Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

_______________

FORM 10-Q

(Mark one)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2008


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to .

Commission File Number: 001-33027

HOME DIAGNOSTICS, INC.

(Exact name of registrant as specified in its charter)


DELAWARE		22-2594392
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)


2400 NW 55^thCourt
Fort Lauderdale, Florida		33309
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: 954-677-9201
Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class		Name of Exchange on Which Registered
Common Stock, $0.01 par value		The NASDAQ Stock Market LLC

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

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 þ No o

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 the definitions of “large accelerated filer”, “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o		Accelerated filer þ
Non-accelerated filer o (Do not check if smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o No þ

As of November 5, 2008, there were 17,482,144 shares of common stock, par value $0.01 per share, of the Registrant issued and outstanding.

Part I — FINANCIAL INFORMATION

Item 1 — Financial Statements

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets


			(Unaudited)
	December 31,		September 30,
	2007		2008
Assets
Current assets:
Cash and cash equivalents	$	32,695,803	$	34,180,268
Accounts receivable, net		18,313,519		26,444,911
Inventory		12,379,668		16,126,369
Prepaid expenses and other current assets		1,013,025		1,714,585
Income taxes receivable		1,241,171		—
Deferred tax asset		4,669,774		4,798,017

Total current assets		70,312,960		83,264,150
Property and equipment, net		22,560,335		23,789,788
Goodwill		35,573,462		35,573,462
Other intangible assets, net		660,776		415,730
Deferred tax asset		1,004,638		776,387
Other assets, net		138,866		141,942

Total assets	$	130,251,037	$	143,961,459


Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	6,103,535	$	8,952,697
Accrued liabilities		18,048,079		22,112,376
Income taxes payable		—		1,464,975

Total current liabilities		24,151,614		32,530,048

Contingencies (Note 11)		—		—

Stockholders’ equity:
Common stock, $.01 par value; 60,000,000 shares authorized; 17,878,691 and 17,515,249 shares issued and outstanding at December 31, 2007 and September 30, 2008, respectively		178,787		175,153
Additional paid-in capital		95,017,973		94,329,081
Retained earnings		10,858,415		17,027,039
Accumulated other comprehensive income (loss)		44,248		(99,862	)

Total stockholders’ equity		106,099,423		111,431,411

Total liabilities and stockholders’ equity	$	130,251,037	$	143,961,459

The accompanying notes are an integral part of these condensed consolidated financial statements.

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2008			2007			2008
Net sales	$	31,684,101		$	35,564,663		$	87,834,473		$	94,040,784
Cost of sales		11,025,302			13,935,429			34,180,896			37,936,438

Gross profit		20,658,799			21,629,234			53,653,577			56,104,346


Operating expenses
Selling, general and administrative (including stock-based compensation expense of $149,525 and $665,350 and $889,490 and $1,408,676 for the three and nine months ended September 30, 2007 and 2008, respectively)		12,028,896			13,399,365			35,136,687			38,968,796
Research and development		2,231,292			2,035,687			6,500,479			6,819,201
Insurance settlement		(450,000	)		—			(450,000	)		—

Total operating expenses		13,810,188			15,435,052			41,187,166			45,787,997

Income from operations		6,848,611			6,194,182			12,466,411			10,316,349

Other income (expense)
Interest income, net		447,763			231,775			1,218,044			773,362
Other, net		12,579			(82,923	)		64,186			(503,512	)

Total other income		460,342			148,852			1,282,230			269,850

Income before provision for income taxes		7,308,953			6,343,034			13,748,641			10,586,199
Provision for income taxes		2,104,805			1,808,650			4,229,903			2,646,190

Net income	$	5,204,148		$	4,534,384		$	9,518,738		$	7,940,009


Earnings per common share:
Basic	$	0.29		$	0.26		$	0.53		$	0.45

Diluted	$	0.27		$	0.24		$	0.48		$	0.42

Weighted average shares used in computing earnings per common share:
Basic		18,115,897			17,610,214			17,953,529			17,782,770

Diluted		19,559,220			18,791,817			19,706,031			18,901,528

The accompanying notes are an integral part of these condensed consolidated financial statements.

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Changes in Stockholders’ Equity
(Unaudited)


	Common Stock												Accumulated
							Additional						other			Total
	Number of						paid-in			Retained			comprehensive			stockholders’
	shares			Amount			capital			earnings			Income			equity
Balance at December 31, 2007		17,878,691		$	178,787		$	95,017,973		$	10,858,415		$	44,248		$	106,099,423
Stock-based compensation expense		—			—			1,408,676			—			—			1,408,676
Stock options exercised, including tax benefit of $273,865		259,083			2,591			1,254,272			—			—			1,256,863
Repurchased common stock		(622,525	)		(6,225	)		(3,351,840	)		(1,771,385	)		—			(5,129,450	)


Comprehensive income:
Foreign currency translation adjustment		—			—			—			—			(144,110	)		(144,110	)
Net income		—			—			—			7,940,009			—			7,940,009


Total comprehensive income		—			—			—			7,940,009			(144,110	)		7,795,899


Balance at September 30, 2008		17,515,249		$	175,153		$	94,329,081		$	17,027,039		$	(99,862	)	$	111,431,411

The accompanying notes are an integral part of these condensed consolidated financial statements.

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)


	Nine Months Ended
	September 30,
	2007			2008
Cash flows from operating activities:
Net income	$	9,518,738		$	7,940,009
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,900,746			2,917,001
Amortization of deferred financing and debt issuance costs		6,763			—
Loss on asset disposal		33,098			110,101
Bad debt expense		37,489			30,000
Non-cash impact of insurance proceeds		(300,000	)		—
Deferred income taxes		(665,545	)		100,008
Stock-based compensation expense		889,490			1,408,676
Changes in assets and liabilities:
Accounts receivable		(4,190,521	)		(8,161,392	)
Inventories		(1,971,755	)		(3,776,542	)
Prepaid expenses and other current and non-current assets		(356,135	)		(707,556	)
Income taxes receivable and income taxes payable		2,629,135			2,706,146
Accounts payable		3,825,929			2,849,162
Accrued liabilities		1,543,824			3,922,518

Net cash provided by operating activities		13,901,256			9,338,131

Cash flows from investing activities:
Capital expenditures		(6,550,868	)		(3,925,491	)

Net cash used in investing activities		(6,550,868	)		(3,925,491	)

Cash flows from financing activities:
Payment of debt financing costs		(4,314	)		—
Proceeds from exercise of stock options		1,946,068			982,998
Excess tax benefits from stock-based compensation expense		820,719			273,865
Repurchases of common stock		(3,390,611	)		(5,129,450	)

Net cash used in financing activities		(628,138	)		(3,872,587	)

Effect of exchange rate changes on cash and cash equivalents		18,189			(105,588	)

Net increase (decrease) in cash and cash equivalents		6,740,439			1,484,465
Cash and cash equivalents
Beginning of period		26,487,163			32,695,803

End of period	$	33,227,602		$	34,180,268

Supplemental cash flows disclosures:
Cash paid during the period for:
Income taxes	$	1,587,778		$	2,004,549

Non-cash supplemental information:
Deemed capital distribution to stockholders	$	(300,000	)	$	—

The accompanying notes are an integral part of these condensed consolidated financial statements.

HOME DIAGNOSTICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

1. Basis of presentation

Home Diagnostics, Inc. was founded in 1985 and has focused exclusively on the diabetes market since inception. The Company is a developer, manufacturer and marketer of technologically advanced blood glucose monitoring systems and disposable supplies for diabetics worldwide.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these interim financial statements should be read in conjunction with the audited consolidated financial statements and related notes to the financial statements of Home Diagnostics, Inc. and its subsidiaries (the “Company”) included in the Company’s most recent Annual Report on Form 10-K. In the opinion of management, these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of interim periods. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

The condensed consolidated financial statements include the accounts of Home Diagnostics, Inc. and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 revenues and expenses during the reporting period. Significant estimates include the Company’s allowance for estimated sales returns, legal contingencies, assumptions used to evaluate the impairment of goodwill and long lived assets and income tax uncertainties. Actual amounts could differ from those estimates.

Property and equipment

Property and equipment, including leasehold improvements, is stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided for using the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized over the lesser of their estimated useful life or the life of the lease. Estimated useful lives are as follows:



Category		Useful lives

Machinery and equipment		1-8 years
Furniture, fixtures and office equipment		1-8 years
Computer software		3 years

At December 31, 2007, equipment not yet placed in service primarily consisted of expenditures for custom manufacturing equipment for new product development. During the three months ended September 30, 2008, the Company received FDA 510(k) clearance for its TRUEresult and TRUE2go testing systems, had substantially completed the installation and validation of the custom manufacturing equipment, and had begun to produce inventory ready for sale. The total cost of approximately $14.0 million related to these assets were placed into service and depreciation commenced during the three months ended September 30, 2008. These assets have an estimated useful life of 7 years.

Maintenance and repairs are expensed as incurred. Expenditures for significant renewals or betterments are capitalized. Upon disposition, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in current operations.

Recent accounting pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), Business Combinations (SFAS 141(R)) which replaces SFAS No. 141, Business Combinations (SFAS 141). SFAS 141(R)’s scope is broader than that of SFAS 141, which applied only to business combinations in which control was obtained by transferring consideration. SFAS 141(R) applies to all transactions and other events in which one entity obtains control over one or more other businesses. The standard requires the fair value of the purchase price, including the issuance of equity securities, to be determined on the acquisition date. SFAS 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interests in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the statement. SFAS 141(R) requires acquisition costs to be expensed as incurred and restructuring costs to be expensed in periods after the acquisition date. Earn-outs and other forms of contingent consideration are to be recorded at fair value on the acquisition date. Changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period will be recognized in earnings rather than as an adjustment to the cost of the acquisition. SFAS 141(R) generally applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 with early adoption prohibited. The Company is currently evaluating the impact that the adoption of SFAS 141(R) will have on its future results of operations or financial position.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (SFAS 160). SFAS 160 requires non-controlling interests or minority interests to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. Upon a loss of control, the interest sold, as well as any interest retained, is required to be measured at fair value, with any gain or loss recognized in earnings. Based on SFAS 160, assets and liabilities will not change for subsequent purchase or sale transactions with non-controlling interests as long as control is maintained. Differences between the fair value of consideration paid or received and the carrying value of non-controlling interests are to be recognized as an adjustment to the parent interest’s equity. SFAS 160 is effective for fiscal year beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company is currently evaluating the impact that the adoption of SFAS 160 will have on its future results of operations or financial position.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — An Amendment of SFAS No. 133” (“SFAS 161”). SFAS 161 seeks to improve financial reporting for derivative instruments and hedging activities by requiring enhanced disclosures regarding the impact on financial position, financial performance, and cash flows. To achieve this increased transparency, SFAS 161 requires (1) the disclosure of the fair value of derivative instruments and gains and losses in a tabular format; (2) the disclosure of derivative features that are credit risk-related; and (3) cross-referencing within the footnotes. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the impact that the adoption of SFAS No. 161 will have on its future results of operations or financial position.

2. Stock option plans and warrants

In July 2006, the Company’s Board of Directors and stockholders approved the 2006 Equity Incentive Plan (the “2006 Plan”). Two million shares of common stock have been reserved for issuance under the 2006 Plan. The term of each option granted under the 2006 Plan cannot exceed ten years from the date of grant. The 2006 Plan authorizes a range of awards including, but not limited to the following: stock options; stock appreciation rights; and restricted stock. Under the 2006 Plan, there were 0.9 million options available for grant and 1.1 million options outstanding at September 30, 2008. These options generally become exercisable on a pro rata basis over a three-year period from the date of grant.

The Company also has two predecessor stock option plans under which options to purchase approximately 2.1 million shares are outstanding as of September 30, 2008. No additional stock options may be granted under either of these plans.

In July 2008, the Company modified the terms of certain stock option grants outstanding under the 2006 Plan and the predecessor plans, whereby for certain employees, upon termination from the Company, other than for “cause”, the outstanding option will remain exercisable and not expire for the remainder of the option term. During the three months ended September 30, 2008, the Company recorded approximately $0.3 million in SFAS 123R expense related to this stock option modification.

A summary of the Company’s stock option activity and related information for the period ended September 30, 2008 is as follows:


						Weighted
				Range of		average
	Number of			exercise		Exercise
	options			prices		Prices

Outstanding at December 31, 2007		3,010,407		$	2.99 – 12.00	$	5.53
Granted		15,000		$	6.85	$	6.85
Exercised		(27,600	)	$	2.99 – 4.27	$	3.71
Forfeited/ Cancelled		(650	)	$	12.00	$	12.00


Outstanding at March 31, 2008		2,997,157		$	2.99 – 12.00	$	5.55
Granted		428,000		$	7.88	$	7.88
Exercised		(158,640	)	$	2.99 – 4.27	$	4.12
Forfeited/ Cancelled		(1,176	)	$	3.85 – 12.00	$	10.78


Outstanding at June 30, 2008		3,265,341		$	2.99 – 12.00	$	5.92
Exercised		(74,952	)	$	2.99 – 3.85	$	3.11
Forfeited/ Cancelled		(23,875	)	$	7.88 – 11.20	$	10.27



Outstanding at September 30, 2008		3,166,514		$	2.99 – 12.00	$	5.95


Exercisable at September 30, 2008		2,379,133		$	2.99 – 12.00	$	4.85

During the nine months ended September 30, 2007 and 2008, the weighted average fair values of options granted were $3.75 and $2.72 respectively. The fair value of stock option grants during the nine months ended September 30, 2007 and 2008 were estimated on the date of grant using the Black-Scholes option-pricing model with assumptions for expected volatility, expected life, risk-free interest rate and dividend yield. The assumptions were as follows:


	Nine Months Ended
	September 30, 2007			September 30, 2008
Weighted average expected term of options (using the simplified method in years)		4.58			4.45
Expected volatility factor (based on peer group volatility)		30	%		36	%
Expected dividend yield	none			none
Weighted average risk-free interest rate (based on applicable U.S. Treasury rates)		4.86	%		3.22	%

The Company’s estimated forfeiture rate during the three and nine months ended September 30, 2007 and 2008 was approximately 8%.

The aggregate intrinsic value for the options outstanding and exercisable at September 30, 2008 was $13.0 million and $12.2 million, respectively. The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between the quoted market price of the Company’s common stock and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2008. This amount changes based on the quoted market price of the Company’s common stock.

At September 30, 2007 and 2008, there was $1.7 million and $1.3 million, respectively, of unrecognized share-based compensation expense associated with non-vested stock option grants subject to SFAS 123R. The Company has elected to recognize compensation expense for stock option awards using a graded vesting attribution methodology, whereby compensation expense is recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards. Stock-based compensation expense is expected to be recognized over a weighted-average period of 3 years.

The Company recognized stock-based compensation expense of $0.1 million and $0.7 million during the three months ended September 30, 2007 and 2008, respectively. During the three months ended September 30, 2007, the $0.1 million in expense was comprised of approximately $0.4 million related to compensation expense calculated in accordance with SFAS 123R for stock options, partially offset by income of approximately $0.3 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the three months ended September 30, 2007 was approximately $0.1 million. During the three months ended September 30, 2008, the $0.7 million in expense was comprised of approximately $0.6 million related to compensation expense calculated in accordance with SFAS 123R for stock options and expense of approximately $0.1 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the three months ended September 30, 2008 was approximately $0.2 million.

The Company recognized stock-based compensation expense of $0.9 million and $1.4 million during the nine months ended September 30, 2007 and 2008, respectively. During the nine months ended September 30, 2007, the $0.9 million in expense was comprised of approximately $1.0 million related to compensation expense calculated in accordance with SFAS 123R for stock options, partially offset by income of approximately $0.1 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the nine months ended September 30, 2007 was approximately $0.3 million. During the nine months ended September 30, 2008, the $1.4 million in expense was comprised of approximately $1.3 million related to compensation expense calculated in accordance with SFAS 123R for stock options and expense of approximately $0.1 million related to the mark-to-market accounting adjustment for variable stock options. The income tax benefit associated with SFAS 123R expense during the nine months ended September 30, 2008 was approximately $0.3 million.

3. Inventories, net

Inventories, net consist of the following:



	December 31,		September 30,
	2007		2008

Raw materials	$	7,589,107	$	8,770,506
Work-in-process		2,780,096		5,569,241
Finished goods		2,010,465		1,786,622


	$	12,379,668	$	16,126,369

4. Property and equipment, net

Property and equipment, net consist of the following:



	December 31,				September 30,
	2007			2008

Machinery and equipment	$	15,931,806		$	31,529,733
Leasehold improvements		4,061,227			4,972,441
Furniture, fixtures, and office equipment		3,136,451			4,283,244
Computer software		1,912,733			2,037,746
Equipment not yet placed in service		15,272,616			1,190,107

		40,314,833			44,013,271
Less: Accumulated depreciation and amortization		(17,754,498	)		(20,223,483	)

	$	22,560,335		$	23,789,788

Depreciation expense was approximately $0.8 million and $1.1 million for the three months ended September 30, 2007 and 2008, respectively. Amortization expense of computer software was approximately $0.1 million for each of the three months ended September 30, 2007 and 2008, respectively.

Depreciation expense was approximately $2.6 million for each of the nine months ended September 30, 2007 and 2008, respectively. Amortization expense of computer software was approximately $0.3 million for each of the nine months ended September 30, 2007 and 2008.

Equipment not yet placed in service at December 31, 2007, primarily consisted of expenditures for custom manufacturing equipment necessary to manufacture the Company’s new TRUEtest test strips which utilize proprietary on-strip coding technology to automatically calibrate with the Company’s TRUEresult and TRUE2go meters. During the three months ended September 30, 2008, the Company received FDA 510(k) clearance for its TRUEresult and TRUE2go testing systems and placed into service approximately $14.0 million of related manufacturing equipment which has an estimated useful life of 7 years.

5. Accrued liabilities

Accrued liabilities consist of the following:



	December 31,			September 30,
	2007		2008

Accrued salaries and benefits	$	3,975,898	$	4,916,401
Sales returns reserve		5,385,361		5,332,823
Accrued customer liabilities		4,030,499		7,128,390
Product warranty and managed care rebates		2,570,495		2,606,609
Other accrued liabilities		2,085,826		2,128,153

	$	18,048,079	$	22,112,376

6. Credit facility and long-term debt

In March 2008, the Company amended it’s credit facility by increasing the amount available under its unsecured revolving line of credit from $7.0 million to $10.0 million (“Amended Credit Facility”). The Amended Credit Facility matures on April 30, 2009. At September 30, 2008, there was no outstanding balance. Borrowings bear interest at LIBOR plus 0.5% (4.0% at September 30, 2008). The Amended Credit Facility contains a financial covenant and other covenants that restrict the Company’s ability to, among other things, incur liens, repurchase shares other than those authorized under the common stock repurchase program and participate in a change in control. The financial covenant requires the Company to maintain a ratio of total liabilities to tangible net worth of not more than 1.0 to 1.0. Failure to comply with this covenant and other restrictions would constitute an event of default. The Company believes that it was in compliance with the financial covenant and other restrictions at September 30, 2008.

7. Income taxes

The Company’s income tax provision for interim periods is determined using an estimate of the Company’s annual effective tax rate. The Company and its subsidiaries file income tax returns in the U.S. Federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities in the United States, Taiwan, the United Kingdom, and Canada. The Internal Revenue Service (IRS) completed income tax audits of the Company’s 2003 through 2004 Federal tax returns in March 2008. In addition, the IRS has completed its review of the Company’s 2005 Federal tax return. The Company is in agreement with all adjustments as proposed by the IRS, considers the 2005 tax year as effectively settled and has recorded the adjustments as described below. In the Company’s most significant jurisdiction, the United States, it is no longer subject to IRS examination for periods prior to 2003, although carry forward attributes that were generated between 1998 and 2002 may still be adjusted upon examination by the IRS if they either have been or will be used in future periods.

During the three and nine months ended September 30, 2008, the Company decreased its unrecognized tax benefits by approximately $0.1 million and $1.1 million, respectively. These adjustments relate to the completion of the 2003-2004 IRS audits and the effective settlement of the 2005 IRS audit. At September 30, 2008, the Company had gross unrecognized tax benefits of approximately $1.1 million. Of the total unrecognized tax benefits, $0.7 million, if recognized, would reduce our effective tax rate in the period of recognition. Interest did not change significantly during the three months ended September 30, 2008.

8. Earnings per common share

Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period presented. Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period plus the effect of dilutive securities outstanding during the period.

The following summarizes the weighted average number of common shares outstanding during the three and nine months ended September 30, 2007 and 2008 that were used to calculate the basic earnings per common share as well as the dilutive impact of stock options using the treasury stock method, as included in the calculation of diluted weighted average shares:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2007		2008		2007		2008

Weighted average number of common shares outstanding for basic earnings per share		18,115,897		17,610,214		17,953,529		17,782,770
Effect of dilutive securities: stock options and warrants		1,443,323		1,181,603		1,752,502		1,118,758

Weighted average number of common and common equivalent shares outstanding		19,559,220		18,791,817		19,706,031		18,901,528

For the three months ended September 30, 2007 and 2008, the Company had approximately 0.7 million and 0.8 million outstanding employee stock options, respectively, that have been excluded from the computation of diluted earnings per share because they are anti-dilutive.

For the nine months ended September 30, 2007 and 2008, the Company had approximately 0.4 million and 0.9 million outstanding employee stock options, respectively, that have been excluded from the computation of diluted earnings per share because they are anti-dilutive.

9. Common stock repurchase program

In August 2007, the Company’s Board of Directors authorized the Company to repurchase up to $5 million of its common stock (the “Common Stock Repurchase Program”). In March 2008, the Company’s Board of Director’s authorized the repurchase of an additional $5.0 million of its common stock. As of September 30, 2008, the Company has repurchased approximately 906,000 shares at a cost of approximately $9.6 million. During the three and nine months ended September 30, 2008, the Company repurchased approximately 321,000 shares and 623,000 shares at a cost of approximately $2.8 million and $5.1 million, respectively. All purchases under the Common Stock Repurchase Program were made in the open market, subject to market conditions and trading restrictions.

In October 2008, the Company completed its $10.0 million Common Stock Repurchase Program by purchasing 37,000 shares at a cost of approximately $0.4 million.

10. Fair Value Measurements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (“SFAS 157”) which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 became effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, the FASB issued Staff Position (FSP) No. 157-2, which delayed the effective date of SFAS 157 one year for all non-financial assets and non-financial liabilities, except those recognized or disclosed at fair value in the financial statements on a recurring basis.

SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based upon assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1: Observable inputs such as quoted prices in active markets;

Level 2: Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and

Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

On January 1, 2008, the Company partially adopted the provisions of SFAS 157. There was no impact to the Company’s financial position or results of operations upon adoption of SFAS 157. The Company has elected to partially defer adoption of SFAS 157 related to our goodwill and indefinite-lived intangible assets in accordance with FASB Staff Position 157-2.

As of September 30, 2008, the Company holds $34.2 million in cash and cash equivalents invested primarily in overnight money market funds which trade at a net asset value (NAV) of $1 per share.

In April 2008, the Company entered into a Non-Deliverable Forward (“NDF”) contract for a notional amount of $4.0 million to reduce exposure of foreign currency fluctuations on transactions with its foreign subsidiary in Taiwan. The NDF contract matures in February 2009. At September 30, 2008, the fair value of the NDF is estimated to be a liability of approximately $225,000. Fair value is estimated based upon Level 2 observable inputs for the current NDF forward rates for similar contracts. During the three and nine months ended September 30, 2008, the Company recorded approximately $290,000 and $225,000 in net market value losses on this contract. Net market value adjustments have been recorded in other income (expense).

11. Contingencies

Litigation
The Company is involved in certain legal proceedings arising in the ordinary course of business. In the opinion of management, except as disclosed below, the outcome of such proceedings will not materially affect the Company’s consolidated financial position, results of operations or cash flows.

Roche Litigation
In February 2004, Roche Diagnostics Corporation filed suit against the Company and three other co-defendants in federal court in Indiana. The three co-defendants settled with Roche in January 2006. The suit alleged that the Company’s TrueTrack Smart System infringed claims in two Roche patents. These patents are related to Roche’s electrochemical biosensors and the methods they use to measure glucose levels in a blood sample. In its suit, Roche sought damages including its lost profits or a reasonable royalty, or both, and a permanent injunction against the accused products. Roche also alleged willful infringement, which, if proven, could result in an award of up to three times its actual damages, as well as its legal fees and expenses. On September 20, 2005, the Court ruled that one of the Roche patents was procured by inequitable conduct before the Patent Office and is unenforceable. On March 2, 2007, the Court granted the Company’s motion for summary judgment for non-infringement with respect to the second patent and denied the Roche motion for a summary judgment. These rulings were subject to appeal by Roche. On December 20, 2007, the Company settled the ongoing litigation, agreeing to pay Roche a lump sum payment of $3.5 million in exchange for a royalty-free, fully paid-up, world-wide license on both of the patents, as well as a covenant by Roche not to sue the Company on the licensed patents.

Brandt Litigation
In March 2007, a settlement was agreed by the parties to a lawsuit against the Company, MIT Development Corp. or MIT, George H. Holley and the Estate of Robert Salem, brought by Leonard Brandt. Mr. Brandt claimed that he was engaged in 1994 to provide financial consulting services for MIT, Mr. George Holley and Mr. Salem. Mr. Brandt claimed he was to receive at least $1,000 per month for consulting services plus 10% of the increase in the value of the assets of MIT, Holley or Robert Salem resulting from cash or other assets received from the Company in connection with any transaction with the Company. In November 1999, the Company acquired MIT from Messrs. Holley and Salem. The settlement provides for a total of $3.0 million of consideration to be paid by the defendants. The Company’s share of the settlement consideration was $0.6 million to be paid in cash, and the remaining $2.4 million was funded in November 2007 by George H. Holley and the Estate of Robert Salem in restricted common stock of the Company. The Company agreed to grant Mr. Brandt “piggy-back” registration rights with respect to such stock for a period of one year from the date of settlement. In December 2006, pursuant to Staff Accounting Bulletin No. 107, Topic 5T “Accounting for Expenses or Liabilities Paid by Principal Stockholders”, the Company recorded a charge of $3.0 million to operating expense and recorded the $2.4 million funded by the other two defendants as additional paid-in capital. On July 19, 2007 and October 31, 2007, the court decided several details concerning the precise quantity of restricted shares to be delivered as part of the final payment terms of the settlement consistent with the foregoing description and ordered the immediate exchange of mutual releases and payment of the escrowed cash and stock. The agreed settlement funds and restricted shares were delivered to an escrow agent in accordance with the court’s order of October 31, 2007; however, Mr. Brandt failed to comply with the court’s rulings. Instead, Mr. Brandt moved to vacate the settlement and sought a new trial, and the Company filed a motion with the court to uphold the settlement. At a hearing on February 28, 2008, the court indicated it would grant the Company’s motion to compel Mr. Brandt to perform the settlement and deny Mr. Brandt’s motion to vacate the settlement and obtain a new trial. In June 2008, Mr. Brandt agreed to settle and took delivery out of escrow of the funds and the shares. Mr. Brandt also withdrew with prejudice his appeal from the Court’s ruling compelling him to comply with the settlement and delivered releases to all defendants. The case is now fully concluded.

In July 2007, the Company reached a settlement agreement with its directors and officers insurance provider, whereby, the Company received $450,000 in insurance proceeds relating to a recovery of losses incurred as part of the Brandt matter. The Company’s share of the insurance proceeds was $150,000 and the remaining $300,000 was distributed to George H. Holley and the Estate of Robert Salem. During the nine months ended September 30, 2007, the Company recorded a reduction to operating expenses of $450,000 and a distribution of capital of $300,000.

Item 2. Management’s discussion and analysis of financial condition and results of operations

The following discussion highlights the principal factors that have affected our financial condition and results of operations, as well as our liquidity and capital resources for the periods described. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report. In addition, reference is made to our audited consolidated financial statements and notes thereto and related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our most recent Annual Report on Form 10-K. As used in this Quarterly Report, the terms “Home Diagnostics”, the “Company”, “HDI”, “we”, “us” and “our” refer to Home Diagnostics, Inc. and its consolidated subsidiaries. The following discussion contains forward-looking statements. Please see our most recent Annual Report on Form 10-K, including the section entitled “Risk Factors,” for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements. In addition, please see “Caution concerning forward-looking statements” below.

Company overview

We are a developer, manufacturer and marketer of technologically advanced blood glucose monitoring systems and disposable supplies for diabetics worldwide. We market our blood glucose monitoring systems both under our own HDI brands and through a unique co-branding strategy in partnership with the leading food and drug retailers, mass merchandisers, distributors, mail service providers and third-party payors in the United States and internationally.

Our co-branding distribution strategy allows our customers to leverage their brand strategy with ours and to deliver high quality, low cost blood glucose monitoring systems to their diabetic customers at attractive price points for the consumer and increased profit margins for the retailer or distributor.

We were founded in 1985 and have focused exclusively on the diabetes market since inception. We have two manufacturing facilities, one located in Fort Lauderdale, Florida, and the other in Hsinchu City, Taiwan. We manufacture, test and package our blood glucose test strips at our facility in Fort Lauderdale. Our blood glucose monitors are assembled in our Taiwan facility. Labeling, final assembly, quality control testing and shipment of our blood glucose monitoring systems are conducted in our Fort Lauderdale facility. Our test strip manufacturing processes are highly automated. We believe we have sufficient capacity to produce test strips for our TRUEtrack, TRUEread and Sidekick biosensor systems and our Prestige photometric system to meet current and future demand, without significant incremental capital investment. In September 2008, we launched our TRUEresult and TRUE2go no-coding systems which utilize our TRUEtest bionsenor test strip platform. We continue to scale our TRUEtest test strip manufacturing operations to provide a sufficient supply of these new products to support our current demand. In order to meet the expected long term demand for these products, our board of directors has approved a significant test strip manufacturing expansion plan. We expect to spend $16 million to $18 million over the next 13 to 15 months on custom manufacturing equipment and facility improvements. We believe this new equipment will be fully operational in early 2010.

We sell our products in the following distribution channels:

	•		Retail — the retail channel generates the majority of sales of blood glucose monitoring products in the United States and includes chain drug stores, food stores and mass merchandisers. We sell our products into the retail channel on a direct basis or through domestic distributors. Our retail net sales include products we sell directly into the retail channel for the larger food and drug retailers.

	•		Domestic distribution — the domestic distribution channel includes sales to domestic wholesalers, including AmerisourceBergen, Cardinal Health, McKesson, and Invacare, who sell products to independent and chain food and drug retailers, primary and long-term care providers, durable medical equipment suppliers and mail service providers.

	•		Mail service — the mail service channel includes sales to leading mail service providers, who market their products primarily to the Medicare population.

	•		International — the international channel consists of sales on a direct basis in the United Kingdom and Canada and through distributors in Latin America, Europe, Australia, and China.

Our net sales by channel were as follows for the periods indicated:


	Three Months Ended September 30,								Nine Months Ended September 30,
	2007 (1)				2008				2007 (1)				2008
Net sales by channel:
Retail	$	5,761,852	18.2	%	$	7,981,132	22.4	%		18,512,802	21.1	%	$	20,536,331	21.8	%
Domestic distribution		18,727,972	59.1	%		18,802,290	52.9	%		46,446,718	52.9	%		48,009,589	51.1	%
Mail service		3,727,131	11.8	%		5,306,346	14.9	%		12,427,571	14.1	%		14,897,250	15.8	%
International		3,467,146	10.9	%		3,474,895	9.8	%		10,447,382	11.9	%		10,597,614	11.3	%

Net sales	$	31,684,101	100.0	%	$	35,564,663	100.0	%	$	87,834,473	100.0	%	$	94,040,784	100.0	%


(1)		Certain prior year amounts have been reclassified to conform with current year presentation.

We strive to maximize our installed base of monitors to drive future sales of our test strips. Monitors, which are sold individually or in a starter kit with a sample of 10 test strips and other supplies, are typically sold at or below cost. It is also common for us to provide monitors free of charge in support of managed care initiatives and other market opportunities. Test strip sales are a significant driver of our overall gross margins. We measure our operating performance in many ways, including the ratio of test strips to monitors sold in a given period. Our gross margins are affected by several factors, including manufacturing cost increases or reductions, the ratio of test strips to monitors, free monitor distributions and product pricing.

Our selling, general and administrative expenses include sales and marketing expenses, legal and regulatory costs, customer and technical service, finance and administrative expenses and stock-based compensation expenses. In the past, we have been involved in patent related litigation concerning certain of our products. Our legal costs can be significant, and the timing difficult to predict.

We have made significant investments in our research and development initiatives. Our research and development costs include salaries and related costs for our scientists and staff as well as costs for clinical studies, materials, consulting and other third-party services. Our research and development team is working to develop new technologies that we believe will broaden our product portfolio and enhance our current products.

Results of operations

The following table sets forth, for the periods indicated, certain information related to our operations, expressed in dollars and as a percentage of sales:


	Three Months Ended September 30,										Nine Months Ended September 30,
	2007					2008					2007					2008
Net sales	$	31,684,101		100.0	%	$	35,564,663		100.0	%	$	87,834,473		100.0	%	$	94,040,784		100.0	%
Cost of sales		11,025,302		34.8	%		13,935,429		39.2	%		34,180,896		38.9	%		37,936,438		40.3	%

Gross profit		20,658,799		65.2	%		21,629,234		60.8	%		53,653,577		61.1	%		56,104,346		59.7	%

Operating Expenses:
Selling, general and administrative		12,028,896		38.0	%		13,399,365		37.7	%		35,136,687		40.0	%		38,968,796		41.4	%
Research and development		2,231,292		7.0	%		2,035,687		5.7	%		6,500,479		7.4	%		6,819,201		7.3	%
Insurance settlement		(450,000	)	(1.4	)%		—		0.0	%		(450,000	)	(0.5	)%		—		0.0	%

Total operating expenses		13,810,188		43.6	%		15,435,052		43.4	%		41,187,166		46.9	%		45,787,997		48.7	%

Income from operations		6,848,611		21.6	%		6,194,182		17.4	%		12,466,411		14.2	%		10,316,349		11.0	%

Interest income		447,763		1.5	%		231,775		0.7	%		1,218,044		1.4	%		773,362		0.8	%
Other, net		12,579		(0.0	%)		(82,923	)	(0.2	%)		64,186		0.1	%		(503,512	)	(0.5	%)

Income before income taxes		7,308,953		23.1	%		6,343,034		17.9	%		13,748,641		15.7	%		10,586,199		11.3	%
Provision for income taxes		2,104,805		6.7	%		1,808,650		5.1	%		4,229,903		4.9	%		2,646,190		2.8	%

Net income	$	5,204,148		16.4	%	$	4,534,384		12.8	%	$	9,518,738		10.8	%	$	7,940,009		8.5	%

Three months ended September 30, 2007 as compared to three months ended September 30, 2008

Net sales increased $3.9 million, or 12.2%, to $35.6 million for the three months ended September 30, 2008, as compared to $31.7 million for the same period in 2007. The increase was due to higher sales volume of $6.8 million and reduced sales returns of $0.3 million, partially offset by lower average selling prices of $2.9 million and increased managed care rebates of $0.3 million. The increased volume of $6.8 million reflects the continued trend of increased distribution of our biosensor systems totaling approximately $7.3 million, partially offset by a decrease in our photometric system and other sales of approximately $0.5 million. The $0.3 million decrease in our provision for sales returns and other rebates resulted primarily from favorable return rates for our biosensor systems. The decrease in our average selling prices of $2.9 million was primarily due to price compression and volume based test strip pricing incentives within our mail service and domestic distribution channel. The increase in managed care rebates was due primarily to increased utilization within the third-party payor environment of our products.

Cost of sales increased $2.9 million, or 26.4%, to $13.9 million for the three months ended September 30, 2008, as compared to $11.0 million for the same period in 2007. This $2.9 million increase was driven primarily by increased sales volume of $1.4 million and increased product manufacturing cost of $1.5 million. Increased product manufacturing costs were primarily associated with scaling our manufacturing process to launch the TRUEresult and TRUE2go biosensor systems as well as higher scrap and other costs related to our other biosensor test strip products. As a percentage of net sales, cost of sales increased to 39.2% for the three months ended September 30, 2008, as compared to 34.8% for the same period in 2007. This 4.4% increase was due to increased product cost which contributed 4.2% and lower pricing which contributed 3.0%. Partially offsetting these increases, were increases in the strip to meter ratio which contributed 2.2% and reduced sales returns of 0.4%.

Gross profit increased $1.0 million, or 4.7%, to $21.6 million for the three months ended September 30, 2008, as compared to $20.7 million for the same period in 2007. The increase is due to higher sales volume of $5.4 million and $0.3 million associated with reduced sales returns. These increases were partially offset by lower average selling prices of $2.9 million, increased product manufacturing costs of $1.5 million and increased managed care rebates of $0.3 million. As a percentage of net sales, gross profit decreased to 60.8% for the three months ended September 30, 2008, as compared to 65.2% for the same period in 2007, due primarily to the items noted above.

Selling, general and administrative expenses increased $1.4 million, or 11.4%, to $13.4 million for the three months ended September 30, 2008, as compared to $12.0 million for the same period in 2007. The increase is primarily due to an increase of $0.6 million in salaries and benefits associated with additional sales and marketing and administrative personnel, increased stock-based compensation of $0.5 million primarily related to market adjustments on options subject to variable accounting, higher sales and marketing costs of $0.3 million related to increased advertising and promotions, including new product launch costs for TRUEresult and TRUE2go, and $0.2 million in other general and administrative expenses associated with supporting the continued growth of our operations. These costs were partially offset by reduced professional fees of $0.2 million. As a percentage of net sales, selling, general and administrative expenses decreased slightly to 37.7% for the three months ended September 30, 2008, as compared to 38.0% for the same period in 2007.

Research and development expenses decreased $0.2 million, or 8.8%, to $2.0 million for the three months ended September 30, 2008, as compared to $2.2 million for the same period in 2007. As a percentage of net sales, research and development costs decreased to 5.7% of sales for the three months ended September 30, 2008, as compared to 7.0% for the same period in 2007. The decrease was due to prior year development costs associated with the TRUEresult and TRUE2go systems.

Insurance settlement income of $0.5 million for the three months ended September 30, 2007 related to a settlement with our director’s and officer’s insurance carrier in connection with litigation brought by Leonard Brandt in 2001 against us and two of our principal shareholders. Our share of the settlement consideration was $0.2 million and the remaining $0.3 million was paid directly to the two principal shareholders. During the three months ended September 30, 2007, we recorded a reduction to operating expenses of $0.5 million and a distribution of capital of $0.3 million.

Operating income was $6.2 million, or 17.4% of net sales, for the three months ended September 30, 2008 as compared to $6.8 million, or 21.6% of net sales, for the same period in 2007. The decrease was due to increased cost of sales and operating expenses, partially offset by increased net sales, as noted above.

Interest income was $0.2 million for the three months ended September 30, 2008 as compared to $0.4 million for the same period in 2007. Interest income consists primarily of earnings on cash balances on hand during the period. The decrease in interest income is primarily associated with transferring certain cash balances into lower pre-tax yielding tax exempt money market funds during 2008 in order to maximize after tax investment returns. There were no borrowings or outstanding amounts under our revolving credit facility at September 30, 2008 and September 30, 2007, respectively.

Other income (expense), net was expense of $0.1 million for the three months ended September 30, 2008, as compared to income of $13,000 for the same period in 2007. The income (expense) during the three months ended September 30, 2008 and 2007 consists primarily of market adjustments on the non-deliverable forward contract entered into during 2008 offset by foreign exchange gains/losses incurred by the Company’s Taiwan subsidiary due to changes in the value of the U.S. dollar.

Our effective tax rate for the three months ended September 30, 2008 and 2007 was 28.5% and 28.8%, respectively. The effective rate in 2008 was lower than the statutory federal rate (35%) due primarily to tax credits and the effective settlement of tax uncertainties associated with the audit of our 2005 Federal income tax return by the Internal Revenue Service (IRS). The effective rate in 2007 was lower than the statutory federal rate (35%) due primarily to tax credits and disqualifying dispositions on incentive stock options in 2007.

Net income was $4.5 million for the three months ended September 30, 2008 as compared to $5.2 million for the same period in 2007. Diluted net income per common share was $0.24 on weighted average shares of 18.8 million for the three months ended September 30, 2008, as compared to $0.27 on weighted average shares of 19.6 million for the same period in 2007.

Nine months ended September 30, 2007 as compared to Nine months ended September 30, 2008

Net sales increased $6.2 million, or 7.1%, to $94.0 million for the nine months ended September 30, 2008, as compared to $87.8 million for the same period in 2007. The increase was due to higher sales volume of $12.3 million, partially offset by average selling prices of $4.4 million, increased managed care rebates of $1.1 million and increased sales returns of $0.6 million. The increased volume of $12.3 million reflects the continued trend of increased distribution of our biosensor systems totaling approximately $16.1 million, partially offset by a decrease in our photometric system and other sales of approximately $3.8 million. The decrease in our average selling price of $4.4 million was primarily due to price compression and volume based test strip pricing incentives within our mail service and domestic distribution channel. The increase in managed care rebates was due primarily to increased utilization within the third-party payor environment of our products. The increase in our provision for sales returns resulted primarily from a return reserve adjustment recorded during the three months ended June 30, 2008 in anticipation of the launch of our new products.

Cost of sales increased $3.8 million, or 11.0%, to $37.9 million for the nine months ended September 30, 2008, as compared to $34.2 million for the same period in 2007. This $3.8 million increase was driven primarily by increased sales volume of $2.8 million and increased product manufacturing costs of $1.0 million. Increased product manufacturing costs were primarily associated with scaling our manufacturing process to launch the TRUEresult and TRUE2go biosensor systems. As a percentage of net sales, cost of sales increased to 40.3% for the nine months ended September 30, 2008, as compared to 38.9% for the same period in 2007. This 1.4% increase was due primarily to decreases in average selling prices which contributed 1.8%, increased product manufacturing costs which contributed 1.1% and increased managed care and other rebates which contributed 0.7%. These increases were partially offset by an increase in the strip to meter ratio which contributed 2.2%.

Gross profit increased $2.4 million, or 4.6%, to $56.1 million for the nine months ended September 30, 2008, as compared to $53.7 million for the same period in 2007. The increase is due to higher sales volume of $9.5 million, partially offset by lower average selling prices of $4.4 million, increased managed care rebates of $1.1 million, increased product manufacturing costs of $1.0 million and increased sales returns of $0.6 million. As a percentage of net sales, gross profit decreased to 59.7% for the nine months ended September 30, 2008, as compared to 61.1% for the same period in 2007, due primarily to the items noted above.

Selling, general and administrative expenses increased $3.8 million, or 10.9%, to $39.0 million for the nine months ended September 30, 2008, as compared to $35.1 million for the same period in 2007. The increase is primarily due to an increase of $2.6 million in salaries and benefits associated with additional sales and marketing and administrative personnel, higher sales and marketing costs of $2.1 million related primarily to increased advertising and promotions, including new product launch costs for TRUEresult and TRUE2go, increased stock-based compensation of $0.5 million and $0.5 million in other general and administrative expenses associated with supporting the continued growth of our operations. These costs were partially offset by reduced overall legal costs of $1.1 million associated with the settlement of the Roche litigation and other corporate matters and a $0.7 million decrease associated with other professional fees. As a percentage of net sales, selling, general and administrative expenses increased to 41.4% for the nine months ended September 30, 2008, as compared to 40.0% for the same period in 2007, primarily due to increased costs described above.

Research and development expenses increased $0.3 million, or 4.9%, to $6.8 million for the nine months ended September 30, 2008, as compared to $6.5 million for the same period in 2007. The increase is primarily due to increased personnel related costs. As a percentage of net sales, research and development costs decreased slightly to 7.3% of sales for the nine months ended September 30, 2008, as compared to 7.4% for the same period in 2007. The decrease was due to increased net sales as noted above.

Insurance settlement income of $0.5 million for the nine months ended September 30, 2007 related to a settlement with our director’s and officer’s insurance carrier in connection with litigation brought by Leonard Brandt in 2001 against us and two of our principal shareholders. Our share of the settlement consideration was $0.2 million and the remaining $0.3 million was paid directly to the two principal shareholders. During the nine months ended September 30, 2007, we recorded a reduction to operating expenses of $0.5 million and a distribution of capital of $0.3 million.

Operating income was $10.3 million, or 11.0% of net sales, for the nine months ended September 30, 2008 as compared to $12.5 million, or 14.2% of net sales, for the same period in 2007. The decrease was due to increased cost of sales and operating expenses, partially offset by increased net sales, as noted above.

Interest income was $0.8 million for the nine months ended September 30, 2008 as compared to $1.2 million for the same period in 2007. Interest income consists primarily of earnings on cash balances on hand during the period. The decrease in interest income is primarily associated with transferring certain cash balances into lower pre-tax yielding tax exempt money market funds during 2008 in order to maximize after-tax investment returns. There were no borrowings or outstanding amounts under our revolving credit facility at September 30, 2008 and September 30, 2007, respectively.

Other income (expense), net was an expense of $0.5 million for the nine months ended September 30, 2008, as compared to income of approximately $0.1 million for the same period in 2007. The expense during the nine months ended September 30, 2008, is due primarily to foreign exchange losses incurred by the Company’s Taiwan subsidiary due to declines in the value of the U.S. dollar.

Our effective tax rate for the nine months ended September 30, 2008 and 2007 was 25.0% and 30.8%, respectively. The effective rate in 2008 was lower than the statutory federal rate (35%) primarily due to tax benefits related to the settlement of tax uncertainties associated with the completion of audits of our 2003 through 2004 Federal income tax returns by the IRS and the effective settlement of the IRS audit of our 2005 Federal income tax return. The effective rate in 2007 was lower than the statutory federal rate (35%) due primarily to tax credits and disqualifying dispositions on incentive stock options.

Net income was $7.9 million for the nine months ended September 30, 2008 as compared to $9.5 million for the same period in 2007. Diluted net income per common share was $0.42 on weighted average shares of 18.9 million for the nine months ended September 30, 2008, as compared to $0.48 on weighted average shares of 19.7 million for the same period in 2007.

Liquidity and capital resources

At September 30, 2008, we had approximately $34.1 million of cash and cash equivalents on hand, no debt outstanding and $10.0 million of capacity under our revolving line of credit. Our primary capital requirements are to fund capital expenditures. Significant sources of liquidity are cash on hand, cash flows from operating activities, working capital and borrowings from our revolving line of credit.

In March 2008, we amended our credit facility by increasing the amount available under an unsecured revolving line of credit from $7.0 million to $10.0 million and extended the maturity date to April 30, 2009 (“Amended Credit Facility”). At September 30, 2008, there was no outstanding balance under the Amended Credit Facility. Borrowings under the Amended Credit Facility bear interest at the LIBOR plus 0.5%. Our Amended Credit Facility contains a financial covenant and other covenants that restrict our ability to, among other things, incur liens, repurchase shares other than those authorized under the common stock repurchase program and participate in a change in control. Our financial covenant requires us to maintain a ratio of total liabilities to total tangible net worth of not more than 1.0 to 1.0. Failure to comply with this covenant and other restrictions would constitute an event of default under our Amended Credit Facility. We believe we were in compliance with the financial covenant and other restrictions applicable to us under the Amended Credit Facility at September 30, 2008.

In August 2007, our Board of Directors authorized a Common Stock Repurchase Program, authorizing us to repurchase up to $5.0 million of our common stock. In March 2008, our Board of Director’s authorized the repurchase of an additional $5.0 million of our common stock. As of September 30, 2008, we have repurchased approximately 906,000 shares at a cost of approximately $9.6 million. During the three and nine months ended September 30, 2008, we have repurchased approximately 321,000 shares and 623,000 shares at a cost of approximately $2.8 million and $5.1 million, respectively. In October 2008, the Company completed its $10.0 million Common Stock Repurchase Program by purchasing 37,000 shares at a cost of approximately $0.4 million. All purchases under the Common Stock Repurchase Program were made in the open market, subject to market conditions and trading restrictions.

Cash flows provided by operating activities were $13.9 million and $9.3 million for the nine months ended September 30, 2007 and September 30, 2008, respectively. The decrease in cash provided by operating activities was due primarily to increased accounts receivable associated with increased 2008 sales volumes and continued investment in inventory associated with the launch of our new products.

Cash flows used in investing activities were $6.6 million and $3.9 million for the nine months ended September 30, 2007 and 2008, respectively. These amounts consist primarily of capital expenditures relating to manufacturing equipment for our new TRUEresult and TRUE2go blood glucose monitoring systems and additional manufacturing equipment used on our existing biosensor test strip manufacturing line. We continue to scale our TRUEtest test strip manufacturing operations to provide a sufficient supply of these new products to support our current demand. In order to meet the expected long term demand for these products, our board of directors has approved a significant test strip manufacturing expansion plan. We expect to spend $16 million to $18 million over the next 13 to 15 months on custom manufacturing equipment and facility improvements. To date, we have entered into purchase commitments totaling approximately $14 million for equipment under this expansion. We believe this new equipment will be fully operational in early 2010. We expect our full year 2008 capital expenditures to be in the range of $14 million to $15 million, including $7 million related to the expansion.

Cash flows used in financing activities were $1.0 million and $3.9 million for the nine months ended September 30, 2007 and 2008, respectively. Amounts consisted primarily of cash used for purchases of common stock under our Common Stock Repurchase Program, noted above, partially offset by proceeds received from the exercise of options.

We expect that funds generated from operations, our current cash on hand and funds available under the Amended Credit Facility, will be sufficient to finance our working capital requirements, fund capital expenditures and meet our contractual obligations for at least the next twelve months.

Recent accounting pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141(R), Business Combinations (SFAS 141(R)) which replaces SFAS No. 141, Business Combinations (SFAS 141). SFAS 141(R)’s scope is broader than that of SFAS 141, which applied only to business combinations in which control was obtained by transferring consideration. SFAS 141(R) applies to all transactions and other events in which one entity obtains control over one or more other businesses. The standard requires the fair value of the purchase price, including the issuance of equity securities, to be determined on the acquisition date. SFAS 141(R) requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interests in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions specified in the statement. SFAS 141(R) requires acquisition costs to be expensed as incurred and restructuring costs to be expensed in periods after the acquisition date. Earn-outs and other forms of contingent consideration are to be recorded at fair value on the acquisition date. Changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period will be recognized in earnings rather than as an adjustment to the cost of the acquisition. SFAS 141(R) generally applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 with early adoption prohibited. We are currently evaluating the impact that the adoption of SFAS 141(R) will have on our results of operations or financial position.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (SFAS 160). SFAS 160 requires non-controlling interests or minority interests to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. Upon a loss of control, the interest sold, as well as any interest retained, is required to be measured at fair value, with any gain or loss recognized in earnings. Based on SFAS 160, assets and liabilities will not change for subsequent purchase or sale transactions with non-controlling interests as long as control is maintained. Differences between the fair value of consideration paid or received and the carrying value of non-controlling interests are to be recognized as an adjustment to the parent interest’s equity. SFAS 160 is effective for fiscal year beginning on or after December 15, 2008. Earlier adoption is prohibited. We are currently evaluating the impact that the adoption of SFAS 160 will have on our results of operations or financial position.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — An Amendment of SFAS No. 133” (“SFAS 161”). SFAS 161 seeks to improve financial reporting for derivative instruments and hedging activities by requiring enhanced disclosures regarding the impact on financial position, financial performance, and cash flows. To achieve this increased transparency, SFAS 161 requires (1) the disclosure of the fair value of derivative instruments and gains and losses in a tabular format; (2) the disclosure of derivative features that are credit risk-related; and (3) cross-referencing within the footnotes. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We are currently evaluating the impact that the adoption of SFAS No. 161 will have on our results of operations or financial position.

Caution concerning forward-looking statements

Certain information included or incorporated by reference in this Quarterly Report may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may include, but are not limited to, statements relating to our objectives, plans and strategies, and all statements (other than statements of historical facts) that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements. These statements are often characterized by terminology such as “believe,” “hope,” “may,” “anticipate,” “should,” “intend,” “plan,” “will,” “expect,” “estimate,” “project,” “positioned,” “strategy” and similar expressions and are based on assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Any forward-looking statements in this Quarterly Report are made as of the date hereof, and we undertake no duty to update or revise any such statements, whether as a result of new information, future events or otherwise. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties. Important factors that could cause actual results, developments and business decisions to differ materially from forward-looking statements are described in the Company’s most recent Annual Report on Form 10-K, including the section entitled “Risk Factors.”

Item 3. Quantitative and qualitative disclosures about market risk

Our Amended Credit Facility is subject to market risk and interest rate changes. The borrowings under the Amended Credit Facility bear interest at LIBOR plus 0.5%. At September 30, 2008, we did not have any borrowings outstanding under the Credit Facility.

Certain of our operations are domiciled outside the U.S. and we translate the results of operations and financial condition of these operations from their local functional currencies into U.S. dollars. Therefore, our reported consolidated results of operations and consolidated financial condition are affected by changes in the exchange rates between these currencies and the U.S. dollar. Assets and liabilities of foreign operations have been translated from the functional currencies of our foreign operations into U.S. dollars at the exchange rates in effect at the relevant balance sheet date, and revenue and expenses of our foreign operations have been translated into U.S. dollars at the average exchange rates prevailing during the relevant period. Unrealized gains and losses on translation of these foreign operations into U.S. dollars are reported as a separate component of stockholders’ equity and are included in comprehensive income (loss). Monetary assets and liabilities denominated in U.S. dollars held by our foreign operations are re-measured from U.S. dollars into the functional currency of our foreign operations with the effect reported currently as a component of net income (loss). For each of the three and nine months ended September 30, 2008 and 2007,we estimate that a 10.0% increase or decrease in the relationship of the functional currencies of our foreign operations to the U.S. dollar would increase or decrease our net income by approximately $0.2 million, respectively.

In April 2008, the Company entered into a Non-Deliverable Forward (“NDF”) contract for a notional amount of $4.0 million to reduce exposure of foreign currency fluctuations on transactions with it’s foreign subsidiary in Taiwan. The NDF contract matures in February 2009. At September 30, 2008, the fair value of the NDF is estimated to be a liability of approximately $225,000. Fair value of the NDF is estimated based on observable inputs for the current NDF forward rates for similar contracts. We estimate that a 10.0% increase or decrease in the NDF forward would increase or decrease our net income by approximately $0.2 million, offsetting the impact of foreign currency market risk described above.

Item 4. Controls and procedures

Evaluation of Disclosure Controls and Procedures

We evaluated, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report.

Changes in Internal Control Over Financial Reporting

There were no changes in internal control over financial reporting that occurred during the quarter ended September 30 2008, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II — OTHER INFORMATION

Item 1A. Risk Factors

There have been no material changes, except as noted below, from the risk factors previously disclosed in the Company’s most recent Annual Report on Form 10-K for the period ending December 31, 2007.

Competitive bidding for durable medical equipment suppliers could negatively affect our business

On April 2, 2007, the Centers for Medicare & Medicaid Services (CMS) issued a final rule to implement a new competitive bidding program in Medicare. The new competitive bidding program, mandated by Congress in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA), will replace the current Medicare fee schedule for certain durable medical equipment, prosthetics, orthotics, and supplies (DMEPOS) in ten of the largest Metropolitan Statistical Areas (MSAs) across the country and will apply initially to ten categories of medical equipment and supplies, including diabetic supplies obtained via mail order arrangements (i.e. test strips and lancets used with blood glucose monitors). On July 15, 2008, the Medicare Improvements for Patients and Providers Act of 2008 (MIPPA) was enacted. This new law has delayed the Medicare DMEPOS Competitive Bidding Program for 18 to 24 months. The new law also mandates a 9.5% reduction in Medicare reimbursement for DMEPOS, including diabetic supplies obtained via mail order arrangements, effective January 1, 2009. To the extent that the competitive bidding program exerts downward pressure on the prices our customers may be willing or able to pay for our products or imposes additional costs, our operating results could be negatively affected.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Use of Proceeds from Sales of Registered Securities

On September 26, 2006, we closed an initial public offering of 6,599,487 shares of our common stock. Of these shares, 3,300,000 were newly issued shares sold by us and 2,299,487 were existing shares sold by certain of our stockholders. On October 4, 2006, an additional 989,923 shares of existing common stock were sold by certain of such selling stockholders pursuant to the exercise by the underwriters of their over-allotment option. The offering was effected pursuant to a Registration Statement on Form S-1 (File No. 333-133713), which the SEC declared effective on September 20, 2006, and a final prospectus filed pursuant to Rule 424(b) under the Securities Act on September 22, 2006 (Reg. No. 333-133713).

We received approximately $35.1 million in net proceeds from the offering after underwriting discounts and offering expenses. These proceeds were used as follows:

	•		$10.4 million to redeem all outstanding shares of our Series F Preferred Stock;

	•		$2.0 million to repay outstanding indebtedness to Wachovia Bank N.A.; and

	•		$4.8 million for manufacturing equipment for new product development ($0.3 million and $1.2 million during the three and nine months ended September 30, 2008, respectively).

The remaining $17.9 million of the net proceeds to us from our initial public offering, have been or will be used for working capital and general corporate purposes.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

On August 9, 2007, the Company announced that its Board of Directors had authorized the Company to repurchase up to $5 million of its common stock. On March 13, 2008, the Company announced that its Board of Directors had authorized an additional $5.0 million share repurchase program (collectively, the “Common Stock Repurchase Program”). As of September 30, 2008, the Company has repurchased approximately 906,000 shares of its common stock at a cost of approximately $9.6 million. During the three months ended September 30, 2008, the Company repurchased approximately 321,000 shares at a cost of approximately $2.8 million. All purchases under the Common Stock Repurchase Program were made in the open market, subject to market conditions and trading restrictions.

ISSUER PURCHASES OF EQUITY SECURITIES

Appropriate Dollar

Total Number of

Value of Shares

Shares Purchased as

That May Yet Be

Total Number of

Average Price Paid

Part of the

Purchased Under the

Period

Shares purchased

Per Share

Repurchase Program

July 1, 2008 to July 31, 2008

149,819

$8.28

149,819

$1,926,713

August 1, 2008 to August 31, 2008

129,650

$8.98

129,650

$758,006

September 1, 2008 to September 30, 2008

41,864

$9.38

41,864

$363,984

Total at September 30, 2008

321,333

$8.71

321,333


		Page
Part I	FINANCIAL SUMMARY		3

Item 1.	Financial Statements		3

	Condensed Consolidated Balance Sheets as of December 31, 2007 and September 30, 2008 (Unaudited)		3

	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2007 and 2008 (Unaudited)		4

	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2008 (Unaudited)		5

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2008 (Unaudited)		6

	Notes to Condensed Consolidated Financial Statements (Unaudited)		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		23

Item 4.	Controls and Procedures		24

Part II	OTHER INFORMATION		24

Item 1A.	Risk Factors		24

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		25

Item 6.	Exhibits		26

SIGNATURES			27

EXHIBIT INDEX			28

CERTIFICATIONS
EX-31.1
EX-31.2
EX-32.1
EX-32.2


	HOME DIAGNOSTICS, INC.
Date: November 7, 2008	By:	/s/ J. RICHARD DAMRON, JR.
		J. Richard Damron, Jr.
		President and Chief Executive Officer (principal executive officer) and Director


Date: November 7, 2008	By:	/s/ RONALD L. RUBIN
		Ronald L. Rubin
		Senior Vice President and Chief Financial Officer (principal financial and accounting officer)


Exhibit
Number			Description

	31.1	—	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

	31.2	—	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

	32.1	—	Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350.

	32.2	—	Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350.

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