##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended October 3, 2009
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from ___________ to ___________
 Commission file number: 0-24663
 
 ASPECT MEDICAL SYSTEMS, INC.
  Delaware
    
    04-2985553(State or Other Jurisdiction of 
Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)
 One Upland Road, Norwood, Massachusetts
    
    02062(Address of Principal Executive Offices)
    
    (Zip Code)
 (617) 559-7000
 
 þ o
 o o
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
(Do not check if smaller reporting company)
    
    Smaller reporting company o
 o þ




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##### 



PagePART I FINANCIAL INFORMATION
    
    1Item 1. Financial Statements
    
    1Condensed Consolidated Balance Sheets (unaudited)
as of October 3, 2009 and December 31, 2008
    
    1Condensed Consolidated Statements of Operations
(unaudited) for the Three and Nine months Ended
October 3, 2009 and September 27, 2008
    
    2Condensed Consolidated Statements of Cash Flows
(unaudited) for the Nine Months Ended October 3,
2009 and September 27, 2008
    
    3Notes to Condensed Consolidated Financial Statements
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    19Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    30Item 4. Controls and Procedures
    
    30PART II OTHER INFORMATION
    
    31Item 1. Legal Proceedings
    
    31Item 1A. Risk Factors
    
    33Item 6. Exhibits
    
    54SIGNATURESEx-10.5 Amendment 1 to BISx Development, Purchase and License Agreement, dated August 26, 2009Ex-10.6 Amendment 2 to OEM Deleplement and Purchase Agreement, dated July 24, 2003Ex-31.1 Section 302 Certification of Chief Executive OfficerEx-31.2 Section 302 Certification of Chief Financial OfficerEx-32.1 Section 906 Certification of Chief Executive OfficerEx-32.2 Section 906 Certification of Chief Financial Officer




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements.
 ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data and per share amounts)
(unaudited)
 October 3,
    
    
    December 31,2009
    
    
    2008ASSETSCurrent assets:Cash and cash equivalents
    
    $
    26,816
    
    
    $
    12,066Short-term investments
    
    
    51,783
    
    
    
    65,985Accounts receivable, net of allowance of $214 at
October 3, 2009 and $121 at December 31, 2008
    
    
    14,298
    
    
    
    13,193Current portion of investment in sales-type leases
    
    
    851
    
    
    
    1,057Inventory
    
    
    8,911
    
    
    
    7,796Deferred tax assets
    
    
    4,729
    
    
    
    4,729Other current assets
    
    
    2,213
    
    
    
    2,905Total current assets
    
    
    109,601
    
    
    
    107,731Property and equipment, net
    
    
    7,530
    
    
    
    8,319Intangible assets, net
    
    
    663
    
    
    
    Restricted cash
    
    
    1,103
    
    
    
    839Long-term investments
    
    
    3,047
    
    
    
    4,561Long-term investment in sales-type leases
    
    
    993
    
    
    
    1,454Deferred financing fees
    
    
    1,424
    
    
    
    1,852Long-term deferred tax assets
    
    
    10,733
    
    
    
    12,090Other long-term assets
    
    
    1,709
    
    
    
    128Total assets
    
    $
    136,803
    
    
    $
    136,974LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,468
    
    
    $
    2,155Accrued liabilities
    
    
    13,151
    
    
    
    13,288Current portion of obligation under capital lease
    
    
    73
    
    
    
    71Deferred revenue
    
    
    502
    
    
    
    236Total current liabilities
    
    
    16,194
    
    
    
    15,750Long-term portion of obligation under capital lease
    
    
    36
    
    
    
    100Long-term portion of deferred revenue
    
    
    69
    
    
    
    94Long-term debt
    
    
    57,950
    
    
    
    65,000Commitments and contingenciesStockholders equity:Preferred stock, $.01 par value; 5,000,000 shares
authorized, no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $.01 par value; 60,000,000 shares
authorized, 17,447,499 and 17,352,438 shares issued
and outstanding at October 3, 2009 and December 31,
2008, respectively
    
    
    176
    
    
    
    176Treasury stock, at cost; 276,493 shares
    
    
    (5,008
    )
    
    
    (5,008
    )Additional paid-in capital
    
    
    191,812
    
    
    
    187,374Accumulated other comprehensive loss
    
    
    (12
    )
    
    
    (105
    )Accumulated deficit
    
    
    (124,414
    )
    
    
    (126,407
    )Total stockholders equity
    
    
    62,554
    
    
    
    56,030Total liabilities and stockholders equity
    
    $
    136,803
    
    
    $
    136,974
  1




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008Revenue
    
    $
    26,235
    
    
    $
    24,758
    
    
    $
    76,428
    
    
    $
    74,371Costs of revenue (1)
    
    
    6,761
    
    
    
    6,104
    
    
    
    18,884
    
    
    
    18,943Gross profit
    
    
    19,474
    
    
    
    18,654
    
    
    
    57,544
    
    
    
    55,428Operating expenses: (1)Research and development
    
    
    4,080
    
    
    
    4,183
    
    
    
    11,753
    
    
    
    12,056Sales and marketing
    
    
    10,318
    
    
    
    12,687
    
    
    
    31,322
    
    
    
    34,561General and administrative
    
    
    5,376
    
    
    
    3,920
    
    
    
    14,197
    
    
    
    12,034Total operating
expenses
    
    
    19,774
    
    
    
    20,790
    
    
    
    57,272
    
    
    
    58,651(Loss) income from operations
    
    
    (300
    )
    
    
    (2,136
    )
    
    
    272
    
    
    
    (3,223
    )Other income (expense):Interest income
    
    
    217
    
    
    
    867
    
    
    
    997
    
    
    
    3,248Interest expense
    
    
    (443
    )
    
    
    (849
    )
    
    
    (1,355
    )
    
    
    (2,725
    )Gain on valuation of warrants
    
    
    1,043
    
    
    
    
    
    
    
    1,043
    
    
    
    Realized gain on sale of
investments
    
    
    
    
    
    
    
    
    
    
    30
    
    
    
    Other-than-temporary
impairment of investments
    
    
    
    
    
    
    (840
    )
    
    
    
    
    
    
    (840
    )Gain on repurchase of debt
    
    
    
    
    
    
    5,881
    
    
    
    3,049
    
    
    
    9,821Income before income taxes
    
    
    517
    
    
    
    2,923
    
    
    
    4,036
    
    
    
    6,281Provision for income taxes
    
    
    685
    
    
    
    1,883
    
    
    
    2,043
    
    
    
    3,577Net (loss) income
    
    $
    (168
    )
    
    $
    1,040
    
    
    $
    1,993
    
    
    $
    2,704Net (loss) income per share:Basic
    
    $
    (0.01
    )
    
    $
    0.06
    
    
    $
    0.11
    
    
    $
    0.16Diluted
    
    $
    (0.01
    )
    
    $
    0.06
    
    
    $
    0.11
    
    
    $
    0.16Weighted average shares used in
computing net (loss) income per
share:Basic
    
    
    17,442
    
    
    
    17,317
    
    
    
    17,411
    
    
    
    17,228Diluted
    
    
    17,442
    
    
    
    23,254
    
    
    
    17,412
    
    
    
    17,373 
 (1) Stock-based compensation
included in costs and expenses:Costs of revenue
    
    $
    99
    
    
    $
    127
    
    
    $
    317
    
    
    $
    370Research and development
    
    
    318
    
    
    
    489
    
    
    
    1,124
    
    
    
    1,445Sales and marketing
    
    
    335
    
    
    
    627
    
    
    
    1,267
    
    
    
    1,972General and administrative
    
    
    508
    
    
    
    647
    
    
    
    1,586
    
    
    
    1,975
  2




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 Nine Months EndedOctober 3,
    
    
    September 27,2009
    
    
    2008Cash flows from operating activities:Net income
    
    $
    1,993
    
    
    $
    2,704Adjustments to reconcile net income to net cash provided
by operating activities Depreciation and amortization
    
    
    2,344
    
    
    
    2,251Gain on repurchase of debt
    
    
    (3,049
    )
    
    
    (9,821
    )Gain on sale of investment
    
    
    (30
    )
    
    
    Loss on other-than-temporary impairment of investments
    
    
    
    
    
    
    840Non-cash gain on valuation of warrants
    
    
    (1,043
    )Provision for doubtful accounts
    
    
    94
    
    
    
    (102
    )Stock-based compensation expense
    
    
    4,233
    
    
    
    5,688Tax benefit for stock option exercises
    
    
    70
    
    
    
    90Deferred taxes
    
    
    1,357
    
    
    
    3,122Changes in assets and liabilities Increase in accounts receivable
    
    
    (1,199
    )
    
    
    (606
    )Increase in inventory
    
    
    (1,115
    )
    
    
    (416
    )Decrease (increase) in other current assets
    
    
    692
    
    
    
    (554
    )Decrease in investment in sales-type leases
    
    
    667
    
    
    
    1,219Decrease in other long-term assets
    
    
    51
    
    
    
    Increase (decrease) in accounts payable
    
    
    313
    
    
    
    (16
    )(Decrease) increase in accrued liabilities
    
    
    (137
    )
    
    
    2,414Increase in deferred revenue
    
    
    241
    
    
    
    78Net cash provided by operating activities
    
    
    5,482
    
    
    
    6,891Cash flows from investing activities:(Increase) decrease in restricted cash
    
    
    (264
    )
    
    
    155Acquisitions of property and equipment
    
    
    (1,308
    )
    
    
    (1,336
    )Acquisition of U.S. distribution rights for LiDCO products
    
    
    (1,266
    )
    
    
    Purchases of investments
    
    
    (48,919
    )
    
    
    (66,072
    )Proceeds from sales and maturities of investments
    
    
    64,595
    
    
    
    90,275Net cash provided by investing activities
    
    
    12,838
    
    
    
    23,022Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    134
    
    
    
    846Repayment of long-term debt
    
    
    (3,805
    )
    
    
    (14,413
    )Repayment of capital lease
    
    
    (62
    )
    
    
    (59
    )Net cash used for financing activities
    
    
    (3,733
    )
    
    
    (13,626
    )Effect of exchange rate changes on cash
    
    
    163
    
    
    
    (50
    )Net increase in cash and cash equivalents
    
    
    14,750
    
    
    
    16,237Cash and cash equivalents, beginning of period
    
    
    12,066
    
    
    
    19,828Cash and cash equivalents, end of period
    
    $
    26,816
    
    
    $
    36,065
  3




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 (1) Basis of Presentation
   (2) Summary of Significant Accounting Policies
  Principles of Consolidation
  Foreign Currency
  Cash, Cash Equivalents and Investments
   4




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 Revenue Recognition
 rapid
       5




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 Research and Development Costs
  Allowance for Doubtful Accounts
  Inventory
  Warranty
  Three Months Ended
    
    
    Nine Months EndedOctober 3, 2009
    
    
    September 27, 2008
    
    
    October 3, 2009
    
    
    September 27, 2008Beginning balance
    
    $
    266
    
    
    $
    254
    
    
    $
    270
    
    
    $
    250Warranty expense
    
    
    23
    
    
    
    12
    
    
    
    52
    
    
    
    42Deductions and other
    
    
    (16
    )
    
    
    (11
    )
    
    
    (49
    )
    
    
    (37
    )Ending balance
    
    $
    273
    
    
    $
    255
    
    
    $
    273
    
    
    $
    255
 Shipping and Handling Costs
  Advertising Costs
  6




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 Property and Equipment
  Income Taxes
  Concentration of Credit Risk
  Single or Limited Source Suppliers
  Net (Loss) Income Per Share
   7




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
  Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008Basic:Net (loss) income
    
    $
    (168
    )
    
    $
    1,040
    
    
    $
    1,993
    
    
    $
    2,704Weighted average shares outstanding
    
    
    17,442
    
    
    
    17,317
    
    
    
    17,411
    
    
    
    17,228Basic net (loss) income per share
    
    $
    (0.01
    )
    
    $
    0.06
    
    
    $
    0.11
    
    
    $
    0.16Diluted:Net (loss) income
    
    $
    (168
    )
    
    $
    1,040
    
    
    $
    1,993
    
    
    $
    2,704Interest expense on convertible
debt, net
    
    
    
    
    
    
    306
    
    
    
    
    
    
    
    Net (loss) income as adjusted
    
    $
    (168
    )
    
    $
    1,346
    
    
    $
    1,993
    
    
    $
    2,704Weighted average shares outstanding
    
    
    17,442
    
    
    
    17,317
    
    
    
    17,411
    
    
    
    17,228Effect of dilutive stock options and
restricted stock
    
    
    
    
    
    
    36
    
    
    
    1
    
    
    
    145Conversion of convertible notes
    
    
    
    
    
    
    5,901
    
    
    
    
    
    
    
    Weighted average shares assuming
dilution
    
    
    17,442
    
    
    
    23,254
    
    
    
    17,412
    
    
    
    17,373Diluted net (loss) income per share
    
    $
    (0.01
    )
    
    $
    0.06
    
    
    $
    0.11
    
    
    $
    0.16
 Comprehensive Income
  Stock-Based Compensation
  Accounting for Stock-Based
Compensation
  8




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
   Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008Options granted
    
    
    322
    
    
    
    157
    
    
    
    1,013
    
    
    
    455Weighted average exercise price
    
    $
    5.99
    
    
    $
    5.20
    
    
    $
    4.99
    
    
    $
    9.18Weighted average grant date
fair value
    
    $
    3.09
    
    
    $
    2.93
    
    
    $
    2.82
    
    
    $
    4.49Assumptions:Risk-free interest rate
    
    
    2.13
    %
    
    
    3.64
    %
    
    
    2.46
    %
    
    
    3.22
    %Expected term
    
    4.33 years
    
    5.76 years
    
    5.54  years
    
    5.76 yearsExpected volatility
    
    
    64
    %
    
    
    58
    %
    
    
    62
    %
    
    
    51
    %
     :
  9




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
   Use of Estimates
  Fair Value of Financial Instruments
  Recent
Accounting Guidance
    Fair Value Measurements
and Disclosures
 10




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 (3) Comprehensive (Loss) Income
  Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008Net (loss) income
    
    $
    (168
    )
    
    $
    1,040
    
    
    $
    1,993
    
    
    $
    2,704Other comprehensive (loss) income:Foreign currency translation
adjustments
    
    
    71
    
    
    
    (50
    )
    
    
    163
    
    
    
    (50
    )Unrealized loss on investments
    
    
    (23
    )
    
    
    (760
    )
    
    
    (70
    )
    
    
    (984
    )Comprehensive (loss) income
    
    $
    (120
    )
    
    $
    230
    
    
    $
    2,086
    
    
    $
    1,670
 (4) Investment in Sales-Type Leases
  October 3,
    
    
    December 31,2008
    
    
    2009Total minimum lease payments receivable
    
    $
    2,679
    
    
    $
    3,457Less:Unearned interest income
    
    
    339
    
    
    
    459Allowance for lease payments
    
    
    496
    
    
    
    487Net investment in sales-type leases
    
    
    1,844
    
    
    
    2,511Less  current portion
    
    
    851
    
    
    
    1,057$
    993
    
    
    $
    1,454
 (5) Inventory
  October 3,
    
    
    December 31,2009
    
    
    2008Raw materials
    
    $
    4,682
    
    
    $
    4,552Work-in-progress
    
    
    49
    
    
    
    25Finished goods
    
    
    4,180
    
    
    
    3,219$
    8,911
    
    
    $
    7,796
 (6) Intangible Assets
 rapid plus ® rapid
 11




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
   AcquisitionAmountExclusive Product Distribution Rights   LiDCOrapidand Aspect BIS Combined Product
    
    $
    562,000Customer Relationships
    
    
    116,000$
    678,000
  (7) Income Taxes
    12




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
   (8) Fair Value Measurements
  Amortized
    
    
    Unrealized
    
    
    UnrealizedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueOctober 3, 2009 U.S. Government debt securities
    
    $
    48,642
    
    
    $
    60
    
    
    $
    (4
    )
    
    $
    48,698Corporate obligations
    
    
    5,803
    
    
    
    37
    
    
    
    
    
    
    
    5,840Certificates of deposit
    
    
    1,396
    
    
    
    
    
    
    
    
    
    
    
    1,396$
    55,841
    
    
    $
    97
    
    
    $
    (4
    )
    
    $
    55,934December 31, 2008 U.S. Government debt securities
    
    $
    50,952
    
    
    $
    323
    
    
    $
    
    
    
    $
    51,275Corporate obligations
    
    
    13,200
    
    
    
    
    
    
    
    (207
    )
    
    
    12,993Commercial paper
    
    
    5,953
    
    
    
    46
    
    
    
    
    
    
    
    5,999Certificates of deposit
    
    
    279
    
    
    
    
    
    
    
    
    
    
    
    279$
    70,384
    
    
    $
    369
    
    
    $
    (207
    )
    
    $
    70,546
       13




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 Fair Value Measurements at October 3, 2009Balance atOctober 3, 2009
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3Money market funds
    
    $
    18,683
    
    
    $
    18,683
    
    
    $
    
    
    
    $
    Available for sale securities
    
    $
    54,537
    
    
    $
    
    
    
    $
    54,537
    
    
    $
    Warrants
    
    $
    1,632
    
    
    $
    
    
    
    $
    
    
    
    $
    1,632
  WarrantsBalance at July 28, 2009
    
    $
    589Total gains included in other income
    
    
    1,043Balance at October 3, 2009
    
    $
    1,632
 (9) Segment Information and Enterprise Reporting
   Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008Geographic Area by RegionDomestic
    
    $
    18,418
    
    
    $
    17,337
    
    
    $
    52,506
    
    
    $
    51,747International
    
    $
    7,817
    
    
    $
    7,421
    
    
    $
    23,922
    
    
    $
    22,624Total
    
    $
    26,235
    
    
    $
    24,758
    
    
    $
    76,428
    
    
    $
    74,371
 Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008Geographic Area by RegionDomestic
    
    
    70
    %
    
    
    70
    %
    
    
    69
    %
    
    
    70
    %International
    
    
    30
    
    
    
    30
    
    
    
    31
    
    
    
    30Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 14




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
  (10) Commitments and Contingencies
 Leases
  Legal Proceedings
  Albert Donnay v. Nassib Chamoun,
et al.
 Roland A. Cherwek v.
Aspect Medical Systems, Inc., et al.
 Milton Pfeiffer v.
Nassib Chamoun, et al.
 15




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
     (11) Loan Agreements
   16




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
   (12) Convertible Debt
  (13) Stock Repurchase Program
  (14) Merger Agreement
    17




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
   (15) Subsequent Event
  Roland A. Cherwek v. Aspect Medical Systems, Inc., et al.
  18




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##### Table of Contents



Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations.
 Agreement and Plan of Merger
  Overview
 ® rapid plus . ®
 rapid
 Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008(dollars in thousands)Domestic revenue
    
    $
    18,418
    
    
    $
    17,337
    
    
    $
    52,506
    
    
    $
    51,747Percent of total revenue
    
    
    70
    %
    
    
    70
    %
    
    
    69
    %
    
    
    70
    %International revenue
    
    $
    7,817
    
    
    $
    7,421
    
    
    $
    23,922
    
    
    $
    22,624Percent of total revenue
    
    
    30
    %
    
    
    30
    %
    
    
    31
    %
    
    
    30
    %Total revenue
    
    $
    26,235
    
    
    $
    24,758
    
    
    $
    76,428
    
    
    $
    74,371BIS Sensor revenue
    
    $
    21,814
    
    
    $
    20,788
    
    
    $
    64,927
    
    
    $
    62,819Percent of total revenue
    
    
    83
    %
    
    
    84
    %
    
    
    85
    %
    
    
    84
    %Equipment revenue
    
    $
    4,345
    
    
    $
    3,970
    
    
    $
    11,425
    
    
    $
    11,552Percent of total revenue
    
    
    17
    %
    
    
    16
    %
    
    
    15
    %
    
    
    16
    %LiDCO revenue
    
    $
    76
    
    
    
    
    
    
    $
    76
    
    
    
    Percent of total revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total revenue
    
    $
    26,235
    
    
    $
    24,758
    
    
    $
    76,428
    
    
    $
    74,371
 19




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20




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New England Journal of Medicine
 Critical Accounting Policies and Estimates
  Revenue Recognition
   21




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Stock-Based Compensation
        Allowance for Doubtful Accounts
  22




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Inventories
  Warranty
  Income Taxes
   Results of Operations
  Three Months Ended
    
    
    Nine Months EndedOctober 3,
    
    
    September 27,
    
    
    October 3,
    
    
    September 27,2009
    
    
    2008
    
    
    2009
    
    
    2008Revenue
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Costs of revenue
    
    
    26
    
    
    
    25
    
    
    
    25
    
    
    
    25Gross margin
    
    
    74
    
    
    
    75
    
    
    
    75
    
    
    
    75Operating expenses:Research and development
    
    
    16
    
    
    
    17
    
    
    
    15
    
    
    
    16Sales and marketing
    
    
    39
    
    
    
    51
    
    
    
    41
    
    
    
    46General and administrative
    
    
    20
    
    
    
    16
    
    
    
    19
    
    
    
    16Total operating expenses
    
    
    75
    
    
    
    84
    
    
    
    75
    
    
    
    78(Loss) income from operations
    
    
    (1
    )
    
    
    (9
    )
    
    
    0
    
    
    
    (3
    )Interest income, net
    
    
    (1
    )
    
    
    
    
    
    
    0
    
    
    
    Gain on valuation of warrants
    
    
    4
    
    
    
    
    
    
    
    1
    
    
    
    Impairment loss on investments
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    (1
    )Gain on repurchase of debt
    
    
    
    
    
    
    24
    
    
    
    4
    
    
    
    13Income before income taxes
    
    
    2
    
    
    
    12
    
    
    
    5
    
    
    
    9Provision for incomes taxes
    
    
    3
    
    
    
    8
    
    
    
    3
    
    
    
    5Net income
    
    
    (1
    )%
    
    
    4
    %
    
    
    2
    %
    
    
    4
    %
 23




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Three and Nine Months Ended October 3, 2009 Compared with the Three and Nine Months Ended September 27, 2008
 Three Months Ended
    
    
    Nine Months EndedPercentage
    
    
    
    
    
    
    
    
    
    
    PercentageOctober 3,
    
    
    September 27,
    
    
    Increase
    
    
    October 3,
    
    
    September 27,
    
    
    Increase2009
    
    
    2008
    
    
    (Decrease)
    
    
    2009
    
    
    2008
    
    
    (Decrease)(in thousands, except
    
    
    
    
    
    
    (in thousands, except unitunit amounts)
    
    
    
    
    
    
    amounts)Revenue  WorldwideBIS Sensor
    
    $
    21,814
    
    
    $
    20,788
    
    
    
    5
    %
    
    $
    64,927
    
    
    $
    62,819
    
    
    
    3
    %BIS monitor
    
    
    2,446
    
    
    
    1,847
    
    
    
    32
    %
    
    
    6,307
    
    
    
    5,888
    
    
    
    7
    %Original equipment
manufacturer products
    
    
    775
    
    
    
    1,227
    
    
    
    (37
    )%
    
    
    2,483
    
    
    
    3,194
    
    
    
    (22
    )%Other equipment and accessories
    
    
    1,124
    
    
    
    896
    
    
    
    25
    %
    
    
    2,635
    
    
    
    2,470
    
    
    
    7
    %Total Equipment
    
    
    4,345
    
    
    
    3,970
    
    
    
    9
    %
    
    
    11,425
    
    
    
    11,552
    
    
    
    (1
    )%LiDCO revenue
    
    
    76
    
    
    
    
    
    
    
    
    
    
    
    76
    
    
    
    
    
    
    
    Total revenue
    
    $
    26,235
    
    
    $
    24,758
    
    
    
    6
    %
    
    $
    76,428
    
    
    $
    74,371
    
    
    
    3
    %Unit Analysis  WorldwideBIS Sensors
    
    
    1,564000
    
    
    
    1,514,000
    
    
    
    3
    %
    
    
    4,770,000
    
    
    
    4,575,000
    
    
    
    4
    %BIS monitors
    
    
    869
    
    
    
    599
    
    
    
    45
    %
    
    
    2,344
    
    
    
    1,986
    
    
    
    18
    %Original equipment manufacturer
BIS products
    
    
    1,415
    
    
    
    1,510
    
    
    
    (6
    )%
    
    
    3,972
    
    
    
    4,294
    
    
    
    (7
    )%Installed base
    
    
    62,327
    
    
    
    53,630
    
    
    
    16
    %
    
    
    62,327
    
    
    
    53,630
    
    
    
    16
    %
 Revenue.
   24




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Expense Overview
 Three Months Ended
    
    
    
    
    
    
    Nine Months EndedPercentage
    
    
    
    
    
    
    
    
    
    
    PercentageOctober 3,
    
    
    September 27,
    
    
    Increase
    
    
    October 3,
    
    
    September 27,
    
    
    Increase2009
    
    
    2008
    
    
    (Decrease)
    
    
    2009
    
    
    2008
    
    
    (Decrease)(in thousands)
    
    
    
    
    
    
    (in thousands)ExpensesResearch and development
    
    $
    4,080
    
    
    $
    4,183
    
    
    
    (2
    )%
    
    $
    11,753
    
    
    $
    12,056
    
    
    
    (3
    )%Sales and marketing
    
    
    10,318
    
    
    
    12,687
    
    
    
    (19
    )
    
    
    31,322
    
    
    
    34,561
    
    
    
    (9
    )General and administrative
    
    
    5,376
    
    
    
    3,920
    
    
    
    37
    
    
    
    14,197
    
    
    
    12,034
    
    
    
    18
 Research and Development.
  Sales and Marketing.
 25




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General and Administrative.
  Interest Income.
 Interest Expense.
 Other Income.
 26




---



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Income Taxes.
   Liquidity and Capital Resources
     27




---



##### Table of Contents



Cash provided by operations.
 Cash provided by investing activities.
 28




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##### Table of Contents



Cash used for financing activities.
 Off-Balance Sheet Arrangements
  Effects of Inflation
  Recent Accounting Pronouncements
    Fair Value Measurements
and Disclosures
 Forward-Looking Statements
 This Quarterly Report on Form 10-Q contains, in addition to historical information,
forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of
1934, including information relating to our ability to maintain profitability, information with
respect to market acceptance of our BIS system, continued growth in sales of our BIS monitors,
original equipment manufacturer products and BIS Sensors, our dependence on the BIS system,
regulatory approvals for our products, our ability to remain competitive and achieve future growth,
information with respect to other plans and strategies for our business, factors that may influence
our revenue for the fiscal quarter ending December 31, 2009 and thereafter and our proposed merger
with Covidien plc. These forward-looking statements involve risks and uncertainties and are not
guarantees of future performance. Words such as expect, anticipate, intend, plan,
believe, seek, estimate and variations of
 29




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these words and similar expressions are intended to
identify forward-looking statements. Our actual results could differ significantly from the results
discussed in these forward-looking statements. The important factors discussed under Part II  Item
1A. Risk Factors below represent some of the current challenges to us that create risk and
uncertainty. In addition, subsequent events and developments may cause our expectations to change.
While we may elect to update these forward-looking statements we specifically disclaim any
obligation to do so, even if our expectations change.
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk.
 Interest Rate Exposure
   Foreign Currency Exposure
  
 Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures.
  Changes in Internal Controls.
  30




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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  Albert Donnay v. Nassib Chamoun, et
al.
 Roland A. Cherwek v.
Aspect Medical Systems, Inc., et al.
 Milton Pfeiffer v. Nassib
Chamoun, et al.
  31




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32




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##### Table of Contents



Item 1A. Risk Factors
  If our acquisition by affiliates of Covidien plc is not completed as expected, our stock price,
business and results of operations may suffer.
   
    
    activities related to the Offer or the merger and related uncertainties may lead
to a loss of revenue and market position that we may not be able to regain if the
proposed transaction does not occur;
    
    the market price of our common stock could decline following an announcement
that the proposed transaction had been abandoned or delayed;
    
    if the merger is delayed or otherwise not consummated within the contemplated
time periods or at all, because the Purchaser would own a substantial majority of our
common stock, there may not be an active trading market for our remaining shares of
common stock and we may not be able to sustain our Nasdaq listing;
    
    we would remain liable for our costs related to the proposed transaction,
including substantial legal, accounting and investment banking expenses; and
    
    we may not be able to take advantage of alternative business opportunities or
effectively respond to competitive pressures.
 Lawsuits have been filed against us and the members of our Board of Directors arising out of our
acquisition by affiliates of Covidien plc, which may delay or prevent the proposed transaction.
  Albert Donnay v. Nassib Chamoun, et
al.
 33




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##### Table of Contents



Roland A. Cherwek v. Aspect
Medical Systems, Inc., et al.
 Milton Pfeiffer v. Nassib
Chamoun, et al.
  We will not continue to be profitable if hospitals and anesthesia providers do not buy and use our
BIS system and purchase our BIS Sensors in sufficient quantities.
  New England Journal of Medicine
 34




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We depend on our BIS system for substantially all of our revenue, and if the BIS system does not
gain widespread market acceptance, then our revenue will not grow.
  Various factors may adversely affect our quarterly operating results through the fourth fiscal
quarter of 2009.
  
    
    a third party study published in March 2008 in the New England Journal of Medicine
compared BIS monitoring with a protocol based on end-tidal gas anesthetic in a patient
population considered to be at high risk of awareness and concluded that, based upon a
similar occurrence of awareness in both groups, no benefit of BIS monitoring was
demonstrated. We believe that the publication of this study has had, and may continue to
have an adverse effect on the rate at which existing or potential new customers purchase
and use our products, which could adversely affect our operating results;
    
    we have expanded our sales force and expect that the resulting increase in operating
expenses would not be offset at least initially by an increase in revenue; as a result our
operating results in such periods could be adversely affected;
    
    we have repurchased a portion of our 2.5% convertible senior notes due 2014, referred to
as our notes, and we may make additional repurchases in the future. If any such
repurchases are made at a discount to the face value of the note, we expect to record a
gain on such transaction, which could affect our operating results in the quarter in which
any such repurchase is made;
    
    we face risks beyond our control with respect to the continued challenges of the U.S.
and worldwide economies, including without limitation the effects of domestic inflation,
declines in the value of our investments, the global rise in energy costs and reductions in
hospital spending; and
    
    we have entered into a Merger Agreement with Parent and Purchaser and activities and
uncertainties related to this transaction may lead to a loss of revenue and market position
that we may not be able to regain.
  Fluctuations in our quarterly operating results could cause our stock price to decrease.
  
    
    the timing and volume of customer orders for our BIS system;
    
    market acceptance of our BIS VISTA monitor;
    
    use of and demand for our BIS Sensors;
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
    
    the timing and amount of sales from new products and technologies we may introduce, such
as products we may sell under the LiDCO Distribution Agreement;
    
    customer cancellations;
    
    introduction of competitive products;
    
    regulatory approvals;
    
    changes in management;
    
    turnover in our direct sales force;
    
    expansion of our direct sales force which has increased our operating expenses, and this
increase will not be offset, at least initially, by an increase in revenue;
    
    effectiveness of new marketing and sales programs;
    
    communications published by industry organizations or other professional entities in the
anesthesia community that are unfavorable to our business, including publication of the
results of clinical studies;
    
    trading in our convertible debt instruments;
    
    repurchases of shares of our common stock or our notes;
    
    the amount of our outstanding indebtedness and interest payments under debt obligations;
    
    reductions in orders by our distributors and original equipment manufacturers; and
    
    the timing and amount of our expenses.
  The current crisis in global credit and financial markets could materially and adversely affect our
business and results of operations and our investment portfolio may become impaired further by a
continuation of the global economic crisis.
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If the estimates we make, and the assumptions on which we rely, in preparing our financial
statements prove inaccurate, our actual results may vary from those reflected in our financial
statements.
  Compliance with changing regulation of corporate governance and public disclosure as well as
potential new accounting pronouncements are likely to impact our future financial position or
results of operations.
   37




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Failure to maintain effective internal controls in accordance with section 404 of the
Sarbanes-Oxley act could have a material adverse effect on our business and stock price.
  We may need additional financing for our future capital needs and may not be able to raise
additional funds on terms acceptable to us, or at all.
  
    
    the research and development costs of our products or technology currently under
development increase beyond current estimates;
    
    we decide to expand faster than currently planned;
    
    we develop new or enhanced services or products ahead of schedule;
    
    we decide to undertake new sales and/or marketing initiatives;
    
    we are required to defend or enforce our intellectual property rights, or respond to
other legal challenges with respect to our products, including product liability claims;
    
    sales of our products do not meet our expectations domestically or internationally,
including sales of our BIS Sensors;
    
    we are required or elect to pay the principal under our notes in cash at or prior to
maturity or we determine to repurchase any portion of our notes;
    
    we experience unexpected losses in our cash investments or are otherwise unable to
liquidate these investments due to unfavorable conditions in the capital markets;
    
    we need to respond to competitive pressures; or
    
    we decide to acquire complementary products, businesses or technologies.
  Cases of awareness with recall during monitoring with the BIS system could limit market acceptance
of the BIS system and could expose us to product liability claims.
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We may not be able to compete with new products or alternative techniques developed by others,
which could impair our ability to remain competitive and achieve future growth.
  
    
    other new monitoring products, based on new or improved technologies;
    
    new products or technologies used on patients or in the operating room during surgery in
lieu of monitoring devices;
    
    electrical or mechanical interference from new or existing products or technologies;
    
    alternative techniques for evaluating the effects of anesthesia;
    
    significant changes in the methods of delivering anesthesia; and
    
    the development of new anesthetic agents.
  If we do not maintain our relationships with the anesthesia community and if anesthesiologists and
other healthcare providers do not recommend and endorse our products, our sales may decline or we
may be unable to increase our sales and profits.
  New England Journal of
Medicine
 39




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Negative publicity or unfavorable media coverage could damage our reputation and harm our
operations.
  New England Journal of Medicine
 If we do not successfully develop or acquire and introduce enhanced or new products we could lose
revenue opportunities and customers.
  
    
    identify and respond, in a timely manner, to new market trends or opportunities;
    
    assess customer needs;
    
    successfully develop or acquire competitive products;
    
    complete regulatory clearance in a timely manner;
    
    successfully develop cost effective manufacturing processes;
    
    introduce such products to our customers in a timely manner; and
    
    achieve market acceptance of the BIS system.
  
    
    we may not successfully adapt the BIS system to function properly for procedural
sedation, when used with anesthetics we have not tested or with patient populations we have
not studied, such as infants; and
    
    our technology is complex, and we may not be able to develop it further for applications
outside anesthesia monitoring, such as the diagnosis and tracking of neurological diseases.
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rapid plus ®
 If our clinical trials are delayed or unsuccessful, our business could be adversely affected.
    
    
    delays or the inability to obtain required approvals from institutional review boards or
other governing entities at clinical sites selected for participation in our clinical
trials;
    
    delays in enrolling patients and volunteers into clinical trials;
    
    lower than anticipated retention rates of patients and volunteers in clinical trials; or
    
    failure of our clinical trials to demonstrate the efficacy or clinical utility of our
potential products.
  If we do not develop and implement a successful sales and marketing strategy, we will not expand
our business.
  
    
    provide or assure that distributors and original equipment manufacturers provide the
technical and educational support customers need to use the BIS system successfully;
    
    promote frequent use of the BIS system so that sales of our disposable BIS Sensors
increase;
    
    establish and implement successful sales and marketing and education programs that
encourage our customers to purchase our products or the products that are made by original
equipment manufacturers incorporating our technology;
    
    manage geographically dispersed operations; and
    
    modify our products and marketing and sales programs for foreign markets.
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We encourage our direct sales force, distributors and original equipment manufacturers to maximize
the amount of our products they sell and they may engage in aggressive sales practices that may
harm our reputation.
  Our third-party distribution and original equipment manufacturer relationships could negatively
affect our profitability, cause sales of our products to decline and be difficult to terminate if
we are dissatisfied.
  We may not be able to generate enough additional revenue from our international expansion to offset
the costs associated with establishing and maintaining foreign operations.
  We may not be able to meet the unique operational, legal and financial challenges that we will
encounter in our international operations, which may limit the growth of our business.
  
    
    failure of local laws to provide adequate protection against infringement of our
intellectual property;
    
    protectionist laws and business practices that favor local competitors, which could slow
or prohibit our growth in international markets;
    
    difficulties in terminating or modifying distributor arrangements because of
restrictions in markets outside the United States;
    
    less acceptance by foreign anesthesia providers of the use of disposable products, such
as BIS Sensors;
    
    delays in regulatory approval of our products;
    
    currency conversion issues arising from sales denominated in currencies other than the
United States dollar;
    
    foreign currency exchange rate fluctuations;
 42




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
    
    longer sales cycles to sell products like the BIS system to hospitals and outpatient
surgical centers, which could slow our revenue growth from international sales; and
    
    longer accounts receivable payment cycles and difficulties in collecting accounts
receivable.
  We may experience customer dissatisfaction and our reputation could suffer if we fail to
manufacture enough products to meet our customers demands.
  Our reliance on sole-source suppliers could adversely affect our ability to meet our customers
demands for our products in a timely manner or within budget.
  We may be required to bring litigation to enforce our intellectual property rights, which may
result in substantial expense and may divert our attention from the implementation of our business
strategy.
  43




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We may be sued by third parties which claim that our products infringe on their intellectual
property rights, particularly because there is substantial uncertainty about the validity and
breadth of medical device patents.
  
    
    cease selling, incorporating or using any of our products that incorporate the
challenged intellectual property, which would adversely affect our revenue;
    
    obtain a license from the holder of the infringed intellectual property right, which
license may not be available on reasonable terms, if at all; and
    
    redesign our products, which may be costly, time-consuming and may not be successful.
 We could be exposed to significant product liability claims which could divert management attention
and adversely affect our cash balances, our ability to obtain and maintain insurance coverage at
satisfactory rates or in adequate amounts and our reputation.
  Several class action lawsuits have been filed against the underwriters of our initial public
offering which may result in negative publicity and potential litigation against us that would be
costly to defend and the outcome of which is uncertain and may harm our business.
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We may not reserve amounts adequate to cover product obsolescence, claims and returns, which could
result in unanticipated expenses and fluctuations in operating results.
  We may not be able to compete effectively, which could result in price reductions and decreased
demand for our products.
  Our ability to market and sell our products and generate revenue depends upon receipt of domestic
and foreign regulatory approval of our products and manufacturing operations.
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All of our manufacturing activities are performed at a single site and any disaster at this site
could disrupt our ability to manufacture our products for a substantial length of time, which could
cause our revenues to decrease.
  Even if we obtain the necessary FDA clearances or approvals, if we or our suppliers fail to comply
with ongoing regulatory requirements our products could be subject to restrictions or withdrawal
from the market.
  
    
    untitled letters, warning letters, fines, injunctions and civil penalties;
    
    administrative detention, which is the detention by the FDA of medical devices believed
to be adulterated or misbranded;
    
    customer notification, or orders for repair, replacement or refund;
    
    voluntary or mandatory recall or seizure of our products;
    
    operating restrictions, partial suspension or total shutdown of production;
    
    refusal to review pre-market notification or pre-market approval submissions;
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
    
    rescission of a substantial equivalence order or suspension or withdrawal of a
pre-market approval; and
    
    criminal prosecution.
  We may be subject, directly or indirectly, to federal and state healthcare fraud and abuse laws and
regulations and, if we are unable to fully comply with such laws, could face substantial penalties.
  If we do not retain our senior management and other key employees, we may not be able to
successfully implement our business strategy.
  If we do not attract and retain skilled personnel, or if we do not maintain good relationships with
our employees, we will not be able to expand our business.
   If we make any acquisitions, we will incur a variety of costs and may never successfully integrate
the acquired business into ours.
 rapid plus ®
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Our employees may engage in misconduct or other improper activities, including insider trading.
   Failure of users of the BIS system, or users of future products we may develop, to obtain adequate
reimbursement from third-party payors could limit market acceptance of the BIS system and other
products, which could prevent us from sustaining profitability.
   The market price of our stock is highly volatile, and this volatility could cause your investment
in our stock to suffer a decline in value and cause us to incur significant costs from class action
litigation.
  
    
    variations in our quarterly operating results or those of companies that are perceived
to be similar to us;
    
    third-party sales of large blocks of our common stock;
    
    rumors relating to us or our competitors;
    
    changes to our research and development plans and/or announcements regarding new
technologies by us or our competitors;
    
    adverse results in clinical trials of our BIS monitoring system products and products
under development;
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
    
    negative publicity or unfavorable media coverage;
    
    lawsuits involving us;
    
    sales by us of equity or debt to fund our operations;
    
    the loss of any of our key scientific or management personnel;
    
    information relating to the proposed acquisition of all of our outstanding shares of
common stock pursuant to the Merger Agreement;
    
    FDA or international regulatory actions or lawsuits concerning the safety of our
products; and
    
    market conditions, both in the medical device sector and generally.
  Transactions engaged in by our largest stockholders, our directors or executives involving our
common stock may have an adverse effect on the price of our stock.
   We have various mechanisms in place to discourage takeover attempts, which may reduce or eliminate
our stockholders ability to sell their shares for a premium in a change of control transaction.
  
    
    the terms of the Merger Agreement;
    
    preferred stock that could be issued by our board of directors to make it more difficult
for a third party to acquire, or to discourage a third party from acquiring, a majority of
our outstanding voting stock;
    
    classification of our directors into three classes with respect to the time for which
they hold office;
    
    non-cumulative voting for directors;
    
    control by our board of directors of the size of our board of directors;
    
    limitations on the ability of stockholders to call special meetings of stockholders;
    
    inability of our stockholders to take any action by written consent; and
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
    
    advance notice requirements for nominations of candidates for election to our board of
directors or for proposing matters that can be acted upon by our stockholders at
stockholder meetings.
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Risks Related to our Issuance of $125 Million Principal Amount of
2.5% Convertible Senior Notes due 2014
 Our indebtedness as a result of the issuance of $125 million principal amount of 2.5% convertible
senior notes, or the notes, may harm our financial condition and results of operations.
  
    
    it could adversely affect our ability to satisfy our obligations under the notes;
    
    a substantial portion of our cash flows from operations will have to be dedicated to
interest payments, principal payments and, if we irrevocably elect to net share settle the
notes, conversion payments and may not be available for operations, working capital,
capital expenditures, expansion, acquisitions or general corporate or other purposes;
    
    it may impair our ability to obtain additional financing in the future;
    
    it may limit our flexibility in planning for, or reacting to, changes in our business
and industry; and
    
    it may make us more vulnerable to downturns in our business, our industry or the economy
in general.
  We may not have the cash necessary to pay interest on the notes, to settle conversions of the notes
(if we have obtained stockholder approval to elect net share settlement of the notes, and we
irrevocably elect such settlement method) or to repurchase the notes upon a fundamental change.
  
    
    pay cash in an amount equal to the lesser of one-fortieth of the principal amount of the
notes being converted and the daily conversion value (the product of the conversion rate
and the current trading price) of the notes being converted; and
    
    issue shares of our common stock only to the extent that the daily conversion value of
the notes exceeded one-fortieth of the principal amount of the notes being converted for
each trading day of the relevant 40 trading day observation period.
  The net share settlement feature of the notes, if available, may have adverse consequences.
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
    
    result in holders receiving no shares of our common stock upon conversion or fewer shares of our common stock relative to the conversion value of the notes;
    
    reduce our liquidity because we will be required to pay the principal portion in cash;
    
    delay holders receipt of the proceeds upon conversion; and
    
    subject holders to market risk before receiving any shares upon conversion.
   If we repurchase any portion of our notes, such repurchases could adversely affect the holders of
both our notes and our common stock and could also adversely affect our financial condition and
operating results.
  Future sales of our common stock in the public market or the issuance of securities senior to our
common stock could adversely affect the trading price of our common stock and the value of the
notes and our ability to raise funds in new securities offerings.
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Conversion of the notes will dilute the ownership interest of existing stockholders, including
holders who had previously converted their notes.
  Provisions in the indenture for the notes may deter or prevent a business combination that may be
favorable to note holders.
  The notes may not be rated or may receive a lower rating than anticipated.
  The effective subordination of the notes to our secured indebtedness to the extent of the
collateral securing such indebtedness may limit our ability to satisfy our obligations under the
notes.
  The structural subordination of the notes to our secured liabilities and all liabilities and
preferred equity of our subsidiaries may limit our ability to satisfy our obligations under the
notes.
  Item 5. Other Information.
 Amendment 1 to BISx Development, Purchase and License Agreement with Draeger Medical Systems, Inc.
   
    
    modifies the global distribution rights of Draeger with respect to our BIS Sensors;
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
    
    modifies the calculation of commissions to be paid to Draeger on sales of our BIS
Sensors;
    
    revises specified prices and product specifications under the agreement;
    
    expands the list of products covered under the agreement; and
    
    extends the initial term of the agreement through December 31, 2012, renewable
automatically for successive twelve-month periods unless either party provides notice of
termination to the other party at least sixty days prior to expiration of the agreement.
  Amendment 2 to OEM Development and Purchase Agreement with Mindray DS USA, Inc. (formerly Datascope Corp)
   
    modifies the global distribution rights of Mindray DS with respect to our BIS Sensors;
    eliminates commissions to be paid to Mindray DS on sales of our BIS Sensors;
    modifies the warranty period for Aspect Products;
    revises specified prices and product specifications under the agreement;
    expands the list of products covered under the agreement; and
    revises the initial term of the agreement through October 25, 2009, renewable automatically for successive twelve-month periods unless either party provides notice of termination to the other party at least ninety days prior to expiration of the agreement.
  
 Item 6. Exhibits.
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SIGNATURE
  ASPECT MEDICAL SYSTEMS, INC.Date: November 6, 2009
    By:
    /s/ J. Neal ArmstrongJ. Neal ArmstrongVice President and Chief Financial Officer
(Principal Financial and Accounting Officer) 55




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EXHIBIT INDEX
 EXHIBITNUMBER
    
    EXHIBIT2.1
    
    Agreement and Plan of Merger, dated September 27, 2009, by and
between United States Surgical Corporation, Transformer Delaware
Corp. and the Registrant is incorporated herein by reference to
Exhibit 2.1 to the Registrants Current Report on Form 8-K filed
on September 28, 2009.4.1
    
    Amendment No. 4 to Rights Agreement, dated September 27, 2009, by
and between Computershare Trust Company, N.A. (formerly Equiserve
Trust Company) and the Registrant is incorporated herein by
reference to Exhibit 4.1 to the Registrants Current Report on
Form 8-K filed on September 28, 2009.10.1
    
    Restated Key Employee Change in Control Severance Benefits Plan is
incorporated herein by reference to Exhibit 10.1 to the
Registrants Current Report on Form 8-K filed on September 28,
2009.10.2
    
    Form of Indemnification Agreement dated September 23, 2009 is
incorporated herein by reference to Exhibit 10.2 to the
Registrants Current Report on Form 8-K filed on September 28,
2009.10.3
    
    Amended and Restated 1991 Stock Option Plan is incorporated herein
by reference to Exhibit 10.3 to the Registrants Current Report on
Form 8-K filed on September 28, 2009.10.4
    
    Restated 1999 Employee Stock Purchase Plan is incorporated herein
by reference to Exhibit 10.4 to the Registrants Current Report on
Form 8-K filed on September 28, 2009.10.5 
    
    Amendment 1 to BISx Development, Purchase and License Agreement,
dated October 22, 2009, by and between the Registrant and Draeger
Medical Systems, Inc.10.6 
    
    Amendment 2 to OEM Development and
Purchase Agreement, dated November 5, 2009, by and between the
Registrant and    Mindray DS USA, Inc. (formerly Datascope Corp).31.1
    
    Certification by Chief Executive Officer Pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as
amended.31.2
    
    Certification by Chief Financial Officer Pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as
amended.32.1
    
    Certification by Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2
    
    Certification by Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
  
    
    Confidential treatment has been requested as to certain portions of this exhibit. Such portions have been omitted and filed separately with the Securities and Exchange Commission.