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ENDOCARDIAL SOLUTIONS INC
10-Q, 2000-08-03
SURGICAL & MEDICAL INSTRUMENTS & APPARATUS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

/x/	Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2000
/ /	Transition Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the transition period from                 to               .

Commission File No. 0-22233

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Endocardial Solutions, Inc.
(Exact name of registrant as specified in its charter)

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    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 twelve (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 / /

    Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

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INDEX
Endocardial Solutions, Inc.

				Page No.
PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)
		Balance Sheets—June 30, 2000 and December 31, 1999		3
		Statements of Operations—Three and six months ended June 30, 2000 and June 30, 1999		4
		Statements of Cash Flows—Three and six months ended June 30, 2000 and June 30, 1999		5
		Notes to Financial Statements		6
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations		7-9
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		9
PART II. OTHER INFORMATION
Items 1, 3 and 5 have been omitted since all items are inapplicable or answers negative.
Item 2.		Changes in Securities and Use of Proceeds		10
Item 4.		Submission of Matters to a Vote of Security Holders		10
Item 6.		Exhibits and Reports on Form 8-K		10

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Endocardial Solutions, Inc.

Balance Sheets

				June 30, 2000			December 31, 1999
				(Unaudited)			(Note)
ASSETS
Current Assets:
	Cash and cash equivalents			$	11,773,236		$	1,770,980
	Short-term investments				2,277,250			5,315,806
	Accounts Receivable				4,901,433			3,731,917
	Inventories				3,442,808			2,806,965
	Prepaid expenses and other current assets				493,163			604,770
Total current assets					22,887,890			14,230,438
Furniture and equipment					6,056,384			5,408,709
Less accumulated depreciation					(2,985,764	)		(2,426,976	)
					3,070,620			2,981,733
Deposits					40,174			40,174
Patents, net of accumulated amortization (2000—$96,591; 1999—$89,989)					27,811			27,093
Software development costs, net of accumulated amortization (2000—$44,029; 1999—$0)					748,486			298,548
Total assets				$	26,774,981		$	17,577,986
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
	Accounts payable			$	1,675,494		$	1,691,426
	Accrued salaries and expenses				1,398,124			1,739,427
	Current portion of capital lease obligations				504,435			680,598
	Current portion of long-term debt				7,000,000			—
	Current portion of deferred revenue				569,828			419,327
Total current liabilities					11,147,881			4,530,778
Long-term Liabilities:
	Capital lease obligations				886,387			1,064,339
	Long-term debt				—			3,500,000
	Deferred revenue				206,712			229,297
Stockholders' equity:
	Undesignated Preferred Stock, par value $.01 per share:
		Authorized shares—10,000,000
		Issued and outstanding shares—none			—			—
	Common Stock, $.01 par value
		Authorized shares—40,000,000
		Issued and outstanding shares—June 30, 2000—12,217,891; December 31, 1999—10,185,183			122,179			101,852
	Additional paid-in capital				71,772,958			59,877,434
	Accumulated deficit				(57,335,899	)		(51,696,024	)
	Deferred compensation				(25,237	)		(29,690	)
Total stockholders' equity					14,534,001			8,253,572
Total liabilities and stockholders' equity				$	26,774,981		$	17,577,986

Note: The balance sheet at December 31, 1999 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

See accompanying notes.

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Endocardial Solutions, Inc.

Statements of Operations

(Unaudited)

				For the Three Months Ended						For the Six Months Ended
				June 30, 2000			June 30, 1999			June 30, 2000			June 30, 1999
Revenue				$	3,737,131		$	1,719,053		$	7,097,189		$	3,012,435
	Cost of goods sold				1,929,316			1,411,825			3,804,991			2,853,744
Gross profit					1,807,815			307,228			3,292,198			158,691
Operating expenses:
	Research and development				1,165,236			1,342,020			2,227,645			2,707,001
	General and administrative				533,924			528,724			1,067,443			1,004,273
	Sales and marketing				3,147,878			2,168,768			5,501,670			3,147,309
Operating loss					(3,039,223	)		(3,732,284	)		(5,504,560	)		(6,699,892	)
Other income (expense):
	Interest income				76,505			86,525			202,043			199,602
	Interest expense				(174,743	)		(104,561	)		(337,358	)		(163,112	)
					(98,238	)		(18,036	)		(135,315	)		36,490
Net loss for the period				$	(3,137,461	)	$	(3,750,320	)	$	(5,639,875	)	$	(6,663,402	)
Net loss per share—basic and diluted				$	(0.31	)	$	(0.41	)	$	(0.55	)	$	(0.74	)
Weighted average shares outstanding					10,201,284			9,050,375			10,193,233			9,037,003

See accompanying notes.

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Endocardial Solutions, Inc.

Statements of Cash Flows

(Unaudited)

				For the Three Months Ended						For the Six Months Ended
				June 30, 2000			June 30, 1999			June 30, 2000			June 30, 1999
Operating activities
Net loss				$	(3,137,461	)	$	(3,750,320	)	$	(5,639,875	)	$	(6,663,402	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization				367,862			188,256			610,317			364,453
	Amortization of deferred compensation				2,227			23,198			4,454			46,394
	Loss on disposal of equipment				1,394			—			1,394			—
	Changes in operating assets and liabilities:
		Accounts Receivable			(1,707,873	)		(726,446	)		(1,169,516	)		(1,181,895	)
		Inventory			(373,205	)		(16,580	)		(635,843	)		(117,826	)
		Prepaid expenses and other assets			494,868			(156,657	)		111,606			(177,967	)
		Accounts payable			(72,727	)		409,490			(129,542	)		817,059
		Accrued salaries and expenses			248,807			343,208			(227,692	)		160,849
		Deferred revenue			24,404			153,089			127,915			210,495
Net cash used in operating activities					(4,151,704	)		(3,532,762	)		(6,946,782	)		(6,541,840	)
Investing activities
Purchases of short-term investments					19,475			(1,952,143	)		(1,016,444	)		(3,950,873	)
Maturities of short-term investments					2,555,000			5,805,000			4,055,000			8,515,000
Purchases of furniture and equipment					(430,092	)		(136,492	)		(652,167	)		(223,132	)
Patent expenditures					(7,320	)		—			(7,320	)		—
Software development costs					(210,678	)		—			(493,967	)		—
Proceeds from sale of equipment					2,200			—			2,200			—
Net cash used in investing activities					1,928,585			3,716,365			1,887,302			4,340,995
Financing activities
Proceeds from notes payable					—			—			3,500,000			3,500,000
Principal payments on notes payable and capital lease obligations					(193,663	)		(338,365	)		(354,115	)		(498,679	)
Proceeds from issuance of common stock					11,915,851			8,673			11,915,851			12,829
Net cash provided by (used in) financing activities					11,722,188			(329,692	)		15,061,736			3,014,150
Increase (decrease) in cash and cash equivalents					9,499,069			(146,089	)		10,002,256			813,305
Cash and cash equivalents at beginning of period					2,274,167			1,613,923			1,770,980			654,529
Cash and cash equivalents at end of period				$	11,773,236		$	1,467,834		$	11,773,236		$	1,467,834
Supplemental disclosure of non-cash investing and financing activities
Purchase of equipment and inventory through capital lease obligations				$	—		$	491,440		$	—		$	730,691

See accompanying notes.

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Endocardial Solutions, Inc.
Notes to Financial Statements
(Unaudited)

1. Basis of Presentation

    The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Due to the Company's full market release in Europe in the third quarter 1998, the Company is no longer considered to be in the development stage. Operating results for the three and six months ended June 30, 2000, are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. These financial statements should be read in conjunction with the audited financial statements and accompanying notes for the fiscal year ended December 31, 1999, contained in the Company's Form 10-K.

2. Inventories

    Inventories are carried at the lower of cost (first-in, first-out basis) or market. The majority of inventory consists of purchased components. To determine the technological feasibility of its software efforts, the Company utilizes the working model approach available under SFAS No. 86 and believes that the working model was achieved when the software was available for commercial use in June 1998.

3. Reclassifications

    Certain prior year items have been reclassified to conform to current year presentations.

4. Stock Offering

    In July 1999, the Company received proceeds of $10,000,000 from a private placement of 1,111,111 shares of its common stock at a price of $9.00 per share, to accredited investors. In June 2000, the Company received proceeds of $12,687,500 from a private placement of 2,030,000 shares of its common stock at a price of $6.25 per share, to accredited investors.

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

General

    Endocardial Solutions Inc. (the "Company"), was incorporated in May 1992. The Company develops, manufactures and markets the EnSite 3000® clinical workstation and EnSite® catheter for use by electrophysiologists in diagnosing and mapping abnormal heart rhythms known as arrhythmias. The EnSite 3000 clinical workstation and EnSite catheter received FDA approval for right atrial use in the U.S. during the second quarter 1999. Through a distribution agreement with Medtronic, Inc., the products are available in full market release to electrophysiologists in Europe and Canada.

Results of Operations

    General.  Net losses decreased to $3,137,461, or $.31 per share, for the three months ended June 30, 2000, as compared to $3,750,320, or $.41 per share, for the same period in 1999. Net losses for the six months ended June 30, 2000 were $5,639,875, or $.55 per share, compared to $6,663,402, or $.74 per share, for the same period in 1999. The Company expects losses to continue through mid-2001. The Company is in a period of growth in sales and marketing expenses related to market introduction, including increases in personnel costs.

    Revenue and Cost of Goods Sold.  The Company began recording revenue in the U.S. in the second quarter of 1999 and in Europe during the second quarter 1998. Revenue for the three months ended June 30, 2000 was $3,737,131, compared with revenues of $1,719,053 for the same period in 1999. Revenue for the six months ended June 30, 2000 was $7,097,189, compared to $3,012,435 for the same period in 1999. Revenues include the sale of the Company's EnSite® catheter and EnSite 3000® clinical workstation, including the Company's proprietary software, patient interface unit and other peripherals.

    Cost of goods sold including unabsorbed manufacturing expenses was $1,929,316 and $1,411,825 for the quarters ended June 30, 2000 and 1999, respectively. For the six months ended June 30, 2000, cost of goods sold was $3,804,991, compared to $2,853,744 during the same period in 1999. With the market release of the Company's Clarity™ software starting in June 2000, capitalized software development costs are being amortized through cost of goods sold over the expected 18 month product life cycle.

    The gross profit margin was 48.4% for the three months ended June 30, 2000, compared with 16.0% during the same period in 1999. The gross profit margin for the six months ended June 30, 2000 and 1999 was 46.4% and 5.3%, respectively. The increase in margins for the three and six-month periods ended June 30, 2000 compared to the same periods in 1999 is directly attributable to the Company having a full six months, to date, of U.S. sales in 2000, compared to only a months' worth of U.S. sales in 1999.

    Research and Development Expenses.  Research and development expenses include compensation and benefit costs within the clinical, software, hardware, catheter and applied research departments as well as costs associated with regulatory expenses. Research and development expenses were $1,165,236 for the three month period ended June 30, 2000, compared to $1,342,020 during the same period in 1999, a decrease of $176,784. Expenses for the six months ended June 30, 2000 were $2,227,645, compared to $2,707,001 during the same period in 1999, a decrease of $479,356. The decrease is attributable to the capitalization after reaching technological feasibility, of software development costs related to the Clarity™ release. For the three and six months ended June 30, 1999, all software development costs have been expensed. The Company believes research and development expenditures will increase slightly for the remainder of 2000.

    General and Administrative Expenses.  General and administrative expenses were $533,924 and $528,724 for the three months ended June 30, 2000 and 1999, respectively, an increase of $5,200. Expenses for the six months ended June 30, 2000 were $1,067,443, compared to $1,004,273 during the same period in 1999, an increase of $63,170. The increase is due primarily to an increase in personnel costs.

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    Sales and Marketing Expenses.  Sales and marketing expenses were $3,147,878 during the three months ended June 30, 2000, and $2,168,768 during the same period in 1999, an increase of $979,110. Expenses for the six months ended June 30, 2000 were $5,501,670, compared to $3,147,309 during the same period in 1999, an increase of $2,354,361. The increase is primarily attributable to increases in personnel and costs associated with building and training of the U.S. sales and clinical team. As the Company continues to penetrate the U.S. market, increases in sales and marketing expenses are expected in the next two quarters, as it adds additional headcount in both its selling and field clinical engineering areas.

    Interest Income.  Interest income was $76,505 and $86,525 for the three months ended June 30, 2000 and 1999, respectively. Interest income for the six months ended June 30, 2000 was $202,043, compared to $199,602 during the same period in 1999. The decrease for the three months ended June 30, 2000 was due to lower average balances.

Liquidity and Capital Resources.

    As of June 30, 2000 and December 31, 1999, the Company had cash, cash equivalents and short-term investments of approximately $14,050,486 and $7,086,786, respectively.

    The Company announced a financing agreement with Medtronic, Inc. during the first quarter 1999. Under the agreement, the Company received $7 million from Medtronic Asset Management, which is repayable by February 2001 or, if earlier, at the close of a significant round of debt or equity financing. During the first quarter 1999, $3.5 million was received as part of this financing agreement. The remaining $3.5 million was received during the first quarter 2000.

    In July 1999, the Company received proceeds of $10,000,000 from a private placement of 1,111,111 shares of its common stock to accredited investors. The placement was priced at $9.00 per share. In August 1999, these shares were registered pursuant to the Securities Act of 1933.

    In June 2000, the Company received proceeds of $12,687,500 from a private placement of 2,030,000 shares of its common stock to accredited investors. The placement was priced at $6.25 per share. In July 2000, these shares were registered pursuant to the Securities Act of 1933.

    The Company believes that its existing cash, cash equivalents, short-term investments and bank financing will be sufficient to fund the operations of the Company through early 2001. The Company's future liquidity and capital requirements will depend on numerous factors, including the timing of regulatory actions regarding the Company's products, the results of clinical trials and competition, the extent to which the Company's EnSite System gains market acceptance, the costs and timing of expansion of sales, marketing and manufacturing activities and the ability of the Company to obtain bank financing.

Cautionary Statement

    Except for the historical information contained herein, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in this Form 10-Q and in future filings by the Company with the Securities and Exchange Commission, in the Company's press releases and in oral statements made with the approval of an authorized executive officer, the word or phrases "believes," "anticipates," "expects," "intends," "will likely result," "estimates," "projects" or similar expressions are intended to identify such forward-looking statements, but are not the exclusive means of identifying such statements. These forward-looking statements involve risks and uncertainties that may cause the Company's actual results to differ materially from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, the following: risks associated with the successful development and commercialization of a new technology: continued clinical testing experience; uncertainty of obtaining Food and Drug Administration and international regulatory clearances; uncertainty of availability of treatments employing the Company's EnSite system;

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uncertainty of market acceptance of the EnSite System; training requirements for electrophysiologists; the uncertainty of the ability to diagnose and treat atrial fibrillation; the expectation of future losses; significant competition and rapid technological change in the tachycardia diagnostic market; risks associated with the Company's dependence on patents and proprietary technology; risks associated with the Company's limited manufacturing experience and dependence on suppliers; and the uncertainty of third-party reimbursement for diagnostic medical procedures employing the EnSite System. These factors are discussed in the cautionary statements included in Exhibit 99 to this Form 10-Q for the quarter ended June 30, 2000. Other forward looking statements are found in the Company's disclosures about market risk. The Company cautions investors and others to review the statements set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations, Exhibit 99 and in the Company's other reports filed with the Securities and Exchange Commission and that other factors may prove to be important in affecting the Company's business and results of operations.

Item 3. Qualitative and Quantitative Disclosures about Market Risk.

    The Company had approximately $14 million of cash and investments on June 30, 2000. Substantially all of the investments were U.S. government or investment grade, fixed income securities from domestic issuers. Because of the credit risk criteria of the Company's investment policies, the primary market risk associated with these investments is interest rate risk. The Company does not use derivative financial instruments to manage interest rate risk or to speculate on futures changes in interest rates. A rise in interest rates could negatively affect the fair value of the Company's investments; however, because management considers it unlikely that the Company would need or choose to substantially liquidate the Company's investments, management believes that such an increase in interest rates would not have a material impact on the Company's future earnings or cash flows. Even though the Company distributes products abroad, the Company does not conduct sales in foreign currencies. Therefore, management does believe that Company is exposed to any material foreign currency exchange rate risk.

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Part II. OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds

    In June 2000, the Company completed the sale in a private placement of 2,030,000 shares of its common stock to accredited investors at a price of $6.25 per share, for proceeds of $12,687,500. In July 2000, these shares were registered pursuant to the Securities Act of 1933. Proceeds from the sale of shares will be used for general working capital, including expenses associated with U.S. market introduction, clinical trials and research and development.

Item 4. Submission of Matters to a Vote of Security Holders

    The Annual Meeting of the Company's stockholders was hold on May 23, 2000. At the meeting, stockholders voted on the reelection of two directors for terms expiring at the Annual Meeting of the Company in 2003. Each of the directors was reelected by a vote as follows: James E. Daverman received 6,293,990 "For" and 5,093 "Withheld"; Richard D. Randall received 6,294,990 "For" and 4,093 "Withheld".

Item 6. Exhibits and Reports on Form 8-K

    (a) Exhibits

Exhibit		Description
10.1		Form of Stock Purchase Agreement dated June 27, 2000, among the Company and the Investors named therein.
27		Financial Data Schedule (EDGAR filing only)
99		Cautionary Statement for purposes of the "Safe Harbor" provisions of the Private Securities Litigation Reform Act of 1995.

    (b) Reports

    No reports on Form 8-K were filed by the Company during the quarter ended June 30, 2000.

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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.

		ENDOCARDIAL SOLUTIONS, INC.
Dated:  August 2, 2000		By:	/s/ JAMES W. BULLOCK    James W. Bullock President and Chief Executive Officer (Principal Executive Officer)
Dated:  August 2, 2000		By:	/s/ JAMES W. BULLOCK    James W. Bullock Chief Financial Officer (Principal Financial and Accounting Officer)

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Endocardial Solutions, Inc. Notes to Financial Statements (Unaudited)
SIGNATURES

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