CARDIOGENESIS CORP /CA - 10-Q Quarterly Report

Quarterly report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

	California	77-0223740

	(State of incorporation)	(I.R.S. EmployerIdentification Number)

26632 Towne Center Drive
Suite 320
Foothill Ranch, California 92610
(Address of principal executive offices)

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.

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

PART 1
FINANCIAL INFORMATION
			Page

Item 1.	Financial Statements (unaudited):
	a.	Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001	1
	b.	Consolidated Statements of Operations & Comprehensive Loss for the three and nine months ended September 30, 2002 and 2001	2
	c.	Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001	3
	d.	Notes to Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		5
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		16
Item 4.	Controls and Procedures		17
PART II
OTHER INFORMATION
Item 1.	Legal Proceedings		17
Item 2.	Changes in Securities and Use of Proceeds		17
Item 3.	Defaults Upon Senior Securities		17
Item 4.	Submission of Matters to a Vote of Security Holders		17
Item 5.	Other Information		17
Item 6.	Exhibits and Reports on Form 8-K		18
	Signatures		19
	Certifications		20

CARDIOGENESIS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

	September 30,			December 31,

	2002				2001

Current assets:
Cash and cash equivalents	$	1,801		$	2,629
Accounts receivable, net of allowance for doubtful accounts of $1,299 and $1,114 at September 30, 2002 and December 31, 2001, respectively		1,876			2,330
Inventories, net of reserve of $273 and $1,246 at September 30, 2002 and December 31, 2001, respectively		2,083			3,215
Prepaids and other current assets		766			569

Total current assets		6,526			8,743
Property and equipment, net		655			863
Other assets		1,557			1,703

Total assets	$	8,738		$	11,309

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	1,357		$	1,548
Accrued liabilities		3,073			4,467
Customer deposits		50			54
Deferred revenue		602			931
Note payable		162			170
Current portion of capital lease obligation		30			30
Current portion of long-term liabilities		—			495

Total current liabilities		5,274			7,695
Capital lease obligation, less current portion		9			32

Total liabilities		5,283			7,727

Shareholders’ equity:
Preferred stock:
no par value; 5,000 shares authorized; none issued and outstanding		—			—
Common stock:
no par value; 50,000 shares authorized; 37,059 and 36,507 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively		168,236			167,750
Accumulated other comprehensive loss		(23	)		(88	)
Accumulated deficit		(164,758	)		(164,080	)

Total shareholders’ equity		3,455			3,582

Total liabilities and shareholders’ equity	$	8,738		$	11,309

The accompanying notes are an integral part of these consolidated financial statements.

CARDIOGENESIS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS & COMPREHENSIVE LOSS
(in thousands, except per share amounts)
(unaudited)

	Three months ended						Nine months ended
	September 30,						September 30,

	2002			2001			2002			2001

Net revenues	$	3,210		$	4,221		$	9,378		$	11,362
Cost of revenues		695			1,627			2,193			4,745

Gross profit		2,515			2,594			7,185			6,617

Operating expenses:
Research and development		(261	)		337			382			1,586
Sales, general and administrative		3,357			4,309			9,790			11,203
Restructuring costs		—			442			—			1,132

Total operating expenses		3,096			5,088			10,172			13,921

Operating loss		(581	)		(2,494	)		(2,987	)		(7,304	)
Interest, net		5			13			24			71
Gain on sale of equity investee		—			—			2,285			—
Equity in net loss of investee		—			—			—			(652	)

Net loss		(576	)		(2,481	)		(678	)		(7,885	)

Other comprehensive income (loss):
Foreign currency translation adjustment		23			(74	)		65			(41	)

Other comprehensive income (loss)		23			(74	)		65			(41	)

Comprehensive loss	$	(553	)	$	(2,555	)	$	(613	)	$	(7,926	)

Net loss per share:
Basic and diluted	$	(0.02	)	$	(0.07	)	$	(0.02	)	$	(0.24	)

Weighted average shares outstanding		37,059			34,209			36,850			32,866

The accompanying notes are an integral part of these consolidated financial statements.

CARDIOGENESIS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Nine months ended
	September 30,

	2002			2001

Cash flows from operating activities:
Net loss	$	(678	)	$	(7,885	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		239			352
Gain from sale of equity investee		(2,285	)		—
Loss from equity in investee		—			652
Provision for doubtful accounts		260			135
Inventory reserves		685			932
Amortization of deferred compensation		—			57
Accretion of long-term liability		—			26
Amortization of license fees		146			156
Loss on disposal of property and equipment		28			—
Reduction of clinical trial accrual		(684	)		—
Changes in operating assets and liabilities:
Accounts receivable – short term		194			(127	)
Inventories		447			643
Prepaids and other current assets		427			49
Accounts receivable – long term		—			(138	)
Other assets		—			(19	)
Accounts payable		(191	)		239
Accrued liabilities		(710	)		(195	)
Current portion of long term liabilities		(495	)		(10	)
Long term liabilities		—			(365	)
Customer deposits		(4	)		—
Deferred revenue		(329	)		(414	)

Net cash used in operating activities		(2,950	)		(5,912	)

Cash flows from investing activities:
Proceeds from sale of equity investee		2,285			—
Acquisition of property and equipment		(59	)		(302	)

Net cash provided by (used in) investing activities		2,226			(302	)

Cash flows from financing activities:
Net proceeds from sales of common stock and from issuance of common stock from exercise of options		486			3,697
(Payments on) proceeds from short term borrowings		(632	)		205
Repayments of capital lease obligations		(23	)		(21	)

Net cash (used in) provided by financing activities		(169	)		3,881

Effects of exchange rate changes on cash and cash equivalents		65			(41	)

Net decrease in cash and cash equivalents		(828	)		(2,374	)
Cash and cash equivalents at beginning of period		2,629			3,357

Cash and cash equivalents at end of period	$	1,801		$	983

Supplemental schedule of cash flow information:
Interest paid	$	10		$	18

Taxes paid	$	26		$	49

Supplemental schedule of noncash investing and financing activities:
Deferred compensation	$	—		$	(4	)

Issuance of warrants	$	—		$	94

Financing of insurance premiums with note payable	$	624		$	554

The accompanying notes are an integral part of these consolidated financial statements.

The interim financial statements in this report reflect all adjustments, consisting of normal recurring adjustments, that are, in the opinion of management, necessary for a fair presentation of the results of operations and cash flows for the interim periods covered and of the financial position of the Company at the interim balance sheet date. Results for interim periods are not necessarily indicative of results to be expected for the full fiscal year. The year-end balance sheet information was derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. These financial statements should be read in conjunction with CardioGenesis’ audited financial statements and notes thereto for the year ended December 31, 2001, contained in the Company’s Annual Report on Form 10-K as filed with the U.S. Securities and Exchange Commission (“SEC”).

These financial statements contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. CardioGenesis has sustained significant losses for the last several years and expects to continue to incur losses through 2002. Management believes its cash balance as of September 30, 2002 is sufficient to meet the Company’s capital and operating requirements through the end of the fiscal year ending December 31, 2002, but may not be sufficient to meet requirements through the corresponding period ending September 30, 2003.

CardioGenesis may require additional financing in 2003. There can be no assurance that CardioGenesis will be able to obtain additional debt or equity financing when needed, on terms acceptable to the Company. Any additional debt or equity financing may involve substantial dilution to CardioGenesis’ stockholders, restrictive covenants or high interest costs. The failure to raise needed funds on sufficiently favorable terms could have a material adverse effect on CardioGenesis’ business, operating results and financial condition. CardioGenesis’ long term liquidity also depends upon its ability to increase revenues from the sale of its products and achieve profitability. The failure to achieve these goals could have a material adverse effect on the business, operating results and financial condition.

Basic earnings per share (“EPS”) is computed by dividing the net loss by the weighted average number of common shares outstanding for the period. Dilutive EPS is computed giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares consist of incremental shares issuable upon the exercise of stock options and warrants using the “treasury stock” method.

Options to purchase 3,520,474 and 4,035,728 shares of common stock were outstanding at September 30, 2002 and 2001, respectively. Warrants to purchase 75,000 shares of common stock at $1.63 per share were outstanding as of September 30, 2002 and 2001. Both the options and warrants were not included in the calculation of diluted EPS because their inclusion would have been anti-dilutive.

Inventories are stated at lower of cost or market and consist of the following (in thousands, unaudited):

	September 30,			December 31,

	2002			2001

Raw materials		$	1,147		$	917
Work-in-process			358			323
Finished goods			578			1,975

		$	2,083		$	3,215

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains descriptions of our expectations regarding future trends affecting our business. These forward-looking statements and other forward-looking statements made elsewhere in this document are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Please read the section below titled “Factors Affecting Future Results” to review conditions which we believe could cause actual results to differ materially from those contemplated by the forward-looking statements. Forward-looking statements are identified by words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “will,” “may” and similar expressions. In addition, any statements that refer to our plans, expectations, strategies or other characterizations of future events or circumstances are forward-looking statements. Our business may have changed since the date hereof and we undertake no obligation to update these forward looking statements.

The following discussion should be read in conjunction with financial statements and notes thereto included in this Quarterly Report on Form 10-Q.

CardioGenesis Corporation, formerly known as Eclipse Surgical Technologies, Inc. (“CardioGenesis”, “the Company”, or “we”), incorporated in California in 1989, designs, develops, manufactures and distributes laser-based surgical products and disposable fiber-optic accessories for the treatment of advanced cardiovascular disease through transmyocardial revascularization (“TMR”) and percutaneous transluminal myocardial revascularization (“PMR”).

In 1999, we received approval from the Food and Drug Administration (“FDA”) to sell our TMR products in the U.S. on a commercial basis for use with certain medical indications. We have also received the European Conforming Mark (“CE Mark”) allowing the commercial sale of our TMR laser systems and our PMR catheter system to customers in the European Community. Effective July 1999, the Health Care Financial Administration began providing Medicare coverage for TMR. Hospitals and physicians are now eligible to receive Medicare reimbursement for TMR equipment and procedures.

In 1999, we submitted a Pre Market Approval (“PMA”) application to the FDA along with subsequent amendments for the approval of our PMR device. In July 2001, the FDA’s Circulatory Devices Panel recommended against approval by the FDA of our PMR device for public sale and use in the United States. We have continued to pursue FDA approval for PMR and in July 2002, we submitted a PMA amendment for PMR to the FDA. There can be no assurance, however, that we will receive a favorable decision from the agency.

As of September 30, 2002, we had an accumulated deficit of $164,758,000. We expect to continue to incur operating losses through 2002. The timing and amounts of our expenditures will depend upon a number of factors, including the efforts required to develop our sales and marketing organization, the timing of market acceptance of our products and the status and timing of regulatory approvals.

Net revenues of $3,210,000 for the quarter ended September 30, 2002 decreased $1,011,000, or 24%, when compared to net revenues of $4,221,000 for the quarter ended September 30, 2001. The decrease in net revenues is primarily attributed to a decrease in laser revenue of $620,000. The decrease in laser revenue is primarily attributed to a decrease in lasers sold outright when comparing the third quarter of 2002 to 2001. For the quarter ended September 30, 2002, domestic handpiece revenue decreased by $208,000 compared to the quarter ended September 30, 2001. In the third quarter of 2002, domestic handpiece revenue consisted of $1,230,000 in sales to customers operating under the loaned laser program and $1,003,000 in sales to customers not operating under the loaned laser program. For those sales to customers operating under the loaner laser program, $217,000 was attributed to premiums associated with handpiece sales. In the third quarter of 2001, domestic handpiece revenue consisted of $1,206,000 in sales of product to customers operating under the loaned laser program and $1,235,000 of sales to customers not operating under the loaned laser program. For those sales to customers operating under the loaned laser program, $313,000 was attributed to premiums associated with the handpiece sales.

For the quarter ended September 30, 2002, domestic laser revenue decreased by $620,000 compared to the same quarter in 2001. International sales, accounting for approximately 1% of net revenues for the quarter ended September 30, 2002, decreased $186,000 from the prior year when international sales accounted for 5% of total sales. We define international sales as sales to customers located outside of the United States. In addition, service and other revenue of $264,000 increased $3,000 for the quarter ended September 30, 2002 when compared to $261,000 for the quarter ended September 30, 2001.

Net revenues of $9,378,000 for the nine months ended September 30, 2002 decreased $1,984,000, or 17%, when compared to net revenues of $11,362,000 for the nine months ended September 30, 2001. The decrease in net revenues is primarily attributed to a decrease in domestic hand piece revenue of $1,198,000 and a decrease in international sales of $544,000. The decrease in hand piece revenue is primarily attributed to our current strategy of concentrating our sales resources on increasing procedure volume in our existing installed base, which has had the effect of reducing revenues from laser placements and outright laser sales, when compared to the levels attained in the first nine months of 2001. The decline in new laser placements, when compared to prior year periods, has resulted in a year-over-year reduction in the number of hand pieces sold as each shipped laser is normally accompanied by an order for several hand pieces. For the nine months ended September 30, 2002, domestic handpiece revenue decreased by $1,198,000 compared to the nine months ended September 30, 2001. In the first nine months of 2002, domestic handpiece revenue consisted of $2,519,000 in sales to customers operating under the loaned laser program and $3,841,000 in sales to customers not operating under the loaned laser program. For those sales to customers operating under the loaner laser program, $452,000 was attributed to premiums associated with handpiece sales. In the first nine months of 2001, domestic handpiece revenue consisted of $3,455,000 in sales of product to customers operating under the loaned laser program and $4,103,000 of sales to customers not operating under the loaned laser program. For those sales to customers operating under the loaned laser program, $1,108,000 was attributed to premiums associated with the handpiece sales.

For the nine months ended September 30, 2002, domestic laser revenue decreased by $163,000 compared to the same period in 2001. International sales, accounting for approximately 4% of net revenues for the nine months ended September 30, 2002, decreased $544,000 from the same period in the prior year when international sales accounted for 8% of total sales. In addition, service and other revenue of $743,000 decreased $79,000 for the nine months ended September 30, 2002 when compared to $822,000 for the nine months ended September 30, 2001.

Gross profit increased to 78% of net revenues for the quarter ended September 30, 2002 as compared to 61% of net revenues for the quarter ended September 30, 2001. Gross profit in absolute dollars decreased by $79,000 to $2,515,000 for the quarter ended September 30, 2002, as compared to $2,594,000 for the quarter ended September 30, 2001. Gross profit increased to 77% of net revenues for the nine months ended September 30, 2002 as compared to 58% of net revenues for the nine months ended September 30, 2001. Gross profit in absolute dollars increased by $568,000 to $7,185,000 for the nine months ended September 30, 2002, as compared to $6,617,000 for the nine months ended September 30, 2001. The increase in gross margin as a percent of net revenues for the quarter and nine months ended September 30, 2002 resulted from improved margins on lasers sold as well as improved margins on disposable handpieces due to the outsourcing of disposables manufacturing, which took place in the second half of 2001.

Research and development expenditures decreased $598,000 or 177% resulting in income of $261,000 for the quarter ended September 30, 2002 when compared to expense of $337,000 for the quarter ended September 30, 2001. The decrease in overall research and development expense was primarily attributed to a $684,000 reduction of accrued liabilities established in prior periods for research and development costs associated with estimated clinical trial obligations, as well as a decrease in employee expenses of approximately $90,000 related to a reduction in workforce, and partially offset by an increase in outside services of $165,000.

Research and development expenditures of $382,000 decreased $1,204,000 or 76% for the nine months ended September 30, 2002 when compared to $1,586,000 for the nine months ended September 30, 2001. The decrease in overall research and development expense was primarily attributed to a $684,000 reduction of accrued liabilities established in prior periods for research and development costs associated with estimated clinical trial obligations. In addition, employee expenses decreased by approximately $1,000,000 related to reductions in workforce. These decreases were partially offset by increases in outside services of approximately $450,000.

Sales, general and administrative expenditures of $3,357,000 decreased $952,000 or 22% for the quarter ended September 30, 2002 when compared to $4,309,000 for the quarter ended September 30, 2001. The decrease in expenses resulted primarily from decreases in employee expenses and facilities costs of $639,000 and $201,000, respectively.

Sales, general and administrative expenditures of $9,790,000 decreased $1,413,000 or 13% for the nine months ended September 30, 2002 when compared to $11,203,000 for the nine months ended September 30, 2001. The decrease in expenses resulted primarily from decreases in employee expenses and facilities costs of $875,000 and $528,000, respectively.

We incurred restructuring costs of $442,000 and $1,132,000 for three and nine months ended September 30, 2001, respectively. No restructuring charges were incurred in 2002.

In the second quarter of 2002, we recorded a gain of $2,285,000 resulting from the sale of our minority interest in Microheart.

Equity in net loss of investee of $652,000 for the nine months ended September 30, 2001 represented our share of the net loss of Microheart, Inc., a privately-held company in which our ownership was approximately 30%. There was no net loss recorded for this investment in the same period in 2002 because we had previously reduced the investment balance to zero.

The net loss of $576,000 decreased $1,905,000 for the quarter ended September 30, 2002 when compared to $2,481,000 for the quarter ended September 30, 2001. The decrease in net loss is primarily related to reduced operating expenses, including restructuring costs, as well as the reduction of accrued liabilities established in prior periods for research and development costs associated with estimated clinical trial obligations.

The net loss of $678,000 decreased $7,207,000 for the nine months ended September 30, 2002 when compared to $7,885,000 for the nine months ended September 30, 2001. The decrease in net loss is primarily related to an increase in gross profit of $568,000, reduced operating expenses of $3,749,000, including restructuring costs and the effect of the third quarter 2002 reduction of accrued liabilities associated with estimated clinical trial obligations, and the gain of $2,285,000 from the sale of our minority interest in Microheart in the second quarter of 2002.

Cash and cash equivalents were $1,801,000 at September 30, 2002 compared to $2,629,000 at December 31, 2001, a decrease of $828,000. We used $2,950,000 of cash for operating activities in the nine months ended September 30, 2002 primarily to fund our operating loss and to pay accrued liabilities and the current portion of long term liabilities. Accrued liabilities and the current portion of long term liabilities decreased by $710,000 and $495,000, respectively, from December 31, 2001 to September 30, 2002, primarily due to payments on obligations.

Cash provided by investing activities in the nine months ended September 30, 2002 was $2,226,000, primarily from the proceeds of $2,285,000 from the sale of our ownership interest in Microheart, Inc. Cash used in financing activities consisted primarily of $655,000 in payments on short term borrowings offset by cash proceeds of $486,000 related to the sale of our common stock in the second quarter of 2002.

Since our inception, we have satisfied our capital requirements primarily through sales of our equity securities. In addition, our operations have been funded through sales of our products. In April 2002, we sold our ownership interest in Microheart, Inc. for $2,285,000. In April 2002, we sold 500,000 shares of common stock to a governmental entity at a negotiated purchase price of $1.00 per share. We have incurred significant operating losses for the last several years and at September 30, 2002 have an accumulated deficit of $164,758,000. The accompanying consolidated financial statements have been prepared assuming we will continue as a going concern. Our ability to continue as a going concern is dependent upon achieving profitable operations in the future and may require raising additional capital in 2003. Our plans include increasing revenue by increasing our direct sales and marketing efforts on existing products, achieving timely regulatory approval for certain other products and may require obtaining additional debt or equity financing.

We believe our cash balance as of September 30, 2002 and the borrowing capacity of approximately $1,000,000 available under our receivable financing arrangement will be sufficient to meet our capital and operating requirements through the end of 2002 but may not be sufficient to meet the requirements through the corresponding period ending September 30, 2003. We believe that if revenues from sales or new funds from debt or equity instruments are insufficient to maintain the current expenditure rate, it will be necessary to significantly curtail our operations until an appropriate solution is implemented and such actions could have a material adverse effect on the business, operating results and financial condition.

In addition to the other information included in this Form 10-Q, the following risk factors should be considered carefully in evaluating us and our business.

Our ability to continue as a going concern is dependent upon achieving profitable operations in the future.

We will have a continuing need for new infusions of cash until revenues are increased to meet our operating expenses. We plan to increase our sales through increased direct sales and marketing efforts on existing products and achieving regulatory approval for other products. If we are unable to increase our sales or achieve regulatory approval for our products, we will be unable to significantly increase our revenues. We believe that if we are unable to generate sufficient funds from sales or from debt or equity issuances to maintain our current expenditure rate, it will be necessary to significantly reduce our operations. We may be required to seek additional sources of financing, which could include short-term debt, long-term debt or equity. There is a risk that we may be unsuccessful in obtaining such financing and will not have sufficient cash to fund our operations.

Our common stock could be delisted in the future by the Nasdaq SmallCap Market.

The stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many high technology companies. These fluctuations have often been unrelated or disproportionate to the operating performance of many of these companies. Any negative change in the public’s perception of medical device companies could depress our stock price regardless of our operating results.

On October 2, 2002, the trading of our common stock was transferred from the Nasdaq National Market to the Nasdaq SmallCap Market because we did not meet the minimum $1.00 per share closing bid price requirement for continued listing on the Nasdaq National Market. By transferring to the Nasdaq SmallCap Market, we have until December 24, 2002 to comply with the minimum $1.00 per share closing bid price requirement. Our common stock could be delisted in the future by the Nasdaq SmallCap Market if we do not meet the continued listing standards. Delisting from the Nasdaq SmallCap Market could adversely affect the liquidity and price of our common stock and it could have a long-term adverse impact on our ability to raise capital in the future.

The price of our common stock may fluctuate significantly, which may result in losses for investors.

The market price of our common stock has been and may continue to be volatile. For example, during 52-week period ended October 31, 2002, the closing prices of our common stock as reported on Nasdaq ranged from a high of $1.44 to a low of $0.56. We expect our stock price to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include:

•	announcements of technological innovations or new products or services by us or our competitors;

•	announcements relating to strategic relationships or acquisitions;

•	changes in financial estimates by securities analysts;

•	statements by securities analysts regarding us or our industry;

•	conditions or trends in the medical device industry; and

•	changes in the economic performance and/or market valuations of other medical device companies.

We may fail to obtain required regulatory approvals in the United States to market our PMR laser system.

Our business could be harmed if any of the following events, circumstances or occurrences related to the regulatory process occurred thereby causing a reduction in our revenues:

•	the failure to obtain regulatory approvals for our PMR system;

•	any significant limitations in the indicated uses for which our products may be marketed; and

•	substantial costs incurred in obtaining regulatory approvals.

The Food and Drug Administration has not approved our PMR laser systems for any application in the United States. The Circulatory Devices Panel of the Food and Drug Administration recommended in July 2001 that the Food and Drug Administration not approve our PMR device for public sale and use in the United States based on concerns related to the safety of the device and the data regarding adverse events in the clinical trials. In July 2002, we submitted a PMA amendment for PMR. Although we do not expect to conduct further clinical trials of our PMR device, this recommendation has necessitated the further investment of additional resources toward obtaining the Food and Drug Administration’s approval of our PMR device. We will not be able to derive any revenue from the sale of that device in the United States until such time, if any, that the Food and Drug Administration approves the device. Such inability to realize revenue from sales of our PMR device in the United States may have an adverse effect on our results of operations.

In the future, the Food and Drug Administration could restrict the current uses of our TMR product.

The Food and Drug Administration has approved our TMR product for sale and use by physicians in the United States. At the request of the Food and Drug Administration, we are currently conducting post-market surveillance of our TMR product. We received a letter from the Food and Drug Administration in January of 2001 expressing concern about the progress of our post-market surveillance study for our TMR product. We have submitted a plan to the Food and Drug Administration to enable the timely completion of our post-market surveillance study. However, if we should fail to meet the requirements mandated by the Food and Drug Administration or fail to complete our post-market surveillance study in an acceptable time period, the Food and Drug Administration could withdraw its approval for the sale and use of our TMR product by physicians in the United States. Additionally, though we are not aware of any safety concerns during our on-going post-market surveillance of our TMR product, if concerns over the safety of our TMR product were to arise, the Food and Drug Administration could possibly restrict the currently approved uses of our TMR product. In the future, if the Food and Drug Administration were to withdraw its approval or restrict the range of uses for which our TMR product can be used by physicians, such as restricting TMR’s use with the coronary artery bypass grafting procedure which occurs in more than half the procedures in which TMR is used, either outcome could lead to reduced or no sales of our TMR product in the United States and our business could be adversely affected.

The medical community has not broadly adopted our products, and unless our products are broadly adopted, our business will suffer.

Our TMR products and PMR products have not yet achieved broad commercial and clinical adoption. We cannot predict whether or at what rate and how broadly our products will be adopted by the medical community. Our business would be harmed if our TMR and PMR systems fail to achieve significant market acceptance.

The receipt of positive endorsements by physicians is essential for the success of our products in the market place.

Positive endorsements by physicians are essential for clinical adoption of our TMR and PMR laser systems. Clinical adoption of these products will depend upon:

•	our ability to facilitate training of cardiothoracic surgeons and interventional cardiologists in TMR and PMR therapy;

•	willingness of such physicians to adopt and recommend such procedures to their patients; and

•	raising the awareness of TMR and PMR with the targeted patient population.

•	physician recommendations;

•	the degree of invasiveness;

•	the effectiveness of the procedure; and

•	the rate and severity of complications associated with the procedure as compared to other procedures.

To expand our business, we must establish effective sales, marketing and distribution systems.

To expand our business, we must establish effective systems to sell, market and distribute products. To date, we have had limited sales which have consisted primarily of U.S. sales of our TMR lasers and disposable handpieces on a commercial basis since February 1999 and PMR lasers and disposable catheters outside of the U.S. through international distributors.

With Food and Drug Administration approval of our TMR laser system, we are marketing our products primarily through our direct sales force. If the sales force is not successful in increasing market share and selling our disposable handpieces, our business will suffer.

Expansion of our business may put added pressure on our management and operational infrastructure affecting our ability to meet any increased demand for our products and possibly having an adverse effect on our operating results.

The growth in our business may place a significant strain on our limited personnel, management, financial systems and other resources. The evolving growth of our business presents numerous risks and challenges, including:

•	the dependence on the growth of the market for our TMR and PMR systems;

•	our ability to successfully and rapidly expand sales to potential customers in response to potentially increasing clinical adoption of the TMR procedure;

•	the costs associated with such growth, which are difficult to quantify, but could be significant;

•	domestic and international regulatory developments;

•	rapid technological change;

•	the highly competitive nature of the medical devices industry; and

•	the risk of entering emerging markets in which we have limited or no direct experience.

To accommodate any such growth and compete effectively, we may need to obtain additional funding to improve information systems, procedures and controls and expand, train, motivate and manage our employees, and such funding may not be available in sufficient quantities, if at all. If we are not able to manage these activities and implement these strategies successfully to expand to meet any increased demand, our operating results could suffer.

Our operating results are expected to fluctuate and quarter-to-quarter comparisons of our results may not indicate future performance.

Our operating results have fluctuated significantly from quarter-to-quarter and are expected to fluctuate significantly from quarter-to-quarter. We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Due to the emerging nature of the markets in which we compete, forecasting operating results is difficult and unreliable. Over the past year, our revenue has been lower than anticipated, largely attributable to the transition to our new sales strategy. It is likely or possible that our operating results for a future quarter will fall below the expectations of public market analysts and investors. When this occurred in the past, the price of our common stock fell substantially, and if this occurs again, the price of our common stock may fall again, perhaps substantially.

We may not be able to successfully market our products if third party reimbursement for the procedures performed with our products is not available for our health care provider customers.

Few individuals are able to pay directly for the costs associated with the use of our products. In the United States, hospitals, physicians and other healthcare providers that purchase medical devices generally rely on third party payors, such as Medicare, to reimburse all or part of the cost of the procedure in which the medical device is being used. Effective July 1, 1999 the Centers for Medicare and Medicaid Services, (“CMS”) formerly the Health Care Financing Administration, commenced Medicare coverage for TMR systems for any manufacturer’s TMR procedures. Hospitals and physicians are now eligible to receive Medicare reimbursement covering 100% of the costs for TMR procedures. The CMS has not approved reimbursement for PMR. If it does not in the future provide reimbursement, our ability to successfully market and sell our PMR products will be harmed.

Even though Medicare beneficiaries appear to account for a majority of all patients treated with the TMR procedure, the remaining patients are beneficiaries of private insurance and private health plans. If private insurance and private health plans do not provide reimbursement, our business will suffer.

We face competition from our competitor’s products which could limit market acceptance of our products and render our products obsolete.

The market for TMR laser systems is competitive. If our competitor is more effective in developing new products and procedures and marketing existing and future products, our business will suffer. The market for TMR laser systems is characterized by rapid technical innovation. We currently compete with PLC Systems. PLC Systems recently announced that Edwards Life Sciences has exercised its option to assume full sales and marketing responsibility in the U.S. for PLC’s TMR Heart Laser 2 System and associated kits pursuant to a co-marketing agreement between the two companies that was signed in January 2001. Accordingly, our current or future competitors may succeed in developing TMR products or procedures that:

•	are more effective than our products;

•	are more effectively marketed than our products; or

•	may render our products or technology obsolete.

If we obtain the Food and Drug Administration’s approval for our PMR laser system, we will face competition for market acceptance and market share for that product. Our ability to compete may depend in significant part on the timing of introduction of competitive products into the market, and will be affected by the pace, relative to competitors, at which we are able to:

•	complete clinical testing and regulatory approval processes;

•	obtain third party reimbursement acceptance; and

•	supply adequate quantities of the product to the market.

We have incurred significant losses since inception. Our revenues and operating income will be constrained:

•	until such time, if ever, as we obtain broad commercial adoption of our TMR laser systems by healthcare facilities in the United States;

•	until such time, if ever, as we obtain Food and Drug Administration and other regulatory approvals for our PMR laser systems; and

•	for an uncertain period of time after such approvals are obtained.

Third parties may limit the development and protection of our intellectual property, which could adversely affect our competitive position.

•	obtain patent protection for our products and processes;

•	preserve our trade secrets and proprietary technology; and

•	operate without infringing upon the patents or proprietary rights of third parties.

The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights. Companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. Certain competitors and potential competitors of ours have obtained United States patents covering technology that could be used for certain TMR and PMR procedures. We do not know if such competitors, potential competitors or others have filed and hold international patents covering other TMR or PMR technology. In addition, international patents may not be interpreted the same as any counterpart United States patents.

While we periodically review the scope of our patents and other relevant patents of which we are aware, the question of patent infringement involves complex legal and factual issues. Any conclusion regarding infringement may not be consistent with the resolution of any such issues by a court.

We may have to engage in time consuming and costly litigation to protect our intellectual property rights or to determine the proprietary rights of others. In addition, we may become subject to patent infringement claims or litigation, or interference proceedings declared by the United States Patent and Trademark Office to determine the priority of inventions.

Defending and prosecuting intellectual property suits, United States Patent and Trademark Office interference proceedings and related legal and administrative proceedings are both costly and time-consuming. We may be required to litigate further to:

•	enforce our issued patents;

•	protect our trade secrets or know-how; or

•	determine the enforceability, scope and validity of the proprietary rights of others.

Any litigation or interference proceedings will result in substantial expense and significant diversion of effort by technical and management personnel. If the results of such litigation or interference proceedings are adverse to us, then the results may:

•	subject us to significant liabilities to third parties;

•	require us to seek licenses from third parties;

•	prevent us from selling our products in certain markets or at all; or

•	require us to modify our products.

Although patent and intellectual property disputes regarding medical devices are often settled through licensing and similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. Furthermore, we may not be able to obtain the necessary licenses on satisfactory terms, if at all.

Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling our products. This would harm our business.

The United States patent laws have been amended to exempt physicians, other health care professionals, and affiliated entities from infringement liability for medical and surgical procedures performed on patients. We are not able to predict if this exemption will materially affect our ability to protect our proprietary methods and procedures.

We rely on patent and trade secret laws, which are complex and may be difficult to enforce.

The validity and breadth of claims in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. Issued patent or patents based on pending patent applications or any future patent application may not exclude competitors or may not provide a competitive advantage to us. In addition, patents issued or licensed to us may not be held valid if subsequently challenged and others may claim rights in or ownership of such patents.

•	have not developed or will not develop similar products;

•	will not duplicate our products; or

•	will not design around any patents issued to or licensed by us.

Because patent applications in the United States were historically maintained in secrecy until the patents are issued, we cannot be certain that:

•	others did not first file applications for inventions covered by our pending patent applications; or

•	we will not infringe any patents that may issue to others on such applications.

We may not be able to meet future product demand on a timely basis and may be subject to delays and interruptions to product shipments because we depend on single source third party suppliers and manufacturers.

Certain critical products and components for lasers and disposable handpieces are purchased from single sources. In addition, we are vulnerable to delays and interruptions, for reasons out of our control, because we outsource the manufacturing of some of these products to third parties. We may experience harm to our business if these sources have difficulties supplying our needs for these products and components. In addition, we do not have long term supply contracts. As a result, these sources are not obligated to continue to provide these critical products or components to us. Although we have identified alternative suppliers and manufacturers, a lengthy process would be required to qualify them as additional or replacement suppliers or manufacturers. Also, it is possible some of our suppliers or manufacturers could have difficulty meeting our needs if demand for our TMR and PMR laser systems were to increase rapidly or significantly. In addition, any defect or malfunction in the laser or other products

provided by such suppliers and manufacturers could cause a delay in regulatory approvals or adversely affect product acceptance. Further, we cannot predict:

•	if materials and products obtained from outside suppliers and manufacturers will always be available in adequate quantities to meet our future needs; or

•	whether replacement suppliers and/or manufacturers can be qualified on a timely basis if our current suppliers and/or manufacturers are unable to meet our needs for any reason.

We must comply with Food and Drug Administration manufacturing standards or face fines or other penalties including suspension of production.

We are required to demonstrate compliance with the Food and Drug Administration’s current good manufacturing practices regulations if we market devices in the United States or manufacture finished devices in the United States. The Food and Drug Administration inspects manufacturing facilities on a regular basis to determine compliance. If we fail to comply with applicable Food and Drug Administration or other regulatory requirements, we can be subject to:

•	fines, injunctions, and civil penalties;

•	recalls or seizures of products;

•	total or partial suspensions of production; and

•	criminal prosecutions.

The impact on the company of any such failure to comply would depend on the impact of the remedy imposed on us.

We may suffer losses from product liability claims if our products cause harm to patients.

We are exposed to potential product liability claims and product recalls. These risks are inherent in the design, development, manufacture and marketing of medical devices. We could be subject to product liability claims if the use of our TMR or PMR laser systems is alleged to have caused adverse effects on a patient or such products are believed to be defective. Our products are designed to be used in life-threatening situations where there is a high risk of serious injury or death. We are not aware of any material side effects or adverse events arising from the use of our TMR product. Though we are in the process of responding to the Food and Drug Administration’s Circulatory Devices Panel’s recent recommendation against approval of our PMR product because of concerns over the safety of the device and the data regarding adverse events in the clinical trials, we believe there are no material side effects or adverse events arising from the use of our PMR product. When being clinically investigated, it is not uncommon for new surgical or interventional procedures to result in a higher rate of complications in the treated population of patients as opposed to those reported in the control group. In light of this, we believe that the difference in the rates of complications between the treated groups and the control groups in the clinical trials for our PMR product are not statistically significant, which is why we believe that there are no material side effects or material adverse events arising from the use of our PMR product.

Any regulatory clearance for commercial sale of these products will not remove these risks. Any failure to comply with the Food and Drug Administration’s good manufacturing practices or other regulations could hurt our ability to defend against product liability lawsuits.

Our insurance may be insufficient to cover product liability claims against us.

Our product liability insurance may not be adequate for any future product liability problems or continue to be available on commercially reasonable terms, or at all.

If we were held liable for a product liability claim or series of claims in excess of our insurance coverage, such liability could harm our business and financial condition. We maintain insurance against product liability claims in the amount of $10 million per occurrence and $10 million in the aggregate.

We may require increased product liability coverage as sales of approved products increase and as additional products are commercialized. Product liability insurance is expensive and in the future may not be available on acceptable terms, if at all.

We depend heavily on key personnel and turnover of key employees and senior management could harm our business.

Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel. They also depend in significant part upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations. If we lose a key employee or if a key employee fails to perform in his or her current position, or if we are not able to attract and retain skilled employees as needed, our business could suffer.

During the last nine months, we have had significant changes in our senior management team. In January 2002, our former Chief Financial Officer, J. Stephen Wilkins, resigned and was replaced by Darrell Eckstein who was originally hired in December 2000 as our Vice President of Operations. Also in January 2002, our Vice President of Sales, Thomas Kinder, resigned and was replaced by Michael A. Tuckerman. In May 2002, Mr. Eckstein was promoted to President and Chief Operating Officer, and he currently serves as Acting Chief Financial Officer.

Our future business could be harmed by our turnover in senior management if we have difficulty familiarizing and training our new management with respect to our business. Further significant turnover in our senior management could significantly deplete our institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing the manufacturing, technical, marketing and sales aspects of our business, any part of which could be harmed by further turnover.

We may fail to comply with international regulatory requirements and could be subject to regulatory delays, fines or other penalties.

Regulatory requirements in foreign countries for international sales of medical devices often vary from country to country. In addition, the Food and Drug Administration must approve the export of devices to certain countries. The occurrence and related impact of the following factors would harm our business:

•	delays in receipt of, or failure to receive, foreign regulatory approvals or clearances;

•	the loss of previously obtained approvals or clearances; or

•	the failure to comply with existing or future regulatory requirements.

To market in Europe, a manufacturer must obtain the certifications necessary to affix to its products the CE Marking. The CE Marking is an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. In order to obtain and to maintain a CE Marking, a manufacturer must be in compliance with the appropriate quality assurance provisions of the International Standards Organization and obtain certification of its quality assurance systems by a recognized European Union notified body. However, certain individual countries within Europe require further approval by their national regulatory agencies.

We have completed CE mark registration for all of our products in accordance with the implementation of various medical device directives in the European Union. Failure to maintain the right to affix the CE Marking or other requisite approvals could prohibit us from selling our products in member countries of the European Union or elsewhere. Any enforcement action by international regulatory authorities with respect to past or future regulatory noncompliance could cause our business to suffer. Noncompliance with international regulatory requirements could result in enforcement action such as not being allowed to market our product in the European Union, which would significantly reduce international revenue.

We sell our products internationally which subjects us to specific risks of transacting business in foreign countries.

In future quarters, international sales may become a significant portion of our revenue if our products become more widely used outside of the United States. Our international revenue is subject to the following risks, the occurrence of any of which could harm our business:

•	foreign currency fluctuations;

•	economic or political instability;

•	foreign tax laws;

•	shipping delays;

•	various tariffs and trade regulations;

•	restrictions and foreign medical regulations;

•	customs duties, export quotas or other trade restrictions; and

•	difficulty in protecting intellectual property rights.

We may not achieve wide acceptance of our products in foreign markets if we fail to obtain third party reimbursement for the procedures performed with our products.

If we obtain the necessary foreign regulatory registrations or approvals, market acceptance of our products in international markets would be dependent, in part, upon the availability of reimbursement within prevailing health care payment systems. Reimbursement is a significant factor considered by hospitals in determining whether to acquire new equipment. A hospital is more inclined to purchase new equipment if third-party reimbursement can be obtained. Reimbursement and health care payment systems in international markets vary significantly by country. They include both government sponsored health care and private insurance. Although we expect to seek international reimbursement approvals, any such approvals may not be obtained in a timely manner, if at all. Failure to receive international reimbursement approvals could hurt market acceptance of our TMR and PMR products in the international markets in which such approvals are sought, which would significantly reduce international revenue.

The Company is exposed to market risks inherent in its operations, primarily related to interest rate risk. These risks arise from transactions and operations entered into in the normal course of business. The Company does not use derivatives to alter the interest characteristics of its marketable securities or its debt instruments. The Company has no holdings of derivative or commodity instruments.

Interest Rate Risk. The Company is subject to interest rate risks on cash and cash equivalents and any future financing requirements. The long-term debt at September 30, 2002 consists of an outstanding balance on a lease obligation.

The following table presents the future principal cash flows or amounts and related weighted average interest rates expected by year for the Company’s existing cash and cash equivalents and long-term debt instruments:

	In Thousands	2002			2003		2004		2005		2006		Total Fair Value

Assets	Cash, cash equivalents	$	1,801		$	—	$	—	$	—	$	—	$	1,801
	Weighted average interest rate		1.0	%		—		—		—		—		1.0	%
Liabilities	Fixed Rate Debt
	Lease obligation	$	30		$	9	$	—	$	—	$	—	$	39
	Weighted average interest rate		6.8	%		6.8		—		—		—		6.8	%

Interest Rate Risk. The Company’s primary interest rate risk exposures relate to the impact of interest rate movements on the Company’s ability to obtain adequate financing to fund future operations.

The Company manages interest rate risk on its outstanding long-term debts through the use of fixed rate debt. Management evaluates the Company’s financial position on an ongoing basis.

The Company does not hedge any balance sheet exposures and intercompany balances against future movements in foreign exchange rates. The exposure related to currency rate movements would not have a material impact on future net income or cash flows.

The Company ’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company to be included in the Company’s periodic filings under the Exchange Act.

Since the Evaluation Date, there have not been any significant changes in the Company’s internal controls or in other factors that could significantly affect such controls.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	CARDIOGENESIS CORPORATION
	Registrant




Date: November 14, 2002	/s/ Michael J. Quinn

	Michael J. Quinn
	Chief Executive Officer and
	Chairman of the Board
	(Principal Executive Officer)



Date: November 14, 2002	/s/ Darrell F. Eckstein

	Darrell F. Eckstein
	President, Chief Operating Officer and
	Acting Chief Financial Officer
	(Principal Accounting and Financial Officer)

1.	have reviewed this quarterly report on Form 10-Q of CardioGenesis Corporation;

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

3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, is made known to us, particularly during the period in which this quarterly report is being prepared;

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

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:

	(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

1.	I have reviewed this quarterly report on Form 10-Q of CardioGenesis Corporation;

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

3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, is made known to us, particularly during the period in which this quarterly report is being prepared;

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

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:

	(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF OPERATIONS & COMPREHENSIVE LOSS
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
Part II Other Information
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS