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CAS Medical Systems 10-K 2009
WWW.EXFILE.COM, INC. -- 888-775-4789 -- CAS MEDICAL SYSTEMS, INC. -- FORM 10-K
 


UNITED STATES 
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
For the Fiscal Year ended December 31, 2008

 Commission File Number 0-13839

CAS MEDICAL SYSTEMS, INC.
 (Exact name of registrant as specified in its charter)

Delaware
06-1123096
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification No.)

44 East Industrial Road, Branford, Connecticut  06405
(Address of principal executive offices, including zip code)

(203) 488-6056
(Registrants telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, $.004 par value
The NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  o   No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes  o   No  x

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer  o
Accelerated filer  o
Non-accelerated filer  o
(Do not check if a smaller reporting company)
 Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  o   No  x
 
As of June 30, 2008, which is the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $26,674,000 based on the closing price as reported on the NASDAQ Global Market.  This calculation does not reflect a determination that persons are affiliates for any other purpose.
 
As of March 31, 2009, there were 11,356,662 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement for its Annual Meeting of Stockholders to be held on June 10, 2009 are incorporated by reference in Part III of this Report.  Except as expressly incorporated by reference, the Registrant’s Proxy Statement shall not be deemed to be part of this Form 10-K.



 
INDEX
 
Page
     
PART I
   
     
Item 1
Business
3
Item 1A
Risk Factors
11
Item 1B
Unresolved Staff Comments
15
Item 2
Properties
15
Item 3
Legal Proceedings
15
Item 4
Submission of Matters to a Vote of Security Holders
16
     
     
PART II
   
     
Item 5
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
16
Item 6
Selected Financial Data
17
Item 7
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17 
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
23
Item 8
Financial Statements and Supplementary Data
23
 
Report of Independent Registered Public Accounting Firm
F-1
 
Consolidated Balance Sheets as of December 31, 2008 and 2007
F-2
 
Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007 and 2006
F-3
 
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2008, 2007 and 2006
F-4
 
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006
F-5
 
Notes to Consolidated Financial Statements
F-6 to F-18
     
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
24
Item 9A(T)
Controls and Procedures
24
Item 9B
Other Information
24
     
     
PART III
   
     
Item 10
Directors, Executive Officers and Corporate Governance
25
Item 11
Executive Compensation
25
Item 12
Security Ownership of Certain Beneficial Owners and
 
 
Management and Related Stockholder Matters
25
Item 13
Certain Relationships and Related Transactions, and Director Independence
25
Item 14
Principal Accountant Fees and Services
25
     
     
PART IV
   
     
Item 15
Exhibits and Financial Statement Schedules
26
     
Signatures
 
29
 

 
 

 
Page 3
 
PART I

 
This report may contain information that includes or is based on forward-looking statements within the meaning of the federal securities laws that are subject to risks and uncertainties.  These statements may be identified by the use of words such as anticipates, “expects,” “estimates,” “projects,” “intends” and “believes” and variations thereof and other terms of similar meaning.  Factors that could cause the Company’s actual results and financial condition to differ from the Company’s expectations include, but are not limited to: potential liquidity constraints; price and product competition; rapid technological changes; dependence on new product development; failure to introduce new products effectively or on a timely basis; the mix of products sold; supply and prices of raw materials and products; customer demand for the Company’s products; regulatory actions; changes in reimbursement levels from third-party payors; product liability or other litigation claims; changes in economic conditions that adversely affect the level of demand for the Company’s products; changes in foreign exchange markets; changes in financial markets; changes in the competitive environment; and other risks described in Item 1A of this filing.  While the Company believes that the assumptions underlying such forward-looking statements are reasonable, there can be no assurance that future events or developments will not cause such statements to be inaccurate.  All forward-looking statements contained in this report are qualified in their entirety by this cautionary statement.
 
Unless the context indicates otherwise, as used in this report, the terms “CAS,” “CASMED,” the “Company,” “we,” “us” and “our” refer to CAS Medical Systems, Inc.
 
Item 1. Business

Overview

We develop, manufacture and market medical devices for non-invasive patient monitoring.  Our products include cerebral oximeters and sensors, bedside monitoring products, blood pressure measurement technology, blood pressure cuffs and neonatal supplies. These products are designed to improve the quality of patient care by providing accurate non-invasive measurements that improve patient outcomes.

Our products have well established brand recognition in the markets we serve.  Our most recent addition is the FORE-SIGHT cerebral oximeter.  This device is designed to measure absolute levels of brain oxygenation in the most critically ill patients, including pediatric and neonatal intensive care patients and adults undergoing cardiac bypass surgery.  Use of the FORE-SIGHT system enables the clinician to significantly reduce potentially serious negative outcomes in these settings by providing real-time non-invasive measurement of the level of oxygen in the brain, allowing the clinician to intervene before brain damage occurs.  The brain is the organ least tolerant of oxygen deprivation. Without sufficient oxygen, brain damage may occur within minutes, which can result in stroke, paralysis, other disabilities or death. Reliable measurement of absolute levels of brain oxygen is therefore important to clinicians, especially in critical care situations where there is a high risk of the brain getting less oxygen than it needs.

Description of Products and Services
 
The Company has several categories of products and services.  The combined categories represent one reportable business unit. Categories of products and services are as follows:
 
·  
Critical care monitoring – includes sales of the FORE-SIGHT cerebral oximeter monitors, sensors and accessories.
 
·  
Bedside monitoring– includes sales of the Company’s vital signs monitors and accessories incorporating various combinations of measurement parameters for both human and veterinary use.  Parameters found in these monitors include pulse oximetry, electro-cardiography, temperature, non-invasive blood pressure, and capnography.  Also included in the bedside monitoring category are products developed and manufactured by Analogic Corporation, or otherwise supplied through Analogic, including vital signs monitors utilizing parameters as described above and additional monitors which measure non-invasive cardiac output and hemodynamic status, and maternal/fetal monitors.  These vital signs monitors allow for connectivity to a central station.  Additionally, the Company’s cardio-respiratory monitors and accessories used to monitor apnea in home-based and hospital settings are also included in this category.
 

Page 4
 
 
·  
Blood pressure measurement technology – includes sales to Original Equipment Manufacturers (“OEM”) of the Company’s proprietary non-invasive blood pressure technology (MAXNIBP), blood pressure cuffs and accessories for the OEM market, and related license fees.
 
·  
Supplies and service – includes sales of blood pressure cuffs and rapid infusor cuffs, neonatal intensive care supplies including electrodes and skin temperature probes, and service repair revenues.
 
Critical Care Monitoring

The FORE-SIGHT Cerebral Oximeter non-invasively and continuously measures absolute brain tissue oxygen levels, enabling clinicians to identify and quickly react to instances of lowered brain oxygen levels before the situation becomes critical.  With one or two single-use disposable sensors placed on the patient’s forehead, FORE-SIGHT utilizes the Company’s LASER-SIGHT Optical Technology to project near infrared light into the brain to provide an absolute measurement indicating cerebral tissue oxygen saturation.

Unlike readings obtained from a trend-only monitor, absolute cerebral tissue oxygen saturation readings have stand-alone clinical significance because individual measurements have a direct correlation to the standard invasive measurements with which clinicians are familiar.  Several studies have been published showing that the use of cerebral oximetry during cardiac surgery can significantly reduce adverse clinical outcomes due to neurological complications, including permanent stroke. Other published studies have shown decreased length of stay and decreased post operative ventilator time when cerebral oximetry is used. Use of cerebral oximetry can lead to improved patient outcomes and significant cost savings to hospitals.

In February 2008, the Company received 510(k) clearance expanding the indications for use of its FORE-SIGHT infant sensor to include the neonatal patient population above 2,500 grams of weight. Measuring cerebral oxygen saturation is significant for a variety of neonatal patients, including those born with congenital heart defects that affect the ability of the heart to supply oxygenated blood to the brain. Approximately 550 hospitals in the U.S. contain Neonatal Intensive Care Units (“NICU”) with 13,000 high acuity Level 3 beds. Approximately four million births occur in the U.S. each year of which approximately 4% are babies with a birth defect and about 12% are preterm births (defined as less than 37 weeks from gestation).

The Company began marketing the neonatal/infant FORE-SIGHT oximeter sensor in the second half of 2008, primarily targeting the hospital market for use in the Neonatal/Infant cardiovascular operating room, the Cardiac Intensive Care Unit and the NICU. The FORE-SIGHT product accurately detects low cerebral oxygen saturation events during critical periods, thereby allowing clinicians to intervene and reverse potentially life threatening events before they become critical.  In neonates in particular, the issue is compounded by the lack of physiological reserve mechanisms that the body can use to regulate blood flow and protect the brain from low oxygen levels. CASMED is the only company in the marketplace to have received FDA regulatory clearance with labeling for use of absolute cerebral oximetry in neonatal and infant populations.

Additionally, in March 2009 we received 510(k) clearance from the Food and Drug Administration (“FDA”) for a medium size FORE-SIGHT sensor to complement the large and small sensor offerings. We expect to begin marketing this sensor, targeted at the pediatric patient population, during mid-2009, thus completing our cerebral oximeter sensor offerings. In addition, during 2009 we expect to pursue additional FDA 510(k) clearance for other expanded uses including additional non-cerebral sensors and features.

We are sponsoring and evaluating sponsorship of clinical trials which may allow us to more actively target the sale of the FORE-SIGHT System for use in high risk neonatal and pediatric patient populations.

In January 2009, a review paper published in the Journal of Perinatology and authored by JC Fenik and K. Rais-Bahrami titled “Neonatal cerebral oximetry monitoring during ECMO cannulation”, detailed the benefits of absolute cerebral oximetry in neonatal patients undergoing extracorporeal membrane oxygenation (ECMO) therapy, including its ability to reliably measure brain oxygen levels during CPR when conventional technologies such as pulse oximetry have failed.


Page 5

Additional studies targeted at the pediatric and neonatal populations are underway including the use of monitoring absolute cerebral oximetry on pediatric patients undergoing cardiac catheterization, neonatal pain management, peri-operative monitoring of congenital heart patients, as well as auto-regulation response.

The Company believes that there is also an opportunity for establishment of FORE-SIGHT Absolute Cerebral Oximetry as a standard of care in all cardiac surgical procedures, where nearly 700,000 procedures are performed annually in the U.S.  Several clinical studies have already been published demonstrating the importance and effectiveness of monitoring changes in cerebral oximetry during cardiac surgery.  Examples of these published studies include –

·  
In September 2004 a retrospective, blinded intervention 2,279-patient published as Scott Goldman, M.D., et al., “Optimizing Intraoperative Cerebral Oxygen Delivery Using Noninvasive Cerebral Oximetry Decreases the Incidence of Stroke for Cardiac Surgical Patients”, in the Heart Surgery Forum #2004-1062 showed a significant reduction in permanent stroke when information from cerebral oximetry was used to help manage regional brain blood oxygen saturation in cardiac surgery patients.

·  
In January 2007, a 200-patient study, published as John M. Murkin, M.D., et al., “Monitoring Brain Oxygen Saturation During Coronary Bypass Surgery:  A Randomized, Prospective Study”, in Anesthesia and Analgesia showed a statistically significant reduction in incidences of major organ dysfunction when cerebral oximetry was used to provide information to help manage regional brain blood oxygen saturation in coronary artery bypass surgery patients.

·  
In March 2008, a review paper published as Gregory W. Fischer, M.D., Co-Director of Cardiac Anesthesia at Mount Sinai Medical Center in New York “Recent Advances in the Application of Cerebral Oximetry in Adult Cardiovascular Surgery”, in Seminars in Cardiothoracic and Vascular Anesthesia detailed the benefits of absolute cerebral oximetry in patients undergoing Deep Hypothermic Cardiac Arrest (“DHCA”) aortic arch surgery.

·  
In June 2008, a paper published as Thomas Hemmerling M.D., et al., “Cerebral desaturation during single lung ventilation correlates with postoperative morbidity”, in Canadian Journal of Anesthesia Supplement detailed the benefits of monitoring absolute cerebral oximetry in patients undergoing single lung ventilation (SLV) and showed a positive correlation between the decrease of SctO2 during SLV and postoperative non-pulmonary organ failure.

Additional cardiac and thoracic surgery studies are underway in the U.S and Europe with results from these studies expected to be published during 2009.

The Company is actively supporting several on-going clinical studies throughout North America and Europe, specifically designed to expand the available market by highlighting the benefits of absolute cerebral oximetry.  These studies include –

·  
An NIH-funded major multi-center study researching cognitive decline and delirium in elderly patients undergoing major general surgery.  The study, which began in 2008, involves seven key medical institutions throughout the U.S.  Approximately five million elderly patients have surgery in the U.S. each year.  These surgeries are generally considered high risk due to a variety of factors.  The Company believes that monitoring cerebral oximetry using FORE-SIGHT can also significantly benefit this population of patients.

·  
Two studies to show the benefit of absolute cerebral oximetry monitoring during shoulder surgery in the sitting or “beach chair” position.  In the summer of 2007, a newsletter of the Anesthesia Patient Safety Foundation (“APSF”) described two patients with no significant risk factors or evidence of cerebral vascular disease who both developed permanent neurological deficits likely from global cerebral hypo-perfusion while undergoing shoulder surgery in the beach chair position.  The beach chair position can cause significant hemodynamic changes, the response to which are further blocked by the combination of inhalation/intravenous drugs.  The current standard of care for these patients is to measure blood pressure using a cuff laced on the opposite arm or either leg that automatically identifies oscillometric blood pressure readings.  The Company believes that monitoring cerebral oximetry using FORE-SIGHT can significantly benefit patients during these procedures.
 

Page 6

The Company continues to evaluate sponsoring other clinical studies that expand the use of FORE-SIGHT Absolute Cerebral Oximetry into other patient populations and applications.

During our fiscal year ended December 31, 2008, net sales from disposable sensors comprised approximately 4% of our overall net sales. As of December 31, 2008, 151 FORE-SIGHT monitors were installed in approximately 70 hospitals worldwide.

Bedside Monitoring

The Company offers a full line of non-invasive vital signs monitoring products for a variety of general care settings in hospitals such as outpatient medical surgical units, recovery, procedure labs, physician offices and emergency response settings. The monitors are small, lightweight, portable and easy to use with central station capabilities.

The Company manufactures two platforms of vital signs monitors incorporating various combinations of industry-leading measurement parameters.  The product lines include options for measurement of non-invasive blood pressure using the Company’s proprietary MAXNIBP technology, pulse oximetry, electro-cardiography, temperature, and capnography.  CASMED monitors are ideal for a range of clinical settings (both human and veterinary) including emergency medical service, medical/surgical units, out-patient care, and procedural sedation. During 2003, the Company was awarded a multi-year, sole-source purchasing agreement by the U.S. Department of Veterans Affairs (“VA”) for its vital signs monitors. This agreement expired during 2008. The VA has since issued a blanket purchase agreement in effect through June 2009 naming CASMED as an approved vendor. The Company is currently seeking an extension of the blanket purchase agreement. Management does not believe that its business with the VA will be materially affected should it not be successful in receiving such extension.

Also included in the bedside monitoring category are products developed and manufactured by Analogic Corporation, or otherwise supplied through Analogic, including vital signs monitors utilizing parameters as described above and additional monitors which measure non-invasive cardiac output and hemodynamic status, and maternal/fetal monitors.  These vital signs monitors allow for connectivity to a central station.

The Company also manufactures a line of cardio-respiratory monitors used to monitor apnea in home-based and hospital settings.  This niche market is primarily a replacement market.  Revenues in this market have been steadily declining over the past several years. Revenues generated from this line were less than 5% of overall revenues in 2008. The Company plans to exit this market during 2009.

Blood Pressure Measurement Technology

The Company has developed a proprietary non-invasive blood pressure measurement technology, MAXNIBP.  The Company believes this technology is more accurate, reliable, and able to produce a measurement result faster than its competitors.  These advantages strengthen the Company’s competitive position, especially in clinical situations where measurements can be difficult.  The Company has entered into OEM agreements to supply its MAXNIBP technology to various companies throughout the world.  This technology is used in larger monitoring systems where non-invasive blood pressure is but one measurement parameter.  The Company’s OEM agreements are typically multi-year arrangements.

Supplies and Service

The Company offers a complete line of disposable and reusable blood pressure cuffs that can be used with any manufacturer’s monitoring equipment.  The product line includes cuffs and pressure infusors manufactured by Statcorp, Inc. which was purchased by CASMED in 2005.  The blood pressure cuffs, including UltraCheck and Tuff-Cuff Reusable Cuffs, and SoftCheck and Safe-Cuff Disposable Cuffs, can be used on patients from neonate through adult, as well as on veterinary patients, and complement the Company’s MAXNIBP blood pressure measurement technology.  The Company’s Unifusor line of infusor cuffs are used to rapidly infuse intra-venous fluids into a patient.  The Company has various private-label versions of both the blood pressure and infusor cuffs available for OEM partners.


Page 7

The Company offers a line of specialty neonatal supplies - high quality products designed specifically to meet the unique needs of neonatal intensive care. The varied  product  line  includes  Klear-Trace  ECG Electrodes, NeoGuard skin temperature probes and adhesive reflectors, and SoftCheck neonatal blood pressure cuffs.

Sales and Marketing

The Company markets its products globally, through hospital, alternate site, homecare, veterinary and emergency medical distribution channels. A number of different sales channels are utilized to maximize opportunities with the various product lines we offer.

In 2008, the Company hired a new Vice-President of Sales and Marketing and achieved several important milestones including establishing a full sales, marketing and clinical team to support future efforts in the markets for its FORE-SIGHT cerebral oximetry products.

The Company’s critical care FORE-SIGHT cerebral oximeters are sold via a direct sales force and key manufacturers representatives groups within the U.S. and via distribution partners outside the U.S. In the fourth quarter of 2008 we began the hiring of a direct sales force which was supplemented by an existing base of manufacturer representative groups. As of December 31, 2008, the Company employed a team of 12 sales and clinical support specialist staff dedicated to the FORE-SIGHT product line in the U.S. market. We expect to increase the size of our U.S. direct sales team as the market opportunity expands. Outside the United States, the Company has one sales manager located in Europe focused on FORE-SIGHT sales, selling to select markets via distribution partners.

The Company’s bedside monitoring products and consumable cuff products are sold via a direct sales force within the U.S., supplemented by a small group of key distribution partners, and via distribution partners outside the U.S. Within the U.S., we have six full-time field sales personnel focused primarily on sales to the Veterans Affairs hospitals for our full line of vital signs monitors. International sales are conducted through exclusive distributors in the European, African, Middle Eastern, Pacific Rim and Latin American regions and Canada, working together with regional sales consultants and one employee located outside of the United States.

The Company sells its non-invasive blood pressure technology, in the form of sub-assemblies to be joined to multi-parameter monitors, on a direct basis to various firms operating in both the domestic and international markets. The Company is in the process of pursuing additional OEM agreements.

Sales of the Company’s supplies and services are primarily sold via key distribution partners in both the U.S. and International markets.
 
   
Financial Information Relating to Sales
 
   
Year Ended December 31
 
   
2008
   
2007
   
2006
 
 
Domestic Sales
  $ 30,031,921     $ 29,601,305     $ 27,518,584  
International Sales
    10,617,136       8,631,100       7,683,427  
    $ 40,649,057     $ 38,232,405     $ 35,202,011  

Competition

The Company competes in the medical equipment market where there are many suppliers with greater financial and personnel resources that sell a broad line of both commodity products and monitoring equipment and have a dedicated selling capability.  The Company’s products primarily serve various areas of the hospital market.

For our critical care monitoring products, we believe there are currently only two other companies with FDA 510(k) clearance to sell a cerebral oximeter in the U.S. We believe that in the future the market for cerebral oximetry may become  highly   competitive.   We  are aware that several companies and individuals are engaged in the research and
 

Page 8

development of non-invasive cerebral oximeters, and we believe that there are several other potential entrants into the market. Additionally there are other companies that have FDA clearance to market somatic or tissue oximeters in the United States. Competition might cause our sales cycle to lengthen to the extent that customers take longer to make purchasing decisions. Competition might also reduce our gross margins and market share and prevent us from achieving further market penetration. Competitors might be more successful than we are in obtaining FDA clearance with broader claims in their labeling or more successful than we are in manufacturing and marketing their products and may be able to take advantage of the significant time and effort we have invested to gain medical acceptance of cerebral oximetry.

For our line of bedside monitoring products and supplies, we are in a highly competitive global market with numerous U.S. and international based medical equipment companies.
          
We also compete with numerous medical equipment companies and medical device integration companies for the portions of hospital budgets allocated to capital equipment. Some of these potential competitors have well-established reputations, customer relationships and extensive marketing, distribution and service networks. Some of them have substantially longer histories in the medical products industry, larger product lines and greater financial, technical, manufacturing, research and development and management resources than we do. Many of these potential competitors have long-term product supply relationships with our potential customers. These potential competitors might be able to use their resources, reputations and ability to leverage existing customer relationships to give them a competitive advantage over us, including in securing dollars from hospital capital equipment budgets to purchase their products. They might also succeed in developing products that are at least as reliable and effective as our products, perform additional measurements, are less costly than our products or provide alternatives to our products. Competitors might be more successful than we are in manufacturing and marketing their products and may be able to take advantage of the significant time and effort we have invested in developing our markets.

The Company’s products maintain a high, professional standard of accuracy and quality in demanding environments such as those encountered in hospital and transport situations. We believe that our reputation for producing innovative, accurate, reliable, products that are user-friendly, manufactured in the U.S., and contain best-in-class technology are key factors in our ability to successfully compete with larger organizations in the medical equipment market. With respect to all of its products, the Company competes on the basis of price, features, product quality and promptness of delivery and overall quality of customer service. 

Research and Development

During 2008, 2007 and 2006, the Company incurred expenses of approximately $2,610,000, $2,733,000, and $2,782,000 respectively, on activities related to the research and development of new products, and improvement of existing products. These amounts are before consideration of reimbursements received from the National Institutes of Health (“NIH”) further explained under Grant Awards below. Net research and development (“R&D”) expenses after reimbursements from the NIH approximated $2,028,000 for 2008, $2,254,000 for 2007, and $2,762,000 for 2006.   Reimbursements from the NIH were approximately $582,000 for 2008, $479,000 for 2007, and $20,000 for 2006. Funding provided to the Company is recorded as a reduction in R&D expenses.

The majority of the Company’s 2008 development efforts were directed toward furthering the design and development of its patented LASER-SIGHT Near-Infrared Spectroscopy (“NIRS”) technology used in the FORE-SIGHT Cerebral Oximeter. Other development efforts included enhancements to the Company’s Vital Signs Monitors as well as design improvements to certain of the Company’s OEM non-invasive blood pressure modules.
 
As of December 31, 2008, the Company employed a staff of 16 engineers and scientists focused on internal R&D activities outlined above. For 2009, we expect an increase in our research, development and engineering expenses primarily as a result of costs associated with development of additional FORE-SIGHT sensors, cost reduction programs, further enhancements to the cerebral oximeter and continued clinical research efforts to continue to expand the market opportunities for the Company’s cerebral oximetry products, as well as continued advancement the Company’s proprietary OEM non-invasive blood pressure technology.


Page 9
Grant Awards

On September 17, 2007, the Company was awarded a three year grant totaling $2.8 million by the National Institute of Neurological Disorders (“NINDS”) and Stroke of the NIH under its Small Business Innovative Research Program. The grant was awarded primarily to support advanced clinical outcome studies that focus on the Company’s proprietary LASER-SIGHT technology incorporated into the FORE-SIGHT cerebral oximeter. Further clinical studies funded by this grant will be used to expand the clinical applications for FORE-SIGHT outside of the initial target market of high risk cardio-vascular surgery. As of December 31, 2008, a maximum of approximately $1.7 million remained under the 2007 grant award.
 
The Company has, in prior years, been awarded various grants by the NINDS under its Small Business Innovative Research Program. Grants under this program are being used to support the Company’s LASER-SIGHT NIRS development. In accordance with the terms of these grants, the Company is reimbursed for certain qualifying expenditures. Such grant awards provide substantial support for the Company’s clinical efforts currently being undertaken at multiple adult and neonatal sites.

Trademarks, Patents and Copyrights

Certificates of Registration have been issued to the Company by the United States Department of Commerce Patent and Trademark Office for the following marks:  CASâ, CAS Express®, CASMED®, For Every Life and Breath Situation®,  For What’s Vital®, FORE-SIGHT®, Klear-Traceâ, LASER-SIGHT®, Limboardâ, MAXNIBPâ, NeoGuardâ, OscilloMateâ, Pedisphygâ, Premie Nestieâ, Safe-Cuff®, SoftCheck®, SWANK®, Tuff-Cuffâ, UltraCheck®, Unifusor®, Woods Pump®,  the heart shaped mark for use as a thermal reflector and the Company’s corporate logo.   The Company also holds trademarks for the Event-Linkâ monitoring system, the Edentec Assuranceâ monitor, Edentrendâ software and the AMIâ and AMIâ Plus monitors.

The Company holds various patents for its blood pressure measurement technology which it believes provide it with a competitive market advantage.  In addition, it has patents with respect to apnea monitoring technology. Although the Company holds such patents and has patents pending related to certain of its products, it does not believe that its business as a whole is significantly dependent upon patent protection with the exception of the FORE-SIGHT cerebral oximetry technology.

The FORE-SIGHT NIRS cerebral oximetry technology has four U.S. patents issued (U.S. 6,456,862 B2, 7,047,054, 7,072,701, and 7,313,427) and one international patent issued. In addition, the Company currently has several patents pending with U.S. and foreign patent offices. The Company believes the design concepts covered in its current patent applications and provisional patent applications are important to providing a cerebral oximeter capable of absolute brain tissue oxygen saturation measurements.

Other patents have previously been issued to third parties involving optical spectroscopy and the interaction of light with tissue, some of which relate to the use of optical spectroscopy and NIRS in the area of brain metabolism monitoring. The Company is not aware of any infringement by its products of the claims of any issued patents, and no charge of patent infringement has been asserted against the Company.

The Company also relies on trade secret, copyright and other laws and on confidentiality agreements to protect its technology.  The Company has copyright protection for the software used in its blood pressure, apnea and cerebral oximeter monitors.

The Company will continue to seek patent, trademark and copyright protections as it deems advisable to protect the markets for its products and its R&D efforts.  We believe that neither our patents nor our other legal rights will necessarily prevent third parties from developing or using a similar or a related technology to compete against our products.

Employees

As of December 31, 2008, the Company had 172 employees, of which 170 were full-time.  The Company has no collective bargaining agreements and believes that relations with its employees are good.


Page 10
Government Regulation

Medical products of the type currently being marketed and under development by the Company are subject to regulation under the Food, Drug and Cosmetic Act (the “FD&C Act”) and numerous acts and amendments such as the Quality System Regulations (“QSR”), often referred to as Good Manufacturing Practices (“GMP’s”).

In addition, depending upon product type, the Company must also comply with those regulations governing the Conduct of Human Investigations, Pre-Market Notification Regulations and other requirements, as promulgated by the FDA.  The FDA is authorized to inspect a device, its labeling and advertising, and the facilities in which it is manufactured in order to ensure that the device is not manufactured or labeled in a manner which could cause it to be in violation of the FD&C Act.

The FDA has adopted regulations which classify medical devices based upon the degree of regulation believed necessary to assure safety and efficacy.  A device is classified as a Class I, II, or III device.  Class I devices are subject only to general controls.  Class II devices, in addition to general controls, are or will be subject to “performance standards.”  Most devices are also subject to the 510(k) pre-market notification provision.  In addition, some Class III devices require FDA pre-market approval before they may be marketed commercially because their safety and effectiveness cannot be assured by the general controls and performance standards of Class I or II devices.

The Company’s products are primarily Class I and II devices and several of them have required FDA notification under Section 510(k) of the FD&C Act.

The FDA has the authority to, among other things, deny marketing approval until all regulatory protocols are deemed acceptable, halt the shipment of defective products, and seize defective products sold to customers.  Adverse publicity from the FDA, if any, could have a negative impact upon sales.  In the last factory inspection of the Company there were no material non-conformities.

International Regulatory Compliance

CASMED maintains certification to ISO 13485:2003 by the accredited body, BSI Inc., in each of its manufacturing facilities. These certifications allow CASMED to use the “CE” mark on its products.  The CE mark is required for medical devices to gain access to the European Union common market.  The FDA, recognizing the value of this universally accepted quality system, has patterned its Quality System Regulations after ISO 9001 and ISO 13485. CASMED maintains full compliance with the FDA Quality System Regulations and has recently been recertified to ISO-13485.

Manufacturing and Quality Assurance

The Company assembles its products at its facilities in Branford, Connecticut and Jacksonville, Florida.  The various components for the products, which include plastic sheeting, plastic moldings, wire, printed circuit boards, semi-conductor circuits, electronic and pneumatic components, power supplies, proprietary software and many other parts and sub-assemblies are obtained from outside vendors.  The Company has not experienced any sustained interruption in production or the supply of components and does not anticipate any difficulties in obtaining the components necessary to manufacture its products.

Quality control procedures are performed by the Company at its facilities and occasionally at its suppliers’ facilities to standards set forth in the FDA’s “Quality System Regulations.”  These procedures include the inspection of components and full testing of finished goods.  The Company has a controlled environment where the final assembly of single-patient-use products is conducted.

Customers

Our five largest customers accounted for approximately 31%, 26%, and 33% of revenues in 2008, 2007, and 2006, respectively.  Among these customers, Medtronic, Inc., customarily the Company’s largest customer, accounted for 11% of revenues during both 2008 and 2006. During 2007, no customer accounted for 10% or more of the Company’s revenues. During January 2007, Medtronic announced a voluntary suspension of U.S. product shipments from its Physio-Control division. Despite strong sales to Medtronic during the latter six months of 2007, overall sales to Medtronic for 2007 decreased approximately $1,510,000 from 2006 and represented approximately 7% of overall
 

Page 11

revenues.

Backlog

The Company’s backlog includes orders pursuant to long-term OEM agreements as well as orders for products shippable on a current basis. Total backlog, therefore, is not a meaningful indicator of future sales.

Corporate Information

CAS Medical Systems, Inc. is a Delaware corporation organized in 1984. Our corporate offices are located at 44 East Industrial Road, Branford, CT 06405, and our telephone number is (203) 488-6056. Our website address is www.casmed.com. The information on, or that can be accessed through, our website is not a part of this report.

Item 1A.  Risk Factors

Our business faces many risks.  If any of the events or circumstances described in the following risk factors actually occurs, our business, financial condition or results of operations could suffer, and the trading price of our common stock could decline.  The risks described below may not be the only risks we face.  Additional risks that we do not yet know of or that we currently believe are immaterial may also impair our business operations.  You should consider the following risks, as well as the other information included or incorporated by reference in this Form 10-K before deciding to invest in our common stock.

We Are Subject To Risks Related To Future Liquidity

Our ordinary capital needs are expected to be met from a combination of cash flows from operations and borrowings under our line-of-credit agreement. Future cash flows, however, may be impacted by a number of factors, including changing market conditions, market acceptance of the FORE-SIGHT system, changes in payment terms to one or more major suppliers, loss of one or more key customers, or failure to meet financial covenants under our current or any future loan agreement.

We believe that our current levels of working capital and available debt financing are insufficient to fund major growth initiatives, such as significant increases in our sales and marketing personnel, or material acquisitions. Any major growth initiatives would require us to seek other sources or forms of debt or equity capital. There can be no assurance that we will be successful in securing such funding for major initiatives. Any issuance of equity or equity-linked securities would dilute the ownership interest of existing shareholders.

We Are a Small Company In A Highly Competitive Industry

Competition from other medical device companies, diversified healthcare companies and research and academic institutions is intense and expected to increase.  Many companies engaged in the medical device sector have substantially greater financial and other resources and development capabilities than we do, and have substantially greater experience in testing of products, obtaining regulatory approvals and manufacturing and marketing medical devices.  Therefore, our competitors may succeed in obtaining approval for products more rapidly than we can.  Other companies may succeed in developing and commercializing products earlier than we do.  In addition to competing with universities and other research institutions in the development of products, technologies and processes, the Company may compete with other companies in acquiring rights to products or technologies from  universities.  Also, the medical device market  is  experiencing increasing customer concentration, due to the emergence of large purchasing groups.  We cannot assure you that we will develop products that are more effective or achieve greater market acceptance than competitive products, or that our competitors will not succeed in developing products and technologies that are more effective than those being developed by us or that would render our products and technologies less competitive or obsolete.  Moreover, there can be no assurance that we will be able to successfully sell to large purchasing groups, which are increasingly looking to suppliers that can provide a broader range of products than we currently offer.


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Our Business Is Impacted By Customer Concentration.

Our five largest customers accounted for approximately 31%, 26%, and 33% of revenues in 2008, 2007, and 2006, respectively.  Among these customers, Medtronic, Inc., customarily the Company’s largest customer, accounted for 11% of revenues during both 2008 and 2006. During 2007, no customer accounted for 10% or more of the Company’s revenues. During January 2007, Medtronic announced a voluntary suspension of U.S. product shipments from its Physio-Control division. Despite strong sales to Medtronic during the latter six months of 2007, overall sales to Medtronic for 2007 decreased approximately $1,510,000 from 2006 and represented approximately 7% of overall revenues. The loss of one or more of the major customers noted above could result in a material adverse effect on the Company’s financial condition, our cash flows and results of operations.

The Recent Global Economic Crisis Has Had And May Continue To Have A Negative Effect On Our Business And Operations

The recent global economic crisis has caused, among other things, lower business spending, which has had and is expected to continue to have a negative effect on our business and results of operations.  Many of our customers and suppliers have been affected by the current economic turmoil.  Current or potential customers and suppliers may no longer be in business, may be unable to fund purchases or determine to reduce purchases, all of which has led and is expected to continue to lead to reduced demand for our products and increased customer payment delays.  Further, suppliers may not be able to supply us with needed components on a timely basis, may increase prices or go out of business, which could result in our inability to met customer demand or affect our gross margins.  The timing and     nature of any recovery in the economy remains uncertain, and there can be no assurance that market conditions will   improve in the near future or that our results will not be materially and adversely affected.  Such conditions make it very difficult to forecast operating results, make business decisions and identify and address material business risks.
 
We Are Devoting Substantial Resources To The Development And Marketing Of Our Cerebral Oximetry Products

We expect to devote a significant amount of resources to continue the development and marketing of our FORE-SIGHT cerebral oximetry products. We believe that substantial resources are required to further our opportunity in the markets for these products. Such investments include further research and development, including significant expenditures for clinical studies, manufacturing equipment, further expansion of a direct sales force, marketing expenditures and general working capital requirements. There can be no assurance that we will be successful in these
endeavors.

The Sale Of Our Products May Result In Significant Product Liability Exposure

As a manufacturer of medical diagnostic equipment, we could face product liability claims.  We maintain product liability insurance in an aggregate amount of $5 million.  We cannot assure you that this insurance coverage will be adequate to cover any product liability claims that occur in the future or that product liability insurance will continue to be available at reasonable prices. We are currently a defendant in a product liability action which is scheduled for trial during mid-2009.  We believe that our product liability insurance is sufficient to cover any damages and costs that are likely with respect to this matter.   Any product liability judgments or settlements in excess of insurance coverage could have a material adverse effect on our business and results of operations.

Our Business Could Be Adversely Affected If We Cannot Protect Our Proprietary Technology Or If We Infringe On The Proprietary Technology Of Others.

Our proprietary technology aids our ability to compete effectively with other companies in certain markets in which we compete. Although we have been awarded, have filed applications for, or have been licensed under numerous patents, these patents may not fully protect our technology or competitive position. Further, our competitors may apply for and obtain patents that will restrict our ability to make and sell our products.

Our competitors may intentionally infringe our patents. Third parties may also assert infringement claims against us in the future. Litigation may be necessary to enforce patents issued to us, to protect our trade secrets or know-how, to defend ourselves against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. The defense and prosecution of patent suits are both costly and time-consuming, even if the outcome is favorable to us. Such proceedings can be extremely expensive and their outcome very unpredictable. An adverse outcome in the defense of a patent suit could cause us to lose proprietary rights, subject us to significant
 

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liabilities to third parties or require us to license rights from third parties or to cease selling our products. Any of these events could have a material adverse effect on our business, operating results and financial condition. We also rely on unpatented proprietary technology that others may independently develop or otherwise obtain access to. Our inability to maintain the proprietary nature of our technologies could negatively affect our revenues and earnings.

We Are Subject To Significant Government Regulation

Our business is subject to varying degrees of governmental regulation in the countries in which we operate.  In the United States, our products are subject to regulation as medical devices by the FDA, and by other federal and state agencies.  These regulations pertain to the manufacturing, labeling, development and testing of our devices as well as to the maintenance of required records. An FDA regulation also requires prompt reporting by all medical device manufacturers of an event or malfunction involving a medical device where the device caused or contributed to death or serious injury or is likely to do so.

Federal law provides for several routes by which the FDA reviews medical devices before their entry into the marketplace.  Medical products of the type currently being marketed and under development by us are subject to regulation under the FD&C Act and numerous acts and amendments such as the Quality System Regulations which replaced the regulations formerly called Good Manufacturing Practices.  In addition, depending upon product type, we must also comply with those regulations governing the Conduct of Human Investigations, Pre-Market Regulations and other requirements, as promulgated by the FDA. The FDA is authorized to inspect a device, its labeling and advertising, and the facilities in which it is manufactured in order to ensure that the device is not manufactured or labeled in a manner which could cause it to be injurious to health.

The FDA has adopted regulations which classify medical devices based upon the degree of regulation believed necessary to assure safety and efficacy. A device is classified as a Class I, II, or III device. Class I devices are subject only to general controls. Class II devices, in addition to general controls, are or will be subject to “performance standards.” Most devices are also subject to the 510(k) pre-market notification provision. In addition, some Class III devices require FDA pre-market approval before they may be marketed commercially because their safety and effectiveness cannot be assured by the general controls and performance standards of Class I or II devices.  Our products are primarily Class I and II devices and several of them have required FDA notification under Section 510(k) of the FD&C Act.

Satisfaction of clearance or approval requirements may take up to several years or more and may vary substantially based upon the type, complexity and novelty of the product.  The effect of government regulation may be to delay marketing of new products for a considerable or indefinite period of time, to impose costly procedures upon our activities and to furnish a competitive advantage to larger companies that compete with us.  We cannot assure you that FDA or other regulatory clearance or approval for any products we develop will be granted on a timely basis, if at all, or, once granted, that clearances or approvals will not be withdrawn or other regulatory action taken which might limit our ability to market our proposed products.  Any delay in obtaining or failure to obtain these clearances or approvals would adversely affect the manufacturing and marketing of our products and the ability to generate additional product revenue.

We Rely To A Significant Degree On Our Proprietary Rights

We rely on a combination of patents, trade secrets, trademarks and non-disclosure agreements to protect our proprietary rights.  We cannot assure you that our patent applications will result in the issuance of patents or that any patents owned by us now or in the future will afford protection against competitors that develop similar technology.  We also cannot assure you that our non-disclosure agreements will provide meaningful protection for our trade secrets or other proprietary information.  Moreover, in the absence of patent protection, our business may be adversely affected by competitors who independently develop substantially equivalent or superior technology.

It is possible that we may need to acquire licenses to, or to contest the validity of, issued or pending patents of third parties relating to our technology or to products presently marketed or under development by us.  In addition, we cannot assure that any license required under any patent would be made available to us on acceptable terms, if at all, or that we would prevail in any patent litigation.


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We Are Party To An Arbitration Proceeding

On May 8, 2007, the Company signed an exclusive distribution agreement (the “Agreement”) with Analogic Corporation (“Analogic”) under which the Company obtained worldwide exclusive rights to market the Analogic Lifegard® family of non-invasive patient monitors. Under the Agreement, Analogic would co-brand the devices and reconfigure its Lifegard II monitor to include the Company’s MAXNIBP branded non-invasive blood pressure and    other branded technologies. Accordingly, the Company would reimburse Analogic approximately $900,000 upon meeting agreed milestone dates for such efforts. As of December 31, 2008, the Company had made payments to Analogic of $90,000.

On November 24, 2008, Analogic commenced arbitration against the Company contending that the Company breached the Agreement.  Analogic is seeking damages of approximately $765,000 for costs it allegedly incurred in performing under the Agreement including winding down costs and additional remedies which may provide for relief totaling double or treble damages, in addition to attorney fees.  The Company denies Analogic’s claims and is asserting a counterclaim for damages in excess of those sought by Analogic. The arbitration hearing is expected to be conducted in the second quarter of 2009.  There can be no assurance as to the ultimate outcome of this proceeding.

During 2008, the Company recorded sales of Analogic products of $2,173,000.

Our Products May Become Rapidly Obsolete

The areas in which we are developing, distributing, and/or licensing products involve rapidly developing technology. Others may develop products that might cause products being developed, distributed or licensed by us to become obsolete or uneconomical or result in products superior to our products.

Our international sales subject us to currency and related risks.  Our international sales accounted for 26% of our total net sales for the 2008 fiscal year.  We expect that international sales will continue to constitute a significant portion of our business.  Although we sell our products in United States dollars and are not subject to significant currency risks, an increase in the value of the United States dollar relative to foreign currencies in our international markets could make our products less price competitive in these markets.

An Acquisition Of The Company May Be Hindered

Our Board of Directors is authorized to issue from time to time, without stockholder authorization, shares of preferred stock, in one or more designated series or classes.  We are also subject to a Delaware statute regulating business combinations.  These provisions could discourage, hinder or preclude an unsolicited acquisition of the Company and could make it less likely that stockholders receive a premium for their shares as a result of any takeover attempt.

Sales Of A Substantial Number Of Shares Of Our Common Stock In The Public Market Originally Issued Through The Exercise Of Options Or Warrants Could Adversely Affect The Market Price Of Our Common Stock And May Also Adversely Affect Our Ability To Raise Additional Capital

As of December 31, 2008, options and warrants for the purchase of 1,654,526 shares of our common stock were outstanding.  Historically, our common stock has been thinly traded.  This low trading volume may have had a significant effect on the market price of our common stock, which may not be indicative of the market price in a more liquid market.
 
 We Depend Highly On Certain Key Management Personnel

We believe that our future success will depend to a significant extent on the efforts and abilities of our senior management, in particular, Andrew Kersey, our President and Chief Executive Officer, and Jeffery Baird, our Chief Financial Officer.  The loss of the services of Messrs. Kersey or Baird could have a material adverse effect on our business and results of operations.


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We Do Not Expect To Pay Cash Dividends

We have not paid cash dividends on our common stock since inception, and at this time we do not anticipate that we will pay cash dividends in the foreseeable future.

Item 1B.  Unresolved Staff Comments

None.

Item 2. Properties

The Company currently leases four separate operating facilities as described in further detail below.

On September 6, 2007, the Company closed the sale and leaseback of its headquarters and manufacturing facility in Branford, Connecticut (the “Property”) which comprises approximately 24,000 square feet of office and manufacturing space.  Net proceeds from the sale were $2,791,529 of which $928,872 was used to retire the related outstanding mortgage debt. The gain of $1,346,373 realized on the sale has been deferred and will be recognized in operations against rent expense over the initial term of the lease. The lease has an initial term of ten years expiring on September 6, 2017 and contains an option for two additional five-year periods. The lease provides for an annual base rent in years one through five of $244,800 and $268,800 in years six through ten. The Company will recognize rent   expense on a straight-line basis over the ten years. Under the lease, the Company is responsible for the costs of  utilities, insurance, taxes and maintenance expenses. Further, the Company is required to maintain at least $600,000 in cash and cash equivalents (increasing at 3% per annum) and net current assets of not less than $3,600,000.

In addition, the Company has a right of first offer to lease any additional space or building built by the lessor on the Property, subject to certain restrictions.  The Company also has the right to require the lessor to build an addition or additional building (“Expansion Premises”), subject to certain restrictions.  Upon the delivery of any Expansion Premises, the term of the Lease would extend for a ten year term. The base rent for the Expansion Premises shall be the greater of the then prevailing market rent or an amount equal to a return on actual costs of construction of the greater of 250 basis points over the rate on ten year U.S. Treasury Notes, or 8%.  Upon delivery of the Expansion Premises, the lessor would assume obligations under the Company’s leases of its two adjacent properties, in exchange for a payment equal to three months rent and certain unamortized costs incurred in these facilities.

The Company is also leasing two properties adjacent to its corporate facilities. Approximately 8,300 square feet of office and limited warehouse space is being leased under an agreement effective June 1, 2006, as amended, and expires on May 31, 2014.  Minimum annual rental expense is approximately $78,000 excluding apportioned real estate taxes and certain utility costs. Approximately 9,600 square feet of office and warehouse space is being leased under an agreement effective July 1, 2007, as amended, and expires June 30, 2015. Minimum annual rental expense is approximately $83,000 excluding apportioned real estate taxes and certain common area maintenance charges.

The Company’s subsidiary, Statcorp, is leasing approximately 17,500 square feet of warehouse and office space under an agreement, as amended, which expires March 31, 2012.  Minimum annual rental expense is approximately $84,000 excluding apportioned real estate taxes and certain common area maintenance charges.

The Company believes that its premises meet its current and expected operating needs and are adequately insured.

Item 3. Legal Proceedings
 
The manufacture and sale of our products exposes us to product liability claims and product recalls, including those which may arise from misuse or malfunction of, or design flaws in, our products or use of our products with components or systems not manufactured or sold by us.  Product liability claims or product recalls, regardless of their ultimate outcome, could require us to spend significant time and money in litigation or to pay significant damages.  We are currently a defendant in a product liability action which is scheduled for trial during mid 2009.  We believe that our product liability insurance is sufficient to cover any damages and costs that are likely with respect to this matter. There can be no assurance however, that this will be the case with respect to any future
 

Page 16
 
matters.  Furthermore, we may not be able to obtain insurance in the future at satisfactory rates or in adequate amounts.
 
In addition, publicity pertaining to the misuse or malfunction of, or design flaws in, our products could impair our ability to successfully market and sell our products and could lead to product recalls.

On May 8, 2007, the Company signed an exclusive distribution agreement (the “Agreement”) with Analogic Corporation (“Analogic”) under which the Company obtained worldwide exclusive rights to market the Analogic Lifegard® family of non-invasive patient monitors. Under the Agreement, Analogic would co-brand the devices and reconfigure its Lifegard II monitor to include the Company’s MAXNIBP branded non-invasive blood pressure and other branded technologies. Accordingly, the Company would reimburse Analogic approximately $900,000 upon meeting agreed milestone dates for such efforts. As of December 31, 2008, the Company had made payments to Analogic of $90,000.

On November 24, 2008, Analogic commenced arbitration against the Company contending that the Company breached the Agreement.  Analogic is seeking damages of approximately $765,000 for costs it allegedly incurred in performing under the Agreement including winding down costs and additional remedies which may provide for relief totaling double or treble damages, in addition to attorney fees.  The Company denies Analogic’s claims and is asserting a counterclaim for damages in excess of those sought by Analogic. The arbitration hearing is expected to be conducted in the second quarter of 2009.  There can be no assurance as to the ultimate outcome of this proceeding.

During 2008, the Company recorded sales of Analogic products of $2,173,000.

In addition, we may become in the normal course of our business operations a party to other legal proceedings in addition to those described in the paragraphs above.  None of these other proceedings would be expected to have a material adverse impact on our results of operations, financial condition, or cash flows.

Item 4. Submission of Matters to a Vote of Security Holders

None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Effective December 2005, the common stock of the Company began trading on the NASDAQ Capital Market, under the symbol “CASM.”  Effective December 2006, the common stock of the Company began trading on the NASDAQ Global Market while continuing to utilize the CASM symbol.

The following table shows the high and low sales prices for the Company’s common stock during each quarterly period for the last two years.

 
Quarter Ended
 
High
   
Low
 
               
 
March 31, 2007
  $ 8.40     $ 6.26  
 
June 30, 2007
  $ 8.51     $ 6.27  
 
September 30, 2007
  $ 7.50     $ 4.25  
 
December 31, 2007
  $ 6.47     $ 4.76  
                   
 
March 31, 2008
  $ 5.54     $ 4.05  
 
June 30, 2008
  $ 4.30     $ 2.81  
 
September 30, 2008
  $ 4.21     $ 2.72  
 
December 31, 2008
  $ 4.00     $ 1.66  


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The following table sets forth the approximate number of holders of record of common stock of the Company on December 31, 2008.

 
Title of Class
Number of Shareholders
     
 
Common stock, $.004 par value
1,862

To date, no cash dividends have been declared on the Company’s common stock.  The Company does not currently intend to pay a cash dividend in the near future.

The Company did not issue any shares of common stock during the fourth quarter of 2008 that were not registered under the Securities Act.  In addition, the Company did not repurchase any of its common stock during the fourth quarter of 2008.

Item 6.  Selected Financial Data

For Year Ended December 31,
 
2008(1)
 
 
2007(1)
   
2006(1)
   
2005(2)
   
2004
 
(amounts in thousands, except per
                             
  share amounts)
                             
Net sales
  $ 40,649     $ 38,232     $ 35,202     $ 26,884     $ 20,059  
Cost of sales
    26,748       24,585       20,803       15,092       11,056  
Gross profit
    13,901       13,647       14,399       11,792       9,003  
Operating expenses:
                                       
   Research and development
  $ 2,028     $ 2,254     $ 2,762     $ 1,631     $ 1,033  
   Selling, general and administrative
    12,165       10,815       8,659       7,438       6,263  
   Total operating expenses
    14,193       13,069       11,421       9,069       7,296  
Operating (loss) income
    (291 )     579       2,978       2,723       1,707  
(Loss) income before income taxes
    (564 )     304       2,730       2,556       1,635  
Net (loss) income
    (388 )     306       1,747       1,815       1,205  
Net (loss) income per
                                       
    diluted common share
  $ (0.04 )   $ 0.03     $ 0.14     $ 0.15     $ 0.11  
Diluted shares outstanding
    11,032       12,212       12,147       11,729       11,128  
                                         
At Year End:
                                       
Working capital
  $ 10,819     $ 10,388     $ 9,096     $ 7,482     $ 5,369  
Long-term debt, less current portion
    1,708       2,323       3,807       4,416       1,035  
Total assets
    23,685       23,888       21,443       17,918       10,993  
Stockholder’s equity
  $ 14,900     $ 13,751     $ 12,625     $ 9,117     $ 7,156  


(1)  
Operating income reduced by $410, $303 and $390 for 2008, 2007 and 2006, respectively, from stock compensation expense. The Company adopted FAS 123R – Share-Based Payment, as of January 1, 2006.
(2)
2005 operating income includes $401 credit from curtailment gain of post-retirement benefit plan.
2005 reflects the acquisition of Statcorp, Inc. on May 15, 2005.
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

Certain statements included in this report, including without limitation statements in the Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are not historical facts, are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent the Company’s current expectations regarding future events. The Company cautions that such statements are qualified by important factors that could cause actual results to differ materially from expected results which may be contained in the forward-looking statements. All forward-looking statements involve risks and uncertainties, including, but not limited to, the following:  potential liquidity constraints; price and product competition; rapid technological changes; dependence on new product development; failure to introduce new products effectively or on a timely basis; the mix of products
 

Page 18

sold; supply and prices of raw materials and products; customer demand for the Company’s products; regulatory actions; changes in reimbursement levels from third-party payors; product liability or other litigation claims; changes in economic conditions that adversely affect the level of demand for the Company’s products; changes in foreign exchange markets; changes in financial markets; changes in the competitive environment; and other risks described in Item 1A of this filing.

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

The Company recorded a net loss of $388,000 for 2008 or ($0.04) per basic and diluted common share compared to net income of $306,000 or $0.03 per diluted common share for 2007. Pre-tax (loss) income for 2008 and 2007 were affected by $410,000 and $303,000, respectively, of stock compensation expense.

The operating loss for 2008 was $291,000 or 0.7% of net sales compared to operating income of $579,000 or 1.5% of net sales for 2007. Several key factors contributed to the decrease in operating income during 2008. Cost of sales as a percentage of sales increased to 65.8% from 64.3% for 2007 primarily as a result of higher costs in the first quarter of 2008. Lower than expected sales during that period combined with fixed manufacturing costs resulted in a 70.1% cost of sales percentage during the first quarter. Operating expenses for 2008 increased $1,124,000 or 9% to reach $14,193,000 or 34.9% of net sales from $13,069,000 or 34.2% of net sales for 2007. Sales and marketing expenses related to the cerebral oximetry market reached $3,094,000 in 2008, an increase of $1,355,000 over 2007 spending levels.

The following table provides comparative results of net sales by product and geographic category:

   
Year Ended
   
Year Ended
   
Increase
 
     (amounts in thousands)
 
December 31, 2008
   
December 31, 2007
   
(Decrease)
 
                   
      Bedside Monitoring
  $ 15,889     $ 18,640     $ (2,751 )
      Critical Care Monitoring
    2,258       315       1,943  
      Blood Pressure Measurement Technology
    7,769       5,825       1,944  
      Supplies/Service
    14,733       13,452       1,281  
    $ 40,649     $ 38,232     $ 2,417  
                         
      Domestic Sales
  $ 30,032     $ 29,601     $ 431  
      International Sales
    10,617       8,631       1,986  
    $ 40,649     $ 38,232     $ 2,417  

Net sales for 2008 increased 6% or $2,417,000 to $40,649,000 from $38,232,000 for 2007. Bedside monitoring sales decreased $2,751,000 or 15% from 2007 primarily due to lower sales levels of vital signs monitors and accessories sold to the Veterans Administration and lower sales of veterinary products sold under a private label agreement. Approximately $311,000 of the veterinary sales are classified as of 2008 as blood pressure measurement technology sales. Increased sales of Analogic products marketed by the Company since May 2007 partially offset reductions in vital signs products sales. Critical care monitoring sales increased $1,943,000 to $2,258,000 and represent the Company’s Fore-Sight cerebral oximetry technology launched during mid-2007.  Net sales in this category are primarily sensor related (72% for 2008).  In certain U.S. markets, the Company routinely places the monitor and retains ownership of the device in exchange for commitments to purchase disposable sensors. During 2008, the Company placed or sold approximately 116 monitors with customers bringing the installed base of Fore-Sight monitors worldwide to 151 as of the end of 2008. Blood pressure measurement technology sales increased $1,944,000 or 33% due to a rebound of sales to a key customer, Medtronic. 2007 sales to Medtronic were affected by a voluntary suspension of U.S. product shipments from its Physio-Control division announced during January 2007. Sales of supplies and service increased $1,281,000 or 10% over 2007 sales and are primarily comprised of sales of blood pressure cuffs accounting for approximately 71% of sales in this category. Sales to the U.S. market accounted for $30,032,000 or 74% of the total net sales reported for 2008, an increase of $431,000 or 1% over the $29,601,000 reported for 2007. International sales accounted for $10,617,000 or 26% of total net sales, an increase of $1,986,000 or 23% over 2007 sales levels. The growth in international sales was led by sales of Analogic products and blood pressure cuff sales.


Page 19

Cost of sales as a percentage of net sales increased to 65.8% for 2008 compared to 64.3% of net sales for 2007. The increase in cost of sales as a percentage of sales for 2008 was primarily related to the first quarter of 2008 where lower than expected sales combined with fixed manufacturing costs. The Company is focusing its efforts during 2009 to achieve cost reductions to improve overall gross profit levels.

R&D expenses decreased $226,000 or 10% to $2,028,000 for 2008 from $2,254,000 for 2007. R&D expenses are reported net of reimbursements received from the National Institutes of Health (“NIH”) pertaining to the Company’s development of its Near-Infrared Spectroscopy (“NIRS”) technology. Amounts reimbursed from the NIH, including accruals, for 2008 and 2007 were $582,000 and $480,000, respectively. Increased reimbursements for 2008 reflect the fact that during September 2007 the Company was awarded a three year grant totaling approximately $2,800,000 to support its NIRS research. R&D expenses before NIH reimbursement approximated 6.4% and 7.2%, respectively, of 2008 and 2007 revenues.

Selling, general and administrative (“S,G&A”) expenses increased $1,350,000 or 12.5% to $12,165,000 or 29.9% of net sales for 2008 from $10,815,000 or 28.3% of net sales for 2007. Sales and marketing expenses in 2008 pertaining to the Company’s Fore-Sight cerebral oximeter were approximately $3,094,000 and accounted for 100% of the overall increase in S,G&A spending. Increased manufacturers representative commission expenses from increased sales, salaries and related benefits from expanded direct sales personnel costs, travel and entertainment and depreciation expenses were primarily responsible for the increase in the cerebral oximetry related expenses. General and administrative (“G&A”) expenses increased by $219,000 or 5.9% as a result of increases in salaries and related benefits and legal and accounting expenses which were partially offset by reductions in Sarbanes Oxley section 404  compliance costs, investor relations fees and company-wide incentive payouts. Together, the G&A expenses were offset by reductions in non-cerebral oximetry related marketing costs and decreased international sales support expenses.

Net interest expense decreased $3,000 to $272,000 for 2008 from $275,000 for 2007 as a result of reduced balances on the Company’s long-term debt loan. Higher average balances on the line-of-credit facility for 2008 were offset by reduced costs of borrowed funds.

The income tax benefit for 2008 was $176,000 compared to a benefit of $3,000 for 2007. The benefit for 2008 is related to taxable losses and federal R&D related tax credits.  The benefit for 2007 is primarily related to an exchange of $155,000 of state tax carry-forwards for reduced cash receipts payable to the Company partially offset by certain non-deductible expenses including stock option compensation and entertainment costs.

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net income for 2007 was $306,000 or $0.03 per common share on a diluted basis compared to $1,747,000 or $0.14 per diluted common share for 2006. Pre-tax income for 2007 and 2006 were affected by $303,000 and $390,000, respectively, of stock compensation expense of which $98,000 and $343,000, respectively, was non-deductible for income tax purposes.

Operating income for 2007 was $579,000 or $1.5% of  sales compared to $2,978,000 or 8.5% of  sales for 2006. Several key factors contributed to the decrease in operating income levels during 2007 including significant investments in the cerebral oximetry market particularly in the areas sales and marketing expenditures which increased approximately $1,300,000 over 2006 spending levels; product mix issues largely caused by reduced OEM sales which normally carry higher than average gross margin rates and international sales of Analogic products; increased manufacturing overhead costs including Fore-Sight cerebral oximetry start-up costs; and Sarbanes Oxley 404 internal control consulting fees of approximately $164,000. The Company generated sales of $38,232,000 for 2007, an increase of $3,030,000 or 8.6% over sales of $35,202,000 for 2006.  The following table provides comparative results by product and geographic category:

   
Year Ended
   
Year Ended
   
Increase
 
      (amounts in thousands)
 
December 31, 2007
   
December 31, 2006
   
(Decrease)
 
                   
      Bedside Monitoring
  $ 18,640     $ 16,071     $ 2,569  
      Critical Care Monitoring
    315             315  
      Blood Pressure Measurement Technology
    5,825       6,571       (746 )
 

Page 20
 
                       
                         
      Supplies/Service
    13,452       12,560       892  
    $ 38,232     $ 35,202     $ 3,030  
                         
      Domestic Sales
    29,601       27,519       2,082  
      International Sales
    8,631       7,683       948  
    $ 38,232     $ 35,202     $ 3,030  

Sales for 2007 increased 8.6% or $3,030,000 to $38,232,000 from $35,202,000 for 2006. Bedside monitoring sales increased $2,569,000 or 16% over 2006 led by vital signs monitoring and accessories sales primarily sold to the VA and sales of Analogic products marketed by the Company since May 2007, partially offset by reductions in apnea monitoring products sales. Critical care monitoring sales represent the Company’s Fore-Sight cerebral oximetry technology launched during mid-2007.   Sales in this category are primarily sensor related where the Company places the monitor and retains ownership of the device in exchange for commitments to purchase disposable sensors. Blood pressure measurement technology sales decreased $746,000 or 11% due to reductions in sales to a key customer, Medtronic. During January 2007, Medtronic announced a voluntary suspension of U.S. product shipments from its Physio-Control division. Despite strong fourth quarter sales which exceeded the prior year fourth quarter, overall sales to Medtronic for 2007 decreased $1,510,000 as compared to 2006. Medtronic represented approximately 11% of the Company’s sales for the full year 2006. Sales of supplies and service increased $892,000 or 7% over 2006 sales and are primarily comprised of sales of blood pressure cuffs accounting for approximately 71% of sales in this category. Sales to the U.S. market accounted for $29,601,000 or 77% of the total sales for 2007, an increase of $2,082,000 or 8% over the $27,519,000 reported for 2006. International sales accounted for $8,631,000 or 23% of total revenues, an increase of $948,000 or 12% over 2006 sales levels.

Cost of sales as a percentage of net sales increased to 64.3% for 2007 compared to 59.1% of net sales for 2006. The increase in cost of sales as a percentage of sales for 2007 was related to a number of causes including lost gross margins on the shortfall in OEM  sales which normally carries higher gross margins than other products sold by the Company; lower margins on Analogic product sales particularly in the fourth quarter of 2007 primarily as a result of additional international business; NIRS manufacturing start-up costs; increased indirect manufacturing overhead costs to support the Company’s expanded operations; and reductions in accrued post-retirement benefit costs during  2006 for changes made to terminate the Company’s plan during 2005.

R&D expenses decreased $508,000 or 18% to $2,254,000 for 2007 from $2,762,000 for 2006. R&D expenses are reported net of reimbursements received from the National Institutes of Health (“NIH”) pertaining to the Company’s development of its Near-Infrared Spectroscopy (“NIRS”) technology. Amounts reimbursed from the NIH, including accruals, for 2007 and 2006 were $480,000 and $21,000, respectively. Increased reimbursements for 2007 reflect the fact that during September 2007 the Company was awarded a three year grant totaling approximately $2,800,000 million to support its NIRS research. R&D expenses before NIH reimbursement approximated 7.2% and 7.9%, respectively, of 2007 and 2006 revenues. Increased NIH reimbursements offset increases in project material costs, clinical evaluations and salaries and related fringe benefits.

Selling, general and administrative (“S,G&A”) expenses increased $2,156,000 or 25% to $10,815,000 or 28% of  sales for 2007 from $8,659,000 or 25% of  sales for 2006. Sales and marketing expenses in 2007 pertaining to the Company’s Fore-Sight cerebral oximeter were approximately $1,800,000 and accounted for nearly $1,300,000 or 60% of the increase in S,G&A spending. The Company also increased its investments in personnel in the areas of marketing, customer service, international sales consultants and domestic sales management in order to support   the Company’s growth.   Additionally, increases in general insurance costs, amortization and depreciation, and employee health care costs also impacted S,G&A expenses.  During 2007, the Company also incurred $164,000 in consulting fees pertaining to its Sarbanes Oxley 404 compliance efforts.
 
Net interest expense increased $27,000 to $275,000 for 2007 from $248,000 for 2006 as a result of borrowings on the line-of-credit facility partially offset by reductions in interest expenses associated with lower balances on the Company’s Statcorp acquisition loan and the payoff of the mortgage on the Company’s headquarters facility.

The income tax benefit for 2007 was $3,000 compared to income tax expense of $983,000 for 2006. The benefit for 2007 was primarily related to an exchange of $155,000 of state tax carry-forwards for reduced cash receipts payable to the Company partially offset by certain non-deductible expenses including stock option compensation and entertainment costs. The provision for income taxes for 2006 represented an effective tax rate of 36% which was
 

Page 21

greater than the statutory rate primarily as a result of non-deductible stock compensation expense and state income taxes partially offset by R&D and other tax credits. The income tax benefit for 2007 represented an effective tax rate of approximately 1% resulting primarily from R&D and other tax credits.
 
Financial Condition, Liquidity and Capital Resources

The Company’s cash and cash equivalents were $1,083,000 at December 31, 2008 compared to $667,000 at December 31, 2007. Working capital increased $431,000 to $10,819,000 at December 31, 2008 from $10,388,000 at December 31, 2007. The Company’s current ratio increased slightly to 2.88 to 1 from 2.63 to 1.

Net cash provided by operating activities for 2008 was $1,660,000 compared to cash used of $3,178,000 for the prior year.  The improvement was primarily due to decreases in accounts receivable and inventories which were partially offset by decreases in accounts payable and accrued expenses and the increase in an other receivable related to the transfer of raw material inventories to one of the Company’s primary vendors under a turn-key agreement initiated during the fourth quarter of 2008.
 
Net cash used by investing activities was $1,466,000 for 2008 compared to cash provided of $1,124,000 for 2007. During September 2007, the Company realized proceeds of $2,792,000 from the sale of its headquarters.  The Company incurred $1,413,000 of capital expenditures during 2008 compared to $1,188,000 for 2007. Equipment      purchases during 2008 were driven by Fore-Sight cerebral oximeter demonstration equipment and clinical research units, information technology, manufacturing equipment and furniture and fixtures and leasehold improvements pertaining to the Company’s expansion of its adjacent facilities. Cash used for investing activities in 2007 included $1,188,000 for manufacturing equipment, leasehold improvements commensurate with the expansion of the Company’s adjacent leased space, engineering equipment and enhancements to the Company’s IT infrastructure.  During 2008, the Company incurred $184,000 of expenditures to purchase intangible assets including $60,000 related to deferred finance charges and $70,000 pertaining to patents and trademarks. Current year additions reflect an adjustment of a prior year accrual of $131,000.

Net cash provided by financing activities was $222,000 for 2008 compared to $1,387,000 for 2007. During May of 2008, the Company consummated a private placement of 333,333 shares of its common stock for an aggregate sum of $1,000,000. The Company repaid $577,000 of long-term debt during 2008 and reduced its line-of-credit balance by $255,000 at December 31, 2008. During 2007, the Company received advances under the line-of-credit of $2,250,000 and repaid $1,516,000 of long-term debt which included the retirement of its mortgage debt of $929,000 upon the sale and leaseback of its headquarters.

The Company currently leases four facilities and certain equipment under non-cancelable operating leases. The following table sets forth a summary of the Company’s cash commitments under contractual obligations as of December 31, 2008:

Contractual
 
 
   
One Year
   
2 – 4
   
 5 – 7
   
More Than
 
Obligations
 
Total
   
or Less
   
Years
   
Years
   
Seven Years
 
                                   
Long-term debt
  $ 2,322,560     $ 614,067     $ 1,708,493     $     $  
Operating leases
    3,379,000       472,235       1,289,557       1,169,208       448,000  
    $ 5,701,560     $ 1,086,302     $ 2,998,050     $ 1,169,208     $ 448,000  
 
On February 11, 2008, the Company amended and restated its existing line of credit with NewAlliance Bank (the “Bank”).  The Company entered into a new Commercial Loan Agreement (the “Loan Agreement”) and related Commercial Revolving Promissory Note (the “Note”) which provide for borrowings on a revolving basis, at the Bank’s discretion, in an amount up to $10,000,000.  Loans in excess of $2,000,000 up to $10,000,000 can be made only if the maximum principal amount outstanding does not exceed a borrowing base equal to the sum of (i) 75% of eligible receivables (as defined in the Loan Agreement) and (ii) the lesser of $2,500,000 or 30% of eligible inventory (as defined in the Loan Agreement.)  Borrowings under the Loan Agreement and the Note are secured by a first priority lien in all the business assets of the Company pursuant to a Security Agreement (the “Security Agreement”).  The Loan Agreement contains customary non-financial covenants and financial covenants consisting of a debt service coverage ratio and a debt to tangible net worth ratio.
 

Page 22

On December 31, 2008, the Company amended the line of credit pursuant to a Debt Modification Agreement (the “Modification Agreement”). The Modification Agreement amended the Loan Agreement and related Note. The Modification Agreement extends the maturity date of the Note to July 1, 2010 and also amends the interest rate for the revolving loans under the Credit Agreement by increasing the rate from (i) the Prime Rate (as defined in the Loan Agreement) minus .50% to (ii) the Bank’s Base Rate (as defined in the Modification Agreement) with a minimum interest rate of 3.25% per annum. The Modification Agreement also amended the existing debt service coverage ratio covenant to provide that it would be measured quarterly on a rolling four quarter basis beginning December 31, 2008.

The Company executed an amendment to the line of credit agreement on April 3, 2009 pursuant to a Second Modification Agreement with the Bank effective March 31, 2009. Under the terms of the Second Modification Agreement, the debt service coverage ratio was revised from a quarterly test to an annual test for the twelve months ended December 31, 2009 and the minimum ratio revised from 1.5 to 1.0. As of the first quarter of 2010 and thereafter, the ratio returns to 1.5 with testing resumed on a quarterly basis. The maximum availability under the line of credit was reduced to $5,000,000 from $10,000,000. Further, the interest rate was modified from the Bank’s Base Rate with a floor of 3.25% to the Bank’s Base Rate plus 1.0% with a floor rate of 4.0%.

The Company believes that its sources of funds consisting of cash and cash equivalents, cash flow from operations and funds available from the revolving credit facility will be sufficient to meet its current and expected short-term requirements.  However, future cash flows may be impacted by a number of factors, including changing market conditions or failure to meet financial covenants under our current or any future loan agreement.  Changes in payment terms to one or more major suppliers could also have a material adverse effect on our results of operations and future liquidity.  We believe that our current levels of working capital and available debt financing are insufficient to fund major growth initiatives, such as significant increases in our sales and marketing personnel, or material acquisitions. Any major growth initiatives would require us to seek other sources or forms of debt or equity capital. There can be no assurance that we will be successful in securing such funding for major initiatives. There can be no assurance that we will be successful in obtaining a new credit agreement or that we would be successful in securing additional sources or forms of capital for major initiatives.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than operating leases for office and warehouse space.

Critical Accounting Policies

The Company’s financial statements have been prepared in accordance with generally accepted accounting principles in the United States. In preparing the financial statements, the Company is required to make estimation judgments. Such judgments are based upon historical experience and certain assumptions that are believed to be reasonable in the particular circumstances. Those judgments affect both balance sheet and income statement accounts and disclosures. The Company evaluates its assumptions on an ongoing basis by comparing actual results with its estimates. Actual results may differ from the original estimates. The following accounting policies are those that the Company believes to be most critical to the preparation of its financial statements.

Inventory Valuation–The Company’s inventories are stated at the lower of cost or market. The Company provides allowances on inventories for any material that has become obsolete or may become unsalable based on estimates of future demand and the sale price in the market. Judgments with respect to salability and usage of inventories, estimated market value, and recoverability upon sale are complex and subjective.  Such assumptions are reviewed periodically and adjustments are made, as necessary, to reflect changed conditions.  There were no significant write-offs for any period presented.

Deferred Income Tax Assets–The Company has recorded deferred income tax assets for the estimated benefit of future tax deductions on inventories, property and equipment and other accruals and various tax credits.  Based on the Company’s projection of future taxable income and certain prudent tax planning strategies, management believes its deferred income tax assets will be realized.  Should circumstances change and the Company determine that some or all of the deferred income tax assets would not be realized, a valuation allowance would be recorded resulting in a charge to operations in the period the determination is made.


Page 23

Accrued Warranty Costs–The Company warranties its products for up to three years and records the estimated cost of such product warranties at the time the sale is recorded. Estimated warranty costs are based upon actual past experience of product returns and the related estimated cost of labor and material to make the necessary repairs. Warranty costs have not been material to operating results over the past several years.  However, if actual future product return rates or the actual costs of material and labor differ from the estimates, adjustments to the accrued warranty liability would be made.

Recent Accounting Pronouncements

Recent accounting pronouncements potentially affecting the Company’s future financial statements are described under the caption, “New accounting pronouncements” in Note 2 – Summary of Significant Accounting Policies. There are no new pronouncements which are likely to materially impact the Company’s financial statements.

Item 7A.  Quantitative and Qualitative Disclosures about Market Risk

The Company has certain exposures to market risk related to changes in interest rates.  The Company has an outstanding line-of-credit agreement, under which there were borrowings of $1,994,000 at December 31, 2008.  The line-of-credit agreement, amended effective March 31, 2009, bears interest at variable rates based on prime rate indices. The Company holds no derivative securities for trading purposes and is not subject in any material respect to currency or other commodity risk.

Item 8.  Financial Statements and Supplementary Data
Page
   
Report of Independent Registered Public Accounting Firm
F-1
   
Financial Statements
 
   
Consolidated Balance Sheets as of December 31, 2008 and 2007
F-2
   
Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007 and 2006
F-3
   
   
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2008, 2007 and 2006
F-4
   
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006
F-5
   
Notes to Consolidated Financial Statements
F-6 to F-18

 

 

F-1



Report of Independent Registered Public Accounting Firm


Shareholders and Board of Directors
CAS Medical Systems, Inc:


We have audited the accompanying consolidated balance sheets of CAS Medical Systems, Inc. (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years  in the three-year period ended December 31, 2008.  The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of the Company’s internal control over financial reporting.  An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the each of the years in the three-year period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America.

 As discussed in Note 2, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109, effective January 1, 2007.


/s/ UHY LLP


New Haven, Connecticut
April 3, 2009



 

 

F-2
CAS MEDICAL SYSTEMS, INC.
Consolidated Balance Sheets
As of December 31, 2008 and 2007

ASSETS
 
2008
   
2007
 
             
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 1,082,619     $ 666,722  
Accounts receivable, less allowance of $150,000 in 2008
         
and $125,000 in 2007
    3,681,355       4,947,300  
Recoverable income taxes
    101,185       230,458  
Other receivable
    715,769        
Inventories
    9,786,538       10,021,118  
Deferred income taxes
    791,493       474,265  
Other current assets
    411,938       414,204  
Total current assets
    16,570,897       16,754,067  
                 
PROPERTY AND EQUIPMENT:
               
Leasehold improvements
    281,612       266,493  
Equipment at customers
    1,132,422       272,360  
Machinery and equipment
    5,326,735       4,788,902  
      6,740,769       5,327,755  
Accumulated depreciation and amortization
    (4,013,900 )     (2,987,030 )
Property and equipment, net
    2,726,869       2,340,725  
                 
INTANGIBLE AND OTHER ASSETS, net
    757,378       846,602  
                 
GOODWILL
    3,379,021       3,379,021  
                 
DEFERRED INCOME TAXES
    250,370       567,971  
                 
Total assets
  $ 23,684,535     $ 23,888,386  

LIABILITIES AND SHAREHOLDERS’ EQUITY
           
             
CURRENT LIABILITIES:
           
Current portion of long-term debt
  $ 614,067     $ 577,453  
Notes payable
          71,537  
Line-of-credit
    1,994,008       2,249,349  
Accounts payable
    2,307,675       2,505,460  
Accrued expenses
    835,868       962,154  
Total current liabilities
    5,751,618       6,365,953  
                 
LONG-TERM DEBT, less current portion
    1,708,493       2,322,561  
                 
DEFERRED GAIN ON SALE AND LEASEBACK OF PROPERTY
    1,168,701       1,303,338  
                 
INCOME TAXES PAYABLE
    155,875       145,125  
                 
COMMITMENTS  (Note 11)
           
                 
SHAREHOLDERS’ EQUITY:
               
Series A cumulative convertible preferred stock, $.001 par value per share,
               
1,000,000 shares authorized, no shares issued or outstanding
           
Common stock, $.004 par value per share, 40,000,000 shares authorized,
               
11,419,535 and 10,984,785 shares issued as of December 31, 2008
               
and 2007, respectively, including shares held in treasury
    45,675       43,575  
Common stock held in treasury, at cost – 86,000 shares
    (101,480 )     (101,480 )
Additional paid-in capital
    7,423,340       5,889,007  
Retained earnings
    7,532,313       7,920,307  
Total shareholders’ equity
    14,899,848       13,751,409  
                 
Total liabilities and shareholders’ equity
  $ 23,684,535     $ 23,888,386  

See accompanying notes.
 

F-3
CAS MEDICAL SYSTEMS, INC.

Consolidated Statements of Operations
For the Years Ended December 31, 2008, 2007 and 2006
   
2008
   
2007
   
2006
 
                   
                   
NET SALES
  $ 40,649,057     $ 38,232,405     $ 35,202,011  
                         
COST OF SALES
    26,747,590       24,584,807       20,802,677  
Gross profit
    13,901,467       13,647,598       14,399,334  
                         
OPERATING EXPENSES:
                       
Research and development
    2,027,747       2,253,512       2,762,269  
Selling, general and administrative
    12,164,974       10,815,248       8,658,812  
                         
           Total operating expenses
    14,192,721       13,068,760       11,421,081  
                         
OPERATING (LOSS) INCOME
    (291,254 )     578,838       2,978,253  
                         
Interest expense, net
    272,471       274,977        248,404  
                         
 (LOSS) INCOME BEFORE INCOME TAXES
    (563,725 )     303,861       2,729,849  
                         
Income taxes (benefit)
     (175,731 )      (2,599 )     983,148  
                         
NET (LOSS) INCOME
  $ (387,994 )   $ 306,460     $ 1,746,701  
                         
                         
NET (LOSS) INCOME  PER COMMON SHARE:
                       
Basic
  $ (0.04 )   $ 0.03     $ 0.17  
                         
Diluted
  $ (0.04 )   $ 0.03     $ 0.14  
                         
WEIGHTED AVERAGE NUMBER OF COMMON
                       
SHARES OUTSTANDING:
                       
      Basic
    11,031,855       10,696,217        10,373,225  
                         
      Diluted
    11,031,855       12,211,694        12,147,373  


See accompanying notes.

 

F-4
CAS MEDICAL SYSTEMS, INC.
Consolidated Statements of Changes in Shareholders’ Equity
For the Years Ended December 31, 2008, 2007 and 2006
   
Common Stock
                   
   
Issued
   
Held in Treasury
   
Paid-in
   
Retained
       
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Earnings
   
Total
 
                                           
BALANCE, December 31, 2005
    10,113,860     $ 40,456       86,000     $ (101,480 )   $ 3,176,911     $ 6,001,521     $ 9,117,408  
Net income
                                            1,746,701       1,746,701  
Common stock issued upon exercise of stock options and warrants
    493,425       1,973                       401,349               403,322  
Common stock issued under stock purchase plan
    25,022       100                       101,341               101,441  
Tax benefit from exercise of warrants
                                    865,842               865,842  
Restricted stock issued under equity incentive plans
    47,000       188                       (188 )             -  
Stock compensation
 
 
   
 
   
 
   
 
      390,283    
 
      390,283  
BALANCE, December 31, 2006
    10,679,307       42,717       86,000       (101,480 )     4,935,538       7,748,222       12,624,997  
Adoption of FIN 48
                                            (134,375 )     (134,375 )
Net income
                                            306,460       306,460  
Common stock issued upon exercise of stock options and warrants
    192,824       771                       116,391               117,162  
Common stock issued under stock purchase plan
    21,654       87                       114,543               114,630  
Tax benefit from exercise of warrants
                                    419,399               419,399  
Restricted stock issued under equity incentive plans
    91,000                                            
Stock compensation
 
 
   
 
   
 
   
 
      303,136    
 
      303,136  
BALANCE, December 31, 2007
    10,984,785       43,575       86,000       (101,480 )     5,889,007       7,920,307       13,751,409  
Net loss
                                            (387,994 )     (387,994 )
Common stock issued upon exercise of stock options and warrants
    29,300       118                       40,847               40,965  
Common stock issued under stock purchase plan
    26,417       106                       99,690               99,796  
Private placement
    333,333       1,333                       998,667               1,000,000  
Tax benefit from exercise of warrants
                                    (14,730 )             (14,730 )
Restricted stock issued under equity incentive plans, net of cancellations
    45,700       543                       (543 )              
Stock compensation
 
 
   
 
   
 
   
 
      410,402    
 
      410,402  
BALANCE, December 31, 2008
    11,419,535     $ 45,675       86,000     $ (101,480 )   $ 7,423,340     $ 7,532,313     $ 14,899,848  
 
See accompanying notes.

 
 

 
F-5
 
CAS MEDICAL SYSTEMS, INC.>
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2008, 2007 and 2006

   
2008
   
2007
   
2006
 
OPERATING ACTIVITIES:
                 
Net (loss) income
  $ (387,994 )   $ 306,460     $ 1,746,701  
Adjustments to reconcile net (loss) income to net cash
                       
provided (used) by operating activities:
                       
Depreciation and amortization
    1,169,335       816,286       516,150  
Deferred income taxes
    373       (537,167 )     37,813  
Provision for doubtful accounts
    25,000       50,000        
Stock compensation
    410,402       303,136       390,283  
Amortization of gain on sale and leaseback
    (134,637 )     (43,035 )      
Changes in operating assets and liabilities:
                       
Accounts receivable
    1,240,945       (90,997 )     (1,687,340 )
Other receivable
    (715,769 )            
Recoverable income taxes
    129,273       90,485       (320,943 )
Inventories
    234,580       (3,212,925 )     (1,215,386 )
Other current assets
    2,266       (6,033 )     86,011  
Accounts payable and accrued expenses
    (324,071 )     (865,377 )     1,097,560  
Income taxes payable
    10,750       10,750       (18,999 )
Retirement benefit obligation
                (349,567 )
                         
Net cash provided (used) by operating activities
    1,660,453       (3,178,417 )     282,283  
                         
INVESTING ACTIVITIES:
                       
Purchases of intangible assets
    (53,241 )     (479,543 )     (157,561 )
Proceeds from sale of property
          2,791,529        
Contingent consideration for business purchased
                (300,000 )
Purchases of property and equipment
    (1,413,014 )     (1,188,030 )     (1,042,143 )
                         
Net cash (used) provided by investing activities
    (1,466,255 )     1,123,956       (1,499,704 )
                         
FINANCING ACTIVITIES:
                       
Borrowings under notes payable
    298,704       410,639       312,182  
Repayments of notes payable
    (370,241 )     (408,343 )     (449,300 )
(Repayments) borrowings under line-of-credit, net
    (255,341 )     2,249,349        
Repayments of long-term debt
    (577,454 )     (1,516,188 )     (574,115 )
Tax benefit (reversal) from exercise of warrants
    (14,730 )     419,399       865,842  
Proceeds from issuance of common stock
    1,140,761       231,792       504,763  
                         
Net cash provided by financing activities
    221,699       1,386,648       659,372  
                         
Net change in cash and cash equivalents
    415,897       (667,813 )     (558,049 )
                         
Cash and cash equivalents, beginning of year
    666,722       1,334,535       1,892,584  
CASH AND CASH EQUIVALENTS, END OF YEAR
  $ 1,082,619     $ 666,722     $ 1,334,535  
                         
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
                       
INFORMATION:
                       
Cash paid during the year for interest
  $ 282,056     $ 263,732     $ 247,663  
Cash (collected) paid during the year for income taxes, net
  $ (301,398 )   $ 13,934     $ 417,710  

See accompanying notes.
 

F-6

CAS MEDICAL SYSTEMS, INC.

Notes to Consolidated Financial Statements

(1) 
THE COMPANY

CAS Medical Systems, Inc. (“CASMED”) and its wholly-owned subsidiary, Statcorp, Inc. (“Statcorp”) operate as one reportable business segment. Together, CASMED and Statcorp (the “Company”) develop, manufacture and distribute diagnostic equipment and medical products for use in the healthcare and medical industry. These products are sold by the Company through its own sales force, via distributors and manufacturers representatives under contract, and pursuant to original equipment manufacturer (“OEM”) agreements both internationally and in the United States. The Company’s operations and manufacturing facilities are located in the United States. During 2008 and 2006, one customer accounted for approximately 12% and 11%, respectively, of net sales. No customer accounted for more than 10% of net sales during 2007. The Company generated  international sales of approximately $10.6 million in 2008, $8.6 million in 2007, and $7.7 million in 2006.  In the normal course of business, the Company grants credit to customers and does not require collateral.  Credit losses are provided for in the period the related sales are recognized based on experience and an evaluation of the likelihood of collection.  Credit losses have been within management’s expectations.

(2) 
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period.  Estimates that are particularly sensitive to change in the near-term are the inventory valuation allowances, capitalized software development costs, allowance for doubtful accounts and warranty accrual. Actual results could differ from those estimates.

Principles of consolidation

The consolidated financial statements include the accounts of CASMED and its wholly-owned subsidiary. All intercompany accounts and transactions are eliminated in consolidation.

Cash and cash equivalents

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.  The Company has deposits in a limited number of financial institutions with federally insured limits. Cash (including cash equivalents) at these institutions is normally in excess of the insured limits.  However, the Company believes that the institutions are financially sound and there is only nominal risk of loss.

Inventories

Inventories are stated at the lower of cost, determined by the first-in, first-out method, or market.

Property and equipment

Property and equipment, including leasehold improvements, are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets, which range from two to five years for machinery and equipment, and twenty years for building and improvements.  Leasehold improvements are amortized over the life of the improvement or the lease term, whichever is shorter.  Maintenance and repairs are charged to expense when incurred.


F-7

The Company has separately reported its FORE-SIGHT cerebral oximetry monitors located at customer sites within the U.S.  Such equipment is held under a no cost program whereby customers purchase disposable sensors for use with the Company’s equipment.  The Company retains title to the monitors shipped to its customers under this program. The monitors are depreciated on a straight-line basis over five years to cost of sales.  As of December 31, 2008, the Company has capitalized $1,132,422 of costs pertaining to the monitors which have a net book value of $905,854.

Depreciation and amortization expense on property and equipment was $1,026,870 in 2008, $750,411 in 2007, and $455,755 in 2006.

Long-lived assets

The Company reviews its long-lived assets including goodwill for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company believes that the carrying amounts of its long-lived assets are fully recoverable. Accordingly, no impairment loss has been reflected in the Company’s reported results of operations for any year presented.

Intangible and other assets
 
Intangible and other assets at December 31, 2008 and 2007 consist of:
 
   
2008
   
2007
           
Patents and other assets
  $ 628,273     $ 555,446  
Patents pending
    204,510       161,249  
Purchased technology
    123,893       254,393  
Capitalized software
    177,813       170,063  
Deferred finance charges
    71,938       12,035  
      1,206,427       1,153,186  
Accumulated amortization
    (449,049 )     (306,584 )
    $ 757,378     $