-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LZftV5mLfS9hr+KOMCzKzxfbvzBNNf+ZFTSxQyXn6CsrI/eaCVbFoAkkYtcAM9oq GmzoO6MDN4QMyPsWZrA5Yg== 0000950134-05-009444.txt : 20050509 0000950134-05-009444.hdr.sgml : 20050509 20050509162125 ACCESSION NUMBER: 0000950134-05-009444 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050509 DATE AS OF CHANGE: 20050509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ATS MEDICAL INC CENTRAL INDEX KEY: 0000824068 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 411595629 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-18602 FILM NUMBER: 05812007 BUSINESS ADDRESS: STREET 1: 3905 ANNAPOLIS LA STREET 2: SUITE 105 CITY: MINNEAPOLIS STATE: MN ZIP: 55447 BUSINESS PHONE: 6125537736 MAIL ADDRESS: STREET 1: 3905 ANNAPOLIS LANE STREET 2: SUITE 105 CITY: MINNEAPOLIS STATE: MN ZIP: 55447 FORMER COMPANY: FORMER CONFORMED NAME: ATS MEDCIAL INC DATE OF NAME CHANGE: 19920803 10-Q 1 c95107e10vq.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------- FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005 COMMISSION FILE NO. 0-18602 ATS MEDICAL, INC. (Exact name of registrant as specified in its charter) MINNESOTA 41-1595629 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3905 ANNAPOLIS LANE N., SUITE 105 MINNEAPOLIS, MINNESOTA 55447 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (763) 553-7736 Not Applicable ------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] The number of shares outstanding of each of the registrant's classes of common stock as of April 29, 2005, was: Common Stock, $.01 par value 30,974,354 shares ================================================================================ TABLE OF CONTENTS
Page(s) ------- PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of March 31, 2005, and December 31, 2004 3 Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004 4 Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004 5 Notes to Consolidated Financial Statements 6 - 7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 - 18 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 19 ITEM 4. Controls and Procedures 19 PART II. OTHER INFORMATION ITEM 6. Exhibits 20 SIGNATURES 21 EXHIBIT INDEX 22
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ATS MEDICAL, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share and share data)
MARCH 31, DECEMBER 31, 2005 2004 ----------- ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents $ 5,364 $ 8,302 Short-term investments 4,296 7,692 Accounts receivable, net 8,049 7,893 Other receivables 300 - Inventories 26,982 24,303 Prepaid expenses 1,050 1,053 ----------- ------------ Total current assets 46,041 49,243 Leasehold improvements, furniture and equipment, net 7,865 7,650 Inventories - 3,000 Intangible assets 18,713 18,720 Other assets 436 438 ----------- ------------ Total assets $ 73,055 $ 79,051 =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,811 $ 4,049 Accrued compensation 1,208 1,797 Accrued distributor liabilities 560 527 Other accrued liabilities 341 430 Due to related party 217 217 Current maturities of note payable 833 764 ----------- ------------ Total current liabilities 5,970 7,784 Due to related party 36 90 Note payable 1,528 1,736 Shareholders' equity: Common stock, $.01 par value: authorized 40,000,000 shares; issued and outstanding 30,924,254 and 30,889,637 shares at March 31, 2005 and December 31, 2004 309 309 Additional paid-in capital 136,648 136,562 Deferred compensation (14) (24) Accumulated other comprehensive income 38 95 Accumulated deficit (71,460) (67,501) ----------- ------------ Total shareholders' equity 65,521 69,441 ----------- ------------ Total liabilities and shareholders' equity $ 73,055 $ 79,051 =========== ============
The accompanying notes are an integral part of the consolidated financial statements. 3 ATS MEDICAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (in thousands, except per share data)
THREE MONTHS ENDED MARCH 31, ---------------------------- 2005 2004 -------- -------- Net sales $ 7,063 $ 6,694 Cost of goods sold 4,301 4,766 -------- -------- Gross profit 2,762 1,928 Operating expenses: Sales and marketing 4,731 3,666 Research and development 302 187 General and administrative 1,689 1,381 -------- -------- Total operating expenses 6,722 5,234 -------- -------- Operating loss (3,960) (3,306) Net interest income (expense) 1 1 -------- -------- Net loss ($ 3,959) ($ 3,305) ======== ======== Net loss per share: Basic and diluted ($ 0.13) ($ 0.12) ======== ======== Weighted average number of shares used in calculation: Basic and diluted 30,913 26,802 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 4 ATS MEDICAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (unaudited) (in thousands)
THREE MONTHS ENDED MARCH 31, ---------------------------- 2005 2004 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss ($ 3,959) ($ 3,305) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 369 265 Loss on disposal of equipment 17 - Compensation expense on stock options 4 25 Non-cash interest expense 7 - Changes in operating assets and liabilities: Accounts and other receivables (456) (920) Inventories 321 3,688 Prepaid expenses 5 (209) Other assets - 4 Accounts payable and accrued expenses (1,937) (36) -------- -------- Net cash used by operating activities (5,629) (488) CASH FLOWS FROM INVESTING ACTIVITIES Purchase of short-term investments (497) (996) Sale of short-term investments 3,893 1,246 Purchases of furniture, machinery and equipment (601) (108) -------- -------- Net cash provided by investing activities 2,795 142 CASH FLOWS FROM FINANCING ACTIVITIES Repayments of note payable (139) - Net proceeds from sales of common stock 92 118 -------- -------- Net cash provided by (used in) financing activities (47) 118 -------- -------- Effect of exchange rate changes on cash (57) (11) -------- -------- Decrease in cash and cash equivalents (2,938) (239) Cash and cash equivalents at beginning of period 8,302 6,472 -------- -------- Cash and cash equivalents at end of period $ 5,364 $ 6,233 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. 5 ATS MEDICAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1. BASIS OF PRESENTATION The consolidated financial statements included in this Form 10-Q have been prepared by ATS Medical, Inc. (hereinafter the "Company," "ATS," "we," "us," or "our") without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The consolidated financial statements include the accounts of the Company and its subsidiaries, and all significant inter-company accounts and transactions are eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to these rules and regulations. The year-end balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. These unaudited consolidated interim financial statements should be read in conjunction with the Company's consolidated financial statements and related notes included in its Annual Report on Form 10-K for 2004. These statements reflect, in management's opinion, all adjustments (which include only normal, recurring adjustments) necessary for a fair presentation of the financial position and the results of operations and cash flows for the periods presented. The results of operations for any interim period may not be indicative of results for the full year. NOTE 2. STOCK-BASED COMPENSATION The Company accounts for its stock-based employee compensation plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The exercise price of the Company's employee stock options generally equals the market price of the underlying stock on the date of grant for all options granted, and thus, under APB 25, no compensation expense is recognized. Stock options granted to non-employees are valued and accounted for in accordance with Financial Accounting Statement No. 123, Accounting for Stock-Based Compensation (FAS 123). Accordingly, these costs are charged to operating expenses over the vesting period of the option. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based employee compensation.
Three months ended March 31, ------------------ (in thousands, except per share data) 2005 2004 - ---------------------------------------------- -------- -------- Net loss, as reported ($ 3,959) ($ 3,305) Less: Total stock-based employee compensation expense determined under fair value based method for all awards (519) (673) -------- -------- Pro forma net loss ($ 4,478) ($ 3,978) ======== ======== Net loss per share: As reported Basic and diluted ($ 0.13) ($ 0.12) Pro forma Basic and diluted ($ 0.14) ($ 0.15)
6 NOTE 3. INVENTORIES Inventories consist of the following:
March 31, December 31, (in thousands) 2005 2004 - ---------------------------- --------- ------------ Raw materials $ 7,010 $ 7,780 Work in process 7,280 7,258 Finished goods 12,857 12,465 Obsolescence reserve (165) (200) --------- ------------ Total, net $ 26,982 $ 27,303 ========= ============ Balance sheet classification Current assets $ 26,982 $ 24,303 Non-current assets - 3,000 --------- ------------ Total, net $ 26,982 $ 27,303 ========= ============
At December 31, 2004, the Company maintained significant levels of inventory that exceeded current demand. Therefore, the Company classified $3.0 million of inventories as non-current assets at December 31, 2004. NOTE 4. COMPREHENSIVE INCOME Comprehensive income for the Company includes net income from foreign currency translation which is charged or credited to the cumulative translation account within shareholders' equity. Gains and losses from foreign currency translation are not material. NOTE 5. NEW PRONOUNCEMENTS On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (Revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. The effective date of Statement 123(R) has been delayed and must now be adopted by the Company no later than January 1, 2006. Early adoption will be permitted in periods in which financial statements have not yet been issued. Management expects to adopt Statement 123(R) on January 1, 2006. Management is evaluating which methodology to use in adopting Statement 123(R) and has not determined what effect it will have on its financial statements. In December 2004, the Financial Accounting Standards Board issued FASB Statement No. 151, Inventory Costs. Statement 151 requires abnormal amounts of inventory costs related to idle facility, freight handling, and wasted material expenses to be recognized as current period charges. Additionally, SFAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The standard is effective for fiscal years beginning after June 15, 2005. The Company believes the adoption of SFAS 151 will not have a material impact on its consolidated financial results. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "may," "expect," "believe," "anticipate," or "estimate," identify such forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially from those expressed in such forward-looking statements. Some of the factors that could cause such material differences are identified in "Cautionary Statement." below. We undertake no obligation to correct or update any forward-looking statements, whether as a result of new information, future events, or otherwise. You are advised, however, to consult any future disclosures we make on related subjects in future filings with the SEC. EXECUTIVE OVERVIEW We develop, manufacture, and market medical devices. Our primary interest lies with devices used by cardiovascular surgeons in the cardiac surgery operating theater. Currently, we participate in the mechanical bileaflet portion of the replacement heart valve market and in the market for the surgical treatment of atrial fibrillation. We also are engaged in a development project for autotransfusion products. Carbomedics, Inc. (f/k/a Sulzer Carbomedics, Inc.) developed the basic design from which the ATS heart valve evolved. Carbomedics is a large and experienced manufacturer of pyrolytic carbon components used in mechanical heart valves. Carbomedics has also designed and patented numerous mechanical valves. Carbomedics offered to license a patented and partially developed valve to us if we would complete the development of the valve and agree to purchase carbon components from Carbomedics. We hold an exclusive, royalty-free, worldwide license to an open pivot, bileaflet mechanical heart valve design owned by Carbomedics from which the ATS heart valve has evolved. In addition, we have an exclusive, worldwide right and license to use Carbomedics' pyrolytic carbon technology to manufacture components for the ATS heart valve. We commenced selling the ATS heart valve in international markets in 1992. In October 2000, we received FDA approval to sell the ATS Open Pivot(R) MHV and commenced sales and marketing of our valve in the United States. The original sales forecasts as well as the pricing models that were used when the original supply agreement was signed with Carbomedics proved to be too optimistic. Accordingly, to keep the supply agreement active and the license to sell the valve exclusive, we purchased quantities of inventory far in excess of demand. From 1990 through 2002, we paid Carbomedics approximately $125 million for the development of our valve, the technology to manufacture our pyrolytic carbon components, and for pyrolytic valve components manufactured by Carbomedics. On December 31, 2002, we had remaining payments due under our technology agreement with Carbomedics that totaled $28 million. This led us in 2003 to negotiate an accelerated but reduced payment for all outstanding debts to Carbomedics related to the technology agreement. In August 2003 we paid $12 million to satisfy all future obligations under this agreement. With inventory purchases exceeding sales through the years, we built up significant inventories. The drawing down of these inventories since 2002 has provided a source of cash for operations. During 2004, we started manufacturing our own carbon components. In 2005 our manufacturing levels will approach our sales and in 2006 our inventory levels will flatten with manufacturing and sales being more in balance. We have been steadily building both our domestic and international sales and marketing infrastructure since 2003. This rebuilding is the most significant factor in our expense levels since that time. Because sales prices in the United States exceed selling prices elsewhere, we feel that our future success will depend on achieving increased market share in the United States. Our U.S. sales as a percentage of our overall sales have grown from 4% in 2000 to 41% during the first quarter of 2005. During 2004, we made our first ventures outside the mechanical heart valve market by completing two business development agreements. The first, signed in April 2004, is with ErySave AB (ErySave), a Swedish research firm, for exclusive worldwide rights to ErySave's PARSUS filtration technology for cardiac surgery procedures. We had no revenues in 2004 nor do we expect any for 2005 from this technology. In November, we completed a global partnership agreement with CryoCath Technologies, Inc. (CryoCath) to market CryoCath's surgical cryotherapy products for the ablation of cardiac arrhythmias. We realized revenue from the CryoCath agreement starting in the first quarter of 2005. 8 CRITICAL ACCOUNTING POLICIES AND ESTIMATES We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Management's discussion and analysis of financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect (1) the reported amounts of assets, liabilities, revenues, and expenses; and (2) the related disclosure of contingent assets and liabilities. At each balance sheet date, we evaluate our estimates and judgments. The critical accounting policies that are most important to fully understanding and evaluating the financial condition and results of operations are discussed in our most recent Annual Report on Form 10-K on file with the SEC. RESULTS OF OPERATIONS The following table compares the dollar and percentage change in the Statements of Operations for the three month periods ended March 31, 2005 and 2004.
Three months ended March 31, --------------------------------------- Increase 2005 2004 (Decrease) % -------- ------- ---------- ----- Net sales $ 7,063 $6,694 $ 369 5.5% Cost of goods sold 4,301 4,766 (465) -9.8% -------- ------- ---------- ----- Gross profit 2,762 1,928 834 43.3% Gross profit % 39.1% 28.8% Operating expenses: Sales and marketing 4,731 3,666 1,065 29.1% Research and development 302 187 115 61.5% General and administrative 1,689 1,381 308 22.3% -------- ------- ---------- ----- Total operating expenses 6,722 5,234 1,488 28.4% -------- ------- ---------- ----- Operating loss (3,960) (3,306) (654) -19.8% Net interest income (expense) 1 1 - 0.0% -------- ------- ---------- ----- Net loss ($ 3,959) ($3,305) ($ 654) -19.8% ======== ======= ========== =====
The following table presents the statement of operations as a percentage of net sales for the three month periods ended March 31, 2005 and 2004:
Three months ended March 31, ------------------ 2005 2004 ----- ----- Net sales 100.0% 100.0% Cost of goods sold 60.9% 71.2% ----- ----- Gross profit 39.1% 28.8% Operating expenses: Sales and marketing 67.0% 54.8% Research and development 4.3% 2.8% General and administrative 23.9% 20.6% ----- ----- Total operating expenses 95.2% 78.2% ----- ----- Operating loss -56.1% -49.4% Net interest income (expense) 0.0% 0.0% ----- ----- Net loss -56.1% -49.4% ===== =====
9 Net Sales. The following tables compare net sales between the three month periods ended March 31, 2005 and 2004:
Three months ended March 31, --------------------------------------- Increase (in thousands) 2005 2004 (Decrease) % - --------------------- -------- -------- ---------- ---- United States $ 2,870 $ 2,390 $ 480 20.1% Outside United States 4,193 4,304 (111) -2.6% -------- -------- ---------- ---- Total net sales $ 7,063 $ 6,694 $ 369 5.5% ======== ======== ========== ====
Three months ended March 31, ------------------ 2005 2004 ----- ----- Share of total net sales: United States 40.6% 35.7% Outside United States 59.4% 64.3% ----- ----- Total net sales 100.0% 100.0% ===== =====
2005 change in Mechanical Heart Valve sales ---------------------------- Average Sales Unit Price Sales Total ------- ----- ----- United States -0.1% 10.1% 10.1% Outside United States -9.6% 4.4% -5.6% ---- ---- ---- Total change -5.0% 5.3% 0.0% ==== ==== ====
Our U.S. sales organization in 2005 consists of four area directors managing 31 sales territories, compared to 27 territories in early 2004. Our representation within these territories consists of both direct sales representatives and independent agents. This new sales organization and overall greater sales efforts contributed to our increase in sales for the first three months of 2005 and to our sales within the U.S. accounting for a larger percentage of overall sales. Also contributing to our net sales growth in the first quarter of 2005 was initial commission income and direct sales revenue from CryoCath's surgical cryotherapy products under the global partnership agreement entered into in November 2004. Since 2003, we have aggressively entered several international markets that represent opportunities for greater sales unit growth but at prices lower than our other markets. Prices in some of these territories are lower than our current manufacturing costs. We feel this strategy is reasonable because it allows us to increase our market share while reducing our high priced but paid-for inventories. Once we have exhausted our high priced components, we expect to have lower manufacturing costs per valve which will allow us to realize gross profit in these international markets. Cost of goods sold. Our cost of goods sold as a percentage of net sales has varied due to changes in average selling price. Our gross profit is anticipated to improve as sales within the Unites States increase as a percentage of total sales and as we start selling valves that have been entirely manufactured in our facilities. Our inventories of high priced carbon components currently exceed our expected sales during 2005. The ATS valve is made of materials that do not deteriorate. Other than the need to resterilize the valves periodically, there is no risk of perishability. Pyrolytic carbon, which is the substrate used in manufacturing our valves, has been the only material used to manufacture mechanical heart valves for humans for many years and remains the most advanced raw material for our products. The other sources of prosthetic heart valves for humans are cadaver, bovine and porcine tissues. Inventory obsolescence issues are remote because of certain advantages offered by mechanical heart valves, including superior durability. Similarly, we believe that, given the lead time that would be required, there is no material risk that there would be the introduction and FDA 10 approval of another substrate that would replace pyrolytic carbon prior to the end of the period over which we expect to sell our inventory of valves. Before 2004, all purchased pyrolytic carbon components for the ATS heart valve came from Carbomedics pursuant to a multi-year supply agreement entered into in 1990. The cost of the pyrolytic carbon components represents approximately 80% of the total cost of the ATS heart valve. Under the supply agreement, the cost of the pyrolytic carbon components has varied according to annual volume purchases and has been adjusted annually by reference to increases in the U.S. Department of Labor Employment Cost Index. The supply agreement with Carbomedics is still in effect but has been re-negotiated several times. Our current obligations under the supply agreement call for future purchase obligations starting in 2007 and continuing through 2011. We maintain significant levels of carbon components in inventory due to past purchase requirements under the supply agreement. In addition, the cost of these components has been high and at times exceeded selling prices, necessitating lower of cost or market write-downs of inventories. Pyrolytic carbon purchases after 2000 were at a lower cost than previous purchases. As these lower priced carbon sets are manufactured into finished valves and sold, our gross profit increased. Also contributing to the higher gross profit for the first three months of 2005 was the initial commission revenue and direct sales from sales of CryoCath's surgical cryotherapy products discussed above. Without the CryoCath revenue, gross profit as a percent of net sales for the three months ended March 31, 2005 would have been 2.7% lower than the actual gross profit of 39.1%. Sales and Marketing. Cost increases in the first three months of 2005 over the same period in 2004 were for further development, mostly increased personnel costs, of our worldwide sales and marketing organization. Our U.S. sales and marketing costs increased approximately $0.6 million to support an increase in sales territories, the development of marketing programs in support of the new CryoCath products, and new marketing programs directed at increasing the U.S. market share of our mechanical heart valves. Internationally, our costs increased approximately $0.5 million to support efforts to go direct in China and Germany, and increased sales management. Research and development. Research and development expenses increased $0.1 million for the first three months of 2005 over the same period in 2004 and include the costs to develop and improve current and future products and the costs for regulatory and clinical activities for these products. The increase in R & D spending reflects staff additions as well as an increase in the number of R & D programs. General and administrative. G & A expenses increased $0.3 million for the first three months of 2005 over the same period in 2004. Major cost increases were for employee salary and benefits of $0.1 million and outside consulting services relating primarily to our costs of documenting and testing internal controls of $0.1 million. Net interest income (expense). Interest income is primarily attributable to the investment of our cash balances. In July 2004, we entered into an agreement for a credit facility consisting of a $2.5 million term note and a $6.0 million line of credit, and we fully drew down the term note. Interest expense will be higher in future periods if we borrow funds under the line of credit. Income taxes. At the end of 2004, we had accumulated approximately $62 million of net operating loss (NOL) carryforwards for U.S. tax purposes. We believe that our ability to fully utilize the existing NOL carryforwards could be restricted on a portion of the NOL for changes in control that may have occurred or may occur in the future. We have not conducted a formal study of whether a change in control of ATS has occurred in the past that impairs our NOL carryforwards because we are unable to utilize such NOL carryforwards until we achieve profitability and because this study would be very expensive to complete. When we attain profitability, we will conduct a formal study of any restrictions on our carryforwards. We have not recorded any net assets related to our NOL carryforwards and other deferred items as we currently cannot determine that it is reasonably likely that this asset will be realized and we, therefore, have provided a valuation allowance for the entire asset. Net loss. Our net loss increased $0.7 million to $4.0 million for the first three months of 2005 from a net loss of $3.3 million for the same period in the prior year. The increase in net loss resulted from changes in sales offset by changes in operating costs, all of which are described above. 11 LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and short-term investments were $9.7 million as of March 31, 2005, compared to $16.0 million as of December 31, 2004. This decrease in cash, cash equivalents, and short-term investments is discussed below. Operating activities. During the first three months of 2005, we received cash payments from customers of approximately $6.6 million. We made cash payments to employees and suppliers of approximately $12.2 million. Our operating loss during the first three months of 2005 of $4.0 million was substantially funded through existing cash and investment balances. We have incurred significant expenses commercializing the ATS heart valve in the United States. As we build sales in future periods and our cost of inventories decreases, our operating losses will decrease, and we expect to move steadily towards a cash flow breakeven on sales and eventually to profitability. We believe our current cash and investment balances are adequate to fund our operating activities during 2005. Investing activities. During the first three months of 2005, we purchased equipment, machinery and furniture totaling $0.6 million. For the remainder of 2005, we expect to purchase approximately $2.0 million of additional equipment. Capital purchases during 2005 have been mainly in support of increasing production in our pyrolytic carbon facility. Financing Activities. During each of the first three months of 2005 and 2004, we raised approximately $0.1 million through the issuance of common stock through stock options and our employee stock purchase plan. In July 2004, we entered into a secured credit facility consisting of a $2.5 million term note and a $6.0 million line of credit, and we fully drew down the $2.5 million term note. The term note calls for equal installment payments over 36 months which commenced in February 2005. Accordingly, during the first three months of 2005, we repaid $0.14 million on the note. Under the secured credit facility, we are subject to certain financial covenants, including a liquidity ratio of not less than 2.25 to 1 and a net tangible net worth of at least $46 million through March 31, 2005. At March 31, 2005, the Company was in violation of its liquidity ratio covenant, which was waived by the bank in a letter dated May 6, 2005. Effective April 1, 2005, the credit facility agreement was amended to change the liquidity ratio covenant to 2.0 to 1, and the net tangible net worth covenant to $39 million through June 30, 2005, and $36 million thereafter. CASH MANAGEMENT During 2005 and into 2006, we will deplete our high priced but paid-for inventories of pyrolytic carbon components. We have started increasing production of these components in our own factory. This will require the use of cash as we purchase raw materials and incur employee costs and overhead to manufacture the inventory. We estimate that operating costs will remain high in comparison to sales during 2005 and will require the use of cash to fund operations. We will draw down cash balances to build inventories and fund operations during 2005. In April 2004 we signed an exclusive development and licensing agreement with ErySave AB and made an initial milestone payment of approximately $0.2 million. Future payments under this agreement, based upon the attainment of developmental milestones, could total an additional $1.1 million. These payments are expected to occur during 2005 and 2006. In November 2004 we signed a global partnership agreement with Canadian-based CryoCath Technologies, Inc. to market CryoCath's surgical cryotherapy products for the ablation of cardiac arrhythmias. For certain customers to which we will market, we have agreed to make a payment to CryoCath representing a portion of the prior year's sales to these customers and future payments of a certain percentage of the sales occurring over the following three-year period. These payments are refundable to us upon cancellation of the agreements. We expect that these payments will occur during the second quarter of 2005. Based upon the current forecast of sales and operating expenses, we anticipate having cash to fund our operations through 2005. However, as identified under the heading of "Cautionary Statements" below, any adverse change that affects our revenue, access to the capital markets or future demand for our products will affect our long-term viability. Maintaining adequate levels of working capital depends in part upon the success of our products in the marketplace, the relative profitability of those products and our ability to control operating 12 and capital expenses. Funding of our operations in future periods may require additional investments in ATS in the form of equity or debt. There can be no assurance that we will achieve desired levels of sales or profitability, or that future capital infusions will be available. OFF-BALANCE SHEET ARRANGEMENTS We do not have any "off-balance sheet arrangements" (as such term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. CAUTIONARY STATEMENTS This document contains forward-looking statements within the meaning of federal securities laws that may include statements regarding intent, belief or current expectations of our Company and our management. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information without fear of litigation so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statement. We desire to take advantage of these "safe harbor" provisions. Accordingly, we hereby identify the following important factors which could cause our actual results to differ materially from any such results which may be projected, forecast, estimated or budgeted by us in forward-looking statements made by us from time to time in reports, proxy statements, registration statements and other written communications, or in oral forward-looking statements made from time to time by the Company's officers and agents. We do not intend to update any of these forward-looking statements after the date of this Form 10-Q to conform them to actual results. IF OUR HEART VALVE DOES NOT ACHIEVE WIDESPREAD MARKET ACCEPTANCE IN THE UNITED STATES, OUR OPERATING RESULTS WILL BE HARMED AND WE MAY NOT ACHIEVE PROFITABILITY. Our success will depend, in large part, on the medical community's acceptance of the ATS heart valve in the United Sates, which is the largest revenue market in the world for heart valves. The U.S. medical community's acceptance of the ATS heart valve will depend upon our ability to demonstrate the safety and efficacy, advantages, long-term clinical performance and cost-effectiveness of the ATS heart valve as compared to other prosthetic heart valves. We cannot predict whether the U.S. medical community will accept the ATS heart valve or, if accepted, the extent of its use. Negative publicity resulting from isolated incidents involving the ATS heart valve or other prosthetic heart valves could have a significant adverse effect on the overall acceptance of our heart valve. If we encounter difficulties developing a market for the ATS heart valve in the United States, we may not be able to increase our revenue enough to achieve profitability and our business and results of operations will be seriously harmed. WE CURRENTLY RELY ON THE ATS HEART VALVE AS OUR PRIMARY SOURCE OF REVENUE. IF WE ARE NOT SUCCESSFUL IN SELLING THIS PRODUCT, OUR OPERATING RESULTS WILL BE HARMED. We have developed only one product, which is currently being sold primarily outside the United States. Even if we were to develop additional products, regulatory approval would likely be required to sell them. Clinical testing and the approval process itself are very expensive and can take many years. Therefore, we do not expect to be in a position to sell additional products in the foreseeable future. Adverse rulings by regulatory authorities, product liability lawsuits, the failure to achieve widespread U.S. market acceptance, the loss of market acceptance outside of the United States, or other adverse publicity may significantly and adversely affect our sales of the ATS heart valve, and, as a result, would adversely affect our business, financial condition and results of operations. IN 2002, WE BEGAN USING A COMBINATION OF DIRECT SALES PERSONS AND INDEPENDENT MANUFACTURING REPRESENTATIVES TO SELL OUR VALVES IN THE UNITED STATES. IF OUR U.S. SALES STRATEGY IS NOT SUCCESSFUL, WE WILL NOT BE ABLE TO CONTINUE OUR OPERATIONS AS PLANNED. Our sales approach for the sale of the ATS valve in the United States consists primarily of direct salespersons with a few independent manufacturer's representatives. We will need to continue to expend significant funds and management resources to develop and maintain this hybrid sales force. We believe there is significant competition for sales personnel and independent manufacturing representatives with the advanced sales skills and technical knowledge we need. If we are unable to recruit, retain and motivate qualified personnel and representatives, U.S. sales of the ATS valve could be adversely affected. The loss of key salespersons or independent manufacturer's representatives could have a material adverse effect on our sales or potential sales 13 to current customers and prospects serviced by such salespersons or representatives. Further, we cannot assure the successful expansion of our network of independent manufacturer's representatives on terms acceptable to ATS, if at all, or the successful marketing of our products by our hybrid sales force. To the extent we rely on sales through independent manufacturer's representatives, any revenues we receive will depend primarily on the efforts of these parties. We do not control the amount and timing of marketing resources that these third parties devote to our product. If our U.S. sales strategy is not successful, we may be forced to change our U.S. sales strategy again. Any such change could disrupt sales in the United States. Further, any change in our U.S. sales strategy could be expensive and would likely have a material adverse impact on our results of operations. WE CURRENTLY DEPEND ON THE MARKETING AND SALES EFFORTS OF INTERNATIONAL INDEPENDENT DISTRIBUTORS, AND OUR SALES HAVE BEEN CONCENTRATED IN THREE COUNTRIES. The ATS heart valve is sold internationally through independent distributors. The loss of an international distributor could seriously harm our business and results of operations if a new distributor could not be found on a timely basis in the relevant geographic market. We do not control the amount and timing of marketing resources that these third parties devote to our product. Furthermore, to the extent we rely on sales through independent distributors, any revenues we receive will depend primarily on the efforts of these parties. WE ARE DEPENDENT UPON SALES OUTSIDE THE UNITED STATES, WHICH ARE SUBJECT TO A NUMBER OF RISKS INCLUDING A DROP IN SALES DUE TO CURRENCY FLUCTUATIONS. For the three months ended March 31, 2005, almost 60% of our net sales were derived from international operations. We expect that international sales will account for a substantial majority of our revenue until the ATS heart valve receives wider market acceptance from U.S. customers. Accordingly, any material decrease in foreign sales may materially and adversely affect our results of operations. We sell in U.S. dollars to most of our customers abroad. An increase in the value of the U.S. dollar in relation to other currencies can and has adversely affected our sales outside of the United States. In prior years, the decrease in sales was due primarily to the change in the value of the U.S. dollar against the Euro, as well as competitor price pressure. Our dependence on sales outside of the United States will continue to expose us to U.S. dollar currency fluctuations for the foreseeable future. Our future results of operations could also be harmed by risks inherent in doing business in international markets, including: - unforeseen changes in regulatory requirements and government health programs; - weaker intellectual property rights protection in some countries; - new export license requirements, changes in tariffs or trade restrictions; - political and economic instability in our target markets; and - greater difficulty in collecting payments from product sales. Slow payment of receivables by our international distributors, or the occurrence of any of the other factors listed above, could harm our ability to successfully commercialize our product internationally and could harm our business. WE HAVE A HISTORY OF NET LOSSES. IF WE DO NOT HAVE NET INCOME IN THE FUTURE, WE MAY BE UNABLE TO CONTINUE OUR OPERATIONS. We are not currently profitable and have a very limited history of profitability. As of March 31, 2005, we had an accumulated deficit of $71.5 million. We expect to incur significant expenses over the next several years as we continue to devote substantial resources to the commercialization of the ATS heart valve in the United States. We will not generate net income unless we are able to significantly increase revenue from U.S. sales. If we continue to sustain losses, we may not be able to continue our business as planned. THE MARKET FOR PROSTHETIC HEART VALVES IS HIGHLY COMPETITIVE, AND A NUMBER OF OUR COMPETITORS ARE LARGER AND HAVE MORE FINANCIAL RESOURCES. IF WE DO NOT COMPETE EFFECTIVELY, OUR BUSINESS WILL BE HARMED. The market for prosthetic heart valves is highly competitive. We expect that competition will intensify as additional companies enter the market or modify their existing products to compete directly with us. Our primary competitor, St. Jude Medical, Inc., currently controls approximately 50% of the worldwide mechanical heart valve market. Many of our competitors have long-standing FDA approval for their valves and extensive 14 clinical data demonstrating the performance of their valves. In addition, they have greater financial, manufacturing, marketing and research and development capabilities than we have. For example, many of our competitors have the ability, due to their internal carbon manufacturing facilities and economies of scale, to manufacture their heart valves at a lower cost than we can manufacture our ATS heart valve. Our primary competitor has recently used price as a method to compete in several international markets. If heart valve prices decline significantly we might not be able to compete successfully, which would harm our results of operations. OUR FUTURE RESULTS WILL BE HARMED IF THE USE OF MECHANICAL HEART VALVES DECLINES. Our business could suffer if the use of mechanical heart valves declines. Historically, mechanical heart valves have accounted for over two-thirds of all heart valve replacements. Recently, there has been an increase in the use of tissue valves. We estimate that mechanical heart valves are currently being used in 40% to 65% of all heart valve replacements, depending on the geographic market, down from 65 to 75% about ten years ago. We believe the tissue manufacturers' claims of improvements in tissue valve longevity and an increase in the average age of valve patients have contributed to the recent increase in the use of tissue valves. NEW PRODUCTS OR TECHNOLOGIES DEVELOPED BY OTHERS COULD RENDER OUR PRODUCT OBSOLETE. The medical device industry is characterized by significant technological advances. Several companies are developing new prosthetic heart valves based on new or potentially improved technologies. Significant advances are also being made in surgical procedures, which may delay the need for replacement heart valves. A new product or technology may emerge that renders the ATS heart valve noncompetitive or obsolete. This could materially harm our results of operations or force us to cease doing business altogether. WE MAINTAIN A LARGE VOLUME OF INVENTORY, WHICH EXCEEDS THE CURRENT DEMAND FOR THE ATS HEART VALVE. IF SALES OF OUR PRODUCT DO NOT INCREASE, THE VALUE OF OUR INVENTORY COULD DECREASE SUBSTANTIALLY. We purchased pyrolytic carbon components under a long-term supply agreement with Carbomedics through June 2002, and we are required to resume purchases of such components in 2007. To date, our purchases of pyrolytic carbon components have exceeded our sales of the ATS heart valves. We currently have in inventory enough pyrolytic carbon components to satisfy our projected requirements through 2005. If we are unable to achieve widespread acceptance for the ATS heart valve or if competitive pressures result in price reductions, the value of the excess inventory would likely decrease, which could seriously harm our results of operations and financial condition. Because the pyrolytic carbon components are made to meet the unique specifications of the ATS heart valve, our inventory may have little, if any, value in the open market. WE LICENSE PATENTED TECHNOLOGY AND OTHER PROPRIETARY RIGHTS FROM CARBOMEDICS. IF THESE AGREEMENTS ARE BREACHED OR TERMINATED, OUR RIGHT TO MANUFACTURE THE ATS HEART VALVE COULD BE TERMINATED. Under our carbon technology agreement with Carbomedics, we have obtained a license to use Carbomedics' pyrolytic carbon technology to manufacture components for the ATS heart valve. If this agreement is breached or terminated, we would be unable to manufacture our own product. If our inventory is exhausted and we do not have any other sources of carbon components, we would be forced to cease doing business. A DELAY OR INTERRUPTION IN THE SUPPLY OF PYROLYTIC CARBON COMPONENTS COULD DELAY PRODUCT DELIVERY OR FORCE US TO CEASE OPERATIONS. We cannot be certain that, after our current inventory is exhausted, sufficient quantities of pyrolytic carbon components will be available to assemble the ATS heart valve. Other than our carbon facility, the only other FDA-approved alternate supplier of our pyrolytic carbon components is Carbomedics. Although we have a supply agreement with Carbomedics under which it agrees to supply us with a minimum annual number of pyrolytic carbon components during 2007 through 2011, the amounts available under this agreement are not expected to be sufficient to supply all of our needs for components in those years. If our inventory is exhausted and we are unable to manufacture carbon components or obtain them from other sources, we could be forced to reduce or cease operations. BECAUSE WE LACK MANUFACTURING EXPERIENCE, WE MAY NOT REALIZE EXPECTED SAVINGS FROM MANUFACTURING OUR OWN PRODUCT. IN ADDITION, WE COULD EXPERIENCE PRODUCTION DELAYS AND SIGNIFICANT ADDITIONAL COSTS. Under our agreement with Carbomedics, we have been granted an exclusive worldwide license to manufacture pyrolytic carbon components for the ATS heart valve. We cannot be certain that our strategy to 15 establish internal manufacturing capabilities will result in a cost-effective means for manufacturing the ATS heart valve. We have limited experience in manufacturing pyrolytic carbon. Although we have an FDA-approved carbon manufacturing facility, we have only just started increasing production to higher levels. In the future as we continue to increase production at the plant, we may encounter difficulties in maintaining and expanding our manufacturing operations, including problems involving: - production yields; - quality control; - per unit manufacturing costs; - shortages of qualified personnel; and - compliance with FDA and international regulations and requirements regarding good manufacturing practices. Difficulties encountered by us in establishing or maintaining a commercial-scale manufacturing facility may limit our ability to manufacture our heart valve and therefore could seriously harm our business and results of operations. OUR BUSINESS COULD BE SERIOUSLY HARMED IF THIRD-PARTY PAYERS DO NOT REIMBURSE THE COSTS FOR OUR HEART VALVE. Our ability to successfully commercialize the ATS heart valve depends on the extent to which reimbursement for the cost of our product and the related surgical procedure is available from third-party payers, such as governmental programs, private insurance plans and managed care organizations. Third-party payers are increasingly challenging the pricing of medical products and procedures that they consider not to be cost-effective or are used for a non-approved indication. The failure by physicians, hospitals and other users of our products to obtain sufficient reimbursement from third-party payers would seriously harm our business and results of operations. In recent years, there have been numerous proposals to change the health care system in the United States. Some of these proposals have included measures that would limit or eliminate payment for medical procedures or treatments. In addition, government and private third-party payers are increasingly attempting to contain health care costs by limiting both the coverage and the level of reimbursement. In international markets, reimbursement and health care payment systems vary significantly by country. In addition, we have encountered price resistance from government-administered health programs. Significant changes in the health care system in the United States or elsewhere, including changes resulting from adverse trends in third-party reimbursement programs, could have a material adverse effect on our business and results of operations. WE MAY FACE PRODUCT LIABILITY CLAIMS, WHICH COULD RESULT IN LOSSES IN EXCESS OF OUR INSURANCE COVERAGE AND WHICH COULD NEGATIVELY AFFECT OUR ABILITY TO ATTRACT AND RETAIN CUSTOMERS. The manufacture and sale of mechanical heart valves entails significant risk of product liability claims and product recalls. A mechanical heart valve is a life-sustaining device and the failure of any mechanical heart valve usually results in the patient's death or need for reoperation. A product liability claim or product recall, regardless of the ultimate outcome, could require us to spend significant time and money in litigation or to pay significant damages and could seriously harm our business. We currently maintain product liability insurance coverage in an aggregate amount of $25 million. However, we cannot be assured that our current insurance coverage is adequate to cover the costs of any product liability claims made against us. Product liability insurance is expensive and does not cover the costs of a product recall. In the future, product liability insurance may not be available at satisfactory rates or in adequate amounts. A product liability claim or product recall could also materially and adversely affect our ability to attract and retain customers. OUR BUSINESS WOULD BE ADVERSELY AFFECTED IF WE ARE NOT ABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS. Our success depends in part on our ability to maintain and enforce our patents and other proprietary rights. We rely on a combination of patents, trade secrets, know-how and confidentiality agreements to protect the proprietary aspects of our technology. These measures afford only limited protection, and competitors may gain access to our intellectual property and proprietary information. The patent positions of medical device companies are generally uncertain and involve complex legal and technical issues. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of our proprietary rights. Any litigation could be costly and divert our attention from the growth of the business. We cannot assure you that our patents and other proprietary rights will not be successfully challenged, or that others will not independently develop substantially equivalent information and technology or otherwise gain access to our proprietary technology. 16 WE MAY BE SUED BY THIRD PARTIES WHICH CLAIM THAT OUR PRODUCT INFRINGES ON THEIR INTELLECTUAL PROPERTY RIGHTS. ANY SUCH SUITS COULD RESULT IN SIGNIFICANT LITIGATION OR LICENSING EXPENSES OR WE MIGHT BE PREVENTED FROM SELLING OUR PRODUCT. We may be exposed to future litigation by third parties based on intellectual property infringement claims. Any claims or litigation against us, regardless of the merits, could result in substantial costs and could harm our business. In addition, intellectual property litigation or claims could force us to: - cease manufacturing and selling our product, which would seriously harm us; - obtain a license from the holder of the infringed intellectual property right, which license may not be available on reasonable terms, if at all; or - redesign our product, which could be costly and time-consuming. WE ARE SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATION, WHICH IS COSTLY, TIME CONSUMING AND CAN SUBJECT US TO UNANTICIPATED DELAYS. The ATS heart valve and our manufacturing activities are subject to extensive regulation by a number of governmental agencies, including the FDA and comparable international agencies. We are required to: - maintain the approval of the FDA and international regulatory agencies to continue selling the ATS heart valve; - obtain the approval of international regulatory agencies in countries where the ATS heart valve is not yet marketed; - satisfy content requirements for all of our labeling, sales and promotional materials; - comply with manufacturing and reporting requirements; and - undergo rigorous inspections by these agencies. Compliance with the regulations of these agencies may delay or prevent us from introducing any new or improved products. Violations of regulatory requirements may result in fines, marketing restrictions, product recall, withdrawal of approvals and civil and criminal penalties. THE PRICE OF OUR COMMON STOCK HAS BEEN VOLATILE, WHICH MAY RESULT IN LOSSES TO INVESTORS. Historically, the market price of our common stock has fluctuated over a wide range and it is likely that the price of our common stock will fluctuate in the future. The market price of our common stock could be impacted by the following: - the success of our management in operating ATS effectively; - the failure of the ATS valve to gain market acceptance in the United States; - announcements of technical innovations or new products by our competitors; - the status of component supply arrangements; - changes in reimbursement policies; - government regulation; - developments in patent or other proprietary rights; - public concern as to the safety and efficacy of products developed by us or others; and - general market conditions. In addition, due to one or more of the foregoing factors, in future years our results of operations may fall below the expectations of securities analysts and investors. In that event, the market price of our common stock could be materially and adversely affected. Finally, in recent years the stock market has experienced extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to their operating performance. These broad market fluctuations may materially adversely affect our stock price, regardless of our operating results. 17 OUR CHARTER DOCUMENTS AND MINNESOTA LAW MAY DISCOURAGE AND COULD DELAY OR PREVENT A TAKEOVER OF OUR COMPANY. Provisions of our articles of incorporation, bylaws and Minnesota law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders. These provisions include the following: - No cumulative voting by shareholders for directors; - The ability of our board to set the size of the board of directors, to create new directorships and to fill vacancies; - The ability of our board, without shareholder approval, to issue preferred stock, which may have rights and preferences that are superior to our common stock; - The ability of our board to amend the bylaws; and - Restrictions under Minnesota law on mergers or other business combinations between us and any holder of 10% or more of our outstanding common stock. 18 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the fair market value of the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then prevailing rate and the prevailing interest rate later rises, the fair value of the principal amount of our investment will probably decline. To minimize this risk, our portfolio of cash equivalents and short-term investments may be invested in a variety of securities, including commercial paper, money market funds, and both government and non-government debt securities. The average duration of all our investments has generally been less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. In the United States, Canada, France and Germany, we sell our products directly to hospitals. In other international markets, we sell our products to independent distributors who, in turn, sell to medical hospitals. Loss, termination, or ineffectiveness of distributors to effectively promote our product would have a material adverse effect on our financial condition and results of operations. Transactions with U.S. and non-U.S. customers and distributors, other than in France and Germany, are entered into in U.S. dollars, precluding the need for foreign currency hedges on such sales. Sales through our French and German subsidiaries are in Euros, so we are subject to profitability risk arising from exchange rate movements. We have not used foreign exchange contracts or similar devices to reduce this risk. We will evaluate the need to use foreign exchange contracts or similar devices if sales in France increase substantially. We do not believe that inflation has had a material effect on our results of operations in recent years and periods. There can be no assurance, however, that our business will not be adversely affected by inflation in the future. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective. (b) Changes in Internal Control over Financial Reporting As previously reported, in connection with our assessment of the effectiveness of our internal control over financial reporting at the end of our last fiscal year, we identified a material weakness in our internal control over financial reporting. The deficiency in our internal control related to ineffective application of inventory verification procedures, including cycle count procedures. Historically, we have relied on cycle counting procedure to substantiate inventory quantities in lieu of taking physical inventories. During our evaluation of internal control over our cycle counting procedures, we determined that our processes in place during 2004 were neither sufficient nor documented adequately to rely upon. We therefore conducted a physical inventory after year end which confirmed the accuracy of our inventory as recorded in our financial statements for the year ended December 31, 2004. Other than as described in the preceding paragraph, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 19 PART II. OTHER INFORMATION ITEM 6. EXHIBITS 3.1 Restated Articles of Incorporation, as amended to date (Incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993) 3.2 Bylaws of the Company, as amended to date (Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996) 4.1 Specimen certificate for shares of Common Stock of the Company (Incorporated by reference to Exhibit 4.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997) 10.1 Amendment Agreement, dated March 24, 2005, to the Credit Agreement between Silicon Valley Bank and the Company, dated July 28, 2004 (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on March 30, 2005) 10.2 2005 ATS Medical Management Incentive Compensation Plan (MICP) 31.1 Certification of Chief Executive Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section 302 Certification) 31.2 Certification of Chief Financial Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section 302 Certification) 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification) 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification) 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: May 9, 2005 ATS MEDICAL, INC. By: /s/ Michael D. Dale ------------------- Michael D. Dale, Chief Executive Officer (Duly Authorized Officer) By: /s/ John R. Judd ----------------- John R. Judd, Chief Financial Officer (Principal Accounting Officer) 21 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION 3.1 Restated Articles of Incorporation, as amended to date (Incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993) 3.2 Bylaws of the Company, as amended to date (Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996) 4.1 Specimen certificate for shares of Common Stock of the Company (Incorporated by reference to Exhibit 4.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997) 10.1 Amendment Agreement, dated March 24, 2005, to the Credit Agreement between Silicon Valley Bank and the Company, dated July 28, 2004 (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on March 30, 2005) 10.2 2005 ATS Medical Management Incentive Compensation Plan (MICP) 31.1 Certification of the Chief Executive Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section 302 Certification) 31.2 Certification of the Chief Financial Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section 302 Certification) 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification) 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification)
22 EX-10.2 2 c95107exv10w2.txt 2005 ATS MEDICAL MANAGEMENT INCENTIVE COMPENSATION PLAN (MICP) EXHIBIT 10.2 2005 ATS MEDICAL MANAGEMENT INCENTIVE COMPENSATION PLAN (MICP) The 2005 ATS Medical Management Incentive Compensation Plan (MICP) is designed to pay, in addition to performance based annual salaries, incentive cash compensation to management and other "key employees" who by their assigned responsibilities contribute to the success of the Company. Incentive payments will be based on corporate funding and achievement of individual Objectives/Smart Goals. 1. DEFINITION OF TERMS GOALS The Individual Objectives, as set forth at the beginning of each program year and referred to as Smart Goals, must be specific, measurable, achievable, related to Corporate Goals and time bound. The Board of Directors may amend the goals to reflect material adjustments in or changes to the Company's accounting policies; to reflect major corporate changes such as mergers, acquisitions, or divestitures; and to reflect such other events having a significant impact on the goals. BASE SALARY The annual salary rates effective on the first day of the Plan year. PARTICIPANT Any employee or position which has been designated by the Board as a participant in the Plan for the year or during the year. If a particular employee is not covered by the MICP and has been recognized for extraordinary achievement, he/she may be eligible to participate in the Plan for that particular year at the discretion of the President/CEO. ELIGIBILITY Only regular full time employees may be designated as a participant in the Plan. PROGRAM YEAR The fiscal year of the corporation. FUNDING The total dollar amounts accrued for payment in any program year. The bonus pool will be funded by achievement of the Company's annual operating Plan and will be tied to both top line and bottom line results. 23 PAYOUT The actual amount to be paid to a participant based on operating results achievement rate combined with individual Smart Goals performance. The maximum payout each participant is eligible to receive will be communicated by his/her Manager. 2. DESIGNATION OF PARTICIPANTS The Board, upon the recommendation of the management of the Corporation, shall make all determinations as to the eligibility of employees and positions to participate in the MICP. Following the Board's determination of eligible participants, each participant shall be notified of eligibility to participate in the 2005 MICP and will be provided with a copy of the Plan. The 2005 Plan is designed to include officer, director, and manager level positions as well as employee designated as "key employees." 3. CALCULATION AND PAYMENT OF INCENTIVE AWARDS Individual incentives will not be paid unless the President/CEO and the Compensation Committee of the Board of Directors approve each participant's individual incentive awards with payout contingent upon completion of the Company's year-end financial audit for the program year. PLAN CRITERIA ACHIEVEMENT OF SMART GOALS (20% weight) TOP LINE RESULTS = Revenue (50% weight) BOTTOM LINE RESULTS=Operating Income before taxes (30% weight) 1:3 BONUS POOL FUNDING for overachievement 1:5 BONUS POOL FUNDING for underachievement PAYOUT RATES
PLAN PERFORMANCE 1:0 RATIO 116.7% 150% 115% 145% 110% 130% 105% 115% 100% 100%
PLAN PERFORMANCE 1:5 RATIO 95% 75% 90% 50% 85% 25% 80% 0%
24 4. PROMOTIONS For individuals promoted from a non-bonus to a bonus position during the program year, the effective salary upon assuming the new position will be used in calculating eligible incentive payout. Any payout will be pro rated beginning the first day of the month in which the individual is promoted into the position. 5. DEMOTIONS For individuals demoted to a non-bonus position during the plan year, MICP payout will be pro rated based on the number of months in the bonus position. 6. TERMINATION OF EMPLOYMENT In the event that any participant shall cease to be a full time employee during any year in which he/she is participating in the Plan, such participant shall be entitled to receive no incentive compensation for such year. If he/she terminates after the Plan year but prior to the payout, the participant remains entitled to receive incentive compensation. An exception would be if the individual were subject to termination "for cause" if such "cause" took place during the period covered by the MICP. 7. AMENDMENT OF THE PLAN The Board may, from time to time, make amendments to the Plan as it believes appropriate and may terminate the Plan at any time, provided that no such amendment or termination will affect the right of any participant to receive incentive compensation in accordance with the terms of the Plan for the portion of any year up to the date of the amendment or termination. 8. MISCELLANEOUS Nothing contained in the MICP shall be construed to confer upon any employee any right to continue in the employ of the Company or restrict the Company's right to terminate his/her employment at any time. 25 ESTABLISHMENT OF INDIVIDUAL OBJECTIVES/SMART GOALS (Specific, Measurable, Achievable, Related to Corporate Goals and Time Bound.) In establishing individual objectives, the following guidelines shall be used: - - Each objective should be clear, concise, and measurable (time, cost, and task accomplishment). - - Each objective should be a precise written statement, which is discussed and agreed to by the individual and the manager. - - Individual objectives should measure accomplishment and not effort. - - Individuals will have four (4) Objectives/Smart Goals. Before a participant may receive an incentive award, it will be necessary for his/her immediate manager to: - - Submit written measurable objectives on the appropriate form prior to the commencement of the program year. These objectives will be reviewed and approved by the President/CEO and Director of Human Resources. - - Submit a documented evaluation of results, on a quarterly basis, to the President/CEO. - Modifications or adjustments to the original objectives must be reviewed by the participant and his/her manager and then submitted to the President/CEO. - - Submit the year-end results against objectives within one month following the end of the program year. The President/CEO and the Director of Human Resources will approve these. 26 EX-31.1 3 c95107exv31w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 302 EXHIBIT 31.1 CERTIFICATION I, Michael D. Dale, certify that: 1. I have reviewed this quarterly report on Form 10-Q of ATS Medical, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d- 15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation, and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors; a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 9, 2005 /s/ Michael D. Dale ----------------------------- Name: Michael D. Dale Title: Chief Executive Officer 27 EX-31.2 4 c95107exv31w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 302 EXHIBIT 31.2 CERTIFICATION I, John R. Judd, certify that: 1. I have reviewed this quarterly report on Form 10-Q of ATS Medical, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d- 15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation, and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors; a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 9, 2005 /s/ John R. Judd ----------------------------- Name: John R. Judd Title: Chief Financial Officer 28 EX-32.1 5 c95107exv32w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 906 EXHIBIT 32.1 CERTIFICATION I, Michael D. Dale, Chief Executive Officer of ATS Medical, Inc., certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: The Quarterly Report of Form 10-Q of the Company for the quarter ended March 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) of the Securities and Exchange Act of 1934 (15 U.S.C. 78m); and The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: May 9, 2005 /s/ Michael D. Dale ---------------------------------- Name: Michael D. Dale Title: Chief Executive Officer 29 EX-32.2 6 c95107exv32w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 906 EXHIBIT 32.2 CERTIFICATION I, John R. Judd, Chief Financial Officer of ATS Medical, Inc., certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: The Quarterly Report of Form 10-Q of the Company for the quarter ended March 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) of the Securities and Exchange Act of 1934 (15 U.S.C. 78m); and The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: May 9, 2005 /s/ John R. Judd ---------------------------------- Name: John R. Judd Title: Chief Financial Officer 30 -----END PRIVACY-ENHANCED MESSAGE-----