**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 
| **ý** |   | **Quarterly Report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**                                                                                                |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   | **for  the quarterly period ended September 30, 2003**                                                                                                                                      |
|       |   |                                                                                                                                                                                             |
| **o**      |   | **Transition Report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**                                                                                               |
|       |   | **for  the transition period from              to               .** |

 

**CommissionFile No. 0-22233**

 

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**Endocardial Solutions, Inc.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                   |   | **41-1724963**                                            |
|----------------------------------------------------------------|--------|-----------------------------------------------------------|
| (State or other jurisdiction of  incorporation or organization |   | (IRS Employer  Identification Number)                     |
|                                                           |   |                                                      |
| **1350 Energy Lane  Suite 110  Saint Paul, Minnesota 55108**   |   | **(651) 523-6900**                                   |
| (Address of principal executive offices  and zip code)         |   | (Registrant’s telephone number  including area code) |

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d)Securities Exchange Act of 1934 during the preceding twelve (12) months (or forsuch shorter period that the Registrant was required to file such reports) and (2) has been subject tosuch filing requirements for the past 90 days.Yes ý  No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct)

Yes ý  No o

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 

| **Common  Stock, $.01 par value** |   | **21,528,699**                                      |
|-----------------------------------|--------|-----------------------------------------------------|
| (Class)                           |   | (Number of Shares Outstanding at  November 4, 2003) |

 

 

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**INDEX**

 

**EndocardialSolutions, Inc.**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                       |   |
|--------------|-----------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                            |   |
| Item 1.      | Financial Statements  (Unaudited)                                                                               |   |
|         | Consolidated Balance  Sheets-September 30, 2003 and December 31, 2002                                           |   |
|         | Consolidated  Statements of Operations - Three and nine months ended September 30, 2003 and  September 30, 2002 |   |
|         | Consolidated  Statements of Cash Flows - Three and nine months ended September 30, 2003 and  September 30, 2002 |   |
|         | Notes  to Consolidated Financial Statements                                                                     |   |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |   |
| Item 3.      | Qualitative  and Quantitative Disclosures about Market Risk                                                     |   |
| Item 4.      | Controls and Procedures                                                                                         |   |
|         |                                                                                                            |   |
| **PART II.** | **OTHER INFORMATION**                                                                                           |   |
|         |                                                                                                            |   |
| Item  2.     | Changes  in Securities and Use of Proceeds.                                                                     |   |
| Item 6.      | Exhibits  and Reports on Form 8-K                                                                          |   |
|              |                                                                                                                 |        |  |

 

2

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**PART I -FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**EndocardialSolutions, Inc.**

**Consolidated Balance Sheets**

**(000’s)**

 
|                                                                                                 |   | **September  30,  2003** |   | **December  31,  2002** |   |
|------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                                                                                 |   | **(Unaudited)**          |   | **(Note)**              |   |
| **ASSETS**                                                                                           |   |                     |   |                    |   |
| Current Assets:                                                                                      |   |                     |   |                    |   |
| Cash and cash  equivalents                                                                           |   | $                        | 9,823  |                    | $      | 1,348 |   |
| Accounts  Receivable, net of reserve for doubtful accounts (2003 - $60,000; 2002 -  $60,000)         |   | 10,549                   |   | 8,149                   |   |
| Inventories                                                                                          |   | 4,260                    |   | 4,635                   |   |
| Prepaid expenses  and other current assets                                                           |   | 1,138                    |   | 872                     |   |
| Total current  assets                                                                                |   | 25,770                   |   | 15,004                  |   |
|                                                                                                 |   |                     |   |                    |   |
| Furniture and  equipment                                                                             |   | 9,222                    |   | 8,279                   |   |
| Less accumulated  depreciation                                                                       |   | (6,513                   | )      | (5,828                  | )      |
|                                                                                                 |   | 2,709                    |   | 2,451                   |   |
|                                                                                                 |   |                     |   |                    |   |
| Deposits                                                                                             |   | 51                       |   | 49                      |   |
| Notes Receivable                                                                                     |   | 206                      |   | 206                     |   |
| Patents, net of  accumulated amortization (2003 - $124,555; 2002 - $120,494)                         |   | 7                        |   | 11                      |   |
|                                                                                                 |   |                     |   |                    |   |
| Total assets                                                                                         |   | $                        | 28,743 |                    | $      | 17,721 |   |
|                                                                                                 |   |                     |   |                    |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                       |   |                     |   |                    |   |
| Current  Liabilities:                                                                                |   |                     |   |                    |   |
| Accounts payable                                                                                     |   | $                        | 2,491  |                    | $      | 1,705 |   |
| Accrued  compensation expenses                                                                       |   | 2,415                    |   | 2,672                   |   |
| Bank line of  credit                                                                                 |   | 1,000                    |   | 1,000                   |   |
| Current portion  of capital lease obligations                                                        |   | 380                      |   | 514                     |   |
| Current portion  of deferred revenue                                                                 |   | 2,416                    |   | 2,217                   |   |
| Total current  liabilities                                                                           |   | 8,702                    |   | 8,108                   |   |
|                                                                                                 |   |                     |   |                    |   |
| Long-term  Liabilities:                                                                              |   |                     |   |                    |   |
| Capital lease  obligations                                                                           |   | 97                       |   | 363                     |   |
| Deferred revenue                                                                                     |   | 272                      |   | 435                     |   |
| Total long-term  liabilities                                                                         |   | 369                      |   | 798                     |   |
|                                                                                                 |   |                     |   |                    |   |
| 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—September 30, 2003—21,455,208; December 31, 2002-16,567,593 |   | 215                      |   | 166                     |   |
| Additional  paid-in capital                                                                          |   | 103,917                  |   | 88,987                  |   |
|                                                                                                 |   |                     |   |                    |   |
| Accumulated  deficit                                                                                 |   | (84,908                  | )      | (80,448                 | )      |
| Accumulated  other comprehensive gain/(loss)                                                         |   | 582                      |   | 309                     |   |
| Deferred  compensation                                                                               |   | (134                     | )      | (199                    | )      |
| Total  stockholders’ equity                                                                     |   | 19,672                   |   | 8,815                   |   |
| Total  liabilities and stockholders’ equity                                                     |   | $                        | 28,743 |                    | $      | 17,721 |   |

 

Note: The balance sheet at December 31, 2002 has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements.

 

*See accompanying notes.*

 

3

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**EndocardialSolutions, Inc.**

**ConsolidatedStatements of Operations**

**(000’s)**

(Unaudited)

 
|                                    |   | **For the  Three Months Ended** |   | **For the  Nine Months Ended** |   |
|-----------------------------------------|--------|---------------------------------|--------|--------------------------------|--------|
|                                    |   | **September  30,  2003**        |   | **September  30,  2002**       |   | **September  30,  2003** |   | **September  30,  2002** |   |
|                                    |   |                            |   |                           |   |   |   |   |   |
| Revenue                                 |   | $                               | 9,696  |                           | $      | 5,508 |   | $ | 26,282 |   | $ | 20,148 |   |
|                                    |   |                            |   |                           |   |   |   |   |   |
| Cost of goods  sold                     |   | 3,370                           |   | 2,040                          |   | 9,232 |   | 7,431 |   |
| Gross profit                            |   | 6,326                           |   | 3,468                          |   | 17,050 |   | 12,717 |   |
|                                    |   |                            |   |                           |   |   |   |   |   |
| Operating  expenses:                    |   |                            |   |                           |   |   |   |   |   |
| Research and  development               |   | 1,430                           |   | 1,399                          |   | 4,464 |   | 3,993 |   |
| General and  administrative             |   | 862                             |   | 743                            |   | 2,384 |   | 2,017 |   |
| Sales and  marketing                    |   | 4,889                           |   | 4,418                          |   | 14,569 |   | 13,495 |   |
| Operating loss                          |   | (855                            | )      | (3,092                         | )      | (4,367 | ) | (6,788 | ) |
|                                    |   |                            |   |                           |   |   |   |   |   |
| Other income  (expense):                |   |                            |   |                           |   |   |   |   |   |
| Interest income                         |   | 4                               |   | 16                             |   | 27 |   | 65 |   |
| Interest expense                        |   | (25                             | )      | (40                            | )      | (87 | ) | (100 | ) |
| Other                                   |   | (3                              | )      | (2                             | )      | (33 | ) | (19 | ) |
|                                    |   | (24                             | )      | (26                            | )      | (93 | ) | (54 | ) |
|                                    |   |                            |   |                           |   |   |   |   |   |
| Net loss for the  period                |   | $                               | (879   | )                              | $      | (3,118 | ) | $ | (4,460 | ) | $ | (6,842 | ) |
|                                    |   |                            |   |                           |   |   |   |   |   |
| Net loss per  share - basic and diluted |   | $                               | (0.04  | )                              | $      | (0.19 | ) | $ | (0.22 | ) | $ | (0.42 | ) |
|                                    |   |                            |   |                           |   |   |   |   |   |
| Weighted average  shares outstanding    |   | 20,476,741                      |   | 16,616,195                     |   | 19,916,656 |   | 16,239,211 |   |

 

*See accompanying notes.*

 

4

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**EndocardialSolutions, Inc.**

**ConsolidatedStatements of Cash Flows**

**(000’s)**

(Unaudited)

 
|                                                                         |   | **For the  Nine Months Ended** |   |
|------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                         |   | **September  30,  2003**       |   | **September  30,  2002** |   |
| **Operating  activities**                                                    |   |                           |   |   |   |
| Net loss                                                                     |   | $                              | (4,460 | ) | $ | (6,842 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                           |   |   |   |
| Depreciation and  amortization                                               |   | 702                            |   | 1,103 |   |
| Amortization of  deferred compensation                                       |   | 65                             |   | 67 |   |
| Loss on disposal  of equipment                                               |   | 8                              |   | — |   |
| Changes in  operating assets and liabilities:                                |   |                           |   |   |   |
| Accounts  Receivable                                                         |   | (2,148                         | )      | (1,484 | ) |
| Inventory                                                                    |   | 287                            |   | (1,141 | ) |
| Prepaid expenses  and other assets                                           |   | (209                           | )      | (429 | ) |
| Accounts payable  and accrued expenses                                       |   | 492                            |   | (1,221 | ) |
| Deferred revenue                                                             |   | (5                             | )      | 397 |   |
| Net cash used in  operating activities                                       |   | (5,268                         | )      | (9,550 | ) |
|                                                                         |   |                           |   |   |   |
| **Investing  activities**                                                    |   |                           |   |   |   |
| Purchases of  furniture and equipment                                        |   | (962                           | )      | (489 | ) |
| Proceeds from  sale of equipment                                             |   | —                         |   | — |   |
| Net cash used in  investing activities                                       |   | (962                           | )      | (489 | ) |
|                                                                         |   |                           |   |   |   |
| **Financing  activities**                                                    |   |                           |   |   |   |
| Proceeds from  bank line of credit                                           |   | —                         |   | 250 |   |
| Proceeds from  capital lease obligations                                     |   | —                         |   | 163 |   |
| Principal  payments on notes payable and capital lease obligations           |   | (400                           | )      | (578 | ) |
| Proceeds from  issuance of common stock                                      |   | 14,979                         |   | 9,376 |   |
| Net cash  provided by (used in) financing activities                         |   | 14,579                         |   | 9,211 |   |
|                                                                         |   |                           |   |   |   |
| Effect of  exchange rate changes on cash                                     |   | 126                            |   | 173 |   |
|                                                                         |   |                           |   |   |   |
| Increase  (decrease) in cash and cash equivalents                            |   | 8,475                          |   | (655 | ) |
| Cash and cash  equivalents at beginning of period                            |   | 1,348                          |   | 4,550 |   |
| Cash and cash  equivalents at end of period                                  |   | $                              | 9,823  |   | $ | 3,895 |   |
|                                                                         |   |                           |   |   |   |
| **Supplemental  disclosure of non-cash investing and financing activities**  |   |                           |   |   |   |
| Purchase of  equipment and inventory through capital lease obligations       |   | $                              | — |   | $ | 725 |   |

 

*See accompanying notes.*

 

5

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**Endocardial Solutions, Inc.**

 

**Notes to Consolidated Financial Statements**(Unaudited)

 

**1.****                                      Basisof Presentation**

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions toForm 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all the information andfootnotes required by generally accepted accounting principles for completefinancial statements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included.  Operating results for the nine months endedSeptember 30, 2003, are not necessarily indicative of the results that may beexpected for the year ending December 31, 2003.  These financial statements should be read in conjunction with theaudited financial statements and accompanying notes for the fiscal year endedDecember 31, 2002, 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 feasibilityof its software efforts, the Company utilizes the working model approachavailable under SFAS No. 86 and believes that the working model wasachieved when the software was available for commercial use in June 1998.

 

Inventories consist of the following:

 
|             |   | **September 30,  2003** |          | **December 31,  2002** |   |
|------------------|--------|-------------------------|---------------|------------------------|--------|
| Raw Materials    |   | **$**                   | **2,340,237** |                   | $      | 2,099,943 |   |
| Work-in-progress |   | **318,602**             |          | 497,589                |   |
| Finished goods   |   | **1,601,887**           |          | 2,037,103              |   |
|             |   | **$**                   | **4,260,726** |                   | $      | 4,634,635 |   |

 

**3.****                                      Stock-BasedCompensation**

 

The Company accounts for stock-based compensation inaccordance with the provision of Accounting Principles Board (APB) Opinion No.25, Accounting for Stock Issued to Employees, and related interpretations. Thefollowing table illustrates the effect on net loss and loss per share if theCompany had applied the fair value recognition provisions of FinancialAccounting Standards Board (FASB) Statement of Financial Accounting Standards(SFAS) No. 123, Accounting for Stock-based Compensation, to stock- basedemployer compensation.

 

6

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|                                                                                          |   | **For the three months ended** |           | **For the nine months ended** |       |
|-----------------------------------------------------------------------------------------------|--------|--------------------------------|----------------|-------------------------------|------------|
|                                                                                          |   | **2003**                       |           | **2002**                      |       | **2003** |   | **2002** |   |
| **Net loss, as reported as September 30:**                                                    |   | **$**                          | **(879,221**   | **)**                         | **$**      | **(3,117,673** | **)** | **$** | **(4,460,249** | **)** | **$** | **(6,842,467** | **)** |
| **Add: Stock-based compensation, as reported**                                                |   | **20,587**                     | ** **     | **22,814**                    | ** ** | **64,728** | ** ** | **67,243** | ** ** |
| **Deduct: Stock-based compensation determined under  fair-value-based method for all awards** |   | **(339,031**                   | **)**          | **(426,181**                  | **)**      | **(1,070,910** | **)** | **(1,310,488** | **)** |
| **Adjusted net loss, assuming fair-value-based method for  all stock-based awards**           |   | **$**                          | **(1,197,665** | **)**                         | **$**      | **(3,521,040** | **)** | **$** | **(5,466,431** | **)** | **$** | **(8,085,712** | **)** |
| **Basic and diluted loss per share, as reported**                                             |   | **$**                          | **(0.04**      | **)**                         | **$**      | **(0.19** | **)** | **$** | **(0.22** | **)** | **$** | **(0.42** | **)** |
| **Basic and diluted loss per share, SFAS No. 123 adjusted**                                   |   | **$**                          | **(0.06**      | **)**                         | **$**      | **(0.21** | **)** | **$** | **(0.27** | **)** | **$** | **(0.50** | **)** |

 

**4.****                                      ComprehensiveIncome**

 

The components of comprehensive loss and income, netof related tax, were as follows:

 
|                                        |   | **For the three months ended  September 30** |         | **For the nine months ended  September 30** |   |
|---------------------------------------------|--------|----------------------------------------------|--------------|---------------------------------------------|--------|
|                                        |   | **2003**                                     |         | **2002**                                    |   | **2003** |   | **2002** |   |
| **Net (loss) income**                       |   | **$**                                        | **(879,221** | **)**                                       | **$**  | **(3,117,673** | **)** | **$** | **(4,460,249** | **)** | **$** | **(6,842,467** | **)** |
| **Foreign currency translation adjustment** |   | **135,149**                                  |         | **(74,884**                                 | **)**  | **273,940** |   | **152,254** | ** ** |
| **Comprehensive (loss) income**             |   | **$**                                        | **(744,072** | **)**                                       | **$**  | **(3,192,557** | **)** | **$** | **(4,186,309** | **)** | **$** | **(6,690,213** | **)** |

 

**5.****                                      Guaranteesand Contractual Obligations**

 

In November 2002, the Financial Accounting StandardsBoard issued Interpretation No. 45 (FIN 45), “Guarantor’s Accounting andDisclosure Requirements for Guarantees, Including Indirect Guarantees ofIndebtedness of Others” (the “Interpretation”).  The Interpretation requires disclosure in periodic financialstatements of certain guarantee arrangements. The Interpretation also clarifies situations where a guarantor isrequired to recognize the fair value of certain guarantees in the financialstatements.  The Company does not haveany guarantees that require recognition at fair value under the Interpretation.

 

7

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The Company sells extended warranty contracts thatinclude service and support, and may also include software and/or hardwareupgrades.  These items are required tobe disclosed in periodic financial statements under the Interpretation.  Revenue from the sale of extended warrantycontracts are deferred and recognized ratably over the period in which theservices are provided, and/or at the time the upgrades are performed.  The Company does not recognize revenue fromperiodic upgrades to versions of previously released software upgrades.  Costs associated with extended warrantycontracts are recognized at the time the service is provided, and/or theupgrades performed.

 

Changes in the recorded deferred revenue amounts during the period areas follows:

 
| Balance,  December 31, 2002                    |   | $          | 2,652,455 |   |
|------------------------------------------------|--------|------------|-----------|--------|
| Additional  deferred revenue during the period |   | 3,323,651  |      |
| Deferred revenue  recognized during the period |   | (3,288,209 | )         |
| Balance,  September 30, 2003                   |   | $          | 2,687,897 |   |

 

**6.****                                      Reclassifications**

 

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

 

**7.****                                      StockOffering**

 

In January 2003, the Company received proceeds of$8,516,750 from a private placement of 3,097,000 shares of its common stock ata price of $2.75 per share, to accredited investors.

 

In August 2003, the Company received proceeds of$7,361,123 from a private placement of 1,732,029 shares of its common stock ata price of $4.25 per share, to accredited investors.

 

**8.****                                      SegmentReporting**

 

Sales by geographic destination as a percentage oftotal sales were as follows:

 
|           |   | **For the three  months ended  September 30** |   | **For the nine  months ended  September 30** |   |
|----------------|--------|-----------------------------------------------|--------|----------------------------------------------|--------|
|           |   | **2003**                                      |   | **2002**                                     |   | **2003** |   | **2002** |   |
| Domestic       |   | 78                                            | %      | 81                                           | %      | 77 | % | 76 | % |
| International: |   |                                          |   |                                         |   |   |   |   |   |
| Europe         |   | 18                                            | %      | 14                                           | %      | 15 | % | 16 | % |
| Asia Pacific   |   | 4                                             | %      | 5                                            | %      | 7 | % | 5 | % |
| Canada/Mexico  |   | 0                                             | %      | 0                                            | %      | 1 | % | 3 | % |

 

8

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**Item 2****.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

 

**General**

 

Endocardial Solutions Inc. (the “Company”), wasincorporated in May 1992.  The Companydevelops, manufactures and markets the EnSite® clinical workstation,the EnSiteArrayTM catheter (“EnSite Array”), and the EnSite NavXTMsurface electrode kit (“EnSite NavX”) (collectively, the “EnSite System”) foruse by electrophysiologists in diagnosing and mapping abnormal heart rhythmsknown as tachycardias.  During thesecond quarter of 1999, the Company received clearance from the U.S. Food andDrug Administration (“FDA”) to market the EnSite workstation and the EnSiteArray in the U.S. for use in the right atrium of the heart.  The EnSite workstation with the EnSite Arrayis available to electrophysiologists in Europe for use in the right atrium andleft ventricle of the heart.  In Aprilof 2003, the Company received clearance from the FDA to market EnSite NavX, anew product utilized with the EnSite clinical workstation that enablesnon-fluoroscopic navigation of conventional linear mapping catheters in anychamber of the heart.  EnSite NavXincorporates certain three-dimensional intracardiac location technologylicensed from Medtronic, Inc.  TheEnSite workstation with EnSite NavX also is approved for use in Europe and inall other geographies where the EnSite System is currently sold ordistributed.  The Company commerciallyreleased EnSite NavX worldwide during the second quarter of 2003.

 

**Results of Operations**

 

**General**.  Net losses were $879,221 or $.04 per share,for the three months ended September 30, 2003, compared to $3.1 million or$0.19 per share, for the same period in 2002. For the nine months ended September 30, 2003, net losses were $4.5million or $0.22 per share, compared to $6.8 million or $0.42 per share for thesame period in 2002.  The Companyexpects losses may continue through the fourth quarter of 2003.

 

**Revenueand Cost of Goods Sold**. Worldwide revenue for the three months ended September 30, 2003 wasapproximately $9.7 million, an increase of approximately $4.2 million, or 76%,over the same period in 2002.  For thenine months ended September 30, 2003, worldwide revenues were approximately$26.3 million, an increase of $6.1 million, or 30.4%, over the same period in2002.  In the U.S., revenues for thethree months ended September 30, 2003 increased approximately $3.0 million, or67.7%, over the same three-month period in 2002.  Revenue in the U.S. for the nine months ended September 30, 2003was approximately $20.1 million, an increase of $4.7 million, or 30.3%, overthe same period in 2002.

 

Internationalrevenue for the three months ended September 30, 2003 was approximately $2.2million, an increase of $1.2 million, or 112.2%, compared to the same period in2002.  For the nine months endedSeptember 30, 2003, international revenue of approximately $6.1 million was anincrease of $1.4 million, or 30.9%, over the same period in 2002.  International revenue includes direct salesto end-users in Canada and certain countries in Europe, and to distributors inother countries in Europe, the Middle East, Asia Pacific, and Mexico.

 

With the commercialrelease of EnSite NavX in the second quarter, revenue from the sale of EnSitedisposable products (EnSite Array catheters and EnSite NavX surface electrodekits) for the three month period ended September 30, 2003 was approximately$5.4 million, an increase of approximately $2.3 million, or 75.1%, over thesame period in 2002 (which included EnSite Array sales only).  For the nine month period ended September30, 2003, revenue from the sale of EnSite disposable products was approximately$14.0 million, an increase of $3.3 million, or 31.1%, over the same period in2002 (which included EnSite Array sales only). Domestic sales accounted for 82.3% of total EnSite disposable productrevenue for the three months ended September 30, 2003, compared to 80.1% forthe same period in 2002 (which included EnSite Array sales only).  For the nine months ended September 30,2003, domestic sales accounted for 80.9% of the total EnSite disposable productrevenue, as compared to 80.0% for the same period in 2002 (which includedEnSite Array sales only).

 

Revenue from thesale of EnSite clinical workstations was approximately $3.0 million for thethree months ended September 30, 2003, compared to $2.0 million for the sameperiod in 2002.  EnSite clinicalworkstation revenue for the nine month period ending September 30, 2003 wasapproximately $8.7 million, as compared to $8.2 million for the same period in2002.  Domestic sales accounted for74.4% of EnSite clinical workstation revenue for the three months endedSeptember 30, 2003, compared to 87.5% for the same period in 2002.  Domestic sales

 

9

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accounted for 73.4% of EnSite clinical workstation revenue for the ninemonth period ending September 30, 2003, compared to 74.3% for the same periodin 2002.

 

Other revenue,which represents 5.4% and 7.9%, respectively, of worldwide sales for the threemonth periods ending September 30, 2003 and 2002, and 5.9% and 6.1% for thenine month periods ending September 30, 2002 and 2003, respectively, includesdeferred revenue generated from the sale of extended warranty agreements, aswell as revenue from the sale of EnSite accessories and repairs to EnSiteclinical workstations.

 

As of September30, 2003, the Company has upgraded more than 179 EnSite Systems globally to addEnSite NavX hardware and software.  Forthe three months ended September 30, 2003, the Company recognized revenue ofapproximately $741,000 from deferred revenue related to the installation ofEnSite NavX upgrades.  For the ninemonths ended September 30, 2003, the Company recognized revenue ofapproximately $2.0 million from deferred revenue related to the installation ofEnSite NavX upgrades.

 

Cost of goods soldwas approximately $3.4 million and $2 million for the three month periods endedSeptember 30, 2003 and 2002, respectively. For the nine month periods ending September 30 2003 and 2002, cost ofgoods sold was approximately $9.2 million and $7.4 million, respectively.

 

The Company’sgross profit margin was 65.2% for the three months ended September 30, 2003,compared with 63.0% during the same period in 2002.  Gross margins for the nine month periods ended September 30, 2003and 2002 were 64.9% and 63.1%, respectively. Gross margins on approximately $741,000 and $2.0 million of deferredrevenue recognized during the third quarter and year-to-date from theinstallation of EnSite NavX hardware upgrades were 11.2% and 6.7%,respectively, which has proportionately reduced the Company’s overall grossmargins for both the second and third quarters.

 

Gross margins onthe sale of EnSite disposable products (EnSite Array catheters and EnSite NavXsurface electrode kits) for the three month period ending September 30, 2003were 76.2%, as compared to gross margins of 65.7% from the sale of EnSiteArrays only for the same period in 2002. For the nine month period ended September 30, 2003, gross margins fromthe sale of EnSite disposable products were 75.4%, as compared to gross marginsof 67.4% on the sale of EnSite Arrays only for the same period in 2002.

 

Gross margins onthe sale of EnSite clinical workstations were 58.7% in the third quarter of2003, up from 55.1% in the third quarter of 2002.  Gross margins on the sale of EnSite clinical workstations for thenine month period ending September 30, 2003 were 59.8%, as compared to 55.7%for the same period in 2002.

 

**Researchand Development Expenses**. Research and development expenses include compensation and benefit costsin the clinical, software, hardware, catheter and applied research departments,as well as costs associated with regulatory expenses.  Research and development expenses were approximately $1.4 millionfor the three month period ended September 30, 2003, compared to approximately$1.4 million during the same period in 2002. Research and development expenses for the nine month period endingSeptember 30, 2003 were approximately $4.5 million, as compared to $4 millionfor the same period in 2002.  TheCompany expects to make continued significant investments in research anddevelopment and clinical studies during the remainder of 2003.  The Company is continuing its clinicalstudies using the EnSite System to assist electrophysiologists in stratifyingpatients with congestive heart failure (“CHF”) who are candidates to receivebi-ventricular pacing devices, identifying the optimal pacing, and measuringthe hemodynamic efficiency of the pacing therapy.

 

**Generaland Administrative Expenses**. General and administrative expenses were approximately $863,000 and$743,000 for the three month periods ended September 30, 2003 and 2002,respectively.  General andadministrative expenses for the nine month periods ended September 30, 2003 and2002 were approximately $2.4 million and $2.0 million, respectively.  The increase in expenses is primarily due toprofessional service expenses associated with various information technologyprojects, and actions undertaken by the Company to comply with certainrequirements of the Sarbanes-Oxley Act of 2002.  The Company also incurred fees and professional service expensesassociated with filing for trademark protection in various internationaljurisdictions, and the execution of a new credit facility with Silicon ValleyBank.  The Company expects general andadministrative expenses to remain relatively constant during the fourth quarterof 2003.

 

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**Salesand Marketing Expenses**. Sales and marketing expenses were approximately $4.9 million during thethree months ended September 30, 2003, compared to $4.4 million during the sameperiod in 2002.  For the nine monthperiods ended September 30, 2003 and 2002, sales and marketing expenses were$14.6 million and $13.5 million, respectively. This increase in expense is primarily attributable to travel andtraining costs associated with the installation and upgrade of more than 179EnSite workstations to include EnSite NavX during the second and third quartersof 2003, and an increase in commissions the Company paid for certaindistributor sales in the U.S. and Europe. The Company expects sales and marketing expenses to remain relativelyconstant during the fourth quarter of 2003.

 

**InterestIncome and Expense**. Interest income was approximately $4,000 and $16,000 for the threemonths ended September 30, 2003 and 2002, respectively.  For the nine month periods ending September30, 2003 and 2002, interest income was $27,000 and $65,000, respectively.  The decrease in interest income for thethree and nine month periods ended September 30, 2003 was due to lower averagecash and cash equivalent balances and lower interest rates.  Interest expense was approximately $25,000and $40,000 for the three month periods ended September 30, 2003 and 2002,respectively.  For the nine monthperiods ending September 30, 2003 and 2002, interest expense was $87,000 and$101,000, respectively.

 

**Liquidity and Capital Resources**.

 

The Company’soperations since inception have been funded by net proceeds from the sale ofcommon and preferred stock totaling approximately $104.1 million.  As of September 30, 2003 andDecember 31, 2002, the Company had cash, cash equivalents and short-terminvestments of approximately $9.8 million and $1.3 million, respectively.

 

For the ninemonths ended September 30, 2003, the Company used cash from operatingactivities of approximately $5.3 million, compared to approximately $9.5million for the same period in 2002.

 

The Company’saccounts receivable balance was approximately $10.5 million as of September 30,2003, an increase of approximately $2.4 million from December 31, 2002.  The increase in accounts receivable is, inpart, attributable to the increase in revenues during the nine months endedSeptember 30, 2003 compared to previous periods, and the Company’s transitionfrom a distributor organization to direct sales in Europe during 2002.  Of the approximately $10.5 millionoutstanding balance, as of September 30, 2003, approximately $7.4 million camefrom sales generated in September which equated to $6.6 million of recognizedrevenue for the month.

 

The Company’sinventory balance at September 30, 2003 was approximately $4.3 million, adecrease of approximately $374,000, or 8.1%, over December 31, 2002.  The Company believes inventories of EnSiteArrays will decrease during the fourth quarter of 2003 to historicallevels.  This decrease in EnSite Arrayinventory may be slightly offset by the inventory of EnSite NavX that was notpart of the Company’s inventory in 2002.

 

The Company hasacquired the inventory components necessary to manufacture in the fourthquarter a number of “pre-NavX” EnSite v.3.2 workstations pursuant to a forecastthe Company received from the its distributor in Japan.  The Company may not ship these EnSite v.3.2workstations to the Company’s distributor until early 2004, which wouldincrease the Company’s EnSite workstation inventory at the end of the fourthquarter of 2003.  During the fourthquarter, the Company also expects to complete its conversion of the operatingsoftware and computing platform for its EnSite workstation to a LINUX-basedoperating system on an Intel® Xeon® computing system,from the current UNIX-based operating system on a Silicon Graphics computingsystem.  The Company will purchaseinventory of the new Intel Xeon computer workstations in the fourth quarter foruse in new EnSite System sales, in preparation for upgrading the EnSiteworkstations of those customers who purchase the upgrade, and for internal usein research and development, and marketing. The number of new Intel Xeon workstations purchased may increaseinventory at the end of the fourth quarter.

 

The Company’saccounts payable (including accrued expenses) balance at September 30, 2003 wasapproximately $4.9 million, an increase of approximately $529,000 from December31, 2002.  The slight increase reflectsthe Company’s continued efforts to control its inventory and operatingexpenses, along with the efforts to closely match turns of both receivables andpayables in order to optimize the Company’s cash flow.  The Company expects accounts payable andaccrued expenses to remain relatively constant, or increase slightly during thefourth

 

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quarter as a result of the operating and production expenses requiredto support the continued upgrade of EnSite Systems to include EnSite NavX, aswell as introduction of the new computing platform.

 

Total deferredrevenue from the sale of extended warranty agreements or standard new EnSiteSystem warranty coverage (including service and support and hardware upgrades)was  approximately $2.7 million atSeptember 30, 2003, as compared to approximately $2.7 million at December 31,2002.  This balance reflects the factthat at the end of September 2003, the Company had sold extended warranties onmore than 179 EnSite clinical workstations over the past nine months.

 

The Company had noshort-term investment portfolio as of September 30, 2003 and December 31,2002.  A majority of the Company’savailable cash was in money market funds consistent with the Company’sinvestment policy.

 

In January 2003, the Company received proceeds of$8,516,750 from a private placement of 3,097,000 shares of its common stock toaccredited investors.  The placement waspriced at $2.75 per share.  In August2003, the Company received proceeds of $7,361,123 from a private placement of1,732,029 shares of its common stock to accredited investors.  The placement was priced at $4.25 per share.

 

In September 2003, the Company entered into a $4.5million credit facility agreement with Silicon Valley Bank (“SVB”).  This new credit facility with SVB replaced aprior credit facility with SVB that the Company entered into in June 2001, andmodified as of May 2002 and thereafter to extend the term of the initialagreement.  The September 2003 creditfacility with SVB consists of a $3 million domestic line of credit, and a $1.5million international (EXIM) credit line. This credit facility operates as a revolving line of credit, with $1.25million reserved for use as a capital lease line.  The credit facility agreement contains certain restrictivefinancial covenants, including an obligation to maintain a specified ratio of“current assets” to “current liabilities” (“quick ratio”), as well as a minimum“tangible net worth”.  As of September30, 2003, the Company was in compliance with the tangible net worth covenant ofthe credit facility.  As of September30, 2003, the Company had $477,017 outstanding related to capital leases andhad an additional $1 million outstanding on the credit line.

 

The Companybelieves that its existing cash, cash equivalents, short-term investments andbank financing will be sufficient to fund the operations of the Company throughthe fourth quarter of 2003.  TheCompany’s future liquidity and capital requirements will depend on numerousfactors, including the timing of regulatory actions regarding the Company’sproducts, competition, the results of clinical trials, the extent to which theCompany’s EnSite System and EnSite NavX products continue to gain market acceptance,the cost, timing and method of expanding sales, marketing, research anddevelopment, and manufacturing activities, and the ability of the Company toobtain additional bank or equity financing.

 

**Critical Accounting Policies**

 

The consolidated financial statements are prepared inaccordance with accounting principles generally accepted in the U.S., whichrequire the Company to make estimates and assumptions in certain circumstancesthat affect amounts reported in the accompanying consolidated financial statementsand related footnotes.  In preparingthese financial statements, management has made its best estimates andjudgments of certain amounts included in the financial statements, giving dueconsideration to materiality.  TheCompany does not believe there is a great likelihood that materially differentamounts would be reported related to the accounting policies describedbelow.  However, application of theseaccounting policies involves the exercise of judgment and use of assumptions asto future uncertainties and, as a result, actual results could differ fromthese estimates.

 

*RevenueRecognition. *Revenuefrom the sale of the Company’s EnSite clinical workstation is recognized at thetime of shipment in instances where the Company has evidence of a contract, thepurchase price is fixed and determinable, and collection is probable.  Revenue from service and support contracts,and from extended warranty and hardware upgrade agreements, are deferred andrecognized ratably over the period the services are provided or at the time theupgrades are performed.  The Securitiesand Exchange Commission’s Staff Accounting Bulletin (SAB) No. 101, “RevenueRecognition” provides guidance on the application of generally acceptedaccounting principals to selected revenue recognition issues.  The Company has concluded that its revenuerecognition policy is appropriate and in accordance with SAB No. 101.

 

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*Allowancefor Doubtful Accounts.* Accounts receivable are reduced by an allowance for amounts that maybecome uncollectible in the future.  Theestimated allowance is based on management’s review of accounts receivablebalances sales and historic write-offs.

 

*Inventoriesand Related Allowance for Excess and Obsolete Inventory.*  Inventories are valued at the lower of costor market and have been reduced by an allowance for excess and obsoleteinventories.  The estimated allowance isbased on management’s review of inventories on hand compared to estimatedfuture usage and sales.

 

*New Accounting Standards*. In November 2002, the EITF published EITF Issue No. 00-21, Accounting forRevenue Arrangements with Multiple Deliverables.  EITF Issue No. 00-21 addresses certain aspects of the accountingby a vendor for arrangements under which it will perform multiplerevenue-generating activities.  EITFIssue No. 00-21 establishes three principles: revenue arrangements withmultiple deliverables should be divided into separate units of accounting,arrangement consideration should be allocated among the separate units ofaccounting based on their relative fair values, and revenue recognitioncriteria should be considered separately for separate units of accounting.  EITF Issue No. 00-21 is effective for allrevenue arrangements entered into for fiscal periods beginning after June 15,2003, with early adoption permitted. The Company does not believe the adoption of EITF Issue No. 00-21 willhave a material effect on its consolidated results of operations, financialposition, or cash flows.

 

In December 2002, the Financial Accounting StandardsBoard issued SFAS No. 148, Accounting for Stock-Based Compensation - Transitionand Disclosure.  SFAS No. 148 amendsSFAS No. 123, Accounting for Stock-Based Compensation, to provide alternativemethods of transition for a voluntary change to the fair value method ofaccounting for stock-based employee compensation.  SFAS No. 148 also amends the disclosure requirements of SFAS No.123 to require more disclosure in the summary of significant accountingpolicies, the effects of an entity’s accounting policy with respect tostock-based employee compensation on reported net income and earnings per sharein annual and interim financial statements. The disclosure provision is required for all companies with stock-basedemployee compensation, regardless of whether the company utilizes the fairvalue method of accounting described in SFAS No. 123 or the intrinsic valuemethod described in APB Opinion No. 25, Accounting for Stock Issued toEmployees.  SFAS No. 148’s amendment ofthe transition and annual disclosure provisions of SFAS No. 123 are effectivefor fiscal years ending after December 15, 2002.  The disclosure provisions for interim financial statements areeffective for interim periods beginning after December 15, 2002.  The Company currently accounts forstock-based compensation utilizing the intrinsic value method of accounting forstock-based employee compensation described by APB Opinion No. 25.

 

**Cautionary Statement**

 

Except for the historical information containedherein, this Quarterly Report on Form 10-Q contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended.  These forward-lookingstatements represent the Company’s expectations, beliefs, intentions orstrategies concerning future events, including, but not limited to, anystatements regarding its current assumptions about future financialperformance; the continuation of historical trends; the sufficiency of its cashbalances and cash generated from operating activities for future liquidity andcapital resource needs; the expected impact of changes in accounting policieson the Company’s results of operations, financial condition or cash flows;anticipated problems and its plans for future operations; and the economy ingeneral or the future of the medical device industry, all of which are subjectto various risks and uncertainties.  Whenused in this Form 10-Q and in future filings by the Company with theSecurities and Exchange Commission, in the Company’s press releases and in oralstatements made with the approval of an authorized executive officer, the wordor phrases “believes,” “anticipates,” “expects,” “intends,” “will likelyresult,” “estimates,” “projects” or similar expressions are intended toidentify such forward-looking statements, but are not the exclusive means ofidentifying such statements.  However,any statements contained in this Form 10-Q that are not statements ofhistorical fact may be deemed to be forward-looking statements.

 

The Companycautions that these statements by their nature involve risks and uncertainties,certain of which are beyond its control, and actual results may differmaterially depending on a variety of important factors, including, but notlimited to such factors as market demand and pressures on the pricing for itsproducts; changing market conditions, competition and growth rates within themedical device industry; changes in accounting policies; risks associated withoperations outside of the U.S.; changing economic conditions such as generaleconomic

 

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slowdown, decreased consumer confidence and the impact of war on theeconomy; and other risks and uncertainties, including those described inExhibit 99.1 to our Form 10-Q for the quarter ended September 30,2003.

 

## **Item 3**.  Qualitative and Quantitative Disclosuresabout Market Risk.

 

The Company hadapproximately $9.8 million of cash and investments as of September 30,2003.  Substantially all of theinvestments were U.S. government or investment grade, fixed income securitiesfrom domestic issuers.  Because of thecredit risk criteria of the Company’s investment policies, the primary marketrisk associated with these investments is interest rate risk.  The Company does not use derivativefinancial instruments to manage interest rate risk or to speculate on futureschanges in interest rates.  A rise ininterest rates could negatively affect the fair value of the Company’sinvestments; however, because management considers it unlikely that the Companywould need or choose to substantially liquidate the Company’s investments;management believes that such an increase in interest rates would not have amaterial impact on the Company’s future earnings or cash flows.  Although the Company distributes productsabroad, the Company only conducts international sales in U.S. dollars andEuros.  Management does believe theCompany has any material foreign currency exchange rate risk.

 

**Item 4****.  Controls and Procedures.**

 

 (a) Evaluation of disclosurecontrols and procedures.

 

Under the supervision and with the participation ofour management, including the Company’s Chief Executive Officer and Chief FinancialOfficer, we evaluated the effectiveness of the design and operation of ourdisclosure controls and procedures (as defined in Rule 13a-15(e) under theSecurities Exchange Act of 1934 (the “Exchange Act”)).  Based upon that evaluation, the Chief ExecutiveOfficer and the Chief Financial Officer concluded that, as of the end of theperiod covered by this report, our disclosure controls and procedures areeffective in timely alerting them to the material information relating to us(or our consolidated subsidiaries) required to be included in the reports wefile or submit under the Exchange Act.

 

 

 (b) Changes in internalcontrols over financial reporting.

 

During the quarter ended September 30, 2003, there hasbeen no change in our internal control over financial reporting (as defined inRule 13a-15(f) under the Exchange Act) that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

**PART II.  OTHER INFORMATION**

 

**Item 2.  Changes in Securities and Use of Proceeds**

 

In August 2003, the Company completed the sale in aprivate placement of 1,732,029 shares of its common stock to accreditedinvestors at a price of $4.25 per share, for proceeds of $7,361,123.  The Company relied on the exemption fromregistration provided by Section 4(2) of the Securities Act of 1933.  Pursuant to the terms of the stock purchaseagreement, these shares were registered for resale pursuant to the SecuritiesAct of 1933.  Proceeds from the sale ofthese shares will be used for general working capital, including expensesassociated with research and development, clinical studies and the commercialintroduction of new products.

 

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**Item 6.  Exhibits and Reports on Form 8-K**

 

(a)                                  Exhibits

 
| **Exhibits** |   | **Description**                                                                                                                                                                                                                                                                                                                                                            |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1         |   | Form of Stock  Purchase Agreement, used in transactions dated August 20, 2003 and August 25,  2003, among Endocardial Solutions, Inc. and the Investors named therein  (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on  August 26, 2003, as amended on Form 8-K/A filed on August 27, 2003 and Form  8-K/A filed on September 2, 2003). |
|         |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.2         |   | Loan and  Security Agreement, dated September 24, 2003, by and between Endocardial  Solutions, Inc. and Silicon Valley Bank.                                                                                                                                                                                                                                               |
|         |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.3         |   | Loan and Security Agreement (Exim Program), dated  September 24, 2003, by and between Endocardial Solutions, Inc. and Silicon  Valley Bank.                                                                                                                                                                                                                                |
|         |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.4         |   | Secured  Promissory Note (Exim Program) dated September 24, 2003                                                                                                                                                                                                                                                                                                           |
|         |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1         |   | 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.                                                                                                                                                                                                                                                                  |
|         |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 99.1         |   | Cautionary  Statement for purposes of the “Safe Harbor” provisions of the Private  Securities Litigation Reform Act of 1995.                                                                                                                                                                                                                                     |

 

(b)                                 Reportson Form 8-K

 

A Form 8-K was filed by the Company on July 24, 2003; such reportcontained information disclosed pursuant to Regulation FD under Item 9 andincluded as an exhibit under Item 7, a copy of a press release issued by theCompany announcing its second quarter 2003 earnings results.

 

A Form 8-K was filed by the Company on August 26, 2003, as amended onForm 8-K/A filed on August 27, 2003 and Form 8-K/A filed on September 2, 2003;such report contained information disclosed pursuant to Regulation FD underItem 5 and included as exhibits under Item 7, a copy of the press releasesissued by the Company announcing the sale of approximately $7.4 million of itscommon stock, as well as a copy of the Stock Purchase Agreement entered intowith the Investors.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                            | ENDOCARDIAL SOLUTIONS, INC. |
|---------------------------------|-----------------------------|
|                            |                        |
|                            |                        |
| Dated:   November 14, 2003 |                        | By: | /s/ James W. Bullock |   |
|                            |                        | James W. Bullock |
|                            |                        | *President and Chief Executive  Officer* |
|                            |                        |   |
|                            |                        | /s/ J. Robert Paulson, Jr. |   |
|                            |                        | J. Robert Paulson, Jr. |
|                            |                        | *Chief Financial Officer* |
|                            |                        | *(Principal Accounting Officer)* |
|                                 |                             |  |  |  |  |

 

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