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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------
FORM 10-K
_X_ Annual report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
COMMISSION FILE NO. 0-18602
ATS MEDICAL, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1595629
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3905 ANNAPOLIS LANE
MINNEAPOLIS, MINNESOTA 55447
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (612) 553-7736
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock
$.01 par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes __X__ No ____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ( )
The aggregate market value of voting stock held by nonaffiliates of the
registrant as of March 13, 1998 was approximately $109,087,237 (based on the
last sale price of such stock as reported by the NASDAQ National Market).
The number of shares outstanding of each of the registrant's classes of
common stock as of March 13,1998 was:
Common Stock, $.01 par value 17,589,058 shares
DOCUMENTS INCORPORATED BY REFERENCE
Pursuant to General Instruction G(3), the responses to Items 10, 11, 12
and 13 of Part III of this report are incorporated herein by reference to
certain information contained in the Company's definitive proxy statement for
its 1998 Annual Meeting of Shareholders to be filed with the Securities and
Exchange Commission on or before April 30, 1998.
ATS MEDICAL, INC.
1997 FORM 10-K
PART I
ITEM 1. BUSINESS
GENERAL
ATS Medical, Inc. ("ATS Medical" or the "Company") manufactures and markets a
pyrolytic carbon bileaflet mechanical heart valve. The Company began selling the
ATS Medical(TM) valve (the "Valve") in international markets in 1992. In
December, 1996 the U.S. Food and Drug Administration ("FDA") approved the
Company's Investigational Device Exemption ("IDE") allowing the Company to
initiate a clinical study of the Valve with the eventual goal of regulatory
approval in the United States.
THE ATS OPEN PIVOT VALVE
The ATS Open Pivot valve is designed to advance the standard of existing
mechanical heart valves by combining a proprietary open pivot design and certain
innovative features with the widely accepted biocompatibility and durability of
pyrolytic carbon. The following characteristics are the primary advances of the
ATS Medical valve:
POTENTIAL FOR REDUCED RATES OF THROMBOEMBOLIC COMPLICATIONS
The proprietary open pivot areas of the ATS Medical valve feature
spherical protrusions from the orifice that match spherical notches in the
leaflets. The pivot areas project into the normal blood flow pattern where
the pivots are washed by the flowing blood.
POTENTIAL FOR IMPROVED BLOOD FLOW EFFICIENCIES
The Valve's orifice is a solid pyrolytic carbon ring. By eliminating the
graphite substrate used in some valves, the Company is able to make the
orifice durable and thin, thereby resulting in a larger average inside
diameter. This design characteristic results in blood flow efficiencies
which should reduce the workload on the heart.
POTENTIAL FOR EASE OF IMPLANT
The ATS Medical valve has a low profile design to avoid complications in
the implant procedure. The orifice also is rotatable, thereby allowing the
surgeon to optimize valve orientation by adjusting the position of the
leaflets after the Valve has been sutured in the natural anatomical
position in the patient's heart. The packaging and accessories of the
Valve also are designed to facilitate the implant procedure by including
all of the required items pre-assembled in a sterilized dual barrier
container.
POTENTIAL FOR IMPROVED FOLLOW-UP DIAGNOSTIC CAPABILITY
The ATS Medical valve eases the follow-up diagnostic process by being
highly visible to x-rays. The titanium stiffening ring provides a clear
image on x-rays taken from any angle. The leaflets also have a high
percentage of tungsten impregnated in the substrate, making them highly
visible to x-rays. This increased visibility to x-rays assists
cardiologists during follow-up examinations.
POTENTIAL FOR IMPROVED PATIENT QUALITY OF LIFE THROUGH LOWER NOISE LEVELS
Initial clinical reports and preliminary studies indicate that the ATS
Medical valve is substantially quiet and below the threshold of hearing
for most patients. The Company believes that the reduced noise level of
the Valve further improves the quality of life of the patient.
CLINICAL DATA AND TESTING RESULTS
The Company began the development of the ATS Medical valve in November 1990.
During 1991 and 1992, the Company performed in vitro and animal testing of the
Valve. The in vitro testing included accelerated wear testing which subjected
the Valves to repeated opening and closing at speeds and forces greatly in
excess of those found in the human heart. The Company has accumulated wear data
in excess of 600 million cycles or equivalent to 15 years of performance in a
human. The results of these accelerated wear tests show average wear rates
similar to control valves. The results of the animal testing and the other in
vitro testing also show performance characteristics similar to control valves.
Beginning in May 1992, after obtaining approval from its Medical Advisory Board,
the Company commenced human implants in international markets. Through January
1, 1998, the Company estimates that over 20,000 ATS Medical valves have been
implanted in patients outside of the United States. The Company has received
implant registration data from over 130 institutions in 29 countries which have
implanted the ATS Medical valve in patients. Published reports have documented
the clinical performance of the ATS Medical valve.
PROSTHETIC HEART VALVE MARKET
Prosthetic heart valves have been in general use since the 1960's and represent
an estimated $600 million worldwide market. The worldwide prosthetic heart valve
market has consistently grown at a rate of over 5 percent annually over the last
20 years, principally due to the expansion of cardiovascular surgery facilities
and the acceptance of valve replacement.
The worldwide prosthetic heart valve market is projected to continue to increase
at annual rates of 4 to 5 percent due to the aging of the population and the
expansion of cardiovascular surgery in international markets. One of the
principal causes of valve replacement is the deterioration of natural valves
through the aging process, with the average age of valve replacement patients in
excess of 50 years. As this segment of the population increases, the market for
prosthetic heart valves is expected to increase. In addition, rheumatic heart
disease is a principal cause of valve replacement, particularly in areas where
penicillin has been unavailable until relatively recently.
As cardiovascular surgery facilities expand in developing markets, the number of
prosthetic heart valve implants is expected to increase.
Replacement heart valves are categorized as one of two types: mechanical or
tissue. Mechanical valves are made from materials such as metals, ceramics,
carbon or plastics. Tissue valves are made from animal or cadaver tissue or in
some cases the patient's own tissue. A majority of the prosthetic heart valves
implanted worldwide are mechanical valves. As life expectancies increase,
cardiac surgeons have been less likely to use tissue valves in older patients
and thereby subject the patient to the risks of a possible re-operation.
Mechanical valves are also used in many instances to replace degenerative
prosthetic tissue valves. In 1997, however, two of the largest competitors in
the industry introduced new tissue valves. The impact of these new tissue valves
on the relative number of mechanical and tissue valves implanted remains to be
seen.
MARKETING AND SALES
The Company's marketing strategy is to combine the substantial cardiovascular
sales experience of its senior officers with a network of experienced
independent distributors to sell the Valve internationally while pursuing
regulatory approval in the United States.
Manuel A. Villafana and Richard W. Kramp, the Company's Chief Executive Officer
and Chief Operating Officer, respectively, previously recruited, selected and
managed the independent distributor network of St. Jude Medical, Inc. ("St.
Jude"). St. Jude was founded in 1976 by Mr. Villafana to develop a bileaflet
mechanical heart valve that has become the world's most frequently implanted
prosthetic heart valve and is currently the industry standard. Mr. Kramp headed
St. Jude's worldwide sales and marketing efforts for almost 10 years.
Since 1992, the Company has contracted with independent distributors in most of
the developed international markets. The Company believes that this independent
distributor network provides a rapid and cost efficient means of introducing the
Valve in a wide range of international markets through an experienced sales
force. The selection of an independent distributor does not involve significant
expense to the Company and does not expose the Company to currency fluctuation
risk because the distributor purchases Valves directly from the Company in
United States dollars. The Company has been able to attract experienced
mechanical valve sales organizations familiar with local markets and customs to
act as distributors.
The Company has a standard distributor agreement with variations for certain
distributors. Most of the distributor agreements establish quotas for sales of
the Valve in the distributor's territory. Most of the distributor agreements
also provide for termination at the option of the Company upon the departure of
certain key employees of the distributor or the change in control of ATS
Medical.
At December 31, 1997, the Company had contracts with 30 distributors covering 42
countries outside the United States. Sales to four (three in 1995) of these
distributors represented over 50% of total sales for each of the past three
years. The table below outlines these significant distributors:
Sales as a Percentage of Total Revenue
--------------------------------------
1997 1996 1995
---- ---- ----
Century Medical, Inc. 17.2% 14.0% ---
Biomed, S.A. 9.4 11.3 20.0%
Gemettron GmbH & Co. KG 16.7 24.0 25.4
Medi-Service 11.2 9.2 10.4
The Company sells the Valves to each distributor F.O.B. Minneapolis. The Company
allows the return of unused Valves as long as the Valve has not been opened and
the sterilization date has not expired.
The loss of any one distributor or group of distributors could cause a
disruption in sales and have an adverse impact on the Company's reported
financial results. Management attempts to foster good working relationships with
its distributors and believes that there would be alternative distributors
available to represent the Valve in most markets should it become necessary to
replace one or more of the distributors.
The Company supports its independent distributors through the Company's sales,
marketing and customer service personnel. The Company displays the Valve at
major international, national and regional medical meetings attended by
cardiovascular surgeons and cardiologists. The Company also develops and
distributes product brochures and product information bulletins and conducts
product training sessions. When feasible, the Company also responds to special
requests from physicians for supporting accessories and custom devices.
During 1997 the exchange rate for many international currencies fell in value
relative to the U.S. Dollar. In Europe, these changes caused the value of some
currencies to decrease by as much as 15% relative to the U.S. Dollar. The
consequence of this currency change is the same as a price increase to the
Company's distributors. The Company responded in select countries by lowering
the U.S. Dollar price of the Valve.
COMPETITION
The mechanical heart valve market is highly competitive with one dominant
company, St. Jude Medical, Inc. Other companies that sell mechanical valves
include Medtronic, Inc., CarboMedics, Inc. ("CMI"), Baxter Edwards and Sorin
Biomedica sPa. Medtronic, Inc. sells a monoleaflet mechanical valve that was
introduced in the late 1970's as well as a tissue valve. CMI, which manufactures
pyrolytic carbon components for the Company's valve, markets a bileaflet
pyrolytic carbon valve with cavity pivot areas resembling those in the St. Jude
valve. CMI introduced its bileaflet valve in international markets in 1986 and
in 1993 received FDA approval to sell the valve in the United States. Baxter
Edwards reintroduced a bileaflet valve in international markets. Sorin Biomedica
sPa is an Italian company that sells a monoleaflet and a bileaflet mechanical
valve. These and other competitors have significantly greater financial
resources than the Company. The Company is aware of several companies that are
developing new prosthetic heart valves. Several companies are developing and
testing new autologous (created from the patient's own tissue) valves, more
durable tissue valves and new bileaflet and trileaflet mechanical valves.
Advancements also
are being made in surgical procedures such as mitral valve reconstruction,
whereby the natural mitral valve is repaired, thereby delaying the need for a
replacement valve. Other companies are pursuing biocompatible coatings to be
applied to mechanical valves in an effort to reduce the incidence of
thromboembolic events.
The Company believes that the most important factors in a physician's selection
of a particular prosthetic valve are the physician's perceived benefits of the
valve and the physician's confidence in the valve design. As a result, valves
that have developed a favorable clinical performance record have a significant
marketing advantage over new valves. In addition, negative publicity resulting
from isolated incidents can have a significant negative effect on a valve's
overall acceptance. The Company competes with existing mechanical heart valves
by combining the technical features of the Valve with the sales and heart valve
marketing experience of its key management and independent distributors. The
Company's success is dependent upon the surgeon's willingness to use a new
prosthetic heart valve as well as the future clinical performance of the Valve
compared with the more established competition.
The Company believes that mechanical heart valves are currently being marketed
to hospitals at prices that vary significantly from country to country due to
market conditions, currency valuations, distributor mark-ups and government
regulations. The Company believes that, after distributor mark-up, the ATS
Medical valve sells at or above the current price of other valves in most
markets. In many markets, government agencies are imposing or proposing price
controls or restrictions on medical products. The Company works with its
independent distributors to price the Valve in each market to meet these
limitations. In addition, the Company's primary competitors have the ability,
due to their internal carbon manufacturing facilities and economies of scale, to
manufacture their valves at lower cost than the Company can manufacture the ATS
Medical valve.
MANUFACTURING AND COMPONENT SUPPLY
The basic design from which the ATS Medical valve evolved was developed by CMI.
CMI is the largest and most experienced manufacturer of pyrolytic carbon
components used in mechanical heart valves. CMI has designed and patented
numerous mechanical valves, and was in the process of pursuing the regulatory
and marketing steps for another mechanical valve that it had developed when it
agreed to license its patent (the "CMI Patent") on the basic design of an open
pivot bileaflet mechanical valve to the Company in 1990.
The Company commenced its valve development program by entering into four
agreements with CMI: a license agreement, a development agreement, a supply
agreement and an option agreement. Under the terms of the license agreement with
CMI (the "License Agreement"), the Company received a royalty-free worldwide
exclusive license to the licensed patent. The License Agreement does not include
the right to manufacture the pyrolytic carbon components, except that if CMI is
unable to produce the components, the Company has the right and license to make
or have made components. The License Agreement may be terminated by CMI or CMI
may declare the license to be non-exclusive if the Company fails to meet the
minimum purchase requirements under a supply agreement with CMI (the "Supply
Agreement"). Upon satisfaction of the Company's minimum purchase requirements
under the Supply Agreement, the Company will have a paid-up, exclusive,
royalty-free, worldwide license to the licensed patent. At the same time it
entered into the License Agreement, the Company entered into a development
agreement (the "Development Agreement")
with CMI to complete design development of the pyrolytic carbon components and
perform testing of the Valve. The Development Agreement provided that CMI, at
the Company's direction, perform preliminary tests of the Valve and assist the
Company in making changes in the design. As a result of these tests and certain
design changes initiated by the Company, the Company finalized the design of the
Valve and filed and received an additional U.S. patent covering the design
modifications. The design improvements and the U.S. patent covering the
modifications are the exclusive property of the Company. This today is the ATS
Open Pivot valve.
In late 1992, upon completion of the Development Agreement, the Company began
purchasing sets of Valve components from CMI under the Supply Agreement. The
Company and CMI entered into an amendment to the Supply Agreement in December
1993 that modified the minimum purchase requirements. The Supply Agreement, as
amended, has a term of 15 contract years and provides that the Company purchase
a minimum number of Valve components in each of the first eight contract years.
The fifth contract year was completed in December 1997. The total commitment for
the next three contract years is approximately $47 million. If the minimum
purchase requirements are not met during any of the first eight contract years,
CMI may terminate the License Agreement or may declare the License Agreement to
be non-exclusive. The Company may not purchase Valve components from any source
other than CMI during the first eight contract years unless CMI is unable to
deliver suitable components. After the eighth contract year, the Company must
purchase the lower of either certain specified amounts or the number of Valves
sold and/or disposed of by any means by the Company. The price for each Valve
component set is determined for all fifteen contract years, with a price
reduction for volume purchases and sales into certain developing countries, and
a yearly price adjustment for changes in the U.S. Department of Labor Employment
Cost Index.
The Company's manufacturing operation consists of fabricating the sewing cuff
and assembling, inspecting, testing and packaging all of the components into a
finished Valve. The standard Valve is available in seven sizes ranging from 19mm
to 31mm in diameter, with each size available with sewing cuffs for either
aortic valve or mitral valve replacement. An extended sewing cuff is available
with the pyrolytic carbon components of a 31mm mitral valve to create a 33mm
valve for special mitral valve replacements.
The Company introduced the Advanced Performance ("AP") series of the ATS Medical
valve in international markets in early 1994 and is available in seven sizes
ranging from 16mm to 28mm in diameter. The AP series consists of a reconfigured
sewing cuff, allowing a larger valve to be used in small anulus situations.
The Company receives, inspects and assembles components in its Minneapolis,
Minnesota facility. The Valve is then assembled, inspected, packaged and
sterilized for shipment to distributors.
At any time during the ninth through the fifteenth contract years of the Supply
Agreement, the Company may exercise an option to acquire the carbon technology
necessary to manufacture the Valve under an option agreement with CMI (the
"Option Agreement"). The option may be exercised by paying a one time fee to
CMI. The Option Agreement may be terminated by CMI if the Company fails to meet
the minimum purchase levels for any of the first eight contract years of the
Supply Agreement or if the Company purchases carbon components from a source
other than CMI at any time during the term of the Supply Agreement.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company's policy is to protect its proprietary position by, among other
methods, obtaining United States and international patents to protect
technology, inventions and improvements important to the development of its
business. The Company has received a royalty-free license under the CMI Patent,
subject to certain continuing component purchase requirements. See
"Business--Manufacturing and Component Supply." The Company refined the design
of the Valve to make it suitable for implantation and filed an additional United
States patent application covering the design improvements. The United States
patent on the design improvements was issued in October 1994. The Company also
has filed patent applications in Japan, Belgium, France, Germany, Netherlands,
Spain, Switzerland and the United Kingdom relating to the design improvements,
and patents have been granted in all countries except Japan, where the
application remains pending. No assurance can be given that pending patent
applications will be approved or that any patents will not be challenged or
circumvented by competitors.
The Company also relies on trade secrets and technical know-how in its
manufacture and marketing of the Valve. The Company typically requires its
employees, consultants and contractors to execute appropriate confidentiality
agreements with respect to the Company's proprietary information.
The Company claims trademark protection to ATS Medical(TM) and ATS Open
Pivot(TM).
FDA AND OTHER GOVERNMENT REGULATIONS
As a manufacturer of medical devices, the Company is subject to extensive
regulation by the United States Food and Drug Administration (the "FDA") and, in
some jurisdictions, by state and foreign governmental authorities. These
regulations govern the introduction of new medical devices, the observance of
certain standards with respect to the manufacture, testing and labeling of such
devices, the maintenance of certain records, the ability to track devices and
the reporting of potential product defects and other matters. These regulations
have a material impact on the Company. Developments such as the enactment of the
Safe Medical Devices Act of 1990 reflect a trend toward more stringent product
regulation by the FDA. Recently, the FDA has pursued a more rigorous enforcement
program to ensure that regulated businesses comply with applicable laws and
regulations.
The sale and use of mechanical heart valves is regulated extensively in the
United States by the FDA. Pursuant to the Medical Device Amendments of 1976 to
the Federal Food, Drug and Cosmetic Act, medical devices intended for human use
are classified into three categories, Classes I, II and III, depending on the
degree of regulatory control to which they will be subject. Mechanical heart
valves are considered to be Class III devices which are subject to the strictest
testing requirements. Before clinical studies to determine safety and
effectiveness in humans can begin, a battery of laboratory and animal tests must
be conducted. The Company has proceeded with these pre-clinical tests on the
Valve since 1991.
The Company received approval of an Investigational Device Exemption ("IDE")
Application in December, 1996. The IDE allows limited clinical studies in the
U.S. during which the Company must submit reports to the FDA regarding testing
and patient follow-up. The IDE study and follow-up is expected to take at least
one more year. After obtaining sufficient data from its
clinical studies, the Company may submit a Pre-Market Approval ("PMA")
application. The PMA review process is extremely lengthy and no assurance can be
given concerning the ultimate timing or outcome of a PMA application. Upon
approval of a PMA, the Company would be able to commence full marketing of the
Valve in the United States.
In addition to the FDA approval process, the Company is subject to significant
additional FDA and other United States regulations. The Company's standard
operating procedures and system of documentation used in the manufacturing
process will be subject to the FDA's Quality Systems Regulations ("QSR's") which
incorporates guidelines for Good Manufacturing Practices ("GMP's"). The Company
also will become subject to periodic inspections by the FDA to audit compliance
with QSR's. To the extent the Company will sell the Valve to Medicare or
Medicaid beneficiaries, the Company will become subject to the "fraud and abuse"
laws and regulations promulgated by the U.S. Department of Health and Human
Services and the U.S. Health Care Finance Administration. These regulations
prohibit direct or indirect payment arrangements designed to induce or encourage
the purchase or recommendation of products reimbursable under Medicaid or
Medicare. The Company also will be required to comply with various FDA
regulations for advertising, labeling, patient tracking, post market studies and
reporting of any adverse experience. The FDA actively enforces regulations and
the failure to comply with applicable regulatory requirements can result in
fines, seizures, recalls and criminal prosecutions.
Regulation of heart valves varies widely in foreign countries, but generally is
less stringent than in the United States. Foreign countries vary from having no
regulations to having pre-market notice to a pre-market approval process. The
Company or its independent distributor must obtain the appropriate approval, if
any, from each country's regulatory agency prior to marketing the Valve in that
country. The Company received CE Mark approval for all European Union Countries
in March, 1995. The Company will continue to be subjected to various audits and
tests under the European Community directives. In June, 1996, the Company
received approval to begin commercial sales in the Japanese market through a
Shonin regulatory approval obtained by its distributor, Century Medical, Inc.
The Company is in the process of pursuing regulatory approval for the Valve in
Australia and Canada.
PRODUCT LIABILITY AND INSURANCE
Cardiovascular device companies are subject to an inherent risk of product
liability and other liability claims in the event that the use of their products
results in personal injury. A mechanical heart valve is a life-sustaining
device, and the failure of any mechanical heart valve usually results in the
death of the patient. ATS Medical has not received any reports of mechanical
failure of the Valves implanted to date and has not experienced any product
liability claims. Any future significant failure of the ATS Medical Valve would
subject the Company to substantial litigation, damages and adverse publicity.
The Company currently maintains a $10 million product liability insurance
policy. A $5 million product liability insurance policy is required by the
Supply Agreement. The Company is financially responsible for any uninsured
claims or claims which exceed the insurance policy limits. At the present time,
product liability insurance is expensive for mechanical valves. If insurance
becomes completely unavailable, the Company must either develop a self-insurance
program or sell without insurance, and the Company would be required to obtain
the consent of CMI. The development of a self-insurance program would require
significant capital.
CMI has made no warranty on the Valve components. The Company has agreed to hold
CMI harmless and indemnify CMI in the event claims are made or damages are
assessed against CMI as a result of the Valve.
EMPLOYEES
As of January 1, 1998, the Company had 62 full-time employees, of whom 15 were
engaged in regulatory affairs and quality assurance, 26 in production and 21 in
administrative, purchasing and marketing activities.
ITEM 2. PROPERTIES
The Company currently maintains administrative offices, production and
engineering facilities in 23,912 square feet of leased space in a suburb of
Minneapolis, Minnesota. The lease expires on February 28, 2003. The Company
believes the current facility is adequate for its near-term needs.
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company are as follows:
NAME AGE POSITION
- ---- --- --------
Manuel A. Villafana 57 Chairman and Chief Executive Officer
Richard W. Kramp 52 President and Chief Operating Officer
Russell W. Felkey 47 Executive Vice President of Regulatory Affairs
and Secretary
John H. Jungbauer 48 Vice President, Treasurer and Chief Financial
Officer
MANUEL A. VILLAFANA, a founder of the Company, has served as Chief Executive
Officer and Chairman of the Board since the Company's inception in 1987. From
1983 to 1987, Mr. Villafana served as Chairman of GV Medical, Inc., a company
co-founded by Mr. Villafana to develop, manufacture and market the LASTAC
System, a laser transluminal angioplasty catheter system. From 1976 to 1982, Mr.
Villafana served as President and Chairman of St. Jude Medical, Inc., a company
founded by Mr. Villafana to develop, manufacture and market a prosthetic
bileaflet heart valve manufactured from pyrolytic carbon. From 1972 to 1976, Mr.
Villafana served as President and Chairman of Cardiac Pacemakers, Inc., a
company founded by Mr. Villafana to develop, manufacture and market a new
generation of lithium powered pacemakers.
RICHARD W. KRAMP has served as President and Chief Operating Officer and a
Director of the Company since joining the Company in March 1988. Prior to
joining the Company, Mr. Kramp was Vice President of Sales and Marketing for St.
Jude Medical, Inc., where Mr. Kramp served in a variety of sales and marketing
capacities from 1978 to 1988. From 1976 through 1978, Mr. Kramp served as
Illinois Sales Manager for Life Instruments, a distributor of cardiovascular
products. From 1972 to 1976, Mr. Kramp was the Senior Design Engineer and then
Supervisor of Electrical Design for Cardiac Pacemakers, where he designed the
first lithium powered demand pacemaker for which he received a U.S. patent. Mr.
Kramp also is a director of MedAmicus, Inc., a medical products company.
RUSSELL W. FELKEY has served as Executive Vice President of Regulatory Affairs
of the Company since April 1991 and has served as Secretary since October, 1995.
From 1989 to 1991, Mr. Felkey was Vice President of Regulatory Affairs and
Quality Assurance at Cardiovascular Imaging Systems, Inc., a company involved in
the development of peripheral and coronary ultrasound catheters. From 1984 to
1989, Mr. Felkey was Vice President of Regulatory Affairs at GV Medical, Inc.
JOHN H. JUNGBAUER has served as Vice President of the Company since April 1,
1995 and has served as Treasurer and Chief Financial Officer of the Company
since October 1990. From 1988 to 1990, Mr. Jungbauer was Executive Vice
President of Titan Medical, Inc., a medical products company. Prior to 1987, Mr.
Jungbauer was Vice President of Finance at St. Jude Medical, Inc.
MEDICAL ADVISORY BOARD
The Company has a Medical Advisory Board that meets periodically to review and
guide the design and testing of the Valve as well as to provide assessments of
potential new cardiovascular products. The members of the Medical Advisory Board
are as follows:
DR. DEMETRE M. NICOLOFF is a world-renowned cardiac surgeon practicing with
Cardiac Surgical Associates in association with the Minneapolis Heart Institute
and St. Paul Heart and Lung Center. Previously, Dr. Nicoloff was an Associate
Professor of Surgery at the University of Minnesota and taught in the Department
of Surgery at the University of Minnesota for over 15 years. Dr. Nicoloff
participated in the first human implant of the ATS Medical valve in May 1992.
Dr. Nicoloff also participated in the design of the first generation of
bileaflet valves and performed the first human implant of the most frequently
implanted mechanical bileaflet valve. Dr. Nicoloff previously was a member of
the Scientific Advisory Board of St. Jude Medical, Inc. Dr. Nicoloff received
his medical degree from Ohio State University.
DR. H. DAVID FRIEDBERG is a Clinical Professor of Medicine and Cardiology at the
University of South Florida. Dr. Friedberg is certified in cardiac pacing and
electrophysiology. He is a Fellow of the American College of Cardiology,
American College of Chest Physicians and the Council of Clinical Cardiology of
the American Heart Association. Dr. Friedberg participated in the first implant
of the ATS Medical valve in May 1992. Dr. Friedberg previously was a member of
the Scientific Advisory Board of St. Jude Medical, Inc. Dr. Friedberg obtained
his medical degree in South Africa and performed his internal medicine studies
and residencies in London, England.
PART II
ITEM 5. MARKET OR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS
The Company's common stock (the "Common Stock") is traded on the Nasdaq National
Market under the symbol "ATSI." The following table sets forth the high and low
sale prices since January 1, 1996. Prices represent transactions between dealers
and do not reflect retail markups, markdowns or commissions.
1997 HIGH LOW 1996 HIGH LOW
First Quarter $8.50 $6.50 First Quarter $12.00 $9.00
Second Quarter 7.00 4.75 Second Quarter 11.88 9.38
Third Quarter 6.63 5.00 Third Quarter 11.00 7.00
Fourth Quarter 7.25 4.75 Fourth Quarter 8.63 6.25
As of December 31, 1997 there were 628 record holders of the Common Stock. The
Company has not paid cash dividends and has no present intentions of paying cash
dividends on its Common Stock.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data of the Company have been
derived from its financial statements for the years ended December 31, 1997,
1996, 1995, 1994 and 1993, which financial statements have been audited by Ernst
& Young LLP. The data should be read in conjunction with the Company's audited
financial statements and the notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing elsewhere
herein.
Year ended December 31,
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS DATA:
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
REVENUES:
Net sales ....................................... $ 14,515,915 $ 11,859,765 $ 9,300,540 $ 6,763,408 $ 5,057,640
Less cost of goods sold ......................... 9,428,959 7,474,065 6,011,025 4,189,426 3,082,169
------------ ------------ ------------ ------------ ------------
GROSS PROFIT FROM OPERATIONS ................ 5,086,956 4,385,700 3,289,515 2,573,982 1,975,471
OPERATING EXPENSES:
Research, development and engineering ........... 1,058,318 617,571 718,189 640,032 679,675
Selling, general and administrative ............. 3,339,488 3,065,402 2,549,570 1,993,447 2,428,630
------------ ------------ ------------ ------------ ------------
TOTAL EXPENSES FROM OPERATIONS .............. 4,397,806 3,682,973 3,267,759 2,633,479 3,108,305
Interest income ................................. 1,427,363 641,375 752,880 74,706 165,202
Other income .................................... 0 0 0 0 599,218
Interest expense ................................ 0 0 (31,224) (31,317) 0
Income taxes .................................... (13,846) (22,500) (28,888) (25,243) 0
------------ ------------ ------------ ------------ ------------
NET INCOME (LOSS) ............................... $ 2,102,667 $ 1,321,602 $ 714,524 ($ 41,351) ($ 368,414)
============ ============ ============ ============ ============
NET INCOME (LOSS) PER SHARE-DILUTED(1) ........... $ 0.12 $ 0.08 $ 0.05 $ 0.00 ($ 0.03)
============ ============ ============ ============ ============
Cash dividends declared .......................... 0 0 0 0 0
Weighted average number of shares
outstanding during the period .................. 17,872,989 16,303,317 15,328,596 11,177,881 10,841,123
============ ============ ============ ============ ============
(1) All earnings per share data has been restated. See Note 1 to the financial statements
December 31,
--------------------------------------------------------------------------------
BALANCE SHEET DATA:
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
Cash and cash equivalents ........................ $ 4,568,332 $ 2,320,010 $ 2,213,632 $ 628,368 $ 2,735,421
Working capital .................................. 52,375,893 30,643,942 27,802,438 11,214,977 10,983,019
Total assets ..................................... 54,386,031 33,320,300 31,329,128 14,558,450 13,887,233
Long-term debt ................................... 0 0 0 0 0
Total liabilities ................................ 863,292 1,393,561 2,269,707 1,790,773 1,171,733
Accumulated deficit .............................. (18,491,255) (20,593,921) (21,915,523) (22,630,047) (22,588,696)
Shareholders' equity ............................. 53,522,739 31,926,739 29,059,421 12,767,677 12,715,500
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO 1996
Net sales totaled $14,515,915 for the year ended December 31, 1997, an increase
of $2,656,150 or 22% over the net sales of $11,859,765 reported for the year
ended December 31, 1996. Unit sales increased 25% from 1996 which is about five
times the rate of unit growth in the overall heart valve market. The Company
sells to independent distributors with assigned territories (generally a
specific country or region) who in turn sell the valve to a hospital or clinic.
The Company sells in U.S. dollars so currency risk is borne by the distributor.
During 1997 the exchange rate for many currencies fell in value relative to the
U.S. dollar. In Europe, these changes caused a decrease in value for some
currencies by as much as 15%. The consequence of this currency change is the
same as a price increase to our distributors. The Company responded in select
countries by lowering the dollar price of the Valve. During 1997 the Company was
selling Valves in most developed countries and several lesser developed
countries ("LDC's") so sales growth came primarily from increased usage in
existing markets. In 1996 and each of the previous years, a portion of the sales
increase came from opening new markets as well as increased usage within
existing markets.
The average selling price of the Valve declined 3% from 1996 to 1997. The
average selling price of the Valve increased 3% from 1995 to 1996. Given the
current strength of the U.S. dollar and the pricing strategies of its
competitors the Company does not expect to be able to raise prices in 1998.
Prior to January 1997, all sales of Valves were to customers outside of the
United States. The Company initiated a clinical study of the Valve at nine
hospitals in the United States in 1997. During the study, Valves are provided to
the hospitals at prices designed to recover some of the costs of the clinical
study. The Company may expand the study to six additional hospitals in 1998.
Cost of goods sold increased 26% to $9,428,959 for the year ended December 31,
1997 from $7,474,065 total cost of goods sold for the year ended December 31,
1996. Cost of goods sold as a percentage of sales increased from 63% for the
year ended December 31, 1996 to 65% for the year ended December 31, 1997,
primarily due to lower average selling prices.
The Company purchases pyrolytic carbon components for the Valve from
CarboMedics, Inc. ("CMI"). Approximately 80% of the total cost of a valve is
contained in the cost of the carbon components. The price of the components is
set under a multi-year supply agreement between the Company and CMI. The price
was established in 1990, and varies according to annual volume and is adjusted
annually according to increases in the U.S. Department of Labor Employment Cost
Index. The Company uses the first-in first-out ("FIFO") method of accounting for
inventory. Approximately 75% of the valves sold in 1997 were made with carbon
purchased in 1995 (under FIFO) and the remainder with carbon purchased in 1996.
The cost of carbon components, after giving effect to volume discounts and
inflationary adjustments rose 3.3% in 1995 (the third contract year), decreased
.07% in 1996, and rose 3% in 1997.
For 1998 (the sixth contract year) the Company expects to pay 3.2% more for
carbon components than in 1997.
Gross profit increased from $4,385,700 for the twelve months ended December 31,
1996 to $5,086,956 for the twelve months ended December 31, 1997. Gross profit
as a percent of sales was 35% in 1997 and 37% in 1996. The decrease in the
average selling price per unit was the most significant factor in the erosion of
the gross margin.
Research, development and engineering expenses totaled $1,058,318 for the year
ended December 31, 1997 compared to $617,571 for the year ended December 31,
1996. During 1997 the Company completed design and testing on a product
extension, the aortic valved graft (AVG). This effort accounted for 20% of 1997
research and development expense with most of the remainder being spent on the
clinical study of the Valve. The Company's research efforts in 1996 were on
improved package design and tooling for valve assembly. Approximately 58% of
1997 and 56% of 1996 R & D expenses related to the clinical study of the Valve
outside the United States and physical testing of the Valve and related
consulting to support the Company's IDE application to the FDA.
Selling, general and administrative expenses increased 9% from $3,065,402 for
the year ended December 31, 1996 to $3,339,488 for the year ended December 31,
1997. This increase resulted from primarily two factors in 1997. In October 1997
the Company closed its facility in Scotland and consolidated those operations at
its Plymouth, Minnesota headquarters. One time costs associated with this
closing of approximately $225,000 were charged to selling, general and
administrative expense in 1997. Second, the Company increased the number of
employees from 50 in 1996 to 62 in 1997. In November, 1996 the Company sponsored
the Second International Symposium on the ATS Medical Heart Valve at an expense
of approximately $333,000.
The Company did not have any interest expense in 1996 or 1997.
Following the Company's $14.75 million stock sale in February 1997 and $4.7
million warrant exercise in March 1997, the Company had substantially more cash,
cash equivalents and short-term investments earning interest. Interest income in
1997 increased to $1,427,363 for the year ended December 31, 1997 compared to
$641,375 for the year ended December 31, 1996.
The Company recorded $13,846 and $22,500 in income tax expense for 1997 and
1996, respectively. These taxes arose from certain items of income in the United
Kingdom.
Net income increased to $2,102,667 for the twelve months ended December 31, 1997
from $1,321,602 for the twelve months ended December 31, 1996. The increase in
interest income was the major factor in the increase in net income.
Net income per share (diluted) increased from $.08 for 1996 to $.12 for 1997.
Weighted average number of shares outstanding increased 14% due to option and
warrant exercises, and the sale of shares to ITOCHU Corp.
The Company has accumulated net operating loss carryforwards in both the U.S.
and the U.K. Section 382 of the Internal Revenue Code of 1986, as amended,
provides, in part, that if an "ownership change"
occurs with respect to any corporation with net operating loss carryforwards,
such as the Company, the net operating loss carryforwards can be used to offset
future income only to the extent of the annual "Section 382 limitation." An
ownership change generally occurs if there has been more than a 50 percent
change in the stock ownership of a corporation over a three year period. The
Section 382 limitation is an amount determined by multiplying the value of the
corporation's stock on the date of an ownership change by the federal long-term
tax-exempt rate which is published by the Internal Revenue Service as in effect
for the month of the ownership change. As a result of Section 382, utilization
of all or a portion of a corporation's net operating loss carryforwards may be
limited. The Company believes that as a result of the Company's registered
direct equity offering in early 1995 and the sale of 1,568,940 shares of common
stock in 1997, the Company experienced an ownership change, and the Company's
ability to fully utilize $18 million of its existing net operating loss
carryforwards will be restricted to approximately $3 million per year. Due to
the application of the annual Section 382 limitation and the other provisions of
Section 382, some of the net operating loss carryforwards of the Company may
expire before they can be used by the Company to reduce its federal income tax
liabilities.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO 1995
Net sales totaled $11,859,765 for the year ended December 31, 1996, an increase
of $2,559,225 or 28% over the net sales of $9,300,540 reported for the year
ended December 31, 1995. Unit sales increased 17% overall from 1995. During 1996
the Company's heart valve ("Valve") was approved for commercial distribution in
Japan which accounted for a majority of the sales growth. An average price
increase of 3% was achieved.
Cost of goods sold increased 24% to $7,474,065 for the year ended December 31,
1996 from $6,011,025 total cost of goods sold for the year ended December 31,
1995. Cost of goods sold as a percentage of sales declined from 65% for the year
ended December 31, 1995 to 63% for the year ended December 31, 1996, due to the
price increase as well as an increased absorption of overhead which was the
result of an approximate 14% increase in unit production.
Gross profit increased from $3,289,515 for the twelve months ended December 31,
1995 to $4,385,700 for the twelve months ended December 31, 1996. Gross profit
as a percent of sales was 37% in 1996 and 35% in 1995. The increase in the
average selling price per unit was the most significant factor in the
improvement in the gross margin.
Research, development and engineering expenses totaled $617,571 for the year
ended December 31, 1996 compared to $718,189 for the year ended December 31,
1995. The Company's research efforts in 1996 were on improved package design and
tooling for valve assembly. Approximately 56% of 1996 and 62% of 1995 R & D
expenses related to the clinical study of the Valve outside the United States
and physical testing of the Valve and related consulting to support the
Company's IDE application for the FDA.
Selling, general and administrative expenses increased 20% from $2,549,570 for
the year ended December 31, 1995 to $3,065,402 for the year ended December 31,
1996. In November 1996 the Company sponsored the Second International Symposium
on the ATS Medical Heart Valve. This meeting accounted for almost two-thirds of
the SG&A increase with salaries and benefits increases accounting for the
remainder. No equivalent meeting was held in 1995. The personnel hired in the
sales
and marketing department in the middle of 1995 were on board for all of 1996.
The Company also had directors and officers liability insurance (D&O in place
from November 1995 (2 months) and through all of 1996 (12 months).
In early 1995, the Company borrowed against its line of credit and incurred
$31,224 of interest expense. The Company did not have any interest expense in
1996.
Interest income in 1996 declined to $641,375 for the year ended December 31,
1996 compared to $752,880 for the year ended December 31, 1995. A decrease in
the amount of cash invested and lower market interest rates account for the
decline.
The Company recorded $22,500 and $28,888 in income tax expense for 1996 and
1995, respectively. These taxes arose from certain items of income in the United
Kingdom.
Net income increased $607,078 from $714,524 for the twelve months ended December
31, 1995 to $1,321,602 for the twelve months ended December 31, 1996. The
increase in income from operations more than offset the decline in interest
income. This was due to the increased volume of business and the corresponding
increase in gross profit.
Net income per share increased from $.05 for 1995 to $.08 for 1996. The weighted
average number of shares outstanding increased 6% due to option and warrant
exercises.
YEAR 2000 SITUATION
The Company has been assessing the software and hardware used in daily
operations so that all systems will function properly with respect to dates in
the Year 2000 and beyond. Until recently, computer programs were written to
store only two digits of date-related information in order to more efficiently
handle and store data. Thus, some software programs are unable to distinguish
between the year 1900 and the year 2000. This is frequently referred to as the
"Year 2000 Problem."
Utilizing internal and external resources, the Company determined that
modification or replacement of various programs would be necessary so that all
software, hardware and instrumentation systems are Year 2000 compliant.
Business applications and data for the Company are stored on a local area
network and accessed by personal computers when necessary. In 1997, a
significant number of employee workstations and manufacturing hardware were
upgraded and are now Year 2000 compliant. All future hardware purchases are
required to be Year 2000 compliant.
The Company has purchased "off the shelf" manufacturing and accounting software
supported by vendors who provide updated versions of the software program. These
vendors have indicated that the software upgrades available will be Year 2000
compliant.
The Company also has custom software programs and databases that are used for
manufacturing. These programs are being reviewed and tested for Year 2000
issues. As a part of this process, the Company
has been negotiating conversion of these programs. Requirements of the software
programming include testing and revision for Year 2000 issues.
While the Company believes that its planning efforts are adequate to address
Year 2000 concerns, there is no guarantee that the systems of other companies on
which the Company's systems and operations rely will be converted on a timely
basis and will not have a material effect on the Company. Costs of the Year 2000
initiatives are not expected to be material to the Company's results of
operations or financial position.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents, and short-term investments increased by $15,362,879 from
$10,187,629 at December 31, 1996 to $25,550,508 at December 31, 1997. Inventory
increased by $4,444,207 from $18,242,066 at December 31, 1996 to $22,686,273 at
December 31, 1997. Under the terms of the multi-year agreement with CarboMedics,
Inc., the Company is required to purchase annual minimum quantities of
components. The minimum number of units which the Company purchased during each
of the first five years of the contract have exceeded unit sales and the Company
expects that until the Valve is approved for sale in the United States by the
FDA, the minimum required purchases will continue to exceed sales. During 1998,
the Company is obligated to purchase $13.9 million of heart valve components.
Over the two contract years subsequent to 1998, the aggregate purchases total
approximately $33 million.
Accounts receivable increased by $1,307,275 from $3,139,559 at December 31, 1996
to $4,446,834 at December 31, 1997. Most of the Company's sales have been to
customers in international markets and, while the Company attempts to get
standard 60 day terms for receivables, competitive pressures and geographical
economic situations have caused the Company to selectively extend the terms for
payment. Accounts receivable represented 112 Days Sales Outstanding (DSO) at
December 31, 1997 and 98 DSO at December 31, 1996.
Accounts payable decreased by $569,250 from $1,190,958 December 31, 1996 to
$621,708 at December 31, 1997. In 1996 and 1997, the Company scheduled the
receipt of over 50% of the entire year's components during the fourth quarter.
The decrease in accounts payable at December 31, 1997 is due to timing of
component shipments from CMI.
In June 1997 the Company renewed its line of credit agreement with a bank. Under
the agreement, the Company may borrow up to $5,000,000 as long as it maintains
collateral defined as cash and marketable securities with a discounted value at
least equal to the line amount. The agreement expires on June 30, 1998. There
were no borrowings under the line at December 31, 1997.
The Company received $14.75 million in cash on February 7, 1997 through the sale
of 1,568,940 shares of Common Stock.
The Company expects the obligations under the supply agreement with CMI to
require more cash than will be generated by operations through the year 2000.
During these same years (1998 through 2000) the Company will be conducting a
clinical study of the Valve in the United States and submitting data obtained
from the study to the FDA for Pre-Market Approval Application (PMA) and the
opportunity to
sell the Valve in the United States. The Company estimates that existing cash,
cash equivalents and short-term investments will be sufficient to satisfy its
capital requirements through at least the year 2000.
The Private Securities Litigation Reform Act of 1995 (the "Act") provides a
"safe harbor" for forward-looking statements to encourage companies to provide
prospective information about their business, so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed in the statement. ATS Medical, Inc.
desires to take advantage of the safe harbor provisions with respect to any
forward-looking statements it may make in this filing, other filings with the
Securities and Exchange Commission and any public oral statements or written
releases. The words or phrases "will likely," "is expected," "will continue,"
"is anticipated," "estimate," "projected," "forecast," or similar expressions
are intended to identify forward-looking statements within the meaning of the
Act. Such statements are subject to certain risks and uncertainties that could
cause actual results to differ materially from those projected. The Company
cautions readers not to place undue reliance on any such forward-looking
statements, which speak only as of the date made.
In accordance with the Act, the Company identifies the following important
general factors which if altered from the current status could cause the
Company's actual results to differ from those described in any forward-looking
statements: the continued acceptance of the Company's only product, a mechanical
heart Valve in international markets; the acceptance by the FDA of the Company's
regulatory submissions; the continued performance of the Company's mechanical
heart valve without structural failure; the actions of the Company's competitors
including pricing changes and new product introductions; the continued
performance of the Company's independent distributors in selling the Valve; and
the actions of the Company's supplier of pyrolytic carbon components for the
Valve. This list is not exhaustive, and the Company may supplement this list in
any future filing or in connection with the making of any specific
forward-looking statement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Not applicable
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company are included (with an index
listing all such statements) in a separate financial section at the end of this
Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
See Part I of this Report. Pursuant to General Instruction G(3), reference is
made to information contained under the heading "Election of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's
definitive proxy statement for its 1998 Annual Meeting of Shareholders to be
filed with the Securities and Exchange Commission on or before April 30, 1998,
which information is incorporated herein.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to General Instruction G(3), reference is made to information contained
under the heading "Executive Compensation" in the Company's definitive proxy
statement for its 1998 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission on or before April 30, 1998, which
information is incorporated herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
Pursuant to General Instruction G(3), reference is made to information contained
under the headings "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
statement for its 1998 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission on or before April 30, 1998, which
information is incorporated herein.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to General Instruction G(3), reference is made to information contained
under the headings "Election of Directors" and "Executive Compensation" in the
Company's definitive proxy statement for its 1998 Annual Meeting of Shareholders
to be filed with the Securities and Exchange Commission on or before April 30,
1998, which information is incorporated herein.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The financial statements of the Company are included (with an index listing all
such statements) in a separate financial section at the end of this Annual
Report on Form 10-K.
(a) 2. FINANCIAL STATEMENT SCHEDULES
The financial statement schedule is included (with an index listing such
schedule) in a separate financial section at the end of this Annual Report on
Form 10-K.
All other schedules have been omitted because of absence of conditions under
which they are required or because the required information is included in the
financial statements or notes thereto.
(a) 3. LISTING OF EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
3.1 Restated Articles of Incorporation, as amended to date (Incorporated
by reference to Exhibit 3.1 to the Company's Annual Report on Form
10-K for the year ended December 31, 1993 (the "1993 Form 10-K")).
3.2 Bylaws of the Company, as amended to date. (Incorporated by
Reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996 (the "1996 Form 10-K")).
4.1 Specimen certificate for shares of Common Stock of the Company.
4.2 Form of Warrant issued in 1993 Private Placement (Incorporated by
reference to Exhibit 4.4 to the 1993 Form 10-K).
10.1** 1987 Stock Option and Stock Award Plan, as restated and amended to
date (Incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
10.2** Agreement between the Company and Manuel A. Villafana dated January
26, 1995 (Incorporated by reference to Exhibit 10.3 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1994 (the
"1994 Form 10-K")).
10.3 Lease Agreement between the Company and Crow Plymouth Land Limited
Partnership dated December 22, 1987 (Incorporated by reference to
Exhibit 10(d) to the Form S-18).
10.4 Amendment No. 1 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 5, 1989
(Incorporated by reference to Exhibit 10(e) to the Form S-18).
10.5 Amendment No. 2 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 1989 (Incorporated
by reference to Exhibit 10(f) to the Form S-18).
10.6 Amendment No. 3 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated June 14, 1989 (Incorporated
by reference to Exhibit 10(g) to the Form S-18).
10.7 Amendment No. 4 to Lease Agreement between the Company and Plymouth
Business Center Limited Partnership, dated February 10, 1992
(Incorporated by reference to Exhibit 10.8 to the 1996 Form 10-K).
10.8 Development Agreement dated September 24, 1990, with CarboMedics,
Inc. (confidential treatment granted)* (Incorporated by reference to
Exhibit 10.9 to the 1996 Form 10-K).
10.9 O.E.M. Supply Contract dated September 24, 1990, with CarboMedics,
Inc. (confidential treatment granted)* (Incorporated by reference to
Exhibit 10.10 to the 1996 Form 10-K).
10.10 License Agreement dated September 24, 1990, with CarboMedics, Inc.
(confidential treatment granted)* (Incorporated by reference to
Exhibit 10.11 to the 1996 Form 10-K).
10.11 Option Agreement dated September 24, 1990, with CarboMedics, Inc.
(confidential treatment granted)* (Incorporated by reference to
Exhibit 10.12 to the 1996 Form 10-K).
10.12 Helix BioCore, Inc. Self-Insurance Trust Agreement dated February
28, 1991 (Incorporated by reference to Exhibit 10.13 to the 1996
Form 10-K).
10.13 Amendment 1 to License Agreement dated December 16, 1993, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.17 to the
1993 Form 10-K).
10.14 Amendment 4 to O.E.M. Supply Contract dated December 16, 1993, with
CarboMedics, Inc. (confidential treatment granted)* (Incorporated by
reference to Exhibit 10.18 to the 1993 Form 10-K).
10.15 Amendment 5 to O.E.M. Supply Contract dated September 1, 1994, with
CarboMedics, Inc. (confidential treatment granted)* (Incorporated by
reference to Exhibit 10.19 to the 1994 Form 10-K).
10.16 Amendment 1 to Option Agreement dated December 16, 1993, with
CarboMedics, Inc. (confidential treatment granted)* (Incorporated by
reference to Exhibit 10.19 to the 1993 Form 10-K).
10.17 Line of Credit dated August 11, 1994, between the Company and First
Bank National Association (Incorporated by reference to Exhibit 10.1
to the Company's Form 10-Q for the quarter ended September 30,
1994).
10.18 Form of Distributor Agreement. (Incorporated by reference to Exhibit
10.22 to the 1994 Form 10-K).
10.19** Form of Agreement between ATS Medical, Inc. and each officer dated
June 30, 1995 concerning severance benefits upon a change in
control. (Incorporated by reference to Exhibit 10.23 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1995 (The "1995 Form 10-K")).
10.20 ATS Medical, Inc. Change in Control Severance Pay Plan.
(Incorporated by reference to Exhibit 10.24 to the 1995 Form 10-K).
10.21 Amendment No. 5 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated May 30, 1996 (Incorporated by reference to
Exhibit 10.22 to the 1996 Form 10-K).
10.22 Stock Purchase Agreement dated February 3, 1997 between ITOCHU
Corporation and the Company (Incorporated by reference to Exhibit 1
to Schedule 13D filed with respect to the Company by ITOCHU
Corporation on February 18, 1997).
10.23 Amendment No. 6 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated November 25, 1997.
23 Consent of Ernst & Young LLP.
24 Power of Attorney.
27 Financial Data Schedule.
*Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended,
confidential portions of this exhibit have been redacted.
**Represents a management contract or compensatory plan or arrangement required
to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
(b) Reports on Form 8-K
None
(c) Exhibits
See Exhibit Index and Exhibits attached as a separate section of this report.
(d) Financial Statement Schedule
See Financial Statement Schedule attached on a separate section of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 27, 1998 ATS MEDICAL, INC.
By /s/ John H. Jungbauer
---------------------------
John H. Jungbauer
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the date indicated.
SIGNATURE TITLE
Manuel A. Villafana* Chairman, Chief Executive )
Officer, and Director )
(principal executive officer) )
)
Richard W. Kramp* President, Chief Operating )
Officer and Director ) By: /s/ John H. Jungbauer
---------------------
) John H. Jungbauer
John H. Jungbauer* Vice President, Treasurer ) Pro se and
and Chief Financial Officer ) Attorney-in-fact
(principal financial and )
accounting officer) )
) Dated: March 27, 1998
Charles F. Cuddihy, Jr.* Director )
)
David L. Boehnen* Director )
)
A. Jay Graf* Director )
*By Power of Attorney filed with this report as Exhibit 24 hereto.
ATS MEDICAL, INC.
ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 1997
ITEM 8 AND ITEM 14(a) (1) AND (2) AND (d)
FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
COMMISSION FILE NUMBER 0-18602
ATS MEDICAL, INC.
FORM 10-K ITEM 8 AND ITEM 14(a) (1) and (2) and (d)
LIST OF FINANCIAL STATEMENTS AND STATEMENT SCHEDULE
The following financial statements of ATS Medical, Inc. are incorporated in Part
II, Item 8 and Part IV, Item 14(a)(1) of this Annual Report on Form 10-K by this
reference:
Report of Independent Auditors.
Consolidated Statements of Financial Position at December 31, 1997 and 1996.
Consolidated Statements of Income for the years ended December 31, 1997, 1996
and 1995.
Consolidated Statement of Changes in Shareholders' Equity for the years ended
December 31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the years ended December 31, 1997,
1996 and 1995.
Notes to Consolidated Financial Statements.
The following financial statement schedule of ATS Medical, Inc. is incorporated
in Part IV, Item 14(a)(2) and (d) of this Annual Report on Form 10-K by this
reference:
Schedule II - Valuation and Qualifying Accounts and Reserves
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Auditors F-1
Consolidated Statements of Financial Position
as of December 31, 1997 and 1996 F-2
Consolidated Statements of Income for the
years ended December 31, 1997, 1996 and 1995 F-3
Consolidated Statement of Changes in
Shareholders' Equity for the years ended
December 31, 1997, 1996 and 1995 F-4
Consolidated Statements of Cash Flows for
the years ended December 31, 1997, 1996 and 1995 F-5
Notes to Consolidated Financial Statements F-6
Report of Independent Auditors
Board of Directors and Shareholders
ATS Medical, Inc.
We have audited the accompanying consolidated statements of financial position
of ATS Medical, Inc. and subsidiary as of December 31, 1997 and 1996, and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1997.
Our audit also included the financial statement schedule listed in the index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of ATS Medical, Inc.
and subsidiary at December 31, 1997 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
Ernst & Young LLP
Minneapolis, Minnesota
February 6, 1998
F-1
ATS Medical, Inc.
Consolidated Statements of Financial Position
DECEMBER 31
1997 1996
------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,568,332 $ 2,320,010
Short-term investments 20,982,176 7,867,619
------------------------------------
25,550,508 10,187,629
Accounts receivable, less allowance of $260,000
in 1997 and $200,000 in 1996 4,446,834 3,139,559
Inventories 22,686,273 18,242,066
Prepaid expenses 555,570 468,249
------------------------------------
Total current assets 53,239,185 32,037,503
Furniture and equipment, net 776,187 894,564
Other assets 370,659 388,233
------------------------------------
Total assets $54,386,031 $33,320,300
====================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 621,708 $ 1,190,958
Accrued payroll and expenses 241,584 202,603
------------------------------------
Total current liabilities 863,292 1,393,561
Shareholders' equity:
Common Stock, $.01 par value:
Authorized shares--40,000,000
Issued and outstanding shares--17,589,058 in 1997
and 15,288,042 in 1996 175,891 152,880
Additional paid-in capital 71,797,797 52,313,315
Other 40,306 54,465
Accumulated deficit (18,491,255) (20,593,921)
------------------------------------
Total shareholders' equity 53,522,739 31,926,739
Commitments
------------------------------------
Total liabilities and shareholders' equity $54,386,031 $33,320,300
====================================
SEE ACCOMPANYING NOTES.
F-2
ATS Medical, Inc.
Consolidated Statements of Income
YEAR ENDED DECEMBER 31
1997 1996 1995
------------------------------------------------------
Net sales $14,515,915 $11,859,765 $9,300,540
Cost of goods sold 9,428,959 7,474,065 6,011,025
------------------------------------------------------
Gross profit 5,086,956 4,385,700 3,289,515
Expenses:
Research, development and engineering 1,058,318 617,571 718,189
Selling, general and administrative 3,339,488 3,065,402 2,549,570
------------------------------------------------------
4,397,806 3,682,973 3,267,759
------------------------------------------------------
Operating income 689,150 702,727 21,756
Other income (expense):
Interest income 1,427,363 641,375 752,880
Interest expense - - (31,224)
------------------------------------------------------
1,427,363 641,375 721,656
------------------------------------------------------
Income before income taxes 2,116,513 1,344,102 743,412
Income taxes 13,846 22,500 28,888
------------------------------------------------------
Net income $ 2,102,667 $ 1,321,602 $ 714,524
======================================================
Net income per share:
Basic $.12 $.09 $.05
Diluted $.12 $.08 $.05
Weighted average number of shares outstanding:
Basic 17,284,784 15,168,958 14,184,395
Diluted 17,872,989 16,303,317 15,116,443
F-3
SEE ACCOMPANYING NOTES.
ATS Medical, Inc.
Consolidated Statement of Changes in Shareholders' Equity
COMMON STOCK ADDITIONAL
----------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL OTHER DEFICIT
--------------------------------------------------------------------------
Balance at January 1, 1995 11,177,881 $111,779 $35,253,360 $32,585 $(22,630,047)
Common Stock issued in public offering, net
of selling expenses of $1,400,447 3,600,000 36,000 14,763,553 - -
Compensation expense on stock options - - 13,666 - -
Change in unrealized gains on short-term
investments, net of tax - - - 12,852 -
Stock options exercised 81,143 811 273,161 - -
Stock warrants exercised 104,580 1,046 473,414 - -
Change in foreign currency translation - - - 2,717 -
Net income for the year - - - - 714,524
--------------------------------------------------------------------------
Balance at December 31, 1995 14,963,604 149,636 50,777,154 48,154 (21,915,523)
Change in unrealized gains on short-term
investments, net of tax - - - (7,262) -
Stock options exercised 58,643 586 129,804 - -
Stock warrants exercised 265,795 2,658 1,406,357 - -
Change in foreign currency translation - - - 13,573 -
Net income for the year - - - - 1,321,602
--------------------------------------------------------------------------
Balance at December 31, 1996 15,288,042 152,880 52,313,315 54,465 (20,593,921)
Common stock issued in a private placement,
net of selling expenses of $27,627 1,568,940 15,690 14,706,683 - -
Change in unrealized gain (loss) on
short-term investments, net of tax - - - (5,591) -
Stock options exercised 26,327 263 41,451 - -
Stock warrants exercised 705,749 7,058 4,736,348 - -
Change in foreign currency translation - - - (8,568) -
Net income for the year - - - - 2,102,666
--------------------------------------------------------------------------
Balance at December 31, 1997 17,589,058 $175,891 $71,797,797 $40,306 $(18,491,255)
==========================================================================
F-4
SEE ACCOMPANYING NOTES.
ATS Medical, Inc.
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31
1997 1996 1995
------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 2,102,667 $ 1,321,602 $ 714,524
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation 246,140 233,867 229,736
Loss on disposal of equipment 50,985 17,925 916
Compensation expense on stock options - - 13,666
Changes in operating assets and liabilities:
Accounts receivable (1,307,275) 85,548 (437,975)
Prepaid expenses (87,322) (27,567) (182,574)
Other assets 17,574 (18,799) 255,764
Inventories (4,444,207) (4,820,321) (4,089,603)
Accounts payable and accrued expenses (530,269) (876,146) 1,728,934
------------------------------------------------------
Net cash used in operating activities (3,951,707) (4,083,891) (1,766,612)
INVESTING ACTIVITIES
Purchases of short-term investments (29,435,865) (9,486,341) (16,564,890)
Maturities of short-term investments 16,315,717 12,382,440 5,806,763
Purchases of furniture and equipment (178,748) (258,808) (190,699)
------------------------------------------------------
Net cash (used in) provided by investing activities (13,298,896) 2,637,291 (10,948,826)
FINANCING ACTIVITIES
Payments on notes payable - - (1,250,000)
Net proceeds from issuance of Common Stock 19,507,493 1,539,405 15,547,985
------------------------------------------------------
Net cash provided by financing activities 19,507,493 1,539,405 14,297,985
Effect of exchange rate changes on cash (8,568) 13,573 2,717
------------------------------------------------------
Increase in cash and cash equivalents 2,248,322 106,378 1,585,264
Cash and cash equivalents at beginning of year 2,320,010 2,213,632 628,368
------------------------------------------------------
Cash and cash equivalents at end of year $ 4,568,332 $ 2,320,010 $ 2,213,632
======================================================
F-5
SEE ACCOMPANYING NOTES.
ATS Medical, Inc.
Notes to Consolidated Financial Statements
December 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS ACTIVITY
ATS Medical, Inc. (the "Company") manufactures and sells a bileaflet mechanical
heart valve. The principal markets for the Company's mechanical heart valve
include Europe, Asia, South Africa and South America. The Company is sponsoring
clinical trials of the valve in Australia, Canada and the United States in order
to demonstrate safety and effectiveness and be allowed to market the valve in
these countries.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary, ATS Medical, Ltd., after elimination of significant
intercompany accounts and transactions.
CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three
months or less at the time of purchase to be cash equivalents. Cash equivalents
are carried at cost which approximates market value.
SHORT-TERM INVESTMENTS
Short-term investments are composed of debt securities and are classified as
available-for-sale. Available-for-sale securities are carried at fair value,
with the unrealized gains and losses, net of tax, reported as a separate
component of shareholders' equity. Realized gains and losses and declines in
value judged to be other than temporary on available-for-sale securities are
included in other income.
INVENTORIES
Inventories are carried at the lower of cost (first-in, first-out basis) or
market. The majority of inventory consists of purchased components.
F-6
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER ASSETS
Prior to obtaining directors' and officers' liability insurance, the Company had
placed $370,659 and $353,987 as of December 31, 1997 and 1996, respectively, in
a self-insurance trust. A VAT deferment account of $34,246 at December 31, 1996
had been established to guarantee VAT liabilities for inventory transferred to
Scotland for manufacturing. The account was closed in 1997.
FURNITURE AND EQUIPMENT
Furniture and equipment are stated at cost. Depreciation is provided for at
rates calculated to amortize the cost of the property over its estimated useful
life (three to ten years) using the straight-line method. Leasehold improvements
are amortized over the related lease term or estimated useful life, whichever is
shorter.
REVENUE RECOGNITION
The Company recognizes revenue at the time of shipment of the product.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
INCOME TAXES
Income taxes are accounted for under the liability method. Deferred income taxes
are provided for temporary differences between financial reporting and tax bases
of assets and liabilities.
F-7
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations in accounting
for its stock options. Under APB 25, when the exercise price of stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
NET INCOME PER SHARE
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 128, EARNINGS PER SHARE. Statement 128 replaced the previously
reported primary and fully diluted earnings per share with basic and diluted
earnings per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants, and convertible securities.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. All earnings per share amounts for all periods have
been presented, and where necessary, restated to conform to the Statement 128
requirements.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 and 1996 financial
statements to conform to the 1997 presentation.
2. SHORT-TERM INVESTMENTS
As of December 31, 1997, the cost of short-term investments held by the Company
approximated their fair market value of $20,982,176. As a result no unrealized
gain (loss) was recognized at December 31, 1997. As of December 31, 1996, the
cost of short-term investments and fair market value were $7,858,301 and
$7,867,619, respectively.
An unrealized gain of $9,318 was recognized at December 31, 1996.
All investments have maturity dates of one year or less.
F-8
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
3. FURNITURE AND EQUIPMENT
Furniture and equipment consists of the following:
DECEMBER 31
1997 1996
-----------------------------------
Furniture and fixtures $ 155,363 $ 168,960
Equipment 1,321,068 1,347,034
Leasehold improvements 479,795 474,042
Construction in progress 67,420 24,403
-----------------------------------
2,023,646 2,014,439
Less accumulated depreciation 1,247,459 1,119,875
-----------------------------------
$ 776,187 $ 894,564
===================================
4. FINANCING ARRANGEMENT
The Company has a $5 million revolving line of credit with a bank which accrues
interest at a rate .5% below the bank's reference rate (8% at December 31, 1997)
and is secured by a portion of the Company's short-term investments. The Company
must repay any amounts owed under the line of credit by June 30, 1998. Interest
on the line of credit is payable monthly. The Company had no borrowings against
this facility at December 31, 1997.
5. COMMON STOCK
In connection with its initial public offering, the Company sold a warrant to
the underwriters to purchase 160,000 shares of Common Stock exercisable at $4.20
per share. At December 31, 1996, there were 8,000 of the warrants outstanding.
In November 1997, the remaining warrants were exercised.
In connection with a private placement of Common Stock, the Company had issued
warrants to purchase an additional share of Common Stock at $9.00 per share. The
Company also issued warrants to the agent in the private placement to purchase
161,394 shares of Common Stock at $7.00 per share and 161,394 shares of Common
Stock at $9.00 per share. As of December 31, 1996, the Company had 1,850,485 of
these warrants outstanding. These warrants expired on November 18, 1997.
F-9
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
5. COMMON STOCK (CONTINUED)
In 1993, the Company completed a private placement of 416,667 units at $6.00 per
unit. Each unit consisted of one share of the Company's Common Stock and a
warrant to purchase an additional share of Common Stock at $9.00 per share. The
warrants expire on December 22, 1998 and none have been exercised as of December
31, 1997.
On March 2, 1995, the Company completed a public offering in which the Company
sold 3,600,000 shares of Common Stock at $4.50 per share, including warrants to
purchase an additional 900,000 shares of Common Stock exercisable at $6.75 per
share. As of December 31, 1996, the Company had 826,813 of these warrants
outstanding. During 1997, the holders exercised 697,749 of these warrants. The
remaining 129,064 warrants expired on March 2, 1997. The Company also issued a
warrant to the agent to purchase 180,000 shares of Common Stock at $5.40 per
share. In 1996, 121,059 shares were tendered in the exercise of the warrant to
purchase the 180,000 shares for a net issuance of 58,941 shares.
The Company has 2,808,514 shares of Common Stock reserved for issuance under
various options and warrant grants.
6. STOCK OPTIONS
The Company has a Stock Option and Stock Award Plan (the "Plan") under which
options to purchase Common Stock of the Company may be awarded to employees and
non-employees of the Company. The options may be granted under the Plan as
incentive stock options (ISO) or as non-qualified stock options (non-ISO).
F-10
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCK OPTIONS (CONTINUED)
The following table summarizes the options to purchase shares of the Company's
Common Stock under the Plan:
STOCK OPTIONS
SHARES OUTSTANDING WEIGHTED
RESERVED UNDER THE PLAN AVERAGE
------------------------- EXERCISE PRICE
FOR GRANT ISO NON-ISO PER SHARE
----------------------------------------------------------
Balance January 1, 1995 466,754 477,750 617,500 $2.60
Options granted (12,500) 2,500 10,000 7.90
Options exercised - (66,687) (18,500) 3.62
Options canceled 15,750 (7,750) (8,000) 3.63
-------------------------------------------
Balance December 31, 1995 470,004 405,813 601,000 2.56
Options granted (395,000) 299,500 95,500 9.00
Options exercised - (29,643) (29,000) 2.22
Options canceled 38,125 (21,000) (17,125) 6.07
-------------------------------------------
Balance December 31, 1996 113,129 654,670 650,375 4.37
Additional shares reserved 1,000,000 - -
Options granted (374,600) 284,928 89,672 5.51
Options exercised - (7,500) (18,827) 1.59
Options canceled 151,250 (123,125) (28,125) 9.15
-------------------------------------------
Balance December 31, 1997 889,779 808,973 693,095 4.23
===========================================
F-11
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCK OPTIONS (CONTINUED)
The following table summarizes information about stock options outstanding at
December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ ---------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- -------------------------- ------------------------------------------------ ---------------------------------
$0.0042 271,173 0.20 years $0.0042 271,173 $0.0042
1.00 - 3.63 612,295 5.11 years 3.38 570,795 3.37
5.06 - 8.25 553,600 9.04 years 6.25 99,875 6.83
9.00 - 10.13 97,500 7.79 years 9.73 42,375 9.66
----------------- -----------------
$0.0042 - $10.13 1,534,568 5.84 years 4.22 984,218 $3.06
================= =================
The weighted-average fair value of options granted during the years ended
December 31, 1997 and 1996 was $5.51 and $9.00, respectively.
Non-Plan options to purchase 32,500 and 35,000 shares exercisable at $3.63 per
share were outstanding at December 31, 1997 and 1996, respectively.
At December 31, 1997, 1996 and 1995, Plan and non-Plan options for 984,218,
816,421 and 744,687 shares of Common Stock, respectively, were exercisable at a
weighted-average price of $3.06, $2.44 and $2.09 per share, respectively.
Options can be exercised by tendering shares previously acquired. In 1995, 4,044
shares were tendered in the exercise of 85,187 options for a net issuance of
81,143 shares.
The issuance of certain stock options to employees and consultants caused the
Company to account for the excess of the fair market value of the Company's
Common Stock on the date of grant over the option exercise prices as
compensation. The expense is recognized over the period of expected services.
The compensation expense does not involve the outlay of cash. During the year
ended December 31, 1995, $13,666, of expense was recognized for the unexercised
options. There was no expense recognized in 1997 and 1996.
F-13
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCK OPTIONS (CONTINUED)
The Company has elected to follow Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION ("Statement 123"), requires use of
option valuation models that were not developed for use in valuing employee
stock options.
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of Statement 123. The fair
value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 1997 and 1996: risk-free interest rate of 5.20% and 6.03%,
respectively; dividend yield of 0%; volatility factor of the expected market
price of the Company's common stock of .80 and .46 and a weighted-average
expected life of the option of 5 and 4 years, respectively.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
1997 1996 1995
---------------------------------------
Pro forma net income $1,634,401 $1,122,778 $679,801
Pro forma net income per share - basic
and diluted $.09 $.07 $.04
F-13
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
6. STOCK OPTIONS (CONTINUED)
The pro forma effect on net income is not representative of the pro forma effect
on net income in future years because it does not take into consideration pro
forma compensation expense related to grants made prior to 1995.
7. LEASES
The Company has amended its operating lease for facilities in Plymouth,
Minnesota. The lease is for a period of 62 months and expires February 28, 2003.
Future minimum lease payments under the agreement are as follows:
1998 $ 200,308
1999 204,108
2000 204,108
2001 219,608
2002 222,708
Thererafter 37,118
--------------
$1,087,958
==============
The rent expense was $159,096, $147,101 and $143,000 for 1997, 1996, and 1995,
respectively.
8. INCOME TAXES
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $17,750,000 plus credits for increasing research and development
costs of approximately $616,000 which are available to offset future taxable
income through 2012. The net operating loss carryforwards exclude results of
operations for ATS Medical, Ltd. for 1997, 1996 and 1995. The Company paid
income taxes of $13,800, $23,000 and $29,000 in 1997, 1996 and 1995,
respectively.
F-14
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
8. INCOME TAXES (CONTINUED)
Components of deferred tax assets and liabilities are as follows:
DECEMBER 31
1997 1996
-----------------------------------
Deferred tax assets:
Net operating loss carryforwards $7,100,000 $7,513,000
Research and development credits 616,000 620,000
Accrued compensation 335,000 341,000
Other accrued expenses 49,000 27,000
-----------------------------------
8,100,000 8,501,000
Deferred tax liabilities:
Depreciation (567,000) (555,000)
-----------------------------------
Net deferred tax assets before valuation allowance 7,533,000 7,946,000
Less valuation allowance (7,533,000) (7,946,000)
-----------------------------------
Net deferred tax assets $ - $ -
===================================
The Company's ability to utilize its net operating loss carryforwards to offset
future taxable income is subject to certain limitations under Section 382 of the
Internal Revenue Code due to changes in the equity ownership of the Company.
Income tax expense consists of:
DECEMBER 31
1997 1996 1995
----------------------------------------------------
Current:
Federal $ 3,846 $ - $ -
State 10,000 - -
Foreign - 22,500 28,888
----------------------------------------------------
$13,846 $22,500 $28,888
====================================================
Reconciliation of the statutory federal income tax rate to the Company's
effective tax rate is as follows:
DECEMBER 31
1997 1996 1995
-------------------------------------
Tax at statutory rate 34.0% 34.0% 34.0%
State income taxes 6.0 6.0 6.0
Foreign income taxes - 1.7 3.9
Impact of net operating loss carryforwards (39.0) (40.0) (40.0)
-------------------------------------
1.0% 1.7% 3.9%
=====================================
F-15
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
9. COMMITMENTS
On September 24, 1990, the Company entered into various agreements with
CarboMedics, Inc. giving the Company the exclusive worldwide license to
manufacture and sell a bileaflet mechanical heart valve under patents held by
CarboMedics, Inc. As part of the agreements, the Company entered into a 15 year
supply contract that was amended in December 1993. Under the amended supply
contract, as of December 31, 1997, the Company remains obligated to purchase a
minimum of $47 million of component sets through December 7, 2000. Thereafter,
the Company must purchase the lower of either certain specified amounts or the
number of component sets sold and/or disposed of by the Company. Payments to
CarboMedics, Inc. were $12,478,323, $11,289,218 and $6,182,596 in 1997, 1996 and
1995, respectively.
At December 31, 1997, the Company's inventory is in excess of its current
requirements based on the recent level of sales. Management feels that excess
quantities will be utilized upon FDA approval of its technology and believes no
loss will be incurred on its disposition. As of December 31, 1997, management
cannot estimate a range of amounts of loss that could occur if FDA approval is
not granted. Management is unable to make a meaningful estimate of inventory
usage for the next twelve months and, accordingly, inventory is classified as a
current asset as of December 31, 1997.
10. BENEFIT PLAN
The Company has a defined contribution salary deferral plan covering
substantially all employees under Section 401(k) of the Internal Revenue Code.
The plan allows eligible employees to contribute up to 12% of their annual
compensation with the Company contributing an amount equal to 25% of each
employee's contribution. The Company realized expense for contributions to the
plan of $40,920, $38,125 and $32,911 during 1997, 1996 and 1995, respectively.
11. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
The Company sells to independent distributors who cover assigned international
territories. Approximately 46%, 49%, and 56% of net sales for 1997, 1996, and
1995, respectively, were a result of sales to three distributors.
ATS Medical, Inc.
Notes to Consolidated Financial Statements (continued)
12. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
1997 1996 1995
------------------------------------------------------
Numerator:
Net income $2,102,667 $1,312,602 $714,524
Denominator:
Denominator for basic earnings per
share-weighted-average shares 17,284,784 15,168,958 14,184,395
Effect of dilutive securities:
Stock options 585,908 720,851 729,024
Warrants 2,297 413,508 203,024
------------------------------------------------------
Dilutive potential common shares
Denominator for diluted earnings per
share-adjusted weighted-average shares and
assumed conversions 17,872,989 16,303,317 15,116,443
======================================================
Basic earnings per share $.12 $.09 $.05
Diluted earnings per share $.12 $.08 $.05
F-17
ATS MEDICAL, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
COL. A COL. B COL. C COL. D COL. E
Additions
Balance at (1) (2)
Beginning Charged to Charged to Balance at
of Period Costs and Other Accounts- Deductions- End of
Description Expenses Describe Describe Period
Year ended December 31, 1997:
Deducted from asset accounts:
Allowance for doubtful accounts $200,000 $ 60,000 -- -- $260,000
-------- -------- -------- -------- --------
Totals $200,000 $ 60,000 $ 0 $ 0 $260,000
Year ended December 31, 1996:
Deducted from asset accounts:
Allowance for doubtful accounts $150,000 $ 50,000 -- -- $200,000
-------- -------- -------- -------- --------
Totals $150,000 $ 50,000 $ 0 $ 0 $200,000
Year ended December 31, 1995:
Deducted from asset accounts:
Allowance for doubtful accounts $ 30,000 $120,000 -- -- $150,000
-------- -------- -------- -------- --------
Totals $ 30,000 $120,000 $ 0 $ 0 $150,000
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION PAGE
3.1 Restated Articles of Incorporation, as amended to date (Incorporated
by reference to Exhibit 3.1 to the Company's Annual Report on Form
10-K for the year ended December 31, 1993 (the "1993 Form 10-K")).
3.2 Bylaws of the Company, as amended to date. (Incorporated by
Reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996 (the "1996 Form 10-K")).
4.1 Specimen certificate for shares of Common Stock of the Company.
4.2 Form of Warrant issued in 1993 Private Placement (Incorporated by
reference to Exhibit 4.4 to the 1993 Form 10-K).
10.1** 1987 Stock Option and Stock Award Plan, as restated and amended to
date (Incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
10.2** Agreement between the Company and Manuel A. Villafana dated January
26, 1995 (Incorporated by reference to Exhibit 10.3 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1994 (the
"1994 Form 10-K")).
10.3 Lease Agreement between the Company and Crow Plymouth Land Limited
Partnership dated December 22, 1987 (Incorporated by reference to
Exhibit 10(d) to the Form S-18).
10.4 Amendment No. 1 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 5, 1989
(Incorporated by reference to Exhibit 10(e) to the Form S-18).
10.5 Amendment No. 2 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 1989 (Incorporated
by reference to Exhibit 10(f) to the Form S-18).
10.6 Amendment No. 3 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated June 14, 1989 (Incorporated
by reference to Exhibit 10(g) to the Form S-18).
10.7 Amendment No. 4 to Lease Agreement between the Company and Plymouth
Business Center Limited Partnership, dated February 10, 1992
(Incorporated by reference to Exhibit 10.8 to the 1996 Form 10-K).
10.8 Development Agreement dated September 24, 1990, with CarboMedics,
Inc. (confidential treatment granted)* (Incorporated by reference to
Exhibit 10.9 to the 1996 Form 10-K).
10.9 O.E.M. Supply Contract dated September 24, 1990, with CarboMedics,
Inc. (confidential treatment granted)* (Incorporated by reference to
Exhibit 10.10 to the 1996 Form 10-K).
10.10 License Agreement dated September 24, 1990, with CarboMedics, Inc.
(confidential treatment granted)* (Incorporated by reference to
Exhibit 10.11 to the 1996 Form 10-K).
10.11 Option Agreement dated September 24, 1990, with CarboMedics, Inc.
(confidential treatment granted)* (Incorporated by reference to
Exhibit 10.12 to the 1996 Form 10-K).
10.12 Helix BioCore, Inc. Self-Insurance Trust Agreement dated February
28, 1991 (Incorporated by reference to Exhibit 10.13 to the 1996
Form 10-K).
10.13 Amendment 1 to License Agreement dated December 16, 1993, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.17 to the
1993 Form 10-K).
10.14 Amendment 4 to O.E.M. Supply Contract dated December 16, 1993, with
CarboMedics, Inc. (confidential treatment granted)* (Incorporated by
reference to Exhibit 10.18 to the 1993 Form 10-K).
10.15 Amendment 5 to O.E.M. Supply Contract dated September 1, 1994, with
CarboMedics, Inc. (confidential treatment granted)* (Incorporated by
reference to Exhibit 10.19 to the 1994 Form 10-K).
10.16 Amendment 1 to Option Agreement dated December 16, 1993, with
CarboMedics, Inc. (confidential treatment granted)* (Incorporated by
reference to Exhibit 10.19 to the 1993 Form 10-K).
10.17 Line of Credit dated August 11, 1994, between the Company and First
Bank National Association (Incorporated by reference to Exhibit 10.1
to the Company's Form 10-Q for the quarter ended September 30,
1994).
10.18 Form of Distributor Agreement. (Incorporated by reference to Exhibit
10.22 to the 1994 Form 10-K).
10.19** Form of Agreement between ATS Medical, Inc. and each officer dated
June 30, 1995 concerning severance benefits upon a change in
control. (Incorporated by reference to Exhibit 10.23 to the
Company's Annual Report on Form 10-K for the year ended December 31,
1995 (The "1995 Form 10-K")).
10.20 ATS Medical, Inc. Change in Control Severance Pay Plan.
(Incorporated by reference to Exhibit 10.24 to the 1995 Form 10-K).
10.21 Amendment No. 5 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated May 30, 1996 (Incorporated by reference to
Exhibit 10.22 to the 1996 Form 10-K).
10.22 Stock Purchase Agreement dated February 3, 1997 between ITOCHU
Corporation and the Company (Incorporated by reference to Exhibit 1
to Schedule 13D filed with respect to the Company by ITOCHU
Corporation on February 18, 1997).
10.23 Amendment No. 6 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated November 25, 1997.
23 Consent of Ernst & Young LLP.
24 Power of Attorney.
27 Financial Data Schedule.
*Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended,
confidential portions of this exhibit have been redacted.
**Represents a management contract or compensatory plan or arrangement required
to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.