##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2007
 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
(Address of Principal Executive Offices)
    
    02062
(Zip Code)
 (617) 559-7000
 
  þ o
  o þ o
  o þ




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##### 



PagePART I
    
    FINANCIAL INFORMATION
    
    
    1Item 1.
    
    Financial Statements
(unaudited)
    
    
    1Condensed
Consolidated Balance Sheets (unaudited) as of March 31, 2007
and December 31, 2006
    
    
    1Condensed
Consolidated Statements of Income (unaudited) for the Three Months Ended
March 31, 2007 and April 1, 2006
    
    
    2Condensed
Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended
March 31, 2007 and April 1, 2006
    
    
    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
    
    
    31Item 4.
    
    Controls and Procedures
    
    
    31PART II
    
    OTHER INFORMATION
    
    
    33Item 1A.
    
    Risk Factors
    
    
    33Item 6.
    
    Exhibits
    
    
    46SIGNATURESEx-31.1 Certification of Chief Executive OfficerEx-31.2 Certification of Chief Financial OfficerEx-32.1 Certification of Chief Executive Officer pursuant to Section 906Ex-32.2 Certification of Chief Financial Officer pursuant to Section 906




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS.
 ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 (in thousands, except share data and per share amounts)
 March 31,
    
    
    December 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    9,522
    
    
    $
    9,724Short-term portion of restricted cash
    
    
    82
    
    
    
    140Short-term investments
    
    
    44,883
    
    
    
    45,253Accounts receivable, net of allowance of $215 at March
31, 2007 and $218 at December 31, 2006
    
    
    11,302
    
    
    
    12,486Current portion of investment in sales-type leases
    
    
    1,528
    
    
    
    1,493Inventory
    
    
    6,853
    
    
    
    6,501Deferred tax assets
    
    
    1,844
    
    
    
    1,844Other current assets
    
    
    2,898
    
    
    
    2,157Total current assets
    
    
    78,912
    
    
    
    79,598Property and equipment, net
    
    
    8,571
    
    
    
    7,798Long-term portion of restricted cash
    
    
    929
    
    
    
    911Long-term investments
    
    
    8,857
    
    
    
    7,442Long-term investment in sales-type leases
    
    
    2,993
    
    
    
    2,817Long-term deferred tax assets
    
    
    26,027
    
    
    
    26,398Total assets
    
    $
    126,289
    
    
    $
    124,964LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,306
    
    
    $
    1,925Accrued liabilities
    
    
    8,972
    
    
    
    8,428Deferred revenue
    
    
    466
    
    
    
    1,865Total current liabilities
    
    
    10,744
    
    
    
    12,218Long-term portion of deferred revenue
    
    
    3,491
    
    
    
    3,498Commitments and contingencies
Stockholders 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, 22,429,979 and 22,363,564 shares issued
and outstanding at March 31, 2007 and December 31,
2006, respectively
    
    
    227
    
    
    
    226Treasury Stock, at cost; 276,493 shares
    
    
    (5,008
    )
    
    
    (5,008
    )Additional paid-in capital
    
    
    171,104
    
    
    
    168,440Accumulated other comprehensive loss
    
    
    (5
    )
    
    
    (1
    )Accumulated deficit
    
    
    (54,264
    )
    
    
    (54,409
    )Total stockholders equity
    
    
    112,054
    
    
    
    109,248Total liabilities and stockholders equity
    
    $
    126,289
    
    
    $
    124,964
  1




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ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED
CONSOLIDATED STATEMENTS OF INCOME
 (in thousands, except per share amounts)
 (unaudited)
 Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Product revenue
    
    $
    22,435
    
    
    $
    20,442Strategic alliance revenue
    
    
    1,684
    
    
    
    1,446Total revenue
    
    
    24,119
    
    
    
    21,888Costs of revenue (1)
    
    
    6,079
    
    
    
    5,346Gross profit
    
    
    18,040
    
    
    
    16,542Operating expenses: (1)Research and development
    
    
    4,221
    
    
    
    3,647Sales and marketing
    
    
    10,045
    
    
    
    8,733General and administrative
    
    
    3,663
    
    
    
    2,938Total operating
expenses
    
    
    17,929
    
    
    
    15,318Income from operations
    
    
    111
    
    
    
    1,224Other income:Interest income
    
    
    982
    
    
    
    736Income before income taxes
    
    
    1,093
    
    
    
    1,960Provision for income taxes
    
    
    576
    
    
    
    23Net income
    
    $
    517
    
    
    $
    1,937Net income per share:Basic
    
    $
    0.02
    
    
    $
    0.09Diluted
    
    $
    0.02
    
    
    $
    0.08Weighted average shares used in
computing net income per share:Basic
    
    
    22,411
    
    
    
    22,335Diluted
    
    
    23,027
    
    
    
    23,943(1) Stock-based compensation
included in costs and expenses:Costs of revenue
    
    $
    145
    
    
    $
    105Research and development
    
    
    524
    
    
    
    371Sales and marketing
    
    
    808
    
    
    
    627General and administrative
    
    
    740
    
    
    
    537
  2




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ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 (unaudited)
 Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Cash flows from operating activities:Net income
    
    $
    517
    
    
    $
    1,937Adjustments to reconcile net income to net cash provided by
(used for) operating activities Depreciation and amortization
    
    
    509
    
    
    
    371Provision for doubtful accounts
    
    
    15
    
    
    
    26Stock-based compensation expense
    
    
    2,217
    
    
    
    1,640Changes in assets and liabilities Decrease in accounts receivable
    
    
    1,169
    
    
    
    947Increase in inventory
    
    
    (352
    )
    
    
    (915
    )Increase in
other current assets
    
    
    (741
    )
    
    
    (827
    )(Increase) decrease in investment in sales-type leases
    
    
    (211
    )
    
    
    277(Decrease) increase in accounts payable
    
    
    (248
    )
    
    
    230Increase (decrease) in accrued liabilities
    
    
    149
    
    
    
    (3,138
    )Decrease in deferred revenue
    
    
    (1,406
    )
    
    
    (1,899
    )Net cash provided by (used for) operating activities
    
    
    1,618
    
    
    
    (1,351
    )Cash flows from investing activities:Decrease (increase) in restricted cash
    
    
    40
    
    
    
    (1,018
    )Acquisitions of property and equipment
    
    
    (1,283
    )
    
    
    (1,271
    )Purchases of marketable securities
    
    
    (22,598
    )
    
    
    (15,567
    )Proceeds from sales and maturities of marketable securities
    
    
    21,550
    
    
    
    17,095Net cash used for investing activities
    
    
    (2,291
    )
    
    
    (761
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    471
    
    
    
    1,244Net cash provided by financing activities
    
    
    471
    
    
    
    1,244Net decrease in cash and cash equivalents
    
    
    (202
    )
    
    
    (868
    )Cash and cash equivalents, beginning of period
    
    
    9,724
    
    
    
    20,437Cash and cash equivalents, end of period
    
    $
    9,522
    
    
    $
    19,569
  3




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




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 Revenue Recognition
  Revenue Recognition, Revenue
Arrangements with Multiple Deliverables
 Accounting For Leases
    Accounting for
Contingencies
 5




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 Research and Development Costs
  Allowance for Doubtful Accounts
  Inventory
  Warranty
  Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Beginning balance
    
    $
    220
    
    
    $
    159Warranty expense
    
    
    4
    
    
    
    58Deductions and other
    
    
    (9
    )
    
    
    (23
    )Ending balance
    
    $
    215
    
    
    $
    194
 Shipping and Handling Costs
  Advertising Costs
  6




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 Property and Equipment
 Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use
 Income Taxes
 Accounting for Income
Taxes Accounting for
Uncertainty in Income Taxesan Interpretation of FASB Statement
No. 109
 Concentration of Credit Risk
  Single or Limited Source Suppliers
  7




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 Net Income Per Share
 Earnings Per Share
   Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Basic:Net income
    
    $
    517
    
    
    $
    1,937Weighted average shares outstanding
    
    
    22,411
    
    
    
    22,335Basic net income per share
    
    $
    0.02
    
    
    $
    0.09Diluted:Net income
    
    $
    517
    
    
    $
    1,937Weighted average shares outstanding
    
    
    22,411
    
    
    
    22,335Effect of dilutive stock options and
restricted stock
    
    
    616
    
    
    
    1,608Weighted average shares assuming
dilution
    
    
    23,027
    
    
    
    23,943Diluted net income per share
    
    $
    0.02
    
    
    $
    0.08
 Comprehensive Income
  Stock-Based Compensation
  8




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 Share Based Payment Accounting for Stock-Based Compensation Accounting for Stock Issued to Employees Statement of Cash Flows
    WeightedWeighted
    
    
    AverageNumber of
    
    
    Average
    
    
    Remaining
    
    
    AggregateShares
    
    
    Exercise Price
    
    
    Contractual Life
    
    
    Intrinsic ValueOutstanding at December 31, 2006
    
    
    4,160
    
    
    $
    17.00Granted
    
    
    393
    
    
    
    16.15Exercised
    
    
    (66
    )
    
    
    7.11Canceled
    
    
    (38
    )
    
    
    18.64Outstanding at March 31, 2007
    
    
    4,449
    
    
    $
    17.06
    
    
    
    6.42
    
    
    $
    11,167Vested or expected to vest at March 31, 2007
    
    
    4,378
    
    
    $
    16.99
    
    
    
    6.38
    
    
    $
    11,156Exercisable at March 31, 2007
    
    
    3,001
    
    
    $
    15.03
    
    
    
    5.33
    
    
    $
    10,940
   Weighted AverageNumber of
    
    
    Grant Date FairShares
    
    
    ValueUnvested at December 31, 2006
    
    
    47
    
    
    $
    23.95Granted
    
    
    312
    
    
    
    16.15Vested
    
    
    (25
    )
    
    
    17.46Unvested at March 31, 2007
    
    
    334
    
    
    $
    17.12
  9




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 :
  Three Months EndedMarch 30,
    
    
    April 1,2007
    
    
    2006Options granted
    
    
    393,400
    
    
    
    503,560Weighted average exercise price
    
    $
    16.15
    
    
    $
    29.25Weighted average grant date fair value
    
    $
    7.62
    
    
    $
    12.58Assumptions:Risk-free interest rate
    
    
    4.53
    %
    
    
    4.66
    %Expected term
    
    5.2 years
    
    5 yearsExpected volatility
    
    
    46
    %
    
    
    41
    %Expected dividend yield
    
    
    
    
    
    
    
      :
  10




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
     Use of Estimates
  Fair Value of Financial Instruments
  Reclassifications
  Recent Accounting Pronouncements
 The Fair Value Option for Financial Assets
and Financial Liabilities"
 11




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 Fair Value Measurements
 12




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 (3) Comprehensive Income
  Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Net income
    
    $
    517
    
    
    $
    1,937Other comprehensive income:Unrealized (loss) gain on
marketable securities
    
    
    (4
    )
    
    
    11Comprehensive income
    
    $
    513
    
    
    $
    1,948
 (4) Investment in Sales-Type Leases
  March 31,
    
    
    December 31,2007
    
    
    2006Total minimum lease payments receivable
    
    $
    6,277
    
    
    $
    6,148Less:Unearned interest income
    
    
    989
    
    
    
    972Allowance for lease payments
    
    
    767
    
    
    
    866Net investment in sales-type leases
    
    
    4,521
    
    
    
    4,310Less  current portion
    
    
    1,528
    
    
    
    1,493$
    2,993
    
    
    $
    2,817
 (5) Inventory
  March 31,
    
    
    December 31,2007
    
    
    2006Raw materials
    
    $
    3,554
    
    
    $
    3,607Work-in-progress
    
    
    46
    
    
    
    156Finished goods
    
    
    3,253
    
    
    
    2,738$
    6,853
    
    
    $
    6,501
 13




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##### Table of Contents



ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 (6)      Income Taxes
  Accounting For Income Taxes
   (7) Segment Information and Enterprise Reporting
  14




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
  Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Geographic Area by RegionDomestic
    
    $
    18,374
    
    
    $
    16,817International
    
    
    5,745
    
    
    
    5,071Total
    
    $
    24,119
    
    
    $
    21,888
 Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Geographic Area by RegionDomestic
    
    
    76
    %
    
    
    77
    %International
    
    
    24
    
    
    
    23Total
    
    
    100
    %
    
    
    100
    %
  (8)      Commitments and Contingencies
 Leases
  (9) Loan Agreements
  15




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
   (10)      Agreements with Boston Scientific Corporation
 2002 Strategic Alliance
   2002 Line of Credit Agreement
  16




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
  2004 Stock Purchase Agreement
  2005 Product Development and Distribution Agreement
   17




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousand, except per share amounts)
(unaudited)
 (11)      Stock Repurchase Program
  18




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Item 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
 Overview
 ®
  InitialCommercial
    
    Date of Clearance ofProduct
    
    Shipment
    
    510 (k) Notification
    
    DescriptionEQUIPMENTBIS VIEW
    
    Pending
    
    Pending
    
    Basic-featured standalone monitor which has few optional
user configurations compared with the BIS VISTA monitor.BIS VISTA
    
    
    2006
    
    
    September 2005
    
    Monitor that offers an enhanced
display and user interface as well as greater processing capability compared to our other monitors.BISx system
    
    
    2004
    
    
    February 2004
    
    BIS monitoring solution that provides the processing technology required
to obtain BIS information from a single device the approximate size of a
hockey puck. The BISx system is designed to integrate with a wide range
of patient monitoring platforms sold by original equipment
manufacturers.BIS XP System
    
    
    2001
    
    
    June 2001
    
    BIS system offering enhanced performance capabilities and expanded
benefits as compared to the previous version of the BIS system, designed
to enable more precise measurement of brain activity to assess the level
of consciousness.BIS Module Kit 
4 Channel
Support
    
    
    2001
    
    
    October 2000
    
    Same as standard BIS Module Kit plus 4 channel EEG monitoring capability.A-2000 BIS Monitor
    
    
    1998
    
    
    February 1998
    
    Compact, lightweight, portable third-generation BIS monitor.BIS Module Kit
    
    
    1998
    
    
    October 2000
    
    Components of BIS monitoring technology that are integrated into
equipment sold by original equipment manufacturers.SENORSSemi-Reusable
(SRS) Sensor
    
    
    2005
    
    
    February 2005
    
    Semi-reusable version of a BIS Sensor that uses the same algorithm and
hardware as our disposable sensors. Currently available only in markets
outside the United States, excluding Japan.BIS Extend Sensor
    
    
    2002
    
    
    October 2000
    
    Disposable sensor with electronic memory device for use with our BIS
Monitors, BIS Module Kit and BISx System that was specially designed for
patients who are typically monitored for extended periods.
 19




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##### Table of Contents



InitialCommercial
    
    Date of Clearance ofProduct
    
    Shipment
    
    510 (k) Notification
    
    DescriptionBIS Pediatric 
Sensor
    
    
    2001
    
    
    October 2000
    
    Disposable sensor with electronic memory device for use with our
BIS Monitors, BIS Module Kit and BISx System that is smaller and
easier to apply to children.BIS Quatro Sensor
    
    
    2001
    
    
    October 2000
    
    Disposable sensor with electronic memory device for use with our
BIS Monitors, BIS Module Kit and BISx System that is designed to
offer enhanced performance in deep anesthetic states and enhanced
resistance to interference from noise sources.BIS Sensor Plus
    
    
    2001
    
    
    January 2000
    
    Second-generation disposable sensor for use with our BIS Monitors
and BIS Module Kit.BIS Standard 
Sensor
    
    
    1997
    
    
    October 1996
    
    Disposable sensor for use with our BIS Monitors and BIS Module Kit
  Three Months EndedMarch 31,
    
    April 1,2007
    
    2006Domestic revenue
    
    $
    18,374
    
    
    $
    16,817Percentage of total revenue
    
    
    76
    %
    
    
    77
    %International revenue
    
    $
    5,745
    
    
    $
    5,071Percentage of total revenue
    
    
    24
    %
    
    
    23
    %Total revenue
    
    $
    24,119
    
    
    $
    21,888BIS Sensor revenue
    
    $
    17,554
    
    
    $
    15,585Percentage of total revenue
    
    
    73
    %
    
    
    71
    %Equipment revenue
    
    $
    4,881
    
    
    $
    4,857Percentage of total revenue
    
    
    20
    %
    
    
    22
    %Strategic alliance revenue
    
    $
    1,684
    
    
    $
    1,446Percentage of total revenue
    
    
    7
    %
    
    
    7
    %Total revenue
    
    $
    24,119
    
    
    $
    21,888
    20




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Share-Based Payment Accounting for Stock Issued to Employees
  21




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##### Table of Contents



Critical Accounting Policies and Estimates
  Revenue Recognition
 Revenue
Recognition, Revenue Arrangements with Multiple
Deliverables
   Accounting For Leases
 22




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Stock-Based Compensation
         23




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##### Table of Contents



Allowance for Doubtful Accounts
  Inventories
  Warranty
  Income Taxes
 Accounting For Income Taxes
 24




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##### Table of Contents



Results of Operations
  Three Months EndedMarch 31,
    
    
    April 1,2007
    
    
    2006Revenue
    
    
    100
    %
    
    
    100
    %Costs of revenue
    
    
    25
    
    
    
    24Gross profit
    
    
    75
    
    
    
    76Operating expenses:Research and development
    
    
    18
    
    
    
    17Sales and marketing
    
    
    42
    
    
    
    40General and administrative
    
    
    15
    
    
    
    13Total operating expenses
    
    
    75
    
    
    
    70Income from operations
    
    
    
    
    
    
    6Interest income, net
    
    
    4
    
    
    
    3Income before income taxes
    
    
    4
    
    
    
    9Provision
for income taxes
    
    
    2
    
    
    
    Net income
    
    
    2
    %
    
    
    9
    %
 Three Months Ended March 31, 2007 Compared with the Three Months Ended April 1, 2006
 Three Months EndedPercentageMarch 31,
    
    
    April 1,
    
    
    Increase2007
    
    
    2006
    
    
    (Decrease)(in thousands, exceptunit amounts)Revenue  WorldwideBIS Sensor
    
    $
    17,554
    
    
    $
    15,585
    
    
    
    13
    %BIS monitor
    
    
    2,895
    
    
    
    2,648
    
    
    
    9
    %Original equipment manufacturer products
    
    
    1,117
    
    
    
    1,598
    
    
    
    (30
    )%Other equipment and accessories
    
    
    869
    
    
    
    611
    
    
    
    42
    %Total Equipment
    
    
    4,881
    
    
    
    4,857
    
    
    
    1
    %Total product revenue
    
    
    22,435
    
    
    
    20,442
    
    
    
    10
    %Strategic alliance
    
    
    1,684
    
    
    
    1,446
    
    
    
    16
    %Total revenue
    
    $
    24,119
    
    
    $
    21,888
    
    
    
    10
    %Unit Analysis  WorldwideBIS Sensors
    
    
    1,237,000
    
    
    
    1,087,000
    
    
    
    14
    %BIS monitors
    
    
    958
    
    
    
    852
    
    
    
    12
    %Original equipment manufacturerBIS products
    
    
    1,474
    
    
    
    1,500
    
    
    
    (2
    )%Installed base
    
    
    41,515
    
    
    
    34,208
    
    
    
    21
    %
 Revenue.
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Expense Overview
 Three Months EndedPercentageMarch 31,
    
    
    April 1,
    
    
    Increase2007
    
    
    2006
    
    
    (Decrease)(in thousands)ExpensesResearch and development
    
    $
    4,221
    
    
    $
    3,647
    
    
    
    16
    %Sales and marketing
    
    $
    10,045
    
    
    $
    8,733
    
    
    
    15
    %General and administrative
    
    $
    3,663
    
    
    $
    2,938
    
    
    
    25
    %
 Research and Development.
 Sales and Marketing.
 General and Administrative.
 Interest Income.
 27




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Income Taxes.
 Liquidity and Capital Resources
   Agreements with Boston Scientific Corporation
     28




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Cash provided by operations.
 Cash used for investing activities.
 Cash
provided by financing activities.
 Off-Balance Sheet Arrangements
  Income Taxes
  Accounting For Income Taxes
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Effects of Inflation
  Recent Accounting Pronouncements
 The Fair Value Option for Financial Assets
and Financial Liabilities"
 Fair Value Measurements
 Accounting for Uncertainty in
Income Taxes  an Interpretation of FASB Statement No. 109 Accounting for Income Taxes
 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 and factors that may
influence our revenue for the second quarter ending June 30, 2007 and thereafter. 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
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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.
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Changes in Internal Controls.
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PART II  OTHER INFORMATION
 
 Item 1A. Risk Factors
  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.
   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 second fiscal
quarter of 2007.
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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,
    
    use of and demand for our BIS Sensors,
    
    transition of sales focus from BIS monitors to original equipment manufacturer products,
    
    customer cancellations,
    
    introduction of competitive products,
    
    regulatory approvals,
    
    changes in management,
    
    turnover in our direct sales force,
    
    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,
    
    reductions in orders by our distributors and original equipment manufacturers, and
    
    the timing and amount of our expenses.
  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.
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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 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,
    
    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, our growth will be limited
and our business could be harmed. 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.
   Negative publicity or unfavorable media coverage could damage our reputation and harm our
operations
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If we do not successfully develop or acquire and introduce enhanced or new products we could lose
revenue opportunities and customers.
  
    
    identify in a timely manner 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.
  
    
    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.
   If our clinical trials are delayed or unsuccessful, our business could be adversely affected.
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
    
    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,
    
    negative results from clinical trials for any of our potential products, including
those involving the management of depression and the early diagnosis and tracking of
Alzheimers disease, and
    
    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.
 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.
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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
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,
    
    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.
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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.
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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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Boston Scientific Corporation may be able to affect corporate actions requiring stockholder
approval because it owns a significant amount of our common stock. Additionally, if our strategic
alliance with Boston Scientific Corporation is not successful, our operating results could be
adversely affected.
  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.
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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.
     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,
    
    rescission of a substantial equivalence order or suspension or withdrawal of a pre-market approval, and
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
    
    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.
   Our employees may engage in misconduct or other improper activities, including insider trading.
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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.
   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.
  
    
    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
    
    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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Item 6.      Exhibits.
  46




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SIGNATURE
  ASPECT MEDICAL SYSTEMS, INC.Date: May 10, 2007
    By:
    /s/ Michael FalveyMichael FalveyVice President and Chief Financial Officer
(Principal Financial and Accounting Officer) 47




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EXHIBIT INDEX
 EXHIBITNUMBER
    
    EXHIBIT10.1
    
    Amendment No. 2 to the OEM Product Development Agreement by and
between Aspect Medical Systems, Inc. and Boston Scientific
Corporation dated as of February 5, 2007 is incorporated herein by
reference to Exhibit 10.1 to the Registrants Current Report on
Form 8-K dated February 7, 2007.31.1
    
    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.