<PAGE>
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 September 30, 1997
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)
Delaware 91-1577477
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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 X No
---- ----
At October 22, 1997, there were 11,791,482 shares of the Registrant's Common
Stock outstanding.
<PAGE>
HEARTSTREAM, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item 1. Financial Statements Page
----
<S> <C>
Balance Sheets as of September 30, 1997 (Unaudited) and December 31, 1996................... 3
Statements of Operations (Unaudited) for the three and nine months
ended September 30, 1997 and 1996......................................................... 4
Statements of Cash Flows (Unaudited) for the nine months ended
September 30, 1997 and 1996............................................................... 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 1. Legal Proceedings........................................................................... 16
Item 2. Changes in Securities and Use of Proceeds................................................... 16
Item 6. Exhibits and Reports on Form 8-K............................................................ 17
SIGNATURES................................................................................................ 18
INDEX TO EXHIBITS......................................................................................... 19
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HEARTSTREAM, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents.................... $ 19,994,502 $ 24,726,216
Securities available-for-sale................ 14,727,279 25,353,693
Accounts receivable, net..................... 1,855,292 944,579
Inventories.................................. 4,194,909 1,548,441
Prepaid expenses and other................... 885,069 114,091
------------ ------------
Total current assets........................ 41,657,051 52,687,020
Property and equipment, net................... 2,314,477 2,492,351
Other assets.................................. -- 111,084
------------ ------------
$ 43,971,528 $ 55,290,455
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................ $ 940,480 $ 1,779,871
Accrued compensation and benefits........... 1,114,553 293,312
Other accrued expenses...................... 730,750 127,246
Current portion of long-term obligations.... 279,695 409,207
------------ ------------
Total current liabilities................ 3,065,478 2,609,636
Long-term obligations, less current portion... 38,450 215,753
Commitments and contingencies
Stockholders' equity:
Common stock, $0.001 par value
Authorized shares - 30,000,000
Issued and outstanding shares -
11,789,782 at September 30, 1997 and
11,635,404 at December 31, 1996......... 11,790 11,635
Additional paid-in-capital.................. 77,631,888 77,271,965
Accumulated deficit......................... (36,767,692) (24,779,410)
Deferred compensation....................... (8,386) (39,124)
------------ ------------
Total stockholders' equity............... 40,867,600 52,465,066
------------ ------------
$ 43,971,528 $ 55,290,455
============ ============
</TABLE>
See accompanying notes.
3
<PAGE>
HEARTSTREAM, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
--------------------------- -----------------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
----------- ----------- ------------ ------------
Net sales..................... $ 2,644,386 $ -- $ 6,306,264 $ --
Cost of sales................. (1,530,075) -- (4,034,119) --
----------- ----------- ------------ ------------
Gross margin................. 1,114,311 -- 2,272,145 --
Operating expenses:
Sales and marketing.......... 2,605,766 1,104,628 7,339,346 2,087,425
General and administrative... 1,410,816 1,340,450 4,592,237 3,527,609
Research and development..... 1,319,539 1,641,493 3,980,542 4,602,160
----------- ----------- ------------ ------------
5,336,121 4,086,571 15,912,125 10,217,194
Loss from operations.......... (4,221,810) (4,086,571) (13,639,980) (10,217,194)
Interest income, net.......... 490,027 697,929 1,640,050 1,958,031
----------- ----------- ------------ ------------
Net loss...................... $(3,731,783) $(3,388,642) $(11,999,930) $ (8,259,163)
=========== =========== ============ ============
Net loss per share, historical. $ (0.32) $ (0.29) $ (1.02) $ (0.79)
=========== =========== ============ ============
Shares used to calculate
historical net loss per share. 11,776,024 11,530,046 11,731,464 10,494,404
=========== =========== ============ ============
Net loss per share, pro forma.................................................. $ (0.75)
============
Shares used to calculate
pro forma net loss per share.................................................. 11,038,922
============
</TABLE>
See accompanying notes.
4
<PAGE>
HEARTSTREAM, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------
1997 1996
---------------- --------------
<S> <C> <C>
Operating activities:
Net loss............................................... $(11,999,930) $ (8,259,163)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization........................ 700,445 536,937
Amortization of noncash compensation................. 88,321 144,370
(Accretion) of discounts and amortization of
premiums on securities.............................. (28,336) 172,118
Changes in:
Increase in accounts receivable..................... (910,713) --
Increase in inventories............................. (2,646,468) (755,154)
Increase in prepaid expenses and other.............. (770,978) (90,796)
Decrease (increase) in other assets................. 111,084 (31,149)
Increase in accounts payable and accrued expenses... 585,354 1,025,988
------------ ------------
Net cash used in operating activities.................. (14,871,221) (7,256,849)
Investing activities:
Purchase of property and equipment..................... (522,571) (987,013)
Purchase of securities................................. (5,763,179) (57,558,530)
Sales of securities.................................... 5,400,000 7,900,000
Maturities of securities............................... 11,029,577 13,489,358
------------ ------------
Net cash provided by (used in) investing activities.... 10,143,827 (37,156,185)
Financing activities:
Deferred offering costs............................... -- 301,806
Principal payments on capitalized lease obligations... (306,815) (231,975)
Issuance of common stock, net of issuance costs....... 302,495 49,028,000
------------ ------------
Net cash (used in) provided by financing activities.... (4,320) 49,097,831
------------ ------------
Net (decrease) increase in cash and cash equivalents... (4,731,714) 4,684,797
Cash and cash equivalents, beginning of period......... 24,726,216 5,970,768
------------ ------------
Cash and cash equivalents, end of period............... $ 19,994,502 $ 10,655,565
============ ============
Noncash transaction and supplemental disclosures:
Cash paid for interest................................ $ 55,713 $ 96,247
============ ============
Conversion of preferred stock to common stock.......... $ -- $ 6,190
============ ============
</TABLE>
See accompanying notes.
5
<PAGE>
HEARTSTREAM, INC.
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 and nine months ended September 30, 1997 may not
necessarily be indicative of the results for the year ending December 31,
1997. These financial statements and related notes should be read in
conjunction with the CompanyOs audited financial statements for the year
ended December 31, 1996, included in its Annual Report to Stockholders
incorporated by reference into the Form 10-K filed with the Securities and
Exchange Commission on March 31, 1997.
In June 1997, the Financial Accounting Standards Board issued Statement
No. 130, "Reporting Comprehensive Income" ("Statement 130"), which is
effective for fiscal year 1998. Statement 130 requires the Company to
present comprehensive income and the components of comprehensive income on
the Statement of Operations for all period presented. The impact of
Statement 130 is not expected to result in a material difference between
reported income and comprehensive income for any period presented.
2. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
Raw materials $2,591,759 $1,023,182
Work-in-process 559,062 462,919
Finished goods 1,044,088 62,340
---------- ----------
$4,194,909 $1,548,441
========== ==========
</TABLE>
3. Net Loss Per Share
Historical net loss per share is computed based on the weighted average
number 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 an 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.
6
<PAGE>
HEARTSTREAM, INC.
NOTES TO FINANCIAL STATEMENTS
3. Net Loss Per Share (continued)
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.
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings Per Share" ("Statement 128"), which is effective for
interim and annual periods ending after December 15, 1997. Statement 128
requires the Company to change its method for calculating earnings per share
and restate all prior periods presented. The impact of Statement 128 on the
calculation of net loss per share for all current and prior periods is not
expected to be material.
4. Litigation
In 1995, Physio-Control International 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(R) automatic
external defibrillator. These employees were founders of Heartstream and
former employees of Physio-Control. The complaint included related
allegations that the five employees breached proprietary information
agreements with Physio-Control. The Company filed counterclaims against
Physio-Control. In a separate case, in January 1997, the Company filed a
lawsuit in U.S. Federal District Court in Seattle against Physio-Control for
infringement of a patent relating to the Company's defibrillator self-test
technology. Physio-Control filed a counterclaim charging infringement of one
of its patents by the Company.
In October 1997, the Company and Physio-Control reached a mutually
satisfactory settlement of all outstanding litigation between the companies.
As a result of the settlement, all court actions filed by each company
against the other have been dismissed with prejudice, along with all
counterclaims. The effect of the settlement is not expected to have a
material adverse effect on the Company's business or financial position.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Heartstream, Inc. ("Heartstream" or "Company") was founded in December 1992
and conducted organizational, research and development, market development and
clinical trial activities related to its ForeRunner(R) automatic external
defibrillator ("AED") during its first four years. In 1996 the Company received
the required regulatory approvals to market the ForeRunner AED and its
accessories in several countries, including the United States, Canada and the 18
countries of the European Economic Area. With completion of ForeRunner's
development process and required regulatory approvals, the Company initiated
commercial shipments of the ForeRunner AED and its accessories in November 1996.
As of September 30, 1997, the Company had received regulatory approvals to
market and sell the ForeRunner AED in 34 countries around the world.
The Company's ForeRunner is an innovative AED which utilizes a patented low-
energy, impedance-compensating biphasic waveform for the treatment of sudden
cardiac arrest (SCA), the leading cause of death in the United States. The
Company's ForeRunner AED is the only currently available AED which utilizes a
biphasic waveform.
In 1995, Physio-Control International 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 AED. These employees were founders of
Heartstream and former employees of Physio-Control. The complaint included
related allegations that the five employees breached proprietary information
agreements with Physio-Control. The Company filed counterclaims against Physio-
Control. In a separate case, in January 1997, the Company filed a lawsuit in
U.S. Federal District Court in Seattle against Physio-Control for infringement
of a patent relating to the Company's defibrillator self-test technology.
Physio-Control filed a counterclaim charging infringement of one of its patents
by the Company.
In October 1997, the Company and Physio-Control reached a mutually
satisfactory settlement of all outstanding litigation between the companies. As
a result of the settlement, all court actions filed by each company against the
other have been dismissed with prejudice, along with all counterclaims. The
effect of the settlement is not expected to have a material adverse effect on
the Company's business or financial position.
Results of Operations
Net sales totaled $2.6 million and $6.3 million for the three and nine months
ended September 30, 1997, respectively. The Company had no sales during the
first nine months of 1996 as the Company obtained the required regulatory
clearances in September 1996 and shipments commenced in November 1996. During
the third quarter of 1997 the Company entered into additional domestic
distribution agreements for certain market segments in the United States, and
expects to enter into agreements with other distribution partners throughout the
remainder of 1997. Domestic sales for the third quarter of 1997 accounted for
approximately 80% of gross sales compared to 61% and 75% in the first and second
quarters of 1997, respectively. The increase in domestic sales as a percent of
total sales is due to the Company's expansion of its sales and marketing efforts
in domestic markets and slower international sales in Europe during the summer
vacation
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
months. Accessories accounted for approximately 12% of total sales for the
three months ended September 30, 1997, consistent with results for the first and
second quarters of 1997.
Gross margin totaled $1.1 million, or 42% of net sales, for the three months
ended September 30, 1997. For the nine month period ended September 30, 1997,
gross margin totaled $2.3 million, or 36% of net sales. Margins for the third
quarter of 1997 were higher than margins on a year-to-date basis due to a
significant lower-margin order shipped during the second quarter. In addition,
third quarter margins increased over first and second quarter results of 37% and
29%, respectively, as higher production levels during the quarter reduced the
overall cost per unit. Future margins may be affected by shifts in the sales
distribution channel mix and large sales at volume discounts to certain
customers. In addition, the Company has established production facilities based
on forecasted product demand. Actual utilization of these facilities may affect
future margins.
Sales and marketing expenses totaled $2.6 million for the three months ended
September 30, 1997 compared with $1.1 million for the same period in 1996. For
the nine months ended September 30, 1997 and 1996, sales and marketing expenses
totaled $7.3 million and $2.1 million, respectively. The increase in expenses
is primarily due to the hiring of direct sales representatives and marketing
personnel in 1997, as well as increased promotional and market development
activities. Sales and marketing expenses through September 30, 1996 were
limited to market development activities as commercial sales of the ForeRunner
AED had not yet commenced. Sales and marketing expenses for the remainder of
1997 are expected to increase slightly compared to third quarter of 1997. This
is a result of continued worldwide commercialization of the ForeRunner AED,
including the hiring of additional direct sales representatives, continued
growth of domestic and international distribution channels, and increased
advertising and promotional activities.
General and administrative expenses totaled $1.4 million for the three months
ended September 30, 1997 compared with $1.3 million for the three months ended
September 30, 1996. This represents an increase of $0.1 million, or 5% over the
same period in the prior year. For the nine months ended September 30, 1997,
general and administrative expenses increased 30% to $4.6 million from $3.5
million for the same period in 1996. The year-to-date increase was due to
increased costs to operate as a public company, additional personnel and
facilities costs to support growth of the Company, and additional legal costs in
connection with the Physio-Control litigation in the first and second quarters
of 1997. Increases in general and administrative expenses were less pronounced
in the third quarter due to lower legal costs associated with the Physio-Control
litigation.
Research and development expenses totaled $1.3 million for the three months
ended September 30, 1997, compared with $1.6 million for the same period in
1996. This represents a decrease of 20% from the same period in the prior year.
For the nine months ended September 30, 1997 and 1996, research and development
expenses decreased 14% to $4.0 million from $4.6 million for the same period in
the prior year. Higher expenses in the prior year were due to greater research
and development activities focused on the final validation and qualification of
ForeRunner, and activities associated with obtaining regulatory approval to
manufacture, market and sell the Company's products. The Company expects
research and development expenses during the next several quarters to increase
over third quarter 1997 results as the Company undertakes development of new
products and product enhancements and works to improve existing production
processes of the ForeRunner AED.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Net interest income was $0.5 million for the three months ended September 30,
1997 compared to $0.7 million for the same period in 1996. This represents a
decrease of $0.2 million, or 30%. For the nine months ended September 30, 1997,
net interest income was $1.6 million, compared to $2.0 million for the same
period in 1996. Net interest income in 1997 has been directly affected by the
lower cash and investment balances during the year. Total cash and investments
has decreased each quarter since the Company's February 1996 initial public
offering of common stock as proceeds from the offering have been used to fund
operations.
Income Taxes
The Company has not generated any net income to date and therefore has not
paid any federal income taxes since inception. At September 30, 1997, the
Company had net operating loss carryforwards of approximately $36.0 million and
research and development credit carryforwards of approximately $0.3 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 $1.0 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 September 30, 1997, the CompanyOs cash, cash equivalents and securities
available-for-sale totaled $34.7 million, compared to $50.1 million at December
31, 1996. Cash used to fund operating activities was $14.9 million for the nine
months ended September 30, 1997 compared to $7.3 million for the nine months
ended September 30, 1996, reflecting increased inventory balances and net losses
principally related to increased sales and marketing expenditures. The Company
expects to continue to incur operating losses as it supports the growth of its
sales and marketing organization and undertakes new development activities.
Although the Company believes that its existing liquid assets and cash flows
from sales will be sufficient to fund its operations into 1999, there can be no
assurance that the Company will not require additional financing in the near
future or that additional financing will be available on satisfactory terms, if
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.
Fluctuations in Operating Results. The Company's results of operations will
depend upon numerous factors, including actions relating to regulatory matters,
the extent to which the Company's products gain market acceptance, increased
competition, and changes in pricing policies by the Company and its competitors.
Results of operations will also be affected by the size and timing of orders
received and the ability of its sales force and distributors to effectively
commercialize the Company's products. In addition, the mix of sales to
distribution partners versus sales by direct sales representatives may affect
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
operating results since sales to distribution partners generally are made at
lower prices and their timing is more difficult to predict. Based on these
factors, operating results may fluctuate significantly from quarter to quarter
and differ from expectations of public market analysts and investors.
History of Losses and Expectation of Future Losses. The Company was founded
in December 1992 and to date has generated limited revenues. At September 30,
1997, the Company had an accumulated deficit of approximately $36.8 million.
The Company expects to continue to incur operating losses into 1999 as it
increases market development activities, builds distribution channels, initiates
new research and development projects, seeks regulatory clearance for its
products in additional jurisdictions and increases administrative activities to
support growth of the Company. The Company has limited experience in
manufacturing, marketing and selling its products in commercial quantities and
there can be no assurance that the ForeRunner will ever gain broad commercial
acceptance or that the Company will ever achieve profitability.
Dependence Upon ForeRunner. The ForeRunner AED and its related accessories
are currently the CompanyOs only products. The Company expects that the
ForeRunner and its related accessories will account for substantially all of the
CompanyOs revenues for the foreseeable future. Accordingly, any problem or
disruption in the manufacturing, acceptance or sale of the ForeRunner AED and
its accessories could have a material adverse effect on the Company's business,
financial condition and results of operations.
Product Liability and Recall Risk; Limited Insurance Coverage. The
manufacture and sale of medical products entail significant risk of product
liability claims and product recalls. There can be no assurance that the
Company's existing insurance coverage limits are adequate to protect the Company
from any liabilities it might incur in connection with the sale of its product.
In addition, the Company may require increased product liability coverage as its
products are further commercialized. Such insurance is expensive and in the
future may not be available on acceptable terms, if at all. A successful
product liability claim or series of claims brought against the Company in
excess of its insurance coverage, or a recall of the Company's products, could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Uncertainty of Market Acceptance and Dependence on Market Development. The
Company's success is substantially dependent upon market acceptance of the
ForeRunner AED. Currently, all other commercially available AEDs utilize a
monophasic waveform and utilize 200 to 360 Joules of energy in delivering their
defibrillation therapy. These AEDs comply with the American Heart Association
("AHA") recommended guideline for external defibrillation therapy. The
Company's ForeRunner AED utilizes a biphasic waveform delivered at lower energy
levels. There can be no assurance that the market will broadly accept the
Company's lower energy biphasic waveform protocol. In addition, there can be no
assurance that ForeRunner will demonstrate product benefits or will achieve wide
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 emergency medical technician ("EMT") market, one of the
Company's target markets. 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
11
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
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 first responders who are generally
less trained than EMTs. Doing so may require significant sales and marketing
resources. There can be no assurance that the ForeRunner AED will gain broad
commercial acceptance or that market demand for the ForeRunner will be
sufficient to allow profitable operations.
Several states and foreign jurisdictions 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 physicians or other 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 most AEDs, including the ForeRunner. Accordingly, market
acceptance of the ForeRunner will be significantly dependent upon the Company's
ability to convince state, local and foreign government bodies and medical
directors of the safety and efficacy of the ForeRunner AED and its potential for
widespread deployment. There can be no assurance that restrictions on the use
of AEDs will be eased or removed.
Lengthy Customer Decision Processes. Because of budgetary and bureaucratic
constraints, the Company believes purchasing decisions of some of its customers,
particularly municipal accounts, may be characterized by long decision
processes. Accordingly, the Company's products may be subject to long sales
cycles.
Competition and Risk of Technological Obsolescence. The domestic and
international markets for external defibrillators are highly competitive, and
several of the Company's competitors have substantial installed bases of
products and significantly greater financial, technical, research and
development, or sales and marketing resources than the Company. Several of the
Company's competitors have been manufacturing defibrillators for many years and
may have greater name recognition 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 Laerdal Medical,
Inc. ("Laerdal") and Physio-Control International Corporation ("Physio-
Control"). Other competitors that sell products into this market segment
include SurVivaLink Corporation ("SurVivaLink"), and Zoll Medical, Inc.
Laerdal, Physio-Control and SurVivaLink have recently introduced new AEDs
targeted at markets similar to those targeted by the ForeRunner defibrillator.
The introduction of these or other similar products may cause pricing pressure
on the Company's existing products in order for the Company to remain
competitive in the market.
The Company believes that the principal competitive factors for AEDs in the
professional EMT and first responder market segments are ease of use, low
maintenance and training requirements, cost-effectiveness, size, safety and
reliability. The ForeRunner AED is designed to address all these factors.
However, there can be no assurance that the Company's products will compete
favorably with the products offered by its competitors, or that superior
defibrillation technologies will not be developed by these competitors or others
which may render the Company's technology or products obsolete or
noncompetitive. 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
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
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, products, or
products under development obsolete or noncompetitive.
Limited Sales, Marketing and Distribution Experience. The Company has limited
experience selling and marketing its product in domestic or international
markets. In the United States, the Company currently sells its products through
a direct sales force and distribution partners. The Company intends to expand
the size of its direct sales force during the remainder of 1997 and expects to
sign additional domestic distribution partners by the end of 1997. However,
competition for sales personnel is fierce and there can be no assurance that the
Company will be able to attract or retain qualified sales personnel. In
addition, there can be no assurance that the Company will be able to maintain
its current distribution partners or enter into additional domestic distribution
agreements. In international markets, the Company sells its products primarily
through distributors, and to date has entered into agreements with distributors
throughout the world. However, there can be no assurance that the Company's
distributors will devote adequate resources to selling the Company's products
over other products or will adequately train their sales force about the
Company's products. In addition, there can be no assurance that the Company's
sales and marketing organization will be cost-effective, or that the Company's
sales and marketing efforts will be successful.
Limited Manufacturing Experience. The Company performs final assembly,
testing, and inspection at its facility in Seattle, Washington. Due to limited
experience in manufacturing its products in commercial quantities, the Company
may encounter difficulties in manufacturing the ForeRunner AED, including
problems involving material requirements planning, production yields, quality
control and assurance, and scaling production capacity and other resources to
meet current and future demand for the product. Fluctuations in any of the
above factors could impact the Company's ability to manufacture its products in
a profitable manner.
Potential Component Shortages; Dependence on Sole Sources of Supply. The
Company manufactures its products based on forecasted product orders, and
purchases 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 have long lead times and have been in
short supply. The Company has acquired an inventory of certain 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.
The Company purchases some key components, such as the main energy storage
capacitor and the LCD display screen used in the ForeRunner AED, from sole
source suppliers. For certain components, including the ForeRunner's batteries
and microprocessors, there are relatively few sources of supply. In addition,
several of the subassemblies in the ForeRunner AED require the supplier to
perform extensive testing before the Company accepts the subassembly into its
final manufacturing process. These tests are specific to the design of
ForeRunner and if a supplier is unable to meet the Company's requirements, an
alternate supplier may be required. 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.
13
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Dependence Upon Patents and Proprietary Technology. As of September 30, 1997,
the Company had filed a total of 43 patent applications with the United States
Patent and Trademark Office, 21 of which had either been issued or allowed. In
addition, the Company had filed a total of 19 patent applications in foreign
jurisdictions, two of which have been issued. The Company's success will depend
in part on its ability to obtain additional 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 will continue 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 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
regardless of the outcome of such litigation.
The Company may from time to time rely on trade secrets and unpatented
proprietary technology in the improvement of its existing products and the
development of future products. While the Company generally enters into
confidentiality agreements with its employees and consultants to ensure the
Company's interests are protected, there can be no assurance that these 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.
Government Regulation. 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 and maintaining required regulatory approvals is lengthy,
expensive and uncertain.
As of September 30, 1997, the Company has received regulatory approvals to
market and sell the ForeRunner AED in 34 countries around the world. In order
for the Company to market the ForeRunner AED and its related accessories in
other foreign jurisdictions, the Company and its distributors and agents must
obtain the required regulatory approvals and clearances. These regulations vary
from country to country. There can be no assurance that the Company will obtain
regulatory approvals in such countries in a timely manner, if at all, or that
the Company will not be required to incur significant costs in obtaining or
maintaining its foreign regulatory approvals.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Regulatory approvals may include significant limitations on the indicated
uses for which the product may be marketed. In addition, the Company and its
distributors are required to comply with various regulations regarding product
quality and safety in order to maintain approvals. The Company's manufacturing
processes are required to comply with the 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. 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, delays in or
refusal of additional product approvals, withdrawal of existing approvals and
criminal prosecution.
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 personnel in the future. 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.
Possible Volatility of Stock Price. The stock market has from time to time
experienced significant price and volume fluctuations that are unrelated to the
operating performance of particular companies. These broad market fluctuations
may adversely affect the market price of the Company's common stock. In
addition, the market price of the Company's common stock is likely to be highly
volatile due to the Company's relatively recent introduction of its products.
Factors such as fluctuations in the Company's sales and operating results,
announcements of technological innovations, new products introduced by the
Company or its competitors, significant orders placed by new or existing
customers of the Company or its competitors, FDA and international regulatory
actions, developments with respect to patents or proprietary rights, public
concern as to the safety of products developed by the Company or others, changes
in health care policy in the United States and internationally, changes in stock
market analyst recommendations regarding the Company, other medical device
companies or the medical device industry generally and general market conditions
may have a significant effect on the market price of the common stock.
15
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In 1995, Physio-Control International 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 AED. These employees were founders of
Heartstream and former employees of Physio-Control. The complaint included
related allegations that the five employees breached proprietary information
agreements with Physio-Control. The Company filed counterclaims against Physio-
Control. In a separate case, in January 1997, the Company filed a lawsuit in
U.S. Federal District Court in Seattle against Physio-Control for infringement
of a patent relating to the Company's defibrillator self-test technology.
Physio-Control filed a counterclaim charging infringement of one of its patents
by the Company.
In October 1997, the Company and Physio-Control reached a mutually
satisfactory settlement of all outstanding litigation between the companies. As
a result of the settlement, all court actions filed by each company against the
other have been dismissed with prejudice, along with all counterclaims. The
effect of the settlement is not expected to have a material adverse effect on
the Company's business or financial position.
Item 2. Changes in Securities and Use of Proceeds
The following information is provided as an amendment to the initial report on
Form SR, "Report of Sales of Securities and Use of Proceeds Therefrom",
regarding the use of proceeds from the sale of securities under the Company's
Registration Statement on Form S-1 (No. 33-99908), which was declared effective
on January 31, 1996 (CUSIP number 421963109). The information provided is for
the period from January 31, 1996 through September 30, 1997:
<TABLE>
<CAPTION>
Use of Proceeds Amount
--------------- ------
<S> <C>
Construction of plant, building and facilities $ 0
Purchase and installation of machinery and equipment $ 1,766,000
Purchase of real estate $ 0
Acquisition of other business(es) $ 0
Repayment of indebtedness $ 589,000
Working capital $25,728,764
</TABLE>
All amounts represent estimates of direct or indirect payments of amounts to
third parties. No amounts were paid directly or indirectly for the above
purposes to directors or officers of the Company, to persons owning ten percent
or more of any class of equity securities of the Company, and to affiliates of
the Company. These amounts do not represent a material change in the use of
proceeds described in the offering prospectus.
<TABLE>
<CAPTION>
Temporary Investments Amount
--------------------- ------
<S> <C>
Cash and cash equivalents $13,304,000
Securities $ 8,491,891
</TABLE>
16
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.9A Amendment No. 1 to Employment Letter Agreement dated
April 3, 1997 between the Registrant and Alan J. Levy
11.1 Computation of Net Loss Per Share
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities 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)
Date November 6, 1997 /s/ Gary Onn
---------------------------- ---------------------------------
Gary Onn
Vice President, Finance and
Chief Financial Officer
(Principal Financial and Accounting Officer)
18
<PAGE>
HEARTSTREAM, INC.
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit No.
- -----------
<C> <S>
10.9A Amendment No. 1 to Employment Letter Agreement dated April 3, 1997
between the Registrant and Alan J. Levy
11.1 Computation of Net Loss Per Share
27.1 Financial Data Schedule
</TABLE>
19
<PAGE>
EXHIBIT 10.9A
AMENDMENT NO. 1 TO
EMPLOYMENT LETTER AGREEMENT
This Amendment No. 1 to Employment Letter Agreement (this "Amendment") is
made as of April 3, 1997 by and between Heartstream, Inc., a Delaware
corporation (the "Company"), and Alan J. Levy, Ph.D. (the "Employee").
WHEREAS, the parties have entered into that certain Employment Letter
Agreement dated November 8, 1993 (the "Original Employment Agreement"), which
provides certain terms of Employee's employment with the Company; and
WHEREAS, the parties desire to amend certain provisions of the Original
Employment Agreement, as more fully described below;
NOW, THEREFORE, in consideration of the foregoing recitals and for other
good and valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties agree as follows:
1. Section 10 of the Original Employment Agreement is amended to read in
its entirety as follows:
Your employment with and position on the Board of Directors of
Heartstream, Inc. is "at will." You or the Company may terminate your
employment at any time for any reason or no reason or cause
whatsoever. In the event the Company terminates your employment
without "cause" as defined below, or you become permanently disabled
as determined by the Board of Directors, you will be entitled to
continuation of your base salary, as well as medical benefits, for a
period of twelve (12) months or until you secure a new position,
whichever is sooner. If you secure a new position within the twelve
(12) month continuation period and receive compensation (base salary
plus bonuses) less than your ending compensation (base salary plus
bonuses) at Heartstream, Inc., the Company will pay you the difference
for the remaining portion of the twelve (12) month continuation
period. Stock options will not continue to vest after your termination
date.
If you resign or are terminated with cause, you will be entitled to
only the salary, bonus, benefits and stock options earned and vested,
as of the last date of your actual employment and no additional
severance pay or benefits of any kind will be provided.
<PAGE>
For purposes of this severance provision, "cause" means gross
negligence, gross misconduct, habitual neglect of duties, dishonesty,
criminal acts, violation of any state or federal securities laws or
failure to obey the lawful policies or instruction of the Board of
Directors.
2. In the event of a conflict between the Original Employment Agreement,
as amended by this Amendment, and the Change of Control Severance Agreement
dated June 11, 1997, by and between the Company and the Employee (the "Change of
Control Severance Agreement"), the terms of the Change of Control Severance
Agreement shall govern.
3. Except as expressly modified hereby, the Original Employment Agreement
shall remain in full force and effect in accordance with its original terms.
4. This Amendment shall be governed, construed and enforced in accordance
with the laws of California, without regard to principles of conflict of laws.
HEARTSTREAM, INC. ALAN LEVY, PH.D
By: /s/ MICHAEL LEVINTHAL /s/ ALAN LEVY
------------------------- --------------------------
Name: Michael Levinthal
-----------------------
Title: Board Member
----------------------
-2-
<PAGE>
EXHIBIT 11.1
HEARTSTREAM, INC.
COMPUTATION OF NET LOSS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------- ----------------------------
1997 1996 1997 1996
---------------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Net loss.................................................... $(3,731,783) $(3,388,642) $(11,999,930) $(8,259,163)
----------- ----------- ------------ -----------
Shares used in calculating historical net loss per share:
Weighted average shares outstanding........................ 11,776,024 11,530,046 11,731,464 10,308,602
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.................................................. -- -- -- 135,740
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........................................... -- -- -- 50,062
----------- ----------- ----------- -----------
Shares used in computation of historical net loss
per share.................................................. 11,776,024 11,530,046 11,731,464 10,494,404
----------- ----------- ------------ -----------
Historical net loss per share............................... $ (0.32) $ (0.29) $ (1.02) $ (0.79)
=========== =========== ============ ===========
Net loss............................................................................................................ $(8,259,163)
-----------
Shares used in calculating pro forma net loss per share:
Weighted average shares outstanding................................................................................ 10,308,602
Weighted average common shares giving effect to
the conversion of preferred stock into common
for all periods subsequent to issuance............................................................................ 680,258
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................................................................................................... 50,062
-----------
Shares used in computation of pro forma net loss
per share.......................................................................................................... 11,038,922
-----------
Pro forma net loss per share........................................................................................ $ (0.75)
===========
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Balance
Sheet at September 30, 1997 (unaudited), the Statement of Operations for the
nine months ended September 30, 1997 (unaudited) and the Statement of Cash Flows
for the nine months ended September 30, 1997 (unaudited), and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 19,994,502
<SECURITIES> 14,727,279
<RECEIVABLES> 2,005,146
<ALLOWANCES> 149,854
<INVENTORY> 4,194,909
<CURRENT-ASSETS> 885,069
<PP&E> 4,466,967
<DEPRECIATION> 2,152,490
<TOTAL-ASSETS> 43,971,528
<CURRENT-LIABILITIES> 3,065,478
<BONDS> 38,450
0
0
<COMMON> 11,790
<OTHER-SE> 40,855,810
<TOTAL-LIABILITY-AND-EQUITY> 43,971,528
<SALES> 6,306,264
<TOTAL-REVENUES> 6,306,264
<CGS> 4,034,119
<TOTAL-COSTS> 4,034,119
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 55,713
<INCOME-PRETAX> (13,639,980)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13,639,980)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,999,930)
<EPS-PRIMARY> (1.02)
<EPS-DILUTED> 0
</TABLE>
