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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
For the Quarterly Period Ended October 3, 2009
Commission File Number: 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) |
(763) 553-7736
(Registrant’s Telephone Number, Including Area Code)
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:þ Yeso 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 (Section 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):o Yeso 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 filero | Accelerated filerþ | Non-accelerated filero | Smaller reporting companyo | |||
(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). o Yesþ No
The number of shares outstanding of each of the registrant’s classes of common stock as of November 6, 2009, was:
Common Stock, $.01 par value | 72,077,040 shares |
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Exhibit 12.1 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32.1 | ||||||||
Exhibit 32.2 |
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PART I. FINANCIAL INFORMATION
ITEM 1. | Financial Statements |
ATS Medical, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Data)
October 3, | December 31, | |||||||
2009 | 2008 | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 12,092 | $ | 20,895 | ||||
Accounts receivable, net | 14,416 | 14,532 | ||||||
Inventories, net | 21,352 | 20,208 | ||||||
Prepaid expenses | 2,160 | 958 | ||||||
Total current assets | 50,020 | 56,593 | ||||||
Leasehold improvements, furniture and equipment, net | 6,613 | 7,031 | ||||||
Goodwill | 17,016 | 17,016 | ||||||
Other intangible assets | 29,722 | 32,115 | ||||||
Other assets | 1,526 | 2,226 | ||||||
Total assets | $ | 104,897 | $ | 114,981 | ||||
Liabilities and shareholders’ equity | ||||||||
Current liabilities: | ||||||||
Current maturities of bank notes payable | $ | 2,646 | $ | 2,646 | ||||
Accounts payable | 3,780 | 4,054 | ||||||
Accrued compensation | 2,349 | 3,537 | ||||||
Payable to CryoCath Technologies, Inc. | — | 1,910 | ||||||
Payable to CarboMedics, Inc. | — | 4,500 | ||||||
Other accrued liabilities | 2,648 | 2,257 | ||||||
Total current liabilities | 11,423 | 18,904 | ||||||
Convertible senior notes payable, net of unamortized discounts and bifurcated derivatives of $4,774 at October 3, 2009 and $4,867 at December 31, 2008 | 17,626 | 17,533 | ||||||
Bank notes payable | 1,764 | 3,969 | ||||||
Shareholders’ equity: | ||||||||
Common stock, $.01 par value: | ||||||||
Authorized shares — 150,000,000 | ||||||||
Issued and outstanding shares — 72,047,421 at October 3, 2009 and 71,077,458 at December 31, 2008 | 721 | 711 | ||||||
Additional paid-in capital | 227,768 | 225,657 | ||||||
Accumulated deficit | (154,748 | ) | (151,916 | ) | ||||
Accumulated other comprehensive income | 343 | 123 | ||||||
Total shareholders’ equity | 74,084 | 74,575 | ||||||
Total liabilities and shareholders’ equity | $ | 104,897 | $ | 114,981 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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ATS Medical, Inc.
Consolidated Statements of Operations
(Unaudited)
(In Thousands, Except Per Share Amounts)
Three months ended | Nine months ended | |||||||||||||||
October 3, | September 27, | October 3, | September 27, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net sales | $ | 18,827 | $ | 16,044 | $ | 57,011 | $ | 47,789 | ||||||||
Cost of goods sold | 6,983 | 6,570 | 20,153 | 19,077 | ||||||||||||
Gross profit | 11,844 | 9,474 | 36,858 | 28,712 | ||||||||||||
Operating expenses: | ||||||||||||||||
Sales and marketing | 6,950 | 7,059 | 21,976 | 20,693 | ||||||||||||
Research and development | 2,226 | 1,843 | 6,087 | 6,351 | ||||||||||||
General and administrative | 2,438 | 2,431 | 7,345 | 8,199 | ||||||||||||
Amortization of intangibles | 812 | 891 | 2,412 | 2,672 | ||||||||||||
Total operating expenses | 12,426 | 12,224 | 37,820 | 37,915 | ||||||||||||
Operating loss | (582 | ) | (2,750 | ) | (962 | ) | (9,203 | ) | ||||||||
Net interest expense | (644 | ) | (700 | ) | (2,057 | ) | (1,976 | ) | ||||||||
Other income (expense), net | 383 | (241 | ) | 501 | 637 | |||||||||||
Net loss before income taxes | (843 | ) | (3,691 | ) | (2,518 | ) | (10,542 | ) | ||||||||
Income tax expense | (132 | ) | (55 | ) | (314 | ) | (284 | ) | ||||||||
Net loss | $ | (975 | ) | $ | (3,746 | ) | $ | (2,832 | ) | $ | (10,826 | ) | ||||
Net loss per share: | ||||||||||||||||
Basic and diluted | $ | (0.01 | ) | $ | (0.06 | ) | $ | (0.04 | ) | $ | (0.18 | ) | ||||
Weighted average number of shares outstanding: | ||||||||||||||||
Basic and diluted | 71,941 | 62,300 | 71,626 | 60,691 | ||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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ATS Medical, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In Thousands)
Nine months ended | ||||||||
October 3, | September 27, | |||||||
2009 | 2008 | |||||||
Operating activities: | ||||||||
Net loss | $ | (2,832 | ) | $ | (10,826 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation and amortization | 3,828 | 4,331 | ||||||
Stock-based compensation expense | 1,885 | 1,184 | ||||||
Deferred income taxes | 201 | 144 | ||||||
Non-cash interest expense | 601 | 499 | ||||||
Change in value of warrant liability and derivative liability bifurcated from convertible senior notes | (26 | ) | (286 | ) | ||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable, net | 192 | (652 | ) | |||||
Inventories, net | (1,092 | ) | (1,436 | ) | ||||
Prepaid expenses | (1,150 | ) | 211 | |||||
Accounts payable and accrued expenses | (5,995 | ) | 710 | |||||
Net cash used in operating activities | (4,388 | ) | (6,121 | ) | ||||
Investing activities: | ||||||||
Purchases of short-term investments | — | (938 | ) | |||||
Maturities of short-term investments | — | 5,127 | ||||||
Liquidation of long-term restricted cash investment | 479 | — | ||||||
Payments for licenses and other intangibles | (19 | ) | — | |||||
Payments for business acquisitions | (2,000 | ) | (2,000 | ) | ||||
Purchases of leasehold improvements, furniture and equipment | (990 | ) | (1,208 | ) | ||||
Net cash provided by (used in) investing activities | (2,530 | ) | 981 | |||||
Financing activities: | ||||||||
Payments on bank notes payable | (2,205 | ) | (1,323 | ) | ||||
Net proceeds from issuance of common stock | 236 | 4,002 | ||||||
Other | 29 | 108 | ||||||
Net cash provided by (used in) financing activities | (1,940 | ) | 2,787 | |||||
Effect of foreign exchange rate changes on cash | 55 | (615 | ) | |||||
Decrease in cash and cash equivalents | (8,803 | ) | (2,968 | ) | ||||
Cash and cash equivalents at beginning of period | 20,895 | 10,480 | ||||||
Cash and cash equivalents at end of period | $ | 12,092 | $ | 7,512 | ||||
Significant non-cash transactions: | ||||||||
Transfer of warrant liability to additional paid-in capital | $ | — | $ | 3,670 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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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” or “ATS”) without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and United States Generally Accepted Accounting Principles (“GAAP”) as set forth by the Financial Accounting Standards Board (“FASB”) in its Accounting Standards Codification (“ASC”), to ensure consistent and accurate reporting of the Company’s financial condition, results of operations and cash flows. 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 U. S. GAAP have been condensed or omitted pursuant to SEC rules and regulations. The year-end balance sheet was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. These unaudited consolidated interim financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
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.
The Company utilizes a 52 week calendar year that ends on December 31. For interim periods, the Company utilizes a 13 week quarterly period that ends on the Saturday nearest the end of the calendar quarter. The three month periods ended October 3, 2009 and September 27, 2008 each consisted of 91 calendar days. The nine month periods ended October 3, 2009 and September 27, 2008 consisted of 276 and 271 calendar days, respectively.
Note 2. Stock-Based Compensation and Equity Plans
Stock-Based Compensation
The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles set forth in FASB ASC 718,Stock Compensation, which requires all share-based payments to be recognized in the income statement based on their fair values.
The following table summarizes stock compensation expense recognized in the statements of operations for the three and nine month periods ended October 3, 2009 and September 27, 2008.
Three months ended | Nine months ended | |||||||||||||||
October 3, | September 27, | October 3, | September 27, | |||||||||||||
(in thousands, except per share data) | 2009 | 2008 | 2009 | 2008 | ||||||||||||
Stock compensation expense included in: | ||||||||||||||||
Cost of goods sold | $ | 19 | $ | — | $ | 66 | $ | — | ||||||||
Sales and marketing expenses | 362 | 258 | 982 | 701 | ||||||||||||
Research and development expenses | 74 | — | 223 | — | ||||||||||||
General and administrative expenses | 233 | 157 | 614 | 483 | ||||||||||||
Total stock compensation expense | $ | 688 | $ | 415 | $ | 1,885 | $ | 1,184 | ||||||||
Stock compensation expense per share | $ | 0.01 | $ | 0.01 | $ | 0.03 | $ | 0.02 | ||||||||
Based on an analysis of the Company’s historical data, the Company applied forfeiture rates during the nine month periods ended October 3, 2009 and September 27, 2008 of 9.56% and 10.79%, respectively, to stock options and restricted stock units (“RSUs”) outstanding in determining its stock compensation expense, which it believes are reasonable forfeiture estimates for these periods.
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As of October 3, 2009, the Company had approximately $0.2 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock options that will be recognized over a weighted average period of 4.1 years, and approximately $5.9 million of total unrecognized compensation expense, net of estimated forfeitures, related to RSU awards that will be recognized over a weighted average period of approximately 3.6 years.
Equity Plans
The Company had a total of 8,852,468 shares of common stock reserved for stock option grants and RSU awards at October 3, 2009, of which 2,133,194 shares were available for future grants or awards under the Company’s stock-based compensation plans.
The following table summarizes the 2009 changes in stock options outstanding under the Company’s stock-based compensation plans:
Weighted | ||||||||||||||||||||
Stock Options Outstanding | Average Option | |||||||||||||||||||
Under the Plans | Non-Plan | Exercise Price | ||||||||||||||||||
ISO | Non-ISO | Options | Total | Per Share | ||||||||||||||||
Outstanding at December 31, 2008 | 642,650 | 299,000 | 1,493,200 | 2,434,850 | $ | 2.89 | ||||||||||||||
Options granted | 157,250 | — | — | 157,250 | 2.64 | |||||||||||||||
Options exercised | (3,100 | ) | — | — | (3,100 | ) | 1.05 | |||||||||||||
Options canceled | (67,500 | ) | (10,000 | ) | — | (77,500 | ) | 4.57 | ||||||||||||
Outstanding at October 3, 2009 | 729,300 | 289,000 | 1,493,200 | 2,511,500 | $ | 2.82 | ||||||||||||||
As of October 3, 2009, the aggregate intrinsic value of options outstanding was approximately $1.5 million and the aggregate intrinsic value of options exercisable was approximately $1.4 million.
The following table summarizes 2009 RSU award activity under the Company’s stock-based compensation plans:
Weighted | Weighted | |||||||||||
Average | Average | |||||||||||
Number of | Award Date | Remaining | ||||||||||
Shares | Fair Value | Contractual Term | ||||||||||
Outstanding (unvested ) at December 31, 2008 | 3,391,743 | $ | 2.00 | 2.14 years | ||||||||
Awards granted | 1,929,273 | 2.26 | ||||||||||
Awards vested | (873,286 | ) | 2.08 | |||||||||
Awards forfeited | (239,956 | ) | 1.87 | |||||||||
Outstanding (unvested) at October 3, 2009 | 4,207,774 | $ | 2.11 | 2.10 years | ||||||||
As of October 3, 2009, the aggregate intrinsic value of unvested RSU awards outstanding was approximately $11.0 million.
Note 3. Private Placements of Common Stock
In December 2008, the Company sold 8,510,639 shares of its common stock to Essex Woodlands Health Ventures (“Essex”) at $2.35 per share and received $19.8 million, net of offering costs. In connection with the financing, the Company issued to Essex warrants to purchase 2,533,192 shares of common stock at an exercise price of $2.475 per share during the first year after the closing, $2.85 per share during the second year, and $3.10 thereafter. The warrants expire on December 19, 2015. In connection with the stock sale, a co-founder and managing director of Essex was appointed to the Company’s Board of Directors.
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In June 2007, the Company sold to Alta Partners VIII, L.P. (“Alta”) 9,800,000 shares of its common stock and a seven-year warrant to purchase up to 1,960,000 shares of common stock at an exercise price of $1.65 per share. The Company was required to treat the Alta warrant as a liability pending approval of its shareholders at the Company’s 2008 annual meeting of shareholders (or any subsequent annual meeting) to issue shares of common stock to Alta upon exercise of the warrant. Accordingly, the fair value of the warrant was recorded as a liability on the date of issuance and marked-to-market at each quarter-end, resulting in a change in valuation credit to other income of $1.5 million for the quarter ended March 29, 2008. At the Company’s annual meeting of shareholders in May 2008, the Company received shareholder approval to issue shares of common stock upon exercise of the warrant. Consequently, the liability was marked-to-market through the date of shareholder approval, with the remaining warrant liability balance of $3.7 million credited to additional paid-in capital. Alta warrant liability activity for the nine months ended October 3, 2008 is summarized below:
(in thousands) | ||||
Warrant liability balance on January 1, 2008 | $ | 3,913 | ||
Total losses (gains) included in other expense (income): | ||||
First quarter 2008 | (1,521 | ) | ||
Second quarter 2008 | 1,278 | |||
Transfer to additional-paid-in-capital | (3,670 | ) | ||
Warrant liability balance on October 3, 2008 | $ | — | ||
In June 2008, Alta exercised the warrant on all 1,960,000 shares of common stock. The Company received $3.2 million as a result of the exercise.
Note 4. Inventories
The Company carries and relieves inventories at the lower of manufacturing cost (first-in, first-out basis) or market (net realizable value). Inventories consisted of the following (in thousands):
October 3, | December 31, | |||||||
2009 | 2008 | |||||||
Raw materials | $ | 2,780 | $ | 4,712 | ||||
Work-in-process | 6,122 | 4,880 | ||||||
Finished goods | 13,450 | 11,416 | ||||||
Total inventories | 22,352 | 21,008 | ||||||
Less: non-current inventories | (1,000 | ) | (800 | ) | ||||
Inventories, net | $ | 21,352 | $ | 20,208 | ||||
A portion of the Company’s finished goods inventories was in excess of its current requirements based on the historical and anticipated level of sales. Management believes that these excess quantities will be utilized over the next two years. The Company therefore included $1.0 million and $0.8 million of inventories in non-current other assets on the balance sheets at October 3, 2009 and December 31, 2008, respectively.
Note 5. Comprehensive Income (Loss)
Comprehensive income (loss) for the Company includes gains and losses from foreign currency translation which are charged or credited to the cumulative translation account within shareholders’ equity. The Company recognized net comprehensive gains of $0.1 million and $0.2 million for the three and nine month periods ended October 3, 2009, respectively, and recognized a net comprehensive loss of $0.6 million for the three and nine month periods ended September 27, 2008.
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Note 6. Intangible Assets
Indefinite-lived Intangible Assets
Indefinite-lived intangible assets consist of goodwill, which is carried at cost. The Company applies the accounting principles set forth in FASB ASC 350,Intangibles-Goodwill and Other,to its intangible assets, which prohibits the amortization of intangible assets with indefinite useful lives and requires that these assets be reviewed for impairment at least annually. Management reviews indefinite-lived intangible assets for impairment annually as of the last day of the second quarter, or more frequently if a change in circumstances or occurrence of events suggests the remaining value may not be recoverable. The test for impairment requires management to make estimates about fair-value which are based either on the expected undiscounted future cash flows or on other measures of value such as the market capitalization of the Company. If the carrying amount of the assets is greater than the measures of fair value, impairment is considered to have occurred and a write-down of the asset is recorded. Management completed the annual impairment test as of the end of the second quarter of 2009 and determined that the Company’s goodwill was not impaired. In performing its annual impairment test, the Company used a market capitalization approach based on the closing price of the Company’s common stock on the date of measurement. This market capitalization value was compared to the net book value of the Company (i.e. total assets, including goodwill, minus total liabilities). The total market capitalization exceeded the net book value of the Company; therefore, no goodwill impairment was indicated.
Definite-lived Intangible Assets
Definite-lived intangible assets consist of technology licenses and agreements, which are carried at amortized cost. The Company assesses definite-lived intangible asset impairment in accordance with FASB ASC 360-10-35. If a triggering event occurs, the Company assesses the recoverability of definite-lived intangible assets by reference to future gross profit cash flows from the underlying products using the capitalized technology and trademarks.
Note 7. Debt and Borrowings
Convertible Senior Notes Payable
In 2005, the Company sold a combined $22.4 million aggregate principal amount of 6% Convertible Senior Notes due 2025 (“Notes”) which are convertible into 5,333,334 shares of the Company’s common stock, Warrants to purchase 1,344,000 shares of the Company’s common stock exercisable at $4.40 per share (“Warrants”), and embedded derivatives. Interest is payable under the Notes each April and October. The Company has the right to redeem the Notes at 100% of the principal amount plus accrued interest at any time on or after October 20, 2008, and the investors have the right to require the Company to repurchase the Notes at 100% of the principal amount plus accrued interest on October 15 in 2010, 2015 and 2020. Accordingly, the Company will reclassify the Notes from long-term to current liabilities on its balance sheet in the fourth quarter of 2009.
The total value of the Warrants on the date of issuance was recorded as a discount on the Notes. In addition, the Company has bifurcated embedded derivatives from the Notes as required by FASB ASC 815,Derivatives and Hedging,and applicable SEC rules. The Company recorded a derivative liability on the date of issuance of the Notes, with an offsetting discount on the Notes. The derivative liability includes certain time-based provisions of the Notes which will expire over time, the latest in 2011. The total discount on the Notes is being amortized to interest expense over the 20 year life of the Notes, using the effective interest method. Interest expense attributable to discount amortization totaled approximately $0.1 million for each of the nine month periods ended October 3, 2009 and September 27, 2008, respectively.
The derivative liability is adjusted to fair value on a quarterly basis. Derivative liability activity is summarized below:
Nine months ended | ||||||||
October 3, | September 27, | |||||||
(in thousands) | 2009 | 2008 | ||||||
Derivative liability balance at beginning of period | $ | 90 | $ | 141 | ||||
Change in valuation gain included in other income: | ||||||||
First quarter | (9 | ) | (15 | ) | ||||
Second quarter | (9 | ) | (15 | ) | ||||
Third quarter | (8 | ) | (13 | ) | ||||
Derivative liability balance at end of period | $ | 64 | $ | 98 | ||||
The derivative liability is presented in the balance sheet within the same line as the Convertible Senior Notes payable.
Bank Notes Payable
In 2004, the Company entered into a Loan and Security Agreement (“Loan Agreement”) with Silicon Valley Bank (“Bank”), establishing a secured revolving credit facility. All Company assets are pledged as collateral under the Loan Agreement. The Loan Agreement, as amended, restricts the Company from declaring or paying dividends and subjects the Company to certain financial covenants.
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In June 2007, the Company entered into an Amendment to the Loan Agreement (“June 2007 Amendment”) whereby the Bank consented to (i) the Company’s purchase of the cryoablation surgical device business of CryoCath Technologies, Inc. (“CryoCath Business”) and (ii) certain agreements related to the acquisition of the CryoCath Business. The June 2007 Amendment also provided for an $8.6 million term loan (“Term Loan”) to the Company, which was used to repay the then-outstanding term loan and advances to the Company from the Bank and to purchase the CryoCath Business.
Under the Term Loan, as amended, the Company made monthly payments of interest only from July 2007 until March 2008, and began making 39 monthly payments of principal plus interest effective April 1, 2008 and continuing on the first day of each successive month until June 1, 2011. The Company also has the right to prepay all, but not less than all, of the outstanding Term Loan at any time so long as no event of default has occurred. Interest on the Term Loan accrues at a fixed rate per annum of 9.5%, equal to 1.25% above the Prime Rate in effect as of the funding date of the Term Loan.
The June 2007 Amendment also made certain changes to the liquidity ratio covenant set forth in the Loan Agreement, as amended. The liquidity ratio was changed to require that the Company maintain, at all times, on a consolidated basis, a ratio of (a) the sum of (1) unrestricted cash (and equivalents) of the Company on deposit with the Bank plus (2) 50% of the Company’s accounts receivable arising form the sale or lease of goods, or provision of services, in the ordinary course of business, divided by (b) the indebtedness of the Company to the Bank for borrowed money, equal to or greater than 1.4 to 1.0. In June 2008, the Company entered into an Amendment to the Loan Agreement whereby, for the balance of 2008, the 1.4 to 1.0 required liquidity ratio was reduced to 1.1 to 1.0 for intra-quarter months only. The liquidity ratio remained at 1.4 to 1.0 for quarter-end months and reverted to 1.4 to 1.0 for all months beginning in 2009. In December 2008, the Company entered into an Amendment to the Loan Agreement (“December 2008 Amendment”) whereby the liquidity ratio was raised to 2.0 to 1.0 until the payment of a $4.5 million litigation settlement payment was made to CarboMedics, Inc. (“CarboMedics”) on April 30, 2009, and a related security interest granted to CarboMedics was released. Upon such payment, the Bank agreed to return the liquidity ratio requirement to 1.4 to 1.0. In addition, the December 2008 Amendment required the Company to maintain at least $4.5 million on deposit with the Bank at all times until the litigation settlement payment of $4.5 million was made. On April 30, 2009, the Company made the $4.5 million settlement payment. As of October 3, 2009, the Company was in compliance with the financial covenants as set forth in the Loan Agreement, as amended.
Subordinated Credit Agreement
In June 2008, the Company entered into a Subordinated Credit Agreement (“Credit Agreement”) with Theodore C. Skokos, a member of the Company’s Board of Directors, for a two-year, $5 million Revolving Credit Facility (“Credit Facility”). Advances under the Credit Facility will carry interest at 15% per annum payable quarterly. The Credit Facility also carries an annual commitment fee of 1% of the average unused Revolving Commitment Amount, payable annually. In July 2009, the annual commitment fee of $50,000 was paid to Mr. Skokos. As of October 3, 2009, no advances had been made and all $5 million was available for borrowing under the Credit Facility.
The Company’s obligations to Mr. Skokos under the Credit Agreement have been made subordinate to (1) the Company’s obligations to the holders of its 6% Convertible Senior Notes and (2) the Company’s obligations to Silicon Valley Bank as provided in a Subordination Agreement executed by and between the Bank and Mr. Skokos. All Company assets are pledged as collateral on the Credit Facility.
In connection with the execution of the Credit Agreement, the Company issued to Mr. Skokos a warrant to purchase 245,098 shares of common stock of the Company at $2.04 per share until June 29, 2015 (“Effective Date Warrant”). In July 2008, Mr. Skokos exercised the Effective Date Warrant in full and the Company received $0.5 million from the exercise. The Company is obligated to issue additional seven-year warrants to Mr. Skokos in the future based on the total amount of advances under the Credit Facility. If the aggregate unpaid principal amount of all advances (“Total Outstanding Revolver Amount”) under the Credit Facility, after giving effect to each new advance, is greater than the amount of the highest Total Outstanding Revolver Amount at any time prior to the date of any such advance (“Maximum Total Outstanding Revolver Amount”), then the Company shall issue a warrant to Mr. Skokos for a number of shares of common stock equal to 20% of (a) the difference between (1) such Total Outstanding Revolver Amount less (2) the Maximum Total Outstanding Revolver Amount, (b) divided by the warrant exercise price of $2.04 per share. The maximum number of additional shares issuable pursuant to warrants issued under the Credit Facility is 490,196 shares (not including the Effective Date Warrant), which represents 20% of the maximum amount of advances under the $5 million Credit Facility divided by the $2.04 warrant exercise price.
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Note 8. Income Taxes
For each of the nine month periods ended October 3, 2009 and September 27, 2008, the Company recognized $0.3 million of income tax expense related to (1) deferred income taxes connected with the deductibility of goodwill from the acquisition of the cryoablation surgical device business of CryoCath Technologies, Inc. for tax purposes, but not for book purposes, and the uncertainty of the timing of its reversal for book purposes and (2) current income taxes for certain of its international subsidiaries. In future years, the Company will continue recognizing deferred income tax expense related to the CryoCath goodwill over its tax life as long as there is no impairment of the goodwill’s recorded value.
Note 9. Fair Value Measurements
Effective January 1, 2008, the Company adopted fair value measurement accounting principles related to its financial assets and liabilities as required by FASB ASC 820,Fair Value Measurements and Disclosures(“ASC 820”).ASC 820 defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. The adoption of ASC 820 did not have a material impact on the Company’s financial condition or results of operations.
ASC 820 defines fair value as the 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. ASC 820 also describes three levels of inputs that may be used to measure fair value:
• | Level 1 — quoted prices in active markets for identical assets and liabilities. |
• | Level 2 — observable inputs other than quoted prices in active markets for identical assets and liabilities. |
• | Level 3 — unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions. |
The fair value of the Company’s warrant liability (described in Note 3 above) was determined based on Level 2 inputs. The fair value of the Company’s convertible debt derivative liability (described in Note 7 above) was determined based on Level 3 inputs using discounted probability cash flow valuation models. As discussed in Note 6 above, the Company’s goodwill is analyzed annually for impairment by reference to fair value based on the Company’s market capitalization, a Level 1 input. The Company assesses the potential impairment of definite-lived intangible assets (if a triggering event occurs) by reference to future gross profit cash flows from the underlying products using the capitalized technology and trademarks, a Level 3 input.
The effective date for certain aspects of ASC 820 was deferred until January 1, 2009. Areas impacted by the deferral relate to nonfinancial assets and liabilities that are measured at fair value, but are recognized or disclosed at fair value on a nonrecurring basis. The Company adopted these aspects of the accounting for fair value measurements related to its nonfinancial assets and liabilities effective January 1, 2009. This adoption applies to such items as nonfinancial long-lived asset groups measured at fair value for an impairment assessment and determining the fair value of a financial asset when the market for that asset is not active. The application of these remaining aspects of ASC 820 did not have a material impact on the Company’s financial condition or results of operations.
In August 2009, the FASB issued Accounting Standards Update No. 2009-05 (ASU 2009-05), which amends ASC 820 to provide guidance on fair value measurement of liabilities. ASU 2009-05 requires the use of specific valuation techniques when measuring the fair value of liabilities and is effective for the Company in the fourth quarter of 2009. The implementation of ASU 2009-05 is not expected to have a material impact on the Company’s financial condition or results of operations.
Note 10. Recently Issued Accounting Pronouncements
In June 2009, the FASB issued and established its Accounting Standards Codification as the exclusive authoritative reference for nongovernmental U.S. GAAP for use in financial statements issued for interim and annual periods ending after September 15, 2009, except for SEC rules and interpretative releases, which are also authoritative for SEC registrants. Accordingly, the Company has adopted the ASC effective for its third quarter 2009 financial reporting. All references in this Form 10-Q to U.S. GAAP principles have been changed to reference the relevant topic from the FASB ASC. The adoption did not have a material impact on the Company’s consolidated financial statements.
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In May 2009, the FASB issued standards for accounting and reporting of subsequent events, as required by FASB ASC 855,Subsequent Events(“ASC 855”). ASC 855 sets forth general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued, including:
1. | The period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements. |
2. | The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements. |
3. | The disclosures that an entity should make about events or transactions that occurred after the balance sheet date. |
These standards for accounting and reporting of subsequent events was effective for interim or annual periods ending after June 15, 2009, and were adopted by the Company as of that date. The Company has evaluated subsequent events for potential disclosure through November 12, 2009, the date of filing of this Quarterly Report on Form 10-Q. No subsequent events were identified requiring financial statement recognition or disclosure.
In December 2007, the FASB issued standards (included in FASB ASC 805,Business Combinations) which established principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquired company and the goodwill acquired. These standards made certain changes to then-existing accounting practices for business combinations. Among the changes made were: transaction-related costs will be expensed; restructuring costs that the acquirer expects but is not obligated (as of the acquisition date) to incur will not be included in the measurement of the acquisition cost; and research and development assets will be capitalized. The new standards also established disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. These new business combination accounting standards were effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, were adopted by the Company effective January 1, 2009, and did not have a material impact on the Company’s financial condition or results of operations.
11. Litigation
Abbey Litigation
On January 23, 2006, following execution of the Merger Agreement between the Company and 3F Therapeutics, Inc. (“3F”), 3F was informed of a summons and complaint dated January 19, 2006, which was filed in the U.S. District Court in the Southern District of New York by Arthur N. Abbey (“Abbey”) against 3F Partners Limited Partnership II (a major stockholder of 3F, “3F Partners II”), Theodore C. Skokos (the then chairman of the board and a stockholder of 3F), 3F Management II, LLC (the general partner of 3F Partners II), and 3F (collectively, the “Defendants”) (the “Abbey I Litigation”). The summons and complaint alleges that the Defendants committed fraud under federal securities laws, common law fraud and negligent misrepresentation in connection with the purchase by Abbey of certain securities of 3F Partners II. In particular, Abbey claims that the Defendants induced Abbey to invest $4 million in 3F Partners II, which, in turn, invested $6 million in certain preferred stock of 3F, by allegedly causing Abbey to believe, among other things, that such investment would be short-term. Pursuant to the complaint, Abbey is seeking rescission of his purchase of his limited partnership interest in 3F Partners II and return of the amount paid therefor (together with pre-and post-judgment interest), compensatory damages for the alleged lost principal of his investment (together with interest thereon and additional general, consequential and incidental damages), general damages for all alleged injuries resulting from the alleged fraud in an amount to be determined at trial and such other legal and equitable relief as the court may deem just and proper. Abbey did not purchase any securities directly from 3F and is not a stockholder of 3F. On March 23, 2006, 3F filed a motion to dismiss the complaint. On August 6, 2007, the Court granted 3F’s motion to dismiss the complaint based on plaintiff’s failure to state a claim upon which relief may be granted and ordered the Clerk of the Court to close the case. On August 30, 2007, Abbey filed a Notice of Appeal with the United States Court of Appeals for the Second Circuit seeking to reverse the District Court’s August 6, 2007 Order dismissing the case. On December 18, 2008, the Second Circuit issued a Summary Order that affirmed the District Court’s judgment of dismissal finding that Abbey failed to state a claim against 3F. However, the Second Circuit remanded the case to the District Court to allow Abbey a chance to replead his claims. On or about February 13, 2009, Arthur Abbey filed an amended complaint which purports to allege additional facts to support the same claims against 3F that were asserted and dismissed in the original complaint. On or about March 31, 2009, 3F served and filed its motion to dismiss the amended complaint with prejudice. 3F’s motion to dismiss was fully submitted on June 8, 2009.
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On or about June 14, 2006, Abbey commenced a second civil action in the Court of Chancery in the State of Delaware by serving 3F with a complaint naming both 3F and Mr. Skokos as defendants (the “Abbey II Litigation”). The complaint alleges, among other things, fraud and breach of fiduciary duties in connection with the purchase by Abbey of his partnership interest in 3F Partners II. The Delaware action seeks: (1) a declaration that (a) for purposes of the merger, Abbey was a record stockholder of 3F and was thus entitled to withhold his consent to the merger and seek appraisal rights after the merger was consummated and (b) the irrevocable stockholder consent submitted by 3F Partners II to approve the merger be voided as unenforceable; and (2) damages based upon allegations that 3F aided and abetted Mr. Skokos in breaching Mr. Skokos’s fiduciary duties of loyalty and faith to Abbey. On July 17, 2006, 3F filed a motion to dismiss the complaint in the Abbey II Litigation, or, alternatively, to stay the action pending adjudication of the Abbey I Litigation. On October 10, 2006, the Delaware Chancery Court entered an order staying the Delaware action pending the outcome of the Abbey I litigation. On or about August 17, 2007, the parties informed the Delaware Chancery Court that they would consent to the continued stay of the Delaware action pending the outcome of Abbey’s appeal of the Abbey I Litigation. The stay remains in effect pending the outcome of 3F’s motion to dismiss the amended complaint.
3F has been notified by its director and officer insurance carrier that such carrier will defend and cover all defense costs as to 3F and Mr. Skokos in the Abbey I Litigation and Abbey II Litigation, subject to policy terms and full reservation of rights. In addition, under the merger agreement, 3F and the 3F stockholder representative have agreed that the Abbey I Litigation and Abbey II Litigation are matters for which express indemnification is provided. As a result, the escrow shares and milestone shares, if any, may be used by ATS to satisfy, in part, ATS’s set-off rights and indemnification claims for damages and losses incurred by 3F or ATS, and their directors, officers and affiliates, that are not otherwise covered by applicable insurance arising from the Abbey I Litigation and Abbey II Litigation. See Note 2 of “Notes to Consolidated Financial Statements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, for a description of the escrow and milestone shares. The Company believes the Abbey I Litigation and Abbey II Litigation will not have a material impact on the Company’s financial position or operating results.
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ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
This document 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. The factors that could cause such material differences are identified in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. 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
ATS Medical, Inc. (hereinafter the “Company”, “ATS”, “we”, “us” or “our”) develops, manufactures, and markets medical devices. Our primary interest lies with devices for the treatment of structural heart disease used by cardiovascular surgeons in the cardiac surgery operating theater. Currently, we participate in the markets for heart valve therapy including mechanical bileaflet replacement heart valves, tissue heart valves and valve repair products and the surgical treatment of cardiac arrhythmias, primarily the treatment of atrial fibrillation. Additionally, a small portion of our business is surgical tools and accessories used by the cardiac surgeon.
In 1990, we licensed a patented and partially developed mechanical heart valve from CarboMedics, Inc. Under the terms of the license, we would complete the development of the valve and agreed to purchase carbon components from CarboMedics. As a result, ATS now holds an exclusive, royalty-free, worldwide license to an open pivot, bileaflet mechanical heart valve design owned by CarboMedics. In addition, we have an exclusive, worldwide right and license to use CarboMedics’ pyrolytic carbon technology to manufacture components for the ATS mechanical heart valve. We commenced selling the ATS mechanical heart valve in international markets in 1992. In late 2000, we received U.S. Food and Drug Administration (“FDA”) approval to sell the ATS Open Pivot mechanical heart valve and commenced sales and marketing of our valve in the United States.
During 2002, we reorganized the Company and began the process of rebuilding our sales and marketing teams, both in the United States and internationally. This rebuilding has been a significant factor in our operating expense levels since 2002. During 2004 and 2005, we developed and implemented a plan to ramp-up our own manufacturing facility for pyrolytic carbon. By the end of 2005, this process was substantially complete.
During 2004, we made our first investments outside the mechanical heart valve market. We completed a global partnership agreement with CryoCath Technologies, Inc. (“CryoCath”) to market CryoCath’s surgical cryotherapy products for the ablation of cardiac arrhythmias. CryoCath developed a portfolio of novel products marketed under the SurgiFrost® and FrostByte® trade names which are used by cardiac surgeons to treat cardiac arrhythmias. Treatment is accomplished through the creation of an intricate pattern of lesions on the surface of the heart to block inappropriate electrical conduction circuits which cause the heart to be less effective when pumping blood and can lead to stroke, heart failure and death. Unique to this technology is the use of cryothermy (cold) to create lesions. The agreement with CryoCath has resulted in revenues for ATS since 2005.
During 2005, we continued to expand our business outside the mechanical heart valve market. We entered into an exclusive development, supply and distribution agreement with Genesee BioMedical, Inc. (“GBI”) under which GBI develops, supplies and manufactures cardiac surgical products to include annuloplasty repair rings and bands and accessories, and we have exclusive worldwide rights to market and sell such products. Our agreement with GBI has produced revenues for us since 2006.
In 2006, we completed the acquisition of all the voting and non-voting stock of 3F Therapeutics, Inc. (“3F”), an early stage privately-held medical device company at the forefront of the emerging field of minimally invasive open- and closed-chest tissue valve replacement. The acquisition of 3F was a major step in the execution of our long-standing vision of obtaining a leadership position in the major segments of the cardiac surgery market. The acquisition was consummated pursuant to an agreement and plan of merger, as amended (“the Merger Agreement”). Under the terms of the Merger Agreement, upon closing, we paid each 3F stockholder its pro-rata portion of an initial payment of 9,000,000 shares of our common stock, subject to certain adjustments. In addition to the initial closing payment, we are obligated to make additional contingent payments to 3F stockholders of up to 10,000,000 shares of our common stock with shares issuable upon obtaining each of the CE mark and FDA approval of certain future key products on or prior to December 31, 2013. Milestone share payments may be accelerated upon completion of certain transactions involving these future key products. Our current first generation tissue valve, the ATS 3f Aortic Bioprosthesis, has received the CE mark and is available for sale in Europe and certain other international markets. In the United States, we received FDA approval of this product in October 2008.
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Also in 2006, we entered into an exclusive distribution agreement with Novare Surgical Systems, Inc. (“Novare”). Novare is the owner of the Enclose II® cardiac anastomosis assist device, which is a device used by cardiac surgeons to attach a bypass vessel to the aorta during coronary artery bypass graft surgery. Under the terms of the agreement, we hold the exclusive right to market, sell and distribute the Enclose II product in the United States, Germany, France and the United Kingdom. We discontinued selling the Enclose II device on August 1, 2009.
In June 2007, we acquired the cryoablation surgical device business of CryoCath. The acquisition included the SurgiFrost, FrostByte and SurgiFrost XL family of products for which we served as CryoCath’s exclusive agent in the United States and distributor in certain international markets. Under the acquisition agreement, we paid CryoCath $22.0 million upon closing of the transaction (reduced by $0.9 million subsequent to closing) and $2.0 million during 2008 upon the achievement of certain manufacturing transition milestones. We also paid $2.0 million in June 2009 (two years after closing) and agreed to pay up to $4.0 million in contingent payments based on future sales of Surgifrost XL, an FDA cleared and CE Marked product designed to enable less-evasive ablations. Based on the results of extensive bench and pre-clinical testing as well as human feasibility studies, the Company discontinued development of the SurgiFrost XL product in late 2008. The Company continues to develop less invasive procedures utilizing its existing set of tools. The acquisition of the cryoablation surgical device business of CryoCath enables us to leverage our current operating infrastructure and allows us to better address the rapidly growing cardiac arrhythmia market within cardiac surgery. The transaction was financed with a portion of the proceeds of an $8.6 million senior secured Term Loan from Silicon Valley Bank and the private placement of 9,800,000 shares of our common stock to Alta Partners VIII, L.P., a life sciences venture capital firm.
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 our financial condition and results of operations are discussed in our most recent Annual Report on Form 10-K on file with the SEC.
See Notes 9 and 10 of “Notes to Consolidated Financial Statements” in Item 1 of this Form 10-Q for information on recently issued accounting pronouncements which will or could affect our accounting policies and estimates.
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Results of Operations
The following table provides the dollar and percentage change in the Statements of Operations for the three and nine month periods ended October 3, 2009 and September 27, 2008.
Three months ended | Nine months ended | |||||||||||||||||||||||||||||||
October 3 (September 27) | October 3 (September 27) | |||||||||||||||||||||||||||||||
Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||||||||||||||
(in thousands) | 2009 | 2008 | $ | % | 2009 | 2008 | $ | % | ||||||||||||||||||||||||
Net sales | $ | 18,827 | $ | 16,044 | $ | 2,783 | 17.3 | % | $ | 57,011 | $ | 47,789 | $ | 9,222 | 19.3 | % | ||||||||||||||||
Cost of goods sold | 6,983 | 6,570 | 413 | 6.3 | % | 20,153 | 19,077 | 1,076 | 5.6 | % | ||||||||||||||||||||||
Gross profit | 11,844 | 9,474 | 2,370 | 25.0 | % | 36,858 | 28,712 | 8,146 | 28.4 | % | ||||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||||||
Sales and marketing | 6,950 | 7,059 | (109 | ) | (1.5 | )% | 21,976 | 20,693 | 1,283 | 6.2 | % | |||||||||||||||||||||
Research and development | 2,226 | 1,843 | 383 | 20.8 | % | 6,087 | 6,351 | (264 | ) | (4.2 | )% | |||||||||||||||||||||
General and administrative | 2,438 | 2,431 | 7 | 0.3 | % | 7,345 | 8,199 | (854 | ) | (10.4 | )% | |||||||||||||||||||||
Amortization of intangibles | 812 | 891 | (79 | ) | (8.9 | )% | 2,412 | 2,672 | (260 | ) | (9.7 | )% | ||||||||||||||||||||
Total operating expenses | 12,426 | 12,224 | 202 | 1.7 | % | 37,820 | 37,915 | (95 | ) | (0.3 | )% | |||||||||||||||||||||
Operating loss | (582 | ) | (2,750 | ) | (2,186 | ) | (78.8 | )% | (962 | ) | (9,203 | ) | (8,241 | ) | (89.5 | )% | ||||||||||||||||
Net interest expense | (644 | ) | (700 | ) | (56 | ) | (8.0 | )% | (2,057 | ) | (1,976 | ) | 81 | 4.1 | % | |||||||||||||||||
Other income (expense), net | 383 | (241 | ) | 624 | 258.9 | % | 501 | 637 | (136 | ) | (21.4 | )% | ||||||||||||||||||||
Net loss before income taxes | (843 | ) | (3,691 | ) | (2,848 | ) | (77.2 | )% | (2,518 | ) | (10,542 | ) | (8,024 | ) | (76.1 | )% | ||||||||||||||||
Income tax expense | (132 | ) | (55 | ) | 77 | 140.0 | % | (314 | ) | (284 | ) | 30 | 10.6 | % | ||||||||||||||||||
Net loss | $ | (975 | ) | $ | (3,746 | ) | $ | (2,771 | ) | (74.0 | )% | $ | (2,832 | ) | $ | (10,826 | ) | $ | (7,994 | ) | (73.8 | )% | ||||||||||
The following table presents the Statements of Operations as a percentage of net sales for the three and nine month periods ended October 3, 2009 and September 27, 2008.
Three months ended | Nine months ended | |||||||||||||||
October 3 (September 27) | October 3 (September 27) | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of goods sold | 37.1 | % | 40.9 | % | 35.3 | % | 39.9 | % | ||||||||
Gross profit | 62.9 | % | 59.1 | % | 64.7 | % | 60.1 | % | ||||||||
Operating expenses: | ||||||||||||||||
Sales and marketing | 36.9 | % | 44.0 | % | 38.5 | % | 43.3 | % | ||||||||
Research and development | 11.8 | % | 11.5 | % | 10.7 | % | 13.3 | % | ||||||||
General and administrative | 12.9 | % | 15.2 | % | 12.9 | % | 17.2 | % | ||||||||
Amortization of intangibles | 4.3 | % | 5.6 | % | 4.2 | % | 5.6 | % | ||||||||
Total operating expenses | 66.0 | % | 76.2 | % | 66.3 | % | 79.3 | % | ||||||||
Operating loss | (3.1 | )% | (17.1 | )% | (1.7 | )% | (19.3 | )% | ||||||||
Net interest income (expense) | (3.4 | )% | (4.4 | )% | (3.6 | )% | (4.1 | )% | ||||||||
Other income (expense), net | 2.0 | % | (1.5 | )% | 0.9 | % | 1.3 | % | ||||||||
Net loss before income taxes | (4.5 | )% | (23.0 | )% | (4.4 | )% | (22.1 | )% | ||||||||
Income tax expense | (0.7 | )% | (0.3 | )% | (0.6 | )% | (0.6 | )% | ||||||||
Net loss | (5.2 | )% | (23.3 | )% | (5.0 | )% | (22.7 | )% | ||||||||
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Net Sales.The following table provides the dollar and percentage change in net sales inside and outside the United States for the three and nine month periods ended October 3, 2009 and September 27, 2008.
Three months ended | Nine months ended | |||||||||||||||||||||||||||||||
October 3 (September 27) | October 3 (September 27) | |||||||||||||||||||||||||||||||
Increase | Increase | |||||||||||||||||||||||||||||||
(in thousands) | 2009 | 2008 | $ | % | 2009 | 2008 | $ | % | ||||||||||||||||||||||||
United States | $ | 7,040 | $ | 5,847 | $ | 1,193 | 20.4 | % | $ | 22,553 | $ | 18,274 | $ | 4,279 | 23.4 | % | ||||||||||||||||
Outside United States | 11,787 | 10,197 | 1,590 | 15.6 | % | 34,458 | 29,515 | 4,943 | 16.7 | % | ||||||||||||||||||||||
Total | $ | 18,827 | $ | 16,044 | $ | 2,783 | 17.3 | % | $ | 57,011 | $ | 47,789 | $ | 9,222 | 19.3 | % | ||||||||||||||||
The following table provides net sales inside and outside the United States as a percentage of total net sales for the three and nine month periods ended October 3, 2009 and September 27, 2008.
Three months ended | Nine months ended | |||||||||||||||
October 3 (September 27) | October 3 (September 27) | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
United States | 37.4 | % | 36.4 | % | 39.6 | % | 38.2 | % | ||||||||
Outside United States | 62.6 | % | 63.6 | % | 60.4 | % | 61.8 | % | ||||||||
Total | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
The following table provides net sales by product group for the three and nine month periods ended October 3, 2009 and September 27, 2008.
Three months ended | Nine months ended | |||||||||||||||||||||||||||||||
October 3 (September 27) | October 3 (September 27) | |||||||||||||||||||||||||||||||
Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||||||||||||||
(in thousands) | 2009 | 2008 | $ | % | 2009 | 2008 | $ | % | ||||||||||||||||||||||||
Heart valve therapy | $ | 14,163 | $ | 11,755 | $ | 2,408 | 20.5 | % | $ | 42,144 | $ | 34,529 | $ | 7,615 | 22.1 | % | ||||||||||||||||
Surgical arrhythmia | 4,491 | 4,011 | 480 | 12.0 | % | 14,117 | 12,245 | 1,872 | 15.3 | % | ||||||||||||||||||||||
Surgical tools and accessories | 173 | 278 | (105 | ) | (37.8 | )% | 750 | 1,015 | (265 | ) | (26.1 | )% | ||||||||||||||||||||
Total | $ | 18,827 | $ | 16,044 | $ | 2,783 | 17.3 | % | $ | 57,011 | $ | 47,789 | $ | 9,222 | 19.3 | % | ||||||||||||||||
Total net sales in the third quarter and first nine months of 2009 increased 17% and 19%, respectively, over the same periods in 2008. Our net sales increases in the third quarter and first nine months of 2009 were negatively impacted (approximately 210 and 370 basis points, respectively) by lower foreign currency exchange rates against the U.S. dollar during 2009. Approximately 20% of our total sales for the first nine months of 2009 were invoiced in Euros or other local currencies in European markets where we sell our products directly to hospitals.
Heart valve therapy sales, our largest product group, consists of mechanical and tissue heart valves and heart valve repair products. Our mechanical heart valve products continue to be our primary product line and comprised approximately 60% of our total worldwide sales for the first nine months of 2009, compared to 65% for the same period in 2008. Surgical arrhythmia therapy products consist of cryotherapy products for the ablation of cardiac arrhythmias. We acquired this business from CryoCath in 2007. Surgical tools and accessories consist primarily of cardiac anastomosis assist devices and thoracic port systems. Effective August 1, 2009, we ceased distribution of anastomotic assist devices, which represented approximately $0.5 million and $0.8 million of sales in the first nine months of 2009 and 2008, respectively.
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Worldwide mechanical heart valve revenue for the three and nine months ended October 3, 2009 increased 10% and 11% from the same periods in 2008, respectively, due to stronger mechanical heart valve sales in Asia and certain developing markets. Tissue heart valve revenue increased 375% in the third quarter of 2009 to $1.4 million, and increased 312% in the first nine months of 2009 to $4.1 million compared to the same periods in 2008, driven primarily by the limited commercial launch of the Company’s first generation U.S. tissue valve product, the ATS 3f Aortic Bioprosthesis, approved by the FDA in October 2008. U.S. tissue valve revenue comprised more than 50% of total tissue valve revenue for the first nine months of 2009. Heart valve repair revenue increased 29% for the third quarter of 2009 to $1.2 million, and increased 51% to $3.6 million for the first nine months of 2009, compared to the same periods in 2008, due to the introduction of our semi-rigid line of repair rings in the first quarter of 2008 as well as to continued sales growth of our existing repair ring products.
Surgical arrhythmia therapy revenue in the third quarter and first nine months of 2009 increased 12% and 15%, respectively, compared to the same periods in the prior year. Cryotherapy products in general and CryoMaze procedural growth in particular has benefited from the overall growth of the surgical ablation market and increased market acceptance of cryo-energy (cold) as a preferred technology to perform Cox-Maze lesion sets.
Cost of Goods Sold and Gross Profit.Our third quarter and first nine months 2009 gross profit percentages of net sales improved to 62.9% and 64.7% from 59.1% and 60.1% for the same periods in the prior year, respectively.
Our third quarter and year-to-date 2009 gross profit has benefited significantly from lower product manufacturing costs, particularly for mechanical heart valves. The cost declines are attributable primarily to higher manufacturing volumes as a result of increased demand. Lower product costs increased our third quarter and first nine months 2009 gross profit percentages of net sales by approximately 550 and 830 basis points, respectively, compared to the comparable periods of 2008. Also contributing to the higher third quarter and first nine months 2009 gross profit percentages were higher U.S. average selling prices, attributable in large part to tissue valves, which increased both our third quarter and first nine months 2009 gross profit percentages of net sales by approximately 200 basis points compared to the same periods in the prior year.
Partially offsetting the improved 2009 gross profit percentages of net sales were (1) shifts in the overall product mix to lower margin products, which decreased our third quarter and first nine months 2009 gross profit percentages of net sales by approximately 50 and 300 basis points, respectively, compared to comparable periods of 2008 and (2) lower international selling prices due to foreign currency exchange rate changes and geographical sales mix shifts resulting from higher sales growth in lower-margin countries, which had a net unfavorable impact on our third quarter and first nine months 2009 gross profit percentages of net sales of approximately 320 and 280 basis points, respectively, compared to the comparable periods in the prior year.
Sales and Marketing.In the United States, our sales and marketing costs for the third quarter and first nine months of 2009 increased approximately 1.5% and 12.5%, respectively, over the comparable periods in the prior year, to $4.4 million and $14.2 million, respectively. The increases reflect higher marketing program costs, particularly for our tissue heart valve and cryoablation businesses, as well as additional marketing personnel costs. Field selling costs in the United States were 10.0% higher in the first nine months of 2009 compared to the same period in the prior year, reflecting primarily hospital sales program costs as well as higher independent sales agent commissions connected with increased 2009 sales in the United States.
Internationally, our sales and marketing costs for the third quarter and first nine months of 2009 decreased approximately 6.4% and 3.6% over the comparable periods in the prior year to $2.5 million and $7.8 million, respectively. The decreases are attributable to the impact of lower Euro-to-U.S. dollar foreign exchange rates during 2009 than 2008 (more than 75% of our international sales and marketing costs are denominated in Euros) partially offset by higher costs associated with our continuing investment in international markets, evidenced by the establishment of a European support office in Belgium during the second half of 2008 to continue the support and expansion of our direct sales operations in Europe.
Research and Development.Research and development (“R & D”) expenses for the third quarter of 2009 increased 20.8% over the comparable period in the prior year to $2.2 million. The increase reflects higher clinical program costs related to headcount additions and the timing of clinical trial submissions for tissue valves, partially offset by lower direct tissue valve R & D expenses after FDA approval of our first generation tissue valve in October 2008 and prior year development and start-up costs for surgical cryoablation manufacturing.
R & D expenses for the first nine months of 2009 decreased 4.2% over the comparable period in the prior year to $6.1 million. The decrease reflects lower direct tissue valve R & D expenses, lower clinical program costs for tissue valves and lower bonus accruals, partially offset by the allocation of stock compensation expense to R & D beginning in 2009. R & D expense fluctuations are generally related to the timing and stages of individual projects and programs.
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General and Administrative.General and administrative (“G & A”) expenses were flat for the third quarter of 2009 and decreased 10.4% for the first nine months of 2009 compared to the same periods in 2008. The primary driver behind these results was significantly lower legal fees ($0.2 million for the third quarter of 2009 and $1.4 million for the first nine months of 2009) after the fourth quarter 2008 settlement of the litigation with CarboMedics. Offsetting the lower legal fees in the third quarter of 2009 was higher consulting costs.
In the third quarters of 2009 and 2008, we recognized total stock compensation expense of $0.7 million and $0.4 million, respectively. In the first nine months of 2009 and 2008, we recognized total stock compensation expense of $1.9 million and $1.2 million, respectively. Stock compensation expense has been allocated to cost of goods sold, sales and marketing, R & D and G & A expenses as indicated above in Note 2 of “Notes to Consolidated Financial Statements” in this Form 10-Q. The increase in stock compensation expense is attributable primarily to new equity grants and awards and to fewer forfeitures.
Amortization of Intangibles.Amortization expense for the third quarter and first nine months of 2009 decreased $0.1 million and $0.3 million, respectively, over the comparable periods in 2008, attributable primarily to certain trademark intangibles becoming fully amortized in the third quarter of 2008. Amortization expense for both 2009 and 2008 primarily consists of amortization of our pyrolytic carbon technology license with CarboMedics as well as amortization of definite-lived intangible assets acquired in connection with our 2006 acquisition of 3F and our 2007 acquisition of the surgical cryoablation business of CryoCath. We estimate total amortization expense for full year 2009 will be approximately $3.2 million.
Net Interest Expense. Net interest expense for the third quarter of 2009 declined 8% from the same period in 2008 due to lower interest on the declining principal balance of our loan with Silicon Valley bank, the cessation of imputed interest expense on the $2.0 million acquisition payment made to CryoCath in June 2009, and lower interest income on cash and investment balances.
Net interest expense for the first nine months of 2009 increased approximately 4% over the comparable period in 2008, reflecting lower interest income on cash and investment balances and interest expense related to the June 2008 Credit Agreement and Credit Facility with Theodore C. Skokos, offset in part by lower interest on the declining principal balance of our loan with Silicon Valley bank.
Net interest expense includes (1) commitment fee and deferred financing costs related to the 2008 Credit Agreement and Credit Facility with Theodore C. Skokos (2) interest on the $8.6 million Term Loan with Silicon Valley Bank obtained in connection with the 2007 acquisition of the surgical cryoablation business of CryoCath, and (3) interest on the $22.4 million aggregate principal amount of 6% Convertible Senior Notes issued in 2005. Interest expense on the Notes includes amortization of (a) financing costs, (b) the discount related to the implied value of common stock warrants sold with the Notes, and (c) the discounts related to the bifurcated Convertible Senior Notes derivatives. See Note 7 of “Notes to Consolidated Financial Statements” in this Form 10-Q for more information regarding all of these debt instruments.
Other Income (Expense). The following table summarizes our net other income (expense) for the third quarter and first nine months of 2009 and 2008:
Three months ended | Nine months ended | |||||||||||||||
October 3 (September 27) | October 3 (September 27) | |||||||||||||||
(in thousands) | 2009 | 2008 | 2009 | 2008 | ||||||||||||
Alta warrant liability gain | $ | — | $ | — | $ | — | $ | 243 | ||||||||
Convertible Senior Notes derivative liability gain | 8 | 13 | 26 | 43 | ||||||||||||
Net foreign currency transaction gain (loss) related to intercompany balances with foreign subsidiaries: | ||||||||||||||||
Realized | 222 | 86 | 111 | 774 | ||||||||||||
Unrealized | 153 | (340 | ) | 364 | (423 | ) | ||||||||||
Net other income (expense) | $ | 383 | $ | (241 | ) | $ | 501 | $ | 637 | |||||||
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In our June 2007 private equity placement in connection with the acquisition of the surgical cryoablation business of CryoCath, we sold to Alta 9,800,000 shares of our common stock and a seven-year warrant to purchase up to 1,960,000 shares of our common stock at an exercise price of $1.65 per share. The Company was required to treat the warrant as a liability pending approval of its shareholders at the Company’s 2008 annual meeting of shareholders to provide shares of common stock issuable to Alta upon exercise of the warrant. Accordingly, the fair value of the warrant was recorded as a liability on the date of issuance and marked-to-market at each quarter-end. This resulted in a credit to other income of $1.5 million recorded during the first quarter of 2008 and a charge to other expense of $1.3 million recorded during the second quarter of 2008. At the annual meeting of shareholders in May 2008, we received shareholder approval to issue shares of our common stock upon exercise of the warrant. Consequently, the warrant liability was marked-to-market through the date of shareholder approval and the remaining liability was credited to additional paid-in capital.
Since 2005 we have recorded non-operating other income for the change in fair value of the Convertible Senior Notes derivative liability. See Note 7 of “Notes to Consolidated Financial Statements” in this Form 10-Q for more information regarding the Notes derivative liability.
Net other income also includes net foreign currency transaction gains and losses, including unrealized foreign currency gains and losses related to short-term intercompany balances with our foreign subsidiaries. These gains and losses have increased in 2008 and 2009 due to larger fluctuations in foreign currency exchange rates.
Income Taxes. In the first nine months of both 2009 and 2008, we recognized approximately $0.3 million of income tax expense, respectively, related to (1) deferred income taxes connected with the deductibility of goodwill from the CryoCath acquisition for tax purposes, but not for book purposes, and the uncertainty of the timing of its reversal for book purposes and (2) current income taxes for certain of our European sales and distribution subsidiaries. In future years, we will continue recognizing deferred income tax expense related to this goodwill over its tax life as long as there is no impairment of the goodwill’s recorded value.
Through 2008 we have accumulated approximately $161 million of net operating loss (“NOL”) carryforwards for U.S. tax purposes ($57 million related to 3F). We believe that our ability to fully utilize the existing NOL carryforwards could be restricted on a portion of the NOL by changes in control that may have occurred or may occur in the future and by our ability to generate net income. We are conducting a formal study of whether, or to what extent, past changes in control of ATS impair our NOL carryforwards. We have recorded no net deferred tax asset related to our NOL carryforwards and other deferred items as we currently cannot determine that it is more likely than not that this asset will be realized and we, therefore, have provided a valuation allowance for the entire asset.
Net Loss. Our changes in net losses in the third quarter and first nine months of 2009 compared to the comparable periods in 2008 were due to significantly higher sales and gross profit and smaller changes in operating expenses and non-operating income, all of which are described in detail above.
Liquidity and Capital Resources
Cash and cash equivalents totaled $12.1 million and $20.9 million at October 3, 2009 and December 31, 2008, respectively.
Operating Activities.During the first nine months of 2009, we received cash payments from customers of approximately $57.2 million and made payments to employees and suppliers of approximately $60.5 million. During the first nine months of 2008, we received cash payments from customers of approximately $47.1 million and made payments to employees and suppliers of approximately $52.0 million. Cash payments made during the first nine months of 2009 include the payment of a $4.5 million litigation settlement payment to CarboMedics in April 2009.
Since 2002, we have incurred significant expenses to support the commercialization of ATS products both in the United States and in international markets, have invested in new products and technologies and have completed strategic acquisitions and business partnerships to diversify our product portfolio. As we grow sales in future periods, better leverage our operating expenses and continue to drive declines in our product manufacturing costs, we believe that our operating losses will continue to decrease and that we will move toward a cash flow breakeven on sales and eventually to full-year profitability.
Investing Activities.In June 2009, we made a $2.0 million acquisition payment to CryoCath due two years after the closing of the acquisition of the surgical cryoablation business of CryoCath.
We purchased leasehold improvements, property and equipment totaling $1.0 million and $1.2 million during the first nine months of 2009 and 2008, respectively. Capital spending in 2009 has focused on information technology and manufacturing improvement projects. A significant portion of our capital spending in 2008 was related to the addition of a surgical cryoablation production clean room at our Plymouth, Minnesota location following our 2007 acquisition of the surgical cryoablation business of CryoCath.
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During the first nine months of 2009, we also converted a long-term restricted investment of $0.5 million to cash.
Financing Activities.During the first nine months of 2009, we raised $0.2 million from the issuance of common stock, primarily through exercises of stock options and warrants as well as purchases under our employee stock purchase plan. During the first nine months of 2008, we raised $4.0 million from the issuance of common stock, including $3.2 million received upon the June 2008 exercise of warrants on 1,960,000 shares of our common stock at an exercise price of $1.65 per share. The warrants were originally issued in connection with a June 2007 private placement sale of our common stock.
In June 2008, we entered into a Subordinated Credit Agreement with Theodore C. Skokos, a member of our Board of Directors, for a two-year, $5 million Revolving Credit Facility. Advances under the Credit Facility carry interest at 15% per annum payable quarterly. The Credit Facility also carries an annual commitment fee of 1% of the average unused Revolving Commitment Amount, payable annually. We paid the first annual commitment fee of $0.05 million to Mr. Skokos in July 2009. As of October 3, 2009, no amounts had been drawn under the Credit Facility. Our obligations to Mr. Skokos under the Credit Agreement are subordinate to (1) our obligations to the holders of the Company’s 6% Convertible Senior Notes due 2025 issued in October 2005 and (2) our obligations to Silicon Valley Bank. All assets are pledged as collateral on the Credit Facility. In connection with the execution of the Credit Agreement, we issued to Mr. Skokos a warrant to purchase 245,098 shares of our common stock at $2.04 per share until June 29, 2015. In July 2008, Mr. Skokos exercised this warrant in full and we received $0.5 million from the exercise. We are obligated to issue additional seven-year warrants to Mr. Skokos in the future based on the total amount of advances under the Credit Facility.
Since 2004 we have maintained a Loan Agreement with Silicon Valley Bank. Under the Loan Agreement, as amended, all ATS assets are pledged as collateral and we are subject to certain financial covenants. In June 2007, we entered into an Amendment to the Loan Agreement whereby the Bank provided for an $8.6 million Term Loan, which we used to repay then outstanding term loans and advances from the Bank and to purchase the surgical cryoablation business from CryoCath. Under the Term Loan, as amended, we made monthly payments of interest only from July 2007 through March 2008, and we began making monthly payments of principal plus interest effective April 2008 and continuing until June 2011. Accordingly, we repaid $2.2 million and $1.3 million of principal on the Term Loan during the first nine months of 2009 and 2008, respectively. We have the right to prepay all, but not less than all, of the outstanding Term Loan at any time so long as no event of default has occurred. Interest on the Term Loan accrues at a fixed rate per annum of 9.5%, equal to 1.25% above the Prime Rate in effect as of the funding date of the Term Loan.
The June 2007 Amendment also made certain changes to the liquidity ratio covenant set forth in the Loan Agreement, as amended. The liquidity ratio was changed to require that we maintain, at all times, on a consolidated basis, a ratio of (1) the sum of (a) our unrestricted cash (and equivalents) on deposit with the Bank plus (b) 50% of the our accounts receivable arising form the sale or lease of goods, or provision of services, in the ordinary course of business, divided by (2) our indebtedness to the Bank for borrowed money, of equal to or greater than 1.4 to 1.0. In June 2008, the Company entered into an Amendment to the Loan Agreement whereby, for the balance of 2008, the 1.4 to 1.0 required liquidity ratio was reduced to 1.1 to 1.0 for intra-quarter months only. The liquidity ratio remained at 1.4 to 1.0 for quarter-end months and reverted to 1.4 to 1.0 for all months beginning in 2009. In December 2008, we entered into an Amendment to the Loan Agreement whereby the liquidity ratio was raised to 2.0 to 1.0 until the payment of a $4.5 million litigation settlement payment was made to CarboMedics on April 30, 2009, and a related security interest granted to CarboMedics was released. Upon such payment, the Bank agreed to return the liquidity ratio requirement to 1.4 to 1.0. In addition, the December 2008 Amendment required us to maintain at least $4.5 million on deposit with the Bank at all times until the litigation settlement payment of $4.5 million was. In April 2009, we made the $4.5 million settlement payment. As of October 3, 2009, we were in compliance with all financial covenants set forth in the Loan Agreement, as amended.
In October 2005, we sold a combined $22.4 million aggregate principal amount of 6% Convertible Senior Notes due in 2025, warrants to purchase 1,344,000 shares of our common stock and certain embedded derivatives. The Warrants are exercisable at $4.40 per share and expire in 2010. We used the proceeds from the Notes for general corporate purposes, working capital, capital expenditures and to fund business development opportunities. Interest on the Notes is due semi-annually in April and October. The Notes are convertible into common stock at any time at a fixed conversion price of $4.20 per share, subject to certain adjustments. If fully converted, the Notes would convert into approximately 5,333,334 shares of our common stock. We have the right to redeem the Notes at 100% of the principal amount plus accrued interest at any time on or after October 20, 2008, and the investors have the right to require us to repurchase the Notes at 100% of the principal amount plus accrued interest on October 15 in 2010, 2015 and 2020. Accordingly, we will reclassify the Notes from long-term to current liabilities on our balance sheet in the fourth quarter of 2009.
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Cash Management and Funding of Future Operations
We anticipate that operating costs will remain relatively high in comparison to sales during 2009 and will continue to require the use of cash to fund operations. Based upon the current forecast of sales and operating expenses, we anticipate having sufficient cash to fund our operations. However, we may need to raise additional cash in or after 2009 to fund our strategic investments, refinance long-term obligations or to opportunistically add accretive products to our distribution network. As identified in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008, global economic turmoil may adversely impact our revenue, access to the capital markets or future demand for our products, all of which could affect our long-term viability. Approximately 60% of our revenue is derived from markets outside the United States and this revenue may be adversely impacted by large swings in foreign currency exchange rates and the availability of credit for our distributors in emerging markets. Maintaining adequate levels of working capital depends in part upon the success of our products in the marketplace, the relative profitability of those products and our ability to control operating and capital expenses.
Funding of our operations in future periods may require additional investments in ATS in the form of equity or debt. In addition, as discussed above, the holders of our $22.4 million Convertible Senior Notes have the option to require us to repurchase the Notes in October 2010. If this option is exercised, we would need to raise capital, issue debt securities or borrow to finance the repurchase of the Notes. Any sale of additional equity or issuance of debt securities may result in dilution to our stockholders, and we cannot be certain that additional public or private financing will be available in amounts or on terms acceptable to us, or at all. If we are unable to obtain this additional financing when needed, we may be required to delay, reduce the scope of, or eliminate one or more aspects of our business development activities, which could harm the growth of our business.
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, operating results, liquidity, capital expenditures or capital resources.
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, the United Kingdom, France, Germany, Belgium, the Netherlands and Switzerland, 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 our direct selling markets in Europe, are entered into in U.S. dollars, precluding the need for foreign currency hedges on such sales. Sales through our French and German subsidiaries, as well as sales to Belgium and the Netherlands, are in Euros. Sales to the United Kingdom and Switzerland are denominated in British pounds and Swiss francs, respectively. Therefore, we are subject to profitability risk arising from exchange rate movements. Our foreign subsidiaries are also subject to exchange rate risk related to their U.S dollar-denominated intercompany payable balances. We have not used foreign exchange contracts or similar devices to reduce these risks. We will evaluate the need to use foreign exchange contracts or similar devices if sales in our European direct markets increase substantially.
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ITEM 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Principal Executive Officer and our Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our Principal Executive Officer and our Principal 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 Exchange Act). Based on that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
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 fiscal quarter ended October 3, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. | Legal Proceedings |
Abbey Litigation
On January 23, 2006, following execution of the Merger Agreement between the Company and 3F, 3F was informed of a summons and complaint dated January 19, 2006, which was filed in the U.S. District Court in the Southern District of New York by Arthur N. Abbey (“Abbey”) against 3F Partners Limited Partnership II (a major stockholder of 3F, “3F Partners II”), Theodore C. Skokos (the then chairman of the board and a stockholder of 3F), 3F Management II, LLC (the general partner of 3F Partners II), and 3F (collectively, the “Defendants”) (the “Abbey I Litigation”). The summons and complaint alleges that the Defendants committed fraud under federal securities laws, common law fraud and negligent misrepresentation in connection with the purchase by Abbey of certain securities of 3F Partners II. In particular, Abbey claims that the Defendants induced Abbey to invest $4 million in 3F Partners II, which, in turn, invested $6 million in certain preferred stock of 3F, by allegedly causing Abbey to believe, among other things, that such investment would be short-term. Pursuant to the complaint, Abbey is seeking rescission of his purchase of his limited partnership interest in 3F Partners II and return of the amount paid therefor (together with pre-and post-judgment interest), compensatory damages for the alleged lost principal of his investment (together with interest thereon and additional general, consequential and incidental damages), general damages for all alleged injuries resulting from the alleged fraud in an amount to be determined at trial and such other legal and equitable relief as the court may deem just and proper. Abbey did not purchase any securities directly from 3F and is not a stockholder of 3F. On March 23, 2006, 3F filed a motion to dismiss the complaint. On August 6, 2007, the Court granted 3F’s motion to dismiss the complaint based on plaintiff’s failure to state a claim upon which relief may be granted and ordered the Clerk of the Court to close the case. On August 30, 2007, Abbey filed a Notice of Appeal with the United States Court of Appeals for the Second Circuit seeking to reverse the District Court’s August 6, 2007 Order dismissing the case. On December 18, 2008, the Second Circuit issued a Summary Order that affirmed the District Court’s judgment of dismissal finding that Abbey failed to state a claim against 3F. However, the Second Circuit remanded the case to the District Court to allow Abbey a chance to replead his claims. On or about February 13, 2009, Arthur Abbey filed an amended complaint which purports to allege additional facts to support the same claims against 3F that were asserted and dismissed in the original complaint. On or about March 31, 2009, 3F served and filed its motion to dismiss the amended complaint with prejudice. 3F’s motion to dismiss was fully submitted on June 8, 2009.
On or about June 14, 2006, Abbey commenced a second civil action in the Court of Chancery in the State of Delaware by serving 3F with a complaint naming both 3F and Mr. Skokos as defendants (the “Abbey II Litigation”). The complaint alleges, among other things, fraud and breach of fiduciary duties in connection with the purchase by Abbey of his partnership interest in 3F Partners II. The Delaware action seeks: (1) a declaration that (a) for purposes of the merger, Abbey was a record stockholder of 3F and was thus entitled to withhold his consent to the merger and seek appraisal rights after the merger was consummated and (b) the irrevocable stockholder consent submitted by 3F Partners II to approve the merger be voided as unenforceable; and (2) damages based upon allegations that 3F aided and abetted Mr. Skokos in breaching Mr. Skokos’s fiduciary duties of loyalty and faith to Abbey. On July 17, 2006, 3F filed a motion to dismiss the complaint in the Abbey II Litigation, or, alternatively, to stay the action pending adjudication of the Abbey I Litigation. On October 10, 2006, the Delaware Chancery Court entered an order staying the Delaware action pending the outcome of the Abbey I litigation. On or about August 17, 2007, the parties informed the Delaware Chancery Court that they would consent to the continued stay of the Delaware action pending the outcome of Abbey’s appeal of the Abbey I Litigation. The stay remains in effect pending the outcome of 3F’s motion to dismiss the amended complaint.
3F has been notified by its director and officer insurance carrier that such carrier will defend and cover all defense costs as to 3F and Mr. Skokos in the Abbey I Litigation and Abbey II Litigation, subject to policy terms and full reservation of rights. In addition, under the merger agreement, 3F and the 3F stockholder representative have agreed that the Abbey I Litigation and Abbey II Litigation are matters for which express indemnification is provided. As a result, the escrow shares and milestone shares, if any, may be used by ATS to satisfy, in part, ATS’s set-off rights and indemnification claims for damages and losses incurred by 3F or ATS, and their directors, officers and affiliates, that are not otherwise covered by applicable insurance arising from the Abbey I Litigation and Abbey II Litigation.
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See Note 2 of “Notes to Consolidated Financial Statements” in the Company���s Annual Report on Form 10-K for the year ended December 31, 2008, for a description of the escrow and milestone shares. The Company believes the Abbey I Litigation and Abbey II Litigation will not have a material impact on the Company’s financial position or operating results.
ITEM 1A. | Risk Factors |
You should carefully consider the risk factors discussed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, any of which could have a material impact on our business, financial condition or results of operations.
ITEM 6. | Exhibits |
3.1 | Third Restated Articles of Incorporation of ATS Medical, Inc. (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2008). | |||
3.2 | Bylaws of the Company, as amended February 13, 2007 (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 20, 2007). | |||
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). | |||
12.1 | Computation of Ratio of Earnings to Fixed Charges. | |||
31.1 | Certification of Principal Executive Officer pursuant to Rules 13a-15(e)/15d-15(e) of the Securities Exchange Act, as amended (Section 302 Certification). | |||
31.2 | Certification of Principal Financial Officer pursuant to Rules 13a-15(e)/15d-15(e) of the Securities Exchange Act, as amended (Section 302 Certification). | |||
32.1 | Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification). | |||
32.2 | Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification). |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 12, 2009 | ATS MEDICAL, INC. | |||
By: | /s/ Michael D. Dale | |||
Michael D. Dale | ||||
Chief Executive Officer (Principal Executive Officer) | ||||
By: | /s/ Michael R. Kramer | |||
Michael R. Kramer | ||||
Chief Financial Officer (Principal Financial Officer) |
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EXHIBIT INDEX
Exhibit | ||||
Number | Description | |||
3.1 | Third Restated Articles of Incorporation of ATS Medical, Inc. (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 28, 2008). | |||
3.2 | Bylaws of the Company, as amended February 13, 2007 (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 20, 2007). | |||
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). | |||
12.1 | Computation of Ratio of Earnings to Fixed Charges. | |||
31.1 | Certification of the Principal Executive Officer pursuant to Rules 13a-15(e)/15d-15(e) of the Securities Exchange Act, as amended (Section 302 Certification) | |||
31.2 | Certification of the Principal Financial Officer pursuant to Rules 13a-15(e)/15d-15(e) of the Securities Exchange Act, as amended (Section 302 Certification) | |||
32.1 | Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification) | |||
32.2 | Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification) |
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