ATS Medical (ATSI) 10-Q 2008 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 28, 2008

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 Incorporation or Organization)	(I.R.S. Employer Identification No.)
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.

Yesþ Noo

     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).

Yeso Noþ

     The number of shares outstanding of each of the registrant’s classes of common stock as of August 1, 2008, was:

Common Stock, $.01 par value 62,354,356 shares

TABLE OF CONTENTS

	Page(s)
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited):
Consolidated Balance Sheets as of June 28, 2008 and December 31, 2007	3
Consolidated Statements of Operations for the three and six month periods ended June 28, 2008 and June 30, 2007	4
Consolidated Statements of Cash Flow for the six month periods ended June 28, 2008 and June 30, 2007	5
Notes to Consolidated Financial Statements	6 - 15
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16 - 24
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk	24 - 25
ITEM 4. Controls and Procedures	25
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings	26 - 27
ITEM 1A. Risk Factors	27
ITEM 2 Unregistered Sales of Equity Securities and Use of Proceeds	27
ITEM 4 Submission of Matters to a Vote of Security Holders	28
ITEM 6. Exhibits	28 - 30
SIGNATURES	31
EXHIBIT INDEX	32 - 33
Third Restated Articles of Incorporation
Amendment No. 3 to Original Lease Agreement
2008 Management Incentive Compensation Plan
Certification of the Principal Executive Officer
Certification of the Principal Financial Officer
Certification of the Principal Executive Officer
Certification of the Principal Financial Officer

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

ATS Medical, Inc.

Consolidated Balance Sheets

(In Thousands, Except Share Data)

	June 28,			December 31,
	2008			2007
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	10,907		$	10,480
Short-term investments		7			4,189
Accounts receivable, net		12,853			11,186
Inventories		20,024			18,743
Prepaid expenses		1,165			1,143
Total current assets		44,956			45,741
Leasehold improvements, furniture and equipment, net		7,484			7,739
Goodwill		16,016			15,175
Other intangible assets		33,823			35,604
Other assets		1,444			1,638
Total assets	$	103,723		$	105,897
Liabilities and shareholders’ equity
Current liabilities:
Current maturities of bank notes payable	$	2,646		$	2,457
Accounts payable		5,230			4,794
Accrued compensation		2,830			2,361
Accrued distributor liabilities		475			791
Warrant liability		—			3,913
Other accrued liabilities		2,102			1,209
Total current liabilities		13,283			15,525
Convertible senior notes payable, net of unamortized discounts and bifurcated derivatives of $4,922 and $4,964 at June 28, 2008 and December 31, 2007		17,478			17,436
Payable to CryoCath Technologies, Inc.		1,824			1,742
Notes payable		5,292			6,143
Deferred income taxes		191			95
Shareholders’ equity:
Common stock, $.01 par value:
Authorized shares - 150,000,000
Issued and outstanding shares- 62,041,738 at June 28, 2008 and 59,512,085 at December 31, 2007		620			595
Additional paid-in capital		203,903			196,108
Accumulated deficit		(139,657	)		(132,577	)
Accumulated other comprehensive income		789			830
Total shareholders’ equity		65,655			64,956
Total liabilities and shareholders’ equity	$	103,723		$	105,897

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 June 28 (30)						Six months ended June 28 (30)
	2008			2007			2008			2007
Net sales	$	16,900		$	12,417		$	31,745		$	23,213
Cost of goods sold		6,610			5,545			12,507			10,098
Gross profit		10,290			6,872			19,238			13,115
Operating expenses:
Sales and marketing		7,147			6,115			13,634			12,038
Research and development		2,302			1,901			4,508			3,558
Acquired in-process research and development		—			3,500			—			3,500
General and administrative		2,764			2,491			5,768			5,107
Amortization of intangibles		890			414			1,781			829
Intangible asset impairment		—			755			—			755
Total operating expenses		13,103			15,176			25,691			25,787
Operating loss		(2,813	)		(8,304	)		(6,453	)		(12,672	)
Net interest expense		(657	)		(307	)		(1,276	)		(752	)
Other income (expense), net		(1,040	)		(105	)		878			(111	)
Net loss before income taxes		(4,510	)		(8,716	)		(6,851	)		(13,535	)
Income tax expense		(159	)		(1	)		(229	)		(2	)
Net loss		($4,669	)		($8,717	)		($7,080	)		($13,537	)
Net loss per share:
Basic and diluted		($0.08	)		($0.18	)		($0.12	)		($0.30	)
Weighted average number of shares outstanding:
Basic and diluted		60,018			49,406			59,877			45,749

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

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ATS Medical, Inc.

Consolidated Statements of Cash Flow

(Unaudited)

(In Thousands)

	Six months ended June 28 (30)
	2008			2007
Operating activities:
Net loss		($7,080	)		($13,537	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,946			1,813
Stock compensation expense		769			623
Acquired in-process research and development		—			3,500
Impairment of intangibles		—			755
Deferred income taxes		96			—
Non-cash interest expense		317			230
Change in value of warrant liability and convertible senior notes derivatives		(273	)		241
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(1,631	)		232
Inventories		(1,267	)		808
Prepaid expenses		(22	)		51
Accounts payable and accrued expenses		1,642			856
Net cash used in operating activities		(4,503	)		(4,428	)
Investing activities:
Purchases of short-term investments		(938	)		—
Maturities of short-term investments		5,121			4,224
Payments for business acquisitions		(1,000	)		(22,000	)
Business acquisition costs		—			(1,655	)
Payments for technology and distribution licenses		—			(23	)
Purchases of leasehold improvements, furniture and equipment		(886	)		(273	)
Net cash provided by (used in) investing activities		2,297			(19,727	)
Financing activities:
Advances on bank notes payable		—			8,600
Repayments of bank notes payable		(662	)		(2,327	)
Net proceeds from sales of common stock and warrants		3,381			31,071
Other		31			62
Net cash provided by financing activities		2,750			37,406
Effect of foreign exchange rate changes		(117	)		(89	)
Increase in cash and cash equivalents		427			13,162
Cash and cash equivalents at beginning of period		10,480			4,612
Cash and cash equivalents at end of period	$	10,907		$	17,774
Significant non-cash transactions:
Transfer of warrant liability to additional paid-in capital	$	3,670		$	—
Issuance of common stock for acquisition of intangible assets		—			500
Assumption of liabilities in connection with asset acquisition		—			2,429
License agreement intangible asset tendered in asset acquisition		—			1,765

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”). The consolidated financial statements include the accounts of the Company and its subsidiaries, and all significant inter-company accounts and transactions are eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to these rules and regulations. The year-end balance sheet was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States. These unaudited consolidated interim financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

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 June 28, 2008 and June 30, 2007 each consisted of 91 calendar days. The six month periods ended June 28, 2008 and June 30, 2007 consisted of 180 and 181 calendar days, respectively.

Certain financial statement items have been reclassified to conform to the current year’s format. These reclassifications had no impact on previously reported net loss or total assets.

Note 2. Common Stock and Stock-Based Compensation

Stock-Based Compensation

The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of Statement of Financial Accounting Standard (“SFAS”) No. 123 (Revised 2004),Share-Based Payment, which requires all share-based payments to be recognized in the income statement based on their fair values.

The following table summarizes the 2008 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
Balance at December 31, 2007		669,875			299,000		1,696,950			2,665,825		$	3.02
Options granted		125,900			—		—			125,900			1.57
Options exercised		(16,000	)		—		(56,250	)		(72,250	)		0.75
Options canceled		(119,125	)		—		—			(119,125	)		4.40
Balance at June 28, 2008		660,650			299,000		1,640,700			2,600,350		$	2.95

As of June 28, 2008, the aggregate intrinsic value of options outstanding was approximately $1.0 million and the aggregate intrinsic value of options exercisable was approximately $0.9 million.

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The following table summarizes 2008 restricted stock unit (“RSU”) awards activity under the Company’s stock-based compensation plans:

				Weighted		Weighted
				Average		Average
	Number of			Award Date		Remaining
	Shares			Fair Value		Contractual Term
Unvested at December 31, 2007		2,037,538		$	2.06	2.09 years
Awards granted		1,386,647			1.64		—
Awards vested		(432,178	)		2.29		—
Awards forfeited		(183,562	)		2.13		—
Unvested at June 28, 2008		2,808,445		$	1.82	2.57 years

As of June 28, 2008, the aggregate intrinsic value of RSU awards outstanding was approximately $5.7 million.

The following table summarizes stock compensation expense recognized in the statements of operations for the three and six month periods ended June 28, 2008 and June 30, 2007:

	Three months ended				Six months ended
	June 28 (30)				June 28 (30)
(in thousands)	2008		2007		2008		2007
Stock compensation expense included in:
Sales and marketing expenses	$	251	$	186	$	443	$	373
General and administrative expenses		191		121		326		250
Total stock compensation expense	$	442	$	307	$	769	$	623
Stock compensation expense per share	$	0.01	$	0.01	$	0.01	$	0.01

Based on an analysis of the Company’s historical data, the Company applied average forfeiture rates during the six month periods ended June 28, 2008 and June 30, 2007 of 10.79% and 9.12%, respectively, to stock options and RSUs outstanding in determining its stock compensation expense, which it believes are reasonable forfeiture estimates for these periods.

As of June 28, 2008, the Company had $0.1 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock options that will be recognized over a weighted average period of 4.5 years, and $3.6 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 4.2 years.

The Company had a total of 10,094,342 shares of common stock reserved for stock option grants and RSU awards at June 28, 2008, of which 4,685,547 shares were available for future grants or awards under the Company’s stock-based compensation plans.

Private Placements of Common Stock

In March 2007, the Company sold 8,125,000 shares of its common stock to certain institutional investors and received $15.3 million, net of offering costs. The private placement included the issuance of warrants to purchase 3,250,000 shares of the Company’s common stock at an exercise price of $2.40 per share, subject to adjustment upon certain events. The warrants became exercisable in September 2007 and expire on March 15, 2012.

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 received $15.3 million, net of offering costs. In connection with the stock sale, Guy P. Nohra, a founder and one of three managing directors of the general partner of Alta, was appointed to the Company’s Board of Directors.

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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 (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 changes in valuation credits to other income of $1.5 million for the first quarter of 2008 and $0.3 million for the second quarter of 2007. At the Company’s annual meeting of shareholders on May 8, 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, resulting in a change in valuation charge to other expense of $1.3 million for the second quarter of 2008. The remaining warrant liability balance of $3.7 million was credited to additional paid-in capital. The following table summarizes Alta warrant liability activity in 2008:

(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 June 28, 2008	$	—

On June 26, 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 3. Acquisitions

Acquisition of Assets from CryoCath Technologies, Inc.

In June 2007, the Company completed the acquisition of the cryoablation surgical device business of CryoCath Technologies, Inc. (“CryoCath”). Pursuant to the Asset Purchase Agreement between the Company and CryoCath, the Company paid CryoCath $22.0 million at closing and agreed to pay an additional $2.0 million 24 months after closing. The Company also agreed to pay up to an additional $6.0 million in contingent payments, $2.0 million of which is contingent on the successful transition of manufacturing from CryoCath to the Company and $4.0 million of which is contingent upon the Company reaching certain levels of sales in 2009 and 2010 of SurgiFrost^® XL, a product line in development. In June 2008, the Company paid to CryoCath $1.0 million of the $2.0 million contingent payment due upon the successful transition of manufacturing operations from CryoCath to the Company. This payment was recorded as additional goodwill. The remaining $1.0 million manufacturing transition contingent payment is anticipated to be made during the third quarter of 2008.

The Company and CryoCath also entered into 1) a License Agreement, which provides the Company with an exclusive, perpetual, royalty-free, worldwide license to use CryoCath’s intellectual property related to the cryoablation surgical device business, 2) a Manufacturing Agreement, pursuant to which CryoCath has agreed to manufacture, assemble and supply products relating to the cryoablation surgical business to the Company for a period of up to one year, and 3) a Termination Agreement, which terminated the Distribution Agreement and Agent Agreement, each dated November 9, 2004, between the Company and CryoCath.

Purchase Price.The Company has accounted for the CryoCath asset acquisition as a purchase under U.S. generally accepted accounting principles. Under the purchase method of accounting, the assets and liabilities acquired were recorded as of the acquisition date, at their respective fair values, and consolidated with those of the Company. The purchase price allocation is based upon estimates and valuations of the fair value of assets acquired and liabilities assumed. The valuations required the use of significant assumptions and estimates. Critical estimates included, but were not limited to, future expected cash flows and the applicable discount rates. These estimates were based on assumptions that the Company believes to be reasonable. However, actual results may differ from these estimates.

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The purchase price was as follows (amounts in thousands):

Cash paid (includes $0.9 million post-closing purchase price reduction and $1.0 million manufacturing transition payment)	$	22,074
License payments made under prior Distribution and Agency Agreements		1,765
Non-contingent cash payment to be made (discounted to present value using discount rate of 9.25%)		1,663
Acquisition-related costs		1,791
Total purchase price	$	27,293

Purchase Price Allocation.The following table summarizes the purchase price allocation for the CryoCath asset acquisition (amounts in thousands):

Current assets	$	951
Fixed assets		761
Definite-lived intangible assets subject to amortization		11,800
Goodwill		10,888
Acquired in-process research and development		3,500
Current liabilities		(607	)
Total purchase price allocation	$	27,293

The excess of the purchase price over the fair value of net tangible assets acquired was allocated to specific intangible asset categories and in-process research and development as follows:

			Weighted Average
	Amount		Amortization
(in thousands)	Assigned		Period
Definite-lived intangible assets:
Existing technology — core	$	4,400	16 years
Existing technology — developed		5,600	5 years
Distributor relationships		1,500	12 years
Product trademarks		300	10 years
Total definite-lived intangible assets	$	11,800	10 years
Goodwill	$	10,888
Acquired in-process research and development	$	3,500

The Company believes the estimated intangible assets as determined represent the fair value at the date of acquisition. The Company used the income approach to determine the fair value of the amortizable intangible assets. The product trademarks amortization period was subsequently reduced to 15 months in the fourth quarter of 2007, due to changing product trade names and trademarks.

The $3.5 million acquired in-process research and development (“IPR&D”) associated with the acquisition relates to SurgiFrost XL, a product line in development to enable less invasive stand alone or sole therapy solutions to treat atrial fibrillation. This IPR&D was recorded as a non-recurring charge to operations in the second quarter of 2007. The Company used the income approach to determine the fair value of IPR&D, applying a risk adjusted discount rate of 30% to the development project’s projected cash flows.

Pro Forma Results of Operations

The following unaudited pro forma financial information presents a summary of consolidated results of operations of the Company as if the acquisition of CryoCath’s surgical cryoablation business had occurred at the beginning of the earliest period presented. The historical consolidated financial information has been adjusted to give effect to pro forma events that are directly attributable to the acquisitions and are factually supportable. The unaudited pro forma condensed consolidated financial information is presented for informational purposes only. The pro forma information is not necessarily indicative of what the financial position or results of operations actually would have been had the acquisitions been completed at the dates indicated. In addition, the unaudited pro forma condensed consolidated financial information does not purport to project the future financial position or operating results of the Company after completion of the acquisition.

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For the three and six months ended June 28, 2008, the CryoCath acquisition was included in the Company’s consolidated results of operations; consequently, no pro forma financial information for this period is presented. For purposes of preparing the unaudited pro forma financial information for the three and six months ended June 30, 2007, CryoCath’s surgical cryoablation business unaudited Statement of Sales and Direct Operating Expenses for the six-month period ended March 31, 2007 (allocated 50% to the three month period ended June 30, 2007) was combined with the Company’s consolidated unaudited Statement of Operations for the three and six months ended June 30, 2007. All periods used in preparing the unaudited pro forma financial information represent the most recent financial information available for each entity. The CryoCath financial statements referenced above have been summarized in a format similar to the financial statements of the Company and translated to U.S. dollars in accordance with U.S. generally accepted accounting principles.

	Three months			Six months
	ended			ended
(in thousands, except per share data)	June 30, 2007			June 30, 2007
Net sales	$	14,606		$	27,577
Net loss		($5,191	)		($9,872	)
Net loss per share — basic and diluted		($0.09	)		($0.18	)

The unaudited pro forma net losses include 1) amortization of purchased intangible assets acquired in the acquisition, 2) adjustments to eliminate intercompany sales, commission and distribution rights income and commission expense resulting from sales of CryoCath products, 3) the elimination of certain license amortization recorded by the surgical cryoablation division of Cryocath which does not apply to the combined entity, 4) the estimated impact of the ongoing supply arrangement between CryoCath and the Company and 5) estimated additional interest expense on a pro forma basis due to additional bank financing obtained to partially finance the CryoCath asset acquisition. The unaudited pro forma financial information excludes the $3.5 million non-recurring IPR&D charge recorded in connection with the acquisition.

Note 4. Inventories

Inventories consist of the following, stated at the lower of cost (first-in, first-out basis) or market:

	June 28,		December 31,
(in thousands)	2008		2007
Raw materials	$	4,126	$	3,655
Work-in-process		4,034		2,920
Finished goods		11,864		12,168
	$	20,024	$	18,743

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. Comprehensive income also includes unrealized gains and losses on the Company’s investment portfolio, which are also charged or credited to shareholders’ equity. Unrealized gains and losses on investments are not material.

Note 6. Intangible Assets

Indefinite-lived Intangibles and Impairment Policy

Indefinite-lived intangible assets include goodwill and technology licenses and agreements, all of which are carried at cost. The Company applies SFAS No. 142,Goodwill and Other Intangible Assets, 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 its annual impairment testing as of June 28, 2008 and determined that the Company’s intangible assets were not impaired.

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Intangible Asset Impairment

The Company made licensing fee and development milestone payments to ErySave AB, a Swedish research firm, under an exclusive development and licensing agreement executed in 2004 for worldwide rights to ErySave’s PARSUS filtration technology for cardiac surgery procedures. In July 2007, the Company was informed that ErySave was in the process of declaring bankruptcy and could not continue development work. Accordingly, the $0.8 million ErySave license payments intangible asset was written off for the three months ended June 30, 2007.

Intangible Asset Purchases

As disclosed in Note 3 above, the Company acquired goodwill and certain other intangible assets in connection with the June 2007 acquisition of the surgical cryoablation business of CryoCath.

In January 2007, the Company issued 224,416 shares of its common stock pursuant to the exercise of its option to purchase certain assets of EM Vascular, Inc. (“EM Vascular”), under a May 2005 Option and Asset Purchase Agreement (“Option Agreement”). The payment in shares was at the option of the Company and was in lieu of a $0.5 million cash payment. The most significant asset acquired as part of this purchase is technology that may potentially allow for a non-invasive, non-pharma therapy for the treatment of such disorders as atherosclerotic plaque and blood hyper-cholesterolemia. Under the terms of the Option Agreement, the Company will also be obligated to make additional contingent payments to EM Vascular of up to $2.2 million in the form of ATS common stock upon the attainment of certain milestone events and to pay royalties on applicable product sales.

Note 7. Long-Term Debt

Convertible Senior Notes Payable

In October 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 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 under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities,and related Emerging Issues Task Force interpretations and 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 $0.07 million for each of the six-month periods ended June 28, 2008 and June 30, 2007.

The derivative liability is adjusted to fair value on a quarterly basis, resulting in change in valuation credits to other income of $0.02 million for each of the three month periods ended June 28, 2008 and June 30, 2007, and. $0.03 million and $0.04 million for the six month periods ended June 28, 2008 and June 30, 2007, respectively, The liability balance was $0.11 million at June 28, 2008. 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 for $8.5 million consisting of a $2.5 million three-year term loan as well as a two-year $6.0 million line of credit. In 2006, the Bank agreed to provide for additional advances of up to $1.5 million, which the Company could use to finance or refinance eligible equipment purchased between June 2005 and May 2006. The Company fully drew down both the $2.5 million term loan and the $1.5 million advance amount, which were being repaid over 36 and 60 month periods, respectively. The Company had not drawn any advances and had no outstanding balance on the $6.0 million line of credit. All Company assets are pledged as collateral under the Loan Agreement.

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The Company was subject to certain financial covenants under the Loan Agreement, as amended, to maintain a liquidity ratio of not less than 2.0 to 1.0 and a net tangible net worth of at least $40 million. In February 2007, the Company entered into an Amendment to the Loan Agreement (“February 2007 Amendment”) whereby the liquidity ratio was decreased to be equal to or greater than 1.6 to 1.0 and the tangible net worth requirement was eliminated. The February 2007 Amendment also terminated the line of credit.

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 (“CryoCath Assets”) and (ii) certain agreements related to the acquisition of the CryoCath Assets. The June 2007 Amendment also provided for an $8.6 million term loan (“Term Loan”) to the Company, which was used to repay the outstanding term loan and advances to the Company from the Bank under the Loan Agreement and to purchase the CryoCath Assets.

Under the Term Loan, as amended, the Company is required to make monthly payments of interest only beginning on July 1, 2007, and continuing on the first day of each successive month until March 1, 2008, and 39 monthly payments of principal plus interest beginning on 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, of equal to or greater than 1.4 to 1.0. On June 30, 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 remains at 1.4 to 1.0 for quarter-end months and will revert to 1.4 to 1.0 for all months beginning in 2009. As of June 28, 2008 and December 31, 2007, the Company was in compliance with the financial covenants as set forth in the Loan Agreement, as amended.

Subordinated Credit Agreement

On June 29, 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.

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 dated June 29, 2008, 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”). On July 24, 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 the 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 issued upon execution of the Credit Agreement), 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 the six months ended June 28, 2008, the Company recognized $0.2 million of income tax expense related to 1) deferred income taxes connected with the deductibility of goodwill in the CryoCath asset 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 its Austrian subsidiary. 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 SFAS No. 157,Fair Value Measurements.SFAS No.157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. The adoption of SFAS No. 157 did not have a material impact on the Company’s financial condition or results of operations.

SFAS No. 157 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. SFAS No. 157 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 short-term investments was determined based on Level 1 inputs. The difference between cost and fair value of the Company’s short-term investments is not significant. The fair value of the Company’s warrant liability (described in Note 2 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.

Also effective January 1, 2008, the Company adopted SFAS No 159,The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 amends SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities, and permits entities to choose to measure many financial instruments and certain other items at fair value. The adoption of SFAS No. 159 did not have a material impact on the Company’s financial condition or results of operations.

Note 10. Recently Issued Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board issued SFAS No. 141(R),Business Combinations(“SFAS No. 141(R)”), which establishes 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. Among the changes in SFAS No. 141(R) are: 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. SFAS No. 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS No. 141(R) replaces SFAS No. 141, is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, and will be adopted by the Company in the first quarter of 2009.

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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. The appeal was fully submitted on January 3, 2008. On June 20, 2008, Abbey requested oral argument for his appeal.

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.

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 fiscal year ended December 31, 2007, for a description of the escrow and milestone shares. The Company believes the Abbey I Litigation and Abbey II Litigation will not result in a material impact on the Company’s financial position or operating results.

CarboMedics Litigation

On November 22, 2006, CarboMedics filed a complaint against ATS in the U.S. District Court in the District of Minnesota. The complaint alleges that the Company has breached certain contractual obligations, including an alleged obligation to purchase $22 million of mechanical heart valve carbon components under a long-term supply agreement with CarboMedics.

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CarboMedics initially sought specific performance and claimed damages of approximately $20 million. The Company believes the complaint filed by CarboMedics is without merit, that CarboMedics has repudiated and breached the long-term supply agreement, and that the Company may have affirmative claims against CarboMedics. On February 16, 2007, the Company filed its answer and counterclaims to the complaint. On May 16, 2007, CarboMedics filed an amended complaint withdrawing its request for specific performance. CarboMedics has also revised its damages estimate to $12.5 million before accounting for attorney fees and costs. The Company and CarboMedics agreed to narrow the scope of the case, and on January 24, 2008, the Company’s counterclaims were dismissed pursuant to a joint stipulation. Both fact and expert discovery have been completed. Dispositive and expert motions have been argued and are pending before the court.

On May 30, 2008, the court entered a formal stay to permit the parties to pursue alternative dispute resolution. The stay is ongoing. In light of the stay, the status of previously-scheduled trial dates and pretrial deadlines is uncertain. If the Company is ultimately found to be in breach of the terms of the supply agreement with CarboMedics, it could be required to pay damages that would materially and adversely affect the Company’s financial condition.

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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, 2007. 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 used by cardiovascular surgeons in the cardiac surgery operating theater. Currently, we participate in the markets for mechanical bileaflet replacement heart valves, tissue heart valves, valve repair products, the surgical treatment of atrial fibrillation, and surgical tools and accessories.

In 1990, we licensed a patented and partially developed mechanical heart valve from CarboMedics. 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 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 started 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 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 develop 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 will develop, supply and manufacture cardiac surgical products to include annuloplasty repair rings, c-rings and accessories, and we will have exclusive worldwide rights to market and sell such products. Our agreement with GBI produced revenues for us in both 2006 and 2007. We also entered into a marketing services agreement with Regeneration Technologies, Inc. — Cardiovascular (“RTI-CV”). Under the terms of the agreement, RTI-CV appointed us as its exclusive marketing services representative to promote, market and solicit orders for RTI-CV’s processed cardiovascular allograft tissue from doctors, hospitals, clinics and patients throughout North America. However, the cardiovascular tissue processing business of RTI-CV was sold during 2006 and RTI-CV discontinued its cardiovascular tissue processing operations. As a result, our distribution agreement with RTI-CV terminated at the end of 2007.

In 2006, we completed the acquisition of all the voting and non-voting stock of 3F, a privately-held medical device company specializing in manufacturing tissue heart valves. 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 million 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 million 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. We expect FDA approval of this product during the second half of 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 agreed to pay to Novare a transfer price for each box of Enclose II product we purchase. We are also required to purchase an annual minimum amount of Enclose II product, which increases 15% each year.

In June 2007, we acquired the cryoablation surgical device business of CryoCath. The assets acquired include 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 agreements, we paid CryoCath $22.0 million upon closing of the transaction (reduced by $0.9 million subsequent to closing), and will pay CryoCath $2.0 million upon the achievement of certain manufacturing transition milestones, $2.0 million two years after closing and 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. Surgifrost XL was developed to enable a minimally-invasive beating heart solution for the treatment of cardiac arrhythmias, including atrial fibrillation without concomitant cardiac surgery. This technology enables us to leverage our current operating infrastructure and allows us to better address the rapidly growing $1.5 billion cardiac arrhythmia market. The transaction was financed with part of the proceeds of an $8.6 million senior secured term loan from SVB Silicon Valley Bank and the private placement of 9,800,000 shares of our common stock at a purchase price of $1.65 per share to Alta, a life sciences venture capital firm. Alta also received a warrant to purchase 1,960,000 shares of our common stock at $1.65 per share.

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.

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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 six month periods ended June 28, 2008 and June 30, 2007.

	Three months ended June 28 (30)												Six months ended June 28 (30)
							Increase (Decrease)												Increase (Decrease)
(in thousands)	2008			2007			$			%			2008			2007			$			%
Net sales	$	16,900		$	12,417		$	4,483			36.1	%	$	31,745		$	23,213		$	8,532			36.8	%
Cost of goods sold		6,610			5,545			1,065			19.2	%		12,507			10,098			2,409			23.9	%
Gross profit		10,290			6,872			3,418			49.7	%		19,238			13,115			6,123			46.7	%
Operating expenses:
Sales and marketing		7,147			6,115			1,032			16.9	%		13,634			12,038			1,596			13.3	%
Research and development		2,302			1,901			401			21.1	%		4,508			3,558			950			26.7	%
Acquired in-process R & D		—			3,500			(3,500	)		(100.0	)%		—			3,500			(3,500	)		(100.0	)%
General and administrative		2,764			2,491			273			11.0	%		5,768			5,107			661			12.9	%
Amortization of intangibles		890			414			476			115.0	%		1,781			829			952			114.8	%
Impairment of intangibles		—			755			(755	)		(100.0	)%		—			755			(755	)		(100.0	)%
Total operating expenses		13,103			15,176			(2,073	)		(13.7	)%		25,691			25,787			(96	)		(0.4	)%
Operating loss		(2,813	)		(8,304	)		(5,491	)		(66.1	)%		(6,453	)		(12,672	)		(6,219	)		(49.1	)%
Net interest expense		(657	)		(307	)		350			114.0	%		(1,276	)		(752	)		524			69.7	%
Other income (expense), net		(1,040	)		(105	)		935			890.5	%		878			(111	)		989			891.0	%
Net loss before income taxes		(4,510	)		(8,716	)		(4,206	)		(48.3	)%		(6,851	)		(13,535	)		(6,684	)		(49.4	)%
Income tax expense		(159	)		(1	)		158		NM				(229	)		(2	)		227		NM
Net loss	$	(4,669	)	$	(8,717	)	$	(4,048	)		(46.4	)%	$	(7,080	)	$	(13,537	)	$	(6,457	)		(47.7	)%

The following table presents the Statements of Operations as a percentage of net sales for the three and six month periods ended June 28, 2008 and June 30, 2007.

	Three months ended						Six months ended
	June 28 (30)						June 28 (30)
	2008			2007			2008			2007
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of goods sold		39.1	%		44.7	%		39.4	%		43.5	%
Gross profit		60.9	%		55.3	%		60.6	%		56.5	%
Operating expenses:
Sales and marketing		42.3	%		49.2	%		42.9	%		51.9	%
Research and development		13.6	%		15.3	%		14.2	%		15.3	%
Acquired in-process R & D		0.0	%		28.2	%		0.0	%		15.1	%
General and administrative		16.4	%		20.1	%		18.2	%		22.0	%
Amortization of intangibles		5.3	%		3.3	%		5.6	%		3.6	%
Impairment of intangibles		0.0	%		6.1	%		0.0	%		3.3	%
Total operating expenses		77.5	%		122.2	%		80.9	%		111.1	%
Operating loss		(16.6	)%		(66.9	)%		(20.3	)%		(54.6	)%
Net interest income (expense)		(3.9	)%		(2.5	)%		(4.0	)%		(3.2	)%
Other income (expense), net		(6.2	)%		(0.8	)%		2.8	%		(0.5	)%
Net loss before income taxes		(26.7	)%		(70.2	)%		(21.6	)%		(58.3	)%
Income tax expense		(0.9	)%		0.0	%		(0.7	)%		0.0	%
Net loss		(27.6	)%		(70.2	)%		(22.3	)%		(58.3	)%

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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 six month periods ended June 28, 2008 and June 30, 2007.

	Three months ended June 28 (30)									Six months ended June 28 (30)
					Increase									Increase
(in thousands)	2008		2007		$		%			2008		2007		$		%
United States	$	6,598	$	4,025	$	2,573		63.9	%	$	12,427	$	8,305	$	4,122		49.6	%
Outside United States		10,302		8,392		1,910		22.8	%		19,318		14,908		4,410		29.6	%
Total	$	16,900	$	12,417	$	4,483		36.1	%	$	31,745	$	23,213	$	8,532		36.8	%

The following table provides net sales inside and outside the United States as a percentage of total net sales for the three and six month periods ended June 28, 2008 and June 30, 2007.

	Three months ended						Six months ended
	June 28 (30)						June 28 (30)
	2008			2007			2008			2007
United States		39.0	%		32.4	%		39.1	%		35.8	%
Outside United States		61.0	%		67.6	%		60.9	%		64.2	%
Total		100.0	%		100.0	%		100.0	%		100.0	%

The following table provides net sales by product group for the three and six month periods ended June 28, 2008 and June 30, 2007.

	Three months ended June 28 (30)									Six months ended June 28 (30)
					Increase									Increase
(in thousands)	2008		2007		$		%			2008		2007		$		%
Heart valve therapy	$	12,093	$	10,780	$	1,313		12.2	%	$	22,774	$	19,771	$	3,003		15.2	%
Surgical arrhythmia		4,386		1,341		3,045		227.1	%		8,234		2,819		5,415		192.1	%
Surgical tools and accessories		421		296		125		42.2	%		737		623		114		18.3	%
Total	$	16,900	$	12,417	$	4,483		36.1	%	$	31,745	$	23,213	$	8,532		36.8	%

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 65% of our worldwide sales for the first half of 2008, compared to 79% for the same period in 2007. U.S. mechanical heart valve sales revenue was flat for the second quarter of 2008 compared to the prior year second quarter, but declined approximately 8% for the six months ended June 28, 2008 from the same period in 2007, reflecting the continued decline in the overall mechanical heart valve market due to the encroachment of tissue valves. However, international mechanical heart valve sales for the three and six month periods ended June 28, 2008 increased approximately 10% and 20%, respectively, over the same periods in 2007, due primarily to the expansion of direct selling operations in three international markets during 2007. Worldwide heart valve therapy revenue has also increased due to sales growth of our repair ring products, which were introduced in mid-2006.

Net sales generated from surgical arrhythmia therapy products consist of cryotherapy products for the ablation of cardiac arrhythmias. Since our acquisition of the surgical cryoablation business of CryoCath in late June 2007, these sales have increased significantly as compared to previous periods due to a gross-up on certain sales for which we had served as an agent and received a commission prior to the acquisition and to the addition of direct sales to other CryoCath corporate customers. Net sales of these products for the three and six month periods ended June 30, 2007 are representative of our prior distribution and agency agreements with CryoCath.

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Net sales have been favorably impacted by revenue derived from the acquisitions, new business initiatives and partnerships discussed above, primarily revenue from surgical cryotherapy products, annuloplasty repair rings and accessories and cardiac anastomosis assist devices. Approximately 35% of our worldwide revenue in the first half of 2008 was derived from products other than mechanical heart valves, up from approximately 21% in the first half of 2007.

Approximately 4.8 and 4.5 basis points of our percentage increases in net sales for the three and six month periods ended June 28, 2008, respectively, compared to the same periods in the prior year, are attributable to the rising foreign currency exchange rate environment against the U.S. dollar. Approximately 25% of our total sales in the first half of 2008 were invoiced in Euros or other local currencies in European markets where we sell our products direct to hospitals.

Cost of Goods Sold and Gross Profit.Our second quarter 2008 and six-month year-to-date 2008 gross profit percentages of net sales improved to 60.9% and 60.6%, respectively, from 55.3% and 56.5% for the same periods in the prior year.

Our 2008 gross profit, both in dollars and in percentage of net sales, has benefited from direct sales of surgical cryotherapy products resulting from our acquisition of the surgical cryoablation business of CryoCath in late June 2007. These sales include the gross-up on certain sales for which we had served as an agent and received a commission prior to the acquisition and the addition of direct sales to other CryoCath corporate customers. Our 2008 gross profit has also benefited from higher international average selling prices associated with our migration to more direct European markets, and to lower cost mechanical heart valves which since 2005 have been manufactured in our own facilities. The cost decrease is attributable primarily to higher manufacturing volumes connected with increased international mechanical heart valve demand.

Partially offsetting the improved 2008 gross profit percentages was shifts in the overall sales mix, particularly of our mechanical heart valve product sales, where lower U.S. mechanical heart valve unit sales volume has been coupled with higher international valve sales at lower average selling prices and gross margins than the United States. Our 2008 gross profit percentages were also negatively impacted by period costs related to 1) increases in our tissue expiration reserves, 2) manufacturing variances due to low tissue manufacturing volumes and 3) cryoablation manufacturing start-up costs. These period costs lowered our second quarter and six-month year-to-date 2008 gross profit as a percentage of net sales by approximately 2.4 and 0.2 percentage points compared to the prior year, respectively.

Sales and Marketing.In the United States, our sales and marketing costs for the three and six month periods ended June 28, 2008 increased approximately 16% and 10% over the same periods in the prior year, to $4.3 million and $8.3 million, respectively. The increase reflects the addition of costs for additional marketing personnel, higher marketing program costs and corporate bonus plan accruals. Field selling costs in the United States were unchanged in the first half of 2008 compared to the same period in the prior year, reflecting the 2007 turnover and reduction in field sales personnel offset by higher sales commissions in 2008.

Internationally, our sales and marketing costs for both the three and six month periods ended June 28, 2008 increased approximately 18% over the same periods in the prior year to $2.8 million and $5.3 million, respectively. These increases reflect our continued investment in international markets, including the establishment of a European support office in the second half of 2006 to support the expansion of our direct sales operations in Europe and the commencement of direct sales activities in Switzerland in the third quarter of 2007. Our higher 2008 second quarter and six-months year-to-date international sales and marketing costs were also attributable to rising Euro-to-U.S. dollar foreign exchange rates. More than 75% of our first half 2008 international sales and marketing costs were denominated in Euros.

Research and Development.Research and development (“R & D”) expenses for the three and six month periods ended June 28, 2008 increased 21% and 27% compared to the same period in the prior year to $2.3 million and $4.5 million, respectively. The increases in R & D reflect significantly higher clinical program and product approval costs for tissue valves. Also contributing to the higher R & D costs were development and start-up costs for surgical cryoablation manufacturing, corporate bonus plan accruals and increases in R & D personnel and programs.

Acquired In-Process R & D.In connection with our June 2007 acquisition of the surgical cryoablation business of CryoCath, we recorded a non-recurring in-process R & D (“IPR&D”) charge of $3.5 million in the second quarter of 2007. See Note 3 of “Notes to Consolidated Financial Statements” in this Form 10-Q for additional information regarding the CryoCath asset acquisition, including the purchase price and the allocation of the purchase price. The IPR&D relates to SurgiFrost XL, a product line in development to enable less invasive stand alone or sole therapy solutions to treat atrial fibrillation. We used the income approach to determine the fair value of IPR&D, applying a risk adjusted discount rate of 30% to the development project’s projected cash flows.

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General and Administrative.General and administrative (“G & A”) expenses for the second quarter and six months ended June 28, 2008 increased $0.3 million and $0.7 million, respectively, over the same periods in 2007 to $2.8 million and $5.8 million, respectively.

Major cost increases in G & A expenses for the second quarter and six months year-to-date 2008 over the corresponding periods in 2007 were for legal fees (primarily related to the CarboMedics litigation) of $0.3 million and $1.1 million, respectively, and corporate bonus plan accruals of $0.2 million and $0.3 million, respectively. These cost increases were offset, in part, by $0.1 million and $0.5 million in employee severance costs and $0.1 and $0.2 million of business development expenses incurred in the prior year second quarter and six months year-to-date periods of 2007, respectively.

We recognized total stock compensation expense in the first half of 2008 of $0.8 million, of which $0.3 million was included in G & A expenses and $0.5 million was included in sales and marketing expenses. In the first half of 2007, we recognized total stock compensation expense of $0.6 million, of which $0.2 million was included in G & A expenses and $0.4 million was included in sales and marketing expenses.

Amortization of Intangibles.Amortization expense for the three and six month periods ended June 28, 2008 increased $0.5 million and $1.0 million over the same periods in the prior year to $0.9 million and $1.8 million, respectively. The increases are attributable to amortization of the definite-lived intangible assets acquired in our June 2007 purchase of the surgical cryoablation business of CryoCath. See Note 3 of “Notes to Consolidated Financial Statements” in this Form 10-Q for more information regarding the purchase of the surgical cryoablation business of CryoCath. Amortization expense for both 2008 and 2007 also includes amortization of our pyrolytic carbon technology license with CarboMedics as well as amortization of definite-lived intangible assets acquired in connection with our September 2006 acquisition of 3F. We estimate amortization expense for 2008 to total approximately $3.6 million.

Intangible Asset Impairment.We made licensing fee and development milestone payments to ErySave, a Swedish research firm, under an exclusive development and licensing agreement executed in 2004 for worldwide rights to ErySave’s PARSUS filtration technology for cardiac surgery procedures. In July 2007, we were informed that ErySave was in the process of declaring bankruptcy and could not continue development work. Accordingly, the $0.8 million ErySave license payments intangible asset was written off in the second quarter of 2007.

Net Interest Expense.Net interest expense for the three and six month periods ended June 28, 2008 increased $0.4 million and $0.5 million, respectively, over the comparable periods of the prior year. The increases are attributable to interest on the June 2007 $8.6 million Term Loan (“Term Loan”) with Silicon Valley Bank obtained in connection with the CryoCath asset acquisition. See “Liquidity and Capital Resources-Financing Activities” below for a detailed discussion of the Term Loan.

Net interest expense also includes interest on $22.4 million aggregate principal amount of 6% Convertible Senior Notes issued in 2005. Interest expense on these Notes was $0.5 million and $0.9 million in the second quarter and first half of both 2008 and 2007, respectively, and includes amortization of (1) financing costs, (2) the discount related to the implied value of common stock warrants sold with the Notes, and (3) 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 the Notes.

Interest income during the first half of 2008 and 2007 was $0.1 million and $0.3 million, respectively, and was attributable to the investment of our cash balances.

Other Income (Expense). 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 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 (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 changes in valuation credits to other income of $1.5 million for the first quarter of 2008 and $0.3 million for the second quarter of 2007. At the annual meeting of shareholders on May 8, 2008, we 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, resulting in a change in valuation charge to other expense of $1.3 million for the second quarter of 2008.

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Other income for the three and six month periods ended June 28, 2008 and June 30, 2007 also included the following net foreign currency transaction gains:

	Three months ended					Six months ended
	June 28 (30)					June 28 (30)
(in thousands)	2008			2007		2008			2007
Net realized foreign currency transaction gain (loss)	$	441		$	124	$	688		$	70
Unrealized foreign currency gains (losses) related to short-term intercompany balances with foreign subsidiaries		(219	)		31		(83	)		60
Net foreign currency transaction gains	$	222		$	155	$	605		$	130

During the first six months of 2008 and 2007, we recorded non-operating other income totaling $0.03 million and $0.04 million, respectively, for the change in the Convertible Senior Notes derivative liability to fair value. See Note 7 of “Notes to Consolidated Financial Statements” in this Form 10-Q for more information regarding the Notes derivative liability and our accounting for the related derivative financial instruments under SFAS No.133,Accounting for Derivative Instruments and Hedging Activities.

Income Taxes. In the first half of 2008, we recognized $0.2 million of income tax expense related to 1) deferred income taxes connected with the deductibility of goodwill in the CryoCath asset 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 our Austrian subsidiary. 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 2007 we have accumulated approximately $152 million of net operating loss (“NOL”) carryforwards for U.S. tax purposes ($54 million related to 3F). We believe 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 have initiated a formal study of whether, or to what extent, past changes in control of ATS impairs our NOL carryforwards. We have recorded no 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 decrease in net loss in the second quarter and first six months of 2008 compared to the same periods in 2007 was due to higher sales, gross profit and non-operating other income and the absence of IPR&D in 2008, partially offset by higher operating expenses, all of which are described in detail above.

Liquidity and Capital Resources

Cash, cash equivalents, and short-term investments totaled $10.9 million and $14.7 million at June 28, 2008 and December 31, 2007, respectively.

Operating Activities.During the first half of 2008, we received cash payments from customers of approximately $30.1 million and made payments to employees and suppliers of approximately $34.1 million. During the first half of 2007, we received cash payments from customers of approximately $23.4 million and made payments to employees and suppliers of approximately $27.4 million. Over the last several years, we have incurred significant expenses to commercialize the ATS heart valve both in the United States and in many international markets, have invested in new products and technologies and have completed strategic acquisitions and business partnerships to diversify our product portfolio. As we build sales in future periods and our cost of inventories decrease, we believe our operating losses will decrease and we will move toward a cash flow breakeven on sales and eventually to profitability.

Investing Activities.We purchased leasehold improvements, property and equipment totaling $0.9 million and $0.3 million during the first half of 2008 and 2007, respectively. A significant portion of our capital spending in the first half of 2008 was related to the addition of a surgical cryoablation production clean room following our June 2007 acquisition of the surgical cryoablation business of CryoCath.

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Our major investing activity since the beginning of 2007 was the acquisition of the assets of the surgical cryoablation business of CryoCath in June 2007. We paid $22 million at the closing (subsequently reduced by $0.9 million) and paid approximately $1.8 million in transaction costs. In June 2008, we paid to CryoCath $1.0 million of a $2.0 million contingent acquisition payment due upon the successful transition of manufacturing operations from CryoCath to us. The remaining $1.0 million manufacturing transition contingent payment is anticipated to be made during the third quarter of 2008. See Note 3 of “Notes to Consolidated Financial Statements” in this Form 10-Q for additional details regarding this acquisition.

Financing Activities.During the first half of 2008, we raised $3.4 million from the issuance of common stock, including $3.2 million received upon the June 26, 2008 exercise of warrants issued in connection with the June 2007 private placement discussed below. We received net proceeds of approximately $0.2 million during the first half 2008 from the issuance of common stock through exercises of stock options and purchases under our employee stock purchase plan.

During the first half of 2007, we raised $30.6 million, net of offering costs, through two private placement sales of common stock. The first, in March 2007, raised $15.3 million, net of offering costs, through the sale of 8,125,000 shares of our common stock at a price of $2.00 per share and warrants to purchase 3,250,000 shares of our common stock at an exercise price of $2.40 per share. The second, in June 2007, also raised $15.3 million, net of offering costs, through the sale of 9,800,000 shares of our common stock at a price of $1.65 per share 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, as further described in Note 2 of Notes to Consolidated Financial Statements in this Form 10-Q. We also received net proceeds of $0.4 million during the first half 2007 from the issuance of common stock through exercises of stock options and purchases under our employee stock purchase plan.

On June 29, 2008, we entered into a Subordinated Credit Agreement with Ted Skokos, a member of our Board of Directors, for a two-year, $5 million Revolving 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. 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. On July 24, 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. The maximum number of additional shares issuable pursuant to warrants issued under the Credit Facility is 490,196 shares (not including the warrant issued upon execution of the Credit Agreement), which represents 20% of the maximum amount of advances under the $5 million Credit Facility divided by the $2.04 warrant exercise price.

Since 2004 we have maintained a Loan and Security Agreement with Silicon Valley Bank which established, among other things, a $2.5 million three-year term loan. In 2006, the Bank agreed to provide for additional advances of up to $1.5 million. We fully drew down both the $2.5 million term loan and the $1.5 million advance amount, which were being repaid over 36 and 60 month periods, respectively. 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 consented to (1) our purchase of the surgical cryoablation business from CryoCath and (2) certain agreements related to the acquisition of the CryoCath Assets. The June 2007 Amendment also provided for an $8.6 million Term Loan, which we used to repay the outstanding term loan and advances from the Bank under the Loan Agreement and to purchase the CryoCath Assets. Under the Term Loan, as amended, we were required to make monthly payments of interest only from July 2007 through March 2008, and we are required to make monthly payments of principal plus interest beginning April 2008 and continuing until June 2011. 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.

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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. On June 30, 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 remains at 1.4 to 1.0 for quarter-end months and will revert to 1.4 to 1.0 for all months beginning in 2009. As of June 28, 2008 and December 31, 2007, 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. If the Notes are converted under certain circumstances on or prior to October 15, 2008, we will pay the investors the interest they would have received on the Notes through that date. 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.

Cash Management

We estimate that operating costs will remain high in comparison to sales during 2008 and will require the use of cash to fund operations. Based upon the current forecast of sales and operating expenses, we anticipate having cash to fund our operations through 2008. However, we may need to raise additional cash in or after 2008 to provide operating plan leverage, to fund our strategic investments and accelerate the development platforms for our 3F tissue and/or surgical cryoablation technologies, 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, 2007, any adverse change that affects our revenue, access to the capital markets or future demand for our products will affect our long-term viability. Maintaining adequate levels of working capital depends in part upon the success of our products in the marketplace, the relative profitability of those products and our ability to control operating and capital expenses.

Funding of our operations in future periods may require additional investments in ATS in the form of equity or debt. 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.

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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 through our European export company to Belgium and the Netherlands, are in Euros. Sales to the United Kingdom and Switzerland are made through our European export company and are denominated in British pounds and Swiss francs, respectively. Therefore, we are subject to profitability risk arising from exchange rate movements. We have not used foreign exchange contracts or similar devices to reduce this risk. We will evaluate the need to use foreign exchange contracts or similar devices, if sales in our European direct markets increase substantially.

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 June 28, 2008 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. The appeal was fully submitted on January 3, 2008. On June 20, 2008, Abbey requested oral argument for his appeal.

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.

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 fiscal year ended December 31, 2007, for a description of the escrow and milestone shares. The Company believes the Abbey I Litigation and Abbey II Litigation will not result in a material impact on the Company’s financial position or operating results.

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CarboMedics Litigation

On November 22, 2006, CarboMedics filed a complaint against ATS in the U.S. District Court in the District of Minnesota. The complaint alleges that the Company has breached certain contractual obligations, including an alleged obligation to purchase $22 million of mechanical heart valve carbon components under a long-term supply agreement with CarboMedics.

CarboMedics initially sought specific performance and claimed damages of approximately $20 million. The Company believes the complaint filed by CarboMedics is without merit, that CarboMedics has repudiated and breached the long-term supply agreement, and that the Company may have affirmative claims against CarboMedics. On February 16, 2007, the Company filed its answer and counterclaims to the complaint. On May 16, 2007, CarboMedics filed an amended complaint withdrawing its request for specific performance. CarboMedics has also revised its damages estimate to $12.5 million before accounting for attorney fees and costs. The Company and CarboMedics agreed to narrow the scope of the case, and on January 24, 2008, the Company’s counterclaims were dismissed pursuant to a joint stipulation. Both fact and expert discovery have been completed. Dispositive and expert motions have been argued and are pending before the court.

On May 30, 2008, the court entered a formal stay to permit the parties to pursue alternative dispute resolution. The stay is ongoing. In light of the stay, the status of previously-scheduled trial dates and pretrial deadlines is uncertain. If the Company is ultimately found to be in breach of the terms of the supply agreement with CarboMedics, it could be required to pay damages that would materially and adversely affect the Company’s financial condition.

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, 2007, which could have a material impact on our business, financial condition or results of operations.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

As previously disclosed in our Current Report on Form 8-K filed on July 2, 2008, on June 29, 2008, we entered into a Subordinated Credit Agreement (the “Credit Agreement”) with Theodore C. Skokos, a member of our Board of Directors, for a two-year, $5 million Revolving Credit Facility (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 (the “Warrant”). In addition, 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. If the aggregate unpaid principal amount of all advances (the “Total Outstanding Revolver Amount”) under the Credit Facility, after giving effect to the 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 (the “Maximum Total Outstanding Revolver Amount”), then we 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 Warrant issued upon execution of the Credit Agreement), which represents 20% of the maximum amount of advances under the $5 million Credit Facility divided by the $2.04 warrant exercise price.

On July 24, 2008, Mr. Skokos exercised the Warrant in full by payment of the $500,000 exercise price in cash and was issued 245,098 shares of our common stock.

The issuance of the Warrant and the underlying shares of common stock were effected without registration under the Securities Act of 1933, as amended (the “Securities Act”), in reliance on Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering. Mr. Skokos has access to information about ATS, represented that he was an accredited investor able to bear the economic risk of loss of the investment, and represented that the Warrant and the shares were being acquired for investment purposes only and not with a view to any resale in connection with any distribution.

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ITEM 4. Submission of Matters to a Vote of Security Holders

Our Annual Meeting of Shareholders was held on May 8, 2008, at which time the following proposals were approved:

1) The election of six directors to our Board of Directors to hold office for the ensuing year and until their successors are elected and qualified;

2) An amendment to our Second Restated Articles of Incorporation to increase the number of shares of our common stock authorized for issuance by 50,000,000 shares;

3) Approval of the removal of certain share issuance limitations required by NASDAQ Marketplace Rule 4350(i)(1)(C) to be included in our common stock warrants issued in June 2007;

4) An amendment to the 2000 Stock Incentive Plan to increase the number of shares of common stock of the Company available for awards granted under the Plan by 4,000,000 shares; and

5) The ratification of the selection of Grant Thornton LLP as the Company’s independent registered public accounting firm for the year ending December 31, 2008.

Proxies for the Company were solicited pursuant to Section 14(a) of the Exchange Act, and there was no solicitation in opposition to management’s solicitations. All nominees for directors as listed in the proxy statement were elected. The voting results were as follows:

									Broker
	For		Withhold		Against		Abstain		Non-Votes
Election of Directors:
Michael D. Dale		47,829,809		1,261,412		—		—		—
Steven M. Anderson		46,716,700		2,374,521		—		—		—
Robert E. Munzenrider		46,711,548		2,379,673		—		—		—
Guy P. Nohra		47,884,625		1,206,596		—		—		—
Eric W. Sivertson		46,710,100		2,381,121		—		—		—
Theodore C. Skokos		47,873,125		1,218,096		—		—		—
Amendment to Second Restated Articles of Incorporation to increase the number of authorized shares of common stock		40,795,038		—		8,000,158		296,026		—
Approval of the removal of share issuance limitations included in warrants issued June 2007		29,178,258		—		793,038		140,681		18,979,245
Amendment to 2000 Stock Incentive Plan		21,539,682		—		8,399,077		173,217		18,979,245
Ratification of Grant Thornton LLP		48,709,287		—		277,218		104,716		—

ITEM 6. Exhibits

2.1***	Agreement and Plan of Merger, dated as of January 23, 2006, by and among ATS Medical, Inc., Seabiscuit Acquisition Corp.; 3F Therapeutics, Inc.; and Boyd D. Cox, as Stockholder Representative (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on January 26, 2006).
2.2	Amendment No. 1 to Agreement and Plan of Merger, dated as of June 13, 2006, by and among ATS Medical, Inc., Seabiscuit Acquisition Corp., 3F Therapeutics, Inc. and Boyd D. Cox, as stockholder representative (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on June 19, 2006).

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2.3	Amendment No. 2 to Agreement and Plan of Merger, dated as of August 10, 2006, by and among the Company, Seabiscuit Acquisition Corp., 3F Therapeutics, Inc. and Boyd D. Cox, as stockholder representative (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on August 15, 2006).
2.4	Escrow Agreement, effective as of September 29, 2006, by and among the Company, Boyd D. Cox, as stockholder representative and Wells Fargo Bank, N.A. (Incorporated by reference to Exhibit 2.4 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006).
2.5***	Option and Asset Purchase Agreement, dated as of May 31, 2005, by and among ATS Medical, Inc., em Vascular, Inc., Keith L. March, M.D., John Havek, Walter L. Sembrowich and James E. Shapland II (Incorporated by reference to Exhibit 2.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006).
2.6	Letter Amendment, dated as of November 29, 2006, to the Option and Asset Purchase Agreement, dated as of May 31, 2005, by and among ATS Medical, Inc., em Vascular, Inc., Keith L. March, M.D., John Havek, Walter L. Sembrowich and James E. Shapland II, (Incorporated by reference to Exhibit 2.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006).
2.7***	Asset Purchase Agreement dated June 18, 2007 by and between ATS Medical, Inc. and CryoCath Technologies Inc. (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on June 25, 2007).
3.1	Third Restated Articles of Incorporation of ATS Medical, Inc.
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 (the “1997 Form 10-K”)).
4.2	Warrant, dated June 29, 2008, issued to Theodore C. Skokos (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on July 2, 2008).
10.1	ATS Medical, Inc. 2000 Stock Incentive Plan, as amended (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 13, 2008).
10.2	Amendment No. 3 dated April 30, 2008, to Original Lease Agreement dated April 29, 2000, by and between the Company and St. Paul Properties, Inc.
10.3	2008 ATS Medical Management Incentive Compensation Plan.
10.4	Subordinated Credit Agreement, dated June 29, 2008, by and between ATS Medical, Inc. and Theodore C. Skokos (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 2, 2008).
10.5	Amendment, dated June 30, 2008, to the Loan and Security Agreement between Silicon Valley Bank and the Company dated July 28, 2004 (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on July 2, 2008).
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).

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32.2 Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (Section 906 Certification).

*** Exhibits and Schedules to the acquisition agreement have been omitted but will be provided supplementally to the Securities and Exchange Commission upon request.

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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: August 7, 2008	ATS MEDICAL, INC.
	By:	/s/ Michael D. Dale
		Michael D. Dale
		Chief Executive Officer (Duly Authorized Officer)
	By:	/s/ Michael R. Kramer
		Michael R. Kramer
		Chief Financial Officer (Principal Financial Officer)

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EXHIBIT INDEX

Exhibit
Number	Description
2.1***	Agreement and Plan of Merger, dated as of January 23, 2006, by and among ATS Medical, Inc., Seabiscuit Acquisition Corp.; 3F Therapeutics, Inc.; and Boyd D. Cox, as Stockholder Representative (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on January 26, 2006).
2.2	Amendment No. 1 to Agreement and Plan of Merger, dated as of June 13, 2006, by and among ATS Medical, Inc., Seabiscuit Acquisition Corp., 3F Therapeutics, Inc. and Boyd D. Cox, as stockholder representative (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on June 19, 2006).
2.3	Amendment No. 2 to Agreement and Plan of Merger, dated as of August 10, 2006, by and among the Company, Seabiscuit Acquisition Corp., 3F Therapeutics, Inc. and Boyd D. Cox, as stockholder representative (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on August 15, 2006).
2.4	Escrow Agreement, effective as of September 29, 2006, by and among the Company, Boyd D. Cox, as stockholder representative and Wells Fargo Bank, N.A. (Incorporated by reference to Exhibit 2.4 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006).
2.5***	Option and Asset Purchase Agreement, dated as of May 31, 2005, by and among ATS Medical, Inc., em Vascular, Inc., Keith L. March, M.D., John Havek, Walter L. Sembrowich and James E. Shapland II (Incorporated by reference to Exhibit 2.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006).
2.6	Letter Amendment, dated as of November 29, 2006, to the Option and Asset Purchase Agreement, dated as of May 31, 2005, by and among ATS Medical, Inc., em Vascular, Inc., Keith L. March, M.D., John Havek, Walter L. Sembrowich and James E. Shapland II, (Incorporated by reference to Exhibit 2.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006).
2.7***	Asset Purchase Agreement dated June 18, 2007 by and between ATS Medical, Inc. and CryoCath Technologies Inc. (Incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on June 25, 2007).
3.1	Third Restated Articles of Incorporation of ATS Medical, Inc.
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 (the “1997 Form 10-K”)).
4.2	Warrant, dated June 29, 2008, issued to Theodore C. Skokos (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on July 2, 2008).
10.1	ATS Medical, Inc. 2000 Stock Incentive Plan, as amended (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 13, 2008).
10.2	Amendment No. 3 dated April 30, 2008, to Original Lease Agreement dated April 29, 2000, by and between the Company and St. Paul Properties, Inc.
10.3	2008 ATS Medical Management Incentive Compensation Plan.
10.4	Subordinated Credit Agreement, dated June 29, 2008, by and between ATS Medical, Inc. and Theodore C. Skokos (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 2, 2008).

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Exhibit
Number	Description
10.5	Amendment, dated June 30, 2008, to the Loan and Security Agreement between Silicon Valley Bank and the Company dated July 28, 2004 (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on July 2, 2008).
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)

*** Certain Exhibits and Schedules have been omitted but will be provided supplementally to the Securities and Exchange Commission upon request.

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