##### 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 April 4, 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
    
    (I.R.S. Employer Identification No.)Incorporation or Organization)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 a smaller reporting company)
    
    Smaller reporting company o
 o þ




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##### 



PagePART I FINANCIAL INFORMATION
    
    
    1Item 1. Condensed Consolidated Financial Statements (unaudited)
    
    
    1Condensed Consolidated Balance Sheets (unaudited)
as of April 4, 2009 and December 31, 2008
    
    
    1Condensed Consolidated Statements of Operations
(unaudited) for the Three Months Ended April 4,
2009 and March 29, 2008
    
    
    2Condensed Consolidated Statements of Cash Flows
(unaudited) for the Three Months Ended April 4,
2009 and March 29, 2008
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    27Item 4. Controls and Procedures
    
    
    27PART II OTHER INFORMATION
    
    
    28Item
1. Legal Proceedings
    
    
    28Item 1A. Risk Factors
    
    
    28Item 6. Exhibits
    
    
    48SIGNATURES
    
    
    49Ex-31.1 Certification by Chief Executive OfficerEx-31.2 Certification by Chief Financial OfficerEx-32.1 Certification by Chief Executive Officer (Section 906)Ex-32.2 Certification by Chief Financial Officer (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
(in thousands, except share data and per share amounts)
(unaudited)
 April 4,
    
    
    December 31,2009
    
    
    2008ASSETSCurrent assets:Cash
    
    $
    2,942
    
    
    $
    12,066Short-term investments
    
    
    71,123
    
    
    
    65,985Accounts receivable, net of allowance of $209 at April
4, 2009 and $121 at December 31, 2008
    
    
    14,004
    
    
    
    13,193Current portion of investment in sales-type leases
    
    
    997
    
    
    
    1,057Inventory
    
    
    8,500
    
    
    
    7,796Deferred tax assets
    
    
    4,729
    
    
    
    4,729Other current assets
    
    
    3,046
    
    
    
    2,905Total current assets
    
    
    105,341
    
    
    
    107,731Property and equipment, net
    
    
    8,197
    
    
    
    8,319Restricted cash
    
    
    1,094
    
    
    
    839Long-term investments
    
    
    996
    
    
    
    4,561Long-term investment in sales-type leases
    
    
    1,166
    
    
    
    1,454Deferred financing fees
    
    
    1,575
    
    
    
    1,852Long-term deferred tax assets
    
    
    11,132
    
    
    
    12,090Other long-term assets
    
    
    111
    
    
    
    128Total assets
    
    $
    129,612
    
    
    $
    136,974LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    2,219
    
    
    $
    2,155Accrued liabilities
    
    
    9,942
    
    
    
    13,288Current portion of obligation under capital lease
    
    
    69
    
    
    
    71Deferred revenue
    
    
    100
    
    
    
    236Total current liabilities
    
    
    12,330
    
    
    
    15,750Long-term portion of obligation under capital lease
    
    
    92
    
    
    
    100Long-term portion of deferred revenue
    
    
    81
    
    
    
    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, 17,415,429 and 17,352,438 shares issued
and outstanding at April 4, 2009 and December 31,
2008, respectively
    
    
    176
    
    
    
    176Treasury stock, at cost; 276,493 shares of common stock
    
    
    (5,008
    )
    
    
    (5,008
    )Additional paid-in capital
    
    
    188,888
    
    
    
    187,374Accumulated other comprehensive income
    
    
    (344
    )
    
    
    (105
    )Accumulated deficit
    
    
    (124,553
    )
    
    
    (126,407
    )Total stockholders equity
    
    
    59,159
    
    
    
    56,030Total liabilities and stockholders equity
    
    $
    129,612
    
    
    $
    136,974
  1




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ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 Three Months EndedApril 4,
    
    
    March 29,2009
    
    
    2008Revenue
    
    $
    25,300
    
    
    $
    24,428Costs of revenue (1)
    
    
    5,937
    
    
    
    6,486Gross profit
    
    
    19,363
    
    
    
    17,942Operating expenses: (1)Research and development
    
    
    4,015
    
    
    
    3,939Sales and marketing
    
    
    10,828
    
    
    
    10,202General and administrative
    
    
    4,581
    
    
    
    3,942Total operating expenses
    
    
    19,424
    
    
    
    18,083Loss from operations
    
    
    (61
    )
    
    
    (141
    )Other income:Interest income
    
    
    450
    
    
    
    1,278Interest expense
    
    
    (467
    )
    
    
    (948
    )Realized gain on sale of investment
    
    
    20
    
    
    
    Gain on repurchase of debt
    
    
    3,049
    
    
    
    Income before income taxes
    
    
    2,991
    
    
    
    189Provision for income taxes
    
    
    1,137
    
    
    
    424Net income (loss)
    
    $
    1,854
    
    
    $
    (235
    )Net income (loss) per share:Basic
    
    $
    0.11
    
    
    $
    (0.01
    )Diluted
    
    $
    0.10
    
    
    $
    (0.01
    )Weighted average shares used in computing net
income (loss) per share:Basic
    
    
    17,377
    
    
    
    17,148Diluted
    
    
    20,632
    
    
    
    17,148(1) Stock-based compensation included in costs
and expenses:Costs of revenue
    
    $
    110
    
    
    $
    119Research and development
    
    
    409
    
    
    
    469Sales and marketing
    
    
    480
    
    
    
    676General and administrative
    
    
    519
    
    
    
    678
  2




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ASPECT MEDICAL SYSTEMS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 Three Months EndedApril 4,
    
    
    March 29,2009
    
    
    2008Cash flows from operating activities:Net income (loss)
    
    $
    1,854
    
    
    $
    (235
    )Adjustments
to reconcile net income (loss) to net cash (used for)
provided by operating activities Depreciation and amortization
    
    
    738
    
    
    
    730Gain on repurchase of debt
    
    
    (3,049
    )
    
    
    Gain on sale of investment
    
    
    (20
    )
    
    
    Provision for doubtful accounts
    
    
    88
    
    
    
    12Stock-based compensation expense
    
    
    1,497
    
    
    
    1,916Tax benefit for stock option exercises
    
    
    17
    
    
    
    16Deferred taxes
    
    
    958
    
    
    
    213Changes in assets and liabilities Increase in accounts receivable
    
    
    (899
    )
    
    
    (738
    )(Increase) decrease in inventory
    
    
    (704
    )
    
    
    1,101Increase in other current assets
    
    
    (141
    )
    
    
    (589
    )Decrease in investment in sales-type leases
    
    
    348
    
    
    
    457Decrease in other long-term assets
    
    
    17
    
    
    
    Increase (decrease) in accounts payable
    
    
    64
    
    
    
    (371
    )Decrease in accrued liabilities
    
    
    (3,346
    )
    
    
    (913
    )Decrease in deferred revenue
    
    
    (149
    )
    
    
    (56
    )Net cash (used for) provided by operating activities
    
    
    (2,727
    )
    
    
    1,543Cash flows from investing activities:Increase in restricted cash
    
    
    (255
    )
    
    
    (3
    )Acquisitions of property and equipment
    
    
    (535
    )
    
    
    (684
    )Purchases of marketable securities
    
    
    (21,336
    )
    
    
    (33,683
    )Proceeds from sales and maturities of marketable securities
    
    
    19,600
    
    
    
    24,525Net cash used for investing activities
    
    
    (2,526
    )
    
    
    (9,845
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    
    
    
    
    287Repurchase of long-term debt
    
    
    (3,805
    )
    
    
    Repayment of capital lease
    
    
    (10
    )
    
    
    (7
    )Net cash (used for) provided by financing activities
    
    
    (3,815
    )
    
    
    280Effect of exchange rate changes on cash
    
    
    (56
    )
    
    
    Net decrease in cash
    
    
    (9,124
    )
    
    
    (8,022
    )Cash, beginning of period
    
    
    12,066
    
    
    
    19,828Cash, end of period
    
    $
    2,942
    
    
    $
    11,806
  3




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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 and Investments
  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 thousands, except percentages and 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 thousands, except percentages and per share amounts)
(unaudited)
 Research and Development Costs
  Allowance for Doubtful Accounts
  Inventory
  Warranty
  Three Months EndedApril 4, 2009
    
    
    March 29, 2008Beginning balance
    
    $
    270
    
    
    $
    250Warranty expense
    
    
    5
    
    
    
    (11
    )Deductions and other
    
    
    (16
    )
    
    
    (13
    )Ending balance
    
    $
    259
    
    
    $
    226
 Shipping and Handling Costs
  Advertising Costs
  6




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and 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 thousands, except percentages and per share amounts)
(unaudited)
 Net Income (Loss) Per Share
 Earnings Per Share
   Three Months EndedApril 4,
    
    
    March 29,2009
    
    
    2008Basic:Net income (loss)
    
    $
    1,854
    
    
    $
    (235
    )Weighted average shares outstanding
    
    
    17,377
    
    
    
    17,148Basic net income (loss) per share
    
    $
    0.11
    
    
    $
    (0.01
    )Diluted:Net income (loss)
    
    $
    1,854
    
    
    $
    (235
    )Interest expense on convertible
debt, net
    
    
    287
    
    
    
    Net income (loss) as adjusted
    
    $
    2,141
    
    
    $
    (235
    )Weighted average shares outstanding
    
    
    17,377
    
    
    
    17,148Effect of dilutive stock options and
restricted stock
    
    
    4
    
    
    
    Conversion of convertible notes
    
    
    3,251
    
    
    
    Weighted average shares assuming dilution
    
    
    20,632
    
    
    
    17,148Diluted net income (loss) per share
    
    $
    0.10
    
    
    $
    (0.01
    )
 Comprehensive Income (Loss)
  8




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 Stock-Based Compensation
  Share Based Payment Accounting for Stock-Based Compensation
  Three Months EndedApril 4,
    
    March 29,2009
    
    2008Options granted
    
    
    644
    
    
    
    272Weighted average exercise price
    
    
    $ 4.44
    
    
    
    $11.82Weighted average grant date fair value
    
    
    $ 2.65
    
    
    
    $ 5.54Assumptions:Risk-free interest rate
    
    
    2.56%
    
    
    
    2.96%Expected term
    
    6.13 years
    
    5.76 yearsExpected volatility
    
    
    63%
    
    
    
    46%Expected dividend yield
    
    
    
    
    
    
    
     9




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
      Use of Estimates
  Fair Value of Financial Instruments
   Recent Accounting Pronouncements
 Disclosures about Derivative Instruments and
Hedging Activities, an Amendment of FASB Statement No. 133 .
 Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion
 10




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
   Determining Fair Value When the Volume and Level of Activity for the Asset or Liability have
Significantly Decreased and Identifying Transactions That are not Orderly Interim Disclosures about Fair Value of
Financial Instruments Recognition and
Presentation of Other-Than-Temporary Impairments
 11




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 (3) Comprehensive Income (Loss)
  Three Months EndedApril 4,
    
    
    March 29,2009
    
    
    2008Net income (loss)
    
    $
    1,854
    
    
    $
    (235
    )Other comprehensive income:Foreign currency translation adjustments
    
    
    (56
    )
    
    
    Unrealized (loss) gain on marketable securities
    
    
    (183
    )
    
    
    224Comprehensive income (loss)
    
    $
    1,615
    
    
    $
    (11
    )
 (4) Investment in Sales-Type Leases
  April 4,
    
    
    December 31,2009
    
    
    2008Total minimum lease payments receivable
    
    $
    3,045
    
    
    $
    3,457Less:Unearned interest income
    
    
    390
    
    
    
    459Allowance for lease payments
    
    
    492
    
    
    
    487Net investment in sales-type leases
    
    
    2,163
    
    
    
    2,511Less  current portion
    
    
    997
    
    
    
    1,057$
    1,166
    
    
    $
    1,454
 (5) Inventory
  April 4,
    
    
    December 31,2009
    
    
    2008Raw materials
    
    $
    4,918
    
    
    $
    4,552Work-in-progress
    
    
    28
    
    
    
    25Finished goods
    
    
    3,554
    
    
    
    3,219$
    8,500
    
    
    $
    7,796
 (6) Income Taxes
  12




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
     (7) Fair Value Measurements
 Fair Value Measurements
 Effective Date of FASB
Statement No. 157,
  Fair Value Measurements at April 4, 2009Balance atApril 4, 2009
    
    Level 1
    
    Level 2
    
    Level 3Cash and restricted cash
    
    $
    4,036
    
    
    $
    4,036
    
    
    $
    
    
    
    $
    Available for sale securities
    
    
    72,119
    
    
    
    302
    
    
    
    71,817
    
    
    
    
 13




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 (8) Segment Information and Enterprise Reporting
   Three Months EndedApril 4,
    
    
    March 29,2009
    
    
    2008Geographic area by regionDomestic
    
    $
    17,095
    
    
    $
    17,063International
    
    
    8,205
    
    
    
    7,365Total
    
    $
    25,300
    
    
    $
    24,428
 Three Months EndedApril 4,
    
    March 29,2009
    
    2008Geographic area by regionDomestic
    
    
    68
    %
    
    
    70
    %International
    
    
    32
    
    
    
    30Total
    
    
    100
    %
    
    
    100
    %
  (9) Commitments and Contingencies
 Leases
  14




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 Legal Proceedings
    (10) Loan Agreements
   15




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ASPECT MEDICAL SYSTEMS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(tabular amounts in thousands, except percentages and per share amounts)
(unaudited)
 (11) Convertible Debt
  (12) Stock Repurchase Program
  16




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Item 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS.
 Overview
 ®
  Three Months EndedApril 4,
    
    March 29,2009
    
    2008Domestic revenue
    
    $
    17,095
    
    
    $
    17,063Percentage of total revenue
    
    
    68
    %
    
    
    70
    %International revenue
    
    $
    8,205
    
    
    $
    7,365Percentage of total revenue
    
    
    32
    %
    
    
    30
    %Total revenue
    
    $
    25,300
    
    
    $
    24,428BIS Sensor revenue
    
    $
    21,581
    
    
    $
    20,636Percentage of total revenue
    
    
    85
    %
    
    
    84
    %Equipment revenue
    
    $
    3,719
    
    
    $
    3,792Percentage of total revenue
    
    
    15
    %
    
    
    16
    %Total revenue
    
    $
    25,300
    
    
    $
    24,428
      17




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Share-Based
Payment
 New England Journal of Medicine
 18




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Critical Accounting Policies and Estimates
  Revenue Recognition
 Revenue
Recognition, Revenue Arrangements with Multiple
Deliverables,
 Accounting For Leases
   19




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Stock-Based Compensation
        Allowance for Doubtful Accounts
  Inventories
  20




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Warranty
  Income Taxes
  Accounting for Uncertainty in Income Taxes  an Interpretation of FASB
Statement No. 109 Accounting for
Income Taxes,
 Results of Operations
  Three Months EndedApril 4,
    
    March 29,2009
    
    2008Revenue
    
    
    100
    %
    
    
    100
    %Costs of revenue
    
    
    23
    
    
    
    26Gross profit
    
    
    77
    
    
    
    74Operating expenses:Research and development
    
    
    16
    
    
    
    16Sales and marketing
    
    
    43
    
    
    
    42General and administrative
    
    
    18
    
    
    
    16Total operating expenses
    
    
    77
    
    
    
    74Loss from operations
    
    
    
    
    
    
    Interest income, net
    
    
    
    
    
    
    1Realized gain on sale of investment
    
    
    
    
    
    
    Gain on repurchases of debt
    
    
    12
    
    
    
    Income before income taxes
    
    
    12
    
    
    
    1Provision for income taxes
    
    
    5
    
    
    
    2Net income (loss)
    
    
    7
    %
    
    
    (1
    )%
 21




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Three Months Ended April 4, 2009 Compared with the Three Months Ended March 29, 2008
 Three Months EndedPercentageApril 4,
    
    
    March 29,
    
    
    Increase2009
    
    
    2008
    
    
    (Decrease)(in thousands, exceptunit amounts)Revenue  WorldwideBIS Sensor
    
    $
    21,581
    
    
    $
    20,636
    
    
    
    5
    %BIS monitor
    
    
    1,898
    
    
    
    2,097
    
    
    
    (9
    )Original equipment manufacturer products
    
    
    1,013
    
    
    
    981
    
    
    
    3Other equipment and accessories
    
    
    808
    
    
    
    714
    
    
    
    13Total equipment
    
    
    3,719
    
    
    
    3,792
    
    
    
    (2
    )Total revenue
    
    $
    25,300
    
    
    $
    24,428
    
    
    
    4
    %Unit Analysis  WorldwideBIS Sensors
    
    
    1,598,000
    
    
    
    1,486,000
    
    
    
    8
    %BIS monitors
    
    
    732
    
    
    
    718
    
    
    
    2Original equipment manufacturerBIS products
    
    
    1,362
    
    
    
    1,560
    
    
    
    (13
    )Installed base
    
    
    58,882
    
    
    
    49,295
    
    
    
    19
 Revenue.
   22




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##### Table of Contents



Expense Overview
 Three Months EndedApril 4,
    
    March 29,
    
    Percentage2009
    
    2008
    
    Increase(in thousands)ExpensesResearch and development
    
    $
    4,015
    
    
    $
    3,939
    
    
    
    2
    %Sales and marketing
    
    
    10,828
    
    
    
    10,202
    
    
    
    6General and administrative
    
    
    4,581
    
    
    
    3,942
    
    
    
    16
 Research and Development.
 Sales and Marketing.
 General and Administrative.
 Interest Income.
 Interest Expense.
 Other Income.
 23




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Income Taxes.
   Liquidity and Capital Resources
      24




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##### Table of Contents



Cash used for operations.
 Cash used for investing activities.
 Cash provided by financing activities.
 Off-Balance Sheet Arrangements
  Effects of Inflation
  Recent Accounting Pronouncements
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Disclosures about Derivative Instruments and
Hedging Activities an Amendment of FASB Statement No. 133,
 Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement),
 Determining Whether an Instrument (or
Embedded Feature) Is Indexed to an Entitys Own Stock The Meaning of Indexed to a Companys Own Stock Scope Exceptions: Whether
Options (Including Embedded Conversion Options) Are Indexed to both an Entitys Own Stock and
Currency Exchange Rates
 Determining Fair Value When the Volume and Level of Activity for the Asset or Liability have
Significantly Decreased and Identifying Transactions That are not Orderly Interim Disclosures about Fair Value of
Financial Instruments Recognition and Presentation of Other-Than-Temporary Impairments
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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 fiscal quarter ending July 4, 2009 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 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.
 (a)
    
    Evaluation of Disclosure Controls and Procedures.Our management, with the participation of our chief executive officer and chief financial
officer evaluated the effectiveness of our disclosure controls and procedures as of April 4,
2009. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act, means controls and other procedures of a company that are
designed to ensure that information required to be disclosed by a company in the reports that
it files or submits under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the SECs rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed
to ensure that information required to be disclosed by a company in the reports that it files
or submits under the Exchange Act is accumulated and communicated to the companys
management, including its principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure. Management recognizes
that any
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controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving their objectives and management necessarily applies its
judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based on the evaluation of our disclosure controls and procedures as of April 4, 2009, our
chief executive officer and chief financial officer concluded that, as of such date, our
disclosure controls and procedures were effective at the reasonable assurance level.(b)
    
    Changes in Internal Controls.No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended April 4, 2009 that
has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
 
 PART II  OTHER INFORMATION
 Item 1. Legal Proceedings
    
 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.
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New England Journal of Medicine
  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 2009.
  
    
    a third party study published in March 2008 in the New England Journal
of Medicinecompared 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 shifted the focus of our sales and marketing efforts from
expanding our customer base to deepening our relationships with our
existing customers and increasing their sensor utilization and
procedure penetration. As a result of this shift in focus, we expect
our revenue from the sale of equipment to continue to decrease. As
such, if we do not increase revenue from sales of our BIS Sensors
quickly, or at all, our operating results could be adversely affected;
    
    we may not realize expected benefits of favorable industry
pronouncements on anesthesia awareness, including the position
statements issued by the Joint Commission on Accreditation of
Healthcare Organizations, the American Society of Anesthesiologists
House of Delegates, and the American Association of Nurse
Anesthetists;
    
    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
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to record a gain on such
transaction, which could affect our operating results in the quarter
in which any such repurchase is made; and
    
    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.
  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;
    
    transition of sales focus from expanding our customer base to developing our existing
customers and increasing their sensor utilization and procedure penetration;
    
    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.
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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.
   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.
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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, including costs to fund
our neuroscience program following termination in June 2007 of our alliance with Boston Scientific Corporation,
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
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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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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;
    
    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.
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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;
    
    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
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
    
    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.
  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.
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
    
    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.
   We and Boston Scientific recently jointly terminated our strategic alliance and other agreements
and, as a result, we may not have sufficient funding to finance our neuroscience programs.
  
    
    the original equipment manufacturer product development agreement dated as of
August 7, 2002, pursuant to which we were seeking to develop certain products that
Boston Scientific Corporation would then commercialize in the area of monitoring
patients under sedation in a range of less invasive medical specialties, and pursuant to
which we granted Boston Scientific Corporation an exclusive option to become the
distributor for a period of time of certain of our products;
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
    
    the product development and distribution agreement dated as of May 23, 2005,
pursuant to which we were seeking to develop new applications of its brain-monitoring
technology in the area of the diagnosis and treatment of neurological, psychiatric and
pain disorders and Boston Scientific Corporation was appointed the exclusive distributor
of such products. Under this agreement, which we refer to as the neuroscience alliance,
Boston Scientific Corporation had agreed to provide $25.0 million of funding over a five
year period. We received $10.0 million under this agreement; and
 
    
    the letter agreement dated August 7, 2002, and the security agreement dated August 7,
2002, pursuant to which Boston Scientific Corporation agreed to make revolving
interest-bearing loans to us from time to time at our request, such revolving loans
being evidenced by a promissory note in the original principal amount of $5,000,000
dated August 7, 2002 made by us in favor of Boston Scientific Corporation.
  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.
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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
    
    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.
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If we make any acquisitions, we will incur a variety of costs and may never successfully integrate
the acquired business into ours.
  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.
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
    
    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;
    
    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;
    
    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.
  
    
    preferred stock that could be issued by our board of directors to make it more difficult for a third
party to acquire, or
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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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Risks Related to our Issuance of $125 Million Principal Amount of
2.5% Convertible Senior Notes due 2014
 Our increased 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.
  
    
    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;
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
    
    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 6. Exhibits.
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SIGNATURE
  ASPECT MEDICAL SYSTEMS, INC.Date: May 14, 2009
    By:
    /s/ J. Neal ArmstrongJ. Neal ArmstrongVice President and Chief Financial Officer
(Principal Financial and Accounting Officer) 49




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EXHIBIT INDEX
 EXHIBITNUMBER
    
    EXHIBIT10.1
    
    Severance Agreement and General
Release, dated as of January 1, 2009, by and between the Registrant and Michael Falvey
 is incorporated herein by
reference to Exhibit 10.1 to the Registrants Current Report on
Form 8-K dated January 5, 2009.10.2
    
    Settlement Agreement, dated as of April 8, 2009, by and among
the Registrant,  First Manhattan Co., First BioMed
Management Associates, LLC and First BioMed, L.P. is incorporated herein by reference to Exhibit 99.1 to the Registrants Current Report on Form 8-K dated April 9, 2009.31.1
    
    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.