**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 June 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 ofregistrant 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 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 to such 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 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** |   | **19,701,013**                                     |
|-----------------------------------|--------|----------------------------------------------------|
| (Class)                           |   | (Number of  Shares Outstanding at  August 6, 2003) |

 

 

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**INDEX**

 

**EndocardialSolutions, Inc.**

** **
| **PART I.  FINANCIAL INFORMATION** |
|-----------------------------------------|
|                                    |
|                                    | Item 1.   Financial Statements (Unaudited) |
|                                    | Consolidated Balance  Sheets-June 30, 2003 and December 31, 2002 |
|                                    | Consolidated  Statements of Operations- Three and six months ended June 30, 2003 and June  30, 2002 |
|                                    | Consolidated Statements  of Cash Flows-Three and six months ended June 30, 2003 and June 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.  Control and Procedures |
|                                    |   |
| **PART II.  OTHER INFORMATION**    |
|                                    |
|                                    | Item 4.   Submission of Matters to a Vote of Security Holders |
|                                    | Item 6.   Exhibits and Reports on Form 8-K |

 

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**PART I****- FINANCIAL INFORMATION**

 

**Item 1****.  Financial Statements**

 

**EndocardialSolutions, Inc.**

**ConsolidatedBalance Sheets**

**(000’s)**

 
|                                                                                                                                                              |   | **June 30,  2003** |       | **December  31,  2002** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------------|------------|
|                                                                                                                                                              |   | **(Unaudited)**    |       | **(Note)**              |       |
| **ASSETS**                                                                                                                                                        |   |               | ** ** |                    | ** ** |
| Current  Assets:                                                                                                                                                  |   |               |       |                    |       |
| Cash  and cash equivalents                                                                                                                                        |   | $                  | 2,703      |                    | $          | 1,348 |   |
| Accounts  Receivable, net of reserve for doubtful accounts (2003 - $60,000; 2002 -  $60,000)                                                                      |   | 10,626             |       | 8,149                   |       |
| Inventories                                                                                                                                                       |   | 4,591              |       | 4,635                   |       |
| Prepaid  expenses and other current assets                                                                                                                        |   | 1,163              |       | 872                     |       |
| Total  current assets                                                                                                                                             |   | 19,083             |       | 15,004                  |       |
|                                                                                                                                                              |   |               |       |                    |       |
| Furniture  and equipment                                                                                                                                          |   | 9,092              |       | 8,279                   |       |
| Less  accumulated depreciation                                                                                                                                    |   | (6,358             | )          | (5,828                  | )          |
|                                                                                                                                                              |   | 2,734              |       | 2,451                   |       |
|                                                                                                                                                              |   |               | ** ** |                    | ** ** |
| Deposits                                                                                                                                                          |   | 50                 |       | 49                      |       |
| Notes  Receivable                                                                                                                                                 |   | 206                |       | 206                     |       |
| Patents,  net of accumulated amortization (2003 - $123,708; 2002 - $120,494)                                                                                      |   | 8                  |       | 11                      |       |
|                                                                                                                                                              |   |               |       |                    |       |
| Total  assets                                                                                                                                                     |   | $                  | 22,081     |                    | $          | 17,721 |   |
|                                                                                                                                                              |   |               |       |                    |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                     |   |               | ** ** |                    | ** ** |
| Current  Liabilities:                                                                                                                                             |   |               |       |                    |       |
| Accounts  payable                                                                                                                                                 |   | $                  | 2,118      |                    | $          | 1,705 |   |
| Accrued  compensation expenses                                                                                                                                    |   | 2,461              |       | 2,672                   |       |
| Bank  line of credit                                                                                                                                              |   | 1,000              |       | 1,000                   |       |
| Current  portion of capital lease obligations                                                                                                                     |   | 396                |       | 514                     |       |
| Current  portion of deferred revenue                                                                                                                              |   | 2,171              |       | 2,217                   |       |
| Total  current liabilities                                                                                                                                        |   | 8,146              |       | 8,108                   |       |
|                                                                                                                                                              |   |               |       |                    |       |
| Long-term  Liabilities:                                                                                                                                           |   |               |       |                    |       |
| Capital  lease obligations                                                                                                                                        |   | 188                |       | 363                     |       |
| Deferred  revenue                                                                                                                                                 |   | 359                |       | 435                     |       |
| Total  long-term liabilities                                                                                                                                      |   | 547                |       | 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—June 30, 2003-19,701,013; December 31,  2002—16,567,593 |   | 197                |       | 166                     |       |
| Additional  paid-in capital                                                                                                                                       |   | 96,927             |       | 88,987                  |       |
|                                                                                                                                                              |   |               |       |                    |       |
| Accumulated  deficit                                                                                                                                              |   | (84,029            | )          | (80,448                 | )          |
| Accumulated  other comprehensive gain/(loss)                                                                                                                      |   | 447                |       | 309                     |       |
| Deferred  compensation                                                                                                                                            |   | (154               | )          | (199                    | )          |
| Total  stockholders’ equity                                                                                                                                  |   | 13,388             |       | 8,815                   |       |
| Total  liabilities and stockholders’ equity                                                                                                                  |   | $                  | 22,081     |                    | $          | 17,721 |   |

 

Note: The balancesheet at December 31, 2002 has been derived from the audited financialstatements at that date but does not include all of the information andfootnotes required by generally accepted accounting principles for completefinancial statements.

 

1

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** **

**EndocardialSolutions, Inc.**

**ConsolidatedStatements of Operations**

**(000’s)**

(Unaudited)

 
|                                    |   | **For the  Three Months Ended** |   | **For the  Six Months Ended** |   |
|-----------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                    |   | **June 30,  2003**              |   | **June 30,  2002**            |   | **June 30,  2003** |   | **June 30,  2002** |   |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Revenue                                 |   | $                               | 9,293  |                          | $      | 7,532 |   | $ | 16,585 |   | $ | 14,640 |   |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Cost  of goods sold                     |   | 3,447                           |   | 2,789                         |   | 5,862 |   | 5,390 |   |
| Gross  profit                           |   | 5,846                           |   | 4,743                         |   | 10,723 |   | 9,250 |   |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Operating  expenses:                    |   |                            |   |                          |   |   |   |   |   |
| Research  and development               |   | 1,488                           |   | 1,287                         |   | 3,033 |   | 2,594 |   |
| General  and administrative             |   | 774                             |   | 673                           |   | 1,522 |   | 1,274 |   |
| Sales  and marketing                    |   | 4,973                           |   | 4,700                         |   | 9,680 |   | 9,078 |   |
| Operating  loss                         |   | (1,389                          | )      | (1,917                        | )      | (3,512 | ) | (3,696 | ) |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Other  income (expense):                |   |                            |   |                          |   |   |   |   |   |
| Interest  income                        |   | 11                              |   | 26                            |   | 22 |   | 49 |   |
| Interest  expense                       |   | (32                             | )      | (34                           | )      | (61 | ) | (61 | ) |
| Other                                   |   | (9                              | )      | (5                            | )      | (30 | ) | (17 | ) |
|                                    |   | (30                             | )      | (13                           | )      | (69 | ) | (29 | ) |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Net  loss for the period                |   | $                               | (1,419 | )                             | $      | (1,930 | ) | $ | (3,581 | ) | $ | (3,725 | ) |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Net  loss per share - basic and diluted |   | $                               | (0.07  | )                             | $      | (0.12 | ) | $ | (0.18 | ) | $ | (0.23 | ) |
|                                    |   |                            |   |                          |   |   |   |   |   |
| Weighted  average shares outstanding    |   | 19,688,926                      |   | 16,610,509                    |   | 19,636,613 |   | 16,050,720 |   |

 

*Seeaccompanying notes.*

 

2

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**EndocardialSolutions, Inc.**

**ConsolidatedStatements of Cash Flows**

**(000’s)**

(Unaudited)

 
|                                                                         |   | **For the  Six Months Ended** |       |
|------------------------------------------------------------------------------|--------|-------------------------------|------------|
|                                                                         |   | **June 30,  2003**            | ** ** | **June 30,  2002** | ** ** |
| **Operating  activities**                                                    |   |                          |       |   |   |
| Net loss                                                                     |   | $                             | (3,581     | ) | $ | (3,725 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                          |       |   |   |
| Depreciation and  amortization                                               |   | 534                           |       | 746 |   |
| Amortization of  deferred compensation                                       |   | 44                            |       | 44 |   |
| Changes in  operating assets and liabilities:                                |   |                          |       |   |   |
| Accounts  Receivable                                                         |   | (2,254                        | )          | (3,325 | ) |
| Inventory                                                                    |   | 95                            |       | (979 | ) |
| Prepaid expenses  and other assets                                           |   | (65                           | )          | (39 | ) |
| Accounts payable                                                             |   | 406                           |       | (70 | ) |
| Acrrued  compensation expenses                                               |   | (236                          | )          | (578 | ) |
| Deferred revenue                                                             |   | (167                          | )          | 154 |   |
| Net cash used in  operating activities                                       |   | (5,224                        | )          | (7,772 | ) |
|                                                                         |   |                          |       |   |   |
| **Investing  activities**                                                    |   |                          |       |   |   |
| Purchases of  furniture and equipment                                        |   | (804                          | )          | (95 | ) |
| Net cash used in  investing activities                                       |   | (804                          | )          | (95 | ) |
|                                                                         |   |                          |       |   |   |
| **Financing  activities**                                                    |   |                          |       |   |   |
| Proceeds from  capital lease obligations                                     |   | —                        |       | 163 |   |
| Principal  payments on notes payable and capital lease obligations           |   | (293                          | )          | (331 | ) |
| Proceeds from  issuance of common stock                                      |   | 7,971                         |       | 9,389 |   |
| Net cash  provided by (used in) financing activities                         |   | 7,678                         |       | 9,221 |   |
|                                                                         |   |                          |       |   |   |
| Effect of  exchange rate changes on cash                                     |   | (295                          | )          | 198 |   |
|                                                                         |   |                          |       |   |   |
| Increase  (decrease) in cash and cash equivalents                            |   | 1,355                         |       | 1,552 |   |
| Cash and cash  equivalents at beginning of period                            |   | 1,348                         |       | 4,550 |   |
| Cash and cash  equivalents at end of period                                  |   | $                             | 2,703      |   | $ | 6,102 |   |
|                                                                         |   |                          |       |   |   |
| **Supplemental  disclosure of non-cash investing and financing activities**  |   |                          |       |   |   |
| Purchase of  equipment and inventory through capital lease obligations       |   | $                             | —     |   | $ | 725 |   |

 

*Seeaccompanying notes.*

 

3

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**EndocardialSolutions, Inc.**

** **

**Notes toConsolidated 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 six months endedJune 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:

 
|             |   | **June 30,**  |          | **December  31,** |   |
|------------------|--------|---------------|---------------|-------------------|--------|
|             |   | **2003**      |          | **2002**          |   |
|             |   |          |          |              |   |
| Raw materials    |   | **$**         | **2,816,983** |              | $      | 2,099,943 |   |
| Work-in-progress |   | **590,311**   |          | 497,589           |   |
| Finished goods   |   | **1,183,621** |          | 2,037,103         |   |
|             |   | **$**         | **4,590,915** |              | $      | 4,634,635 |   |

 

**3.            Stock-Based Compensation**

 

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.  The following table illustrates the effecton net loss and loss per share if the Company had applied the fair valuerecognition provisions of Financial Accounting Standards Board (FASB) Statementof Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-basedCompensation, to stock- based employer compensation.

 
|                                                                                               |   | **For the  three  months ended** |            | **For the  six  months ended** |   |
|----------------------------------------------------------------------------------------------------|--------|----------------------------------|-----------------|--------------------------------|--------|
|                                                                                               |   | **2003**                         |            | **2002**                       |   | **2003** |   | **2002** |   |
| Net loss, as reported as June 30:                                                                  |   | **$**                            | **(1,419,121)** |                           | $      | (1,929,875) |   | **$** | **(3,581,028)** |   | $ | (3,724,794) |   |
| ****Add:  Stock-based compensation, as reported****                                                |   | **21,327**                       | ** **      | 22,515                         |   | **44,141** | ** ** | 44,429 |   |
| ****Deduct:  Stock-based compensation determined under fair-value-based method for all  awards**** |   | **(357,265**                     | **)**           | (451,229                       | )      | **(731,879** | **)** |   (884,307 | ) |
| Adjusted net  loss, assuming fair-value-based method for all stock-based awards                    |   | **$**                            | **(1,755,059**  | **)**                          | $      | (2,358,589 | ) | **$** | **(4,268,766** | **)** | $ | (4,564,672 | ) |
|                                                                                               |   |                             | ** **      |                           |   |   | ** ** |   |   |
| ****Basic and diluted loss per share, as reported****                                              |   | **$**                            | **(0.07**       | **)**                          | $      | (0.12 | ) | **$** | **(0.18** | **)** | $ | (0.23 | ) |
| Basic and  diluted loss per share, SFAS No. 123 adjusted                                           |   | **$**                            | **(0.09**       | **)**                          | $      | (0.14 | ) | **$** | **(0.22** | **)** | $ | (.028 | ) |

 

**4.            Comprehensive Income**

 

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

 
|                                     |   | **For the  three  months ended June 30** |           | **For the  six  months ended June 30** |   |
|------------------------------------------|--------|------------------------------------------|----------------|----------------------------------------|--------|
|                                     |   | **2003**                                 |           | **2002**                               |   | **2003** |   | **2002** |   |
| Net (loss)  income                       |   | **$**                                    | **(1,419,121** | **)**                                  | $      | (1,929,875 | ) | **$** | **(3,581,028** | **)** | $ | (3,724,794 | ) |
|                                     |   |                                     | ** **     |                                   |   |   | ** ** |   |   |
| Foreign currency  translation adjustment |   | **10,691**                               | ** **     | 233,646                                |   | **138,791** | ** ** | 227,138 |   |
| Comprehensive  (loss) income             |   | **$**                                    | **(1,408,430** | **)**                                  | $      | (1,696,229 | ) | **$** | **(3,442,237** | **)** | $ | (3,497,656 | ) |

 

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

 

In November 2002, theFinancial Accounting Standards Board issued Interpretation No. 45 (FIN 45),"Guarantor's Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantees of Indebtedness of Others." Theinterpretation requires disclosure in periodic financial statements of certainguarantee arrangements. The interpretation also clarifies situations where aguarantor is required to recognize the fair value of certain guarantees in thefinancial statements. The Company does not have any guarantees that requirerecognition at fair value under the interpretation.

 

The Company sells serviceand support contracts, extended warranty and hardware upgrade agreements. Theseitems are required to be disclosed in periodic financial statements under theinterpretation. Revenue from service and support contracts, and from extendedwarranty and hardware upgrade agreements, are deferred and recognized ratablyover the period the services are provided or at the time the upgrades areperformed. Costs associated with service and support contracts, extendedwarranty, and hardware upgrade agreements are recognized at the time theservice was provided or the upgrades performed.

 

Changes in the recordeddeferred revenue amounts during the period are as follows:

 
| Balance,  December 31, 2002                    |   | $          | 2,652,455 |   |
|------------------------------------------------|--------|------------|-----------|--------|
| Additional  deferred revenue during the period |   | 2,000,158  |      |
| Deferred revenue  recognized during the period |   | (2,122,414 | )         |
| Balance, June  30, 2003                        |   | $          | 2,530,199 |   |

 

 

**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.

** **

**8.****                                     SegmentReporting**

 

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

 
|           |   | **For the  three  months ended  June 30** |   | **For the  six  months ended  June 30** |       |
|----------------|--------|-------------------------------------------|--------|-----------------------------------------|------------|
|           |   | **2003**                                  |   | **2002**                                | ** ** | **2003** | ** ** | **2002** | ** ** |
| Domestic       |   | 79                                        | %      | 80                                      | %          | 76 | % | 75 | % |
| International: |   |                                      |   |                                    |       |   |   |   |   |
| Europe         |   | 14                                        | %      | 12                                      | %          | 13 | % | 16 | % |
| Asia  Pacific  |   | 4                                         | %      | 4                                       | %          | 9 | % | 5 | % |
| Canada/Mexico  |   | 3                                         | %      | 4                                       | %          | 2 | % | 4 | % |

 

4

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**Item2.  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 and theEnSite® catheter (together, the “EnSite System”) for use byelectrophysiologists in diagnosing and mapping abnormal heart rhythms known astachycardias.  During the second quarterof 1999, the Company received clearance from the U.S. Food and DrugAdministration (“FDA”) to market the EnSite System in the U.S. for use in the rightatrium of the heart.  The EnSite Systemis 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 NavXTM, anew product for the EnSite clinical workstation that enables non-fluoroscopicnavigation of conventional linear mapping catheters in any chamber of theheart.  EnSite NavX incorporates certainthree-dimensional intracardiac location technology licensed from Medtronic, Inc.  EnSite NavX is approved for use in Europeand in all other geographies where the EnSite System is currently sold ordistributed.  The Company commerciallyreleased EnSite NavX worldwide during the second quarter of 2003.

** **

**Resultsof Operations**

** **

**General**.  Net losses were $1.4 million or $.07 pershare, for the three months ended June 30, 2003, compared to $1.9 million or$0.12 per share, for the same period in 2002. For the six months ended June 30, 2003, net losses were $3.6 million or$0.18 per share, compared to $3.7 million or $0.23 per share for the sameperiod in 2002.  The Company expectslosses to continue through the third quarter of 2003.

** **

**Revenueand Cost of Goods Sold**. Worldwide revenue for the three months ended June 30, 2003 wasapproximately $9.3 million, an increase of approximately $1.8 million, or23.4%, over the same period in 2002. For the six months ended June 30, 2003, worldwide revenue wasapproximately $16.6 million, an increase of $1.9 million or 13.3% over the sameperiod in 2002.  In the U.S., revenuefor the three months ended June 30, 2003 increased approximately $1.4 million,or 22.9%, over the same three-month period in 2002.  Revenue in the U.S. for the six months ended June 30, 2003 wasapproximately $12.6 million, an increase of $1.6 million or 15.0% over the sameperiod in 2002.

 

International revenue for the three months ended June30, 2003 was approximately $1.9 million, an increase of $0.4 million, or 25.5%,compared to the same period in 2002. For the six months ended June 30, 2003, international revenue wasapproximately $4.0 million, an increase of $0.3 million, or 8.1%, over the sameperiod in 2002.  International revenueincludes sales direct to end-users in Europe and Canada, and to distributors inEurope, Asia Pacific and Mexico.

 

With the commercial release of EnSite NavX in thesecond quarter 2003, revenue from the sale of EnSite disposable products(EnSite catheters plus EnSite NavX surface electrode kits) for the three monthperiod ended June 30, 2003 was approximately $4.9 million, an increase ofapproximately $0.9 million, or 22.0%, over the same period in 2002 (whichincluded EnSite catheter sales only). For the six month period ended June 30, 2003, revenue from the sale ofEnSite disposable products was $8.6 million, an increase of $1.0 million, or13.2%, over the same period in 2002 (which included EnSite catheter salesonly).  Domestic sales accounted for80.1% of total EnSite disposable product revenue for the three months endedJune 30, 2003, compared to 82.2% for the same period in 2002 (which includedEnSite catheter sales only).  For thesix months ended June 30, 2003, domestic sales accounted for 80.0% of the totalEnSite disposable product revenue, as compared to 80.0% for the same period in2002 (which included EnSite catheter sales only).

 

Revenue from the sale of EnSite clinical workstationswas approximately $2.6 million for the three months ended June 30, 2003,compared to $3.1 million for the same period in 2002.  EnSite clinical workstation revenue for the six month periodended June 30, 2003 was approximately $5.7 million, as compared to $6.3 millionfor the same period in 2002.  Domesticsales accounted for 84.6% of EnSite clinical workstation revenue for the threemonths ended June 30, 2003, compared to 79.4% for the same period in 2002.  Domestic sales accounted for 72.8% of EnSiteclinical workstation revenue for the six month period ended June 30, 2003,compared to 70.1% for the same period in 2002.

 

5

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Other revenue, which represents 5.5% and 5.6%,respectively, of worldwide sales for the three month periods ended June 30,2003 and 2002, and 6.1% and 5.4% for the six month periods ended June 30, 2003and 2002, respectively, includes deferred revenue generated from the sale of serviceand support contracts, and extended warranty agreements, as well as revenuefrom the sale of EnSite accessories and repairs to EnSite clinicalworkstations.

 

Following the commercial release of EnSite NavX in thesecond quarter of 2003, the Company upgraded 115 EnSite systems globally to addEnSite NavX hardware and software, resulting in the recognition of $1.3 millionof deferred revenue related to the installation of EnSite NavX upgrades for thethree month period ended June 30, 2003.

 

Cost of goods sold, including unabsorbed manufacturingexpenses, was approximately $3.5 million and $2.8 million for the three monthperiods ended June 30, 2003 and 2002, respectively.  For the six month periods ended June 30, 2003 and 2002, cost ofgoods sold was approximately $5.9 million and $5.4 million, respectively.

 

The Company’s gross profit margin was 62.9% for thethree months ended June 30, 2003, compared with 63.0% during the same period in2002.  Gross margin for the six monthperiods ended June 30, 2003 and 2002 was 64.7% and 63.2%, respectively.  Gross margin on the $1.3 million of deferredrevenue recognized during the second quarter from the installation of EnSiteNavX hardware upgrades was 1.7%, which proportionately reduced the Company’soverall gross margin for the second quarter.

 

Gross margin on the sale of EnSite disposable products(EnSite catheters and EnSite NavX surface electrode kits) for the three monthperiod ended June 30, 2003 was 77.4%, as compared to gross margin of 65.4% onEnSite catheter-only sales for the same period in 2002.  For the six month period ended June 30,2003, gross margin from the sale of EnSite disposable products was 74.9%, ascompared to gross margin of 68.1% on the sale of EnSite catheters-only for thesame period in 2002.

 

Gross margin on the sale of EnSite clinicalworkstations improved to 64.5% in the second quarter of 2003, up from 61.1% inthe second quarter of 2002.  Grossmargin on the sale of EnSite clinical workstations for the six month periodended June 30, 2003 was 62.4%, as compared to 58.6% for the same period in2002.  These gross margin improvementsduring the second quarter, and year-to-date, in 2003 were the result of higheraverage selling prices for EnSite clinical workstations with the inclusion ofEnSite NavX as part of new EnSite system sales, and the fact that 84.2% ofEnSite clinical workstation revenue in the second quarter was from domesticsales (72.8% from domestic sales in the first six months of 2003), which havesubstantially higher gross margins than international sales.

 

The Company expects gross margin to continue toimprove on EnSite clinical workstations and on EnSite disposable products forthe remaining quarters of 2003.

 

**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 three month period ended June 30, 2003, compared to approximately $1.3million during the same period in 2002. Research and development expenses for the six month period ended June30, 2003 were approximately $3.0 million, as compared to $2.6 million for thesame period in 2002.  The Companyexpects to make continued significant investments in research and developmentand clinical studies during the remainder of 2003.

 

**Generaland Administrative Expenses**. General and administrative expenses were approximately $0.8 million and$0.7 million for the three month periods ended June 30, 2003 and 2002,respectively.  General andadministrative expenses for the six month periods ended June 30, 2003 and 2002were approximately $1.5 million and $1.3 million, respectively.  The increase in expenses is primarily due toprofessional service expenses associated with various information technologyprojects, actions undertaken by the Company to comply with certain requirementsof the Sarbanes-Oxley Act of 2002, as well as compensation and benefits of theCompany’s CFO who was hired in the third quarter of 2002.  The Company expects general andadministrative expenses to remain relatively constant for the remainingquarters of 2003.

 

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**Salesand Marketing Expenses**. Sales and marketing expenses were approximately $5.0 million during thethree months ended June 30, 2003, compared to $4.7 million during the sameperiod in 2002.  For the six monthperiods ended June 30, 2003 and 2002, sales and marketing expenses were $9.7million and $9.1 million, respectively. The increase is primarily attributable to increases in personnel andcosts associated with the hiring and training of additional personnel during2002 for the U.S. and European sales and clinical support teams.  The Company expects sales and marketingexpenses to remain relatively constant for the remaining quarters of 2003.

 

**InterestIncome and Expense**. Interest income was approximately $11,000 and $26,000 for the threemonths ended June 30, 2003 and 2002, respectively.  For the six month periods ended June 30,2003 and 2002, interest income was $23,000 and $49,000, respectively.  The decrease in interest income for thethree and six month periods ended June 30, 2003 was due to lower average cashand cash equivalent balances and lower interest rates.  Interest expense was approximately $32,000and $34,000 for the three month periods ended June 30, 2003 and 2002,respectively.  For the six month periodsended June 30, 2003 and 2002, interest expense was $61,000 and $61,000,respectively.

 

**Liquidityand Capital Resources**.

 

The Company’s operations since inception have beenfunded by net proceeds from the sale of common and preferred stock totalingapproximately $97.1 million.  As of June30, 2003 and December 31, 2002, the Company had cash, cash equivalents andshort-term investments of approximately $2.7 million and $1.3 million,respectively.

 

For the six months ended June 30, 2003, the Companyused cash of approximately $5.2 million, compared to approximately $7.8 millionfor the same period in 2002.

 

The Company’s accounts receivable balance wasapproximately $10.6 million as of June 30, 2003, an increase of approximately$2.5 million from December 31, 2002. The increase in accounts receivable is, in part, attributable to theincrease in revenues during the six months ended June 30, 2003 compared toprevious periods, and the Company’s transition from a distributor organizationto direct sales in Europe during 2002. Of the approximately $10.6 million outstanding balance, as of June 30,2003, approximately $6.6 million was generated from June 2003 sales.

 

The Company’s inventory balance at June 30, 2003 wasapproximately $4.6 million, a decrease of approximately $44,000, or 1%, overDecember 31, 2002.  The Company believesinventories of EnSite clinical workstations and EnSite catheters will decreasethroughout the remainder 2003 to historical levels, slightly offset by theinventory of EnSite NavX upgrade kits and EnSite NavX surface electrode kitsthat were not part of the Company’s inventory in 2002.

 

The Company’s accounts payable (including accruedexpenses) balance at June 30, 2003 was approximately $4.6 million, an increaseof approximately $0.2 million from December 31, 2002.  The slight increase reflects the Company’s continued efforts tocontrol its inventory and operating expenses, along with the efforts to closelymatch turns of both receivables and payables in order to optimize the Company’scash flow.  The Company

 

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expects accounts payable and accrued expenses to increase during theremaining quarters of 2003 as operating and production expenses increase tosupport continued growth in revenue and the introduction of EnSite NavX.

 

The deferred revenue from the sale of service andsupport contracts, and extended warranty agreements (including the remainingEnSite NavX upgrades not yet installed at June 30, 2003) was approximately $2.5million at June 30, 2003, as compared to approximately $2.7 million at December31, 2002.  This slight decrease reflectsthe reduction of deferred revenue related to the recognition from theinstallation of EnSite NavX upgrades during the period offset with an increasein extended warranty agreements sold.

 

The Company had no short-term investment portfolio asof June 30, 2003 and December 31, 2002. A majority of the Company’s available cash was in money market funds dueto the inability to attain higher rates of interest in short-term investmentsdictated by the Company’s investment 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 June 30,2003, the Company was in compliance with both the quick ratio and tangible networth covenants of the credit facility. The Company and Silicon Valley Bank subsequently amended this creditfacility to extend the term of the facility until June 2003.  As of June 30, 2003, the Company had$572,067 outstanding on the expired capital lease line and had $1 millionoutstanding on the revolving line of credit.

 

The Company believes that its existing cash, cashequivalents, short-term investments and bank financing will be sufficient tofund the operations of the Company through the fourth quarter of 2003.  The Company’s future liquidity and capitalrequirements will depend on numerous factors, including the timing ofregulatory actions regarding the Company’s products, competition, the resultsof clinical trials, the extent to which the Company’s EnSite System and EnSiteNavX products continue to gain market acceptance, the cost, timing and methodof expanding sales, marketing, research and development, and manufacturingactivities, and the ability of the Company to obtain additional bank or equityfinancing.

 

**CriticalAccounting 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 described below.  However, application of these accountingpolicies involves the exercise of judgment and use of assumptions as to futureuncertainties and, as a result, actual results could differ from theseestimates.

 

*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 

 

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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 EITFpublished EITF Issue No. 00-21, Accounting for Revenue Arrangements withMultiple Deliverables.  EITF Issue No.00-21 addresses certain aspects of the accounting by a vendor for arrangementsunder which it will perform multiple revenue-generating activities.  EITF Issue No. 00-21 establishes threeprinciples: revenue arrangements with multiple deliverables should be dividedinto separate units of accounting, arrangement consideration should beallocated among the separate units of accounting based on their relative fairvalues, and revenue recognition criteria should be considered separately forseparate units of accounting.  EITFIssue No. 00-21 is effective for all revenue arrangements entered into forfiscal periods beginning after June 15, 2003, with early adoptionpermitted.  The Company does not believethe adoption of EITF Issue No. 00-21 will have a material effect on itsconsolidated results of operations, financial position, 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.

 

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**CautionaryStatement**

 

Except for the historicalinformation contained herein, this Quarterly Report on Form 10-Q containsforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended.  Theseforward-looking statements represent the Company’s expectations, beliefs, intentionsor strategies 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. When used in this Form 10-Q and in future filings by the Companywith the Securities and Exchange Commission, in the Company’s press releasesand in oral statements made with the approval of an authorized executiveofficer, the word or phrases “believes,” “anticipates,” “expects,” “intends,”“will likely result,” “estimates,” “projects” or similar expressions areintended to identify such forward-looking statements, but are not the exclusivemeans of identifying such statements. However, any statements contained in this Form 10-Q that are notstatements of historical fact may be deemed to be forward-looking statements.

 

The Company cautions that these statements by theirnature involve risks and uncertainties, certain of which are beyond itscontrol, and actual results may differ materially depending on a variety ofimportant factors, including, but not limited to such factors as market demandand pressures on the pricing for its products; changing market conditions,competition and growth rates within the medical device industry; changes inaccounting policies; risks associated with operations outside of the U.S.;changing economic conditions such as general economic slowdown, decreasedconsumer confidence and the impact of war on the economy; and other risks anduncertainties, including those described in Exhibit 99.1 to ourForm 10-K for the year ended December 31, 2002.

 

**Item 3****.  Qualitativeand Quantitative Disclosures about Market Risk.**

 

The Company had approximately $2.7 million of cash andinvestments as of June 30, 2003. Substantially all of the investments were U.S. government or investmentgrade, fixed income securities from domestic issuers.  Because of the credit risk criteria of the Company’s investmentpolicies, the primary market risk associated with these investments is interestrate risk.  The Company does not usederivative financial instruments to manage interest rate risk or to speculateon futures changes in interest rates.  Arise in interest 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 not believe thatCompany is exposed to any material foreign currency exchange rate risk.

 

**Item4.  Controls and Procedures.**

 

(a) Evaluation ofdisclosure controls 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-15(e) underthe Securities Exchange Act of 1934 (the "Exchange Act")).  Based upon that evaluation, the ChiefExecutive Officer and the Chief Financial Officer concluded that, as of the endof the period covered by this report, our disclosure controls and proceduresare effective in timely alerting them to the material information relating tous (or our consolidated subsidiaries) required to be included in the reports wefile or submit under the Exchange Act.

 

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(b) Changes in internal controls over financial reporting.

 

During the quarter ended June 30, 2003, there has beenno change in our internal control over financial reporting (as defined in Rule13a-15(f) under the Exchange Act) that has materially affected, or isreasonably likely to materialy affect, our internal control over financialreporting.

 

**PART II****.  OTHERINFORMATION**

 

**Item4.  Submission ofMatters to a Vote of Security Holders**

 

The Annual Meeting of the Company’s stockholders washeld on May 21, 2003.  At the meeting,stockholders voted on the election of two directors and the re-election of onedirector for terms expiring at the Annual Meeting of the Company in 2006.  The votes cast for each of the directors wasas follows:  Richard D. Randall received14,597,975 votes “For” and 155,613 votes were “Withheld”; Richard J. Nigonreceived 14,682,860 votes “For” and 70,728 votes were “Withheld”; Jean-Paul M.Peltier received 13,633,887 votes “For” and 1,119,701 votes were“Withheld”.  The Company’s 2003 StockIncentive Plan was approved with the number of shares authorized under the Planset at 1,250,000 with 7,481,063 votes in favor, 563,611 votes against, 153,945abstentions and 6,554,969 broker non-votes.

 

**Item6.  Exhibits andReports on Form 8-K**

 

(a)                                  Exhibits

 
| **Exhibits** |   | **Description**                                                                                           |
|--------------|--------|-----------------------------------------------------------------------------------------------------------|
| 10.1         |   | 2003 Stock Incentive  Plan (as approved May 21, 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. |

 

(b)                              Reportson Form 8-K

 

A Form 8-K was filed bythe Company on April 17, 2003; such report contained information disclosedunder Item 5 and included a copy of a press release issued by the Companyannouncing the election by the Company’s Board of Directors of two newdirectors.

 

A Form 8-K was filed bythe Company on April 23, 2003; such report contained information disclosedpursuant to Regulation FD under Item 9 and included a copy of a press releaseissued by the Company announcing FDA clearance of the Company’s EnSite NavXintracardiac navigation system.

 

A Form 8-K was filed bythe Company on April 23, 2003; such report contained information disclosedpursuant to Regulation FD under Item 9 and included a copy of a press release issuedby the Company announcing its first quarter 2003 earnings results.

 

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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:  August 14, 2003 | By:                          | /s/ James W. Bullock |   |
|                         |                         |   | James W. Bullock |
|                         |                         |   | *President  and Chief Executive Officer* |
|                         |                         |   |   |
|                         |                         |   |   |
|                         | By:                          | /s/ J. Robert Paulson, Jr. |   |
|                         |                         |   | J. Robert Paulson, Jr. |
|                         |                         |   | *Chief  Financial Officer* |
|                         |                         |   | *(Principal  Accounting Officer)* |
|                              |                              |  |  |  |

 

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