<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
---------------------
FORM 10-Q
(X) Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarter ended June 30, 1998
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 0-24540
INCONTROL, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 91-1501619
- ------------------------------------------------ ----------------------------------------
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification Number)
organization)
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6675 - 185TH AVENUE N.E.
REDMOND, WA 98052-6734
(425) 861-9800
(Address and telephone number of registrant's principal executive offices)
---------------------
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 shorter periods that the registrant has been
required to file such reports), and (2) has been subject to filing requirements
for the past 90 days. Yes ( X ) No ( )
As of August 11, 1998, there were 20,974,122 shares of the registrant's $.01 par
value Common Stock and 2,999 shares of the registrant's $1,000 par value
convertible preferred stock outstanding.
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INCONTROL, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I
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PAGE NO.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements .....................................................................3
Consolidated Balance Sheets -
June 30, 1998 (unaudited) and December 31, 1997........................................3
Consolidated Statements of Operations -
three and six months ended June 30, 1998 and 1997 (unaudited)..........................4
Consolidated Statements of Cash Flows -
six months ended June 30, 1998 and 1997 (unaudited)....................................5
Notes to Consolidated Financial Statements (unaudited)....................................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..........................................8
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................12
PART II
PART II OTHER INFORMATION
Item 5. Other Information ........................................................................13
Item 6. Exhibits and Reports on Form 8-K..........................................................13
Signature ................................................................................14
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Page 2 of 15 sequentially numbered pages
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PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
INCONTROL, INC.
CONSOLIDATED BALANCE SHEETS
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JUNE 30,
1998 DECEMBER 31,
ASSETS (UNAUDITED) 1997
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Current assets:
Cash and cash equivalents $ 6,010,891 $ 2,336,703
Restricted cash 714,574 --
Securities available-for-sale -- 13,333,038
Trade accounts receivable, net 1,353,168 915,285
Inventories 3,085,513 2,492,583
Prepaid expenses and other current assets 797,326 964,424
------------- -------------
Total current assets 11,961,472 20,042,033
Property and equipment, net 7,773,953 7,835,514
Notes receivable from employees 816,042 801,042
Other assets 221,890 239,716
------------- -------------
Total assets $ 20,773,357 $ 28,918,305
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 702,023 $ 608,908
Accrued expenses 3,559,772 1,972,958
Current portion of long-term obligations 3,310,607 3,674,333
------------- -------------
Total current liabilities 7,572,402 6,256,199
Long-term obligations, less current portion 480,968 525,076
Commitments (Note 1) -- --
Designated Series B convertible preferred stock 7,475,331 --
Stockholders' equity:
Preferred stock, $1,000 par value:
Authorized shares--10,000,000;
Designated Series B issued and outstanding 7,500 at
June 30, 1998 and none at December 31, 1997 -- --
Common stock, $.01 par value:
Authorized shares--40,000,000;
Issued and outstanding shares--
19,193,661 at June 30,1998 and 18,775,864
at December 31, 1997 155,521,939 152,505,419
Accumulated deficit (150,106,394) (129,688,761)
Notes receivable from stockholders (167,000) (581,000)
Accumulated other comprehensive income/(loss) (3,889) (98,628)
------------- -------------
Total stockholders' equity 5,244,656 22,137,030
------------- -------------
Total liabilities and stockholders' equity $ 20,773,357 $ 28,918,305
============= =============
</TABLE>
See accompanying notes.
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INCONTROL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
-------------------------------- --------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
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Revenues $ 990,987 $ 301,737 $ 1,886,011 $ 612,485
Cost of revenues 627,740 258,517 1,233,439 484,406
------------ ------------ ------------ ------------
Gross profit 363,247 43,220 652,572 128,079
Expenses:
Research and development 6,584,308 5,525,307 13,151,334 11,027,302
Sales and marketing 1,413,069 1,150,710 2,978,874 2,201,249
General and administrative 1,769,231 1,256,909 2,981,900 2,527,449
Restructure charge 1,400,000 -- 1,400,000 --
------------ ------------ ------------ ------------
11,166,608 7,932,926 20,512,108 15,756,000
Interest income 131,329 387,823 293,564 899,366
Interest expense (79,150) (131,478) (294,321) (235,946)
------------ ------------ ------------ ------------
Net loss (10,751,182) (7,633,361) (19,860,293) (14,964,501)
Preferred dividend (557,340) -- (557,340) --
------------ ------------ ------------ ------------
Net loss applicable to common
shareholder $(11,308,522) $ (7,633,361) $(20,417,633) $(14,964,501)
============ ============ ============ ============
Net loss per share (Note 1) $ (0.59) $ (0.45) $ (1.08) $ (0.88)
============ ============ ============ ============
Shares used in computation of
net loss per share 19,157,906 17,090,747 18,983,627 17,011,349
============ ============ ============ ============
</TABLE>
See accompanying notes.
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INCONTROL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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SIX MONTHS ENDED JUNE 30,
1998 1997
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OPERATING ACTIVITIES:
Net loss $(19,860,293) $(14,964,501)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,529,128 1,386,110
Changes in operating assets and liabilities:
(Increase) decrease in trade accounts receivable,
prepaid expenses and other current assets 229,211 (445,450)
(Increase) decrease in inventories (592,930) (73,106)
Increase (decrease) in accounts payable and accrued
expenses 1,681,852 837,865
------------ ------------
Net cash used in operating activities (17,013,032) (13,259,082)
INVESTING ACTIVITIES:
Purchases of property and equipment (1,434,820) (3,257,530)
Loans to employees (15,000) (30,000)
Proceeds from collection of employee loans 5,000 20,000
Purchases of securities -- (1,169,911)
Proceeds from maturity of securities 9,731,000 15,863,623
Proceeds from sale of securities 3,186,392 --
------------ ------------
Net cash provided by investing activities 11,472,572 11,426,182
FINANCING ACTIVITIES:
Proceeds from lease financing 609,852 1,510,188
Payments on lease financing (1,015,744) (594,290)
Purchase of certificates of deposit (714,574) --
Proceeds from collection of stockholders' loans 414,000 79,000
Proceeds from sale of preferred stock, net of fees 7,402,386 --
Proceeds from sale of common stock, net of fees 2,445,887 --
Proceeds from exercise of stock options 86,238 95,161
------------ ------------
Net cash provided by financing activities 9,228,045 1,090,059
Effect of exchange rate changes on cash (13,397) (46,644)
------------ ------------
Net increase (decrease) in cash and cash equivalents 3,674,188 (789,485)
Cash and cash equivalents at beginning of period 2,336,703 4,287,617
------------ ------------
Cash and cash equivalents at end of period $ 6,010,891 $ 3,498,132
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH PAID:
Interest $ 333,686 $ 235,946
============ ============
</TABLE>
See accompanying notes.
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INCONTROL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
INTERIM FINANCIAL INFORMATION
The consolidated financial statements included herein have been prepared by
InControl, Inc. ("InControl" or the "Company") without audit, according to the
rules and regulations of the Securities and Exchange Commission (the
"Commission"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted pursuant to such rules and regulations. The
financial statements reflect, in the opinion of management, all adjustments,
which include only normal recurring adjustments, necessary to present fairly the
financial position and results of operations as of and for the periods
indicated.
The results of operations for the six-month period ended June 30, 1998 are not
necessarily indicative of results to be expected for the entire year ending
December 31, 1998 or for any other fiscal period.
CASH AND CASH EQUIVALENTS
Liquid investments with a purchased maturity of three months or less are
considered to be cash equivalents. Cash equivalents are stated at cost, which
approximate fair value.
RESTRICTED CASH
Restricted cash includes a three-month certificate of deposit, which is held to
satisfy a leasing agency's requirement to hold said investment as a compensating
balance for a current liability. In addition, the Company has cash which is
deposited and restricted for a three-month period as a compensating balance for
its leased European office space. Both deposits earn interest at the current
market rate.
INVENTORIES
Inventories are valued at the lower of cost (first in, first out method) or
market. Allowances are made for obsolete, unsalable, or unusable inventories.
The components of inventories are as follows:
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JUNE 30, DECEMBER 31,
1998 1997
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Raw materials $ 1,276,337 $ 1,498,530
Work in process 983,128 865,450
Finished products 1,329,426 967,714
----------- -----------
3,588,891 3,331,694
Reserves (503,378) (839,111)
----------- -----------
$ 3,085,513 $ 2,492,583
=========== ===========
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The Company purchases components and certain related peripheral equipment for
its products from outside vendors, including components from sole source
vendors. The establishment of additional or replacement sources of supply would
require the Company to certify the new vendors, which, in the case of certain
components, would cause a delay in the Company's ability to manufacture its
products.
COMMITMENTS
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In addition to lease commitments, in the normal course of business, the Company
has entered into certain agreements with vendors who have been contracted to
manufacture programmers and system analyzers. These agreements permit the vendor
to procure raw material for production once firm orders have been placed by the
Company and require the Company to pay for these raw materials in the event of
order cancellation. There is no guarantee that the raw materials procured based
upon firm orders would be of any value. Based upon firm orders placed to date,
the Company estimates that $1.8 million of raw material may have been procured
by the vendor.
Also, in the normal course of business, the Company enters into agreements with
certain vendors for services to be rendered. These agreements may include
certain termination fees or payments.
PREFERRED STOCK AND STOCKHOLDERS' EQUITY
In April 1998, the Company raised $10 million through two private financings. Of
the $10 million, $7.5 million was raised through the sale of convertible
preferred stock, which is redeemable under certain circumstances. The preferred
stock accrues dividends of $50 per annum per share, payable quarterly in cash or
in additional shares of preferred stock, at the option of the Company. At the
end of June, the Company's Board of Directors chose to pay the first quarterly
interest payment due July 15, 1998 in additional shares of preferred stock. As
of June 30, 1998, the amount has been reflected as a preferred dividend. The
preferred stock is convertible into common stock with certain restrictions at a
discount to the prevailing price of the common stock at the time of conversion.
This discount has also been reflected as a dividend to preferred shareholders.
The remaining funds were raised through the private sale of 400,000 shares of
common stock.
On June 30, 1998, the Board of Directors approved a stock option repricing
program pursuant to which employees of the Company who held options with
an exercise price of $3.00 or greater could elect to exchange their then
outstanding employee stock options for fewer new employee stock options having
an exercise price of $2.625 per share. A total of 2,233,541 options were
exchanged by employees under the program, resulting in 663,446 options being
granted at the new exercise price.
COMPREHENSIVE LOSS
As of January 1, 1998, the Company adopted Statement No. 130, "Reporting
Comprehensive Income" (FAS 130). FAS 130 establishes new rules for reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or stockholders'
equity. FAS 130 requires unrealized gains or losses on the Company's
available-for-sale securities and foreign currency translation adjustments,
which, prior to adoption, were reported separately in stockholders' equity, to
be included in other comprehensive income. Prior year financial statements have
been reclassified to conform to the requirements of FAS 130.
During the second quarter ended June 30, 1998 and 1997, total comprehensive loss
amounted to $10.8 million and $7.7 million, respectively.
Components of comprehensive loss for the three and six month periods ended June
30, 1998 and 1997 are as follows:
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THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
1998 1997 1998 1997
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Net loss $(10,751,182) $ (7,633,361) $(19,860,293) $(14,964,501)
Unrealized gain/(loss) on securities -- (166,833) (25,082) 43,703
Foreign currency translation (6,977) 116,476 119,817 (4,040)
------------ ------------ ------------ ------------
Comprehensive loss $(10,758,159) $ (7,683,718) $(19,765,558) $(14,924,838)
============ ============ ============ ============
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Components of accumulated other comprehensive loss at June 30, 1998 and December
31, 1997 are as follows:
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1998 1997
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Unrealized gain/(loss) on securities $ -- $ 25,078
Foreign currency translation (3,889) (123,706)
--------------- --------------
Comprehensive loss $ (3,889) $ (98,628)
=============== ==============
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The Company will incorporate this information into the Consolidated Statement of
Stockholders' Equity for the year ending December 31, 1998. Per share
calculations based upon comprehensive loss are not required.
BASIC AND DILUTED NET LOSS PER SHARE
Basic and diluted net loss per share are computed based upon the weighted
average number of shares of common stock outstanding. The effect of outstanding
options and warrants have been excluded from the calculation because they are
antidilutive.
NEW ACCOUNTING PRONOUNCEMENT
In 1997, the FASB issued Statement No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (FAS 131). FAS 131 replaces FASB Statement
No. 14, "Financial Reporting for Segments of a Business Enterprise" and is
effective for financial statements with fiscal years beginning after December
15, 1997. The Statement requires a company to report segment information based
upon how management internally evaluates operating performance of its business
segments. Segment information is not required to be reported in interim
financial statements in the first year of application. The Company intends to
adopt the disclosure requirements for FAS 131 for the year ending December 31,
1998 and does not expect its provisions to be significant.
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS
This discussion contains forward-looking statements that are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those projected. The words "believe", "expect", "intend", "anticipate",
variations of such words, and similar expressions identify forward-looking
statements, but their absence does not mean that the statement is not
forward-looking. These statements are not guarantees of future performance and
are subject to certain risks, uncertainties and assumptions that are difficult
to predict. Factors that could affect the Company's actual results include,
among other things, the availability of adequate funding, the progress and costs
of preclinical studies and clinical trials, the recruitment of suitable
patients, the timing of regulatory approvals, the rate of market acceptance and
the adoption of the METRIX System and related future products, the availability
of third-party reimbursement for the Company's products, the ability to obtain
and defend patent and intellectual property rights and to market the Company's
products and the status of competing products. Reference is made to the
Company's Annual Report on Form 10-K/A filed with the Commission for a more
detailed description of such factors. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date of
this report. InControl undertakes no obligation to update publicly any
forward-looking statements to reflect new information, events or circumstances
after the date of this report or to reflect the occurrence of unanticipated
events.
SUBSEQUENT EVENTS
On August 11, 1998, the Company and Guidant Corporation (including its
subsidiaries, "Guidant") announced that they had entered into an Agreement and
Plan of Merger on August 10, 1998 between Guidant, Pegasus Acquisitions Corp.
("Pegasus") and the Company (the "Merger Agreement") providing for the
acquisition of the Company by Guidant. Pursuant to the Merger Agreement, Guidant
has agreed to purchase each outstanding share of the Company's Common Stock,
$.01 par value per share (the "Common Stock"), at an offer price of $6.00 per
share (the "Offer Price"). To implement the Merger Agreement, Guidant has agreed
to commence a cash tender offer on or before August 17, 1998. The completion of
the tender offer is subject to a number of customary conditions, including the
acquisition of a majority of the Company's outstanding Common Stock on a fully
diluted basis and the expiration of the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act. Also on August 10, 1998, certain
of the Company's stockholders owning approximately 9.4% of the outstanding
shares of the Company's Common Stock entered into a Shareholder Agreement with
Guidant agreeing to tender their shares to Guidant and granting proxies to
representatives of Guidant to vote such shares.
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In the event that the tender offer is completed successfully, and subject to
certain customary conditions, Pegasus, an indirect wholly owned subsidiary of
Guidant, will be merged with and into the Company and the Company will continue
as the surviving corporation. As a result of the merger, each outstanding share
of the Company's Common Stock not tendered pursuant to the tender offer, if any,
will be converted into the right to receive cash in the amount of the Offer
Price, or such higher price as Guidant may pay pursuant to the tender offer.
There can be no assurance that the conditions to the tender offer will be
satisfied or waived, and, therefore, there can be no assurance that the tender
offer or the subsequent merger will be consummated on the terms provided in the
Merger Agreement, if at all. If the tender offer or the subsequent merger are
not consummated, the Company's stockholders will have no right to receive the
Offer Price pursuant to the tender offer or the Merger Agreement.
Also on August 10, 1998, the Company entered into a Credit Agreement by and
between the Company and Guidant (the "Credit Agreement"). Pursuant to the terms
of the Credit Agreement, Guidant has agreed to loan to the Company up to $10
million, provided that the facility will be increased to $15 million in the
event that Guidant breaches its obligations under the Merger Agreement. The
Company may request disbursements from Guidant in respect of the loan in amounts
not to exceed in the aggregate $3 million per month, provided certain customary
conditions are satisfied, provided that this amount may be exceeded in the event
the Company requires funds to redeem shares of its Series B Preferred Stock, pay
taxes or pay the fees of its financial advisors in connection with the merger.
The Company is required to repay the outstanding principal amount of the loan,
together with accrued interest, on February 19, 1999, unless Guidant breaches
its obligations under the Merger Agreement, in which event the maturity date
will be extended to August 19, 1999. Notwithstanding the foregoing, all amounts
owed under the loan will become immediately due and payable upon the occurrence
of a sale, lease exchange or transfer of all or substantially all of the assets
of the Company or upon the occurrence of an Event of Default, as defined in the
Credit Agreement. Moreover, Guidant may require, at its option, prepayment of
amounts due under the loan upon a Change of Control of the Company, as defined
in the Credit Agreement. The Company is entitled to prepay amounts due under the
loan at its option without penalty.
If the Company is unable to complete the merger with Guidant, the Company will
need to seek substantial additional funding in 1998, through either public or
private sources, to meet its future operational requirements. There can be no
assurance such funds will be available as needed or on terms that are acceptable
to the Company. If funding is insufficient at any time in the future, the
Company will be forced to delay, reduce or eliminate some or all of its research
and development activities, clinical studies and trials and manufacturing and
administrative programs, dispose of assets or technology, or cease operations.
On July 6, 1998, the Board of Directors approved a stock option
repricing program pursuant to which medical advisors and consultants of the
Company who held options with an exercise price of $3.00 or greater could elect
to exchange their then outstanding stock options for new stock options having
an exercise price of $2.438 per share. A total of 146,738 options were
exchanged on a one-for-one basis by medical advisors and consultants under the
program. On July 10, 1998, the Board of Directors of the Company approved a
similar stock option repricing program with respect to options held by the
Company's directors, whereby such directors who held options with an exercise
price of $3.00 or greater could elect to exchange their then outstanding stock
options for fewer new stock options having an exercise price of $2.75 per
share. A total of 412,072 options were exchanged by directors under this
program, resulting in 124,494 options being generated at the new exercise
price.
OVERVIEW
InControl is engaged in the design, development and manufacture of implantable
atrial defibrillators and related products, including transvenous defibrillation
leads, and temporary defibrillation catheters. The majority of the Company's
resources have been, and continue to be, devoted to research and development
activities related to the METRIX System, a proprietary system designed to treat
atrial fibrillation. The METRIX System is comprised of an implantable
defibrillator, transvenous leads to connect the defibrillator to the heart, a
system analyzer and a system programmer. The Company is also party to agreements
under which the Company distributes defibrillation and diagnostic catheters and
related products in certain geographic markets.
The following discussion contains forward-looking statements which are
based upon the assumption that the Company will continue as an independent
entity. Such statements are qualified in their entirety by the Company's plans
to complete the merger with Guidant, as described above.
The design and development of an implantable medical device has required
the Company to make significant investments in research and development a
ctivities since its incorporation in November 1990 and, as a result, the
Company has accumulated a deficit of $150.1 million as of June 30, 1998.
The Company expects to incur substantial additional losses in the near
future. The Company's independent auditors have included an explanatory
paragraph in their report covering the December 31, 1997 consolidated financial
statements, which expresses substantial doubt about the Company's ability to
continue as a going concern. The Company expects that revenues from clinical
trials and sales of the Company's products will increase, which will moderate
future deficit growth. Future increases in expenses are expected to be
primarily due to the Company's continuing investment in research and
development efforts, increases in clinical trial activities, the maintenance of
the European sales organization, the
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expansion of domestic marketing and sales capabilities and increasing domestic
manufacturing activity. The amount and timing of the Company's future revenues
and, accordingly, the amount and timing of the Company's future losses will be
affected by, among other things, the availability of adequate funding, the
progress and costs of preclinical studies and clinical trials, including the
recruitment of suitable patients, the timing of regulatory approvals, the rate
of market acceptance and the adoption of the METRIX System and related future
products, the availability of third-party reimbursement for the Company's
products, the ability to obtain and defend patent and intellectual property
rights and to market the Company's products and the status of competing
products. There can be no assurance that the Company will ever achieve
profitability or generate product revenues sufficient to offset the Company's
losses.
The Company believes that it will incur losses at least until the METRIX System
has gained market acceptance in the United States. Market acceptance of the
METRIX System in the United States is dependent on, among other things,
obtaining regulatory approval from the FDA for its commercial release, which is
in turn dependent on the success of the METRIX System clinical trials. There can
be no assurance that clinical trials will be successful. If the clinical trials
are successful and if the transactions contemplated by the Merger Agreement are
not consummated, the Company expects to file a Pre-Market Approval ("PMA")
application during the fourth quarter of 1998. There can be no assurance that
regulatory approval for the METRIX System will be obtained, or, if such approval
is obtained, that the METRIX System will achieve market acceptance in the United
States. In Europe, the Company has received the needed certifications required
in order to affix the CE mark to the METRIX System. While the CE mark allows the
Company to distribute and market the METRIX System throughout the European
Community (EC), the Company will need to complete studies regarding the cost
benefits and quality of life improvements of the therapy in order to be eligible
for reimbursement approvals from the medical reimbursing authorities in various
EC member countries. There can be no assurance that such approvals from
reimbursing authorities will be obtained in a timely manner, if at all. Even
with reimbursement approvals, there can be no assurance that the METRIX System
will achieve market acceptance in Europe.
RESULTS OF OPERATIONS
REVENUES
Net revenues were $991,000 for the quarter ended June 30, 1998. This represents
an increase of $689,000 or 228% over the comparable period in 1997. Of the
$991,000, $307,000 relate to revenues earned in the United States and $684,000
relate to revenues earned outside the United States. Revenues result from the
sale of METRIX devices, leads and accessories and distribution of catheters and
related products in Europe together with sales of METRIX Systems in clinical
investigations in the United States.
Revenues in future quarters will be dependent on the timing and outcome of
certain limited clinical studies required for European reimbursement approvals,
the success and timing of the Company's United States clinical trial activities
and the subsequent rate of market acceptance in the United States and Europe.
There can be no assurance, however, that such studies and trials will be
completed successfully or that the METRIX System will achieve market acceptance
in the United States or Europe.
GROSS PROFITS
Gross profits for the quarter ended June 30, 1998 totaled $363,000 or 37% of net
revenues. The 1997 comparable period totaled $43,000 or 14% of net revenues. The
Company's products are at an early stage in their product life cycles; current
cost of sales and gross profits therefore may not be indicative of future cost
of sales or gross profits.
The Company's cost of sales and gross profits are affected by many factors.
Currently, the Company has limited experience in manufacturing and is operating
at volumes well below expected facility capacity. These two factors give rise to
certain experience and capacity-related costs which the Company considers part
of its ongoing manufacturing development. Accordingly, the Company has charged
these expenses to research and development. The Company anticipates that in
future years, to the extent its products gain market acceptance, the Company's
sales volume and manufacturing experience will increase. As a result, these
manufacturing development costs will both decrease and be incorporated into cost
of revenues and, to that extent, will be excluded from research and development.
In addition, net revenues and, as a result, gross profits will be influenced by
sales discounts and
Page 10 of 15 sequentially numbered pages
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allowances that the Company may make during clinical trials or in connection
with the initial commercial release of the Company's products in the United
States. The Company's gross profits from European sales have been influenced by
sales discounts and allowances that the Company has offered on a situational
basis in connection with the commercial release of the METRIX System in Europe.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expense was $6.6 million and $5.5 million for the
quarters ended June 30, 1998 and 1997, respectively. The quarter-to-quarter
increase of $1.1 million or 20% over the comparable period last year is due to
the increase in personnel engaged in the design, development and primary
research associated with the current and next generations of atrial
defibrillation systems, the funding of preclinical and clinical trials and
expenditures associated with manufacturing development. Research and development
expenses in future periods will be primarily dependent on the level of personnel
the Company maintains in order to meet its objectives in primary research and
development activities associated with future atrial defibrillation products.
Research and development expense will also be affected by the level of activity
in preclinical studies and clinical trials in the United States and Europe.
Manufacturing development expenditures will continue to be a component of
research and development, but are expected to moderate in future periods as the
Company increases production volume and gains manufacturing experience.
SALES AND MARKETING EXPENSES
Sales and marketing expenses for the quarters ended June 30, 1998 and 1997 were
$1.4 million and $1.2 million, respectively. The increase is primarily related
to increased sales and marketing personnel. These additional personnel have been
hired to support the commercial release and ongoing distribution of the
Company's products in Europe. Sales and marketing expenses in future periods
will be primarily dependent on the number of sales and marketing personnel and
related activities in both the United States and Europe that the Company
maintains to support the sales and distribution of the Company's products.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the quarters ended June 30, 1998 and
1997 were $1.8 million and $1.3 million, respectively. The increase represents a
compensation charge of $513,000 associated with the write-off of certain AMT
loans. The Company expects general and administrative expense will reflect
overall Company employment and activity levels which will fluctuate from period
to period.
RESTRUCTURE CHARGE
In the second quarter of 1998, the Company refocused its operations and recorded
a restructure charge of $1.4 million to account for severance payments for
involuntary terminations, relocation of the European office and identified costs
relating to eliminating the Company's post-operative temporary atrial
defibrillation heartwires and certain third-party catheters sold by the Company.
Future costs incurred for these identified items will offset the liability,
which, as of June 30, 1998 was $1.2 million.
INTEREST INCOME AND INTEREST EXPENSE
Interest income was $131,000 and $388,000 for the quarters ended June 30, 1998
and 1997, respectively. The quarter-to-quarter decrease primarily is
attributable to the decrease in the average balances of cash, cash equivalents,
and securities available-for-sale resulting from the use of cash to fund
operations. Interest income will fluctuate with the average balances of cash,
cash equivalents, and securities available-for-sale, which in turn will
fluctuate with the success and timing of the Company's financing activities and
the rate resources are used to fund operations.
Interest expense was $79,000 and $131,000 for the quarters ended June 30, 1998
and 1997, respectively. The increase is primarily related to the increase in the
Company's average balance of equipment lease financing. Interest
Page 11 of 15 sequentially numbered pages
<PAGE> 12
expense in future periods will depend on the rate of capital expenditures and
the success and timing of the Company's efforts to secure additional sources of
lease financing for those expenditures.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1998, the Company had cash, cash equivalents, and securities
available-for-sale totaling $6.0 million, excluding certificates of deposit
restricted as to their use, compared to a balance of $15.7 million at December
31, 1997. The decrease of $9.7 million or 62% was used to fund $17.0 million in
operating activities, $1.4 million in purchases of property and equipment,
$715,000 in purchases of certificates of deposit, and $406,000 of payments, net
of proceeds, from lease financing. The cash outflows were partially offset by
proceeds, net of financing costs, of $9.8 million relating to two private
financings completed in the month of April 1998. During the comparable period in
1997, the Company funded $13.3 million in operating activities and $3.3 million
in purchases of property and equipment, both of which were partially offset by
net proceeds from lease financing of $916,000. As a result of the Company's
available cash, the Company has failed to comply with certain covenants
associated with its capital lease agreements. As a result, $1.6 million of the
amounts payable under these capital lease agreements have been classified as a
current liability in the accompanying consolidated financial statements.
In April, the Company raised $10 million (gross proceeds) through two private
financings. Of the $10 million, $7.5 million was raised through the sale of
convertible preferred stock, which is redeemable under certain circumstances.
The remaining funds were raised through the private sale of 400,000 shares of
common stock.
The Company estimates that, at its planned rate of spending, its existing cash,
cash equivalents, securities available-for-sale and interest income thereon,
including the $10 million in capital that was raised in April 1998 and the
funds available under the Company's $10 million credit agreement with Guidant,
will be sufficient to meet its capital requirements into the first quarter of
1999. Whether or not these assumptions prove to be accurate, if the Company is
unable to consummate the transactions contemplated by the Merger Agreement, the
Company will need to raise substantial additional capital in 1998 to fund
operations. If necessary, the Company intends to seek additional funding through
public or private financing, including equity financing. Adequate funds for
these purposes, whether obtained through financial markets or from other
sources, may not be available when needed or may not be available on terms
favorable to the Company, if at all. If additional funds are raised by issuing
equity securities, dilution to existing stockholders will result. If funding is
insufficient at any time in the future, the Company will be forced to delay,
reduce or eliminate some or all of its research and development activities,
clinical studies and trials and manufacturing and administrative programs,
dispose of assets or technology, or cease operations.
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs or products that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
a system failure or miscalculations causing disruptions in the Company's
operations or potential problems with its products.
The Company has begun an assessment of its software, key suppliers and products
to determine whether the Company faces any business or financial risk from the
Year 2000 issue. Inquiries to the Company's software vendors have revealed no
problems and the Company plans to test these vendors' assertions, before the
year 2000. The Company is also planning to inquire with key component suppliers
to verify that supplies of raw material components will not be at risk from this
problem. If tests of the Company's software reveal Year 2000 compliance problems
or any of the Company's key components suppliers do not successfully and in a
timely manner achieve Year 2000 compliance, the Company's business or operations
could be adversely affected. The Company believes its products are not subject
to this problem, with certain Programmers needing only minor adjustments in the
year 2000.
Page 12 of 15 sequentially numbered pages
<PAGE> 13
These minor adjustments can be done by the Company's field clinical engineers.
Based on these early indications from the Company's assessment, there appears to
be no material business or financial risk to the Company.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
PART II: OTHER INFORMATION
ITEM 5: OTHER INFORMATION
In accordance with the Company's Bylaws, a shareholder proposing to transact
business at the Company's annual meeting must provide written notice of such
proposal, in the manner provided by the Company's Bylaws, no later than 60 days
prior to the date of such annual meeting (or, if the Company provides less then
60 days notice of such meeting, no later than 10 days after the date of the
Company's notice). The Securities and Exchange Commission (the "SEC") recently
amended Rule 14a-4, which governs the use by the Company of discretionary voting
authority with respect to shareholder proposals. SEC Rule 14a-4(c)(1) provides
that, if the proponent of a shareholder proposal fails to notify the Company at
least 45 days prior to the month and day of mailing the prior year's proxy
statement, the proxies of the Company's management would be permitted to use
their discretionary authority at the Company's next annual meeting of
shareholders if the proposal were raised at the meeting without any discussion
of the matter in the proxy statement. For purposes of the Company's 1999 Annual
Meeting of Shareholders, this deadline is February 10, 1999.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit No.
27.1 Financial Data Schedule
b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, as amended by
Form 8-K/A No. 1, Form 8-K/A No. 2 and Form 8-K/A No. 3, dated April 20, 1998,
with respect to the sale and issuance of 7,500 shares of its Series B
Convertible Preferred Stock at $1,000 per share, pursuant to an exemption from
registration provided by Regulation D promulgated by the Securities and Exchange
Commission under the Securities Act of 1933, as amended.
The Company filed a Current Report on Form 8-K, dated June 28, 1998,
with respect to its election not to exercise its rights under the Letter
Agreement between Advantage Fund II Ltd. and InControl, Inc., dated April 16,
1998 providing for the issuance and sale of an additional 7,500 shares of
Series B Convertible Preferred Stock.
No other reports on Form 8-K were filed during the quarter ended June 30, 1998.
Page 13 of 15 sequentially numbered pages
<PAGE> 14
SIGNATURE
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.
INCONTROL, INC.
(Registrant)
Dated: August 14, 1998 By: /s/ Philip A. Okeson
-------------------------- ---------------------------------------
Philip A. Okeson
Chief Financial Officer, Treasurer and
Secretary (Authorized Officer and
Principal Financial Officer)
Page 14 of 15 sequentially numbered pages
<PAGE> 15
EXHIBIT INDEX
Exhibits
Exhibit No.
-----------
27.1 Financial Data Schedule
Page 15 of 15 sequentially numbered pages
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<MULTIPLIER> 1,000
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 6,725
<SECURITIES> 0
<RECEIVABLES> 1,802
<ALLOWANCES> 449
<INVENTORY> 3,086
<CURRENT-ASSETS> 11,961,472
<PP&E> 18,332
<DEPRECIATION> (10,558)
<TOTAL-ASSETS> 20,773
<CURRENT-LIABILITIES> 7,572
<BONDS> 481
0
7,475
<COMMON> 155,522
<OTHER-SE> (150,277)
<TOTAL-LIABILITY-AND-EQUITY> 20,773
<SALES> 1,886
<TOTAL-REVENUES> 1,886
<CGS> 1,233
<TOTAL-COSTS> 1,233
<OTHER-EXPENSES> 20,512
<LOSS-PROVISION> 316
<INTEREST-EXPENSE> 294
<INCOME-PRETAX> (19,860)
<INCOME-TAX> 0
<INCOME-CONTINUING> (19,860)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (20,418)
<EPS-PRIMARY> (1.08)
<EPS-DILUTED> (1.08)
</TABLE>
