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EX-31.1 - CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER, SECTION 302 - NMT MEDICAL INCdex311.htm
EX-32.2 - CERTIFICATION OF COO AND CFO, SECTION 906 - NMT MEDICAL INCdex322.htm
EX-31.2 - CERTIFICATION OF COO AND CFO, SECTION 302 - NMT MEDICAL INCdex312.htm
EX-32.1 - CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER, SECTION 906 - NMT MEDICAL INCdex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2010

or

 

¨ Transition Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             .

Commission File No. 000-21001

 

 

NMT MEDICAL, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   95-4090463

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

27 Wormwood Street, Boston, Massachusetts 02210
(Address of Principal Executive Offices, Including Zip Code)

Registrant’s telephone number, including area code: (617) 737-0930

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

(Check one):

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  x
     

(Do not check if a

smaller reporting company)

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes  ¨    No   x

As of August 5, 2010, there were 16,020,069 shares of Common Stock, $.001 par value per share, outstanding.

 

 

 


Table of Contents

INDEX

 

         Page Number    
Part I. Financial Information   

Item 1.

  Unaudited Condensed Consolidated Financial Statements   
  Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009    3    
 

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30,
2010 and 2009

   4    
 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and
2009

   5    
  Notes to Condensed Consolidated Financial Statements    6    

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    13    

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk    19    

Item 4.

  Controls and Procedures    19    
Part II. Other Information   

Item 1

  Legal Proceedings    20    

Item 1A.

  Risk Factors    20    

Item 6.

  Exhibits    26    
Signatures    27    
Exhibit Index    28    

 

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NMT Medical, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited)

 

     At June 30,
2010
   At December 31,
2009

Assets

     

Current assets:

     

Cash and cash equivalents

     $ 3,147,835        $ 8,926,329  

Marketable securities

     3,386,339        -  

Accounts receivable, net of allowances of $105,000 at

June 30, 2010 and $85,000 at December 31, 2009

     1,313,834     

 

1,683,829  

Inventories

     1,947,999        1,658,646  

Prepaid expenses and other current assets

     1,054,650        1,029,348  
             

Total current assets

     10,850,657        13,298,152  
             

Property and equipment, at cost:

     

Laboratory and computer equipment

     2,009,431        2,003,209  

Leasehold improvements

     1,276,121        1,276,121  

Office furniture and equipment

     331,415        331,415  
             
     3,616,967        3,610,745  

Less accumulated depreciation and amortization

     3,032,911        2,916,225  
             

Total property and equipment, net

     584,056        694,520  
             

Total Assets

     $ 11,434,713        $ 13,992,672  
             

Liabilities and Stockholders’ Equity

     

Current liabilities:

     

Accounts payable

     $ 3,877,300        $ 5,017,863  

Accrued expenses

     5,022,599        5,840,908  
             

Total current liabilities

     8,899,899        10,858,771  

Warrant liability

     585,568        -  

Other long-term liabilities

     581,616        554,143  
             

Total liabilities

     10,067,083        11,412,914  
             

Commitments and contingencies (Note 10)

     

Stockholders’ equity:

     

Preferred stock, $.001 par value
Authorized -- 3,000,000 shares
Issued and outstanding -- none

     -        -  

Common stock, $.001 par value
Authorized -- 30,000,000 shares
Issued and outstanding -- 16,060,069 shares at June 30, 2010 and

13,268,294 shares at December 31, 2009

     16,060        13,268  

Additional paid-in capital

     57,310,669        53,175,464  

Treasury stock - 40,000 shares at cost

     (119,600)       (119,600) 

Accumulated other comprehensive loss

     (2,112)       -  

Accumulated deficit

     (55,837,387)       (50,489,374) 
             

Total stockholders’ equity

     1,367,630        2,579,758  
             

Total Liabilities and Stockholders’ Equity

     $             11,434,713        $             13,992,672  
             

See accompanying notes.

 

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Table of Contents

NMT Medical, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

 

     For the Three Months Ended    For the Six Months Ended
     June 30,    June 30,
     2010    2009    2010    2009

Product sales

     $ 2,574,844        $ 3,181,843        $ 5,569,152        $ 6,659,614  

Costs and expenses:

           

Cost of product sales

     1,389,938        1,416,760        2,616,887        2,826,006  

Research and development

     1,840,521        2,432,422        3,664,527        4,626,658  

General and administrative

     2,047,307        1,701,954        4,002,951        4,104,481  

Selling and marketing

     1,298,914        1,516,459        2,488,595        2,816,918  
                           

Total costs and expenses

     6,576,680        7,067,595        12,772,960        14,374,063  
                           

Loss from operations

     (4,001,836)       (3,885,752)       (7,203,808)       (7,714,449) 
                           

Other income (expense):

           

Gain on change in fair value of warrants

     6,410,503        -        1,755,906        -  

Currency transaction (loss) gain

     (24,228)       23,623        (74,797)       2,733  

Interest income

     2,438        24,741        4,117        81,393  
                           

Total other income, net

     6,388,713        48,364        1,685,226        84,126  
                           

Income (loss) before income taxes

     2,386,877        (3,837,388)       (5,518,582)       (7,630,323) 

Income tax (benefit) expense

     (181,058)       10,557        (170,569)       20,395  
                           

Net income (loss)

     $ 2,567,935        $ (3,847,945)       $ (5,348,013)       $ (7,650,718) 
                           

Basic net income (loss) per common share:

     $ 0.16        $ (0.29)       $ (0.35)       $ (0.58) 
                           

Diluted net income (loss) per common share:

     $ 0.16        $ (0.29)       $ (0.35)       $ (0.58) 
                           

Weighted average common shares outstanding:

           

Basic

     16,019,272        13,204,106        15,346,602        13,152,940  
                           

Diluted

             16,276,453                13,204,106                15,346,602                13,152,940  
                           

See accompanying notes.

 

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Table of Contents

NMT Medical, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

     For the Six Months Ended
June 30,
     2010    2009

Cash flows from operating activities:

     

Net loss

     $ (5,348,013)       $ (7,650,718) 

Adjustments to reconcile net loss to net cash used in
operating activities:

     

Depreciation and amortization

     116,687        140,115  

Amortization of bond premium

     18,185        19,367  

Share-based compensation expense

     354,471        213,685  

Gain on change in fair value of warrants

     (1,755,906)       -  

Change in assets and liabilities-

     

Accounts receivable

     369,995        764,365  

Inventories

     (289,353)       284,708  

Prepaid expenses and other current assets

     (25,302)       (21,762) 

Accounts payable

     (1,140,563)       1,749,571  

Accrued expenses and long-term liabilities

     (458,772)       (772,210) 
      

Net cash used in operating activities

     (8,158,571)       (5,272,879) 
      

Cash flows from investing activities:

     

Purchases of property and equipment

     (6,223)       (27,071) 

Purchases of marketable securities

     (3,406,636)       (515,275) 

Maturities of marketable securities

     -        12,025,000  
             

Net cash (used in) provided by investing activities

     (3,412,859)       11,482,654  
             

Cash flows from financing activities:

     

Proceeds from private placement

     5,759,759        -  

Proceeds from exercise of common stock options

     33,177        -  

Proceeds from issuance of common stock under the employee stock purchase plan

     -        6,437  
             

Net cash provided by financing activities

     5,792,936        6,437  
             

Net (decrease) increase in cash and cash equivalents

     (5,778,494)       6,216,212  

Cash and cash equivalents, beginning of period

     8,926,329        4,899,179  
             

Cash and cash equivalents, end of period

     $         3,147,835        $         11,115,391  
             

Supplemental cash flow information:

     

Settlement of accrued expenses with company stock

     $ 332,063        $ 71,840  
             

See accompanying notes.

 

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Table of Contents

NMT Medical, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

1. Operations

We are an advanced medical technology company that designs, develops, manufactures and markets proprietary implant technologies that allow interventional cardiologists to treat structural heart disease through minimally invasive, catheter-based procedures. We are investigating the potential connection between a common heart defect that allows a right to left shunt or flow of blood through a defect like a patent foramen ovale, or PFO, and brain attacks such as embolic stroke, transient ischemic attacks, or TIA, and migraine headaches. A PFO is a common right to left shunt that can allow venous blood, unfiltered and unmanaged by the lungs, to directly enter the arterial circulation of the brain, possibly triggering a cerebral event or brain attack. More than 33,000 PFOs have been treated globally with our minimally invasive, catheter-based implant technology.

2. Interim Financial Statements

The accompanying condensed consolidated financial statements at June 30, 2010 and for the three and six month periods ended June 30, 2010 and 2009 are unaudited and include the accounts of our company and our wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. These unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2009, and include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the results for such interim periods. We consider events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. These financial statements should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2009. The results of operations for the three and six month periods ended June 30, 2010 are not necessarily indicative of the results expected for the fiscal year ending December 31, 2010.

We have incurred operating losses of $12.5 million and $18.7 million during each of the past two fiscal years, respectively, and have experienced decreasing sales over those time periods. We also incurred an operating loss of $7.2 million for the six months ended June 30, 2010. We have an accumulated deficit of $55.8 million as of June 30, 2010. In addition, we expect to incur significant additional research and development and other costs for the remainder of fiscal 2010—including costs to complete our CLOSURE I trial and continue our discussions with the U.S. Food and Drug Administration, or FDA, to evaluate our next steps relating to the stroke/TIA indication. Our costs, including research and development for our product candidates and sales, marketing and promotion expenses for any of our existing or future products to be marketed by us or our distributors currently exceed and will likely continue to exceed revenues during this period.

We have historically funded our operations primarily through public offerings of equity securities, the sale of non-strategic business assets, and settlements from the successful defense of our patents. At June 30, 2010, we had cash, cash equivalents and marketable securities of approximately $6.5 million.

In tightly managing our capital resources, we have taken several actions over the last year to both reduce our expenditures and further enhance our ability to generate revenue. The reductions in expenditures have included i) general and administrative costs, ii) program specific research and development costs relating to CLOSURE I which will be approximately $500,000 less in 2010 than 2009 and iii) non-program specific research and development costs. We have repositioned our direct sales force in Europe and the rest of the world to increase coverage and maintain our historical sales levels. Despite our efforts, the Company’s 2010 revenues have declined from 2009 levels more than we anticipated directly impacting our liquidity. As a result, we will and have the ability to further reduce our spending in the coming months to manage our limited resources.

Our primary goal at this time is to bring to completion our CLOSURE I trial. Data analysis for CLOSURE I commenced in April 2010. On June 17, 2010, we announced that we received preliminary results of the data analysis and that the trial did not achieve its primary endpoint: to demonstrate that treatment by device closure with the STARFlex® technology is superior to current best medical therapy for preventing recurrent strokes and TIAs. However, the preliminary results indicate that closure with STARFlex® provided a small, but not statistically significant, benefit over current best medical therapy. The trial’s preliminary results indicate that the safety profile of the STARFlex® device had a low rate of complications, similar to that of current best medical therapy. We will have the entire patient data available in late October, so the complete CLOSURE I presentation is scheduled for the American Heart Association, or AHA, meeting in mid-November. We are in discussions with the FDA to evaluate our possible next steps relating to the stroke/TIA indication. Successful completion of our CLOSURE I clinical trial will require significant expenditures in the last two quarters of 2010 and potentially beyond depending on the results of the discussions with the FDA.

Based on our current projections and plans, we believe that we will be required to raise additional capital to continue our ongoing efforts in bringing the CLOSURE I trial to completion. While we have an established credit facility to draw from that is pledged against certain receivables and inventory, our borrowing availability is significantly limited (approximately $1.0 million at June 30, 2010) based on the covenants of the line. Based on our current anticipated sales levels, the availability under the line will decrease as we progress through the remainder of 2010.

 

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Table of Contents

We will continue to review financing alternatives and we will need to raise additional capital within the next six months. We may not be able to obtain additional financing on satisfactory terms. On August 4, 2010, as we previously reported, we received notifications from the NASDAQ of the Company’s failure to comply with the NASDAQ’s minimum per share stock price and market value requirements. We have until January 26, 2011 to regain compliance. Failure to raise capital could materially and adversely impact our business, financial condition, results of operations and cash flows and impact our ability to continue as a going concern.

3. Share-Based Compensation

We have various types of share-based compensation plans. These plans are administered by our Joint Compensation and Options Committee of our Board of Directors. A description of our share-based compensation plans is contained in Note 8 of the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2009.

The expense for share-based payment awards made to our employees and directors consisting of stock options issued based on the estimated fair values of the share-based payments on the date of grant was recorded in the following captions in the consolidated statements of operations:

 

     For The Three Months Ended June 30,    For The Six Months Ended June 30,
     2010    2009    2010    2009

Cost of product sales

     $ 1,310      $ 2,248      $ (209)      $ 3,021

Research and development

     5,865      19,587      22,426      42,675

General and administrative

     39,151      44,336      321,464      145,724

Selling and marketing

     1,218      10,492      10,790      22,265
                           
     $                 47,544      $                 76,663      $                 354,471      $                 213,685
                           

We use the Black-Scholes option-pricing model to estimate fair value of share-based payment awards with the following weighted average assumptions:

 

     For the Six Months  Ended
June 30,
     2010    2009
         

Expected life (years)

   4    4

Expected stock price volatility

   79.56% -81.23%    74.18% -81.41%

Weighted average stock price volatility

   80.79%    76.92%

Expected dividend yield

   0%    0%

Risk-free interest rate

   2.09% - 2.38%    1.31% - 2.05%

The risk-free interest rate is based on U.S. Treasury interest rates whose term is consistent with the expected life of the stock options. Expected volatility, weighted average volatility and expected life are based on our historical experience. Expected dividend yield was not considered in the option pricing formula since we do not pay dividends and have no current plans to do so in the future. We adjust the estimated forfeiture rate based upon actual experience. The expected life for options granted during the six months ended June 30, 2010 and 2009 was based upon the actual forfeiture rate for the preceding four years, which resulted in an expected life equal to the vesting period.

The following table summarizes a reconciliation of all stock option activity for the six months ended June 30, 2010:

 

   Number of shares
of common stock
issuable upon
exercise of options
    
 
 
Weighted
average exercise
price per share
   Weighted
average
remaining
contractual
term
    
 
Aggregate
intrinsic value
                       
         (in years)      (in thousands)

Options outstanding at January 1, 2010

   1,970,210        $ 6.24        

Granted

   22,400        3.25        

Exercised

   19,850        1.67           $ 9  

Cancelled/Forfeited

   63,125        5.46        
             

Options outstanding at June 30, 2010

   1,909,635        $ 6.27      4.86        $ -  
             

Options vested or expected to vest at June 30, 2010

   1,834,288        $ 6.35      4.71        $ -  

Options exercisable at June 30, 2010

   1,532,902        $             6.71      3.95        $             -  

 

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The aggregate intrinsic value represents the pre-tax value (the period’s closing market price, less the exercise price, times the number of in-the-money options) that would have been received by all option holders had they exercised their options at the end of the period.

The weighted average grant-date fair value of options granted during the three and six months ended June 30, 2010 was $3.28 and $3.25, respectively. The aggregate intrinsic value of options exercised during the three and six months ended June 30, 2010 was $4,515 and $9,415, respectively. Net cash proceeds from the exercise of stock options were $1,978 and $33,177 for the three and six months ended June 30, 2010, respectively.

The weighted average grant-date fair value of options granted during the three and six months ended June 30, 2009 was $0.85 and $0.78, respectively. There were no options exercised during the six months ended June 30, 2009.

At June 30, 2010, there was approximately $350,000, net of expected forfeitures, of unrecognized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of approximately 4 years.

We have not recorded any tax benefit from stock option exercises, since the realization of tax benefits is not considered likely.

4. Fair Value Measurements

We consider investments with maturities of 90 days or less from the date of purchase to be cash equivalents and investments with original maturity dates greater than 90 days to be marketable securities. Cash and cash equivalents, which are carried at cost and approximate market, consist of cash, money market accounts and commercial paper investments.

We have classified our marketable securities as available-for-sale. Available-for-sale marketable securities at June 30, 2010, consisted of approximately $3.4 million of debt instruments with maturities ranging from July 2010 to December 2010. Accrued interest receivable of approximately $21,000 has been reported in prepaid expenses and other current assets in the accompanying condensed consolidated balance sheet at June 30, 2010.

Marketable securities are recorded at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs that may be used to measure fair value, of which the first two are considered observable and the last unobservable. The fair value hierarchy levels are as follows:

Level 1 - Quoted prices in active markets that are accessible at the market date for identical unrestricted assets or liabilities.

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs for which all significant inputs are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. We determine the fair value of our corporate bonds, commercial paper and certificates of deposit at the reporting date using Level 2 inputs. These types of instruments trade in markets that are not considered to be active, but our initial value is based on quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. We engage a financial advisor to assist us in validating the assumptions and data obtained from our primary valuation source. We also access publicly available market activity from third party databases and credit ratings of the issuers of the securities we hold to corroborate the data used in the fair value calculations obtained from our primary source.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable. We initially recorded the warrant liability at its fair value using Black-Scholes option-pricing model and revalue it at each reporting date until the warrants are exercised or expire. The fair value of warrants is subject to significant fluctuation based on our stock price, expected volatility, remaining contractual life and the risk-free interest rate.

The following tables present information about our assets and liabilities that are measured at fair value as of June 30, 2010:

 

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          Fair Value Measurements at the Reporting Date  Using
     June 30,
2010
   Level 1    Level 2    Level 3

Assets

           

Money Market Fund

     $ 2,212,699        $ 2,212,699        $ -        $ -  

Corporate Debentures/Bonds

     1,187,306        -        1,187,306        -  

Commercial Paper

     1,349,469        -        1,349,469        -  

Agency Discount Note

     849,564        -        849,564        -  
                           

Total assets at fair value

     $       5,599,038        $             2,212,699        $             3,386,339        $ -  
                           

Liabilities

           

Warrant liability

     585,568              $               585,568  
                           

Total liabilities at fair value

     $ 585,568        $ -        $ -        $ 585,568  
                           

We have issued common stock warrants in connection with the February 16, 2010 private placement (See Note 5). The warrants are accounted for as derivative liabilities at fair value in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification 815, Derivatives and Hedging, or ASC 815. The warrants do not meet the scope-exemption criteria in ASC 815 that a contract should not be considered a derivative instrument if it is (1) indexed to its own stock and (2) classified in stockholders’ equity. Therefore upon issuance, we have recorded a liability for the fair value of the warrants, as an allocation from the private placement proceeds. Changes in the fair value of the warrant liability have been recorded in the Consolidated Statements of Operations under the caption “Gain on change in fair value of warrants.”

The table below includes a rollforward of the balance sheet amounts for the three months and year to date periods ended June 30, 2010 for the warrant liability, which is classified as Level 3. When a determination is made to classify a financial instrument within Level 3, the determination is based upon the significance of the unobservable parameters to the overall fair value measurement. However, Level 3 financial instruments typically include, in addition to the unobservable components, observable components (that is, components that are actively quoted and can be validated to external sources). Accordingly, the gain in the table below includes changes in fair value due in part to observable factors that are part of the methodology.

 

     Three Months Ended June 30, 2010
     Fair Value of
Warrants upon
issuance at
March 31, 2010
   Settlement of
Warrant Liability
during the period ended
June 30, 2010
   Change in Fair Value of
Warrant Liability
during the period ended
June 30, 2010
   Fair Value of
Warrants Liability at
June 30, 2010

Warrant Liability

     $ 6,996,071      $ -        $ (6,410,503)       $ 585,568  
                           
     Year to Date Period Ended June 30, 2010
     Fair Value of
Warrants upon
issuance at
February 16, 2010
   Settlement of
Warrant Liability
during the period ended
June 30, 2010
   Change in Fair Value of
Warrant Liability
during the period ended
June 30, 2010
   Fair Value of
Warrants Liability at
June 30, 2010

Warrant Liability

     $             2,341,474        $                     -        $         (1,755,906)       $                 585,568  
                           

5. Private Placement of our Common Stock and Warrants

On February 16, 2010, the Company completed a private placement of its common stock and warrants to purchase additional shares of common stock to existing and new shareholders for aggregate proceeds of approximately $5.8 million. Under terms of the placement, we sold 2,678,958 shares of our common stock at a purchase price of $2.15 per share. Included in the financing terms were warrants to purchase an additional 2,143,166 shares of our common stock with an exercise price of $2.90 per share. The warrants are exercisable no earlier than August 17, 2010 and are exercisable until February 16, 2015.

 

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Assumptions used for the Black-Scholes option-pricing models to determine the fair value of the warrant liability as of February 16, 2010 and June 30, 2010 were determined in a similar manner as those for share-based payment awards, as discussed in Note 3. These assumptions are as follows:

 

     February 16,
2010
       June 30,    
2010
     

Expected life (years)

     5.0      4.6

Expected stock price volatility

     78%      109%

Expected dividend yield

     0      0

Risk-free interest rate

     2.32%      1.79%

Common stock price

     $ 1.95      $ 0.52

6. Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market and consisted of the following:

 

         At June 30,    
    2010    
   At December  31,
2009
     

Raw materials

     $ 796,395      $ 669,223

Work-in-process

     179,624      100,427

Finished goods

     971,980      888,996
             
     $ 1,947,999      $ 1,658,646
             

Finished goods and work-in-process consisted of materials, labor and manufacturing overhead.

7. Income Taxes

For the three and six months ended June 30, 2010, we recorded a net benefit for income taxes of $181,058 and $170,569, respectively. For the three months ended June 30, 2010, we recorded an income tax benefit of $190,832, related to the suspended alternative tax net operating loss limitation and extended carryback period recently made available under the Worker, Homeownership, and Business Assistance Act of 2009. For the three and six months ended June 30, 2010, this income tax benefit was offset by a provision for income taxes of $9,774 and $20,263, respectively, as a result of the increase to the liability for uncertain tax positions. For the three and six months ended June 30, 2009, we also recorded a provision for income taxes of $10,557 and $20,395, respectively, as a result of the increase to the liability for uncertain tax positions.

Our liability for uncertain tax positions was $216,366 and $226,525 at December 31, 2009 and June 30, 2010 respectively and relates to various tax jurisdictions. If the uncertain tax positions of $226,525 at June 30, 2010 were recognized, they would decrease our annual effective tax rate. We also recorded a liability during the three and six months ended June 30, 2010 for potential interest in the amount of $3,787 and $7,573, respectively. The uncertain tax positions and the accrual for potential interest are included in long-term liabilities. It is our policy to record and classify the provision for interest and penalties as income tax expense. We do not expect our uncertain tax positions to change significantly over the next twelve months.

We are subject to U. S. federal income tax as well as income tax of certain state and foreign jurisdictions. The tax years ranging from 2005 to 2009 remain subject to examination by federal, state and foreign tax authorities. The amount of the net operating loss, or NOL, carryforwards or carrybacks, and other tax attributes that may be utilized to offset taxable income, may be subject to certain limitations, based upon changes in the ownership of the Company’s common stock under IRC Section 382.

8. Basic and Diluted Net Income (Loss) per Share

Basic and diluted net income (loss) per share were determined by dividing net income (loss) by the weighted average common shares outstanding during the periods presented. The number of diluted shares outstanding include the dilutive effect of in-the-money options and warrants which is calculated based on the average share price for each period using the treasury stock method.

 

     For the Three Months Ended    For the Six Months Ended
     June 30,    June 30,
     2010    2009    2010    2009

Weighted average common shares outstanding - basic

   16,019,272    13,204,106    15,346,602    13,152,940

Stock options, warrants

   257,181    -    -    -
                   

Weighted average common shares outstanding - diluted

   16,276,453    13,204,106    15,346,602    13,152,940
                   

 

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The following were not included in the weighted average shares outstanding – diluted because they were anti-dilutive:

 

     For the Three Months Ended    For the Six Months Ended
     June 30,    June 30,
     2010    2009    2010    2009

Stock options

   1,410,322    1,876,035    1,909,635    1,876,035

Warrants

   -    -    2,143,166    -
                   

Total

           1,410,322            1,876,035            4,052,801            1,876,035
                   

9. Comprehensive income (loss)

Comprehensive income (loss), defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, is as follows:

 

     For The Three Months Ended June 30,    For The Six Months Ended June 30,
     2010    2009    2010    2009

Net income (loss)

     $ 2,567,935      $ (3,847,945)      $ (5,348,013)      $ (7,650,718)

Unrealized (loss) gain on marketable securities

     (1,255)      62,010      (2,112)      113,501
                           

Net comprehensive income (loss)

     $         2,566,680      $         (3,785,935)      $         (5,350,125)      $         (7,537,217)
                           

The accumulated other comprehensive loss in the accompanying consolidated balance sheet consists entirely of unrealized losses on marketable securities.

10. Commitments and Contingencies

(a) Litigation

In September 2004, we and the Children’s Medical Center Corporation, or CMCC, filed a civil complaint in the U.S. District Court for the District of Minnesota, or the District Court, for infringement of a patent owned by CMCC and licensed exclusively to us. The complaint alleges that Cardia, Inc., or Cardia, of Burnsville, Minnesota is making, selling and/or offering to sell a medical device in the United States that infringes CMCC’s U.S. patent relating to a device and method for repairing septal defects. We sought an injunction from the District Court to prevent further infringement by Cardia, as well as monetary damages. On August 30, 2006, the District Court entered an order holding that Cardia’s device does not infringe the patent-in-suit. The order had no effect on the validity and enforceability of the patent-in-suit and had no impact on our ability to sell our products. We appealed the ruling to the U.S. Court of Appeals for the Federal Circuit and on June 6, 2007 the Federal Circuit ruled that the District Court incorrectly interpreted one of the patent’s claims and incorrectly found no triable issue of fact concerning other claims. The Federal Circuit remanded the case to the District Court for further proceedings consistent with its opinion and instructed that on remand the district court may reconsider the question of summary judgment for us and CMCC based on the Federal Circuit’s claim construction. On November 8, 2007, the District Court granted summary judgment in our and CMCC’s favor, ruling that Cardia’s device infringes the patent-in-suit and striking all of Cardia’s invalidity defenses. On March 19, 2008, we and CMCC agreed with Cardia to settle this litigation. As part of the settlement, a judgment was entered against Cardia and in favor of us and CMCC, with Cardia agreeing to pay $2.25 million. The settlement will be shared equally between us and CMCC after deduction of our legal fees and expenses. The first and second payments of $500,000 each were received in 2008. We received the third and fourth installments of $375,000 each on March 31, 2009 and June 30, 2009 and we received the fifth and sixth installments of $250,000 each on September 30, 2009 and December 15, 2009. All of these payments were recorded as a reduction to general and administrative expenses, to offset legal fees incurred in connection with this legal proceeding.

In December 2007, we commenced proceedings for defamation against Dr. Peter Wilmshurst in the English High Court. Dr. Wilmshurst has filed a defense to the claim arguing, inter alia, that the words alleged to be defamatory are true. If the matter proceeds to trial, this is likely to take place in 2011. If the case continues, we may be required to pay money into court by way of security for costs. The amount of security depends on whether Dr. Wilmshurst has the funds to pay for further legal representation. Our potential liability is to pay Dr. Wilmshursts’ costs, if we either lose, or withdraw from, the proceedings.

Other than as described above, we have no material pending legal proceedings.

(b) Clinical Trials

We have commitments to third parties in excess of amounts accrued. While these commitments are not significant, we expect to spend significant amounts in our clinical trials.

 

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CLOSURE I

We have committed significant financial and personnel resources to the execution of our pivotal CLOSURE I clinical trial. Including contracts with third party providers, agreements with participating clinical sites, internal clinical department costs and manufacturing costs of the STARFlex® devices to be implanted, total costs are currently estimated to be approximately $31 million through completion of the trial and submission to the FDA. Of this total, approximately $26.4 million was incurred through December 31, 2009. We project 2010 costs to approximate $3.0 million and approximately $1.3 million was incurred during the six months ended June 30, 2010. Patient enrollment was completed in October 2008. On September 16, 2009 we announced that, with guidance from an independent group of statistical advisors and the approval of the CLOSURE I Executive Committee and the FDA, we elected to initiate the data analysis in April 2010, six months earlier than the originally planned October 2010 date. As of April 2010, 99.4% of all patient follow-up months were completed and 95.1% of patients have completed the two-year follow-up and it was determined that there was appropriate statistical power to support testing of the primary outcome result. On June 17, 2010, we announced that we received preliminary results of the data analysis and that the trial did not achieve its primary endpoint: to demonstrate that treatment by device closure with the STARFlex® technology is superior to current best medical therapy for preventing recurrent strokes and TIAs. However, the preliminary results indicate that closure with STARFlex® provided a small, but not statistically significant, benefit over current best medical therapy. The trial’s preliminary results indicate that the safety profile of the STARFlex® device had a low rate of complications, similar to that of current best medical therapy. In addition, there was a very low rate of thrombus formation. Implant closure rate in the trial was 86.5%, which is consistent with our previously reported results for the STARFlex® device. The closure rate reported in the CLOSURE I trial is the first evaluation of a large cohort of randomized patients where the results were adjudicated by an independent core lab. Despite preliminary results of the CLOSURE I data analysis indicating that the trial did not achieve its primary endpoint, we are currently in discussions with the FDA to evaluate our next steps relating to the stroke/TIA indication. We will have the entire patient data available in late October, so the complete CLOSURE I presentation is scheduled for the AHA meeting in mid-November.

11. Loan and Security Agreement

On June 26, 2009 we entered into a Loan and Security Agreement, or the Agreement, with a lending institution.

The Agreement provides for a revolving credit facility, or the Revolving Line, that allows us to borrow up to a maximum of $4 million, subject to borrowing availability. Up to $500,000 of the Revolving Line may be used to secure letters of credit, foreign exchange contracts and cash management services of the calendar month following the advance under the Agreement. The Revolving Line may be used by us to finance working capital needs and matures on June 25, 2011, or the Maturity Date.

The principal amount outstanding under the Revolving Line made pursuant to the Agreement will accrue interest at a floating rate equal to the Lender’s prime rate plus two and one-half percentage points (2.50%), but in no event less than 6.5%, with such interest to be paid monthly, in arrears, and any unpaid principal to be due and payable on the Maturity Date. In addition, we will pay 0.5% per annum to the Lender for any amount not advanced under the line, payable monthly.

On May 3, 2010 we entered into an amendment to the Loan and Security Agreement, or the Loan Modification Agreement, in order to revise certain covenants and we are in compliance with those revised covenants at period end.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of operations of our Company should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2010. Matters discussed in this Quarterly Report on Form 10-Q and in our public disclosures, whether written or oral, relating to future events or our future performance, including any discussion, express or implied, of our anticipated growth, operating results, future earnings per share, plans and objectives, contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are often identified by the words “believe”, “plans”, “estimate”, “project”, “target”, “continue”, “intend”, “expect”, “future”, “anticipates”, and similar expressions that are not statements of historical fact. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Our actual results and timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q and in our other public filings with the Securities and Exchange Commission, or the SEC. It is routine for internal projections and expectations to change as the year or each quarter in the year progresses, and therefore it should be clearly understood that all forward-looking statements and the internal projections and beliefs upon which we base our expectations included in this Quarterly Report on Form 10-Q are made only as of the date of this Quarterly Report on Form 10-Q and may change. While we may elect to update forward-looking statements at some point in the future, we do not undertake any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise.

CRITICAL ACCOUNTING POLICIES

Certain of our accounting policies are particularly important to the portrayal and understanding of our financial position and results of operations and require the application of significant judgment by our management. As a result, these policies are subject to an inherent degree of uncertainty. In applying these policies, we use our judgment in making certain assumptions and estimates. Our critical accounting policies, which consist of revenue recognition, inventory reserves, expenses associated with clinical trials, share-based compensation and fair value measurements of marketable securities and warrants are described in our Annual Report on

Form 10-K for the year ended December 31, 2009, or are described below. With the exception of the update listed below, there have been no material changes to our critical accounting policies since the year ended December 31, 2009.

Fair Value Measurements of Marketable Securities and Warrants

In determining the fair value of our marketable securities, we consider the level of market activity and the availability of prices for the specific security that we hold. If a security is traded in an active market and prices are regularly and readily available (“Level 1 inputs”), valuation of these securities does not entail a significant degree of judgment. When using Level 1 inputs, we do not adjust the quoted market price for such instruments. If we conclude that the market is not active for the identical security we hold, we evaluate various observable data points (“Level 2 inputs”) for the identical security or similar securities in developing the fair value estimates. The identification of similar securities requires some level of judgment. We use quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency to develop our initial value. We also access publicly available market activity from third party databases and credit ratings of the issuers of the securities we hold to corroborate the data used in the fair value calculations obtained from our primary source. We then apply judgment to ensure the fair value is reflective of any credit rating degradation of the issuer or recent marketplace activity. Adjustments to the Level 2 inputs, which are primarily to reflect the volume and level of activity in the markets for the similar securities compared to the security we hold, are evaluated for significance to the overall fair value measurement. We do not have any marketable securities for which the fair value is determined using Level 3 inputs which rely on significant unobservable inputs.

The warrant liability is a Level 3 instrument. We initially recorded the warrant liability at its fair value using the Black-Scholes option-pricing model and revalue it at each reporting date until the warrants are exercised or expire. Changes in the fair value of the warrants are reported in our Statements of Operations as non-operating income or expense under the caption “Gain on change in fair value of warrants”. The fair value of the warrant liability is subject to significant fluctuation based on changes in our stock price, expected volatility, remaining contractual life and the risk-free interest rate. The market price for our common stock has been and may continue to be volatile. Consequently, future fluctuations in the price of our common stock may cause significant increases or decreases in the fair value of the warrant liability.

RESULTS OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2010 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2009

The following table presents consolidated statements of operations information as a reference for management’s discussion and analysis which follows thereafter. This table presents dollar and percentage changes for each listed line item for the three months ended June 30, 2010 compared to the three months ended June 30, 2009, as well as consolidated statements of operations information as a percentage of product sales for such periods.

 

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     Three Months Ended
June 30,
   Increase
(Decrease)

2009  to 2010
   % Change
2009 to  2010
                 
   2010    %    2009    %      
     (In thousands, except percentages)

Product sales

     $ 2,575      100.0%      $ 3,182      100.0%      $ (607)     (19.1)%

Costs and expenses:

                 

Cost of product sales

     1,390      54.0%      1,417      44.5%      (27)     (1.9)%

Research and development

     1,841      71.5%      2,432      76.4%      (591)     (24.3)%

General and administrative

     2,047      79.5%      1,702      53.5%      345      20.3%

Selling and marketing

     1,299      50.4%      1,517      47.7%      (218)     (14.4)%
                                 

Total costs and expenses

     6,577      255.4%      7,068      222.1%      (491)     (6.9)%
                                   

Loss from operations

     (4,002)     (155.4)%      (3,886)      (122.1)%      (116)     3.0%
                                   

Other income (expense):

                 

Gain on change in fair value of warrants

     6,411      249.0%      -      0.0%      6,411      -

Currency transaction (loss) gain

     (24)     (0.9)%      24      0.8%      (48)     (200.0)%

Interest income

     2      0.1%      25      0.8%      (23)     (92.0)%
                                   

Total other income, net

     6,389      248.1%      49      1.5%      6,340      12938.8%
                                   

Income (loss) before income taxes

     2,387     92.7%      (3,837)     (120.6)%      6,224      (162.2)%

Income tax (benefit) expense

     (181)     (7.0)%      11      0.3%      (192)     (1745.5)%
                                   

Net income (loss)

     $     2,568      99.7%      $     (3,848)     (120.9)%      $     6,416      (166.7)%
                                   

REVENUES

THREE MONTHS ENDED JUNE 30, 2010 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2009

 

     Three Months Ended June 30,    Increase
(Decrease)

2009  to 2010
   % Change
2009 to 2010
   2010    2009      
     (In thousands, except percentages)

Product sales:

           

CardioSEAL®, STARFlex® and BioSTAR®:

           

North America

     $       1,914        $ 2,403        $ (489)     (20.3)%

Rest of world

     661        779        (118)     (15.1)%
                         

Total product sales

   $ 2,575        $       3,182        $       (607)     (19.1)%
                         

Product sales for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 decreased by 19.1%. During the second quarter, we believe the medical community was eagerly anticipating the results of our CLOSURE I trial, which we believe slowed the referral pattern and the number of procedures performed during the three months ended June 30, 2010. Tightly managed hospital inventories have continued to impact our sales performance. In an effort to more tightly manage their cash flow, we believe that hospitals are continuing to reduce their inventories. As a result, while our implants continue to be used in procedures, hospitals are taking longer to re-order product in the near-term, thus slowing our sales cycle. Outside of North America, we have experienced an increase in competition in some markets, where foreign manufacturers are able to price their products lower than our prices. Over the past several quarters, we have implemented a strategy designed to increase unit sales of BioSTAR® by developing new distribution partnerships outside of North America. This strategy has worked better in some markets than in others. We now believe a more direct sales strategy, especially in Germany, offers the best potential for improving European implant sales. Sales outside of North America represented approximately 25.7% and 24.5% of total product sales for three months ended June 30, 2010 and 2009, respectively.

Cost of Product Sales. For the three months ended June 30, 2010, cost of product sales, as a percentage of total product sales, was approximately 54.0% compared with approximately 44.5% in the corresponding period in 2009. The increase in cost of product sales as a percentage of product sales was primarily the result of the impact of fixed manufacturing overhead expenses on lower than budgeted production volumes. In addition, royalty expenses also increased as a percentage of sales due to lower sales volumes. For the

 

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full year 2010, we currently expect cost of product sales to be approximately 47.0% of total product sales, compared with approximately 41.6% for fiscal 2009. Included in cost of product sales are royalty expenses of approximately $420,000 and $480,000 for the three months ended June 30, 2010 and 2009, respectively.

Research and Development. Research and development expense decreased approximately $590,000, or 24.3%, for the three months ended June 30, 2010 compared with the three months ended June 30, 2009. The decrease in research and development expenses was primarily due to reduced costs associated with our clinical trials and the timing of expenditures related to our development programs. We currently expect full year 2010 research and development expense to decrease to approximately $7.5 million compared to approximately $8.9 million in 2009. This anticipated decrease is primarily related to the completion of our clinical trial enrollment and patient follow-up work.

General and Administrative. General and administrative expense increased approximately $350,000, or 20.3%, for the three months ended June 30, 2010 compared with the three months ended June 30, 2009. Included as a reduction to general and administrative expense for the three months ended June 30, 2009, is a payment received of $375,000 pursuant to a settlement agreement with Cardia, Inc. Reductions in expense for the three months ended June 30 ,2010, compared to the comparable prior period occurred in payroll costs, insurance costs and professional fees.

General and administrative expense is currently expected to increase to approximately $7.9 million in 2010 compared to approximately $6.8 million in 2009, as a result of non-recurring transactions impacting the prior year. In 2009, recorded as reductions to general and administrative expense were payments received pursuant to settlements with Cardia, Inc. and Gore, Inc. of $1.2 million and $800,000 respectively.

Selling and Marketing. Selling and marketing expense decreased approximately $220,000, or 14.4%, for the three months ended June 30, 2010 compared to the same period in 2009. This decrease was primarily the result of decreased expenses related to lower headcount. We currently expect worldwide selling and marketing expense in 2010 to be approximately $5.2 million, or slightly less than selling and marketing expense in 2009.

Gain on Change in Fair Value of Warrants. The liability related to warrants issued to investors in connection with the February 16, 2010 private placement was initially recorded at fair market value and is adjusted to fair market value at the end of each reporting period. The decrease in the liability from March 31, 2010 to June 30, 2010 of $6.4 million was due primarily to the decrease in our stock price during that period from $4.53 to $0.52. The market price for our common stock has been and may continue to be volatile. Consequently, future fluctuations in the price of our common stock may cause significant increases or decreases in the reported value of the warrant liability.

Currency Transaction Loss. The currency transaction loss of approximately $25,000 for the three months ended June 30, 2010 occurred primarily due to the strengthening of the dollar.

Interest Income. The decrease in interest income of approximately $20,000 for the three months ended June 30, 2010 compared to the same period in 2009 was primarily related to lower cash balances and lower interest rates during 2010. We anticipate only a small amount of interest income in 2010 as interest rates remain low and we maintain conservative investments.

Income Tax Provision. We provide for income taxes based upon our anticipated effective income tax rate. We anticipate incurring a loss in 2010 and therefore have not made a provision for taxes in the three months ended June 30, 2010. For the three months ended June 30, 2010 we recorded an income tax benefit of $190,832, related to the suspended alternative tax net operating loss limitation and extended carryback period recently made available under the Worker, Homeownership, and Business Assistance Act of 2009. For the three months ended June 30, 2010 and 2009 we also recorded income tax expense of $9,774 and $10,557, respectively, for the establishment of a liability for uncertain tax positions, which do not impact our measurement of required valuation allowance on unrealized deferred tax assets.

SIX MONTHS ENDED JUNE 30, 2010 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2009

The following table presents consolidated statements of operations information as a reference for management’s discussion and analysis which follows thereafter. This table presents dollar and percentage changes for each listed line item for the six months ended June 30, 2010 compared to the six months ended June 30, 2009, as well as consolidated statements of operations information as a percentage of product sales for such periods.

 

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     Six Months Ended
June 30,
  

Increase

(Decrease)

   % Change
   2010   

%

   2009   

%

   2009 to 2010    2009 to 2010
   (In thousands, except percentages)

Product sales

     $     5,569      100.0%      $     6,660      100.0%      $     (1,091)     (16.4)%

Costs and expenses:

                 

Cost of product sales

     2,617      47.0%      2,826      42.4%      (209)     (7.4)%

Research and development

     3,664      65.8%      4,627      69.5%      (963)     (20.8)%

General and administrative

     4,003      71.9%      4,104      61.6%      (101)     (2.5)%

Selling and marketing

     2,489      44.7%      2,817      42.3%      (328)     (11.6)%
                               

Total costs and expenses

     12,773      229.4%      14,374      215.8%      (1,601)     (11.1)%
                                   

Loss from operations

     (7,204)     (129.4)%      (7,714)      (115.8)%      510      (6.6)%
                                   

Other income (expense):

                 

Gain on change in fair value of warrants

     1,756      31.5%      -      0.0%      1,756      -  

Currency transaction (loss) gain

     (75)      (1.3)%      3      0.0%      (78)     -  

Interest income

     4      0.1%      81      1.2%      (77)     (95.1)%
                                   

Total other income, net

     1,685      30.3%      84      1.3%      1,601      1906.0%
                                   

Loss before income taxes

     (5,519)     (99.1)%      (7,630)     (114.6)%      2,111      (27.7)%

Income tax (benefit) expense

     (171)     (3.1)%      21      0.3%      (192)     (914.3)%
                                   

Net loss

     $     (5,348)    (96.0)%      $     (7,651)    (114.9)%      $     2,303    (30.1)%
                                   

REVENUES

SIX MONTHS ENDED JUNE 30, 2010 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2009

     Six Months Ended June 30,    Increase
(Decrease)
   % Change
   2010    2009    2009 to 2010    2009 to 2010
               
     (In thousands, except percentages)

Product sales:

           

CardioSEAL®, STARFlex® and BioSTAR®:

           

North America

     $     3,886      $     4,695      $     (809)    (17.2)%

Rest of world

     1,683      1,965      (282)    (14.4)%
                         

Total product sales

     $         5,569      $         6,660      $     (1,091)    (16.4)%
                         

Product sales for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 decreased by 16.4%. During the first six months of 2010, we believe the medical community was eagerly anticipating the results of our CLOSURE I trial, which we believe slowed the referral pattern and the number of procedures performed during that period. Also, tightly managed hospital inventories have continued to impact our sales performance. In an effort to more tightly manage their cash flow, we believe that hospitals are continuing to reduce their inventories. As a result, while our implants continue to be used in procedures, hospitals are taking longer to re-order product in the near-term, thus slowing our sales cycle. Outside of North America, we have experienced an increase in competition in some markets, where foreign manufacturers are able to price their products lower than our prices. Over the past several quarters, we have implemented a strategy designed to increase unit sales of BioSTAR® by developing new distribution partnerships outside of North America. This strategy has worked better in some markets than in others. We now believe a more direct sales strategy, especially in Germany, offers the best potential for improving European implant sales. Sales outside of North America represented approximately 30.2% and 29.5% of total product sales for the six months ended June 30, 2010 and 2009, respectively

Cost of Product Sales. For the six months ended June 30, 2010, cost of product sales, as a percentage of total product sales, was approximately 47.0% compared with approximately 42.4% in the comparable period of 2009. The increase in cost of product sales as a percentage of product sales was primarily the result of the impact of fixed manufacturing overhead expenses on lower than budgeted production volumes. In addition, royalty expenses also increased as a percentage of sales due to lower sales volumes. Included in cost

 

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of product sales were royalty expenses of approximately $900,000 and $1 million for the six months ended June 30, 2010 and 2009, respectively.

Research and Development. Research and development expense decreased approximately $1 million, or 20.8%, for the six months ended June 30, 2010 compared with the six months ended June 30, 2009. The decrease in research and development expenses was primarily due to reduced costs associated with our clinical trials and the timing of expenditures related to our development programs. Additional savings resulted from lower personnel costs.

General and Administrative. General and administrative expense decreased approximately $100,000, or 2.5%, for the six months ended June 30, 2010 compared with the six months ended June 30, 2009. Our former CEO retired as of February 9, 2009 and we entered into a Settlement Agreement and Release at that time. The charges in connection with this agreement, including severance in the form of continued payment of his salary for twelve months in the amount of $460,000, accrued and unused vacation pay in the amount of approximately $35,000, health benefits for a period of 18 months, and the acceleration of the vesting of the CEO’s unvested stock options in the amount of approximately $50,000 were included in general and administrative expenses for the six months ended June 30, 2009. During the six months ended June 30, 2010, in connection with his re-joining our board of directors, we modified certain fully vested stock options of our former CEO, to restore the exercise period to its contractual life. As a result of the modification, we incurred a non-cash charge to general and administrative expense of $243,000. In addition, in the first six months of 2009, we received a payment of $750,000 pursuant to a settlement agreement with Cardia, Inc. For the six months ended June 30, 2010, expense savings were spread across numerous account classifications including insurance and occupancy costs.

Selling and Marketing. Selling and marketing expense decreased approximately $330,000, or 11.6%, for the six months ended June 30, 2010 compared to the same period in 2009. This decrease was primarily the result of decreased expenses related to lower headcount.

Gain on Change in Fair Value of Warrants. The liability related to warrants issued to investors in connection with the February 16, 2010 private placement was initially recorded at fair market value and is adjusted to fair market value at the end of each reporting period. The decrease in the liability from February 16, 2010 to June 30, 2010 of $1.8 million was due primarily to the decrease in our stock price during that period from $1.95 to $0.52.

Currency Transaction Loss. The currency transaction loss of approximately $75,000 for the six months ended June 30, 2010 occurred primarily due to the strengthening of the dollar.

Interest Income. The decrease in interest income for the six months ended June 30, 2010 compared to the same period in 2009 was primarily related to lower cash balances and lower interest rates during 2010.

Income Tax Provision. We provide for income taxes based upon our anticipated effective income tax rate. We anticipate incurring a loss in 2010 and therefore have not made a provision for taxes in the six months ended June 30, 2010. For the six months ended June 30, 2010 we recorded an income tax benefit of $190,832, related to the suspended alternative tax net operating loss limitation and extended carryback period recently made available under the Worker, Homeownership, and Business Assistance Act of 2009. For the six months ended June 30, 2010 and 2009 we also recorded income tax expense of $20,263 and $20,395, respectively, for the establishment of a liability for uncertain tax positions, which do not impact our measurement of required valuation allowance on unrealized deferred tax assets.

LIQUIDITY AND CAPITAL RESOURCES

We have incurred operating losses of $12.5 million and $18.7 million during each of the past two fiscal years, respectively, and have experienced decreasing sales over those time periods. We also incurred an operating loss of $7.2 million for the six months ended June 30, 2010. We have incurred and we have an accumulated deficit of $55.8 million as of June 30, 2010. In addition, we expect to incur significant additional research and development and other costs for the remainder of fiscal 2010—including costs to complete our CLOSURE I trial and continue our discussions with the U.S. Food and Drug Administration, or FDA, to evaluate our next steps relating to the stroke/TIA indication. Our costs, including research and development for our product candidates and sales, marketing and promotion expenses for any of our existing or future products to be marketed by us or our distributors currently exceed and will likely continue to exceed revenues during this period.

We have historically funded our operations primarily through public offerings of equity securities, the sale of non-strategic business assets, and settlements from the successful defense of our patents. At June 30, 2010, we had cash, cash equivalents and marketable securities of approximately $6.5 million.

In tightly managing our capital resources, we have taken several actions over the last year to both reduce our expenditures and further enhance our ability to generate revenue. The reductions in expenditures have included i) general and administrative costs, ii) program specific research and development costs relating to CLOSURE I which will be approximately $500,000 less in 2010 than 2009 and iii) non-program specific research and development costs. We have repositioned our direct sales force in Europe and the rest of the world

 

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to increase coverage and maintain our historical sales levels. Despite our efforts, the Company’s 2010 revenues have declined from 2009 levels more than we anticipated directly impacting our liquidity. As a result, we will and have the ability to further reduce our spending in the coming months to manage our limited resources.

Our primary goal at this time is to bring to completion our CLOSURE I trial. Data analysis for CLOSURE I commenced in April 2010. On June 17, 2010, we announced that we received preliminary results of the data analysis and that the trial did not achieve its primary endpoint: to demonstrate that treatment by device closure with the STARFlex® technology is superior to current best medical therapy for preventing recurrent strokes and TIAs. However, the preliminary results indicate that closure with STARFlex® provided a small, but not statistically significant, benefit over current best medical therapy. The trial’s preliminary results indicate that the safety profile of the STARFlex® device had a low rate of complications, similar to that of current best medical therapy. We will have the entire patient data available in late October, so the complete CLOSURE I presentation is scheduled for the American Heart Association, or AHA, meeting in mid-November. We are in discussions with the FDA to evaluate our possible next steps relating to the stroke/TIA indication. Successful completion of our CLOSURE I clinical trial will require significant expenditures in the last two quarters of 2010 and potentially beyond depending on the results of the discussions with the FDA.

Based on our current projections and plans, we believe that we will be required to raise additional capital to continue our ongoing efforts in bringing the CLOSURE I trial to completion. While we have an established credit facility to draw from that is pledged against certain receivables and inventory, our borrowing availability is significantly limited (approximately $1.0 million at June 30, 2010) based on the covenants of the line. Based on our current anticipated sales levels, the availability under the line will decrease as we progress through the remainder of 2010.

We will continue to review financing alternatives and we will need to raise additional capital within the next six months. We may not be able to obtain additional financing on satisfactory terms. On August 4, 2010, as we previously reported, we received notifications from the NASDAQ of the Company’s failure to comply with the NASDAQ’s minimum per share stock price and market value requirements. We have until January 26, 2011 to regain compliance. Failure to raise capital could materially and adversely impact our business, financial condition, results of operations and cash flows and impact our ability to continue as a going concern.

 

      For the Six Months Ended June 30,
   2010    2009
   (In thousands)

Cash, cash equivalents and marketable securities at period end

     $                   6,534        $                 12,374  

Net cash used in operating activities

     (8,159)       (5,273) 

Net cash provided by investing activities

     (3,413)       11,483  

Net cash provided by financing activities

     5,793        6  

Net Cash Used in Operating Activities

Net cash used in operating activities for the six months ended June 30, 2010 totaled approximately $8.2 million and consisted of a net loss of approximately $5.3 million, a net increase in working capital requirements of approximately $1.6 million and non-cash items impacting the statement of operations of approximately $1.3 million.

The non-cash items of approximately $1.3 million during the six months ended June 30, 2010 consisted of (i) a gain on change in fair value of the warrant liability of approximately $1.8 million, offset by (ii) stock-based compensation, (iii) depreciation of property and equipment and (iv) amortization of bond premium.

The primary elements of the $1.6 million net increase in working capital during the six months ended June 30, 2010 consisted of a decrease in accounts payable and accrued expenses of approximately $1.6 million due primarily to the timing of royalty payments and an increase in inventories of approximately $300,000, offset by a decrease in accounts receivable of approximately $370,000.

Net cash used in operating activities for the six months ended June 30, 2009 totaled approximately $5.3 million and consisted of a net loss of approximately $7.7 million partially offset by a net decrease in working capital requirements of approximately $2.0 million and non-cash charges of approximately $373,000.

The non-cash charges of approximately $373,000 during the six months ended June 30, 2009 consisted of (i) stock-based compensation, (ii) depreciation of property and equipment and (iii) amortization of bond premium.

 

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The primary elements of the $2.0 million net decrease in working capital during the six months ended June 30, 2009 consisted of an increase in accounts payable of approximately $1.7 million due primarily to the timing of royalty payments and decreases in accounts receivable of approximately $760,000 and inventories of approximately $300,000, offset by a decrease in accrued expenses and long-term liabilities of approximately $770,000.

Net Cash (Used In) Provided By Investing Activities

Net cash used in investing activities of approximately $3.4 million during the six months ended June 30, 2010 consisted primarily of approximately $3.4 million of purchases of marketable securities. This compared to net cash provided by investing activities of approximately $11.5 million during the six months ended June 30, 2009.

Net Cash Provided By Financing Activities

Net cash provided by financing activities was approximately $5.8 million and $6,000 for the six months ended June 30, 2010 and 2009, respectively. Cash provided by financing activities for the six month period ended June 30, 2010, were primarily from a private placement of our common stock and warrants to purchase additional shares of common stock to existing shareholders for aggregate proceeds of approximately $5.8 million. Under terms of the placement, we sold 2,678,958 shares of our common stock at a purchase price of $2.15. Included in the financing terms were warrants to purchase an additional 2,143,166 shares of our common stock with an exercise price of $2.90. The warrants are exercisable no earlier than August 17, 2010 and are exercisable until February 16, 2015.

Factors Affecting Sources of Liquidity

We will require additional funds for our research and product development programs, regulatory processes, preclinical and clinical testing, sales and marketing infrastructure and programs and potential licenses and acquisitions. Any additional equity financing will be dilutive to stockholders, and additional debt financing, if available, may involve restrictive covenants. We may not be able to obtain additional financing on satisfactory terms. On August 4, 2010, as we previously reported, we received notifications from the NASDAQ of the Company’s failure to comply with the NASDAQ’s minimum per share stock price and market value requirements. We have until January 26, 2011 to regain compliance. Our capital requirements will depend on numerous factors, including the level of sales of our products, the progress of our research and development programs, the progress of clinical testing, the time and cost involved in obtaining regulatory approvals, the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, competing technological and market developments, developments and changes in our existing research, licensing and other relationships and the terms of any collaborative, licensing and other similar arrangements that we may establish. We also have an established credit facility to draw from, that allows us to borrow up to a maximum of $4 million, subject to borrowing availability, pledged against certain receivables and inventory. This significantly limits our borrowing availability and we currently would not have access to the full credit amount.

OFF-BALANCE SHEET FINANCING

During the quarter ended June 30, 2010, we did not engage in any off-balance sheet activities.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our investments are primarily short-term money market accounts that are carried on our books at cost, which approximates fair market value, and corporate and U.S. government agency debt instruments that are carried on our books at amortized cost, increased or decreased by unrealized gains or losses, net of tax, respectively, which amounts are recorded as a component of stockholders’ equity in our consolidated financial statements. Accordingly, we have no quantitative information concerning the market risk of participating in such investments.

We are subject to market risk in the form of foreign currency risk. We denominate certain product sales and operating expenses in non-U.S. currencies, resulting in exposure to adverse movements in foreign currency exchange rates. These exposures may change over time and could have a material adverse impact on our financial condition.

The warrants we issued on February 16, 2010 in connection with the private placement of our common stock were determined to be derivative financial instruments and accounted for as a liability. We revalue these warrants on a quarterly basis and we reflect the change in value in our reported earnings. We update the value of these warrants using various assumptions, including our stock price as of the end of each reporting period, the historical volatility of our common stock, and risk-free interest rates commensurate with the remaining contractual term of the warrants. Accordingly, changes in our stock price or in interest rates would result in a change in the value of the warrants.

 

ITEM 4. CONTROLS AND PROCEDURES

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2010. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

 

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Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2010, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

In September 2004, we and the Children’s Medical Center Corporation, or CMCC, filed a civil complaint in the U.S. District Court for the District of Minnesota, or the District Court, for infringement of a patent owned by CMCC and licensed exclusively to us. The complaint alleges that Cardia, Inc., or Cardia, of Burnsville, Minnesota is making, selling and/or offering to sell a medical device in the United States that infringes CMCC’s U.S. patent relating to a device and method for repairing septal defects. We sought an injunction from the District Court to prevent further infringement by Cardia, as well as monetary damages. On August 30, 2006, the District Court entered an order holding that Cardia’s device does not infringe the patent-in-suit. The order had no effect on the validity and enforceability of the patent-in-suit and had no impact on our ability to sell our products. We appealed the ruling to the U.S. Court of Appeals for the Federal Circuit and on June 6, 2007 the Federal Circuit ruled that the District Court incorrectly interpreted one of the patent’s claims and incorrectly found no triable issue of fact concerning other claims. The Federal Circuit remanded the case to the District Court for further proceedings consistent with its opinion and instructed that on remand the district court may reconsider the question of summary judgment for us and CMCC based on the Federal Circuit’s claim construction. On November 8, 2007, the District Court granted summary judgment in our and CMCC’s favor, ruling that Cardia’s device infringes the patent-in-suit and striking all of Cardia’s invalidity defenses. On March 19, 2008, we and CMCC agreed with Cardia to settle this litigation. As part of the settlement, a judgment was entered against Cardia and in favor of us and CMCC, with Cardia agreeing to pay $2.25 million. The settlement will be shared equally between us and CMCC after deduction of our legal fees and expenses. The first and second payments of $500,000 each were received in 2008. We received the third and fourth installments of $375,000 each on March 31, 2009 and June 30, 2009 and we received the fifth and sixth installments of $250,000 each on September 30, 2009 and December 15, 2009. All of these payments were recorded as a reduction to general and administrative expenses, to offset legal fees incurred in connection with this legal proceeding.

In December 2007, we commenced proceedings for defamation against Dr. Peter Wilmshurst in the English High Court. Dr. Wilmshurst has filed a defense to the claim arguing, inter alia, that the words alleged to be defamatory are true. If the matter proceeds to trial, this is likely to take place in 2011. Dr. Wilmshurst is reportedly seeking alternative sources of funding, including applying for state aid. If the case continues, we may be required to pay money into court by way of security for costs. The amount of security depends on whether Dr. Wilmshurst has the funds to pay for further legal representation. Our potential liability is to pay Dr. Wilmshursts’ costs, if we either lose, or withdraw from, the proceedings.

Other than as described above, we have no material pending legal proceedings

 

ITEM 1A. RISK FACTORS

The following important factors, among others, could cause actual results to differ materially from those contained in the forward-looking statements made in this Quarterly Report on Form 10-Q and presented elsewhere by us from time to time.

OUR FINANCIAL RESOURCES ARE LIMITED. WE WILL REQUIRE ADDITIONAL FUNDING IN THE NEAR TERM

TO ACHIEVE OUR BUSINESS GOALS.

We have experienced significant operating losses in funding the development of our product candidates, accumulating a deficit of approximately $55.8 million of June 30, 2010, and we expect to continue to incur substantial operating losses for the foreseeable future. We have historically funded our operations primarily through public offerings of common stock, the sale of non-strategic business assets, and settlements from the successful defense of our patents. As of June 30, 2010, we had approximately $6.5 million in cash and cash equivalents. The cash balance includes proceeds from a private placement of our common stock and warrants to purchase additional shares common stock to existing and new shareholders for aggregate proceeds of approximately $5.8 million. Under the terms of the private placement, on February 16, 2010, we sold approximately 2.7 million shares of our common stock at a

 

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purchase price of $2.15 per share. Included in the financing terms were warrants exercisable for an aggregate of an additional 2.1 million shares of our common stock with an exercise price of $2.90 per share.

We will require additional funds for our research and product development programs, regulatory processes, preclinical and clinical testing, sales, marketing and manufacturing infrastructure and programs and potential licenses and acquisitions. Our capital requirements will depend on numerous factors, including the level of sales of our products, the progress of our research and development programs, the progress of clinical testing, the time and cost involved in obtaining regulatory approvals, the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, competing technological and market developments, developments and changes in our existing research, licensing and other relationships and the terms of any collaborative, licensing and other similar arrangements that we may establish. Successful completion of our CLOSURE I clinical trial and bringing the STARFlex® implant with an indication for PFO closure to commercial market in the United States, subject to the approval of the United States Food and Drug Administration, or FDA, and, ultimately, the attainment of profitable operations is dependent upon achieving a level of revenues adequate to support our cost structure and if necessary, obtaining additional financing and/or reducing expenditures. There are no assurances, however, that we will be able to achieve an adequate level of sales to support our cost structure or obtain additional financing on favorable terms, or at all. We believe that we will need to raise additional capital to adequately fund our development programs and market the product, subject to the FDA approval. Failure to raise capital if needed could materially adversely impact our business, financial condition, results of operations and cash flows and impact our ability to continue as a going concern.

Within the next few months we intend to seek additional funding through public or private sales of our equity securities, debt financings, collaborations, licensing arrangements or other strategic transactions. However, we may not be able to obtain sufficient additional funding on satisfactory terms, including potential dilution to existing stockholders, if at all. We believe global economic conditions, including the credit crisis, have adversely impacted our ability to raise additional capital and may continue to do so. If we are unable to obtain additional financing or consummate a strategic transaction on commercially reasonable terms, our business, financial condition and results of operations will be materially and adversely affected and we may be unable to continue as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements. Based on our current working capital and estimated costs of implementing an orderly liquidation of our assets, we do not expect that there will be material cash available for distribution to our stockholders.

WE MAY FACE UNCERTAINTIES WITH RESPECT TO THE EXECUTION, COST AND ULTIMATE OUTCOME OF

CLOSURE I.

In March 2003, the FDA approved CLOSURE I, our investigational device exemption, or IDE, clinical trial comparing STARFlex® structural heart repair implant with medical therapy in preventing recurrent stroke and TIA. The trial is a first of its kind, prospective, multi-center, randomized, controlled clinical trial designed to evaluate the safety and effectiveness of our STARFlex® septal closure system versus medical therapy in patients who have had a stroke and/or a TIA due to a presumed paradoxical embolism through a PFO. On April 23, 2007, we announced that we received conditional approval from the FDA for our revised study hypothesis and statistical plan in the CLOSURE I PFO/stroke and TIA trial in the U.S. Based on a planned interim analysis, the Data Safety Monitoring Board, an independent entity charged with assessing the safety aspects of our study, determined that an enrollment of 900 patients would provide conditional power to show, if it exists, a statistically significant benefit at the end of the data review. In October 2008, we announced that we completed patient enrollment in this clinical trial. In September 2009, we announced that, upon recommendation of the CLOSURE I Executive Committee, initial data analysis would commence in April of 2010. On June 17, 2010, we announced that we received preliminary results of the data analysis and that the trial did not achieve its primary endpoint: to demonstrate that treatment by device closure with the STARFlex® technology is superior to current best medical therapy for preventing recurrent strokes and TIAs. However, the preliminary results indicate that closure with STARFlex® provided a small, but not statistically significant, benefit over current best medical therapy. The trial’s preliminary results indicate that the safety profile of the STARFlex® device had a low rate of complications, similar to that of current best medical therapy. In addition, there was a very low rate of thrombus formation. Implant closure rate in the trial was 86.5%, which is consistent with our previously reported results for the STARFlex® device. The closure rate reported in the CLOSURE I trial is the first evaluation of a large cohort of randomized patients where the results were adjudicated by an independent core lab. We will have the entire patient data available in late October, so the complete CLOSURE I presentation is scheduled for the AHA meeting in mid-November. We currently estimate the total costs of CLOSURE I to be approximately $31 million through completion of the clinical trial. To date, we have incurred approximately $27.7 million in total costs. We have limited direct experience conducting a clinical trial of this magnitude. We cannot be certain that the projected costs of CLOSURE I will not need to be adjusted upwards. Furthermore, we cannot be certain that we will obtain a PMA from the FDA based upon the results of the trial. If CLOSURE I does not result in a PMA, we may face uncertainties and/or limitations as to the growth of revenues of our CardioSEAL® and STARFlex® products, which will negatively impact our profitability.

OUR ABILITY TO RAISE CAPITAL MAY BE LIMITED BY APPLICABLE LAWS AND REGULATIONS.

Under current SEC regulations, at any time during which the aggregate market value of our common stock held by non-affiliates, or public float, is less than $75.0 million (calculated as set forth in Form S-3 and SEC rules and regulations), the amount we

 

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can raise through primary offerings of our securities in any twelve-month period using a registration statement on Form S-3 will be limited to an aggregate of one-third of our public float. As of July 22, 2010, our public float was approximately 15.3 million shares, the value of which was approximately $7.7 million based upon the closing price of our common stock of $0.50 on such date. As of July 22, 2010, the value of one-third of our public float calculated on the same basis was approximately $2.6 million. Alternative means of raising capital through sales of our securities, including through the use of a Form S-1 registration statement, may be more costly and time-consuming.

In addition, our ability to timely raise sufficient capital may be limited by the Nasdaq Capital Market’s requirements relating to stockholder approval for transactions involving the issuance of our common stock or securities convertible into our common stock. For instance, the Nasdaq Capital Market requires that we obtain stockholder approval of any transaction involving the sale, issuance or potential issuance by us of our common stock (or securities convertible into our common stock) at a price less than the greater of book or market value, which (together with sales by our officers, directors and principal stockholders) equals 20% or more of our presently outstanding common stock, unless the transaction is deemed a “public offering” by the Nasdaq Capital Market staff. Based on our outstanding common stock and closing price as of July 22, 2010, we could not raise more than approximately $1.6 million without stockholder approval, unless the transaction is deemed a public offering or does not involve the sale, issuance or potential issuance by us of our common stock (or securities convertible into our common stock) at a price less than the greater of book or market value.

Obtaining stockholder approval is a costly and time-consuming process. If we are required to obtain stockholder approval, we would expect to spend additional money and resources. In addition, seeking stockholder approval would delay our receipt of otherwise available capital, which may materially and adversely affect our ability to continue as a going concern, and there is no guarantee our stockholders would ultimately approve a proposed transaction. A public offering under Nasdaq Capital Market rules typically involves broadly announcing the proposed transaction, which often times has the effect of depressing the issuer’s stock price. Accordingly, the price at which we could sell our securities in a public offering may be less and the dilution existing stockholders experience may in turn be greater than if we were able to raise capital through other means.

RAISING ADDITIONAL CAPITAL MAY CAUSE DILUTION TO OUR EXISTING STOCKHOLDERS, REQUIRE US TO

RELINQUISH PROPRIETARY RIGHTS OR RESTRICT OUR OPERATIONS.

We will likely need to raise additional capital and may do so through one or more financing alternatives, including public or private sales of our equity securities, debt financings, collaborations, licensing arrangements or other strategic transactions. Each of these financing alternatives carries certain risks. Raising capital through the issuance of common stock may depress the market price of our stock and may substantially dilute our existing stockholders. If we instead seek to raise capital through strategic transactions, such as licensing arrangements or sales of one or more of our technologies or product candidates, we may be required to relinquish valuable rights. For example, any licensing arrangement would likely require us to share a significant portion of any revenues generated by our licensed technologies with our licensees. Additionally, the development of any product candidates licensed or sold to third parties will no longer be in our control and thus we may not realize the full value of any such product candidates. Debt financings could involve covenants that restrict our operations. These restrictive covenants may include limitations on additional borrowing and specific restrictions on the use of our assets, as well as prohibitions on our ability to create liens or make investments and may, among other things, preclude us from making distributions to stockholders (either by paying dividends or redeeming stock) and taking other actions beneficial to our stockholders. In addition, investors could impose more one-sided investment terms and conditions on companies that have or are perceived to have limited remaining funds or limited ability to raise additional funds. As we continue to use our cash and cash equivalents to fund our operations, it will likely become increasingly difficult to raise additional capital on commercially reasonable terms, or at all.

SUBSTANTIALLY ALL OF OUR REVENUES ARE DERIVED FROM SALES OF ONE PRODUCT LINE.

In February 1996, we acquired the exclusive rights to the CardioSEAL® cardiac septal repair implant from InnerVentions, Inc., a licensee of the Children’s Medical Center Corporation, or CMCC, also known as Children’s Hospital Boston. In connection with this acquisition, we acquired all of the existing development, manufacturing, testing equipment, patent licenses, know-how and documentation necessary to manufacture cardiac septal repair implant devices. Under the license agreements, as amended, we pay royalties to CMCC on all commercial sales of our cardiac septal repair products. We sell CardioSEAL® in the United States, Canada and Europe. We sell BioSTAR® in Europe and Canada. We sell STARFlex® in the United States and Europe. We derive substantially all of our ongoing revenues from sales of our CardioSEAL®, STARFlex® and BioSTAR® products. As demand for, and costs associated with, these products fluctuates, including the potential impact of our revenue and non-revenue producing PFO IDE clinical trials on product sales, our financial results on a quarterly or annual basis may be significantly impacted. Accordingly, events or circumstances adversely affecting the sales of any of these products would directly and adversely impact our business. These events or circumstances may include reduced demand for our products, lack of regulatory approvals, product liability claims and/or increased competition.

 

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WE FACE UNCERTAINTIES WITH RESPECT TO THE AVAILABILITY OF THIRD-PARTY REIMBURSEMENT.

In the United States, Medicare, Medicaid and other government insurance programs, as well as private insurance reimbursement programs, greatly affect revenues for suppliers of health care products and services. Such third-party payors may affect the pricing or relative attractiveness of our products by regulating the maximum amount, if any, of reimbursement which they provide to the physicians and hospitals using our devices, or any other products that we may develop. If, for any reason, the third-party payors decided not to provide reimbursement for our products, our ability to sell our products would be materially adversely affected. Moreover, mounting concerns about rising healthcare costs may cause the government or private insurers to implement more restrictive coverage and reimbursement policies in the future. In the international market, reimbursement by private third-party medical insurance providers and by governmental insurers and providers varies from country to country. In certain countries, our ability to achieve significant market penetration may depend upon the availability of third-party governmental reimbursement.

WE MAY BE UNABLE TO SUCCESSFULLY GROW OUR PRODUCT REVENUES OR EXPAND GEOGRAPHICALLY DUE TO LIMITED MARKETING AND SALES EXPERIENCE.

Our structural heart repair implant devices are marketed primarily through our direct sales force. Our combined U.S. and European sales and marketing organization headcount is 13. We are uncertain that we can further expand geographically in Europe, Latin America or other potential markets for our products. In order to market directly the CardioSEAL®, STARFlex® and BioSTAR® septal implants and any related products, we will have to continue to develop a marketing and sales organization with technical expertise and distribution capabilities. Expanding in these markets could also impose foreign currency risks on sales not denominated in US dollars, increase our costs to remain in compliance with foreign laws, and heighten risk of non-performance by the other parties to agreements to which the company is a party.

WE MAY BE UNABLE TO COMPETE SUCCESSFULLY BECAUSE OF INTENSE COMPETITION AND RAPID TECHNOLOGICAL CHANGE IN OUR INDUSTRY.

The medical device industry is characterized by rapidly evolving technology and intense competition. Existing and future products, therapies, technological approaches and delivery systems will continue to compete directly with our products. Many of our competitors have substantially greater capital resources, greater research and development, manufacturing and marketing resources and experience and greater name recognition than we do. In addition, new surgical procedures and medications could be developed that replace or reduce the importance of current or future procedures that utilize our products. As a result, any products that we develop may become obsolete before we recover any expenses incurred in connection with development of these products.

WE MAY FACE UNCERTAINTIES WITH RESPECT TO COMMERCIALIZATION, PRODUCT DEVELOPMENT AND MARKET ACCEPTANCE OF OUR PRODUCTS.

We cannot be certain that our current products, or products currently under development, will achieve or maintain market acceptance. Certain of the medical indications that can be treated by our devices can also be treated by surgery, drugs or other medical devices. Currently, the medical community widely accepts many alternative treatments, and these other treatments have a long history of use. We cannot be certain that our devices and procedures will be able to replace such established treatments or that either physicians or the medical community, in general, will accept and utilize our devices or any other medical products that we may develop. In addition, our future success depends, in part, on our ability to develop new and improved implant technology products. Even if we determine that a product candidate has medical benefits, the cost of commercializing that product candidate may be too high to justify development. In addition, competitors may develop products that are more effective, cost less or are ready for commercial introduction before our products. If we are unable to develop additional, commercially viable products, our future prospects will be limited.

WE MAY FACE CHALLENGES IN EXECUTING OUR FOCUSED BUSINESS STRATEGY.

As a result of the 2001 sale of our vena cava filter product line and the 2002 sale of our neurosciences business unit, we have focused our business growth strategy to concentrate on the developing, manufacturing, marketing and selling of our cardiac septal repair implant devices used for structural heart repair. Our future sales growth and financial results depend almost exclusively upon the growth of sales of this product line. CardioSEAL®, STARFlex® and BioSTAR® product sales may not grow as quickly as we expect for various reasons, including, but not limited to, delays in receiving further FDA approvals for additional indications and product enhancements, difficulties in recruiting additional experienced sales and marketing personnel and increased competition. This focus has placed significant demands on our senior management team and other resources. Our future success will depend on our ability to manage and implement our focused business strategy effectively, including:

 

   

achieving successful stroke and/or TIA related clinical trials;

 

   

developing next generation product lines;

 

   

improving our sales and marketing capabilities;

 

   

improving our ability to successfully manage inventory as we expand production;

 

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continuing to train, motivate and manage our employees; and

 

   

developing and improving our operational, financial and other internal systems.

REVENUE GENERATED BY CARS IDE MAY BE LIMITED.

In August 2006, we announced FDA approval for a new PFO/stroke IDE, called CARS. The CARS IDE will supplement our ongoing CLOSURE I clinical trial to evaluate the connection between PFO and stroke. We will provide eligible patients of CARS with our newer STARFlex® implant technology. Patients previously covered by the Humanitarian Device Exemption, or HDE, only had access to our original CardioSEAL® device. The CARS IDE will provide continued PFO closure access to certain patients who previously were eligible for treatment under the HDE. However, while patients in the CLOSURE I trial received the implant at no cost, those covered under the CARS IDE can be charged for the device. We anticipate a shift of some recurrent stroke patients with PFOs to the CARS IDE from the original HDE because patients will have access to the newer STARFlex® technology. At this time it is difficult to determine the impact on product revenue in the U.S. as a result of the transition from paid-for HDE devices to the paid-for devices under CARS. We believe the CARS IDE is a competitive achievement for us and is necessary to accommodate the growing demand for more advanced PFO/stroke treatments.

OUR MANUFACTURING OPERATIONS AND RELATED PRODUCT SALES MAY BE ADVERSELY AFFECTED BY A

REDUCTION OR INTERRUPTION IN SUPPLY AND AN INABILITY TO OR DELAYS IN DEVELOPING

ALTERNATIVE SOURCES OF SUPPLY.

We procure certain components from a sole supplier in connection with the manufacture of some of our products. While we work closely with our suppliers to try to ensure continuity of supply while maintaining high quality and reliability, we cannot guarantee that those efforts will continue to be successful. In addition, due to the stringent regulations and requirements of governmental regulatory bodies, both in the U.S. and abroad, regarding the manufacture of our products, we may not be able to move quickly enough to establish alternative sources for these components. A reduction or interruption in supply, and an inability to develop alternative sources for such supply, would adversely affect our ability to manufacture our products in a timely and cost effective manner and, accordingly, could potentially negatively impact our related product sales.

WE MAY EXPERIENCE LOWER SALES AND EARNINGS DUE TO GOVERNMENT REGULATIONS.

The manufacture and sale of medical devices intended for commercial distribution are subject to extensive governmental regulations in the United States and abroad. Medical devices generally require pre-market clearance or pre-market approval prior to commercial distribution. Certain material changes or modifications to medical devices are also subject to regulatory review and clearance or approval. The regulatory approval process is expensive, uncertain and lengthy. If granted, the approval may include significant limitations on the indicated uses for which a product may be marketed. In addition, any products that we manufacture or distribute are subject to continuing regulation by the FDA. We cannot be certain that we will be able to obtain necessary regulatory approvals or clearances for our products on a timely basis or at all. The occurrence of any of the following events could materially affect our business:

 

   

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

 

   

the loss of previous approvals or clearances, including our voluntary withdrawal of our PFO HDE;

 

   

the ability to enroll patients and charge for implants in the CARS IDE;

 

   

limitations on the intended use of a device imposed as a condition of regulatory approvals or clearances; and

 

   

our failure to comply with existing or future regulatory requirements.

In addition, sales of medical device products outside the United States are subject to foreign regulatory requirements that vary widely from country to country. Failure to comply with foreign regulatory requirements also could materially affect our business.

WE MAY FACE SIGNIFICANT UNCERTAINTY IN THE INDUSTRY DUE TO GOVERNMENT HEALTHCARE

REFORM.

Political, economic and regulatory influences are subjecting the healthcare industry to fundamental changes. President Obama recently signed federal legislation enacting sweeping reforms to the U.S. healthcare industry, including mandatory health insurance, reforms to Medicare and Medicaid, the creation of large insurance purchasing groups, and other significant modifications to the healthcare delivery system. Due to uncertainties regarding the ultimate features of the new federal legislation and its implementation, we cannot predict what impact it may have on us.

 

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WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS AND MAY FACE INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS.

Our success will depend, in part, on our ability to obtain patents, maintain trade secret protection and operate without infringing the proprietary rights of third parties. We cannot be certain that:

 

   

any of our pending patent applications or any future patent applications will result in issued patents;

 

   

the scope of our patent protection will exclude competitors or provide competitive advantages to us;

 

   

any of our patents will be held valid if subsequently challenged; or

 

   

others will not claim rights in or ownership of the patents and other proprietary rights held by us.

Furthermore, we cannot be certain that others have not or will not develop similar products, duplicate any of our products or design around any patents issued, or that may be issued, in the future to us or to our licensors. Whether or not patents are issued to us or to our licensors, others may hold or receive patents which contain claims having a scope that covers products developed by us. We could incur substantial costs in defending any patent infringement suits or in asserting any patent rights, including those granted by third parties. In addition, we may be required to obtain licenses to patents or proprietary rights from third parties. There can be no assurance that such licenses will be available on acceptable terms, if at all.

Our issued U.S. patents expire at various dates ranging from 2010 to 2026. When each of our patents expires, competitors may develop and sell products based on the same or similar technologies as those covered by the expired patent. We have invested in significant new patent applications, and we cannot be certain that any of these applications will result in an issued patent to enhance our intellectual property rights.

WE RELY ON A SMALL GROUP OF SENIOR EXECUTIVES, AND INTENSE INDUSTRY COMPETITION FOR

QUALIFIED EMPLOYEES COULD AFFECT OUR ABILITY TO ATTRACT AND RETAIN NECESSARY, QUALIFIED

PERSONNEL.

We rely on a small group of senior executives and in the medical device field, there is intense competition for qualified personnel, such that we cannot be assured that we will be able to continue to attract and retain the qualified personnel necessary for the development of our business. Both the loss of the services of existing personnel, as well as the failure to recruit additional qualified scientific, technical and managerial personnel in a timely manner, would be detrimental to our anticipated growth and expansion into areas and activities requiring additional expertise. The failure to attract and retain such personnel could adversely affect our business.

WE ARE EXPOSED TO UNCERTAIN ROYALTY EXPENSE IN EXCESS OF ROYALTY REVENUE.

Commencing in 2003, we earned royalties from C.R. Bard, Inc., or Bard, on its sales of the vena cava filter products we sold to Bard in 2001. Since 2008, the royalty rate we receive from Bard decreased substantially from the royalty rate we earned prior to 2008, while the royalty rate we pay to the estate of the original inventor of these products will remain the same. Accordingly, we cannot assure you of the actual royalty expense we will incur in 2010.

OUR LIMITED MANUFACTURING HISTORY AND THE POSSIBILITY OF NON-COMPLIANCE WITH

MANUFACTURING REGULATIONS RAISE UNCERTAINTIES WITH RESPECT TO OUR ABILITY TO

COMMERCIALIZE FUTURE PRODUCTS.

We have a limited history in manufacturing our products, including our CardioSEAL®, STARFlex® and BioSTAR® structural heart repair implants, and we may face difficulties as the commercialization of our products and the medical device industry changes. Increases in our manufacturing costs, or significant delays in our manufacturing process, could have a material adverse effect on our business.

The FDA and other regulatory authorities require that our products be manufactured according to rigorous standards including, but not limited to, Good Manufacturing Practices and International Standards Organization, or ISO, standards. These regulatory requirements may significantly increase our production or purchasing costs and may even prevent us from making or obtaining our products in amounts sufficient to meet market demand. If we or a third-party manufacturer change our approved manufacturing process, the FDA will require a new approval before that process could be used. Failure to develop our manufacturing capabilities may mean that, even if we develop promising new products, we may not be able to produce them profitably, as a result of delays and additional capital investment costs.

PRODUCT LIABILITY CLAIMS, PRODUCT RECALLS AND UNINSURED OR UNDERINSURED LIABILITIES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.

The testing, marketing and sale of implantable devices and materials carry an inherent risk that users will assert product liability claims against us or our third-party distributors. In these claims, users might allege that their use of our devices had adverse effects on

 

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their health. A product liability claim or a product recall could have a material adverse effect on our business. Certain of our devices are designed to be used in life-threatening situations where there is a high risk of serious injury or death. Although we currently maintain limited product liability insurance coverage, we cannot be certain that in the future we will be able to maintain such coverage on acceptable terms, or that current insurance or insurance subsequently obtained will provide adequate coverage against any or all potential claims. Furthermore, we cannot be certain that we will avoid significant product liability claims and the attendant adverse publicity. Any product liability claim, or other claim, with respect to uninsured or underinsured liabilities could have a material adverse effect on our business.

OUR EXPANDING NON-US OPERATIONS EXPOSE US TO RISK INHERENT IN FOREIGN OPERATIONS.

As we increase our presence in Europe, Canada and Latin America, the impact of foreign currency fluctuations on our revenue and expenses could have an adverse impact on our profitability.

 

ITEM 6. EXHIBITS

See the Exhibit Index on page 28 of this quarterly report on Form 10-Q.

 

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SIGNATURES

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

 

  NMT MEDICAL, INC.
Date: August 11, 2010   By:  

/s/ FRANCIS J. MARTIN

    Francis J. Martin
    President and Chief Executive Officer
Date: August 11, 2010   By:  

/s/ RICHARD E. DAVIS

    Richard E. Davis
    Chief Operating Officer and Chief Financial Officer

 

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EXHIBIT INDEX

 

Number

  

Description of Exhibit

31.1    Certification of Francis J. Martin, President and Chief Executive Officer, pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.
31.2    Certification of Richard E. Davis, Chief Operating Officer and Chief Financial Officer, pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended.
32.1    Certification of Francis J. Martin, President and Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of Richard E. Davis, Chief Operating Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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