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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
    FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to Commission File Number
0-22233    ENDOCARDIAL SOLUTIONS, INC.  Delaware
    
    41-1724963(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)1350 Energy Lane, Suite 110,St. Paul, MN
    
    55108(Address of principal executive offices)
    
    (Zip Code)
 (651) 523-6900
(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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes þ No o As of May 4, 2004 the number of shares outstanding of the registrants
common stock, par value $.01 per share, was 21,947,360.




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INDEX Endocardial Solutions, Inc.  
 PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated
Balance SheetsMarch 31, 2004 and December 31, 2003Consolidated
Statements of OperationsThree months ended March 31,
2004 and 2003Consolidated
Statements of Cash FlowsThree months ended March 31,
2004 and 2003Notes to Consolidated Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and
Results of OperationsItem 3. Quantitative and Qualitative Disclosures about Market RiskItem 4. Controls and ProceduresPART II. OTHER INFORMATIONItems 1 through 5 have been omitted since all items are inapplicable or
answers negative.Item 6. Exhibits and Reports on Form 8-KCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  2




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PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements Endocardial Solutions, Inc. 
 Consolidated Balance Sheets As of March 31,
    
    As of December 31,2004
    
    2003(Unaudited)AssetsCurrent Assets:Cash and cash equivalents
    
    $
    6,826,383
    
    
    $
    10,216,385Accounts
receivable, net of allowance for doubtful accounts (2004 
$151,996; 2003  $151,996)
    
    
    12,238,379
    
    
    
    10,378,401Inventories
    
    
    4,065,599
    
    
    
    4,075,747Prepaid expenses and other current assets
    
    
    1,437,130
    
    
    
    1,435,102Total Current Assets
    
    
    24,567,491
    
    
    
    26,105,635Furniture and equipment
    
    
    9,702,454
    
    
    
    9,331,606Less accumulated depreciation
    
    
    (6,835,933
    )
    
    
    (6,628,801
    )2,866,521
    
    
    
    2,702,805Deposits
    
    
    50,939
    
    
    
    51,179Notes receivable
    
    
    206,226
    
    
    
    206,226Other assets
    
    
    647,748
    
    
    
    624,760Intangible
assets, net of accumulated amortization (2004  $141,486; 2003
 $125,266)
    
    
    581,152
    
    
    
    585,032Total assets
    
    $
    28,920,077
    
    
    $
    30,275,637Liabilities and stockholders equityCurrent Liabilities:Accounts payable and accrued expenses
    
    $
    3,962,174
    
    
    $
    5,683,372Bank line of credit
    
    
    1,000,000
    
    
    
    1,000,000Current portion of capital lease obligations
    
    
    286,917
    
    
    
    318,011Current portion of deferred revenue
    
    
    2,786,903
    
    
    
    2,634,751Total Current Liabilities
    
    
    8,035,994
    
    
    
    9,636,134Long-Term liabilities:Capital lease obligations
    
    
    
    
    
    
    63,956Deferred revenue
    
    
    270,656
    
    
    
    262,282Total Long-Term liabilities
    
    
    270,656
    
    
    
    326,238Stockholders equity:Undesignated preferred stock, par value $0.1 per share:Authorized
shares  10,000,000Issued and outstanding shares  none
    
    
    
    
    
    
    Common stock, $0.01 par value:Authorized
shares  40,000,000Issued and
outstanding shares  March 31, 2004  21,944,121;
December 31, 2003  21,597,241
    
    
    218,440
    
    
    
    215,972Additional paid-in capital
    
    
    106,371,172
    
    
    
    104,680,168Accumulated deficit
    
    
    (85,181,159
    )
    
    
    (84,956,006
    )Accumulated other comprehensive income
    
    
    285,054
    
    
    
    486,525Deferred compensation
    
    
    (1,080,080
    )
    
    
    (113,394
    )Total stockholders equity
    
    
    20,613,427
    
    
    
    20,313,265Total liabilities and stockholders equity
    
    $
    28,920,077
    
    
    $
    30,275,637
 See accompanying notes. 3




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Consolidated Statements of Operations
(Unaudited) For the Three Months Ended March 31,2004
    
    2003Revenue
    
    $
    10,604,609
    
    
    $
    7,291,744Cost of Goods Sold
    
    
    3,546,083
    
    
    
    2,415,004Gross Margin
    
    
    7,058,526
    
    
    
    4,876,740Operating Expenses:Research and Development
    
    
    1,167,216
    
    
    
    1,545,370General and Administrative
    
    
    708,308
    
    
    
    747,229Sales and Marketing
    
    
    5,341,239
    
    
    
    4,707,383Total Operating Expenses
    
    
    7,216,763
    
    
    
    6,999,982Operating Loss
    
    
    (158,237
    )
    
    
    (2,123,242
    )Other Income/(Expense)Interest Income
    
    
    7,778
    
    
    
    11,405Interest Expense
    
    
    (28,788
    )
    
    
    (28,866
    )Other
    
    
    (45,906
    )
    
    
    (21,204
    )Total Other Income/(Expense)
    
    
    (66,916
    )
    
    
    (38,665
    )Net Loss
    
    $
    (225,153
    )
    
    $
    (2,161,907
    )Net loss per share  basic and diluted
    
    $
    (0.01
    )
    
    $
    (0.11
    )Weighted average shares outstanding
    
    
    21,826,072
    
    
    
    19,584,300
 See accompanying notes. 4




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Consolidated Statements of Cash Flows
(Unaudited) For the Three Months Ended March 31,2004
    
    2003Operating activitiesNet loss
    
    $
    (225,153
    )
    
    $
    (2,161,907
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    260,285
    
    
    
    268,407Amortization of deferred compensation
    
    
    74,314
    
    
    
    22,814Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,961,239
    )
    
    
    (733,062
    )Inventories
    
    
    (207,572
    )
    
    
    (655,698
    )Prepaid expenses
    
    
    (26,640
    )
    
    
    (31,512
    )Other assets
    
    
    (94,515
    )
    
    
    323,141Accounts payable and accrued expenses
    
    
    (1,714,618
    )
    
    
    (819,840
    )Deferred revenue
    
    
    172,163
    
    
    
    680,847Net cash used in operating activities
    
    
    (3,722,975
    )
    
    
    (3,106,810
    )
Investing activitiesPurchases of furniture and equipment
    
    
    (376,392
    )
    
    
    (364,159
    )Net cash used in investing activities
    
    
    (376,392
    )
    
    
    (364,159
    )
Financing activitiesPrincipal payments on notes payable and capital lease obligations
    
    
    (95,050
    )
    
    
    (156,904
    )Proceeds from issuance of common stock
    
    
    766,471
    
    
    
    7,964,158Net cash provided by financing activities
    
    
    671,421
    
    
    
    7,807,254
Effect of exchange rate changes on cash
    
    
    151,945
    
    
    
    (102,992
    )
Decrease (increase) in cash and cash equivalents
    
    
    (3,276,001
    )
    
    
    4,233,293
Cash and cash equivalents at beginning of period
    
    
    10,216,384
    
    
    
    1,347,753Cash and cash equivalents at end of period
    
    $
    6,826,383
    
    
    $
    5,581,046Supplemental disclosure of non-cash investing and financing activitiesValue of restricted stocks granted in connection with consulting agreement
    
    $
    1,041,000
    
    
    $
    
 See accompanying notes. 5




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##### Table of Contents



Endocardial Solutions, Inc. 
 Notes to Consolidated Financial Statements 1. Basis of Presentation The accompanying unaudited consolidated 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. Operating results for the three
months ended March 31, 2004 are not necessarily indicative of the results that
may be expected for the year ending December 31, 2004. These financial
statements should be read in conjunction with the audited financial statements
and accompanying notes for the fiscal year ended December 31, 2003 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. Inventories consisted of the following: March 31,
    
    December 31,2004
    
    2003Raw materials
    
    $
    2,777,539
    
    
    $
    2,852,690Work-in-progress
    
    
    312,136
    
    
    
    168,231Finished goods
    
    
    975,924
    
    
    
    1,054,826$
    4,065,599
    
    
    $
    4,075,747
 3. Stock-Based Compensation The Company accounts for stock-based compensation in accordance with the
provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The following table
illustrates the effect on net loss and net loss per share if the Company had
applied the fair value recognition provisions of Financial Accounting Standards
Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-based Compensation, to stock- based employee compensation. For the three months ended March 31,2004
    
    2003Net loss, as reported:
    
    $
    (225,153
    )
    
    $
    (2,161,907
    )Add: Stock-based compensation, as reported
    
    
    74,314
    
    
    
    22,814
 6




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For the three months ended March 31,2004
    
    2003Deduct: Stock-based compensation determined under
fair-value-based method for all awards
    
    
    (375,723
    )
    
    
    (374,614
    )Adjusted net loss, assuming fair-value-based method
for all stock-based awards
    
    $
    (526,562
    )
    
    $
    (2,513,707
    )Basic and diluted loss per share, as reported
    
    $
    (0.01
    )
    
    $
    (0.11
    )Basic and diluted loss per share, SFAS No. 123 adjusted
    
    $
    (0.02
    )
    
    $
    (0.13
    )
 4. Comprehensive Loss The components of comprehensive loss and income, net of related tax, were
as follows: For the three months ended March 31,2004
    
    2003Net loss
    
    $
    (225,123
    )
    
    $
    (2,161,907
    )Foreign currency translation adjustment
    
    
    (201,471
    )
    
    
    128,100Comprehensive loss
    
    $
    (426,594
    )
    
    $
    (2,033,807
    )
 5. Guarantees and Contractual Obligations In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others(the Interpretation). The Interpretation requires disclosure in
periodic financial statements of certain guarantee arrangements. The
Interpretation also clarifies situations where a guarantor is required to
recognize the fair value of certain guarantees in the financial statements.
The Company does not have any guarantees that require recognition at fair value
under the Interpretation. The Company sells extended warranty contracts that include service and
support, and may also include software and/or hardware upgrades. These items
are required to be disclosed in periodic financial statements under the
Interpretation. Revenue from the sale of extended warranty contracts is
deferred and recognized ratably over the period in which the services are
provided, and revenue from the sale of hardware upgrades is deferred and
recognized until the upgrades are performed. Costs associated with extended
warranty contracts are recognized at the time the service is provided. Costs
associated with upgrades are recognized at time the upgrades are performed. Changes in deferred revenue amounts the three months ended March 31, 2004 are
as follows: Balance, December 31, 2003
    
    $
    2,897,033Revenue deferred during the period
    
    
    1,617,736Deferred revenue recognized during the period
    
    
    (1,457,210
    )Balance, March 31, 2004
    
    $
    3,057,559
 7




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6. Reclassifications Certain prior year items have been reclassified to conform to current
period presentation. 7. Restricted Stock On February 16, 2004, the Company issued a restricted grant of 100,000
shares of the Companys common stock in connection with the execution of a
consulting agreement. 8. Segment Reporting Revenue by geographic destination as a percentage of total revenue was as
follows: For the three monthsended March 312004
    
    2003Domestic
    
    
    64
    %
    
    
    72
    %International:Europe
    
    
    22
    %
    
    
    13
    %Asia Pacific
    
    
    12
    %
    
    
    15
    %Canada/Mexico
    
    
    2
    %
    
    
    0
    %
 
 Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations Overview Endocardial Solutions, Inc. develops, manufactures and markets the EnSite
clinical workstation and the EnSite Array catheter for use by
electrophysiologists in diagnosing and mapping abnormal heart rhythms known as
tachycardias, and EnSite NavX surface electrodes for use by
electrophysiologists in visualizing and navigating the precise placement of
conventional linear catheters used during diagnostic and therapeutic
electrophysiology procedures. The EnSite clinical workstation and EnSite Array
were first available in full market release to electrophysiologists in Europe
in 1998. The EnSite clinical workstation and EnSite Array catheter received
FDA approval for right atrial use in the U.S. and Canada in 1999, and the
Company received general approval to market the EnSite System for cardiac
mapping in Australia, Korea, Thailand, Malaysia, China and Hong Kong in 2000,
and in Taiwan in 2001. The Company commercially released EnSite NavX worldwide
during the second quarter of 2003 following clearance from the FDA. The
Company commercially released EnSite DIF, a software application that enables
physicians to view segmented CT images of a patients cardiac anatomy on the
EnSite workstation, in the fourth quarter of 2003 following clearance from the
FDA; EnSite DIF also is approved for use in Europe and all other geographies
where the EnSite System is currently sold and distributed. The Company derives
revenues from the sale of these EnSite products, as well as from the sale of
extended warranty service and support agreements and miscellaneous ancillary
support products used in conjunction with the EnSite System. The Company
reported net sales for the three months ended March 31, 2004 of approximately
$10.6 million, an increase of 45% over the same period in 2003. The Companys
gross profit margin for the three months ended March 31, 2004 was 66.6%,
compared with 66.9% during the same period in 2003. The EnSite System is an innovative and expanding technology platform for
mapping cardiac arrhythmias, and enabling the precise 3D, non-fluoroscopic
visualization and navigation of a variety of linear electrophysiology catheters
used in the diagnosis and treatment of cardiac arrhythmias. The Companys
ability to increase revenues and derive future profits from this business in
the future depends, in part, on the Companys ability to effectively market and
sell the EnSite System to the more than 2,200 electrophysiology laboratories
worldwide in which 8




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these electrophysiology procedures are performed, and to
have the physicians who perform these electrophysiology procedures continue to
increase their clinical adoption and use of the EnSite System, together with
adopting future products introduced by the
Company. The Company employs a direct sales force in the United States and
Europe, and uses distributors for certain other international markets. The
Company has established an exclusive distribution arrangement in Japan with
Nihon Kohden, one of Japans leading manufacturers, developers and distributors
of medical electronic products, and expects regulatory approval for the sale of
its products in Japan in 2004. With more than 375 EnSite Systems now sold
globally, the Company has broadened its sales and marketing efforts to include
a growing number of smaller, regional and community-based electrophysiology
labs who are seeking to acquire and utilize advanced EP mapping and navigation
technologies such as the EnSite System. Results of Operations General. Net loss was $225,153, or $.01 per share, for the three months
ended March 31, 2004, compared to $2.2 million, or $0.11 per share, for the
same period in 2003. Revenue and Cost of Goods Sold. Worldwide revenue for the three months
ended March 31, 2004 was $10.6 million, an increase of approximately $3.3
million, or 45%, over the same period in 2003. Worldwide revenue from EnSite
clinical workstation sales during the three months ended March 31, 2004 was
approximately $3.4 million (net of revenue deferred for EnSite System warranty
obligations), compared to approximately $3.1 million for the same period in
2003, an increase of 13%. Domestic sales accounted for 50% of total EnSite
clinical workstation sales during the three months ended March 31, 2004,
compared to 63% during the same period in 2003. Worldwide revenue from the
sale of EnSite disposable products (EnSite Array catheters and EnSite NavX
surface electrode kits) during the three months ended March 31, 2004 was
approximately $5.6 million, compared to $3.7 million during the same period in
2003 (which included only EnSite Array catheter sales), an increase of 51%.
Domestic revenue from the sale of EnSite disposable products accounted for 75%
of total EnSite disposable product revenue during the three months ended March
31, 2004, compared to 80% (which included only EnSite Array catheter sales)
during the same period in 2003. U.S. revenues were approximately $7.0 million for the three months ended
March 31, 2004, an increase of approximately $1.7 million, or 33%, over the
same period in 2003. Revenue from the sale of EnSite clinical workstations in
the U.S. (net of revenue deferred for EnSite System warranty obligations)
during the first quarter of 2003 was approximately $1.7 million, a decrease of
approximately $0.2 million, or 10%, over the same period in 2003. Revenue from
the sale of EnSite disposable products (EnSite Array catheters and EnSite NavX
surface electrode kits) for the three months ended March 31, 2004 was
approximately $4.2 million, an increase of $1.2 million, or 41%, compared to
the same period in 2003 (which did not include revenue from the sale of EnSite
NavX surface electrodes kits as EnSite NavX was not commercially released until
the second quarter of 2003). International revenues during the three months ended March 31, 2004 were
approximately $3.6 million, an increase of approximately $1.6 million, or 77%,
over the same period in 2003. International revenues include sales directly to
end-users in certain countries in Europe and Canada, and to distributors in
other areas of Europe and the Asia Pacific region. International revenue from
EnSite clinical workstation sales during the three months ended March 31, 2004
were approximately $1.7 million, an increase of approximately $0.6 million, or
51%, over the same period in 2003. Revenue from the sale of EnSite disposable
products (EnSite Array catheters and EnSite NavX surface electrode kits) for
the three months ended March 31, 2004 was $1.4 million, an increase of
approximately $0.7 million or 90% compared to the same period in 2003 (which
did not include revenue from the sale of EnSite NavX surface electrodes kits as
EnSite NavX was not commercially released until the second quarter of 2003). Other revenue, which includes (i) the recognition of deferred revenue
generated from extended warranty and service contracts, (ii) the recognition of
deferred revenue from the upgrade of EnSite Systems with hardware and software
to configure these systems to utilize EnSite NavX, and (iii) revenue from the
sale of accessories and repairs related to the EnSite clinical workstation, was
approximately $1.6 million during the three months ended March 31, 2004, an
increase of approximately $1.1 million, or 318%, compared to the same period in
2003. This increase was primarily related to the fact that the Company had no
EnSite NavX upgrades during the first quarter of 2003, and the Company
accelerated its planned upgrades of NavX-ready EnSite Systems with the
Companys new EnSite v.4.2 hardware and software platform 9




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during the first
quarter of 2004. The portion of deferred revenue related to the upgrade of
these EnSite systems was recognized at the time the upgrade was installed.
Revenue related to extended warranty and service contracts is recognized ratably
over the warranty and service period (typically one year). Cost of goods sold was approximately $3.5 million and $2.4 million for the
three month periods ended March 31, 2004 and 2003, respectively. The Companys gross profit margin for the three months ended March 31,
2004 was 66.6%, compared with 66.9% during the same period in 2003. Gross
margins on EnSite clinical workstations for the three months ended March 31,
2004 was 67% compared to 61% in the same period in 2003. Gross margins on
EnSite disposable products (EnSite Array catheters and EnSite NavX surface
electrode kits) improved to 83% for the three months ended March 31, 2004, up
from 72% in the same period in 2003, primarily attributable to the fact that
EnSite NavX surface electrodes kits were not commercially released until the
second quarter of 2003. The Companys overall gross margin for the three
months ended March 31, 2004 compared to the same period in 2003 was negatively
impacted by the Companys decision to accelerate the upgrade of NavX-ready
EnSite Systems to the Companys new EnSite v.4.2 hardware and software platform
during the first quarter of 2004. The Company decided to absorb the
incremental costs associated with accelerating these upgrades in an effort to
drive the incremental use of EnSite NavX surface electrode kits for atrial
fibrillation procedures beginning in the second quarter. Research and Development Expenses. Research and development expenses
include compensation and benefit costs for the clinical, software, hardware,
catheter, and applied research departments, as well as costs associated with
regulatory expenses. Research and development expenses were approximately $1.2
million for the three months ended March 31, 2004, compared to $1.5 million
during the same period in 2003, a decrease of $0.3 million, or 24%. This
decrease was primarily due to the Companys decision to discontinue its left
atrial mapping protocol study of the EnSite Array catheter in the fourth
quarter of 2003. The Company expects to make continued significant R&D
investments during 2004 in EnSite product development and clinical studies. General and Administrative Expenses. General and administrative expenses
were approximately $708,000 and $747,000 for the three month periods ended
March 31, 2004 and 2003, respectively. This decrease in spending was primarily
due to non-recurring costs in 2003 related to the hiring and relocation of the
Companys CFO, non-recurring fees and professional service expenses. The
Company expects ongoing general and administrative expenses to remain
relatively constant during 2004, although the Company will incur certain
non-recurring fees and professional service expenses during each of the next
three quarters in 2004 necessary to comply with requirements of the
Sarbanes-Oxley Act of 2002. Sales and Marketing Expenses. Sales and marketing expenses were
approximately $5.3 million and $4.7 million for the three month periods ended
March 31, 2004 and 2003, respectively, an increase of approximately $0.6
million, or 13%. This increase was primarily attributable to the larger number
of U.S. and European field clinical support personnel and associated travel
expenses during the first quarter of 2004, together with increased commissions
driven by the 45% increase in revenue compared to the first quarter of 2003.
As a percentage of revenue, sales and marketing expenses are expected to
decline in 2004 compared to 2003. Interest Income and Expense. Interest income was approximately $8,000 and
$11,000 for the three month periods ended March 31, 2004 and 2003,
respectively. The decrease in interest income for the three month period
ended March 31, 2004 was due to lower average cash and cash equivalent
balances. Interest expense was approximately $29,000 and $29,000 for the three
month periods ended March 31, 2004 and 2003, respectively. Liquidity and Capital Resources. The Companys operations since inception have been partially funded by net
proceeds from the sale of common and preferred stock totaling approximately
$104.3 million. As of March 31, 2004 and December 31, 2003, the Company had
cash and cash equivalents of approximately $6.8 million and $10.2 million,
respectively. For the three months ended March 31, 2004, the Company used cash of
approximately $3.7 million in its operations, compared to approximately $3.1
million for the same period in 2003. 10




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The Companys accounts receivable balance was approximately $12.2 million
as of March 31, 2004, an increase of approximately $1.8 million from December
31, 2003. The increase in accounts receivable was, in part,
attributable to the increase in revenues during the three months ended
March 31, 2004 compared to previous periods, and a delay in the Companys
normal accounts receivable collection process. During the first quarter of
2004, the Company implemented a new integrated financial system, which delayed
the Companys financial department from undertaking its normal receivables
collection activities until late in the quarter. The Companys inventory balance at March 31, 2004 was approximately $4.1
million, with no significant change compared to December 31, 2003. The Company
believes its inventory of EnSite clinical workstation components will decrease
over the course of 2004 as the Company completes its currently planned hardware
upgrades of EnSite workstations to EnSite v.4.2. Inventories of EnSite Array
catheters and EnSite NavX surface electrode kits are expected to remain
relatively constant throughout 2004. The Companys accounts payable (including accrued expenses) balance at
March 31, 2004 was approximately $4.0 million, a decrease of approximately $1.7
million from December 31, 2003. The decrease reflects the timely payment of
certain liabilities and the Companys accrued 2003 year-end incentive bonuses
in the first quarter of 2004. The Company expects accounts payable and accrued
expenses to remain relatively constant throughout the remainder of 2004. The Company had no short-term investment portfolio as of March 31, 2004
and December 31, 2003. A majority of the Companys available cash was in money
market funds consistent with the Companys investment policy. In September 2003, the Company entered into a $4.5 million credit facility
agreement with Silicon Valley Bank (SVB). This credit facility replaced a
prior credit facility with SVB that the Company entered into in June of 2001,
and modified in May 2002 to extend the term of the initial agreement. The
September 2003 credit facility with SVB consists of a $3.0 million domestic
line of credit, and a $1.5 million international (EXIM) credit line. This
facility operates as a revolving line of credit, with $1.3 million reserved for
use as a capital lease line. The terms of the credit facility include certain
restrictive financial covenants, including the Companys obligation to maintain
a specified ratio of current assets to current liabilities (quick ratio),
as well as a minimum tangible net worth. As of March 31, 2004, the Company
was in compliance with the financial covenants of the credit facility. During
the first quarter of 2004, the Companys implementation of its new integrated
financial reporting system prevented the Company from delivering certain
intra-quarter monthly financial statements required by SVB. The Company met
its financial reporting requirements to SVB for the three month period ended
March 31, 2004, and SVB granted the Company a written waiver of the
intra-quarter monthly financial reporting defaults from January and February
of 2004. The Company expects to meet its monthly financial reporting
requirements going forward. As of March 31, 2004, the Company had $0.3 million
outstanding related to capital leases and had an additional $1.0 million
outstanding on the credit line. The Company believes its existing cash, cash equivalents and bank
financing will be sufficient to fund the operations of the Company, and the
Company does not currently anticipate raising additional financing to fund
capital expenditures or operations of the Company during the remainder of 2004.
If the Company achieves profitability as forecasted, the need for additional
financing is not presently anticipated. The Companys future liquidity and
capital requirements will depend on numerous factors, including (i) the timing
of regulatory actions regarding the Companys current and future products; (ii)
the results of future clinical trials; (iii) market acceptance of products
competitive with the Companys products; (iv) the extent to which the Companys
EnSite System and disposable products gain additional market acceptance; (v)
the costs, timing and method of expansion of sales, marketing, research and
development and manufacturing activities; and (vi) the Companys ability to
obtain additional bank financing, if necessary. Critical Accounting Policies The Companys consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the U.S., which require the
Company to make estimates and assumptions in certain circumstances that affect
amounts reported in the accompanying consolidated financial statements and
related footnotes. In preparing these consolidated financial statements, the
Companys management has made its best estimates and judgments of certain
amounts included in the consolidated financial statements, giving due
consideration 11




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to materiality. The Company does not believe there is a great
likelihood that materially different amounts would be reported related to the
accounting policies described below. However, application of these
accounting policies involves the exercise of judgment and use of
assumptions as to future uncertainties and, as a result, actual results could
differ from these estimates. Revenue Recognition.Revenue from the sale of the Companys EnSite
clinical workstations, EnSite Array catheters, and EnSite NavX surface
electrode kits is recognized at the time of shipment in instances where the
Company has evidence of a contract or binding commitment, the purchase price is
fixed and determinable, and collection is probable. Revenue from service and
support contracts and extended maintenance and hardware upgrade agreements is
deferred and recognized ratably over the period the services are provided, or
as the upgrades are performed, respectively. The Securities and Exchange
Commissions Staff Accounting Bulletins (SAB) Nos. 101 and 104, Revenue
Recognition and ETIF 00-21 Accounting for Revenue Arrangements with Multiple
Deliverables provide guidance on the application of generally accepted
accounting principles to selected revenue recognition issues. The Company has
concluded that its revenue recognition policies are appropriate and in
accordance with SAB No. 101. Allowance for Doubtful Accounts.Accounts receivable are reduced by an
allowance for amounts that may become uncollectible in the future. The
estimated allowance is based on managements review of accounts receivable
balances and historical write-offs. During the three months ended March 31,
2004, the Company did not take any material write-offs of outstanding accounts
receivable balances. Inventories and Related Allowance for Excess and Obsolete Inventory.
Inventories are valued at the lower of cost or market and have been reduced by
an allowance for excess and obsolete inventories. The estimated allowance is
based on managements review of inventories on hand compared to estimated
future usage and sales. As of March 31, 2004, the Company believes its
allowance for excess and obsolete inventories was adequate. New Accounting Standards. In May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. This statement establishes standards for the
classification and measurement of certain financial instruments with
characteristics of both liabilities and equity. This statement requires that
an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of those instruments were
previously classified as equity. This statement is effective for financial
instruments entered into or modified after May 31, 2003 and otherwise is
effective at the beginning of the first interim period beginning after June 14,
2003. These effective dates are not applicable to the provisions of paragraph
9 and 10 of SFAS No. 150 as they apply to mandatory redeemable non-controlling
interest, as the FASB has delayed these provisions. The Company does not
believe the adoption of this statement will have a material impact upon its
financial condition, or results of operations or cash flow. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk The Company had approximately $6.8 million of cash and cash equivalents on
March 31, 2004. Substantially all of this cash is invested in money market
funds. 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 future 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 prior
to their maturity, 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 conducts sales in foreign currencies through
its European subsidiary, management does not believe the Company is exposed to
any material foreign currency exchange rate risk. 
 Item 4. Controls and Procedures (a) Evaluation of disclosure controls and procedures.Under the
supervision and with the participation of our management, including the
Companys Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934 (the Exchange Act)). Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that, as of the end of the period
covered by this report, our 12




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disclosure controls and procedures were effective
in timely alerting them to the material information relating to us (or our
consolidated subsidiaries) required to be included in the reports we file or
submit under the Exchange Act. (b) Changes in internal controls over financial reporting. During the
quarter ended March 31, 2004, there has been no change in our internal control
over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act)
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting. 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. These forward-looking statements
represent the Companys expectations, beliefs, intentions or strategies
concerning future events, including, but not limited to, any statements
regarding its current assumptions about future financial performance; the
continuation of historical trends; the sufficiency of its cash balances and
cash generated from operating activities for future liquidity and capital
resource needs; the expected impact of changes in accounting policies on the
Companys results of operations, financial condition or cash flows; anticipated
problems and its plans for future operations; and the economy in general or the
future of the medical device industry, all of which are subject to various
risks and uncertainties. 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 of the Company, 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.
However, any statements contained in this Form 10-Q that are not statements of
historical fact may be deemed to be forward-looking statements. The Company cautions that these statements, by their nature, involve risks
and uncertainties, certain of which are beyond its control, and actual results
may differ materially depending on a variety of important factors, including,
but not limited to such factors as market demand, pressures on product pricing,
changing market conditions, and competition and growth rates within the medical
device industry; changes in accounting policies; risks associated with
operations outside of the U.S.; changing economic conditions such as general
economic slowdown, decreased consumer confidence and the impact of war on the
economy; and other risks and uncertainties, including those described in
Exhibit 99.1 to our Form 10-K for the year ended December 31, 2003. 
 PART II. OTHER INFORMATION 
 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibits
    
    Description31.1
    
    Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
 (b) Reports on Form 8-K A Form 8-K was filed by the Company on
January 26, 2004; such report contained
information disclosed under Item 12 and
included as an exhibit under Item 7 a copy
of a press release issued by the Company
announcing its fourth quarter and 2003
earnings results. 13




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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: May 7, 2004
    By:
    /s/ James W. BullockJames W. BullockPresident and Chief Executive
Officer/s/  J. Robert PaulsonJ. Robert Paulson, Jr.Chief Financial Officer
(Principal Accounting Officer)