored and re-qualified our manufacturing capability ordeveloped alternative manufacturing facilities.

 

Our success inobtaining future prescriptions from physicians is dependent upon our ability topromptly deliver monitors and sensors to our patients, and a failure in thisregard would have an adverse effect on our revenues and growth prospects.

 

***Interruptions or delays in telecommunications systems or inthe data services provided to us by QUALCOMM or the loss of our wireless ordata services could impair the delivery of our CardioNet System services.***

 

The success of theCardioNet System is dependent upon our ability to store, retrieve, process andmanage data and to maintain and upgrade our data processing and communicationcapabilities. The monitors we use in connection with the CardioNet System relyon a third party wireless carrier to transmit data over its data network duringtimes that the monitor is removed from its base. All data sent by our monitorsvia this wireless data network or via landline is routed directly to QUALCOMMdata centers and subsequently routed to our monitoring center. We are dependentupon these third parties to provide data transmission and data hosting servicesto us. We do not have an agreement directly with this third party wirelesscarrier. Although we do have an agreement with QUALCOMM that has an initialtermination date in September 2010, QUALCOMM may terminate its agreementwith us if certain conditions occur, including if QUALCOMM’s agreement with thethird party wireless carrier terminates or in the event we fail to maintain anagreed-upon number of active cardiac monitoring devices on the QUALCOMMnetwork. We have no control over the status of the agreement between QUALCOMMand the wireless carrier. If we fail to maintain our relationships withQUALCOMM or if we lose wireless carrier services, we would be forced to seekalternative providers of data transmission and data hosting services, whichmight not be available on commercially reasonable terms or at all.

 

As we expand ourcommercial activities, an increased burden will be placed upon our dataprocessing systems and the equipment upon which they rely. Interruptions of ourdata networks or the data networks of QUALCOMM for any extended length of time,loss of stored data or other computer problems could have a material adverseeffect on our business, financial condition and results of operations. Frequentor persistent interruptions in our arrhythmia monitoring services could causepermanent harm to our reputation and could cause current or potential users ofthe CardioNet System or prescribing physicians to believe that our systems areunreliable, leading them to switch to our competitors. Such interruptions couldresult in liability, claims and litigation against us for damages or injuriesresulting from the disruption in service.

 

Our systems arevulnerable to damage or interruption from earthquakes, floods, fires, powerloss, telecommunication failures, terrorist attacks, computer viruses,break-ins, sabotage, and acts of vandalism. Despite any precautions that we maytake, the occurrence of a natural disaster or other unanticipated problemscould result in lengthy interruptions in these services. We do not carrybusiness interruption insurance to protect against losses that may result frominterruptions in service as a result of system failures. Moreover, thecommunications and information technology industries are subject to rapid andsignificant changes, and our ability to operate and compete is dependent insignificant part on our ability to update and enhance the communicationtechnologies used in our systems and services.

 

***The market for arrhythmia monitoring solutions is highlycompetitive. If our competitors are able to develop or market monitoringsolutions that are more effective, or gain greater acceptance in themarketplace, than any solutions we develop, our commercial opportunities willbe reduced or eliminated.***

 

The market forarrhythmia monitoring solutions is evolving rapidly and becoming increasinglycompetitive. Our industry is highly fragmented and characterized by a smallnumber of large providers and a large number of smaller regional serviceproviders. These third parties compete with us in marketing to payors andprescribing physicians, recruiting and retaining qualified personnel, acquiringtechnology and developing solutions complementary to our programs. In addition,as companies with substantially greater resources than ours enter our market,we will face increased competition. If our competitors are better able todevelop and patent arrhythmia monitoring solutions than us, or develop moreeffective and/or less expensive arrhythmia monitoring solutions that render oursolutions obsolete or non-competitive or deploy larger or more effectivemarketing and sales resources than ours, our business will be harmed and ourcommercial opportunities will be reduced or eliminated.

 

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***If we need to raise additional funding in the future, we maybe unable to raise such capital when needed, or at all, and the terms of suchcapital may be adverse to our stockholders.***

 

We believe thatthe net proceeds from our initial public offering, together with our existingcash and cash equivalent balances, will be sufficient to meet our anticipatedcash requirements for the foreseeable future. However, our future fundingrequirements will depend on many factors, including:

 

·                  the costsassociated with manufacturing and building our inventory of our next generationC3 monitor;

 

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

 

·                  thereimbursement rates 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.

 

If we need to, orchoose to, raise additional capital in the future, such capital may not beavailable on reasonable terms, or at all. If we raise additional funds byissuing equity securities, substantial dilution to existing stockholders wouldlikely result. If we raise additional funds by incurring debt financing, theterms of the debt may involve significant cash payment obligations as well ascovenants and financial ratios that may restrict our ability to operate ourbusiness.

 

***Our manufacturing facilities and the manufacturingfacilities of our suppliers must comply with applicable regulatoryrequirements. If we or our suppliers fail to achieve or maintain regulatoryapproval of these manufacturing facilities, our growth could be limited and ourbusiness could be harmed.***

 

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

 

***Our dependence on a limited number of suppliers may preventus from delivering our devices on a timely basis.***

 

We currently relyon a limited number of suppliers of components for the CardioNet System. Ifthese suppliers became unable to provide components in the volumes needed or atan acceptable price, we would have to identify and qualify acceptablereplacements from alternative sources of supply. Qualifying suppliers is alengthy process. Delays or interruptions in the supply of our requirementscould limit or stop our ability to provide sufficient quantities of devices ona timely basis, meet demand for our services, which could have a materialadverse effect on our business, financial condition and results of operations.

 

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

 

The design, manufactureand marketing of services of the types we provide entail an inherent risk ofproduct liability claims. Any such claims against us may require us to incursignificant defense costs, irrespective of whether such claims have merit. Inaddition, we provide information to health care providers and payors upon whichdeterminations affecting medical care are made, and claims 

may be madeagainst us resulting from adverse medical consequences to patients resultingfrom the information we provide. In addition, we may become subject toliability in the event that the monitors and sensors we use fail to correctlyrecord or transfer patient information or if we provide incorrect informationto patients or health care providers using our services. We have also agreed 

 

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to indemnifyQUALCOMM for any claims resulting from the provision of our services. If weincur one or more significant claims 

against us, if weare required to indemnify QUALCOMM as a result of the provision of ourservices, or if we are required to undertake remedial actions in response toany such claims, such claims or actions would adversely affect our business andresults of operations.

 

Our liabilityinsurance is subject to deductibles and coverage limitations. In addition, ourcurrent insurance may not continue to be available to us on acceptable terms,if at all, and, if available, the coverages may not be adequate to protect usagainst any future claims. If we are unable to obtain insurance at anacceptable cost or on acceptable terms with adequate coverage or otherwiseprotect against any claims against us, we will be exposed to significantliabilities, which may harm our business.

 

****If we do not obtain and maintain adequate protection forour intellectual property, the value of our technology and devices may beadversely affected.***

 

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

 

As of March 31,2008, we had 14 issued U.S. patents, seven foreign patents and 42 pending U.S.,foreign and international patent applications relating to various aspects ofthe CardioNet System. As of March 31, 2008, we also had 14 trademarkregistrations and one pending trademark application in the United States for avariety of word marks and slogans. We do not believe that any single patent,trademark or other intellectual property right of ours, or combination of ourintellectual property rights, is likely to prevent others from competing withus using a similar business model. There are many issued patents and patentapplications held by others in our industry and the electronics field. Ourcompetitors may independently develop technologies that are substantiallysimilar or superior to our technologies, or design around our patents or otherintellectual property to avoid infringement. In addition, we may not apply fora patent relating to products or processes that are patentable, we may fail toreceive any patent for which we apply or have applied, and any patent owned byus or issued to us could be circumvented, challenged, invalidated, or held tobe unenforceable, or rights granted thereunder may not adequately protect ourtechnology or provide a competitive advantage to us. For example, with respectto one of our U.S. patents, we have a corresponding foreign patent, the claimsof which were amended substantially more so than in the United States, toovercome art that was of record in the U.S. patent. If a third-party challengesthe validity of any patents or proprietary rights of ours, we may becomeinvolved in intellectual property disputes and litigation that would be costlyand time-consuming.

 

Although thirdparties may infringe our patents and other intellectual property rights, we maynot 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. Any decision whether or not to take further action inresponse to potential infringement of our patent or other intellectual propertyrights may be based on any one or more of a variety of factors, such as thepotential costs and benefits of taking such action, and business and legalissues and circumstances. Litigation of claims of infringement of a patent orother intellectual property rights may be costly and time-consuming and divertthe attention of key company personnel, and may not be successful or result inany significant recovery of compensation for any infringement or enjoining ofany infringing activity. Litigation or licensing discussions may also involveor lead to counterclaims that could be brought by a potential infringer tochallenge the validity or enforceability of our patents and other intellectualproperty.

 

To protect ourtrade secrets and other proprietary information, we generally require ouremployees, consultants, contractors and outside collaborators to enter intowritten nondisclosure agreements. These agreements, however, may not provideadequate protection to prevent any unauthorized use, misappropriation ordisclosure of our trade secrets, know-how or other proprietary information.These agreements may be breached, and we may not become aware of, or haveadequate remedies in the event of, any such breach. Also, others mayindependently develop the same or substantially equivalent proprietary informationand techniques or otherwise gain access to our trade secrets.

 

****Our ability to market our services may be impaired by theintellectual property rights of third parties.***

 

Our success isdependent in part upon our ability to avoid infringing the patents orproprietary rights of others. Our industry and the electronics field arecharacterized by a large number of patents, patent filings and frequentlitigation based on allegations of patent infringement. Competitors may havefiled applications for or have been issued patents and may obtain additionalpatents and proprietary rights related to devices, services or processes thatwe compete with or are similar to ours. We may not be aware of all of thepatents or patent applications potentially adverse to our interests that mayhave been or may later be issued to or filed by others. U.S. patentapplications may be kept confidential while pending in the Patent and TrademarkOffice. If other companies have or obtain patents relating to our products orservices, we may be required to obtain licenses to those patents or to developor obtain alternative technology. We may not be able to obtain any suchlicenses on acceptable terms, or at all. Any failure to obtain such licensescould impair or foreclose our ability to make, use, market or sell our productsand services.

 

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Based on thelitigious nature of our industry and the electronics field and the fact that wemay pose a competitive threat to some companies who own or control variouspatents, it is always possible that one or more third parties may assert apatent infringement claim seeking damages and to enjoin the manufacture, use,sale and marketing of our products and services. If a third-party asserts thatwe have infringed its patent or proprietary rights, we may become involved inintellectual property disputes and litigation that would be costly andtime-consuming and could impair or foreclose our ability to make, use, marketor sell our products and services. For example, a competitor initiated a patentinfringement lawsuit against us in November 2004, which we defended andultimately settled in March 2006. Other lawsuits may have already beenfiled against us without our knowledge. Additionally, we have received andexpect to continue to receive notices from other third parties suggesting orasserting that we are infringing their patents and inviting us to license suchpatents. We do not believe, however, that we are infringing any third party’spatents or that a license to any such patents is necessary. Should litigationover such patents arise, which could occur if, for example, a third partyfiles a lawsuit alleging infringement of such patents or if we file alawsuit 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 our commercialbusiness. Moreover, regardless of the outcome, patent litigation against or byus could significantly disrupt our business, divert our management’s attentionand consume our financial resources. We cannot predict if or when any thirdparty will file suit for patent or other intellectual property infringement.

 

****We are highly dependent on our Executive Chairman,President and Chief Executive Officer, Chief Financial Officer and other keyemployees, and if we are not able to retain them or to recruit and retainadditional qualified personnel, our business may suffer.***

 

We are highlydependent upon our Executive Chairman, President and Chief Executive Officer,Chief Financial Officer and other key employees. The loss of their servicescould have a material adverse effect on our business, financial condition andresults of operations. In particular, our Executive Chairman, James M. Sweeney,and our President and Chief Executive Officer, Arie Cohen, are critical to ouroperations. The employment of our executive officers and key employees with usis “at will”, and each employee can terminate his or her relationship with usat any time. We do not carry “key person” life insurance on any of ouremployees other than James M. Sweeney, our Executive Chairman.

 

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

 

****Our business operations could be significantly disrupted ifwe fail to properly integrate our management team.***

 

Our ChiefExecutive Officer and Chief Financial Officer recently joined CardioNet and arebeing integrated into our management team. Each of these officers will havesignificant responsibility for our operations and success, but have onlylimited experience with our business. If they do not smoothly and rapidlydevelop knowledge of our business and integrate with our existing management,our business operations could be significantly disrupted.

 

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

 

The monitors andsensors that we manufacture and sell as part of the CardioNet System areclassified as medical devices and are subject to extensive regulation by theFDA. Further, we maintain establishment registration with the FDA as adistributor of medical devices. FDA regulations govern manufacturing, labeling,promotion, distribution, importing, exporting, shipping and sale of thesedevices.

 

The CardioNetSystem, including our C3 monitor, and our arrhythmia detection algorithms have “510(k) clearance”status from the FDA. Modifications to the CardioNet System or our algorithmsthat could significantly affect safety or effectiveness, or that couldconstitute a significant change in intended use, would require a new clearancefrom the FDA. If in the future we make changes to the CardioNet System or ouralgorithms, the FDA could determine that such modifications require new FDA clearance,and we may not be able to obtain such FDA clearances in a timely fashion or atall.

 

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We are subject tocontinuing regulation by the FDA, including quality regulations applicable tothe manufacture of the CardioNet System and various reporting regulations andregulations that govern the promotion and advertising of medical devices. TheFDA could find that we have failed to comply with one of these requirements,which could result in a wide variety of enforcement actions, ranging from awarning letter to one or more severe sanctions, including the following:

 

·                  fines,injunctions and civil penalties;

 

·                  recall orseizure of the CardioNet System;

 

·                  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 theseenforcement actions could be costly and significantly harm our business,financial condition and results of operations.

 

***Enforcement of federal and state laws regarding privacy andsecurity of patient information may adversely affect our business, financialcondition or operations.***

 

The use anddisclosure of certain health care information by health care providers andtheir business associates have come under increasing public scrutiny. Recentfederal standards under the Health Insurance Portability and Accountability Actof 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, these lawsand 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 andother federal and state laws and regulations are correct, we could be heldliable for unauthorized uses or disclosures of patient information as a resultof inadequate systems and controls to protect this information or as a resultof the theft of information by unauthorized computer programmers who penetrateour network security. Enforcement of these laws against us could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

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

 

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

 

***The operation of our call centers and monitoring facilitiesis subject to rules and regulations governing Independent DiagnosticTesting Facilities; failure to comply with these rules could prevent usfrom receiving reimbursement from Medicare and some commercial payors.***

 

We have call centersand monitoring facilities in Pennsylvania, Georgia, Florida, and Minnesota thatanalyze the data obtained from arrhythmia monitors and report the results tophysicians. In order for us to receive reimbursement from Medicare and somecommercial payors, we must have a call center certified as an IndependentDiagnostic Testing Facility, or IDTF. Certification as an

 

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IDTF requires that we follow strict regulations governing how thecenter 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 to obtain and maintain IDTF certification,our services may no longer be reimbursed by Medicare and some commercialpayors, which could have a material adverse impact on our business.

 

***We may be subject to federal and state false claims lawswhich impose substantial penalties.***

 

Many of thephysicians and patients who use our services file claims for reimbursement withgovernment programs such as Medicare and Medicaid. As a result, we may besubject to the federal False Claims Act if we knowingly “cause” the filing offalse claims. Violations may result in substantial civil penalties, includingtreble damages. The federal False Claims Act also contains “whistleblower” or “quitam” provisions that allow private individuals to bring actions on behalf ofthe government alleging that the defendant has defrauded the government. Inrecent years, the number of suits brought in the medical industry by privateindividuals has increased dramatically. Various states have enacted lawsmodeled after the federal False Claims Act, including “qui tam” provisions, andsome of these laws apply to claims filed with commercial insurers.

 

We are unable topredict whether we could be subject to actions under the federal False ClaimsAct, or the impact of such actions. However, the costs of defending claimsunder the False Claims Act, as well as sanctions imposed under the False ClaimsAct, could significantly affect our financial performance.

 

***Changes in the regulatory environment may constrain orrequire us to restructure our operations, which may harm our revenues andoperating results.***

 

Health care lawsand regulations change frequently and may change significantly in the future.We may not be able to adapt our operations to address every new regulation, andnew regulations may adversely affect our business. We cannot provide assurancethat a review of our business by courts or regulatory authorities would not resultin a determination that adversely affects our revenues and operating results,or that the health care regulatory environment will not change in a way thatrestricts our operations. In addition, as a result of the focus on health carereform in connection with the 2008 presidential election, there is risk thatCongress may implement changes in laws and regulations governing health careservice providers, including measures to control costs, or reductions inreimbursement levels, which may adversely affect our business and results ofoperations.

 

***Changes in the health care industry or tort reform couldreduce the number of arrhythmia monitoring solutions ordered by physicians,which could result in a decline in the demand for our solutions, pricing pressureand decreased revenues.***

 

Changes in thehealth care industry directed at controlling health care costs or perceivedover-utilization of arrhythmia monitoring solutions could reduce the volume ofsolutions ordered by physicians. If more health care cost controls are broadlyinstituted throughout the health care industry, the volume of cardiacmonitoring solutions could decrease, resulting in pricing pressure anddeclining demand for our services, which could harm our operating results. Inaddition, it has been suggested that some physicians order arrhythmiamonitoring solutions even when the services may have limited clinical utilityin large part to establish a record for defense in the event of a claim 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 the value of our goodwill or intangibleassets could adversely affect our results of operations.***

 

As of March 31,2008, we had $46.0 million of goodwill and $2.6 million of intangible assets,most of which resulted from acquisition of PDSHeart. Current accounting rules requirethat goodwill and certain intangible assets be assessed for impairment usingfair value measurement techniques. If the carrying amount of a reporting unitexceeds its fair value, then a goodwill impairment test is performed to measurethe amount of the impairment loss, if any. The goodwill impairment testcompares the implied fair value of the reporting unit’s goodwill with thecarrying amount of that goodwill. Determining the fair value of the impliedgoodwill is judgmental in nature and often involves the use of significantestimates 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.

 

**Risksrelated to the securities market and investment in our common stock**

 

****Our quarterly operating results and stock price may bevolatile or may decline regardless of our operating performance.***

 

The market pricefor our common stock has been and is likely to continue to be volatile and mayfluctuate significantly in response to a number of factors, most of which wecannot control, including:

 

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·                  changes inreimbursement rates 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 inaccounting principles.

 

In addition, thestock markets, and in particular the Nasdaq Global Market, have experiencedextreme price and volume fluctuations that have affected and continue to affectthe market prices of equity securities of many health care companies. Stockprices of many health care companies have fluctuated in a manner unrelated ordisproportionate to the operating performance of those companies. In the past,stockholders have instituted securities class action litigation followingperiods of market volatility. If we were involved in securities litigation, wecould incur substantial costs, and our resources and the attention ofmanagement could be diverted from our business.

 

****Future sales of our common stock or securities convertibleinto our common stock may depress our stock price.***

 

Sales of asubstantial number of shares of our common stock or securities convertible intoour common stock in the public market could occur at any time. These sales, orthe perception in the market that the holders of a large number of sharesintend to sell shares, could reduce the market price of our common stock. As ofMarch 31, 2008, we had 23,065,145 outstanding shares of common stock. Ofthese, approximately 18,445,551 shares of common stock are subject to lock-upagreements that expire on September 14, 2008. Substantially all of theshares of our common stock subject to lock-up agreements may be sold uponexpiration of such agreements. In addition, we have outstanding warrants topurchase up to 6,250 shares of our common stock that, if exercised, wouldresult in these additional shares becoming available for sale upon expirationof the lock-up agreements.

 

Effective February 15,2008, the SEC adopted revisions to Rule 144. Under the newly adoptedrevisions:

 

·                  the holdingperiod for restricted shares of our common stock has been reduced to six monthsunder specified circumstances;

 

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·                  the restrictionson the sale of restricted shares of our common stock held by affiliates andnon-affiliates of ours has been reduced; and

 

·                  certain otherrestrictions on resale of the shares of our common stock under Rule 144were modified to make it easier for our stockholders under specifiedcircumstances to sell their shares upon the expiration of the lock-upagreements beginning 180 days after the date of the final prospectusrelating to our initial public offering.

 

Based on thenumber of shares outstanding as of March 31, 2008, holders of up toapproximately 14,016,792 shares of common stock (including shares of our commonstock issuable upon the exercise of a warrant to purchase up to 6,250 shares ofour common stock) will have rights, subject to some conditions, to require usto file registration statements covering their shares or to include theirshares in registration statements that we may file for ourselves or otherstockholders. These rights will terminate on March 25, 2011, or for anyparticular holder with registration rights who holds less than one percent ofour outstanding capital stock, at any time when all securities held by thatstockholder that are subject to registration rights may be sold pursuant to Rule 144under the Securities Act of 1933, as amended, within a single 90 dayperiod. We have also registered all shares of common stock that we may issueafter our initial public offering under our equity compensation plans. Theseshares can be freely sold in the public market upon issuance, subject to thelock-up agreements described above.

 

We agreed toregister the 7,680,902 shares of our common stock that were issued at theclosing of our initial public offering upon conversion of our mandatorilyredeemable convertible preferred stock prior to June 23, 2008, and usecommercially reasonable best efforts to cause the registration statement tobecome effective prior to September 21, 2008. Once registered, theseshares will be freely tradable. If we fail to register these shares when and asrequired, we will be required to pay liquidated damages at a rate of 0.5% ofthe original purchase price of the mandatorily redeemable convertible preferredstock, plus accrued and unpaid dividends, for the initial failure and 1.0% ofthe original purchase price of the mandatorily redeemable convertible preferredstock, plus accrued and unpaid dividends, for each 30-day period thereafterthat the failure goes uncured. We intend to comply with our obligationsrelating to such registration.

 

If a large numberof our shares of our common stock or securities convertible into our commonstock are sold in the public market after they become eligible for sale, thesales could reduce the trading price of our common stock and impede our abilityto raise future capital.

 

****Anti-takeover provisions in our charter documents andDelaware law might deter acquisition bids for us that our stockholders mightconsider favorable.***

 

Our amended andrestated certificate of incorporation and bylaws contain provisions that maymake the acquisition of our company more difficult without the approval of ourboard 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 to Section 203 ofthe Delaware General Corporation Law which, subject to certain exceptions,prohibits stockholders owning in excess of 15% of our outstanding voting stockfrom merging or combining with us. These anti-takeover provisions and otherprovisions under Delaware law could discourage, delay or prevent a transactioninvolving a change of control of our company, even if doing so would benefitour stockholders. These provisions could also discourage proxy contests andmake it more difficult for our stockholders to elect directors of theirchoosing and cause us to take other corporate actions such stockholders desire.

 

****Our existing principal stockholders, executive officers anddirectors have substantial control over us, which may prevent our stockholdersfrom influencing significant corporate decisions and may harm the market priceof our common stock.***

 

Including stockoptions that are exercisable within 60 days of March 31, 2008, our existingprincipal stockholders, executive officers and directors, together with theiraffiliates, beneficially own, in the aggregate, approximately 28.2% of ouroutstanding common stock. These stockholders may have interests that conflictwith other stockholders and, if acting together, have the ability to

 

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determine the outcome of matters submitted to our stockholders forapproval, 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 a potential acquirerfrom making a tender offer or otherwise attempting to obtain control of us.

 

****We do not expect to pay any cash dividends for theforeseeable future.***

 

The continuedexpansion of our business may require substantial funding. Accordingly, we donot anticipate that we will pay any cash dividends on shares of our commonstock for the foreseeable future. Even if we were not prohibited from payingdividends, any determination to do so in the future would be at the discretionof our board of directors and will depend upon our results of operations,financial condition, contractual restrictions, restrictions imposed byapplicable law and other factors our board of directors deems relevant.Accordingly, realization of a gain on your investment will depend on theappreciation of the price of our common stock, which may never occur. Investorsseeking cash dividends in the foreseeable future should not purchase our commonstock.

 

**Item2.  Unregistered Sales of Equity Securities and Use of Proceeds.**

 

**RecentSales of Unregistered Securities**

 

From January 1,2008 to March 31, 2008, we granted stock options topurchase 307,875 shares of our common stock at a weighted averageexercise price of $12.19 per share to our employees and directors underour 2003 equity incentive plan. From January 1, 2008 to March 31,2008, we issued an aggregate of 21,283 shares of our common stock to ouremployees, directors and consultants at a weighted average price of$1.26 per share for an aggregate of $26,740 pursuant to exercises ofoptions granted under our 2003 equity incentive plan.

 

Thesales and issuances of securities in the transactions described above weredeemed to be exempt from registration under the Securities Act of 1933, asamended, in reliance upon Rule 701 promulgated under Section 3(b) ofthe Securities Act of 1933, as amended, as transactions pursuant tocompensatory benefit plans and contracts relating to compensation as providedunder Rule 701. The recipients of securities in each transactionrepresented their intentions to acquire the securities for investment only andnot with a view to or for sale in connection with any distribution thereof andappropriate legends were affixed to the securities issued in thesetransactions. All recipients had adequate access, through employment or otherrelationships, to information about us. All certificates representing thesecurities issued in these transactions included appropriate legends settingforth that the securities had not been offered or sold pursuant to aregistration statement and describing the applicable restrictions on transferof the securities. There were no underwriters employed in connection with anyof the transactions set forth above.

 

**Use ofProceeds**

 

Ourinitial public offering of common stock was effected through a RegistrationStatement on Form S-1 (File No. 333-145547) that was declaredeffective 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 $54,000,000 tous, and $27,000,000 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 $1,764,000 to the selling stockholder. The underwriters ofthe offering were Citigroup Global Markets Inc., Lehman Brothers Inc., LeerinkSwann LLC and Thomas Weisel Partners LLC. Following the sale of the shares inconnection with the over-allotment closing of our initial public offering, theoffering terminated.

 

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

 

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As of March 31,2008, we had invested $47.3 million, excluding offering expenses not yet paid,of net proceeds from the offering in money market funds. Through March 31,2008, 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 $200,000 in connection with the offering to the lender of such long-termdebt, and to pay $2.6 million of the $5.0 million owed to former stockholdersof PDSHeart holding certificates of subordinated contingent payment interest tofully extinguish our obligations under such certificates. We intend to use theremaining proceeds for research and development, to build our inventory offuture generations of our CardioNet System, to increase our sales and marketingcapabilities for our CardioNet System, to hire additional personnel, to investin infrastructure, to pursue new markets and geographies and to acquire orlicense products, technologies or businesses, although we currently have noagreements or commitments relating to material acquisitions or licenses. Wecannot specify with certainty all of the particular uses for the net proceedsfrom our initial public offering. Accordingly, our management will have broad discretion in theapplication of the net proceeds.

 

**Item4.  Submission of Matters to a Vote of Security Holders.**

 

On February 21,2008, our stockholders acted by written consent to approve thereincorporation of CardioNet, Inc. from a California corporation to aDelaware corporation and related matters. Such action was effected pursuant to an action by written consent of ourstockholders in compliance with Section 603 of the California CorporationsCode.

 

Stockholdersholding an aggregate of 22,138,737 shares approved the above matters andstockholders holding approximately 2,145,005 shares did not vote with respectto such matters. The share numbers reported above do not reflect the 1-for-2reverse stock split of our outstanding common stock effected on March 5,2008.

 

On March 5,2008, our stockholders acted by written consent to approve and adopt anamendment to our amended and restated certificate of incorporation to be filedprior to the effectiveness of our initial public offering to implement a1-for-2 reverse split of our common stock. Such action was effected pursuant to an action by written consent of ourstockholders in compliance with Section 228 of the Delaware GeneralCorporation Law.

 

Stockholdersholding an aggregate of 15,532,133 shares approved the above matters andstockholders holding approximately 8,753,026 shares did not vote with respectto such matters. The share numbers reported above do not reflect the 1-for-2reverse stock split of our outstanding common stock effected on March 5,2008.

 

On March 25,2008, our stockholders acted by written consent to approve the following: (1) theapproval and adoption of our amended and restated certificate of incorporationto become effective upon the closing of our initial public offering; (2) theapproval and adoption of our amended and restated bylaws to become effectiveupon the closing of our initial public offering; (3) the approval andadoption of our 2008 Equity Incentive Plan; (4) the approval and adoptionof our 2008 Employee Stock Purchase Plan; (5) the approval and adoption ofour 2008 Non-Employee Directors’ Stock Option Plan; and (6) the approvalof the form of indemnity agreement between us and each of our directors andexecutive officers. Such action was effected pursuant to an action by writtenconsent of our stockholders in compliance with Section 228 of the DelawareGeneral Corporation Law.

 

Stockholdersholding an aggregate of 11,262,725 shares approved the above matters andstockholders holding approximately 8,802,460 shares did not vote with respectto such matters. The share numbers reported above reflect the 1-for-2 reversestock split of our outstanding common stock effected on March 5, 2008.

 

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**Item6.  Exhibits.**

 

**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | ** ** |
|---------------------|------------|------------|
|                |       |       |   |
| 3.1                 |       |       | Amended and Restated  Certificate of Incorporation.(1) |
|                |       |       |   |
| 3.2                 |       |       | Amended and Restated  Bylaws.(1) |
|                |       |       |   |
| 4.1                 |       |       | Form of Common  Stock Certificate.(1) |
|                |       |       |   |
| 4.2                 |       |       | Warrant issued by  Registrant on August 9, 2000 to Silicon Valley Bank.(1) |
|                |       |       |   |
| 10.1                |       |       | Form of Indemnity  Agreement. (1) |
| 10.2                |       |       | 2008 Equity Incentive  Plan and Form of Stock Option Agreement thereunder. (1) |
| 10.3                |       |       | 2008 Non-Employee  Directors’ Stock Option Plan and Form of Stock Option Agreement  thereunder. (1) |
| 10.4                |       |       | 2008 Employee Stock  Purchase Plan and Form of Offering Document thereunder. (1) |
| 10.5                |       |       | Form of Letter  Agreement between the Company and the stockholders selling shares of the  Registrant’s common stock in the initial public offering. (1) |
| 31.1                |       |       | Certification of Chief  Executive Officer pursuant to Rules 13a-14(a) and  15d-14(a) promulgated under the Securities and Exchange Act of 1934, as  amended. |
| 31.2                |       |       | Certification of Chief  Financial Officer pursuant to Rules 13a-14(a) and  15d-14(a) promulgated under the Securities and Exchange Act of 1934, as  amended. |
| 32.1                |       |       | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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

 

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**CardioNet, Inc.**

 

**SIGNATURES**

 

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

 
| ** **               | **CARDIONET, INC.** |
|--------------------------|--------------------------|
| ** **               | ** **               |
|                     |                     |
| Date: May 15,  2008 | By:                      | /s/ Martin P.  Galvan |
|                     |                     | Martin P. Galvan |
|                     |                     | *Chief  Financial Officer and Chief Operating  Officer, PDSHeart*(Duly Authorized Officer and Principal  Financial Officer) |

 

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