Date of
                      Initial        Clearance
                    Commercial       of 510 (k)
Product              Shipment       Notification    Description

EQUIPMENT

BIS VIEW                 2007      August 2007      Basic-featured standalone monitor which has
                                                    fewer optional user configurations compared
                                                    with the BIS VISTA monitor.

BIS VISTA                2006      September 2005   Monitor that offers an enhanced display and
                                                    user interface as well as greater processing
                                                    capability compared to our other monitors.

BISx system              2004      February 2004    BIS monitoring solution that provides the
                                                    processing technology required to obtain BIS
                                                    information from a single device the
                                                    approximate size of a hockey puck. The BISx
                                                    system is designed to integrate with a wide
                                                    range of patient monitoring platforms sold by
                                                    original equipment manufacturers.

BIS XP System            2001      June 2001        BIS system offering enhanced performance
                                                    capabilities and expanded benefits as
                                                    compared to the previous version of the BIS
                                                    system, designed to enable more precise
                                                    measurement of brain activity to assess the
                                                    level of consciousness.

BIS Module Kit -         2001      October 2000     Same as standard BIS Module Kit plus 4
4 Channel                                           channel EEG monitoring capability.
Support

A-2000 BIS               1998      February 1998    Compact, lightweight, portable
Monitor                                             third-generation BIS monitor.

BIS Module Kit           1998      October 2000     Components of BIS monitoring technology that
                                                    are integrated into equipment sold by
                                                    original equipment manufacturers.

SENSORS

Semi-Reusable            2005      February 2005    Semi-reusable version of a BIS Sensor that
(SRS) Sensor                                        uses the same algorithm and hardware as our
                                                    other disposable sensors. Currently available
                                                    only in markets outside the United States,
                                                    excluding Japan.

BIS Extend               2002      October 2000     Disposable sensor with electronic memory
Sensor                                              device for use with our BIS Monitors, BIS
                                                    Module Kit and BISx System that was designed
                                                    for patients who are typically monitored for
                                                    extended periods.

                                         Date of
                          Initial       Clearance
                        Commercial      of 510 (k)
Product                  Shipment      Notification   Description

BIS Pediatric Sensor         2001      October 2000   Disposable sensor with electronic memory
                                                      device for use with our BIS Monitors, BIS
                                                      Module Kit and BISx System that is smaller
                                                      and easier to apply to children.

BIS Quatro Sensor            2001      October 2000   Disposable sensor with electronic memory
                                                      device for use with our BIS Monitors, BIS
                                                      Module Kit and BISx System that is designed
                                                      to offer enhanced performance in deep
                                                      anesthetic states and enhanced resistance to
                                                      interference from noise sources.

BIS Sensor Plus              2001      January 2000   Second-generation disposable sensor for use
                                                      with our BIS Monitors and BIS Module Kit.

BIS Standard Sensor          1997      October 1996   Disposable sensor for use with our BIS
                                                      Monitors and BIS Module Kit.

We derive our revenue primarily from sales of BIS monitors, our original equipment manufacturer products (including BIS Module Kits and the BISx system) and related accessories, which we collectively refer to as Equipment, and sales of BIS Sensors. We have also historically derived a portion of our revenue from our strategic alliances, primarily with Boston Scientific Corporation, which was terminated in June 2007. To assist management in assessing and managing our business, we segregate our revenue by sales by region, sales by products and revenue derived from our strategic alliance, as shown in the following table:

                                                         Three Months Ended                          Nine Months Ended
                                                September 29,         September 30,         September 29,         September 30,
                                                     2007                  2006                  2007                  2006
                                                                             (dollars in thousands)
Domestic revenue                                 $    16,655          $     18,031          $     55,737          $     52,692
Percent of total revenue                                  74 %                  79 %                  76 %                  78 %

International revenue                            $     5,977          $      4,824          $     17,655          $     14,681
Percent of total revenue                                  26 %                  21 %                  24 %                  22 %

Total revenue                                    $    22,632          $     22,855          $     73,392          $     67,373

BIS Sensor revenue                               $    19,031          $     16,126          $     55,148          $     47,578
Percent of total revenue                                  84 %                  71 %                  75 %                  71 %

Equipment revenue                                $     3,601          $      5,019          $     12,998          $     15,189
Percent of total revenue                                  16 %                  22 %                  18 %                  22 %

Strategic alliance revenue                       $         -          $      1,710          $      5,246          $      4,606
Percent of total revenue                                   -                     7 %                   7 %                   7 %

Total revenue                                    $    22,632          $     22,855          $     73,392          $     67,373

At September 29, 2007, we had cash, cash equivalents, restricted cash and investments of approximately $107.0 million and working capital of approximately $98.8 million.
We follow a system of fiscal quarters as opposed to calendar quarters. Therefore, the first three quarters of each fiscal year end on the Saturday closest to the end of the calendar quarter and the last quarter of the fiscal year always ends on December 31.
We believe our ability to grow our revenue is directly related to our ability to sell our Equipment to healthcare organizations and influence our customers after they purchase our Equipment to continue to purchase and use our BIS Sensors. We believe the primary reason for the growth in product revenue is a direct result of continuing to shift the focus of our sales and marketing emphasis from expanding our customer base to developing our existing customers and increasing their sensor utilization and procedure penetration. To continue to achieve this growth, we plan to implement new sales and marketing programs, particularly in the area of clinical education programs. We expect that as we grow our business, revenue from the sale of BIS Sensors will contribute an increasing percentage of product revenue. Additionally, we believe that, over time, revenue from the sale of BIS Module Kits and our BISx system will increase as a percentage of total

Equipment revenue as healthcare organizations purchase our technology as part of an integrated solution offered by our original equipment manufacturers.
In order to sustain profitability, we believe that we need to continue to maintain our gross profit margin and control the growth of our operating expenses. To maintain our gross profit margin we believe we must continue to focus on maintaining the average unit sales prices of our BIS Sensors, increasing revenue from the sale of BIS Sensors as a percentage of total revenue, as BIS Sensors have a higher gross profit margin than Equipment, and continuing to reduce the costs of manufacturing our products.
For those healthcare organizations desiring to acquire our BIS monitors directly from us, we offer two options. Our customers have the option either to purchase BIS monitors outright or to acquire BIS monitors pursuant to a sales-type lease agreement whereby the customer contractually commits to purchase a minimum number of BIS Sensors per BIS monitor per year. Under our sales-type leases, customers purchase BIS Sensors and the BIS monitor for the purchase price of the BIS Sensors plus an additional charge per BIS Sensor to pay for the purchase price of the BIS monitor and related financing costs over the term of the agreement. We also grant these customers an option to purchase the BIS monitors at the end of the term of the agreement, which is typically three to five years. We recognize Equipment revenue under sales-type lease agreements either at shipment or delivery in accordance with the agreed upon contract terms with interest income recognized over the life of the sales-type lease. The cost of the BIS monitor acquired by the customer is recorded as costs of revenue in the same period it is acquired.
Under certain limited circumstances, we also offer customers the opportunity to use the BIS monitors under our Equipment Placement program, which we refer to as the EP program. Under the EP program, the customer is granted the right to use the BIS monitors for a mutually agreed upon period of time. During this period, the customer purchases BIS Sensors at a price that includes a premium above the list price of the BIS Sensors to cover the rental of the equipment, but without any minimum purchase commitments. At the end of the agreed upon period, the customer has the option of purchasing the BIS monitors, continuing to use them under the EP program or returning them to us.
We have subsidiaries in The Netherlands and the United Kingdom to facilitate the sale of our products into the international market. We are continuing to develop our international sales and distribution program through a combination of distributors and marketing partners, including companies with which we have entered into original equipment manufacturer relationships.
We are party to a distribution agreement with Nihon Kohden Corporation to distribute BIS monitors in Japan. Nihon Kohden has received approval from the Japanese Ministry of Health, Labor and Welfare for marketing in Japan our A-1050 EEG Monitor with BIS, our A-2000 BIS Monitor, our BIS module (our product that integrates BIS monitoring technology into equipment sold by original equipment manufacturers) and, most recently in 2005, our BIS XP system. In January 2002, the Japanese Ministry of Health, Labor and Welfare granted reimbursement approval for use of our BIS monitors. With this approval, healthcare providers in Japan are eligible to receive partial reimbursement of 1,000 Yen each time BIS monitoring is used. Sales to Nihon Kohden represented approximately 14% of international revenue in both the three and nine months ended September 29, 2007 and approximately 11% and 12% of international revenue in the three and nine months ended September 30, 2006, respectively.
During the first quarter of 2006, we adopted Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standard, or SFAS, 123 (revised 2004), Share-Based Payment, or SFAS No. 123R, using the modified prospective transition method. Prior to the adoption of SFAS No. 123R, we accounted for share-based payments to employees using the intrinsic value method under Accounting Principles Bulletin, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, and, as such, generally recognized no compensation expense for employee stock options. For the three and nine months ended September 29, 2007, we recognized approximately $2.2 million and $6.5 million, respectively, of stock-based compensation expense in our condensed consolidated statements of operations and in the three and nine months ended September 30, 2006, we recognized approximately $1.6 million and $4.9 million of stock-based compensation expense. See Note 2 of the Notes to our Condensed Consolidated Financial Statements contained in Item 1 of this Quarterly Report on Form 10-Q for further information regarding our adoption of SFAS No. 123R.
Various factors may adversely affect our quarterly operating results through the fourth quarter of 2007 and beyond. These factors include the impact of the shift in our emphasis from expanding our customer base to developing our existing customer base and increasing their sensor utilization and procedure penetration, the continued challenges of the worldwide economy and the risk that we may not realize expected benefits of industry pronouncements on anesthesia awareness,

including the Sentinel Event Alert issued by the Joint Commission on Accreditation of Healthcare Organizations, the Practice Advisory on Interoperative Awareness, which was approved by the American Society of Anesthesiologists House of Delegates in October 2005 and the position statement regarding unintended awareness issued by the American Association of Nurse Anesthetists, or AANA. In addition, in Japan, Nihon Kohden received approval of the BIS XP system in 2005 and we may not recognize the potential benefits of this approval for some time, if at all.
Critical Accounting Policies and Estimates Management's discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Note 2 of the Notes to Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q includes a summary of our significant accounting policies and methods used in the preparation of our financial statements. In preparing these financial statements, we have made estimates and judgments in determining certain amounts included in the financial statements. The application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. We believe that our critical accounting policies and estimates are as follows:
Revenue Recognition
We sell our BIS monitors primarily through a combination of a direct sales force and distributors. Our original equipment manufacturer products are sold to original equipment manufacturers who in turn sell them to the end-user. BIS Sensors are sold through a combination of a direct sales force, distributors and original equipment manufacturers. Direct product sales are structured as sales, sales-type lease arrangements or sales under our EP program. We recognize revenue when earned in accordance with Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, and Emerging Issues Task Force, or, EITF, Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Revenue is recognized when persuasive evidence of an arrangement exists, product delivery has occurred or services have been rendered, the price is fixed or determinable and collectibility is reasonably assured. For product sales, revenue is not recognized until title and risk of loss have transferred to the customer.
We also recognize revenue from prepaid license and royalty fees. This revenue is deferred until product shipment or delivery in accordance with the terms of the agreement and license and royalty fees are earned in accordance with the terms of the respective agreements. In August 2002, we recorded approximately $6.3 million of deferred revenue related to an OEM product development and distribution agreement with Boston Scientific Corporation, which we refer to as the 2002 OEM product development and distribution agreement. In June 2007, we terminated the 2002 OEM product development and distribution agreement and as a result, at that time we recognized the remaining $3.8 million that had been previously deferred under this agreement.
In May 2005, we entered into a product development and distribution agreement with Boston Scientific Corporation, which we refer to as the 2005 product development and distribution agreement. Pursuant to this agreement, Boston Scientific Corporation agreed to provide to us up to $25.0 million to fund the development of products that incorporate EEG analysis technology for the diagnosis of neurological, psychiatric or pain disorders or screening or monitoring patient response to treatment options for such disorders. In June 2007, we terminated the 2005 product development and distribution agreement with Boston Scientific Corporation. In connection with the termination of the agreement, we reversed a receivable of approximately $285,000 that we had recorded in March 2007 against the strategic alliance revenue where it had originally been recorded in the statement of income. Revenue was being recognized on allowable product development activities pursuant to this agreement as the services were performed and costs were incurred.
We follow SFAS No. 13, Accounting For Leases, in connection with our sales-type lease agreements. Under our sales-type leases, customers purchase BIS Sensors and the BIS monitor for the purchase price of the BIS Sensors plus an additional charge per BIS Sensor to pay for the purchase price of the BIS monitor and related financing costs over the term of the agreement. The minimum lease payment, consisting of the additional charge per BIS Sensor, less the unearned interest income, which is computed at the interest rate implicit in the lease, is recorded as the net investment in sales-type leases. We recognize Equipment revenue under sales-type lease agreements either at shipment or delivery in accordance with the agreed upon contract terms with interest income recognized over the life of the sales-type lease. The cost of the BIS monitor acquired by the customer is recorded as costs of revenue in the same period it is acquired. We review and assess the net realizability of our investment in sales-type leases at each reporting period. This review includes determining, on a customer specific basis, if a customer is significantly underperforming relative to the customer's cumulative level of committed BIS Sensor purchases as required by the sales-type lease agreement. If a customer is underperforming, we record an allowance for lease payments as a charge to revenue to reflect the lower estimate of the net realizable investment in sales-type lease

balance. Changes in the extent of underperformance in the agreements could increase or decrease the amount of revenue recorded in future periods.
We recognize revenue either at shipment or delivery in accordance with the agreed upon contract terms with distributors and original equipment manufacturers in accordance with SAB No. 104. Contracts executed for sales to distributors and original equipment manufacturers include a clause that indicates that customer acceptance is limited to confirmation that our products function in accordance with our applicable product specifications in effect at the time of delivery. Formal acceptance by the distributor or original equipment manufacturer is not necessary to recognize revenue provided that we objectively demonstrate that the criteria specified in the acceptance provisions are satisfied. Each product is tested prior to shipment to ensure that it meets the applicable product specifications in effect at the time of delivery. Additionally, we have historically had a minimal number of defective products shipped to distributors and original equipment manufacturers, and any defective products are subject to repair or replacement under warranty as distributors and original equipment manufacturers do not have a right of return. Stock-Based Compensation
SFAS No. 123R, which we adopted in the first quarter of 2006, requires that stock-based compensation expense associated with equity instruments be recognized in the condensed consolidated statements of operations, rather than being disclosed in a pro forma footnote to the condensed consolidated financial statements. Determining the amount of stock-based compensation to be recorded requires us to develop estimates to be used in calculating the grant-date fair value of stock options. We calculate the grant-date fair value using the Black-Scholes valuation model. The use of valuation models requires us to make estimates with respect to the following assumptions:
Risk-free interest rate: the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used as the assumption in the model.
Expected term: the expected term of an employee option is the period of time for which the option is expected to be outstanding. We use a Monte Carlo simulation model to estimate the expected term assumption in determining the grant date valuation as we believe that this information is currently the best estimate of the expected term of a new option.
Expected volatility: in estimating expected volatility, we consider both trends in historical volatility and the implied volatility of our publicly traded options. We used a combination of our implied volatility and historical volatility to estimate expected volatility for the three and nine months ended September 29, 2007. We believe that in addition to the relevance of historical volatility, consideration of implied volatility achieves the objectives of SFAS No. 123R since it represents the expected volatility that marketplace participants would likely use in determining an exchange price for an option, and is therefore an appropriate assumption to use in the calculation of grant date fair value.
Additionally, we are required to make assumptions regarding the forfeiture rate. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We used a forfeiture rate of approximately 5.0% in our calculation at September 29, 2007. We re-evaluate this forfeiture rate on a quarterly basis and adjust the rate as necessary.
These assumptions involve significant judgment and estimates. Future stock-based compensation expense could vary significantly from the amount recorded in the current period due to changes in assumptions and due to the extent of stock option activity and the amount of restricted stock issued in future periods.
As of September 29, 2007, the total unrecognized compensation cost related to unvested stock options and unvested restricted stock awards was $11.2 million and $5.0 million, respectively, which will be amortized over the weighted average remaining requisite service periods of 26 months and 36 months, respectively.

Allowance for Doubtful Accounts
We determine our allowance for doubtful accounts by making estimates and judgments based on our historical collections experience, current trends, historical write-offs of our receivables, our credit policies and a percentage of our accounts receivable by aging category. We also review the credit quality of our customer base as well as changes in our credit policies. We continuously monitor collections and payments from our customers. While credit losses have historically been within our expectations and the provisions established, our credit loss rates in the future may not be consistent with our historical experience. To the extent that we experience a deterioration in our historical collections experience or increased credit losses, bad debt expense would likely increase in future periods.
Inventories
We value inventory at the lower of cost or estimated market value, and determine cost on a first-in, first-out basis. We regularly review inventory quantities on hand and record a provision for excess or obsolete inventory primarily based on production history and on our estimated forecast of product demand. The medical device industry in which we market our products is characterized by rapid product development and technological advances that could result in obsolescence of inventory. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we would need to change our estimate of the provision required for excess or obsolete inventory. If revisions are deemed necessary, we would recognize the adjustments in the form of a charge to costs of revenue at the time of the determination. Therefore, although we continually update our forecasts of future product demand, any significant unanticipated declines in demand or technological developments, such as the introduction of new products by our competitors, could have a significant negative impact on the value of our inventory, results of operations and cash flows in future periods.
Warranty
Equipment that we sell generally is covered by a warranty period of one year. We accrue a warranty reserve for estimated costs to provide warranty services. Our estimate of costs to service our warranty obligations is based on our historical experience and expectation of future conditions. While our warranty costs have historically been within our expectations and the provisions . . .