UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the
- Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
COMMISSION FILE NO. 0-18602
ATS MEDICAL, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1595629
(state or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3905 ANNAPOLIS LANE, SUITE 105 55447
MINNEAPOLIS, MINNESOTA (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (763) 553-7736
Former name, if changed since last report: N/A
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
The number of shares outstanding of each of the registrant's classes of
common stock as of November 11, 2002 was:
Common Stock $.01 par value 22,305,920 shares
ATS MEDICAL, INC.
INDEX
<Table>
<Caption>
PART I. FINANCIAL INFORMATION PAGE
Item 1. Statements of Financial Position - 3
September 30, 2002 (unaudited) and
December 31, 2001
Statements of Operations - 4
Three and Nine Months Ended September 30, 2002 and
2001 (unaudited)
Statements of Cash Flows - 5
Nine Months Ended September 30, 2002 and
2001 (unaudited)
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of 8
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About 15
Market Risk
Item 4. Controls and Procedures 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Default Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of 16
Security Holders
Item 5. Other Information 16
Item 6 Exhibit and Reports on Form 8-K 16
Signatures 17
</Table>
2
ITEM 1. FINANCIAL STATEMENTS
ATS MEDICAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION
<Table>
<Caption>
September 30, December 31,
2002 2001
------------- ------------
ASSETS (Unaudited) (Note)
Current assets:
Cash and cash equivalents $ 7,945,250 $ 5,078,750
Short-term investments 1,498,476 7,698,290
------------ ------------
9,443,726 12,777,040
Accounts receivable, less allowance of $415,000
in 2002 and $400,000 in 2001 3,876,874 4,082,992
Inventories 16,285,771 17,348,901
Prepaid expenses 234,421 570,716
------------ ------------
Total current assets 29,840,792 34,779,649
Furniture, machinery and equipment, net 6,119,828 6,753,483
Inventories 40,000,000 40,000,000
Technology license 18,500,000 13,000,000
Other assets 438,785 438,100
------------ ------------
Total assets $ 94,899,405 $ 94,971,232
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 211,402 $ 1,345,780
Notes payable 2,500,000 --
Accrued liabilities 1,957,400 1,402,203
------------ ------------
Total current liabilities 4,668,802 2,747,983
Long-term debt 11,339,000 --
Shareholders' equity:
Common Stock, $.01 par value:
Authorized 40,000,000 shares; Issued and
outstanding 22,281,325 and 22,203,940 shares at
September 30, 2002 and December 31, 2001, respectively 222,813 222,039
Additional paid-in capital 111,462,485 111,354,615
Accumulated deficit (32,793,695) (19,353,405)
------------ ------------
Total shareholders' equity 78,891,603 92,223,249
------------ ------------
Total liabilities and shareholders' equity $ 94,899,405 $ 94,971,232
============ ============
</Table>
Note: The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See notes to condensed financial statements.
3
ATS MEDICAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<Table>
<Caption>
Three months ended September 30, Nine months ended September 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net sales $ 3,184,351 $ 3,744,095 $ 9,561,856 $ 12,412,890
Less cost of goods sold 2,179,420 3,252,971 7,194,342 8,733,319
------------ ------------ ------------ ------------
Gross profit 1,004,931 491,124 2,367,514 3,679,571
Expenses:
Research, development and engineering 345,790 1,102,737 1,940,140 2,951,613
Sales and marketing 389,432 1,304,415 2,691,637 3,603,502
General and administrative 634,882 658,085 2,089,450 2,327,372
Impairment of technology license 0 0 8,100,000 0
Reorganization expenses 22,897 0 888,081 0
------------ ------------ ------------ ------------
Total expenses 1,393,001 3,065,237 15,709,308 8,882,487
------------ ------------ ------------ ------------
Operating loss (388,070) (2,574,113) (13,341,794) (5,202,916)
Interest expense (239,000) 0 (239,000) 0
Interest income 37,864 199,803 140,504 905,526
------------ ------------ ------------ ------------
Net loss $ (589,206) $ (2,374,310) $(13,440,290) $ (4,297,390)
============ ============ ============ ============
Net loss per share:
Basic and diluted $ (0.03) $ ( 0.11) $ (0.60) $ (0.19)
Weighted average number of shares outstanding:
Basic and diluted 22,270,880 22,179,009 22,245,458 22,145,413
</Table>
See notes to condensed financial statements.
4
ATS MEDICAL, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
NINE MONTHS ENDED SEPTEMBER 30,
2002 2001
------------ ------------
OPERATING ACTIVITIES
Net loss $(13,440,290) $ (4,297,390)
Adjustment to reconcile net loss to net cash
used in operating activities:
Depreciation 536,544 504,887
Loss on disposal of equipment 29,790 11,307
Imputed interest long-term debt 239,000 0
Impairment of technology license 8,100,000 0
Changes in operating assets and liabilities:
Accounts receivable 206,118 (591,101)
Inventories 1,063,130 (3,315,525)
Prepaid expenses 336,295 300,912
Other assets (685) (12,063)
Accounts payable and accrued expenses (579,181) (1,015,460)
------------ ------------
Net cash used in operating activities (3,509,279) (8,414,433)
INVESTING ACTIVITIES
Purchase of short-term investments (2,612,008) (16,691,055)
Sale of short-term investments 8,811,822 20,685,689
Purchases of furniture, machinery and equipment (97,468) (3,158,370)
Proceeds on disposal of equipment 164,789 0
------------ ------------
Net cash provided by investing activities 6,267,135 836,264
FINANCING ACTIVITIES
Net proceeds from sale of common stock 108,644 474,740
------------ ------------
Net cash provided by financing activities 108,644 474,740
Increase (decrease) in cash and cash equivalents 2,866,500 (7,103,429)
Cash and cash equivalents at beginning of period 5,078,750 14,804,195
------------ ------------
Cash and cash equivalents at end of period $ 7,945,250 $ 7,700,766
============ ============
</Table>
See notes to condensed financial statements.
5
ATS MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2002
Note A - BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three and nine
months ended September 30, 2002 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2002.
Note B - COMMITMENTS
In June, 2002 the Company amended the supply and technology transfer agreements
it has with Carbomedics. The amendment to the supply agreement suspends
component set purchases until January 2007. This postpones component purchases
totaling approximately $3 million in 2002 and approximately $18 million for the
years 2003 to 2006. In January of 2007, the purchase obligations for 2003 would
resume, with the obligations for 2004 through 2006 to follow in each subsequent
year. In addition, the technology transfer fee of $5,000,000 due at the end of
2002 will be paid in two equal installments in June and December of 2003. The
Company will pay interest at the rate of 7% on this note from the original due
date until the payment date. Furthermore, the technology payments due in 2003,
2004, 2005 and 2006 totaling $23 million begin to be paid based on a percentage
of the value of the inventories drawn down starting in January of 2005 with the
first payment in June 2005 and subsequent payments every six months based on a
percent of the inventory drawn down during the previous six months. The Company
has recorded a $2.4 million discount on the non-interest bearing debt owed to
Carbomedics for milestones achieved to date. The discount is to be amortized as
interest expense over the estimated term of the debt. As part of this agreement,
the Company has provided Carbomedics a security interest in its inventories
covering all of its material obligations under its agreements with Carbomedics.
Note C - IMPAIRMENT OF TECHNOLOGY LICENSE
At the end of the first quarter of 2002, the Company evaluated the carrying
value of its technology license asset of $13 million in accordance with the
provisions of FASB Statement 142 (FASB No. 142), Goodwill and Other Intangible
Assets, which were effective for the Company as of January 1, 2002. Utilizing a
discounted cash flow model, that analysis indicated the asset's carrying value
was recoverable and the Company recognized no impairment as a result of the
adoption of FASB No. 142. In the second quarter of 2002, the Company experienced
decreased sales volumes, decreased average selling prices and initiated certain
restructuring activities pertaining to its executive team and the manner in
which it sells its product, changing from a direct sales force to a hybrid sales
force of a few direct salespeople and
6
several independent manufacturers representatives. In response to these
conditions, the Company modified its pricing strategy and sales volume estimates
in conjunction with the reorganization plan implemented and the increased
competitive pressures in the European market. As a result of these conditions
and changes, the Company reviewed its future cash flow analysis and changed its
expectations of the sales volumes estimated and its selling prices of the heart
valve in the cash flow model to evaluate the recoverability of its technology
license. When compared to the revised fair value as calculated by discounting
the new future cash flows projections at June 30, 2002, the Company determined a
non-cash charge representing an impairment of this asset needed to be recognized
in the amount of $8.1 million in the second quarter. This charge also reflects
in part the effect of the amended milestone payments in the early years of the
technology transfer agreement relative to the benefits of lower cost carbon not
being realized until future years after the depletion of inventories currently
on hand.
Note D - REORGANIZATION OF THE COMPANY
In June 2002, the Board of Directors decided to implement new cost containment
measures and to seek a new management team to lead the business. As part of
these cost reduction measures, one half of the workforce, including all of the
executive officers of the Company with the exception of the Company's CEO at
that time, were released from employment. The Company had 41 employees at June
30, 2002 compared to 131 employees at June 30, 2001. For the quarter ended June
30, 2002 the Company had $865,184 in reorganization expenses. During the quarter
ended September 30, 2002, the Company had an additional $22,897 in
reorganization expenses, bringing the total to $888,081. The reorganization
expenses consist of approximately $743,600 of severance pay and benefits, and
$144,500 of rent that was expensed for the vacated portion of the Company's
leased facility. Of the total reorganization expenses approximately $345,000 has
not been paid as of September 30, 2002. In the fourth quarter, 2002 the Company
will be accruing approximately $220,000 in additional reorganization expense
related to releasing the Company's former CEO from employment.
Note E - Subsequent Event
On September 22, 2002, the Company communicated to its distributor covering
France and Belgium that it was in violation of several conditions of its
distributor agreement. The distributor failed to cure these defaults, resulting
in the termination of the distributor agreement between the two parties
effective October 22, 2002. The distributor has the right to return all valves
to the Company as a result of the early termination clause within the
distributor agreement. The Company anticipates that a termination charge of
approximately $700,000 will be recorded in the fourth quarter, representing the
margin on the valves that are expected to be returned to the Company and the
estimated costs related to restocking such inventory for resale.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ATS Medical manufactures and markets a mechanical bileaflet heart valve with our
patented open pivot design. Our heart valve is used to treat valvular heart
disease caused by the natural aging process, rheumatic heart disease and
congenital defects. We have received regulatory approvals to market the ATS
heart valve in the United States and most international markets, principally
Europe, Japan, Canada and Australia.
We commenced selling the ATS heart valve in international markets in 1992.
Internationally, we sell the valve to independent distributors with assigned
territories (generally a specific country or region) who in turn sell the valve
to hospitals or clinics. Most of our sales to international distributors are
denominated in U.S. dollars so currency risk is borne by the distributor;
however, as the dollar increases in value relative to the distributor's local
currency, the cost of the valve increases for the distributor even though ATS
does not change the selling price. From time to time, this has caused us to
adjust the selling price to the affected distributors to help offset a portion
of the currency loss.
During 2001 we hired a direct sales force and began selling the ATS heart valve
in the United States. As a result of these efforts, our U.S. sales as a
percentage of our overall sales increased from 4% in 2000 to 12% in 2001 and 21%
as of the third quarter 2002. Due to the cost of maintaining a full direct sales
force, however, we decided in mid-June 2002 to switch to a hybrid sales force in
the U.S. consisting of our top performing direct sales people plus independent
manufacturers representatives who are now being recruited. During the quarter
ended September 30, 2002, we signed contracts with two major independent
representative organizations.
In the U.S. market, ATS reports the selling price to the hospital, net of sales
commission in the case of U.S. distributor sales. In non-U.S. markets, ATS
reports the selling price to the distributor. As U.S. sales increase as a
percentage of overall sales, the overall average selling price may increase,
even though the average selling prices in some non-U.S. markets may be steady or
declining. Hospital administrators continue to apply pressure for lower prices,
and the willingness of competitors to reduce prices will continue to put
pressure on revenue growth and margins.
To date we have purchased all of the pyrolytic carbon components for the ATS
heart valve from Carbomedics, a division of Centerpulse (formerly Sulzer Medica)
pursuant to a multi-year supply agreement entered into in 1990. The cost of the
pyrolytic carbon components represents approximately 80% of the total cost of
the ATS heart valve. Under the supply agreement, the cost of the pyrolytic
carbon components has varied according to annual volume purchases and is
adjusted annually by reference to increases in the U.S. Department of Labor
Employment Cost Index. In December 1999, we renegotiated the supply agreement
with Carbomedics resulting in significant reductions in our minimum purchase
requirements and unit costs beginning in 2001. In late June 2002, we again
amended the supply agreement such that our purchase obligations for the
remainder of 2002 (with the exception of approximately eight weeks of work in
process) would be suspended along with 100% of our purchase obligations for
2003, 2004, 2005 and 2006. In January of 2007 the purchase obligations for 2003
would resume, with the obligations for 2004 through 2006 to follow in each
subsequent year.
We also renegotiated the timing of the technology fee payments due under the
carbon agreement with Carbomedics, such that, the $5 million payment that would
have been due in December 2002 will now be paid in two equal installments in
June and December 2003. ATS will pay interest at the rate of 7% on this note
from the original due date until the payment date. Furthermore, the technology
payments initially due in 2003, 2004, 2005 and 2006 totaling a maximum of $23
million for milestones achieved by the Company will begin to be paid based on a
percentage of the value of the inventories drawn down starting in January of
2005 with the first payment in June 2005 and subsequent payments every six
months based on a percent of the inventories drawn down during the previous six
months. These adjustments to the timing of cash
8
disbursements, relative to our two agreements with Carbomedics, together with
our reduced operating costs are projected to provide working capital through
2005. As a part of this agreement, we have provided Carbomedics a security
interest in our inventories covering all of our material obligations under our
agreement with Carbomedics.
In our Form 10-K filed with the Securities and Exchange Commission for the year
ended December 31, 2001, we identified critical accounting policies and
estimates for our business. There have been no material changes in these polices
and estimates during the nine months ended September 30, 2002.
Results of Operations
Net sales for the quarter ended September 30, 2002 decreased 15% to $3,184,351
compared to $3,744,095 for the quarter ended September 30, 2001. Net sales for
the nine months ended September 30, 2002 totaled $9,561,856 compared to
$12,412,890 for the nine months ended September 30, 2001. Unit sales for the
quarter ended September 30, 2002 decreased approximately 7% compared to unit
sales for the quarter ended September 30, 2001. For the nine months ended
September 30, 2002, unit sales decreased 17% compared to nine months ended
September 30, 2002. The decrease in unit sales from last year's units sales was
primarily attributable to Europe where Italy remains on distributor accounting
and France did not place orders in the second or third quarters of 2002. The
average selling price for the three months ended September 30, 2002 decreased 9%
compared to the average selling price for three months ended September 30, 2002.
For the nine months ended September 30, 2002 the average selling price decreased
7 % compared to the nine months ended September 30, 2001. The decreases in
average selling price is primarily attributable to lower prices in Europe due to
competitive pricing. Revenue in the United States decreased 28% in the quarter
ended September 30, 2002 compared to the quarter ended September 30, 2001 as we
are in the midst of reorganizing our sales representation. The transition to a
new distributor in Germany was successfully completed during the third quarter
2002.
On September 22, 2002, the Company communicated to its distributor covering
France and Belgium that it was in violation of several conditions of its
distributor agreement. The distributor failed to cure these defaults, resulting
in the termination of the distributor agreement between the two parties
effective October 22, 2002. The distributor has the right to return all valves
to the Company as a result of the early termination clause within the
distributor Agreement. The Company anticipates that a termination charge of
approximately $700,000 will be recorded in the fourth quarter, representing the
margin on the valves that are expected to be returned to the Company and the
estimated costs related to restocking such inventory for resale.
In the United States, we had established a direct sales force to sell the valve
during the first several months of 2001. In mid-June 2002, we took certain cost
savings measures including a reduction in our work force which included the
majority of our direct sales people. Independent manufacturers representatives
are being recruited to take the place of the former direct territories affected
by the reduction in force. We will to continue our efforts to organize our sales
distribution in the U.S. during the fourth quarter 2002 and the first quarter
2003. Valves are consigned to hospitals desiring to use the ATS valve and a sale
is recorded once the valve is implanted. The "sales cycle" for new accounts can
take from one to three months and we anticipate additional delays caused by the
transition from direct sales to sales through independent representatives. We
feel that we have a superior product, however, our competitors
9
have larger sales staffs and greater financial resources so they are currently
able to reach more potential customers. The rate at which we will open new
accounts and realize new implants with our hybrid sales force is difficult to
forecast from quarter to quarter.
Another factor that may affect sales is the recent introduction into the U.S.
market of the ATS Aortic Valves Graft ("AVG"). On June 7, 2002, the FDA approved
our PMA Supplement Application for our ATS AVG. The AVG is designed to be used
when replacement of the aortic valve and a portion of the ascending aorta is
needed. Our sales of AVGs in other approved markets has been approximately 7% of
sales and we expect similar results in the U.S. market.
Cost of goods sold including under absorbed manufacturing costs for the three
months ended September 30, 2002 totaled $2,179,420 or 68% of net sales compared
to $3,252,971 or 87% of net sales for the three months ended September 30, 2001.
The decrease in cost of goods sold in the third quarter of 2002 primarily
results from a $1,000,000 charge against inventory relating to the lower of cost
or market in the third quarter of 2001. For the nine months ended September 30,
2002, cost of goods sold, including under absorbed manufacturing costs, totaled
$7,194,342 or 75% of net sales compared to $8,733,319 or 70% of net sales for
the nine months ended September 30, 2001.
Gross profit totaled $1,004,931 for the quarter ended September 30, 2002 or 32%
of net sales, compared to gross profit of $491,124 or 13% of net sales for the
quarter ended September 30, 2001. For the nine months ended September 30, 2002
gross profit totaled $2,367,514 or 25% of net sales compared to gross profit for
the nine months ended September 30, 2001 of $3,679,571 or 30% of net sales.
Research, development and engineering expenses totaled $345,790 for the quarter
ended September 30, 2002 versus $1,102,737 for the quarter ended September 30,
2001, a decrease of 69%. For the nine months ended September 30, 2002 research,
development and engineering expenses totaled $1,940,140 a decrease of 34% over
the $2,951,613 research, development and engineering expense reported for the
nine months ended September 30, 2001. Approximately 78% of research and
development expenses for the nine months ended September 30, 2002 were related
to our own carbon manufacturing facility. Our focus during 2001 and the first
quarter of 2002 was making qualification and verification coating runs, training
ATS personnel on the new carbon manufacturing equipment installed during the
period, and documenting procedures. This culminated with the submissions at the
end of the first quarter 2002 to the TUV, who we use as a notified body for our
European approval, and to the U.S. Food and Drug Administration. On May 29,
2002, we received notification from the FDA of full approval of our carbon
manufacturing plant. As our existing inventories are depleted over the next few
years, components from this facility are expected to allow for significant
reduction in the cost of goods sold.
Sales and marketing expenses decreased in the quarter ended September 30, 2002
to $389,432 compared to $1,304,415 in the quarter ended September 30, 2001. For
the nine months ended September 30, 2002 sales and marketing expenses totaled
$2,691,637 compared to $3,603,502 for the nine months ended September 30, 2001.
The decrease in expenses is due to the restructuring that took place in June
2002. Since the restructuring, we are utilizing a hybrid sales force consisting
of direct sales people and independent manufacturers representatives. As of
September 30, 2002, we have signed contracts with two major independent
representative organizations.
10
General and administrative expenses totaled $634,882 for the three months ended
September 30, 2002 a slight decrease from the $658,085 reported for the three
months ended September 30, 2001. For the nine months ended September 30, 2002
general and administrative expenses totaled $2,089,450, down 10% from the
$2,327,372 general and administrative expense reported for the nine months ended
September 30, 2001. The decrease is due to fewer personnel in the general and
administrative departments during the third quarter 2002 compared to third
quarter 2001.
For the quarter ended June 30, 2002, we took an impairment charge on our
technology license in the amount of $8,100,000. During that quarter, we reached
three additional milestones in conjunction with our technology license agreement
with Carbomedics, which resulted in an additional $13.6 million of long-term
obligations to be recognized on our balance sheet. At the end of our first
quarter of 2002, we evaluated the carrying value of our technology license asset
of $13 million in accordance with the provisions of FASB Statement 142 (FASB No.
142), Goodwill and Other Intangible Assets, which were effective for the Company
as of January 1, 2002. Utilizing a discounted cash flow model, that analysis
indicated the asset's carrying value was recoverable and we recognized no
impairment as a result of the adoption of FASB NO. 142. In the second quarter of
2002, we experienced decreased sales volumes, decreased average selling prices
and initiated certain restructuring activities pertaining to our executive team
and the manner in which we sell our products from a direct sales force to a
hybrid sales force of a few direct salespeople and several independent
manufacturers representatives. In response to these conditions, we modified our
pricing strategy and sales volume estimates in conjunction with the
reorganization plan implemented and the increased competitive pressures in the
European market. As a result of these conditions and changes, we reviewed our
future cash flow analysis and changed our expectations of the sales volume
estimates and selling prices of the heart valve in the cash flow model to
evaluate the recoverability of our technology license. When compared to the
revised fair value as calculated by discounting the changed future cash flows at
June 30, 2002, we determined a non-cash charge representing an impairment of
this asset needed to be recognized in the amount of $8.1 million in the second
quarter. This charge also reflects in part the effect of the amended milestone
payments in the early years of the technology transfer agreement relative to the
benefits of lower cost carbon not being realized until future years after the
depletion of inventories currently on hand.
For the quarter ended September 30, 2002, we had an additional $22,897 in
reorganization expense, bringing the total to $888,081. In June 2002, management
proposed new cost containment measures and the Board of Directors decided to
implement the new measures and to seek a new management team to lead the
business. As part of these cost reduction measures, one half of the workforce,
including all of the executive officers of the Company with the exception of the
Company's CEO at that time, were released from employment. As of September 30,
2002 we had 43 employees compared to 121 employees at September 30, 2001. The
reorganization expenses consist of approximately $743,600 of severance pay and
benefits, and $144,500 of rent that was expensed for the vacated portion of the
Company's leased facility. Of the total reorganization expenses approximately
$345,000 has not been paid as of September 30, 2002. In the fourth quarter, 2002
the Company will be accruing approximately $220,000 in additional reorganization
expense related to releasing the Company's former CEO from employment.
For the quarter ended September 30, 2002, we recognized interest expense of
$239,000 on the long-term debt. This interest results from the amortization of
the $2.4 million discount amount
11
on the non-interest bearing debt owed to Carbomedics for milestones achieved to
date on the technology transfer agreement.
Interest income totaled $37,864 for the quarter ended September 30, 2002
compared to $199,803 for the quarter ended September 30, 2001. Interest income
for the nine months ended September 30, 2002 totaled $140,504 compared to
$905,526 for the nine months ended September 30, 2001. The decreases in interest
income for the quarter and the nine months ended September 30, 2002 were the
result of lower average investable cash balances and lower interest rates.
ATS recorded a net loss of $589,206 or ($0.03) per share for the quarter ended
September 30, 2002 compared to a net loss of $2,374,310 or ($0.11) per share for
the quarter ended September 30, 2001. This decrease in net loss is primarily
attributable to the cost reduction measures put into place last quarter. For the
nine months ended September 30, 2002, the company recorded a net loss of
$13,440,290 or ($0.60) per share compared to a net loss of $4,297,390 or ($0.19)
per share for the nine months ended September 30, 2001. The decreases in gross
margin and interest income, coupled with the impairment charge and
reorganization expenses, were the reasons for the increased loss. We are
recruiting independent manufacturers representatives in the United States and
making some changes in our international representation to increase sales and to
return to profitability in future quarters.
ATS has accumulated approximately $21 million of net operating loss (NOL)
carryforwards for U.S. tax purposes. ATS believes that its ability to fully
utilize the existing net operating loss carryforwards could be restricted on a
portion of the NOL for changes in control that may have occurred or may occur in
the future. We have not accrued any tax benefits for such tax loss benefit.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments decreased by $3,333,314 from
$12,777,040 at December 31, 2001 to $9,443,726 at September 30, 2002. Inventory
purchases and operating losses including the reorganization expenses were
primarily responsible for the cash used during fiscal 2002. With the reductions
in personnel and spending enacted by ATS in the second quarter 2002, we were
cash flow positive by $991,000 for the quarter ended September 30, 2002.
Accounts receivable decreased from $4,082,992 at December 31, 2001 to $3,876,874
at September 30, 2002. The majority of the receivable balances are amounts owing
from our international customers, where payments terms are 60 days or longer.
Current liabilities increased $1,920,819 from $2,747,983 at December 31, 2001 to
$4,668,802 at September 30, 2002. The majority of this increase is a $2.5
million short-term note on the technology transfer payment due in June 2003
netted against a decrease in accounts payables.
ATS had contracted to purchase $8.4 million of components during 2002 in
accordance with the terms of its supply agreement with Carbomedics. On June 27,
2002 this agreement was amended to suspend carbon component purchases until
January 2007, except for the current work in process that we received in the
third quarter 2002. This suspension of component purchases will reduce cash
expenditures for the Company by approximately $3 million dollars in 2002. For
the years 2003 to 2006, the total deferred expenditures will be approximately
$18 million.
12
Under the carbon agreement entered into in December 1999, ATS agreed to pay
Carbomedics a license fee of $41 million in annual installments ending in
December 2006. In addition to granting ATS an exclusive worldwide right and
license to use its carbon coating technology to manufacture pyrolytic carbon
components for the ATS valve under this agreement, Carbomedics agreed to assist
ATS in designing, building and commencing operations in its own pyrolytic carbon
production facility in Minneapolis, Minnesota. In May 2002, the Company received
notice of approval of its carbon plant from the U.S. Food and Drug
Administration. At the end of June 2002, the timing of the technology fee
payments was delayed. The $5 million payment that was due in December 2002 will
be paid in two equal installments in June and December of 2003. The technology
transfer fees due in subsequent years will be paid in semi-annual installments
beginning in June 2005 in amounts equal to a percentage of the reduction in
inventory occurring in the previous six months. These adjustments to the timing
of cash disbursements, relative to our two agreements with Carbomedics, will
defer cash expenditures of approximately $8 million dollars in 2002.
In the quarter ended September 30, 2002, we recorded imputed interest in the
amount of $239,000, which increased the long-term debt amount to $11,339,000. In
June 2002, long-term debt in the amount of $11,100,000 was set up for the
discounted amounts owing to Carbomedics for milestones achieved on the
technology transfer agreement that are payable in December 2003 and semi-annual
installments beginning June 2005 and beyond. The total amount owing for
milestones already achieved is $16 million, of which, $2.5 million is a
short-term note in current liabilities due in June 2003, $2.5 million is due in
December 2003, and the remaining $11 million is due starting in June 2005 and
continuing in semi-annual installments based on inventory reduction until the
total amount is paid in full. There is no interest being charged to the Company
on the $11 million portion, so a present value calculation was done using a 7%
interest rate and this amount was discounted $2.4 million to determine the long
term liability. The adjustments to the timing of cash disbursements, relative to
our two agreements with Carbomedics, together with our reduced operating costs
have significantly strengthened our present and projected cash position.
Based upon the current forecast of sales and our reduced operating expenses,
along with the adjustments to the timing of our payments to Carbomedics, we
anticipate having cash to fund our operations through 2005. However, as
identified under the heading of "Cautionary Statements Pursuant to the Private
Litigation and Securities Reform Act of 1995" below and in Exhibit 99.1 to this
Report, 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. There can be no assurance that we will achieve desired
levels of sales or profitability, or that future capital infusions will be
available.
THE SINGLE EUROPEAN CURRENCY
A significant portion of our sales occur in Europe. We sell to all of our
customers in U.S. dollars. Our selling prices are similar to most of our
European distributors and therefore should not cause significant disruption
whether in U.S. dollars or Euros. From its introduction in January 1999, the
rate of exchange for the Euro versus the U.S. dollar declined by as much as 34%,
although it has recovered substantially all of that decline over the last 90
days. Several of
13
our European distributors were unable to increase their local currency selling
price for the valve, and, as a result, they informed us that their profits were
being significantly reduced and we adjusted our pricing to give them some
relief. Europe is a very important market for us. Disruption or loss of a
portion of the European business could have a material and adverse impact on our
financial position.
CAUTIONARY STATEMENTS PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995
The Private Securities Litigation Reform Act of 1995 (the "Act") provides a
"safe harbor" for forward-looking statements to encourage companies to provide
prospective information about their business, so long as those statements are
identified as forward-looking and are accompanied by meaningful cautionary
statements identifying important factors that could cause actual results to
differ materially from those discussed in the statement. ATS desires to take
advantage of the safe harbor provisions with respect to any forward-looking
statements it may make in this filing, other filings with the Securities and
Exchange Commission and any public oral statements or written releases. The
words or phrases "will likely," "is expected," "will continue," "is
anticipated," "estimate," "projected," "forecast," or similar expressions are
intended to identify forward-looking statements within the meaning of the Act.
Such statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those projected. ATS cautions readers
not to place undue reliance on any such forward-looking statements, which speak
only as of the date made.
In accordance with the Act, ATS identifies the following important general
factors which if altered from the current status could cause our actual results
to differ from those described in any forward-looking statements: the continued
acceptance of our mechanical heart valve in international markets, the rate of
increase of acceptance of the valve in the United States, our ability to engage
a new management team and the performance of such team, our ability to recruit
and manage an independent manufacturers representatives sales force in the
United States, the continued performance of our mechanical heart valve without
structural failure, the actions of our competitors including pricing changes and
new product introductions, the continued performance of our independent
distributors in international markets selling the valve, the risk of product
returns in connection with distributor terminations, the actions of our supplier
of pyrolytic carbon components for the valve and difficulties we may encounter
operating our own pyrolytic carbon manufacturing capability. This list is not
exhaustive, and we may supplement this list in filings with the Securities and
Exchange Commission (including Exhibit 99.1 to this Form 10-Q) or in connection
with the making of any specific forward-looking statement.
14
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 in which we invest
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 we maintain our portfolio of cash equivalents and
short-term investments in a variety of securities, including commercial paper,
money market funds, government and non-government debt securities. The average
duration of all of 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.
We do not use derivatives and, therefore, do not face market risk from currency
or interest rate changes on these types of instruments. If we were required to
finance future operations with debt, we would have exposure to increases in
interest rates or borrowings.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our Chief Executive Officer and our Controller, we evaluated the effectiveness
of the design and operation of our disclosure controls and procedures (as
defined in Rule 13a-14(c) under the Exchange Act) as of a date (the "Evaluation
Date") within 90 days prior to the filing date of this report. Based upon that
evaluation, the Chief Executive Officer and Controller concluded that, as of the
Evaluation Date, our disclosure controls and procedures were effective in timely
alerting them to the material information relating to us required to be included
in our periodic SEC filings.
(b) Changes in Internal Control
There were no significant changes made in our internal controls during the
period covered by this report or, to our knowledge, in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
On July 31, 2002, the Company received a written notification from
Nasdaq that it does not comply with the $1.00 minimum bid price
continued listing standard of The Nasdaq National Market and thus may
be delisted from The Nasdaq National Market. The Company had 90
calendar days, or until October 29, 2002, to demonstrate compliance by
having the bid price of the Company's common stock close at $1.00 per
share or more for a minimum of 10 consecutive trading days. On October
30, 2002, the Company filed an application with Nasdaq to transfer its
common stock listing to The Nasdaq SmallCap Market. The Company
anticipates that this application will be approved within the next few
weeks and that the listing of its common stock will then move to the
Nasdaq SmallCap Market. The Company will then have until January 27,
2003 (or July 28, 2003, if the Company then satisfies all other
criteria for listing on the Nasdaq SmallCap Market) to satisfy the
$1.00 minimum bid price continued listing standard for the Nasdaq
SmallCap Market. If it fails to satisfy the minimum bid price
requirement at that time, it may then be delisted from the Nasdaq
SmallCap Market.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Cautionary Statements
99.2 Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.3 Certification of the Controller pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
None
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 12, 2002 ATS MEDICAL, INC.
By: /s/ Michael D. Dale
--------------------------------------
Michael D. Dale, Chief Executive
Officer (Principal Executive Officer
and Authorized Signatory)
By: /s/ Deborah K. Chapman
--------------------------------------
Deborah K. Chapman, Controller
(Principal Accounting Officer)
17
CERTIFICATIONS
I, Michael D. Dale, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ATS Medical,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Michael D. Dale
------------------------------
Name: Michael D. Dale
Title: Chief Executive Officer
CERTIFICATIONS
I, Deborah Chapman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ATS Medical,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 12, 2002
/s/ Deborah K. Chapman
------------------------
Name: Deborah K. Chapman
Title: Controller
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT NUMBER DESCRIPTION
99.1 Cautionary Statements
99.2 Certification of the Chief Executive Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
99.3 Certification of the Controller pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
</Table>
18