Medical Device Daily Associate

Cardiac Science (Irvine, California), a maker of automatic public-access automated external defibrillators (AEDs), reported earlier this week that it plans to merge with cardiology product maker Quinton Cardiology Systems (Bothell, Washington) in order to better leverage distribution and marketing operations.

Under the agreement, each share of Cardiac Science will be exchanged for 0.10 of a share in the combined company; each Quinton share will be worth 0.77 of a share. Cardiac Science's shareholders, together with senior note holders, will own about 51% of the combined company, and Quinton's shareholders will own roughly 49%.

Cardiac Science's senior note holders agreed to exchange the entire balance of principal and accrued interest, or about $61 million, as well as warrants, for $20 million in cash and $53.75 million, or about 13%, of the new holding company's common stock.

While the merger is largely looked upon as favorable for both firms, some Cardiac Science shareholders disagree, yesterday filing a class action to block the combination, in the Delaware Court of Chancery, New Castle County. The suit was filed by the law firm of Wolf Popper (New York).

The complaint seeks to block the merger on the grounds that the transaction "is grossly unfair to Cardiac Science's public shareholders," according to the law firm. The complaint also alleges that the proposed transaction provides a dominant member of the board with preferential treatment.

The companies said that the deal was unanimously approved by the boards of both firms, and they estimated its closing in 3Q05, subject to regulatory review. The new lawsuit, of course, may provide a larger delaying hurdle.

The merger will result in an estimated $10 million in annual operating expense savings, eliminate $9 million in annual interest expense and generate post-merger cash tax savings of at least $4 million, the companies said.

The new management team, comprised of executives from both companies, will be led by John Hinson, Quinton's current president and CEO, and Michael Matysik, Quinton's current CFO. They will continue in those roles for the combined company. Raymond Cohen, Cardiac Science's current chairman and CEO, will serve as chairman of the board, and Dr. Ruediger Naumann-Etienne, Quinton's current chairman, will serve as vice chairman. The nine-member board will be comprised of five current Quinton directors and four current Cardiac Science directors.

In a conference call, Matysik said that if the two companies were already together for all 2005, pro forma combined revenues would be in the range of $170 to $180 million. "In 2006 and beyond, we expect revenue to increase in double-digit percentage terms." He added: "Excluding one-time merger-related costs and integration expenses, the new company is expected to be immediately profitable and generate positive operating cash flow. With integration activities completed by the end of 2005, both profits and operating cash flows of the combined company in 2006 are expected to be substantially more than would have been achievable if the two companies were operating independently, given $10 million in estimated operating cost synergies and the additional savings of nearly $9 million in interest charges."

Hinson said during the call that the current integration plans call for the elimination of the current Cardiac Science corporate headquarters in Irvine, with movement of the majority of those activities to Quinton's Bothell headquarters. He said the company plans to leave in place the existing Cardiac Science R&D team in Lake Forest, California, and move sales and marketing functions associated with the Irvine location to Lake Forest. Hinson also said the combined company would eliminate the 40,000 square foot Cardiac Science manufacturing facility in Minnetonka, Minnesota, relocating those activities to Quinton's existing 100,000 square foot facility in Deerfield, Wisconsin.

Hinson noted that the company would offer relocation to its employees "where it makes sense." Where it does not make sense, he said that the company would structure "appropriate retention and severance programs to help ensure a smooth transition both for the company and for these employees as they move on to their next opportunities."

Matysik estimated the total costs of these severance activities in the neighborhood of $5 million.

"Cardiac Science has demonstrated excellent growth during the past several years by leveraging its intellectual property position to achieve leadership in the fast-growing public-access defibrillation market," said Hinson in a statement. "We believe the combination of Quinton and Cardiac Science will yield significant operational, product development and marketing synergies. With a well-established global presence, millions in cost savings and a balance sheet free of long-term debt, we expect the new company to be well-positioned to achieve significantly greater size and scale."

With the merger agreement, a new holding company named Cardiac Science will be formed. Upon approval by Nasdaq, its shares will trade under the symbol DFIB. Immediately following close of the transaction, the new holding company will have 22.3 million shares of common stock issued and outstanding, including shares issued to Cardiac Science's senior note holders.

In the U.S., the combined company will have more than 100 direct sales personnel calling on hospitals, physician offices, corporations, municipalities, schools, fire and police departments, and the military. In addition, there will be more than 200 service personnel providing training, installation and support services. Internationally, the combined company will have independent distributors in more than 90 countries around the world, along with direct operations in the UK.

Currently, the public-access AED market segment accounts for roughly $275 million and is estimated to grow at double digit rates to $900 million by 2010.

Sun Trust Robinson Humphrey acted as financial advisor to Quinton in the transaction. CIBC World Markets acted as financial advisor to Cardiac Science.