**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

| **ý**                           | **Quarterly Report pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                                                       |
|--------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                 |                                                                                                                                                                                                                                                                                                    |
|                                 | **for the quarterly period ended March 31, 2003**                                                                                                                                                                                                                                                  |
|                                 |                                                                                                                                                                                                                                                                                                    |
| **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 No. 0-22233** |

 

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**EndocardialSolutions, Inc.**

(Exact name of registrant as 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 checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) Securities Exchange Act of 1934 during thepreceding twelve (12) months (or for such shorter period that the Registrantwas required to file such reports) and (2) has been subject to such filingrequirements for the past 90 days.

Yes ý  No o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act)

 

Yes ý  No o

 

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

 

| **Common Stock, $.01 par value** |   | **19,696,593**                               |
|----------------------------------|--------|----------------------------------------------|
| (Class)                          |   | (Number of Shares Outstanding at May 5, 2003 |

 

 

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**INDEX**

 

**Endocardial Solutions,Inc.**

 
| **PART I.  FINANCIAL INFORMATION** |
|-----------------------------------------|
|                                    |   |   |
|                                    | Item 1. | Financial Statements  (Unaudited) |
|                                    |   | Consolidated Balance  Sheets-March 31, 2003 and December 31, 2002 |
|                                    |   | Consolidated  Statements of Operations- Three months ended March 31, 2003 and March 31,  2002 |
|                                    |   | Consolidated  Statements of Cash Flows-Three months ended March 31, 2003 and March 31, 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**    |   |
|                                    |   |   |
|                                    | Items 1 and 3 through 5 have been omitted since all  items are inapplicable or answers negative. |
|                                    | Item  2. | Changes  in Securities and Use of Proceeds |
|                                    | Item 6. | Exhibits  and Reports on Form 8-K |
|                                         |  |  |  |

 

1

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**PART I -FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**EndocardialSolutions, Inc.**

 

**Consolidated Balance Sheets**

 
|                                                                                                  |   | **March 31,  2003** |       | **December  31,  2002** |   |
|-------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|--------|
|                                                                                                  |   | **(Unaudited)**     |       | **(Note)**              |   |
| **ASSETS**                                                                                            |   |                |       |                    |   |
| Current Assets:                                                                                       |   |                |       |                    |   |
| Cash and cash  equivalents                                                                            |   | $                   | 5,581,046  |                    | $      | 1,347,753 |   |
| Accounts  Receivable, net of reserve for doubtful accounts (2003 - $60,000; 2002 -  $60,000)          |   | 8,948,302           |       | 8,148,723               |   |
| Inventories                                                                                           |   | 5,046,516           |       | 4,634,635               |   |
| Prepaid expenses  and other current assets                                                            |   | 1,004,222           |       | 872,684                 |   |
| Total current  assets                                                                                 |   | 20,580,086          |       | 15,003,795              |   |
|                                                                                                  |   |                |       |                    |   |
| Furniture and  equipment                                                                              |   | 8,643,243           |       | 8,278,575               |   |
| Less accumulated  depreciation                                                                        |   | (6,094,352          | )          | (5,827,679              | )      |
|                                                                                                  |   | 2,548,891           |       | 2,450,896               |   |
|                                                                                                  |   |                |       |                    |   |
| Deposits                                                                                              |   | 49,628              |       | 49,344                  |   |
| Notes Receivable                                                                                      |   | 206,226             |       | 206,226                 |   |
| Patents, net of  accumulated amortization (2003 - $122,265; 2002 - $120,494)                          |   | 9,033               |       | 10,804                  |   |
|                                                                                                  |   |                |       |                    |   |
| Total assets                                                                                          |   | $                   | 23,393,864 |                    | $      | 17,721,065 |   |
|                                                                                                  |   |                |       |                    |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                        |   |                |       |                    |   |
| Current  Liabilities:                                                                                 |   |                |       |                    |   |
| Accounts payable                                                                                      |   | $                   | 1,842,143  |                    | $      | 1,705,316 |   |
| Accrued  compensation expenses                                                                        |   | 1,721,483           |       | 2,671,764               |   |
| Bank line of  credit                                                                                  |   | 1,000,000           |       | 1,000,000               |   |
| Current portion  of capital lease obligations                                                         |   | 435,100             |       | 513,593                 |   |
| Current portion  of deferred revenue                                                                  |   | 2,908,147           |       | 2,217,285               |   |
| Total current  liabilities                                                                            |   | 7,906,873           |       | 8,107,958               |   |
|                                                                                                  |   |                |       |                    |   |
| Long-term  Liabilities:                                                                               |   |                |       |                    |   |
| Capital lease  obligations                                                                            |   | 284,799             |       | 363,195                 |   |
| Deferred revenue                                                                                      |   | 434,284             |       | 435,170                 |   |
| Total long-term  liabilities                                                                          |   | 719,083             |       | 798,365                 |   |
|                                                                                                  |   |                |       |                    |   |
| 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–March 31, 2003–19,664,593; December 31, 2002–16,567,593 |   | 196,646             |       | 165,676                 |   |
| Additional  paid-in capital                                                                           |   | 96,920,097          |       | 88,986,908              |   |
|                                                                                                  |   |                |       |                    |   |
| Accumulated  deficit                                                                                  |   | (82,609,576         | )          | (80,447,669             | )      |
| Accumulated  other comprehensive gain/(loss)                                                          |   | 436,637             |       | 308,537                 |   |
| Deferred  compensation                                                                                |   | (175,896            | )          | (198,710                | )      |
| Total  stockholders’ equity                                                                      |   | 14,767,908          |       | 8,814,742               |   |
| Total  liabilities and stockholders’ equity                                                      |   | $                   | 23,393,864 |                    | $      | 17,721,065 |   |

 

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.*

 

2

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**ConsolidatedStatements of Operations**

(Unaudited)

 
|                                    |   | **For the  Three Months Ended** |       |
|-----------------------------------------|--------|---------------------------------|------------|
|                                    |   | **March 31,  2003**             |       | **March 31,  2002** |   |
|                                    |   |                            |       |   |   |
| Revenue                                 |   | $                               | 7,291,744  |   | $ | 7,108,296 |   |
|                                    |   |                            |       |   |   |
| Cost of goods  sold                     |   | 2,415,004                       |       | 2,601,295 |   |
| Gross margin                            |   | 4,876,740                       |       | 4,507,001 |   |
|                                    |   |                            |       |   |   |
| Operating expenses:                     |   |                            |       |   |   |
| Research and  development               |   | 1,545,370                       |       | 1,306,921 |   |
| General and  administrative             |   | 747,229                         |       | 601,699 |   |
| Sales and  marketing                    |   | 4,707,383                       |       | 4,377,121 |   |
| Operating loss                          |   | (2,123,242                      | )          | (1,778,740 | ) |
|                                    |   |                            |       |   |   |
| Other income  (expense):                |   |                            |       |   |   |
| Interest income                         |   | 11,405                          |       | 23,099 |   |
| Interest expense                        |   | (28,866                         | )          | (27,156 | ) |
| Other                                   |   | (21,204                         | )          | (12,122 | ) |
|                                    |   | (38,665                         | )          | (16,179 | ) |
|                                    |   |                            |       |   |   |
| Net loss for the  period                |   | $                               | (2,161,907 | ) | $ | (1,794,919 | ) |
|                                    |   |                            |       |   |   |
| Net loss per  share - basic and diluted |   | $                               | (0.11      | ) | $ | (0.12 | ) |
|                                    |   |                            |       |   |   |
| Weighted average  shares outstanding    |   | 19,584,300                      |       | 15,490,930 |   |

 

*See accompanying notes.*

 

3

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**EndocardialSolutions, Inc.**

 

**ConsolidatedStatements of Cash Flows**

(Unaudited)

 
|                                                                         |   | **For the  Three Months Ended** |       |
|------------------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                                         |   | **March 31,  2003**             |       | **March 31,  2002** |   |
| **Operating  activities**                                                    |   |                            |       |   |   |
| Net loss                                                                     |   | $                               | (2,161,907 | ) | $ | (1,794,919 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                            |       |   |   |
| Depreciation and  amortization                                               |   | 268,407                         |       | 421,738 |   |
| Amortization of  deferred compensation                                       |   | 22,814                          |       | 21,914 |   |
| Changes in  operating assets and liabilities:                                |   |                            |       |   |   |
| Accounts  Receivable                                                         |   | (733,062                        | )          | (1,378,528 | ) |
| Inventory                                                                    |   | (332,557                        | )          | (331,758 | ) |
| Prepaid expenses  and other assets                                           |   | (31,512                         | )          | 79,159 |   |
| Accounts payable                                                             |   | 139,898                         |       | 244,030 |   |
| Accrued  compensation expenses                                               |   | (959,738                        | )          | (1,069,123 | ) |
| Deferred revenue                                                             |   | 680,847                         |       | 54,442 |   |
| Net cash used in  operating activities                                       |   | (3,106,810                      | )          | (3,753,045 | ) |
|                                                                         |   |                            |       |   |   |
| **Investing  activities**                                                    |   |                            |       |   |   |
| Purchases of  short-term investments                                         |   | —                          |       | — |   |
| Maturities of  short-term investments                                        |   | —                          |       | — |   |
| Purchases of  furniture and equipment                                        |   | (364,159                        | )          | — |   |
| Patent  expenditures                                                         |   | —                          |       | — |   |
| Software  development costs                                                  |   | —                          |       | — |   |
| Proceeds from  sale of equipment                                             |   | —                          |       | — |   |
| Net cash used in  investing activities                                       |   | (364,159                        | )          | — |   |
|                                                                         |   |                            |       |   |   |
| **Financing  activities**                                                    |   |                            |       |   |   |
| Proceeds from  notes payable                                                 |   | —                          |       | — |   |
| Proceeds from  capital lease obligations                                     |   | —                          |       | 162,617 |   |
| Principal  payments on notes payable and capital lease obligations           |   | (156,904                        | )          | (164,944 | ) |
| Proceeds from  issuance of common stock                                      |   | 7,964,158                       |       | 9,381,158 |   |
| Net cash  provided by financing activities                                   |   | 7,807,254                       |       | 9,378,831 |   |
|                                                                         |   |                            |       |   |   |
| Effect of  exchange rate changes on cash                                     |   | (102,992                        | )          | 16,855 |   |
|                                                                         |   |                            |       |   |   |
| Increase in cash  and cash equivalents                                       |   | 4,233,293                       |       | 5,642,641 |   |
| Cash and cash  equivalents at beginning of period                            |   | 1,347,753                       |       | 4,550,059 |   |
| Cash and cash  equivalents at end of period                                  |   | $                               | 5,581,046  |   | $ | 10,192,700 |   |
|                                                                         |   |                            |       |   |   |
| **Supplemental  disclosure of non-cash investing and financing activities**  |   |                            |       |   |   |
| Purchase of  equipment through capital lease obligations                     |   | $                               | —     |   | $ | 503,690 |   |

 

*See accompanying notes.*

 

4

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**EndocardialSolutions, Inc.**

 

**Notes toConsolidated Financial Statements**

 

**(Unaudited)**

 

**1.**                                      Basis ofPresentation

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith generally accepted accounting principles for interim financial informationand with the instructions to Form 10-Q and Article 10 of RegulationS-X.  Accordingly, they do not includeall the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management all adjustments (consisting of normalrecurring adjustments) considered necessary for a fair presentation have beenincluded.  Operating results for thethree months ended March 31, 2003, are not necessarily indicative of theresults that may be expected for the year ending December 31, 2003.  These financial statements should be read inconjunction with the audited financial statements and accompanying notes forthe fiscal year ended December 31, 2002, contained in the Company’sForm 10-K.

 

**2.**                                      Inventories

** **

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

 

Inventories consist of the following:

 
|             |   | **March 31,  2003** |          | **December  31,  2002** |   |
|------------------|--------|---------------------|---------------|-------------------------|--------|
|             |   |                |          |                    |   |
| Raw materials    |   | **$**               | **2,707,544** |                    | $      | 2,099,943 |   |
| Work-in-progress |   | **466,607**         |          | 497,589                 |   |
| Finished goods   |   | **1,872,365**       |          | 2,037,103               |   |
|             |   | **$**               | **5,046,516** |                    | $      | 4,634,635 |   |

 

**3.**                                      Stock-BasedCompensation

 

The Companyaccounts for stock-based compensation in accordance with the provision ofAccounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued toEmployees*, and related interpretations.  The following table illustrates the effect on net loss and lossper share if the Company had applied the fair value recognition provisions ofFinancial Accounting Standards Board (FASB) Statement of Financial AccountingStandards (SFAS) No. 123, *Accounting for Stock-based Compensation*,to stock-based employee compensation. The pro forma financial information, in the following table, is reportedas of March 31:

 
|                                                                                               |   | **2003**     |           | **2002** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------|----------------|----------|--------|
| Net loss as  reported                                                                              |   | **$**        | **(2,161,907** | **)**    | $      | (1,794,919 | ) |
| ****Add:  Stock-based compensation, as reported****                                                |   | **22,814**   | ** **     | 21,914   |   |
| ****Deduct:  Stock-based compensation determined under fair-value-based method for all  awards**** |   | **(374,614** | **)**          | (433,078 | )      |
| Adjusted net  loss, assuming fair-value-based method for all stock-based awards                    |   | **$**        | **(2,513,707** | **)**    | $      | (2,206,083 | ) |
|                                                                                               |   |         | ** **     |     |   |
| ****Basic and diluted loss per share, as reported****                                              |   | **$**        | **(0.11**      | **)**    | $      | (0.12 | ) |
| Basic and  diluted loss per share, SFAS No. 123 adjusted                                           |   | **$**        | **(0.13**      | **)**    | $      | (0.14 | ) |

 

5

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**4.**                                      ComprehensiveIncome

 

**Thecomponents of comprehensive loss and income, net of related tax, for the threemonths ended March 31:**

 
|                                     |   | **2003**    |           | **2002** |   |
|------------------------------------------|--------|-------------|----------------|----------|--------|
|                                     |   |        | ** **     |     |   |
| Net (loss)  income                       |   | **$**       | **(2,161,907** | **)**    | $      | (1,794,919 | ) |
|                                     |   |        | ** **     |     |   |
| Foreign currency  translation adjustment |   | **128,100** | ** **     | (6,508   | )      |
| Comprehensive  (loss) income             |   | **$**       | **(2,033,807** | **)**    | $      | (1,801,427 | ) |

 

**5.**                                      Reclassifications

 

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

 

**6.**                                      StockOffering

 

In January 2003,the Company received proceeds of $8,516,750 from a private placement of3,097,000 shares of its common stock at a price of $2.75 per share, toaccredited investors.

 

**7.**                                      SegmentReporting

 

Sales bygeographic destination as a percentage of total sales were as follows for thethree months ended March 31:

 

|           |   | **2003** |   | **2002** |   |
|----------------|--------|----------|--------|----------|--------|
| Domestic       |   | 72       | %      | 70       | %      |
| International: |   |     |   |     |   |
| Europe         |   | 13       | %      | 22       | %      |
| Asia Pacific   |   | 15       | %      | 5        | %      |
| Canada/Mexico  |   | 0        | %      | 3        | %      |

 

## **Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

**General**

 

EndocardialSolutions Inc. (the “Company”), was incorporated in May 1992.  The Company develops, manufactures andmarkets the EnSite® clinical workstation and the EnSite® catheter (together,the “EnSite System”) for use by electrophysiologists in diagnosing and mappingabnormal heart rhythms known as tachycardias. During the second quarter of 1999, the Company received clearance fromthe U.S. Food and Drug Administration (“FDA”) to market the EnSite System inthe U.S. for use in the right atrium of the heart.  The EnSite System is available to electrophysiologists in Europefor use in the right atrium and left ventricle of the heart.  In April of 2003, the Company receivedclearance from the FDA to market EnSite NavXTM, a new product for the EnSiteclinical workstation that enables non-fluoroscopic navigation of conventionallinear mapping catheters in any chamber of the heart.  EnSite NavX incorporates certain three-dimensional intracardiaclocation technology licensed from Medtronic, Inc.  EnSite NavX is approved for use in Europe and in all othergeographies where the EnSite System is currently sold or distributed.

 

6

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**Resultsof Operations**

 

**General**.  Net losses increased to $2.2 million or $.11per share, for the three months ended March 31, 2003, compared to $1.8million or $0.12 per share, for the same period in 2002.  The Company expects losses to continue intothe fourth quarter of 2003.

 

**Revenueand Cost of Goods Sold**. Worldwide revenue for the three months ended March 31, 2003 wasapproximately $7.3 million, an increase of approximately $0.2 million, or 3%,over the same period in 2002.  In theU.S., revenues increased approximately $0.3 million, or 6%, over the samethree-month period in 2002.  EnSitecatheter revenue in the U.S. increased approximately $0.2 million, or 6%, overthe same three-month period in 2002. EnSite System revenue in the U.S. declined approximately $0.02 million,or 6%, over the same three-month period in 2002.

 

Internationalrevenues decreased approximately $0.09 million, or 4%, for the three monthsended March 31, 2003, compared to the same period in 2002.  International revenues include sales directto the end-user in Europe and Canada, and to distributors in Europe, AsiaPacific and Mexico.  EnSite catheterrevenue internationally decreased approximately $.06 million, or 7%, over thesame period in 2002.  EnSite systemrevenue internationally decreased approximately $1.0 million, or 7%, over thesame period in 2002.

 

Other revenue,which represents 6% and 3%, respectively, of worldwide sales for the threemonth periods ending March 31, 2003 and 2002, includes deferred revenuegenerated from extended service agreements, as well as revenue from accessoriessales and repairs related to EnSite clinical workstations.

 

EnSite clinicalworkstation revenue was approximately $3.1 million for the three months endedMarch 31, 2003, compared to $3.3 million for the same period in 2002.  The decrease is due primarily to theadditional revenue the Company deferred related to the EnSite clinicalworkstation revenue in 2003, versus 2002, related to extended warranties withhardware upgrades that the Company sold in 2003.  With the FDA approval and commercial release of EnSite NavX inthe second quarter of 2003, the Company will begin to recognize this deferredrevenue as EnSite clinical workstations are upgraded to include EnSiteNavX.    Domestic revenues accounted for62% of total EnSite clinical workstation sales for the three months ended March31, 2003, compared to 61% for the same period in 2002.

 

EnSite catheterrevenue was approximately $3.7 million for the three months ended March 31,2003, compared to $3.6 million for the same period in 2002, or an increase of6%.  Domestic revenue accounted for 80%of total EnSite catheter sales for the three months ended March 31, 2003,compared to 78% for the same period in 2002.

 

Cost of goodssold, including unabsorbed manufacturing expenses, was approximately $2.4million and $2.6 million for the three months ended March 31, 2003 and 2002,respectively.

 

The Company’sgross profit margin was 66.9% for the three months ended March 31, 2003,compared with 63.4% during the same period in 2002.  Gross margins on EnSite catheters improved to 71.5% in the firstquarter of 2003, up from 71.1% in the first quarter of 2002.  Gross margins on EnSite Systems improved to59.1% in the first quarter of 2003, up from 56.1% in the first quarter of2002.  This increase in gross marginswas primarily attributable to improvements in the EnSite catheter manufacturingprocess and material costs, together with improved absorption of manufacturingoverhead from increased EnSite catheter revenue over the comparable period inthe prior year.  Additionally, becausethe Company’s gross margins on its domestic sales are substantially higher thanthose on its international sales, this increase in the Company’s gross marginsduring the first quarter were positively impacted by the fact that 72% of therevenue recorded during the quarter was from domestic sales, compared to 70%from the same period in 2002.  TheCompany expects these gross margin improvements will continue to be recognizedfor the remaining quarters of 2003 on both the EnSite catheters and EnSiteclinical workstations.

 

**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 $1.5 millionfor the 

 

7

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three-month period ended March 31, 2003, compared to approximately $1.3million during the same period in 2002. The Company expects to make continued significant investments inresearch and development and clinical studies during the remainder of 2003.

 

**Generaland Administrative Expenses**. General and administrative expenses were approximately $0.7 million and$0.6 million for the three months ended March 31, 2003 and 2002,respectively.  The increase is due to anincrease in professional service expenses associated with various informationtechnology projects and actions necessary for the Company to comply withcertain requirements of the Sarbanes-Oxley Act of 2002, as well as  compensation, benefits and relocationexpenses associated with the hiring the Company’s CFO.  The Company expects general andadministrative expenses to remain relatively constant for the remainingquarters of 2003.

 

**Salesand Marketing Expenses**. Sales and marketing expenses were approximately $4.7 million during thethree months ended March 31, 2003, compared to $4.4 million during the same periodin 2002.  The increase is primarilyattributable to increases in personnel and costs associated with the hiring andtraining of additional personnel during 2002 for the U.S. and European salesand clinical support teams.  The Companyexpects sales and marketing expenses to remain relatively constant for theremaining quarters of 2003.

 

**InterestIncome and Expense**. Interest income was approximately $11,000 and $23,000 for the threemonths ended March 31, 2003 and 2002, respectively.  The decrease for the three months ended March 31, 2003 was due tolower average cash and cash equivalent balances and lower interest rates.  Interest expense was approximately $29,000and $27,000 for the three months ended March 31, 2003 and 2002, respectively.

 

**Liquidityand Capital Resources**.

 

The Company’soperations since inception have been funded by net proceeds from the sales ofcommon and preferred stock totaling approximately $97.1 million.  As of March 31, 2003 and December 31,2002, the Company had cash, cash equivalents and short-term investments ofapproximately $5.6 million and $1.3 million, respectively.

 

For the threemonths ended March 31, 2003, the Company used cash of approximately $3.1million, compared to approximately $3.8 million for the same period in 2002.

 

The Company’saccounts receivable balance was approximately $8.9 million for the three monthsended March 31, 2003, an increase of approximately $2.5 million from March 31,2002.  The increase in accountsreceivable is attributable to the sale of 10 EnSite clinical workstations tothe Company’s distributor in Japan during the first quarter of 2003, and theCompany’s transition from a distributor organization to direct sales in Europeduring 2002.    The other factoraffecting the increase in accounts receivable relates to the Company’s effortsduring the first quarter of 2003 to sell extended warranty agreements withhardware upgrades to its current installed base of EnSite customers in theU.S., Europe and Asia Pacific.  The Company sold approximately 45 extended warranty agreements withhardware upgrades during the first quarter of 2003, but deferred that portionof the revenue from these sales related to the hardware upgrade, to berecognized at the time of installation, with the remainder to be recognizedover the warranty period.  The Companyexpects to recognize the majority of the revenue from the sale of theseextended warranty agreements with hardware upgrades over the remainder of 2003(and thereafter, in some cases, depending upon the length of the extendedwarranty period).  The deferred revenuefrom the sale of these extended warranty agreements, in addition to the 85extended warranty agreements the Company sold during the third and fourthquarters of 2002, is reflected in the current liability portion of deferredrevenue of approximately $2.9 million at March 31, 2003, as compared toapproximately $0.7 million at March 31, 2002.

 

The Company’sinventory balance at March 31, 2003 was approximately $5.0 million, an increaseof approximately $2.0 million, or 65%, over March 31, 2002.  This increase in inventory was primarilyattributable to three factors.  First,the Company increased the production of EnSite Version 3.2 clinicalworkstations during the fourth quarter of 2002 and first quarter of 2003 inanticipation of beginning the manufacture of the new hardware configurationassociated with anticipated commercial release EnSite NavX during the secondquarter of 2003.  This increasedproduction of EnSite workstations was based on EnSite System sales forecast forthe first and second quarters of 2003 during the time when the Company’shardware production is focused on building the EnSite NavX hardware upgradekits.    Second, because of long leadtimes on several components for the EnSite NavX upgrade 

 

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kits, the Company built inventory levels of these components during thefirst quarter of 2003 in order to be prepared to begin production following FDAapproval, which was anticipated and received in the second quarter of2003.  Third, the Company had alsoincreased production of EnSite catheters during the second and third quartersof 2002 in anticipation of higher EnSite catheter sales during 2003.  The Company reduced EnSite catheterproduction during the first quarter of 2003 to usual levels.    The Company believes inventories of EnSiteSystems and EnSite catheters will decrease throughout the remainder 2003 tohistorical levels, offset slightly by an increase in inventory due to theaddition of EnSite NavX upgrade kits and EnSite NavX surface electrode kitsthat were not part of the Company’s inventory in 2002.

 

The Company’saccounts payable (including accrued expenses) balance at March 31, 2003 wasapproximately $3.6 million, a decrease of approximately $0.3 million from March31, 2002.  The slight decrease 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 flows.  The Company expects accounts payable andaccrued expenses to increase during the remaining quarters of 2003 as operatingand production expenses increase to support continued growth in revenue and theintroduction of EnSite NavX.

 

The Company had noshort-term investment portfolio as of March 31, 2003 and December 31,2002.  A majority of the Company’savailable cash was in money market funds due to the inability to attain higherrates of interest in short-term investments dictated by 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 June 2001, the Company entered into a $3.5million credit facility agreement with Silicon Valley Bank, consisting of a$1.5 million capital lease line and a $2 million revolving line of credit.  In May of 2002, the Company modified thiscredit facility agreement to increase the credit line to $3 million of creditin connection with the June 2002 expiration of the Company’s right to makeadditional advances against the 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 December31, 2002, while the Company was not in compliance with either the quick ratioor the tangible net worth covenants, Silicon Valley Bank had granted theCompany a forbearance under the credit agreement, pending completion of theequity offering described above.  Uponreceipt of the private placement proceeds in January 2003, the Company wasagain in compliance with the restrictive covenants of the Silicon Valley Bankcredit facility.  As of March 31, 2003,the Company was in compliance with both the quick ratio and tangible net worthcovenants of the credit facility.  TheCompany and Silicon Valley Bank subsequently amended this credit facility toextend the term of the facility until May 2003.  As of March 31, 2003, the Company had $667,117 outstanding on theexpired capital lease line and had $1 million outstanding on the revolving lineof credit.

 

The Companybelieves that its existing cash, cash equivalents, short-term investments andbank financing will be sufficient to fund the operations of the Company throughfourth quarter of 2003.  The Company’sfuture liquidity and capital requirements will depend on numerous factors,including the timing of regulatory actions regarding the Company’s products,the results of clinical trials and competition, the extent to which theCompany’s EnSite System and EnSite NavX products continue to gain marketacceptance, the cost, timing and method of expanding sales, marketing, researchand development, 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 financialstatements and related footnotes.  Inpreparing these financial statements, management has made its best estimatesand judgments of certain amounts included in the financial statements, givingdue consideration 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.

 

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*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 extended warranty and hardware upgrade agreements are deferred andrecognized ratably over the period the services are provided or as the upgradesare performed.  The Securities andExchange 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.

 

*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.

 

*NewAccounting Standards*.  In November 2002, the EITF issuedEITF Issue No. 00-21, Accounting for Revenue Arrangements with MultipleDeliverables.  EITF Issue No. 00-21addresses certain aspects of the accounting by a vendor for arrangements underwhich it will perform multiple revenue-generating activities. EITF Issue No.00-21 establishes three principles: revenue arrangements with multipledeliverables should be divided into separate units of accounting, arrangementconsideration should be allocated among the separate units of accounting basedon their relative fair values, and revenue recognition criteria should beconsidered separately for separate units of accounting. EITF Issue No. 00-21 iseffective for all revenue arrangements entered into in fiscal periods beginningafter June 15, 2003, with early adoption permitted.  The Company does not believe the adoption of EITF Issue No. 00-21will have 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 amends SFAS No. 123, Accounting for Stock-BasedCompensation, to provide alternative methods of transition for a voluntarychange to the fair value method of accounting for stock-based employeecompensation.  SFAS No. 148 also amendsthe disclosure requirements of SFAS No. 123 to require more disclosure in thesummary of significant accounting policies, the effects of an entity’saccounting policy with respect to stock-based employee compensation on reportednet income and earnings per share in annual and interim financialstatements.  The disclosure provision isrequired for all companies with stock-based employee compensation, regardlessof whether the company utilizes the fair value method of accounting describedin SFAS No. 123 or the intrinsic value method described in APB Opinion No. 25,Accounting for Stock Issued to Employees. SFAS No. 148’s amendment of thetransition and annual disclosure provisions of SFAS No. 123 are effective forfiscal years ending after December 15, 2002. The disclosure provisions for interim financial statements are effectivefor interim periods beginning after December 15, 2002. The Company currentlyaccounts for stock-based compensation utilizing the intrinsic value method ofaccounting for stock-based employee compensation described by APB Opinion No.25.

 

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**CautionaryStatement**

 

Except for the historical information contained herein, this QuarterlyReport on Form 10-Q contains forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements representthe Company’s expectations, beliefs, intentions or strategies concerning futureevents, including, but not limited to, any statements regarding its currentassumptions about future financial performance; the continuation of historicaltrends; the sufficiency of its cash balances and cash generated from operatingactivities for future liquidity and capital resource needs; the expected impactof changes in accounting policies on the Company’s results of operations,financial condition or cash flows; anticipated problems and its plans forfuture operations; and the economy in general or the future of the medicaldevice industry, all of which are subject to various risks and uncertainties.  When used in this Form 10-Q and infuture filings by the Company with the Securities and Exchange Commission, inthe Company’s press releases and in oral statements made with the approval ofan authorized executive officer, the word or phrases “believes,” “anticipates,”“expects,” “intends,” “will likely result,” “estimates,” “projects” or similarexpressions are intended to identify such forward-looking statements, but arenot the exclusive means of identifying such statements.  However, any statements contained in thisForm 10-K that are not statements of historical fact may be deemed to beforward-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 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-K for the year ended December 31,2002.

 

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

 

The Company hadapproximately $5.6 million of cash and investments as of March 31, 2003.  Substantially all of the investments wereU.S. government or investment grade, fixed income securities from domesticissuers.  Because of the credit riskcriteria of the Company’s investment policies, the primary market riskassociated 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.  Even though the Company distributes productsabroad, the Company does not conduct sales in foreign currencies.  Therefore, management does believe thatCompany is exposed to any material foreign currency exchange rate risk.

 

**Item4.  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 ChiefFinancial Officer, we evaluated the effectiveness of the design and operationof our disclosure controls and procedures (as defined in Rule 13a-14(c) underthe Exchange Act) as of a date (the “Evaluation Date”) within 90 days prior tothe filing date of this report.  Based uponthat evaluation, the Chief Executive Officer and the Chief Financial Officerconcluded that, as of the Evaluation Date, our disclosure controls andprocedures are effective in timely alerting them to the material informationrelating to us (or our consolidated subsidiaries) required to be included inour periodic SEC filings.

 

 (b) Changes in internalcontrols.

 

There were no significant changes made in our internalcontrols during the period covered by this report or, to our knowledge, inother factors that could significantly affect these controls subsequent to thedate of their evaluation.

 

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# **PARTII.  OTHER INFORMATION**

 

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

 

In January 2003, the Company completed the sale in aprivate placement of 3,097,000 shares of its common stock to accreditedinvestors at a price of $2.75 per share, for proceeds of $8,516,750.  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 expenses associatedwith new product development, clinical studies and the commercial introductionof EnSite NavX.

 

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

 

(a)                                  Exhibits

 
| **Exhibit** |   | **Description**                                                                                                                                                                                                                                                      |
|-------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |   | Form of Stock  Purchase Agreement, dated January 2, 2003, among the Company and the  Investors named therein (incorporated by reference to Exhibit 10.21 to the  Company’s Annual Report on Form 10-K for the year ended December 31, 2002  (File No. 0-22233)) |
|        |   |                                                                                                                                                                                                                                                                 |
| 99.1        |   | Certification of  the Chief Executive Officer, filed herewith, dated May 14, 2003, pursuant to  18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                          |
|        |   |                                                                                                                                                                                                                                                                 |
| 99.2        |   | Certification of  the Chief Financial Officer, filed herewith, dated May 14, 2003, pursuant to  18 U.S.C. Sec. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                          |

 

(b)                                 Reportson Form 8-K

 

A Form 8-K was filed by the Company on January 6, 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 the sale of approximately $8.5 million of its common stock.

 

A Form 8-K was filed by the Company on January 9, 2003; such reportcontained information disclosed pursuant to Regulation FD under Item 5 andincluded as an exhibit under Item 7 a copy of form of Stock Purchase Agreement,dated January 2, 2003, among the Company and the Investors named therein.

 

A Form 8-K was filed by the Company on January 28, 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 fourth quarter and 2002 earnings results.

 

A Form 8-K was filed by the Company on February 5, 2003; such reportcontained information disclosed pursuant to Regulation FD and included as anExhibit under Item 5 a copy of a press release issued by the Company announcingthe promotion of Patrick J. Wethington to the position of Vice President, NorthAmerican Sales.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                      | ENDOCARDIAL SOLUTIONS,  INC. |
|---------------------------|------------------------------|
|                      |                         |
|                      |                         |
| Dated:  May 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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**Certificationof Chief Executive Officer Pursuant to Section 302 of theSarbanes-Oxley Act of 2002**

 

I, James W. Bullock, certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Endocardial Solutions, Inc.;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               This registrant’sother certifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalent function):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weakness in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

Date:May 14, 2003

 
|   |   |   | /s/ James W. Bullock    |
|--------|--------|--------|-------------------------|
|   | Name:  |   | James W. Bullock        |
|   | Title: |   | Chief Executive Officer |

 

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**Certificationof Chief Financial OfficerPursuant to Section 302 of theSarbanes-Oxley Act of 2002**

 

I, J. Robert Paulson, Jr., certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of Endocardial Solutions, Inc.;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               This registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

d)             all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weakness in internal controls; and

 

e)              any fraud, whetheror not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

Date:May 14, 2003

 
|   |   |   | /s/ J. Robert Paulson, Jr. |
|--------|--------|--------|----------------------------|
|   | Name:  |   | J. Robert Paulson, Jr.     |
|   | Title: |   | Chief Financial Officer    |

 

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