<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(Mark One)
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 1996.
or
/ / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from to .
COMMISSION FILE NUMBER: 0-27330
HEARTSTREAM, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 91-1577477
(State or other jurisdiction (I.R.S. Employer
of Identification Number)
incorporation or
organization)
</TABLE>
2401 4TH AVENUE, SUITE 300
SEATTLE, WA 98121
(Address of principal executive offices, including zip code)
(206) 443-7630
(Registrant's telephone number, including area code)
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 / / No /X/
At April 19, 1996, there were 11,405,638 shares of the Registrant's Common Stock
outstanding.
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<PAGE>
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
QUARTERLY REPORT ON FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE NO.
-------------
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets as of March 31, 1996 (Unaudited) and December 31, 1995...................... 3
Statements of Operations (Unaudited) for the three months ended March 31, 1996 and 1995.... 4
Statements of Cash Flows (Unaudited) for the three months ended March 31, 1996 and 1995.... 5
Notes to Financial Statements.............................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 8
PART II. OTHER INFORMATION
Item 2. Changes in Securities...................................................................... 16
Item 6. Exhibits and Reports on Form 8-K........................................................... 16
SIGNATURES.............................................................................................. 17
INDEX TO EXHIBITS....................................................................................... 18
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
1995
MARCH 31, 1996 --------------
--------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents...................................................... $ 21,344,871 $ 5,970,768
Securities available-for-sale.................................................. 39,595,699 7,867,929
Inventories.................................................................... 913,423 602,462
Prepaid expenses............................................................... 214,714 104,445
-------------- --------------
Total current assets......................................................... 62,068,707 14,545,604
Property and equipment, net...................................................... 1,986,886 1,965,984
Deferred offering costs.......................................................... -- 301,806
Other assets..................................................................... 63,275 50,486
-------------- --------------
$ 64,118,868 $ 16,863,880
-------------- --------------
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................... $ 781,626 $ 523,649
Accrued compensation and benefits.............................................. 231,194 108,531
Other accrued expenses......................................................... 268,655 245,636
Current portion of long-term obligations....................................... 352,020 313,249
-------------- --------------
Total current liabilities.................................................... 1,633,495 1,191,065
Long-term obligations, less current portion...................................... 505,866 618,741
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $0.001 par value
Authorized shares --
5,000,000 at March 31, 1996 and 6,264,000 at December 31, 1995
Issued and outstanding shares --
no shares at March 31, 1996 and 6,190,341 at December 31, 1995.............. -- 6,190
Common stock, $0.001 par value
Authorized shares --
30,000,000 at March 31, 1996 and 15,000,000 at December 31, 1995
Issued and outstanding --
11,401,724 at March 31, 1996 and 967,307 at December 31, 1995............... 11,402 967
Additional paid-in-capital..................................................... 77,006,931 28,010,289
Deficit accumulated during the development stage............................... (14,898,734) (12,757,351)
Deferred compensation.......................................................... (140,092) (206,021)
-------------- --------------
Total stockholders' equity................................................... 61,979,507 15,054,074
-------------- --------------
$ 64,118,868 $ 16,863,880
-------------- --------------
-------------- --------------
</TABLE>
See accompanying notes.
3
<PAGE>
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
PERIOD FROM DECEMBER
8, 1992 (DATE OF
THREE MONTHS ENDED MARCH 31, INCORPORATION) TO
------------------------------ MARCH 31,
1996 1995 1996
-------------- -------------- ---------------------
<S> <C> <C> <C>
Operating expenses:
Research and development................................ $ 1,347,866 $ 1,003,332 $ 10,019,321
General and administrative.............................. 916,781 371,390 4,524,779
Marketing............................................... 340,031 145,120 1,543,311
-------------- -------------- ---------------------
Loss from operations.................................. 2,604,678 1,519,842 16,087,411
Interest income........................................... 548,670 67,786 1,543,162
Interest expense.......................................... (34,884) (29,586) (290,264)
Other expense............................................. -- -- (18,748)
-------------- -------------- ---------------------
Net loss.................................................. $ (2,090,892) $ (1,481,642) $ (14,853,261)
-------------- -------------- ---------------------
-------------- -------------- ---------------------
Net loss per share, historical............................ $ (0.25) $ (0.55)
-------------- --------------
-------------- --------------
Shares used to calculate historical net loss per share.... 8,525,522 2,708,332
-------------- --------------
-------------- --------------
Net loss per share, pro forma............................. $ (0.21) $ (0.23)
-------------- --------------
-------------- --------------
Shares used to calculate pro forma net loss per share..... 10,159,074 6,559,415
-------------- --------------
-------------- --------------
</TABLE>
See accompanying notes.
4
<PAGE>
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
PERIOD FROM DECEMBER
8, 1992 (DATE OF
THREE MONTHS ENDED MARCH 31, INCORPORATION) TO
------------------------------ MARCH 31,
1996 1995 1996
-------------- -------------- ---------------------
<S> <C> <C> <C>
Operating activities:
Net loss.................................................. $ (2,090,892) $ (1,481,642) $ (14,853,261)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 166,311 74,781 878,733
Amortization of deferred compensation................... 65,929 -- 693,942
(Accretion) of discounts and amortization of premiums on
securities............................................. 16,918 (1,056) (90,042)
Loss on sale of assets.................................. -- -- 18,748
Changes in:
Increase in inventories............................... (310,961) -- (913,423)
Increase in prepaid expenses.......................... (110,269) 33,749 (214,714)
Increase in other assets.............................. (12,789) (17,249) (63,275)
Increase in accounts payable and accrued expenses..... 403,659 669,137 1,281,475
-------------- -------------- ---------------------
Net cash used in operating activities..................... (1,872,094) (722,280) (13,261,817)
Investing activities:
Purchases of property and equipment....................... (187,213) (470,292) (2,239,268)
Purchases of securities................................... (34,297,669) -- (50,453,620)
Sales of securities....................................... 500,000 -- 2,000,000
Maturities of securities.................................. 2,002,490 1,500,000 8,902,490
-------------- -------------- ---------------------
Net cash used in investing activities..................... (31,982,392) 1,029,708 (41,790,398)
Financing activities:
Proceeds from investor notes.............................. -- -- 530,000
Proceeds from financing agreements........................ -- 197,436 629,354
Deferred offering costs................................... 301,806 85,344 --
Principal payments on capitalized lease obligations....... (74,104) (41,819) (416,567)
Issuance of common stock, net of issuance costs........... 49,000,887 375 49,042,897
Issuance of preferred stock, net of issuance costs........ -- 18,030,460 26,611,402
-------------- -------------- ---------------------
Net cash provided by financing activities................. 49,228,589 18,271,796 76,397,086
-------------- -------------- ---------------------
Net increase in cash and cash equivalents................. 15,374,103 18,579,224 21,344,871
Cash and cash equivalents, beginning of period............ 5,970,768 2,041,496 --
-------------- -------------- ---------------------
Cash and cash equivalents, end of period.................. $ 21,344,871 $ 20,620,720 $ 21,344,871
-------------- -------------- ---------------------
-------------- -------------- ---------------------
Noncash transactions and supplemental disclosures
Cash paid for interest.................................... $ 34,884 $ 29,586 $ 290,264
-------------- -------------- ---------------------
-------------- -------------- ---------------------
Property and equipment acquired through capital lease
agreements............................................... $ -- $ -- $ 645,099
-------------- -------------- ---------------------
-------------- -------------- ---------------------
Conversion of note payable to common stock................ $ -- $ -- $ 530,000
-------------- -------------- ---------------------
-------------- -------------- ---------------------
Conversion of preferred stock to common stock............. $ 6,190 $ -- $ 6,190
-------------- -------------- ---------------------
-------------- -------------- ---------------------
Deferred compensation on stock option grants.............. $ -- $ -- $ 834,034
-------------- -------------- ---------------------
-------------- -------------- ---------------------
</TABLE>
See accompanying notes.
5
<PAGE>
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared by
Heartstream, Inc. ("Heartstream" or the "Company") according to the rules and
regulations of the Securities and Exchange Commission. Accordingly, they do not
include all of the information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles. In the opinion of management, the financial statements reflect all
adjustments, which include only normal and recurring items, necessary for fair
presentation of the interim periods presented. The results for the three months
ended March 31, 1996, may not necessarily be indicative of the results for the
year ending December 31, 1996. These financial statements and related notes
should be read in conjunction with the Company's audited financial statements
for the year ended December 31, 1995, included in its Registration Statement on
Form S-1 (No. 33-99908) filed with the Securities and Exchange Commission.
2. INITIAL PUBLIC OFFERING
On February 5, 1996, the Company completed an initial public offering,
selling 4,140,000 shares of common stock at $13 per share. In conjunction with
the closing of this offering, the Company's Board of Directors approved an
increase in the total number of authorized shares to 35,000,000, of which
30,000,000 are for common stock and 5,000,000 are for preferred stock. In
addition, all of the Company's preferred stock converted to 6,190,341 shares of
common stock.
3. SECURITIES AVAILABLE-FOR-SALE
Securities available-for-sale at March 31, 1996 consisted of the following:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
-------------- -------------- ----------- --------------
<S> <C> <C> <C> <C>
Government-backed securities............. $ 15,573,065 $ -- $ (24,422) $ 15,548,643
Corporate debt obligations............... 24,068,106 -- (21,050) 24,047,056
-------------- -------------- ----------- --------------
$ 39,641,171 $ -- $ (45,472) $ 39,595,699
-------------- -------------- ----------- --------------
-------------- -------------- ----------- --------------
</TABLE>
Securities available-for-sale at December 31, 1995 consisted of the
following:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
Government-backed securities.................. $ 1,005,559 $ 892 $ -- $ 1,006,451
Corporate debt obligations.................... 6,857,352 4,126 -- 6,861,478
------------- ----------- ------------- -------------
$ 7,862,911 $ 5,018 $ -- $ 7,867,929
------------- ----------- ------------- -------------
------------- ----------- ------------- -------------
</TABLE>
There were no realized gains or losses on sales of securities
available-for-sale for the periods ended March 31, 1996 or 1995. The maturities
of securities available-for-sale at March 31, 1996 are as follows:
<TABLE>
<CAPTION>
COST FAIR VALUE
-------------- --------------
<S> <C> <C>
Due within one year.................................................... $ 22,619,907 $ 22,574,911
Due between one and two years.......................................... 4,541,751 4,549,618
Due after ten years.................................................... 12,479,513 12,471,170
-------------- --------------
$ 39,641,171 $ 39,595,699
-------------- --------------
-------------- --------------
</TABLE>
6
<PAGE>
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
4. INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or market
and consist primarily of component parts to be used in the Company's product.
5. NET LOSS PER SHARE
Historical net loss per share is computed based on the weighted average
number of shares of common shares outstanding and gives effect to the following
adjustments: common equivalent shares are not included in the per-share
calculation where the effect of their inclusion would be antidilutive, except
that, in accordance with Securities and Exchange Commission requirements, common
and common equivalent shares issued during the 12-month period prior to the
filing of a proposed initial public offering have been included in the
calculation as if they were outstanding for all periods using the treasury stock
method and the initial public price of $13 per share even though their inclusion
would be antidilutive.
The pro forma net loss per share is computed based on the historical net
loss per share adjusted for the assumed conversion of all outstanding shares of
convertible preferred stock into common stock at the time of issuance.
6. LITIGATION
In 1995, Physio-Control Corporation ("Physio-Control") filed a lawsuit in
Washington state court alleging trade secret misappropriation and tortious
interference with business relations against the Company and five of its
employees and their spouses in connection with the development of the
ForeRunner. These employees were founders of Heartstream and former employees of
Physio-Control, and the complaint includes related allegations that they
breached proprietary information agreements with Physio-Control. The complaint
seeks injunctive relief, unspecified monetary damages, and an order declaring
Physio-Control the owner of certain patent applications filed by the Company and
any patents that may issue from those applications. While the litigation is at a
very early stage, the Company has conducted a review of its technology in light
of the Physio-Control claims and, after consultation with its intellectual
property and litigation counsels, believes that the Company should prevail in
the litigation based on several defenses including, among other things, the
Company's conclusion that it has independently developed the technology at
issue. However, litigation is subject to inherent uncertainties, especially
cases such as this where complex technical issues may be decided by a lay jury.
Adverse determinations in the litigation with Physio-Control could have a
material adverse effect on the Company's business, financial condition and
results of operations.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Heartstream was founded in December 1992 and to date has engaged primarily
in organizational, research and product development efforts and clinical trials.
Heartstream has never generated any revenues and, accordingly, has experienced
operating losses since its inception. As of March 31, 1996, the Company had an
accumulated deficit of approximately $ 14.9 million. Heartstream expects to
continue to incur operating losses at least through 1997. Further, Heartstream
expects operating expenses and losses to increase as Heartstream completes
development of its automatic external defibrillator, the ForeRunner, seeks
regulatory clearance for its products, expands its sales and marketing efforts
in contemplation of product introduction and market development, initiates new
research and development projects, and increases administrative activities to
support growth of the Company. The Company does not have experience in
manufacturing, marketing or selling its products in commercial quantities and
there can be no assurance that the Company's development efforts will result in
a commercially available product, that the Company will be successful in
introducing the ForeRunner, or that required regulatory approvals will be
obtained in a timely manner, or at all. Further, there can be no assurance that
the ForeRunner will ever gain commercial acceptance or that the Company will
ever generate revenues or achieve profitability.
In 1995, Physio-Control Corporation ("Physio-Control"), a competitor of the
Company, filed a lawsuit in Washington state court alleging trade secret
misappropriation and tortious interference with business relations against the
Company and five of its employees and their spouses in connection with
development of the ForeRunner. These employees were founders of Heartstream and
former employees of Physio-Control, and the complaint includes related
allegations that they breached proprietary information agreements with
Physio-Control. The complaint seeks injunctive relief, unspecified monetary
damages and an order declaring Physio-Control the owner of certain patent
applications filed by the Company and any patents that may issue from those
applications. Heartstream has filed counterclaims against Physio-Control. The
pending litigation has resulted and will continue to result in substantial
expense to the Company and significant diversion of effort by the Company's
technical and management personnel. If the court finds against the Company, the
Company could be enjoined from manufacturing or commercializing the ForeRunner,
the Company could be required to seek licenses from Physio-Control, and the
Company could also be held liable for damages. While the litigation is at a very
early stage, the Company has conducted a review of its technology in light of
the Physio-Control claims and, after consultation with its intellectual property
and litigation counsels, believes that the Company should prevail in the
litigation based on several defenses including, among other things, the
Company's conclusion that it has independently developed the technology at
issue. However, litigation is subject to inherent uncertainties, especially in
cases such as this where complex technical issues may be decided by a lay jury.
Adverse determinations in the litigation with Physio-Control could have a
material adverse effect on the Company's business, financial condition and
results of operations.
RESULTS OF OPERATIONS
Research and development expenses, which include clinical trial and
regulatory submission expenses, for the three months ended March 31, 1996 were
$1.3 million, an increase of $0.3 million from the same period of the prior
year. The increase was due primarily to increased development staff and related
personnel costs. Research and development expenses represent 52% of the loss
from operations in the first quarter of 1996 and 66% of the loss from operations
in the same period of 1995. The Company expects research and development
expenses in the remainder of 1996 to increase slightly over 1995 expenditures as
development of the ForeRunner is completed and new projects are undertaken.
General and administrative expenses for the three months ended March 31,
1996 were $0.9 million, an increase of $0.5 million over the three months ended
March 31, 1995. The increase was due to increased personnel and facilities costs
and legal costs to support the Physio-Control litigation. General and
administrative expenses are expected to increase in 1996 to support the ongoing
litigation with Physio-Control, additional personnel and the increasing scope of
business activities.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Marketing expenses totaled $0.3 million for the three months ended March 31,
1996 compared with $0.1 million for the three months ended March 31, 1995,
primarily due to increased headcount and related personnel costs. Sales and
marketing expenses are expected to increase significantly in 1996 with the
hiring of direct sales personnel, establishment of domestic and international
distribution channels, initiation of advertising and promotional campaigns, and
other efforts directed toward launch of the ForeRunner. The Company expects that
a substantial portion of such expenses shall be incurred in anticipation of
regulatory clearances and product launch.
Interest income on cash, cash equivalents and securities available-for-sale
was $0.5 million for the three month period ended March 31, 1996 compared to
$68,000 for the same period in 1995. The increase was primarily due to increased
cash, cash equivalents and securities available-for-sale resulting from
completion of the Company's initial public offering in February 1996.
INCOME TAXES
The Company has not generated any net income to date and therefore has not
paid any federal income taxes since inception. At March 31, 1996, the Company
had net operating loss carryforwards of approximately $13.5 million and research
and development credit carryforwards of approximately $0.4 million, net of
carryforwards expected to expire before their complete utilization. The
operating loss carryforwards and research and development carryforwards begin to
expire in the year 2008. Utilization of federal income tax carryforwards is
subject to certain limitations under Section 382, of the Internal Revenue Code
of 1986, as amended. The Company's past sales of preferred and common stock have
resulted in "ownership changes" as defined under Section 382, resulting in
limitations on the future use of carryforwards. These limitations are expected
to result in the expiration of approximately $0.5 million of net operating loss
carryforwards and approximately $0.1 million research and development credit
carryforwards before their complete utilization.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1996, the Company's cash, cash equivalents and securities
available-for-sale were $60.9 million, compared to $13.8 million at December 31,
1995. On February 5, 1996, the Company completed an initial public offering of
4,140,000 shares of common stock at a price of $13.00 per share. The net
proceeds to the Company from the offering were approximately $49 million.
Cash used in operating activities increased from $0.7 million in the first
quarter of 1995 to $1.9 million in the first quarter of 1996, reflecting
increasing net losses from ongoing research and development and general growth
in size and scale of operations as well as purchases of inventory for future
production.
The Company expects to continue to incur substantial expenses in support of
research and development activities, growth of its sales and marketing
organization and support for ongoing litigation and administrative activities.
The Company believes that its existing cash, cash equivalents and securities
available-for-sale will be sufficient to fund its operations through 1997,
although there can be no assurance that the Company will not require additional
funding within two years. The Company's capital requirements may vary materially
from those planned because of results of research and development programs,
competitive and technological advances, FDA or other regulatory processes,
changes in the Company's marketing and distribution strategy, and other factors.
There can be no assurance that additional financing, if required, will be
available on satisfactory terms, or at all.
RISK FACTORS
This quarterly report on Form 10-Q contains forward-looking statements which
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated by such forward-looking statements as a result
of certain factors including those set forth below.
9
<PAGE>
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
LIMITED OPERATING HISTORY; HISTORY OF LOSSES AND EXPECTATION OF FUTURE
LOSSES. The Company was founded in December 1992 and to date has engaged
primarily in organizational, research and product development efforts and
clinical trials. The Company has never generated revenues and, as of March 31,
1996, the Company had an accumulated deficit of approximately $14.9 million.
Heartstream expects to continue to incur operating losses at least through 1997.
Futher, Heartstream expects operating expenses and losses to increase as
Heartstream completes development of its automatic external defibrillator, the
ForeRunner, seeks regulatory clearance for its products, expands its sales and
marketing efforts in contemlation of product introduction and market
development, initiates new research and development projects, and increases
administrative activities to support growth of the Company. There can be no
assurance that the Company's development efforts will result in a commercially
available product, that the Company will be successful in introducing the
ForeRunner, or that required regulatory approvals will be obtained in a timely
manner, or at all. Further, the Company does not have experience in
manufacturing, marketing or selling its products in commercial quantities. There
can be no assurance that the ForeRunner will ever gain commercial acceptance or
that the Company will ever generate revenues or achieve profitability.
DEPENDENCE UPON FORERUNNER. The ForeRunner and its related accessories are
currently the Company's only products. These products will require further
development and regulatory approvals before they can be marketed in the United
States or internationally. The Company has never sold any products, and there
can be no assurance that the Company's development efforts will be successful or
that the ForeRunner and its related accessories or any other product developed
by the Company will be safe or effective, capable of being manufactured in
commercial quantities at acceptable costs, approved by regulatory authorities or
successfully marketed. The Company expects that the ForeRunner and its related
accessories, if commercialized, will account for substantially all of the
Company's revenues for the foreseeable future. Furthermore, because the
ForeRunner currently represents the Company's sole product focus, if the
ForeRunner is not successfully commercialized, the Company's business, financial
condition and results of operations could be materially adversely affected.
LACK OF REGULATORY APPROVALS. The design, manufacturing, labeling,
distribution and marketing of the Company's products are subject to extensive
and rigorous government regulation in the United States and certain other
countries where the process of obtaining required regulatory approvals is
lengthy, expensive and uncertain. In order for the Company to market the
ForeRunner and related accessories in the United States, the Company must obtain
clearance or approval from the United States Food and Drug Administration
("FDA"). The Company intends to seek clearance to market the ForeRunner and its
related accessories through a 510(k) premarket notification, which the Company
submitted for filing in December 1995. There can be no assurance that the FDA
will act favorably or quickly on the Company's 510(k) submission, and
significant difficulties and costs may be encountered by the Company in its
efforts to obtain FDA clearance that could delay or preclude the Company from
selling its products in the United States. Furthermore, there can be no
assurance that the FDA will not request additional data, require that the
Company conduct further clinical studies or require a more extensive regulatory
submission known as a premarket approval application ("PMA"), causing the
Company to incur substantial cost and delay. In addition, there can be no
assurance that the FDA will not impose strict labeling requirements, onerous
operator training requirements or other requirements as a condition of its
510(k) clearance or PMA approval, any of which could limit the Company's ability
to market the ForeRunner, particularly in the first responder market. Further,
if a company wishes to modify a product after FDA clearance of a 510(k)
premarket notification or approval of a PMA, including changes in indications or
other modifications that could affect safety and efficacy, additional clearances
or approvals will be required from the FDA. Failure to receive or delays in
receipt of FDA clearances or approvals, including the need for additional
clinical trials or data as a
10
<PAGE>
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
prerequisite to clearance or approval, or any FDA conditions that limit the
ability of the Company to market the ForeRunner, could have a material adverse
effect on the Company's business, financial condition and results of operations.
In order for the Company to market the ForeRunner and its related
accessories in Europe and certain other foreign jurisdictions, the Company and
its distributors and agents must obtain required regulatory approvals and
clearances and otherwise comply with extensive regulations regarding safety and
quality. These regulations, including the requirements for approvals or
clearance to market and the time required for regulatory review, vary from
country to country. There can be no assurance that the Company will obtain
regulatory approvals in such countries or that it will not be required to incur
significant costs in obtaining or maintaining its foreign regulatory approvals.
Delays in receipt of approvals to market the Company's products, failure to
receive these approvals, or future loss of previously received approvals could
have a material adverse effect on the Company's business, financial condition
and results of operations.
The European Union has promulgated rules which require that medical products
receive by mid-1998 the right to affix the CE mark, an international symbol of
adherence to quality assurance standards and compliance with applicable European
medical device directives. In order to obtain the right to affix the CE mark to
the ForeRunner, the Company will need to obtain certification that its processes
meet European quality standards. Failure to receive the right to affix the CE
mark will prohibit the Company from selling the ForeRunner in member countries
of the European Union, and there can be no assurance that the Company will be
successful in meeting European quality standards or other certification
requirements.
CONTINUING GOVERNMENT REGULATION. Regulatory approvals, if granted, may
include significant limitations on the indicated uses for which the product may
be marketed. FDA enforcement policy strictly prohibits the marketing of approved
medical devices for unapproved uses. In addition, the Company's manufacturing
processes will be required to comply with Good Manufacturing Practices ("GMP")
regulations of the FDA. These regulations include design, testing, production,
control, documentation and other requirements. Enforcement of GMP regulations
has increased significantly in the last several years, and the FDA has publicly
stated that compliance will be more strictly scrutinized. The Company's
facilities and manufacturing processes, as well as those of certain of the
Company's third party suppliers, are subject to periodic inspection by the FDA
and other agencies. To date, the Company has not undergone such an inspection.
Failure to comply with these and other applicable regulatory requirements could
result in, among other things, warning letters, fines, injunctions, civil
penalties, recall or seizure of products, total or partial suspension of
production, refusal of the government to grant premarket clearance or premarket
approval for devices, withdrawal of approvals and criminal prosecution, any of
which could have material adverse effect on the Company's business, financial
condition and results of operations.
Several states have enacted laws and regulations which govern the delivery
of emergency medical services, including the use of external defibrillators.
These laws and regulations in many cases currently restrict use of these devices
to specified categories of trained personnel, mandate levels of operator
training and, in some cases, require that certain features be incorporated into
external defibrillators, including features such as an ECG strip chart printer
which are not currently incorporated into the ForeRunner. Accordingly, market
acceptance of the ForeRunner will be significantly dependent upon the Company's
ability to convince state and local government bodies and medical directors of
the safety and efficacy of the ForeRunner and its potential for widespread
deployment. There can be no assurance that such restrictions on the use of AEDs
will be eased or removed, which could have a material adverse effect on the
Company's ability to market the ForeRunner.
11
<PAGE>
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
UNCERTAINTY OF MARKET ACCEPTANCE AND DEPENDENCE ON MARKET DEVELOPMENT. The
Company's success is substantially dependent upon market acceptance of the
ForeRunner. Currently, all commercially available AEDs utilize a monophasic
waveform and utilize 200 to 360 Joules of energy in delivering their
defibrillation therapy. Many of these AEDs have been marketed for several years,
comply with the AHA recommended guideline for external defibrillation therapy
and have been extensively used in the field. The current AHA recommended
guideline for external defibrillation calls for an initial shock of 200 Joules,
a second shock, if required, of 200-300 Joules, and a third shock, if required,
of 200-360 Joules. The Company's ForeRunner AED utilizes a biphasic waveform
delivered at energy levels lower than that specified in the AHA guideline. There
can be no assurance that the AHA will ammend its recommended guideline to
include the Company's lower energy biphasic waveform protocol. The failure of
the ForeRunner's defibrillation protocol to be included in the AHA's recommended
guideline in a timely fashion, or at all, could have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, individual elements of the ForeRunner have only been tested in a
laboratory setting, and the complete, finished product has not been subjected to
the rigors of field use. There can be no assurance that the ForeRunner will
demonstrate effectiveness with less energy or that it will demonstrate benefits
in ease of use, maintenance and safety or will achieve acceptance in its target
markets.
The Company's success is also substantially dependent upon market
development and expansion. AEDs are currently marketed by a number of companies
into the existing professional EMT market, the Company's initial target market.
The Company's future success depends upon substantially increasing the number of
AEDs sold into the professional EMT market segment, as well as the emerging
first responder market. Development of the first responder market will depend in
large part on the Company's ability to demonstrate to physicians and potential
customers the benefits, safety, efficacy and cost-effectiveness of widespread
use of its AED by responders who are less trained than EMTs. There can be no
assurance that the ForeRunner will gain market acceptance or that market demand
for the ForeRunner will be sufficient to allow profitable operations.
COMPETITION AND RISK OF TECHNOLOGICAL OBSOLESCENCE. The domestic and
international markets for external defibrillators are highly competitive, and
most of the Company's competitors have substantial installed bases of products
and significantly greater financial, technical, research and development, and
marketing and sales resources than the Company. Accordingly, the Company's
competitors may be able to bring new product offerings to market quickly and may
be able to increase sales of their products by leveraging their installed bases
and established distribution channels. The Company believes that its primary
competitors are companies that currently market AEDs into the professional EMT
segment of the market. This market segment is dominated by Physio-Control
International Corporation and Laerdal Medical, Inc. Other competitors that sell
products into this market segment include Marquette Electronics, Inc.,
SurVivaLink Corporation and Zoll Medical, Inc. The Company believes that the
principal competitive factors for AEDs in the professional EMT and first
responder market segments are maintenance and training requirements, ease of
use, safety and reliability, cost-effectiveness and size. There can be no
assurance that the Company's products will compete favorably with respect to
these competitive factors. In addition, a number of companies may be engaged in
the development of approaches for the treatment of sudden cardiac arrest other
than those utilized by the Company. There can be no assurance that superior
defibrillation technologies will not be developed by these competitors or
others, or that alternative therapies or approaches, including pharmaceutical or
other alternatives, will not render the Company's technology or products under
development obsolete or noncompetitive, which would have material adverse effect
on the Company's business, financial condition and results of operations.
LIMITED SALES, MARKETING AND DISTRIBUTION EXPERIENCE. The Company currently
has no commercial sales and only has a small sales and marketing organization.
In the United States, the Company intends to sell its products primarily through
a direct sales force and through distributors. The
12
<PAGE>
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Company expects to expand its sales and marketing organization substantially
beginning in 1996. In international markets, the Company intends to sell its
products primarily through distributors. There can be no assurance that the
Company will be able to build a direct sales force or marketing organization,
that establishing a direct sales force or marketing organization will be
cost-effective, or that the Company's sales and marketing efforts will be
successful. In addition, the Company has only had discussions with a limited
number of domestic and international distributors and, to date, has only entered
into agreements with two international distributors covering a limited number of
European countries. There can be no assurance that the Company will be able to
enter into agreements with desired distributors on a timely basis or at all, or
that such distributors will devote adequate resources to selling the Company's
products. Failure to establish appropriate distribution relationships could have
a material adverse effect on the Company's business, financial condition and
results of operations. Further, the Company expects that the initial purchasers
of its products will be composed of state and local governments and medical
service providers under contract to such entities, and that sales of the
ForeRunner may be characterized by long sales cycles.
DEPENDENCE UPON PATENTS AND PROPRIETARY TECHNOLOGY; RELATED LITIGATION. The
Company's success will depend in part on its ability to obtain patent protection
for its products and processes, to preserve its trade secrets and to operate
without infringing the proprietary rights of third parties. The Company's
strategy is to actively pursue patent protection in the United States and
foreign jurisdictions for technology that it believes to be proprietary and that
offers a potential competitive advantage for its products. However, no assurance
can be given that any patents from pending patent applications or from any
future patent application will be issued, that the scope of any patent
protection will exclude competitors or provide competitive advantages to the
Company, that any of the Company's patents will be held valid if subsequently
challenged or that others will not claim rights in or ownership of the patents
and other proprietary rights held by the Company. In addition, the laws of
certain foreign countries do not protect the Company's intellectual property
rights to the same extent as do the laws of the United States. Litigation or
regulatory proceedings, which could result in substantial cost and uncertainty
to the Company, may also be necessary to enforce patent or other intellectual
property rights of the Company or to determine the scope and validity of other
parties' proprietary rights. There can be no assurance that that third parties
will not assert infringement claims in the future with respect to the Company's
current or future products or that any such claims will not require the Company
to enter into license arrangements or result in litigation, regardless of the
merits of such claims. No assurance can be given that any necessary licenses can
be obtained on commercially reasonable terms, or at all. Should litigation with
respect to any such claims commence, such litigation could be extremely
expensive and time consuming and could have a material adverse effect on the
Company's business, financial condition and results of operations regardless of
the outcome of such litigation.
The medical device market has been characterized by extensive litigation
regarding patents, trade secrets and other intellectual property rights. On
November 13, 1995, Physio-Control Corporation ("Physio-Control"), a competitor
of the Company, filed a lawsuit in Washington state court alleging trade secret
misappropriation and tortious interference with business relations against the
Company and five of its employees and their spouses in connection with the
development of the ForeRunner. These employees were founders of Heartstream and
former employees of Physio-Control, and the complaint includes related
allegations that they breached propriety information agreements with
Physio-Control. The pending litigation has resulted and will continue to result
in substantial expense to the Company and significant diversion of effort by the
Company's technical and management personnel. If the court finds against the
Company, the Company could be enjoined from manufacturing or commercializing the
ForeRunner, the Company could be required to seek licenses from Physio-Control,
and the Company could also be held liable for damages. While the litigation is
at a very early stage, the Company has conducted a review of its technology in
light of the
13
<PAGE>
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
Physio-Control claims and, after consultation with its intellectual property and
litigation counsels, believes that the Company should prevail in the litigation
based on several defenses including, among other things, the Company's
conclusion that it has independently developed the technology at issue. However,
litigation is subject to inherent uncertainties, especially in cases such as
this where complex technical issues may be decided by a lay jury. Accordingly,
no assurance can be given that the lawsuit will not be decided against the
Company. Adverse determinations in the litigation with Physio-Control could have
a material adverse effect on the Company's business, financial condition and
results of operations.
While the Company generally enters into confidentiality agreements with its
employees and consultants, there can be no assurance that the Company's trade
secrets or proprietary technology will not become known or be independently
developed by competitors in such a manner that the Company has no practical
recourse.
LIMITED MANUFACTURING EXPERIENCE. To date, the Company's manufacturing
activities have consisted only of manufacturing investigational devices for use
in clinical trials and prototype devices. As a result, the Company has no
experience manufacturing its products in the volumes that will be necessary for
the Company to achieve significant commercial sales, and there can be no
assurance that reliable, high-volume manufacturing can be established or
maintained at commercially reasonable costs. The Company may encounter
difficulties in scaling up production of ForeRunner devices, including problems
involving quality control and assurance, and shortages of qualified personnel.
In addition, the Company's manufacturing facilities are subject to GMP
regulations, international quality standards and other regulatory requirements.
Failure by the Company to maintain its facilities in accordance with GMP
regulations, international quality standards or other regulatory requirements
may entail a delay or termination of production, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
POTENTIAL COMPONENT SHORTAGES; DEPENDENCE ON SOLE SOURCES OF SUPPLY. The
Company expects to manufacture its products based on forecasted product orders,
and intends to purchase subassemblies and components prior to receipt of
purchase orders from customers. Lead times for materials and components ordered
by the Company vary significantly, and depend upon factors such as the specific
supplier, contract terms and demand for a component at a given time. In
addition, certain components used in the Company's products, such as flash
memory chips and other electronic components, have long lead times and have been
in short supply. The Company has acquired an inventory of flash memory chips and
certain other components in anticipation of possible shortages, and may continue
this practice for these or other components in the future. If orders do not
match forecasts, the Company may have excess or inadequate inventory of certain
materials and components. In addition, the Company purchases some key
components, such as the main energy storage capacitor and the LCD display screen
used in the ForeRunner, from sole source suppliers. For certain components,
including the ForeRunner's batteries and microprocessors, there are relatively
few sources of supply. There can be no assurance that establishment of
additional or replacement suppliers for these components can be accomplished
quickly, or at all. Any significant component supply delay or interruption could
require the Company to qualify new sources of supply, if available, and could
have a material adverse effect on the Company's ability to manufacture its
products and therefore on its business, financial condition and results of
operations.
DEPENDENCE UPON KEY PERSONNEL. The Company's ability to operate
successfully depends in significant part upon the continued service of certain
key scientific, technical and managerial personnel, and its continuing ability
to attract and retain additional highly qualified scientific, technical and
managerial personnel. Competition for such personnel is intense, and there can
be no assurance that the Company can retain such personnel or that it can
attract or retain other highly qualified scientific, technical and managerial
personnel in the future, including key sales and marketing personnel. The
14
<PAGE>
ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
loss of key personnel or the inability to hire or retain qualified personnel
could have a material adverse effect upon the Company's business, financial
condition and results of operations. In addition, many employees of the Company,
including a number of its key scientific, technical and managerial personnel,
are subject to the terms of confidentiality agreements with respect to
proprietary information of their former employers. The failure of these
employees to comply with the terms of their agreements with, or other
obligations to, such former employers could result in assertion of claims
against the Company and such employees, which, if successful, could restrict
their role with the Company and have a material adverse effect on the Company's
business, financial condition and results of operations.
15
<PAGE>
PART II.
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
Upon the closing of the Company's initial public offering in February 1996,
all outstanding shares of preferred stock were automatically converted into
6,190,341 shares of common stock. Following such closing, the Company filed a
Restated Certificate of Incorporation with the Delaware Secretary of State which
eliminated the previously authorized preferred stock, authorized 5,000,000
shares of undesignated preferred stock and increased the authorized common stock
to 30,000,000 shares.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<S> <C> <C>
(a) 3.1+ Restated Certificate of Incorporation of Registrant, as in effect
prior to initial public offering.
3.2+ Restated Certificate of Incorporation, as currently in effect.
3.3+ Bylaws.
4.1+ Specimen Common Stock Certificate.
10.1+ Form of Indemnification Agreement between the Company and each of its
directors and officers.
10.2+ 1993 Employee and Consultant Stock Plan and form of Stock Option
Agreement thereunder.
10.3+ 1995 Director Option Plan and form of Stock Option Agreement
thereunder.
10.4+ 1995 Employee Stock Purchase Plan and forms of agreements thereunder.
10.5+ Lease dated May 25, 1994 between the Registrant and Martin Selig.
10.6+ Restated Investors Rights Agreement dated March 16, 1995 between the
Registrant and certain holders of the Registrant's securities.
10.7+ Agreement dated August 3, 1995 between the Registrant and Oki
Semiconductor.
10.8+0 International Distributor Agreement (undated) between the Registrant
and Schiller AG.
10.9+ Employment Agreement dated November 8, 1993 between the Registrant
and Alan J. Levy.
10.10+0 International Distributor Agreement dated January 1996 between the
Registrant and Nellcor Puritan-Bennett Europe B.V.
11.1 Calculation of earnings per share.
27 Financial Data Schedules.
</TABLE>
- ------------------------
+ Incorporated by reference to the same numbered exhibit previously filed with
the Company's Registration Statement on Form S-1 (No. 33-99908).
0 Confidential treatment requested.
(b) Reports on Form 8-K
None.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HEARTSTREAM, INC.
(Registrant)
<TABLE>
<S> <C> <C>
Date May 14, 1996 /s/ Gary Onn
-------------------------------------- -------------------------------------------
Gary Onn
Director of Finance and Administration
(Principal Financial and Accounting Officer)
Date May 14, 1996 /s/ Alan Levy
-------------------------------------- -------------------------------------------
Alan Levy
President and Chief Executive Officer and
Director
(Principal Executive Officer)
</TABLE>
17
<PAGE>
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO.
- -----------
<S> <C>
3.1+ Restated Certificate of Incorporation of Registrant, as in effect prior to initial public offering.
3.2+ Restated Certificate of Incorporation, as currently in effect.
3.3+ Bylaws.
4.1+ Specimen Common Stock Certificate.
10.1+ Form of Indemnification Agreement between the Company and each of its directors and officers.
10.2+ 1993 Employee and Consultant Stock Plan and form of Stock Option Agreement thereunder.
10.3+ 1995 Director Option Plan and form of Stock Option Agreement thereunder.
10.4+ 1995 Employee Stock Purchase Plan and forms of agreements thereunder.
10.5+ Lease dated May 25, 1994 between the Registrant and Martin Selig.
10.6+ Restated Investors Rights Agreement dated March 16, 1995 between the Registrant and certain holders
of the Registrant's securities.
10.7+ Agreement dated August 3, 1995 between the Registrant and Oki Semiconductor.
10.8+0 International Distributor Agreement (undated) between the Registrant and Schiller AG.
10.9+ Employment Agreement dated November 8, 1993 between the Registrant and Alan J. Levy.
10.10+0 International Distributor Agreement dated January 1996 between the Registrant and Nellcor
Puritan-Bennett Europe B.V.
11.1 Calculation of earnings per share.
27 Financial Data Schedules.
</TABLE>
- ------------------------
+ Incorporated by reference to the same numbered exhibit previously filed with
the Company's Registration Statement on Form S-1 (No. 33-99908).
0 Confidential treatment requested.
18
<PAGE>
EXHIBIT 11.1
HEARTSTREAM, INC.
(A DEVELOPMENT STAGE COMPANY)
COMPUTATION OF NET LOSS PER SHARE
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1996 1995
-------------- --------------
<S> <C> <C>
Net loss.......................................................................... $ (2,090,892) $ (1,481,642)
-------------- --------------
-------------- --------------
Shares used in calculating historical net loss per share:
Weighted average shares outstanding............................................. 7,968,115 754,375
Net effect of preferred stock issued, after giving effect to the conversion into
common stock, at less than the offering price during the 12 months prior to the
Company's filing of its initial public offering, calculated using the treasury
stock method at an offering price of $13 per share, and treated as outstanding
for all periods prior to the closing date of the Company's initial public
offering....................................................................... 407,220 1,235,234
Net effect of stock options granted or exercised at less than the offering price
during the 12 months prior to the Company's filing of its initial public
offering, calculated using the treasury stock method at an offering price of
$13 per share, and treated as outstanding for all periods prior to the closing
date of the Company's initial public offering.................................. 150,187 718,723
Shares used in computation of historical net loss per share....................... 8,525,522 2,708,332
-------------- --------------
-------------- --------------
Historical net loss per share..................................................... $ (0.25) $ (0.55)
-------------- --------------
-------------- --------------
Net loss...................................................................... $ (2,090,892) $ (1,481,642)
-------------- --------------
-------------- --------------
Shares used in calculating pro forma net loss per share:
Weighted average shares outstanding............................................. 7,968,115 754,375
Weighted average common shares giving effect to the conversion of preferred
stock into common for all periods subsequent to issuance....................... 2,040,772 3,987,321
Net effect of preferred stock issued, after giving effect to the conversion into
common stock, at less than the offering price during the 12 months prior to the
Company's filing of its initial public offering, calculated using the treasury
stock method at an offering price of $13 per share, and treated as outstanding
for all periods prior to issuance.............................................. -- 1,098,996
Net effect of stock options granted or exercised at less than the offering price
during the 12 months prior to the Company's filing of its initial public
offering, calculated using the treasury stock method at an offering price of
$13 per share, and treated as outstanding for all periods prior to the closing
date of the Company's initial public offering.................................. 150,187 718,723
Shares used in computation of pro forma net loss per share........................ 10,159,074 6,559,415
-------------- --------------
-------------- --------------
Pro forma net loss per share...................................................... $ (0.21) $ (0.23)
-------------- --------------
-------------- --------------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEETS AT MARCH 31, 1996 (UNAUDITED), THE STATEMENTS OF OPERATIONS FOR THE THREE
MONTHS ENDED MARCH 31, 1996 (UNAUDITED) AND THE STATEMENTS OF CASH FLOW FOR THE
THREE MONTHS ENDED MARCH 31, 1996 (UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 21,344,871
<SECURITIES> 39,595,699
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 913,423
<CURRENT-ASSETS> 62,068,707
<PP&E> 1,986,886
<DEPRECIATION> 0
<TOTAL-ASSETS> 64,118,868
<CURRENT-LIABILITIES> 1,633,495
<BONDS> 505,866
0
0
<COMMON> 11,402
<OTHER-SE> 61,968,105
<TOTAL-LIABILITY-AND-EQUITY> 64,118,868
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,090,892
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 34,884
<INCOME-PRETAX> (2,090,892)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,090,892)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,090,892)
<EPS-PRIMARY> (0.21)
<EPS-DILUTED> 0
</TABLE>
