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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the
--- Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
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
incorporation or organization) Identification No.)
3905 ANNAPOLIS LANE N., SUITE 105
MINNEAPOLIS, MINNESOTA 55447
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (763) 553-7736
Not Applicable
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act).
Yes X No
--- ---
The number of shares outstanding of each of the registrant's classes of
common stock as of October 31, 2004, was:
Common Stock, $.01 par value 30,765,316 shares
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INDEX
Page(s)
-------
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of
September 30, 2004, and December 31, 2003 3
Consolidated Statements of Operations for the three
and nine months ended September 30, 2004 and 2003 4
Consolidated Statements of Cash Flows for the nine
months ended September 30, 2004 and 2003 5
Notes to Consolidated Financial Statements 6 - 8
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9 - 20
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 21
ITEM 4. Controls and Procedures 21
PART II. OTHER INFORMATION
ITEM 6. Exhibits 22
SIGNATURES 23
EXHIBIT INDEX 24
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ATS MEDICAL, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share and share data)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------------- -------------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $20,670 $6,472
Short-term investments 22 2,003
Accounts receivable, net 6,772 4,939
Inventories 20,398 20,377
Other current assets 497 508
------------------- -------------------
Total current assets 48,359 34,299
Furniture, machinery and equipment, net 6,933 5,895
Inventories 8,000 17,000
Intangible assets 18,727 18,500
Other assets 437 440
------------------- -------------------
Total assets $82,456 $76,134
=================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $2,851 $989
Due to related party 217 217
Accrued payroll and expenses 1,669 1,343
Accrued distributor liabilities 430 475
Current maturities of long-term debt 556 -
------------------- -------------------
Total current liabilities 5,723 3,024
Due to related party 145 307
Long-term debt 1,944 -
Shareholders' equity:
Common stock, $.01 par value:
authorized 40,000,000 shares; issued and
outstanding 30,764,816 and 26,778,557 shares at
September 30, 2004 and December 31, 2003 307 268
Additional paid-in capital 136,337 123,412
Deferred compensation (27) (70)
Accumulated other comprehensive income 84 51
Accumulated deficit (62,057) (50,858)
------------------- -------------------
Total shareholders' equity 74,644 72,803
------------------- -------------------
Total liabilities and shareholders' equity $82,456 $76,134
=================== ===================
The accompanying notes are an integral part of the consolidated financial
statements.
3
ATS MEDICAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
----------------- ---------------- ----------------- -----------------
Net sales $6,547 $4,639 $20,789 $12,850
Cost of goods sold 5,178 3,255 15,372 9,252
----------------- ---------------- ----------------- -----------------
Gross profit 1,369 1,384 5,417 3,598
Operating expenses:
Sales and marketing 4,211 2,809 11,827 6,350
Research and development 278 384 651 1,213
General and administrative 1,423 1,091 4,171 3,121
Gain on extinguishment of debt - (2,575) - (2,575)
----------------- ---------------- ----------------- -----------------
Total operating expenses 5,912 1,709 16,649 8,109
----------------- ---------------- ----------------- -----------------
Operating loss (4,543) (325) (11,232) (4,511)
Net interest income (expense) 17 18 33 (438)
----------------- ---------------- ----------------- -----------------
Net loss ($4,526) ($307) ($11,199) ($4,949)
================= ================ ================= =================
Net loss per share:
Basic and diluted ($0.15) ($0.01) ($0.40) ($0.21)
Weighted average number of shares
used in calculation:
Basic and diluted 30,730 24,743 28,215 23,138
The accompanying notes are an integral part of the consolidated financial
statements.
4
ATS MEDICAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)
(in thousands)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2004 2003
--------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ($11,199) ($4,949)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 802 583
Loss on disposal of equipment 14 2
Compensation expense on stock options 33 5
Non-cash interest expense 5 320
Extinguishment of debt - (2,575)
Changes in operating assets and liabilities:
Accounts receivable (1,833) (666)
Inventories 8,979 7,947
Prepaid expenses 14 (346)
Other assets - 2
Accounts payable and accrued expenses 1,981 (360)
---------------- --------------
Net cash used by operating activities (1,204) (37)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of short-term investments (1,018) (4,231)
Sale of short-term investments 2,999 3,488
Purchases of intangible assets (232) (12,000)
Purchases of furniture, machinery and equipment (1,854) (595)
---------------- --------------
Net cash used by investing activities (105) (13,338)
CASH FLOWS FROM FINANCING ACTIVITIES
Loan advances 2,500 -
Net proceeds from sales of common stock 12,975 11,555
---------------- --------------
Net cash provided by financing activities 15,475 11,555
---------------- --------------
Effect of exchange rate changes on cash 32 -
---------------- --------------
Increase in cash and cash equivalents 14,198 (1,820)
Cash and cash equivalents at beginning of period 6,472 7,472
---------------- --------------
Cash and cash equivalents at end of period $20,670 $5,652
================ ==============
The accompanying notes are an integral part of the consolidated financial
statements.
5
ATS MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements included in this Form 10-Q have been
prepared by ATS Medical, Inc. (hereinafter the "Company," "ATS," "we," "us," or
"our") without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission (SEC). The consolidated financial statements include the
accounts of the Company and its subsidiaries, and all significant inter-company
accounts and transactions are eliminated in consolidation. Certain information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted pursuant to these rules and regulations. The
year-end balance sheet was derived from audited financial statements, but does
not include all disclosures required by accounting principles generally accepted
in the United States. These unaudited consolidated interim financial statements
should be read in conjunction with the Company's consolidated financial
statements and related notes included in its Annual Report on Form 10-K for
2003.
These statements reflect, in management's opinion, all adjustments (which
include only normal, recurring adjustments) necessary for a fair presentation of
the financial position and the results of operations and cash flows for the
periods presented. The results of operations for any interim period may not be
indicative of results for the full year.
NOTE 2. STOCK-BASED COMPENSATION
The Company accounts for its stock-based employee compensation plan under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The exercise price of
the Company's employee stock options generally equals the market price of the
underlying stock on the date of grant for all options granted, and thus, under
APB 25, no compensation expense is recognized. Stock options granted to
non-employees are valued and accounted for in accordance with Financial
Accounting Statement No. 123, Accounting for Stock-Based Compensation (FAS 123).
Accordingly, these costs are charged to operating expenses over the vesting
period of the option.
The following table illustrates the effect on net loss and net loss per share if
the Company had applied the fair value recognition provisions of FAS 123 to
stock-based employee compensation.
Three months ended Nine months ended
September 30, September 30,
------------- -------------
(in thousands, except per share data) 2004 2003 2004 2003
------------------------------------------------ ----------- ---------- ----------- -----------
Net loss, as reported ($4,526) ($307) ($11,199) ($4,949)
Less: Total stock-based employee compensation
expense determined under fair value based
method for all awards (537) (424) (1,789) (835)
----------- ---------- ----------- -----------
Pro forma net loss ($5,063) ($731) ($12,988) ($5,784)
=========== ========== =========== ===========
Net loss per share:
As reported
Basic and diluted ($0.15) ($0.01) ($0.40) ($0.21)
Pro forma
Basic and diluted ($0.16) ($0.03) ($0.46) ($0.25)
6
NOTE 3. INVENTORIES
Inventories consist of the following:
September 30, December 31,
(in thousands) 2004 2003
---------------------------------- -------------- -------------
Raw materials $ 7,703 $12,033
Work in process 8,477 9,615
Finished goods 12,418 15,929
Obsolescence reserve (200) (200)
-------------- --------------
Total, net $28,398 $37,377
============== ==============
Balance sheet classification
Current assets $20,398 $20,377
Non-current assets 8,000 17,000
-------------- --------------
Total, net $28,398 $37,377
============== ==============
The Company maintains significant levels of inventory that exceed current
demand. Management believes that these excess quantities will be utilized over
several years. Therefore, the Company has classified $8.0 million and $17.0
million of inventories as non-current assets at September 30, 2004 and December
31, 2003, respectively.
NOTE 4. COMPREHENSIVE INCOME
Comprehensive income for the Company includes net income from foreign currency
translation which is charged or credited to the cumulative translation account
within shareholders' equity. Gains and losses from foreign currency translation
are not material.
NOTE 5. NEW PRONOUNCEMENTS
In December 2003, the FASB issued FASB Interpretation No. 46R (FIN 46R),
Consolidation of Variable Interest Entities, which addresses how a business
enterprise should evaluate whether it has a controlling financial interest in an
entity through means other than voting rights and accordingly should consolidate
the entity. The Company believes it has no variable interest entities and,
therefore, FIN 46R did not have an impact on the Company's consolidated
financial statements.
NOTE 6. ACQUISITION OF LICENSING AGREEMENT
On April 26, 2004, the Company signed an exclusive development and licensing
agreement with ErySave AB and made an initial milestone payment of approximately
$0.2 million. The agreement grants the Company worldwide rights for ErySave's
filtration technology for cardiac surgery procedures. Payments under the
agreement, based upon the achievement of certain development milestones, could
total approximately $1.3 million.
NOTE 7. SHAREHOLDER'S EQUITY
On June 28, 2004, in a private placement, the Company issued 3.7 million shares
of common stock and received $12.4 million, net of offering costs.
NOTE 8. LONG-TERM DEBT
On July 28, 2004, the Company entered into an agreement with Silicon Valley Bank
to establish a secured revolving credit facility for $8.5 million. Under terms
of the agreement, the Company received a $2.5 million three-year term loan as
well as a two-year $6.0 million line of credit. The credit facility contains two
financial covenants: a leverage ratio, and a required minimum tangible net
worth. The term loan carries an interest rate of prime plus 1.0% with a minimum
of 5.25%. The line of credit carries an interest rate of prime plus 1.5% with a
minimum rate of 5.75%.
7
As of September 30, 2004, the Company had drawn all $2.5 million of the
three-year term loan. The term loan carries 36 equal installment payments
beginning January 30, 2005. Accordingly, $556,000 of the loan amount is included
as current maturities of long-term debt at September 30, 2004. The Company had
no outstanding balances on the line of credit at September 30, 2004.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. Words such as "may,"
"expect," "believe," "anticipate," or "estimate," identify such forward-looking
statements. These statements by their nature involve substantial risks and
uncertainties, and actual results may differ materially from those expressed in
such forward-looking statements. Some of the factors that could cause such
material differences are identified in "Cautionary Statements." We undertake no
obligation to correct or update any forward-looking statements, whether as a
result of new information, future events, or otherwise. You are advised,
however, to consult any future disclosures we make on related subjects in future
filings with the SEC.
EXECUTIVE OVERVIEW
We manufacture and market a mechanical bileaflet heart valve with a patented
pivot design. Our heart valve is used to treat valvular heart disease caused by
the natural aging process, rheumatic heart disease and congenital defects.
Carbomedics Inc., f/k/a Sulzer Carbomedics, Inc. (Carbomedics), developed the
basic design from which the ATS heart valve evolved. Carbomedics is a large and
experienced manufacturer of pyrolytic carbon components used in mechanical heart
valves. Carbomedics has also designed and patented numerous mechanical valves.
Carbomedics offered to license a patented and partially developed valve to us if
we would complete the development of the valve and agree to purchase carbon
components from Carbomedics. We hold an exclusive, royalty-free, worldwide
license to an open pivot, bileaflet mechanical heart valve design owned by
Carbomedics from which the ATS heart valve has evolved. In addition, we have an
exclusive, worldwide right and license to use Carbomedics' pyrolytic carbon
technology to manufacture components for the ATS heart valve.
We commenced selling the ATS heart valve in international markets in 1992. In
October 2000, we received FDA approval to sell the ATS Open Pivot(R) MHV and
commenced sales and marketing of our valve in the United States. The original
sales forecasts as well as the pricing models that were used when the original
supply agreement was signed with Carbomedics proved to be too optimistic.
Accordingly, to keep the supply agreement active and the license to sell the
valve exclusive, we purchased quantities of inventory far in excess of demand.
From 1990 through 2002, we paid Carbomedics approximately $125 million for the
development of our valve, the technology to manufacture our pyrolytic carbon
components, and for pyrolytic valve components manufactured by Carbomedics. On
December 31, 2002, we had remaining payments due under our technology agreement
with Carbomedics that totaled $28 million. This led us in 2003 to negotiate an
accelerated but reduced payment for all outstanding debts to Carbomedics related
to the technology agreement. In August 2003, we paid $12 million to satisfy all
future obligations under this agreement.
With inventory purchases exceeding sales through the years, we have built
inventory levels that today provide a source of cash. We are drawing down these
paid-for inventories and using the cash it generates to fund operations. Prior
to June 30, 2004, our manufacturing facility for pyrolytic carbon components had
been producing limited quantities. We have now increased production in this
facility and expect to be fully ramped-up for production by the end of 2004.
Once we have exhausted our high priced components, we expect to have lower
manufacturing costs per valve which will allow us to realize higher gross profit
in all markets.
In June 2002, we reorganized the Company by laying off more than half of the
work force including all executive management. With the hiring of a new
president late in 2002, we started the process of rebuilding our sales and
marketing teams, especially in the United States. This rebuilding is the most
significant factor contributing to our increase in expense levels during 2003
and into 2004. Because sales prices in the United States exceed selling prices
elsewhere, we feel that our future success will depend on achieving increased
market share in the United States. Our U.S. sales as a percentage of our overall
sales have grown from 4% in 2000 to 33% during the first three quarters of 2004.
9
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. Management's
discussion and analysis of financial condition and results of operations are
based upon the consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect (1) the reported amounts of assets, liabilities, revenues,
and expenses; and (2) the related disclosure of contingent assets and
liabilities. At each balance sheet date, we evaluate our estimates and
judgments. The critical accounting policies that are most important to fully
understanding and evaluating the financial condition and results of operations
are discussed in our most recent Annual Report on Form 10-K on file with the
SEC.
Results of Operations
The following table compares the dollar and percentage change in the Statements
of Operations for the three and nine month periods ended September 30, 2004 and
2003.
Three months ended September 30, Nine months ended September 30,
--------------------------------------- ----------------------------------------
Increase Increase
2004 2003 (Decrease) % 2004 2003 (Decrease) %
------ ------ ---------- --------- --------- -------- ----------- ---------
Net sales $6,547 $4,639 $1,908 41.1% $20,789 $12,850 $7,939 61.8%
Cost of goods sold 5,178 3,255 1,923 59.1% 15,372 9,252 6,120 66.1%
------- ------- ------ ----- ------- ------- ----------- ---------
Gross profit 1,369 1,384 (15) -1.1% 5,417 3,598 1,819 50.6%
Gross profit % 20.9% 29.8% 26.1% 28.0%
Operating expenses:
Sales and marketing 4,211 2,809 1,402 49.9% 11,827 6,350 5,477 86.3%
Research and development 278 384 (106) -27.6% 651 1,213 (562) -46.3%
General and administrative 1,423 1,091 332 30.4% 4,171 3,121 1,050 33.6%
Gain on extinguishment of
debt - (2,575) - (2,575)
------- ------- ------ ----- ------- ------- ----------- ---------
Total operating expenses 5,912 1,709 4,203 245.9% 16,649 8,109 8,540 105.3%
------- ------- ------ ----- ------- ------- ----------- ---------
Operating loss (4,543) (325) (4,218) -1297.8% (11,232) (4,511) (6,722) -149.0%
Net interest income (expense) 17 18 (1) -5.6% 33 (438) 471 107.5%
------- ------- ------ ----- ------- ------- ----------- ---------
Net loss ($4,526) ($307) ($4,219) -1374.3% ($11,199) ($4,949) ($6,250) -126.3%
======== ======== ========== ========== ========= ======== =========== =========
10
The following table presents the statement of operations as a percentage of net
sales for the three and nine month periods ended September 30, 2004 and 2003:
Three months ended Nine months ended
September 30, September 30,
------------- -------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 79.1% 70.2% 73.9% 72.0%
--------- --------- --------- ---------
Gross profit 20.9% 29.8% 26.1% 28.0%
Operating expenses:
Sales and marketing 64.3% 60.6% 56.9% 49.4%
Research and development 4.2% 8.3% 3.1% 9.4%
General and administrative 21.7% 23.5% 20.1% 24.3%
Gain on extinguishment of debt 0.0% -55.5% 0.0% -20.0%
--------- --------- --------- ---------
Total operating expenses 90.3% 36.8% 80.1% 63.1%
--------- --------- --------- ---------
Operating loss -69.4% -7.0% -54.0% -35.1%
Net interest income (expense) 0.3% 0.4% 0.2% -3.4%
--------- --------- --------- ---------
Net loss -69.1% -6.6% -53.9% -38.5%
========= ========= ========= =========
NET SALES. The following table compares net sales between the three and nine
month periods ended September 30, 2004 and 2003:
Three months ended September 30, Nine months ended September 30,
---------------------------------------- ------------------------------------------
Increase Increase
(in thousands) 2004 2003 (Decrease) % 2004 2003 (Decrease) %
- ------------------------ ---------- --------- ----------- ------- ---------- --------- ------------ --------
United States $2,003 $1,452 $551 37.9% $6,855 $3,358 $3,497 104.1%
Outside United States 4,544 3,187 1,357 42.6% 13,934 9,492 4,442 46.8%
---------- --------- ----------- ------- ---------- --------- ------------ --------
Total $6,547 $4,639 $1,908 41.1% $20,789 $12,850 $7,939 61.8%
========== ========= =========== ======= ========== ========= ============ ========
2004 Change in 2004 Change in
-------------------------------- ---------------------------------
Average Average
Sales Unit Sales Unit
Price Sales Total Price Sales Total
---------- --------- ----------- ---------- --------- ------------
United States 1.1% 36.4% 37.9% 2.1% 99.9% 104.1%
Outside United States 1.9% 40.0% 42.6% -4.1% 53.2% 46.8%
---------- --------- ----------- ---------- --------- ------------
Total 1.2% 39.5% 41.1% 2.3% 62.2% 61.8%
========== ========= =========== ========== ========= ============
Three months ended Nine months ended
September 30, September 30,
-------------------- --------------------
2004 2003 2004 2003
---------- --------- ---------- ---------
Share of total sales:
United States 30.6% 31.3% 33.0% 26.1%
Outside United States 69.4% 68.7% 67.0% 73.9%
---------- --------- ---------- ---------
Total 100.0% 100.0% 100.0% 100.0%
========== ========= ========== =========
11
In June 2002, the majority of our U.S. sales persons were terminated. In the
fourth quarter of 2002, we hired a new CEO and began building our "new sales
organization" in the United States. consisting of four area directors managing
31 sales territories. Our representation within these territories now consists
of both direct sales representatives and independent agents. This new sales
organization and overall greater sales efforts contributed to our increase in
sales in 2004 as compared to 2003 and to our sales within the United States.
accounting for a larger percentage of overall sales.
During 2003, we aggressively entered several international markets that
represented opportunities for greater sales unit growth but at prices lower than
our other markets. Prices in some of these territories are lower than our
current manufacturing costs. We feel this strategy is reasonable because it
allows us to increase our market share while reducing our high priced but
paid-for inventories. Once we have exhausted our high priced components, we
expect to have lower manufacturing costs per valve which will allow us to
realize gross profit in these international markets.
COST OF GOODS SOLD. Our cost of goods sold as a percentage of net sales has
varied due to changes in average selling price. Our gross margin is anticipated
to improve as sales within the Unites States increase as a percentage of total
sales and as we start selling valves that have been entirely manufactured in our
facilities. Our inventories of high priced carbon components currently exceed
our expected sales during 2004.
The ATS valve is made of materials that do not deteriorate. Other than the need
to resterilize the valves periodically, there is no risk of perishability.
Pyrolytic carbon, which is the substrate used in manufacturing our valves, has
been the only material used to manufacture mechanical heart valves for humans
for many years and remains the most advanced raw material for our products. The
other sources of prosthetic heart valves for humans are cadaver and porcine
tissues. Inventory obsolescence issues are remote because of certain advantages
offered by mechanical heart valves, including superior durability. Similarly, we
believe that, given the lead time that would be required, there is no material
risk that there would be the introduction and FDA approval of another substrate
that would replace pyrolytic carbon prior to the end of the period over which we
expect to sell our inventory of valves.
To date, all purchased pyrolytic carbon components for the ATS heart valve have
come from Carbomedics, pursuant to a multi-year supply agreement entered into in
1990. The cost of the pyrolytic carbon components represents approximately 80%
of the total cost of the ATS heart valve. Under the supply agreement, the cost
of the pyrolytic carbon components has varied according to annual volume
purchases and has been adjusted annually by reference to increases in the U.S.
Department of Labor Employment Cost Index.
The supply agreement with Carbomedics is still in effect but has been
re-negotiated several times. Our current obligations under the supply agreement
call for future purchase obligations starting in 2007 and continuing through
2011.
We maintain significant levels of carbon components in inventory that exceed
current demand due to past purchase requirements under the supply agreement. In
addition, the cost of these components has been high and at times exceeded
selling prices, necessitating lower of cost or market write-downs of
inventories.
Late in the second quarter of 2004, we started the process of increasing
production of our own carbon components in our own facility. This ramping-up
process is expected to continue through 2004 and be substantially complete by
year end. During the quarter ended September 30, 2004, approximately $0.4
million was charged to cost of goods sold as production ramp-up costs. Without
these production ramp up costs, gross profit as a percent of net sales for the
three and nine months ended September 30, 2004 would have been 6.3% and 2.0%
higher than the actual gross profit of 20.9% and 26.1%, respectively.
Specific costs related to the production ramp-up have been expensed directly to
cost of sales and total approximately $0.4 million for the three months ended
September 2004 and are expected to total approximately $0.5 million during the
three months ending December 2004.
SALES AND MARKETING. Cost increases in 2004 over 2003 were for the building of
our "new sales and marketing organizations". We have substantially completed the
hiring and training of our new sales and marketing organizations.
12
RESEARCH AND DEVELOPMENT. Research and development expenses include the costs to
develop and improve current and future products and the costs for regulatory and
clinical activities for these products. In addition, during 2003, the costs to
set up and maintain our carbon components manufacturing facility while it was in
pre-production mode, the operational qualification and validation of the carbon
production equipment, and making pilot coating runs were charged to research and
development costs and totaled approximately $0.3 million and $0.8 million,
respectively, during the three and nine months ended September 30, 2003.
GENERAL AND ADMINISTRATIVE. Cost increases in the three month period ended
September 2004 over the same period in 2003 were for employee salary and
benefits of $0.1 million, corporate insurance costs of $0.1 million, and outside
consulting services relating to our costs of documenting and testing internal
controls of $0.1 million. For the nine month period ended September 30, 2004
over the same period in 2003, cost increases were for employee salary and
benefits of $0.3 million, corporate insurance costs of $0.3 million, accruals
for management performance bonuses of $0.2 million, and costs of documenting and
testing internal controls of $0.2 million.
EXTINGUISHMENT OF DEBT. On July 21, 2003, we entered into an agreement with
Centerpulse USA Holdings Co. (Centerpulse) pursuant to which we paid Centerpulse
$12 million in exchange for cancellation of all of our payment obligations under
our carbon technology agreement as well as a fully paid exclusive license to use
the carbon technology to produce components for our valve. Prior to this
agreement, we were obligated to pay Centerpulse an aggregate of $28.2 million
under carbon the technology agreement over a period of approximately four years.
These payments were accrued as milestones were met. Of the total $28.2 million
future obligations, there were two uncompleted milestones totaling $12 million
that were not accrued. Since the amount accrued exceeded the amount due, we
realized a non-cash gain on the extinguishment of debt in the amount of $2.6
million on this transaction during the three month period ended September 30,
2003.
NET INTEREST INCOME (EXPENSE). Prior to June 30, 2004, our interest expense was
primarily attributable to imputed interest on our long-term debt previously owed
to Centerpulse. Our current interest income is primarily attributable to the
investment of our cash balances. On July 28, 2004, we entered into an agreement
for a credit facility consisting of a $2.5 million term loan and a $6.0 million
line of credit. On July 30, 2004, we fully drew down the term loan. Interest
expense will be higher in future periods if we borrow funds under the line of
credit.
INCOME TAXES. At the end of 2003, we had accumulated approximately $42 million
of net operating loss (NOL) carryforwards for U.S. tax purposes. We believe that
our ability to fully utilize the existing NOL carryforwards could be restricted
on a portion of the NOL for changes in control that may have occurred or may
occur in the future. We have not conducted a formal study of whether a change in
control of ATS has occurred in the past that impairs our NOL carryforwards
because we are unable to utilize such NOL carryforwards until we achieve
profitability and because this study would be very expensive to complete. When
we attain profitability, we will conduct a formal study of any restrictions on
our carryforwards. We have not recorded any net assets related to our NOL
carryforwards and other deferred items as we currently cannot determine that it
is reasonably likely that this asset will be realized and we, therefore, have
provided a valuation allowance for the entire asset.
NET LOSS. Our increase in net loss during the first nine months of 2004 compared
to 2003 resulted from changes in sales offset by changes in operating costs, all
of which are described above.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments were $20.7 million as of
September 30, 2004, compared to $8.5 million as of December 31, 2003. This
increase in cash, cash equivalents, and short-term investments is described
below.
OPERATING ACTIVITIES. During the first nine months of 2004, we received cash
payments from customers of $19.0 million. We made cash payments to employees and
suppliers of $20.2 million. Our operating loss during 2004 of $11.2 million was
substantially funded through the depletion of inventories. Starting in early
2003 we incurred significant expenses commercializing the ATS heart valve in the
United States. As we build sales in future periods and our cost of inventories
decrease, our operating losses will decrease and we expect to move steadily
towards a cash flow breakeven on sales and eventually to profitability.
13
INVESTING ACTIVITIES. During the first nine months of 2004, we purchased
property and equipment totaling $1.9 million. For the remainder of 2004, we
expect to purchase approximately $1.0 million of additional equipment. Capital
purchases during 2004 have been mainly in support of increasing production in
our pyrolytic carbon facility.
On April 26, 2004, the Company signed an exclusive development and licensing
agreement with ErySave AB (ErySave) and made an initial milestone payment of
approximately $0.2 million. The agreement grants the Company worldwide rights to
ErySave's filtration technology for cardiac surgery procedures. Payments under
the agreement, based upon the achievement of certain development milestones,
could total approximately $1.3 million.
FINANCING ACTIVITIES. On June 28, 2004, we raised approximately $12.4 million in
a private placement of common stock. During the first nine months of 2004, we
raised approximately $0.6 million through the issuance of common stock through
stock options and our employee stock purchase plan.
On July 28, 2004, we entered into a secured credit facility consisting of a $2.5
million term loan and a $6.0 million line of credit. On July 30, 2004, we drew
$2.5 million on the term loan. The term loan calls for equal installment
payments over 36 months starting on January 30, 2005.
Under the secured credit facility, we are subject to, and in compliance with as
of September 30, 2004, certain financial covenants, including a liquidity ratio
of not less than 2.25 to 1 and a net tangible net worth of at least $52 million.
CASH MANAGEMENT
During 2004 and into 2005, we will increase production of pyrolytic carbon
components in our own manufacturing facility. This will require the use of cash
as we purchase raw materials and hire employees to make the inventory. Current
inventory levels are adequate into 2005. We estimate that operating costs will
remain high in comparison to sales during 2004 and 2005 and will require the use
of cash to fund operations. We will draw down cash balances to build inventories
and fund operations during 2004 and 2005.
Based upon the current forecast of sales and operating expenses, we anticipate
having cash to fund our operations through 2005. However, as identified under
the heading of "Cautionary Statements" below, any adverse change that affects
our revenue, access to the capital markets or future demand for our products
will affect our long-term viability. Maintaining adequate levels of working
capital depends in part upon the success of our products in the marketplace, the
relative profitability of those products and our ability to control operating
and capital expenses. Funding of our operations in future periods may require
additional investments in ATS in the form of equity, debt or a combination of
both. There can be no assurance that we will achieve desired levels of sales or
profitability, or that future capital infusions will be available.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any "off-balance sheet arrangements" (as such term is defined in
Item 303 of Regulation S-K) that are reasonably likely to have a current or
future effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources.
CAUTIONARY STATEMENTS
This document contains forward-looking statements within the meaning of federal
securities laws that may include statements regarding intent, belief or current
expectations of our Company and our management. The Private Securities
Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking
statements to encourage companies to provide prospective information without
fear of litigation 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
projected in the statement. We desire to take advantage of these "safe harbor"
provisions. Accordingly, we hereby identify the following important factors
which could cause our actual results to differ materially from any such results
which may be projected, forecasted, estimated or budgeted by us in
forward-looking statements made by us from time to time in reports, proxy
statements, registration statements and other written communications, or in oral
forward-looking statements made from time to time by the Company's officers and
agents. We do not intend to update any of these forward-looking statements after
the date of this Form 10-Q to conform them to actual results.
14
IF OUR HEART VALVE DOES NOT ACHIEVE WIDESPREAD MARKET ACCEPTANCE IN THE UNITED
STATES, OUR OPERATING RESULTS WILL BE HARMED AND WE MAY NOT ACHIEVE
PROFITABILITY.
Our success will depend, in large part, on the medical community's
acceptance of the ATS heart valve in the United Sates, which is the largest
revenue market in the world for heart valves. The U.S. medical community's
acceptance of the ATS heart valve will depend upon our ability to demonstrate
the safety and efficacy, advantages, long-term clinical performance and
cost-effectiveness of the ATS heart valve as compared to other prosthetic heart
valves. We cannot predict whether the U.S. medical community will accept the ATS
heart valve or, if accepted, the extent of its use. Negative publicity resulting
from isolated incidents involving the ATS heart valve or other prosthetic heart
valves could have a significant adverse effect on the overall acceptance of our
heart valve. If we encounter difficulties developing a market for the ATS heart
valve in the United States, we may not be able to increase our revenue enough to
achieve profitability and our business and results of operations will be
seriously harmed.
WE CURRENTLY RELY ON THE ATS HEART VALVE AS OUR SOLE SOURCE OF REVENUE. IF WE
ARE NOT SUCCESSFUL IN SELLING THIS PRODUCT, OUR OPERATING RESULTS WILL BE
HARMED.
We have developed only one product, which is currently being sold
primarily outside the United States. Even if we were to develop additional
products, regulatory approval would likely be required to sell them. Clinical
testing and the approval process itself are very expensive and can take many
years. Therefore, we do not expect to be in a position to sell additional
products in the foreseeable future. Adverse rulings by regulatory authorities,
product liability lawsuits, the failure to achieve widespread U.S. market
acceptance, the loss of market acceptance outside of the United States, or other
adverse publicity may significantly and adversely affect our sales of the ATS
heart valve, and, as a result, would adversely affect our business, financial
condition and results of operations.
IN 2002, WE BEGAN USING A COMBINATION OF DIRECT SALES PERSONS AND INDEPENDENT
MANUFACTURING REPRESENTATIVES TO SELL OUR VALVES IN THE UNITED STATES. IF OUR
NEW U.S. SALES STRATEGY IS NOT SUCCESSFUL, WE WILL NOT BE ABLE TO CONTINUE OUR
OPERATIONS AS PLANNED.
Our sales approach for the sale of the ATS valve in the United States
consists primarily of direct salespersons with a few independent manufacturer's
representatives. We will need to continue to expend significant funds and
management resources to develop and maintain this hybrid sales force. We believe
there is significant competition for sales personnel and independent
manufacturing representatives with the advanced sales skills and technical
knowledge we need. If we are unable to recruit, retain and motivate qualified
personnel and representatives, U.S. sales of the ATS valve could be adversely
affected. The loss of key salespersons or independent manufacturer's
representatives could have a material adverse effect on our sales or potential
sales to current customers and prospects serviced by such salespersons or
representatives. Further, we cannot assure the successful expansion of our
network of independent manufacturer's representatives on terms acceptable to
ATS, if at all, or the successful marketing of our products by our hybrid sales
force. To the extent we rely on sales through independent manufacturer's
representatives, any revenues we receive will depend primarily on the efforts of
these parties. We do not control the amount and timing of marketing resources
that these third parties devote to our product. If our U.S. sales strategy is
not successful, we may be forced to change our U.S. sales strategy again. Any
such change could disrupt sales in the United States. Further, any change in our
U.S. sales strategy could be expensive and would likely have a material adverse
impact on our results of operations.
WE CURRENTLY DEPEND ON THE MARKETING AND SALES EFFORTS OF INTERNATIONAL
INDEPENDENT DISTRIBUTORS, AND OUR SALES HAVE BEEN CONCENTRATED IN THREE
COUNTRIES.
The ATS heart valve is sold internationally through independent
distributors. The loss of an international distributor could seriously harm our
business and results of operations if a new distributor could not be found on a
timely basis in the relevant geographic market. We do not control the amount and
timing of marketing resources that these third parties devote to our product.
Furthermore, to the extent we rely on sales through independent distributors,
any revenues we receive will depend primarily on the efforts of these parties.
15
WE ARE DEPENDENT UPON SALES OUTSIDE THE UNITED STATES, WHICH ARE SUBJECT TO A
NUMBER OF RISKS INCLUDING A DROP IN SALES DUE TO CURRENCY FLUCTUATIONS.
For the first nine months of 2004, 67% of our net sales were derived
from international operations. We expect that international sales will account
for a substantial majority of our revenue until the ATS heart valve receives
wider market acceptance from U.S. customers. Accordingly, any material decrease
in foreign sales may materially and adversely affect our results of operations.
We sell in U.S. dollars to most of our customers abroad. An increase in
the value of the U.S. dollar in relation to other currencies can and has
adversely affected our sales outside of the United States. In prior years, the
decrease in sales was due primarily to the change in the value of the U.S.
dollar against the Euro, as well as competitor price pressure. Our dependence on
sales outside of the United States will continue to expose us to U.S. dollar
currency fluctuations for the foreseeable future.
Our future results of operations could also be harmed by risks inherent
in doing business in international markets, including:
o unforeseen changes in regulatory requirements and government
health programs;
o weaker intellectual property rights protection in some
countries;
o new export license requirements, changes in tariffs or trade
restrictions;
o political and economic instability in our target markets; and
o greater difficulty in collecting payments from product sales.
Slow payment of receivables by our international distributors, or the
occurrence of any of the other factors listed above, could harm our ability to
successfully commercialize our product internationally and could harm our
business.
WE HAVE A HISTORY OF NET LOSSES. IF WE DO NOT HAVE NET INCOME IN THE FUTURE, WE
MAY BE UNABLE TO CONTINUE OUR OPERATIONS.
We are not currently profitable and have a very limited history of
profitability. As of September 30, 2004, we had an accumulated deficit of $62
million. We expect to incur significant expenses over the next several years as
we continue to devote substantial resources to the commercialization of the ATS
heart valve in the United States. We will not generate net income unless we are
able to significantly increase revenue from U.S. sales. If we continue to
sustain losses, we may not be able to continue our business as planned.
THE MARKET FOR PROSTHETIC HEART VALVES IS HIGHLY COMPETITIVE, AND A NUMBER OF
OUR COMPETITORS ARE LARGER AND HAVE MORE FINANCIAL RESOURCES. IF WE DO NOT
COMPETE EFFECTIVELY, OUR BUSINESS WILL BE HARMED.
The market for prosthetic heart valves is highly competitive. We expect
that competition will intensify as additional companies enter the market or
modify their existing products to compete directly with us. Our primary
competitor, St. Jude Medical, Inc., currently controls approximately 50% of the
worldwide mechanical heart valve market. Many of our competitors have
long-standing FDA approval for their valves and extensive clinical data
demonstrating the performance of their valves. In addition, they have greater
financial, manufacturing, marketing and research and development capabilities
than we have. For example, many of our competitors have the ability, due to
their internal carbon manufacturing facilities and economies of scale, to
manufacture their heart valves at a lower cost than we can manufacture our ATS
heart valve. Our primary competitor has recently used price as a method to
compete in several international markets. If heart valve prices decline
significantly we might not be able to compete successfully, which would harm our
results of operations.
16
OUR FUTURE RESULTS WILL BE HARMED IF THE USE OF MECHANICAL HEART VALVES
DECLINES.
Our business could suffer if the use of mechanical heart valves
declines. Historically, mechanical heart valves have accounted for over
two-thirds of all heart valve replacements. Recently, there has been an increase
in the use of tissue valves. We estimate that mechanical heart valves are
currently being used in 40% to 65% of all heart valve replacements, depending on
the geographic market, down from 65 to 75% about ten years ago. We believe the
tissue manufacturers' claims of improvements in tissue valve longevity and an
increase in the average age of valve patients have contributed to the recent
increase in the use of tissue valves.
NEW PRODUCTS OR TECHNOLOGIES DEVELOPED BY OTHERS COULD RENDER OUR PRODUCT
OBSOLETE.
The medical device industry is characterized by significant
technological advances. Several companies are developing new prosthetic heart
valves based on new or potentially improved technologies. Significant advances
are also being made in surgical procedures, which may delay the need for
replacement heart valves. A new product or technology may emerge that renders
the ATS heart valve noncompetitive or obsolete. This could materially harm our
results of operations or force us to cease doing business altogether.
WE MAINTAIN A LARGE VOLUME OF INVENTORY, WHICH EXCEEDS THE CURRENT DEMAND FOR
THE ATS HEART VALVE. IF SALES OF OUR PRODUCT DO NOT INCREASE, THE VALUE OF OUR
INVENTORY COULD DECREASE SUBSTANTIALLY.
We purchased pyrolytic carbon components under a long-term supply
agreement with Carbomedics through June 2002, and we are required to resume
purchases of such components in 2007. To date, our purchases of pyrolytic carbon
components have exceeded our sales of the ATS heart valves. We currently have in
inventory enough pyrolytic carbon components to satisfy our projected
requirements through 2004. If we are unable to achieve widespread acceptance for
the ATS heart valve or if competitive pressures result in price reductions, the
value of the excess inventory would likely decrease, which could seriously harm
our results of operations and financial condition. Because the pyrolytic carbon
components are made to meet the unique specifications of the ATS heart valve,
our inventory may have little, if any, value in the open market.
WE LICENSE PATENTED TECHNOLOGY AND OTHER PROPRIETARY RIGHTS FROM CARBOMEDICS. IF
THESE AGREEMENTS ARE BREACHED OR TERMINATED, OUR RIGHT TO MANUFACTURE THE ATS
HEART VALVE COULD BE TERMINATED.
Under our carbon technology agreement with Carbomedics, we have
obtained a license to use Carbomedics' pyrolytic carbon technology to
manufacture components for the ATS heart valve. If this agreement is breached or
terminated, we would be unable to manufacture our own product. If our inventory
is exhausted and we do not have any other sources of carbon components, we would
be forced to cease doing business.
A DELAY OR INTERRUPTION IN THE SUPPLY OF PYROLYTIC CARBON COMPONENTS COULD DELAY
PRODUCT DELIVERY OR FORCE US TO CEASE OPERATIONS.
We cannot be certain that, after our current inventory is exhausted,
sufficient quantities of pyrolytic carbon components will be available to
assemble the ATS heart valve. Other than our carbon facility, the only other
FDA-approved alternate supplier of our pyrolytic carbon components is
Carbomedics. Although we have a supply agreement with Carbomedics under which it
agrees to supply us with a minimum annual number of pyrolytic carbon components
during 2007 through 2011, the amounts available under this agreement are not
expected to be sufficient to supply all of our needs for components in those
years. If our inventory is exhausted and we are unable to manufacture carbon
components or obtain them from other sources, we could be forced to reduce or
cease operations.
BECAUSE WE LACK MANUFACTURING EXPERIENCE, WE MAY NOT REALIZE EXPECTED SAVINGS
FROM MANUFACTURING OUR OWN PRODUCT. IN ADDITION, WE COULD EXPERIENCE PRODUCTION
DELAYS AND SIGNIFICANT ADDITIONAL COSTS.
Under our agreement with Carbomedics, we have been granted an exclusive
worldwide license to manufacture pyrolytic carbon components for the ATS heart
valve. We cannot be certain that our strategy to establish internal
manufacturing capabilities will result in a cost-effective means for
manufacturing the ATS heart valve. We have limited experience in manufacturing
pyrolytic carbon. Although we have an FDA-approved carbon manufacturing
facility, it is currently operating at the minimal level necessary to maintain
the plant and our technical
17
expertise in producing carbon components. In the future when we increase
production at the plant we may encounter difficulties in maintaining and
expanding our manufacturing operations, including problems involving:
o production yields;
o quality control;
o per unit manufacturing costs;
o shortages of qualified personnel; and
o compliance with FDA and international regulations and
requirements regarding good manufacturing practices.
Difficulties encountered by us in establishing or maintaining a
commercial-scale manufacturing facility may limit our ability to manufacture our
heart valve and therefore could seriously harm our business and results of
operations.
OUR BUSINESS COULD BE SERIOUSLY HARMED IF THIRD-PARTY PAYORS DO NOT REIMBURSE
THE COSTS FOR OUR HEART VALVE.
Our ability to successfully commercialize the ATS heart valve depends
on the extent to which reimbursement for the cost of our product and the related
surgical procedure is available from third-party payors, such as governmental
programs, private insurance plans and managed care organizations. Third-party
payors are increasingly challenging the pricing of medical products and
procedures that they consider are not cost-effective or are used for a
non-approved indication. The failure by physicians, hospitals and other users of
our product to obtain sufficient reimbursement from third-party payors would
seriously harm our business and results of operations.
In recent years, there have been numerous proposals to change the
health care system in the United States. Some of these proposals have included
measures that would limit or eliminate payment for medical procedures or
treatments. In addition, government and private third-party payors are
increasingly attempting to contain health care costs by limiting both the
coverage and the level of reimbursement. In international markets, reimbursement
and health care payment systems vary significantly by country. In addition, we
have encountered price resistance from government-administered health programs.
Significant changes in the health care system in the United States or elsewhere,
including changes resulting from adverse trends in third-party reimbursement
programs, could have a material adverse effect on our business and results of
operations.
WE MAY FACE PRODUCT LIABILITY CLAIMS, WHICH COULD RESULT IN LOSSES IN EXCESS OF
OUR INSURANCE COVERAGE AND WHICH COULD NEGATIVELY AFFECT OUR ABILITY TO ATTRACT
AND RETAIN CUSTOMERS.
The manufacture and sale of mechanical heart valves entails significant
risk of product liability claims and product recalls. A mechanical heart valve
is a life-sustaining device and the failure of any mechanical heart valve
usually results in the patient's death or need for reoperation. A product
liability claim or product recall, regardless of the ultimate outcome, could
require us to spend significant time and money in litigation or to pay
significant damages and could seriously harm our business. We currently maintain
product liability insurance coverage in an aggregate amount of $25 million.
However, we cannot assure you that our current insurance coverage is adequate to
cover the costs of any product liability claims made against us. Product
liability insurance is expensive and does not cover the costs of a product
recall. In the future, product liability insurance may not be available at
satisfactory rates or in adequate amounts. A product liability claim or product
recall could also materially and adversely affect our ability to attract and
retain customers.
OUR BUSINESS WOULD BE ADVERSELY AFFECTED IF WE ARE NOT ABLE TO PROTECT OUR
INTELLECTUAL PROPERTY RIGHTS.
Our success depends in part on our ability to maintain and enforce our
patents and other proprietary rights. We rely on a combination of patents, trade
secrets, know-how and confidentiality agreements to protect the proprietary
aspects of our technology. These measures afford only limited protection and
competitors may gain access to our intellectual property and proprietary
information. The patent positions of medical device companies are generally
uncertain and involve complex legal and technical issues. Litigation may be
necessary to enforce our
18
intellectual property rights, to protect our trade secrets and to determine the
validity and scope of our proprietary rights. Any litigation could be costly and
divert our attention from the growth of the business. We cannot assure you that
our patents and other proprietary rights will not be successfully challenged, or
that others will not independently develop substantially equivalent information
and technology or otherwise gain access to our proprietary technology.
WE MAY BE SUED BY THIRD PARTIES WHICH CLAIM THAT OUR PRODUCT INFRINGES ON THEIR
INTELLECTUAL PROPERTY RIGHTS. ANY SUCH SUITS COULD RESULT IN SIGNIFICANT
LITIGATION OR LICENSING EXPENSES OR WE MIGHT BE PREVENTED FROM SELLING OUR
PRODUCT.
We may be exposed to future litigation by third parties based on
intellectual property infringement claims. Any claims or litigation against us,
regardless of the merits, could result in substantial costs and could harm our
business. In addition, intellectual property litigation or claims could force us
to:
o cease manufacturing and selling our product, which would
seriously harm us;
o obtain a license from the holder of the infringed intellectual
property right, which license may not be available on
reasonable terms, if at all; or
o redesign our product, which could be costly and
time-consuming.
WE ARE SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATION, WHICH IS COSTLY, TIME
CONSUMING AND CAN SUBJECT US TO UNANTICIPATED DELAYS.
The ATS heart valve and our manufacturing activities are subject to
extensive regulation by a number of governmental agencies, including the FDA and
comparable international agencies. We are required to:
o maintain the approval of the FDA and international regulatory
agencies to continue selling the ATS heart valve;
o obtain the approval of international regulatory agencies in
countries where the ATS heart valve is not yet marketed;
o satisfy content requirements for all of our labeling, sales
and promotional materials;
o comply with manufacturing and reporting requirements; and
o undergo rigorous inspections by these agencies.
Compliance with the regulations of these agencies may delay or prevent
us from introducing any new or improved products. Violations of regulatory
requirements may result in fines, marketing restrictions, product recall,
withdrawal of approvals and civil and criminal penalties.
THE PRICE OF OUR COMMON STOCK HAS BEEN VOLATILE, WHICH MAY RESULT IN LOSSES TO
INVESTORS.
Historically, the market price of our common stock has fluctuated over
a wide range and it is likely that the price of our common stock will fluctuate
in the future. The market price of our common stock could be impacted by the
following:
o the success of our management in operating ATS effectively;
o the failure of the ATS valve to gain market acceptance in the
United States;
o announcements of technical innovations or new products by our
competitors;
o the status of component supply arrangements;
19
o changes in reimbursement policies;
o government regulation;
o developments in patent or other proprietary rights;
o public concern as to the safety and efficacy of products
developed by us or others; and
o general market conditions.
In addition, due to one or more of the foregoing factors, in future
years, our results of operations may fall below the expectations of securities
analysts and investors. In that event, the market price of our common stock
could be materially and adversely affected. Finally, in recent years the stock
market has experienced extreme price and volume fluctuations. This volatility
has had a significant effect on the market prices of securities issued by many
companies for reasons unrelated to their operating performance. These broad
market fluctuations may materially adversely affect our stock price, regardless
of our operating results.
OUR CHARTER DOCUMENTS AND MINNESOTA LAW MAY DISCOURAGE AND COULD DELAY OR
PREVENT A TAKEOVER OF OUR COMPANY.
Provisions of our articles of incorporation, bylaws and Minnesota law
could make it more difficult for a third party to acquire us, even if doing so
would be beneficial to our shareholders. These provisions include the following:
o No cumulative voting by shareholders for directors;
o The ability of our board to set the size of the board of
directors, to create new directorships and to fill vacancies;
o The ability of our board, without shareholder approval, to
issue preferred stock, which may have rights and preferences
that are superior to our common stock;
o The ability of our board to amend the bylaws; and
o Restrictions under Minnesota law on mergers or other business
combinations between us and any holder of 10% or more of our
outstanding common stock.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we invest in
may have market risk. This means that a change in prevailing interest rates may
cause the fair market value of the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then prevailing rate and the prevailing interest rate later
rises, the fair value of the principal amount of our investment will probably
decline. To minimize this risk, our portfolio of cash equivalents and short-term
investments may be invested in a variety of securities, including commercial
paper, money market funds, and both government and non-government debt
securities. The average duration of all our investments has generally been less
than one year. Due to the short-term nature of these investments, we believe we
have no material exposure to interest rate risk arising from our investments.
In the United States, Canada, and France, we sell our products directly to
hospitals. In other international markets, we sell our products to independent
distributors who, in turn, sell to medical hospitals. Loss, termination, or
ineffectiveness of distributors to effectively promote our product would have a
material adverse effect on our financial condition and results of operations.
Transactions with U.S. and non-U.S. customers and distributors, other than in
France, are entered into in U.S. dollars, precluding the need for foreign
currency hedges on such sales. Sales through our French subsidiary, which was
established in 2002 to replace a distributor, are in Euros, so we are subject to
profitability risk arising from exchange rate movements. We have not used
foreign exchange contracts or similar devices to reduce this risk. We will
evaluate the need to use foreign exchange contracts or similar devices if sales
in France increase substantially.
We do not believe that inflation has had a material effect on our results of
operations in recent years and periods. There can be no assurance, however, that
our business will not be adversely affected by inflation in the future.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our Chief Executive Officer and our Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934, as amended (the Exchange Act)). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that, as of the end of
the period covered by this report, our disclosure controls and procedures were
effective in timely alerting them to the material information relating to us
required to be included in our periodic SEC filings.
(b) Changes in Internal Control
During the most recent fiscal quarter, there has been no change in our internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
21
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
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)
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)
4.1 Specimen certificate for shares of Common Stock of
the Company (Incorporated by reference to Exhibit 4.1
to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997)
10.1 Credit Agreement between Silicon Valley Bank and the
Company, dated July 28, 2004
10.2 Form of Employee Stock Option Agreement under the
Company's 2000 Stock Incentive Plan
10.3 Form of Non-Qualified Stock Option Agreement under
the Company's 2000 Stock Incentive Plan
10.4 Form of Non-Plan Non-Qualified Stock Option Agreement
31.1 Certification of Chief Executive Officer pursuant to
Rules 13a-15(e)/15d-15(e) (Section 302 Certification)
31.2 Certification of Chief Financial Officer pursuant to
Rules 13a-15(e)/15d-15(e) (Section 302 Certification)
32.1 Certification of the Chief Executive Officer pursuant
to 18 U.S.C. Section 1350 (Section 906 Certification)
32.2 Certification of the Chief Financial Officer pursuant
to 18 U.S.C. Section 1350 (Section 906 Certification)
22
SIGNATURES
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.
Date: November 5, 2004 ATS MEDICAL, INC.
By: /s/ Michael D. Dale
-----------------------------
Michael D. Dale, Chief
Executive Officer
By: /s/ John R. Judd
-----------------------------
John R. Judd, Chief Financial
Officer (Principal
Accounting Officer)
23
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION
10.1 Credit Agreement between Silicon Valley Bank and the Company, dated July 28, 2004
10.2 Form of Employee Stock Option Agreement under the Company's 2000 Stock Incentive Plan
10.3 Form of Non-Qualified Stock Option Agreement under the Company's 2000 Stock Incentive Plan
10.4 Form of Non-Plan Non-Qualified Stock Option Agreement
31.1 Certification of the Chief Executive Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section 302
Certification)
31.2 Certification of the Chief Financial Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section 302
Certification)
32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (Section 906
Certification)
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906
Certification)
24