UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-K/A
(AMENDMENT NO. 2)
Annual Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
COMMISSION FILE NO. 0-18602
ATS MEDICAL, INC.
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1595629
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3905 ANNAPOLIS LANE NORTH
MINNEAPOLIS, MINNESOTA 55447
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (763) 553-7736
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock $.01
par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes No X
--- ---
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes No X
--- ---
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
---
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check
one):
Large accelerated filer Accelerated filer X Non-accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
--- ---
The aggregate market value of voting and non-voting stock held by non-affiliates
of the registrant as of June 30, 2005, was approximately $107,457,665 (based on
the last sale price of such stock as reported by the NASDAQ National Market on
such date).
The number of shares outstanding of the registrant's common stock, $.01 par
value per share, as of July 5, 2006, was 31,231,891 shares.
Documents Incorporated by Reference: None.
1
EXPLANATORY NOTES
OVERVIEW. This Amendment No. 2 on Form 10-K/A (the "Form 10-K/A") to our Annual
Report on Form 10-K for the fiscal year ended December 31, 2005, initially filed
with the Securities and Exchange Commission ("SEC") on March 7, 2006 (the
"Original Filing") and as amended by Amendment No. 1 filed on April 28, 2006, is
being filed to restate our 2005 consolidated financial statements, certain notes
to our 2005 consolidated financial statements and other financial information to
give effect to derivative accounting treatment required for the Company's
Convertible Senior Notes issued in October, 2005 (the "Notes").
The information contained in this Form 10-K/A, including the financial
statements and notes thereto, amends only Items 1A, 6, 7, 8, 9A and 15 of our
Original Filing, in each case to reflect only the adjustments described herein,
and no other information in our Original Filing is amended hereby. Except for
the foregoing amended information, the Original Filing, as amended, continues to
describe conditions as of March 7, 2006, the date of the Original Filing, and
does not reflect events occurring after March 7, 2006, or modify or update those
disclosures that may have been affected by subsequent events.
FINANCIAL STATEMENT RESTATEMENT. As stated above, we are filing this Form 10-K/A
to restate our 2005 consolidated financial statements and other financial
information to give effect to derivative accounting treatment required for the
Notes. The determination to restate these financial statements was made after an
error was discovered in June 2006 in the accounting for embedded derivatives
related to the Notes under Financial Accounting Standards Board (FASB) Statement
No.133, Accounting for Derivative Instruments and Hedging Activities and related
Emerging Issues Task Force (EITF) interpretations and SEC rules.
The following table summarizes the effect of the restatement on the statement of
operations (dollars in thousands):
Year Ended December 31, 2005
-----------------------------------------
As Previously
Reported Adjustments As Restated
------------- ----------- -----------
Operating loss $(16,187) -- $(16,187)
Interest expense, net of interest income (376) 38 (338)
Change in value of derivative liability bifurcated
from convertible senior notes -- 2,131 2,131
Net loss $(16,563) $2,169 $(14,394)
Net loss per share-basic and diluted $ (0.53) $ 0.07 $ (0.46)
The restatement does not have an impact on cash flow.
IMPACT ON MANAGEMENT'S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING.
In connection with the restatement, we reevaluated our disclosure controls and
procedures. We concluded that our failure to correctly apply FASB Statement
No.133 and its related interpretations and rules with respect to the embedded
derivative accounting treatment required for our Convertible Senior Notes
constituted a material weakness in our internal control over financial
reporting. Solely as a result of this material weakness, we concluded that our
disclosure controls and procedures were not effective as of December 31, 2005.
We have performed a thorough analysis of all of the provisions in the Notes and
related agreements for embedded derivatives under FASB Statement No.133 and the
related EITF interpretations and SEC rules, in an effort to ensure that this
Amendment reflects all necessary adjustments.
CERTIFICATIONS. Pursuant to the rules of the SEC, Item 15 of Part IV of the
Original Filing has been amended to contain currently-dated certifications from
our Chief Executive Officer and Chief Financial Officer, as required by Sections
302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of our Chief
Executive Officer and Chief Financial Officer are attached to this Form 10-K/A
as Exhibits 31.1, 31.2, 32.1 and 32.2.
2
PART I
ITEM 1A. RISK FACTORS
Our business faces many risks. Any of the risks discussed below, or elsewhere in
this Form 10-K or our other filings with the Securities and Exchange Commission,
could have a material impact on our business, financial condition or results of
operations. Additional risks and uncertainties not presently known to us or that
we currently believe to be immaterial may also impair our business operations.
IF OUR HEART VALVE DOES NOT ACHIEVE WIDESPREAD MARKET ACCEPTANCE IN THE UNITED
STATES, OUR OPERATING RESULTS WILL BE HARMED AND WE MAY NOT ACHIEVE
PROFITABILITY.
Our success will depend, in large part, on the medical community's acceptance of
the ATS heart valve in the United States, which is the largest revenue market in
the world for heart valves. The U.S. medical community's acceptance of the ATS
heart valve will depend upon our ability to demonstrate the safety and efficacy,
advantages, long-term clinical performance and cost-effectiveness of the ATS
heart valve as compared to other prosthetic heart valves. We cannot predict
whether the U.S. medical community will accept the ATS heart valve or, if
accepted, the extent of its use. Negative publicity resulting from isolated
incidents involving the ATS heart valve or other prosthetic heart valves could
have a significant adverse effect on the overall acceptance of our heart valve.
If we encounter difficulties developing a market for the ATS heart valve in the
United States, we may not be able to increase our revenue enough to achieve
profitability and our business and results of operations will be seriously
harmed.
WE CURRENTLY RELY ON THE ATS HEART VALVE AS OUR PRIMARY SOURCE OF REVENUE. IF WE
ARE NOT SUCCESSFUL IN SELLING THIS PRODUCT, OUR OPERATING RESULTS WILL BE
HARMED.
While we commenced marketing additional products during 2005 that totaled 10% of
net revenues for the year ended December 31, 2005, there can be no assurance
that these new products will decrease our dependence on the sales of mechanical
heart valves. Increasing revenues from new products cannot be guaranteed. Even
if we were to develop additional products, regulatory approval would likely be
required to sell them. Clinical testing and the approval process itself are very
expensive and can take many years. Therefore, we do not expect to be in a
position to sell additional products in the foreseeable future. Adverse rulings
by regulatory authorities, product liability lawsuits, the failure to achieve
widespread U.S. market acceptance, the loss of market acceptance outside of the
United States, or other adverse publicity may significantly and adversely affect
our sales of the ATS heart valve, and, as a result, would adversely affect our
business, financial condition and results of operations.
THE ANTICIPATED BENEFITS OF ACQUIRING 3F THERAPEUTICS MAY NOT BE REALIZED.
ATS and 3F entered into the merger agreement with the expectation that the
merger will result in various benefits, including, among others, benefits
relating to an expanded heart valve product line, enhanced revenues, a
strengthened market position for ATS in the heart valve industry, cross selling
opportunities, technology, cost savings and operating efficiencies. Achieving
the anticipated benefits of the merger is subject to a number of uncertainties,
including whether 3F's development-stage products are ultimately marketable,
whether ATS integrates 3F in an efficient and effective manner, and general
competitive factors in the marketplace. Failure to achieve these anticipated
benefits could result in increased costs, decreases in the amount of expected
revenues and diversion of management's time and energy and could materially
impact ATS's business, financial condition and operating results.
ATS MEDICAL MAY HAVE DIFFICULTY INTEGRATING 3F THERAPEUTICS AND MAY INCUR
SUBSTANTIAL COSTS IN CONNECTION WITH THE INTEGRATION.
Integrating 3F's operations into ATS's business will be a complex,
time-consuming and expensive process. Before the merger, ATS and 3F operated
independently, each with its own business, products, customers, employees,
culture and systems. ATS may experience material unanticipated difficulties or
expenses in connection with the integration of 3F due to various factors. These
factors may include:
1
- retaining and integrating management and other key employees of the
combined company;
- costs and delays in implementing common systems and procedures and
integrating 3F's products and operations into ATS's business;
- potential charges to earnings resulting from the application of
purchase accounting to the transaction;
- difficulty comparing financial reports due to differing financial and
accounting systems;
- diversion of management resources from the business of the combined
company; and
- reduction or loss of customer sales due to the potential for market
confusion, hesitation and delay.
Many of these factors are outside the control of either company. The time and
expense associated with converting the businesses of the combined company to a
single combined company may exceed management's expectations and limit or delay
the intended benefits of the transaction. To the extent any of these events
occurs, the benefits of the transaction may be reduced, at least for a period of
time. In addition, it is possible that unexpected transaction costs, such as
taxes, fees or professional expenses, or unexpected future operating expenses,
such as increased personnel costs, as well as other types of unanticipated
adverse developments, could have a material adverse effect on ATS's business,
financial condition and results of operations.
IF THE CONDITIONS TO THE MERGER ARE NOT MET, THE MERGER MAY NOT OCCUR.
Certain conditions set forth in the merger agreement must be satisfied or waived
to complete the merger. If the conditions are not satisfied or waived, the
merger will not occur or will be delayed, and each of ATS and 3F may lose some
or all of the intended benefits of the merger. In addition to other customary
closing conditions, the following conditions must be satisfied or waived, if
permissible, before ATS and 3F are obligated to complete the merger:
- the issuance of the shares in the merger must be approved by the
shareholders of ATS; and
- there must be no fact, event or circumstance that would have a
material adverse effect on the business of ATS or 3F, taken as a
whole.
We cannot assure you that these conditions will be satisfied.
IN 2002, WE BEGAN USING A COMBINATION OF DIRECT SALES PERSONS AND INDEPENDENT
MANUFACTURING REPRESENTATIVES TO SELL OUR VALVES IN THE UNITED STATES. IF OUR
U.S. SALES STRATEGY IS NOT SUCCESSFUL, WE WILL NOT BE ABLE TO CONTINUE OUR
OPERATIONS AS PLANNED.
Our sales approach for the sale of the ATS valve in the United States consists
primarily of direct salespersons with a few independent manufacturer's
representatives. We will need to continue to expend significant funds and
management resources to develop and maintain this hybrid sales force. We believe
there is significant competition for sales personnel and independent
manufacturing representatives with the advanced sales skills and technical
knowledge we need. If we are unable to recruit, retain and motivate qualified
personnel and representatives, U.S. sales of the ATS valve could be adversely
affected. The loss of key salespersons or independent manufacturer's
representatives could have a material adverse effect on our sales or potential
sales to current customers and prospects serviced by such salespersons or
representatives. Further, we cannot assure the successful expansion of our
network of independent manufacturer's representatives on terms acceptable to
ATS, if at all, or the successful marketing of our products by our hybrid sales
force. To the extent we rely on sales through independent manufacturer's
representatives, any revenues we receive will depend primarily on the efforts of
these parties. We do not control the amount and timing of marketing resources
that these third parties devote to our product. If our U.S. sales strategy is
not successful, we may be forced to change our U.S. sales strategy again. Any
such change could disrupt sales in the United States. Further, any change in our
U.S. sales strategy could be expensive and would likely have a material adverse
impact on our results of operations.
2
WE CURRENTLY DEPEND ON THE MARKETING AND SALES EFFORTS OF INTERNATIONAL
INDEPENDENT DISTRIBUTORS, AND OUR SALES HAVE BEEN CONCENTRATED IN THREE
COUNTRIES.
The ATS heart valve is sold internationally through independent distributors.
The loss of an international distributor could seriously harm our business and
results of operations if a new distributor could not be found on a timely basis
in the relevant geographic market. We do not control the amount and timing of
marketing resources that these third parties devote to our product. Furthermore,
to the extent we rely on sales through independent distributors, any revenues we
receive will depend primarily on the efforts of these parties.
WE ARE DEPENDENT UPON SALES OUTSIDE THE UNITED STATES, WHICH ARE SUBJECT TO A
NUMBER OF RISKS INCLUDING A DROP IN SALES DUE TO CURRENCY FLUCTUATIONS.
For the year ended December 31, 2005, almost 62% of our net sales were derived
from international operations. We expect that international sales will account
for a substantial majority of our revenue until the ATS heart valve receives
wider market acceptance from U.S. customers. Accordingly, any material decrease
in foreign sales may materially and adversely affect our results of operations.
We sell in U.S. dollars to most of our customers abroad. An increase in the
value of the U.S. dollar in relation to other currencies can and has adversely
affected our sales outside of the United States. In prior years, the decrease in
sales was due primarily to the change in the value of the U.S. dollar against
the Euro, as well as competitor price pressure. Our dependence on sales outside
of the United States will continue to expose us to U.S. dollar currency
fluctuations for the foreseeable future.
Our future results of operations could also be harmed by risks inherent in doing
business in international markets, including:
- unforeseen changes in regulatory requirements and government health
programs;
- weaker intellectual property rights protection in some countries;
- new export license requirements, changes in tariffs or trade
restrictions;
- political and economic instability in our target markets; and
- greater difficulty in collecting payments from product sales.
Slow payment of receivables by our international distributors, or the occurrence
of any of the other factors listed above, could harm our ability to successfully
commercialize our product internationally and could harm our business.
WE HAVE A HISTORY OF NET LOSSES. IF WE DO NOT HAVE NET INCOME IN THE FUTURE, WE
MAY BE UNABLE TO CONTINUE OUR OPERATIONS.
We are not currently profitable and have a very limited history of
profitability. As of December 31, 2005, we had an accumulated deficit in excess
of $80 million. We expect to incur significant expenses over the next several
years as we continue to devote substantial resources to the commercialization of
the ATS heart valve in the United States. We will not generate net income unless
we are able to significantly increase revenue from U.S. sales. If we continue to
sustain losses, we may not be able to continue our business as planned.
WE HAVE A HISTORY OF REGULARLY RAISING FUNDS AND INCURRING DEBT TO FUND NET
LOSSES. IF OUR CURRENT CASH AND INVESTMENT BALANCES ARE INADEQUATE TO CARRY US
TO PROFITABILITY, WE MAY NEED TO RAISE EQUITY OR INCUR DEBT IN THE FUTURE.
During the last three years, we have completed financings to fund our
operations. If our future operations require greater cash than our current
balances, we would again be required to raise equity or issue debt. If we were
unable to raise these funds, we may not be able to continue our business as
planned.
3
THE MARKET FOR PROSTHETIC HEART VALVES IS HIGHLY COMPETITIVE, AND A NUMBER OF
OUR COMPETITORS ARE LARGER AND HAVE MORE FINANCIAL RESOURCES. IF WE DO NOT
COMPETE EFFECTIVELY, OUR BUSINESS WILL BE HARMED.
The market for prosthetic heart valves is highly competitive. We expect that
competition will intensify as additional companies enter the market or modify
their existing products to compete directly with us. Our primary competitor, St.
Jude Medical, Inc., currently controls approximately 50% of the worldwide
mechanical heart valve market. Many of our competitors have long-standing FDA
approval for their valves and extensive clinical data demonstrating the
performance of their valves. In addition, they have greater financial,
manufacturing, marketing and research and development capabilities than we have.
For example, many of our competitors have the ability, due to their internal
carbon manufacturing facilities and economies of scale, to manufacture their
heart valves at a lower cost than we can manufacture the ATS heart valve. Our
primary competitor has recently used price as a method to compete in several
international markets. If heart valve prices decline significantly we might not
be able to compete successfully, which would harm our results of operations.
OUR FUTURE RESULTS WILL BE HARMED IF THE USE OF MECHANICAL HEART VALVES
DECLINES.
Our business could suffer if the use of mechanical heart valves declines.
Historically, mechanical heart valves have accounted for over two-thirds of all
heart valve replacements. Recently, there has been an increase in the use of
tissue valves. We estimate that mechanical heart valves are currently being used
in 40% to 65% of all heart valve replacements, depending on the geographic
market, down from 65% to 75% about ten years ago. We believe the tissue
manufacturers' claims of improvements in tissue valve longevity and an increase
in the average age of valve patients have contributed to the recent increase in
the use of tissue valves.
NEW PRODUCTS OR TECHNOLOGIES DEVELOPED BY OTHERS COULD RENDER OUR PRODUCT
OBSOLETE.
The medical device industry is characterized by significant technological
advances. Several companies are developing new prosthetic heart valves based on
new or potentially improved technologies. Significant advances are also being
made in surgical procedures, which may delay the need for replacement heart
valves. A new product or technology may emerge that renders the ATS heart valve
noncompetitive or obsolete. This could materially harm our results of operations
or force us to cease doing business altogether.
WE LICENSE PATENTED TECHNOLOGY AND OTHER PROPRIETARY RIGHTS FROM CARBOMEDICS. IF
THESE AGREEMENTS ARE BREACHED OR TERMINATED, OUR RIGHT TO MANUFACTURE THE ATS
HEART VALVE COULD BE TERMINATED.
Under our carbon technology agreement with Carbomedics, we have obtained a
license to use Carbomedics' pyrolytic carbon technology to manufacture
components for the ATS heart valve. If this agreement is breached or terminated,
we would be unable to manufacture our own product. If our inventory is exhausted
and we do not have any other sources of carbon components, we would be forced to
cease doing business.
A DELAY OR INTERRUPTION IN OUR MANUFACTURING OF PYROLYTIC CARBON COMPONENTS
COULD DELAY PRODUCT DELIVERY OR FORCE US TO CEASE OPERATIONS.
Although we have a supply agreement with Carbomedics under which it agrees to
supply us with a minimum annual number of pyrolytic carbon components starting
in 2007 continuing through 2011, the amounts available under this agreement are
not expected to be sufficient to supply all of our needs for components in those
years. If our inventory is exhausted and we are unable to manufacture carbon
components or obtain them from other sources, we could be forced to reduce or
cease operations.
BECAUSE WE LACK MANUFACTURING EXPERIENCE, WE MAY NOT REALIZE EXPECTED SAVINGS
FROM MANUFACTURING OUR OWN PRODUCT. IN ADDITION, WE COULD EXPERIENCE PRODUCTION
DELAYS AND SIGNIFICANT ADDITIONAL COSTS.
Under our agreement with Carbomedics, we have been granted an exclusive
worldwide license to manufacture pyrolytic carbon components for the ATS heart
valve. We cannot be certain that our strategy to establish internal
manufacturing capabilities will result in a cost-effective means for
manufacturing the ATS heart valve. We have limited experience in manufacturing
pyrolytic carbon. Although we have an FDA-approved carbon manufacturing
facility, we have only just started increasing production to higher levels. In
the future, as we continue to increase
4
production at the plant, we may encounter difficulties in maintaining and
expanding our manufacturing operations, including problems involving:
- production yields;
- quality control;
- per unit manufacturing costs;
- shortages of qualified personnel; and
- compliance with FDA and international regulations and requirements
regarding good manufacturing practices.
Difficulties encountered by us in establishing or maintaining a commercial-scale
manufacturing facility may limit our ability to manufacture our heart valve and
therefore could seriously harm our business and results of operations.
OUR BUSINESS COULD BE SERIOUSLY HARMED IF THIRD-PARTY PAYERS DO NOT REIMBURSE
THE COSTS FOR OUR HEART VALVE.
Our ability to successfully commercialize the ATS heart valve depends on the
extent to which reimbursement for the cost of our product and the related
surgical procedure is available from third-party payers, such as governmental
programs, private insurance plans and managed care organizations. Third-party
payers are increasingly challenging the pricing of medical products and
procedures that they consider not to be cost-effective or are used for a
non-approved indication. The failure by physicians, hospitals and other users of
our products to obtain sufficient reimbursement from third-party payers would
seriously harm our business and results of operations.
In recent years, there have been numerous proposals to change the health care
system in the United States. Some of these proposals have included measures that
would limit or eliminate payment for medical procedures or treatments. In
addition, government and private third-party payers are increasingly attempting
to contain health care costs by limiting both the coverage and the level of
reimbursement. In international markets, reimbursement and health care payment
systems vary significantly by country. In addition, we have encountered price
resistance from government-administered health programs. Significant changes in
the health care system in the United States or elsewhere, including changes
resulting from adverse trends in third-party reimbursement programs, could have
a material adverse effect on our business and results of operations.
WE MAY FACE PRODUCT LIABILITY CLAIMS, WHICH COULD RESULT IN LOSSES IN EXCESS OF
OUR INSURANCE COVERAGE AND WHICH COULD NEGATIVELY AFFECT OUR ABILITY TO ATTRACT
AND RETAIN CUSTOMERS.
The manufacture and sale of mechanical heart valves entails significant risk of
product liability claims and product recalls. A mechanical heart valve is a
life-sustaining device and the failure of any mechanical heart valve usually
results in the patient's death or need for re-operation. A product liability
claim or product recall, regardless of the ultimate outcome, could require us to
spend significant time and money in litigation or to pay significant damages and
could seriously harm our business. We currently maintain product liability
insurance coverage in an aggregate amount of $25 million. However, we cannot be
assured that our current insurance coverage is adequate to cover the costs of
any product liability claims made against us. Product liability insurance is
expensive and does not cover the costs of a product recall. In the future,
product liability insurance may not be available at satisfactory rates or in
adequate amounts. A product liability claim or product recall could also
materially and adversely affect our ability to attract and retain customers.
OUR BUSINESS WOULD BE ADVERSELY AFFECTED IF WE ARE NOT ABLE TO PROTECT OUR
INTELLECTUAL PROPERTY RIGHTS.
Our success depends in part on our ability to maintain and enforce our patents
and other proprietary rights. We rely on a combination of patents, trade
secrets, know-how and confidentiality agreements to protect the proprietary
aspects of our technology. These measures afford only limited protection, and
competitors may gain access to our intellectual property and proprietary
information. The patent positions of medical device companies are generally
uncertain and involve complex legal and technical issues. Litigation may be
necessary to enforce our intellectual property rights, to protect our trade
secrets and to determine the validity and scope of our proprietary rights. Any
litigation could be costly and divert our attention from the growth of the
business. We cannot assure you that our patents and other proprietary rights
will not be successfully challenged, or that others will not independently
develop substantially equivalent information and technology or otherwise gain
access to our proprietary technology.
5
WE MAY BE SUED BY THIRD PARTIES WHICH CLAIM THAT OUR PRODUCT INFRINGES ON THEIR
INTELLECTUAL PROPERTY RIGHTS. ANY SUCH SUITS COULD RESULT IN SIGNIFICANT
LITIGATION OR LICENSING EXPENSES OR WE MIGHT BE PREVENTED FROM SELLING OUR
PRODUCT.
We may be exposed to future litigation by third parties based on intellectual
property infringement claims. Any claims or litigation against us, regardless of
the merits, could result in substantial costs and could harm our business. In
addition, intellectual property litigation or claims could force us to:
- cease manufacturing and selling our product, which would seriously
harm us;
- obtain a license from the holder of the infringed intellectual
property right, which license may not be available on reasonable
terms, if at all; or
- redesign our product, which could be costly and time-consuming.
WE ARE SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATION, WHICH IS COSTLY, TIME
CONSUMING AND CAN SUBJECT US TO UNANTICIPATED DELAYS.
The ATS heart valve and our manufacturing activities are subject to extensive
regulation by a number of governmental agencies, including the FDA and
comparable international agencies. We are required to:
- maintain the approval of the FDA and international regulatory agencies
to continue selling the ATS heart valve;
- obtain the approval of international regulatory agencies in countries
where the ATS heart valve is not yet marketed;
- satisfy content requirements for all of our labeling, sales and
promotional materials;
- comply with manufacturing and reporting requirements; and
- undergo rigorous inspections by these agencies.
Compliance with the regulations of these agencies may delay or prevent us from
introducing any new or improved products. Violations of regulatory requirements
may result in fines, marketing restrictions, product recall, withdrawal of
approvals and civil and criminal penalties.
THE PRICE OF OUR COMMON STOCK HAS BEEN VOLATILE, WHICH MAY RESULT IN LOSSES TO
INVESTORS.
Historically, the market price of our common stock has fluctuated over a wide
range and it is likely that the price of our common stock will fluctuate in the
future. The market price of our common stock could be impacted by the following:
- the success of our management in operating ATS effectively;
- the failure of the ATS valve to gain market acceptance in the United
States;
- announcements of technical innovations or new products by our
competitors;
- the status of component supply arrangements;
- changes in reimbursement policies;
- government regulation;
- developments in patent or other proprietary rights;
- public concern as to the safety and efficacy of products developed by
us or others; and
- general market conditions.
In addition, due to one or more of the foregoing factors, in future years our
results of operations may fall below the expectations of securities analysts and
investors. In that event, the market price of our common stock could be
materially and adversely affected. Finally, in recent years the stock market has
experienced extreme price and
6
volume fluctuations. This volatility has had a significant effect on the market
prices of securities issued by many companies for reasons unrelated to their
operating performance. These broad market fluctuations may materially adversely
affect our stock price, regardless of our operating results.
OUR CHARTER DOCUMENTS AND MINNESOTA LAW MAY DISCOURAGE AND COULD DELAY OR
PREVENT A TAKEOVER OF OUR COMPANY.
Provisions of our articles of incorporation, bylaws and Minnesota law could make
it more difficult for a third party to acquire us, even if doing so would be
beneficial to our shareholders. These provisions include the following:
- No cumulative voting by shareholders for directors;
- The ability of our board to set the size of the board of directors, to
create new directorships and to fill vacancies;
- The ability of our board, without shareholder approval, to issue
preferred stock, which may have rights and preferences that are
superior to our common stock;
- The ability of our board to amend the bylaws; and
- Restrictions under Minnesota law on mergers or other business
combinations between us and any holder of 10% or more of our
outstanding common stock.
7
PART II
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
---------------------------------------------------------
2005 2004 2003 2002 2001
---------- --------- --------- --------- --------
(in thousands, except per share data) (Restated)
STATEMENT OF OPERATIONS DATA:
Net sales $ 34,636 $ 28,015 $ 18,484 $ 13,301 $ 15,080
Cost of sales 22,828 21,227 17,632 12,307 10,310
--------- --------- --------- --------- --------
Gross profit 11,808 6,788 852 994 4,770
Operating expenses:
Sales and marketing 18,948 16,520 10,180 2,425 3,906
Research and development 1,733 1,011 1,764 3,312 4,904
General and administrative 7,314 5,954 4,350 3,114 3,844
Impairment of technology license -- -- -- 8,100 --
Reorganization expense -- -- -- 1,130 --
Distributor termination expenses -- -- -- 821 --
Gain on extinguishment of debt -- -- (2,575) -- --
--------- --------- --------- --------- --------
Total operating expenses 27,995 23,485 13,719 18,902 12,654
--------- --------- --------- --------- --------
Operating loss (16,187) (16,697) (12,867) (17,908) (7,884)
Interest income (expense) (338) 54 (425) (304) 1,040
Change in value of derivative liability
bifurcated from convertible senior
notes 2,131 -- -- -- --
--------- --------- --------- --------- --------
Loss before income taxes (14,394) (16,643) (13,292) (18,212) (6,844)
Income tax expense -- -- -- -- --
--------- --------- --------- --------- --------
Net loss ($14,394) ($16,643) ($13,292) ($18,212) ($6,844)
========= ========= ========= ========= ========
Net loss per share:
Basic ($0.46) ($0.58) ($0.55) ($0.82) ($0.31)
Diluted ($0.46) ($0.58) ($0.55) ($0.82) ($0.31)
Weighted average number of shares outstanding:
Basic 31,009 28,856 24,076 22,259 22,159
Diluted 31,009 28,856 24,076 22,259 22,159
As of December 31,
---------------------------------------------------------
2005 2004 2003 2002 2001
---------- ------- ------- ------- -------
(in thousands) (Restated)
BALANCE SHEET DATA:
Cash and cash equivalents $16,620 $ 8,302 $ 6,472 $ 7,472 $ 5,079
Working capital 46,417 41,459 31,275 21,674 32,466
Total assets 85,443 79,051 76,134 91,756 94,971
Long-term liabilities, excluding
current maturities 19,679 1,826 307 9,514 --
Shareholders' equity 57,529 69,441 72,803 74,127 92,223
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (RESTATED)
EXECUTIVE OVERVIEW
We develop, manufacture, and market medical devices. Our primary interest lies
with devices used by cardiovascular surgeons in the cardiac surgery operating
theater. Currently, we participate in the markets for mechanical bileaflet
replacement heart valves, allograft tissues, the surgical treatment of atrial
fibrillation, and the market for surgical tools and accessories. We also are
engaged in a development project for autotransfusion products.
Sulzer Carbomedics (Carbomedics) developed the basic design from which the ATS
heart valve evolved. Carbomedics is a large and experienced manufacturer of
pyrolytic carbon components used in mechanical heart valves. Carbomedics has
also designed and patented numerous mechanical valves. In 1990, Carbomedics
offered to license a patented and partially developed valve to us if we would
complete the development of the valve and agree to purchase carbon components
from Carbomedics. As a result, we now hold an exclusive, royalty-free, worldwide
license to an open pivot, bileaflet mechanical heart valve design owned by
Carbomedics from which the ATS heart valve has evolved. In addition, we have an
exclusive, worldwide right and license to use Carbomedics' pyrolytic carbon
technology to manufacture components for the ATS heart valve.
We commenced selling the ATS heart valve in international markets in 1992. In
October 2000, we received FDA approval to sell the ATS Open Pivot(R) MHV and
commenced sales and marketing of our valve in the United States. The original
sales forecasts as well as the pricing models that were used when our original
supply agreement was signed with Carbomedics proved to be too optimistic.
Accordingly, to keep the supply agreement active and the license to sell the
valve exclusive, we purchased quantities of inventory far in excess of demand.
With inventory purchases exceeding sales through the years, we built up our
inventory levels. Since 2002, we have drawn down these paid-for inventories and
used the cash it generated to fund operations. 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.
From 1990 through 2003, we paid Carbomedics approximately $125 million for the
development of our valve, the technology to manufacture pyrolytic carbon
components, and for pyrolytic valve components manufactured by Carbomedics. By
the end of 2002, we had remaining payments due under the technology agreement
that totaled $28 million. This led us in 2003 to negotiate an accelerated but
reduced payment for all outstanding debts to Carbomedics related to the
technology agreement. In 2003 we paid $12 million to satisfy all future
obligations under this agreement.
During 2002, we reorganized the Company, laying off more than half of the work
force, including all executive management. With the hiring of a new president
late in 2002, we started the process of rebuilding our sales and marketing
teams, especially in the United States. This rebuilding is the most significant
factor in our operating expense levels during the last three fiscal years.
Because sales prices in the United States exceed selling prices elsewhere, we
feel that our future success will depend on achieving increased market share in
the United States. Our U.S. sales as a percentage of our overall sales have
grown from 4% in 2000 to 38% in 2005.
During 2004, we made our first investments outside the mechanical heart valve
market by completing two business development agreements. The first, signed in
April, was with ErySave AB, a Swedish research firm, for exclusive worldwide
rights to ErySave's PARSUS filtration technology for cardiac surgery procedures.
We had no revenues in 2005 nor do we expect any for 2006 from this technology.
In November 2004, we completed a global partnership agreement with CryoCath
Technologies, Inc. to market CryoCath's surgical cryotherapy products for the
ablation of cardiac arrhythmias. The agreement with CryoCath has resulted in
revenues for our Company in 2005.
During 2005, we continued to develop our business outside the mechanical heart
valve market by entering into two additional business development agreements. In
June, we entered into a marketing services agreement with Alabama Tissue Center,
Inc. (ATC, a/k/a Regeneration Technologies, Inc. - Cardiovascular), a subsidiary
of Regeneration Technologies, Inc. Under the terms of the agreement, ATC has
appointed us as its exclusive marketing services representative to promote,
market and solicit orders for ATC's processed cardiovascular allograft tissue
from
9
doctors, hospitals, clinics and patients throughout North America. The agreement
with ATC has also resulted in revenues for our Company in 2005. Also in June
2005, 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 will produce revenues for
our Company in 2006.
On January 23, 2006, we entered into an agreement and plan of merger with 3F
Therapeutics, Inc. (3F). Under the terms of the merger agreement, upon closing
we will pay each 3F stockholder its pro-rata portion of an initial payment of
9,000,000 shares of our common stock, subject to certain post-closing
adjustments and a 10% escrow fund. We will deposit 900,000 of the shares to be
delivered at closing into an escrow to be held for at least 18 months after
closing of the merger to cover indemnification claims and certain contingencies.
After expiration of the escrow, any shares remaining in the escrow will be
distributed pro-rata to holders of 3F capital stock. In addition to the initial
closing payment, we will be obligated to deliver up to an additional 10 million
shares of our common stock to 3F stockholders. These additional shares will be
made in two payments of up to 5 million shares each, each of which are
contingent upon ATS obtaining either CE mark or FDA approval for 3F's key
products on or prior to December 31, 2013. These contingent payments are subject
to certain rights of set-off for indemnification claims and certain other
events, and also may be paid in whole or in part in the event that ATS engages
in a sale of one or more of those key products.
The consummation of the merger with 3F is subject to customary conditions, and
the merger agreement is subject to approval by our shareholders and the
stockholders of 3F; however, stockholders of 3F holding the number of shares
necessary to approve the transaction have agreed to do so. We anticipate that
the merger will close in the second quarter of fiscal 2006.
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. This discussion and
analysis of our financial condition and results of operations is based upon our
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 liabilities. At each balance sheet
date, we evaluate our estimates, including but not limited to, those related to
accounts receivable, inventories, long-lived assets, and income taxes. The
critical accounting policies that are most important in fully understanding and
evaluating the financial condition and results of operations are discussed
below.
REVENUE RECOGNITION POLICY. A significant portion of our revenue in the United
States, Canada, France and Germany is generated from consigned inventory
maintained at hospitals or with field representatives. In these situations,
revenue is recognized at the time that the product has been implanted or used.
In all other instances, revenue is recognized at the time product is shipped.
Certain independent distributors in select international markets receive rebates
against invoiced sales amounts. In these situations, we accrue for these rebates
at the time of the original sale. The total of these accrued rebates was $0.1
million and $0.4 million as of December 31, 2005 and 2004, respectively.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We maintain an allowance for doubtful accounts
that is calculated using subjective judgments and estimates to establish this
valuation account. Our distribution in international markets through independent
distributors concentrates relatively large amounts of receivables in relatively
few customer accounts. We have successfully done business with most of these
distributors for many years. We monitor amounts that are not paid according to
terms. We attempt to accrue for potential losses due to non-payment. Financial
conditions in international markets can change very quickly and our allowance
for doubtful accounts cannot anticipate all potential changes. Our allowance for
doubtful accounts was approximately $0.4 million at both December 31, 2005 and
2004. As a percentage of total accounts receivable, the allowance was 3.3% on
December 31, 2005 and 4.7% on December 31, 2004. The decrease in allowance as a
percent of total accounts receivable is due primarily to the legal resolution
late in 2005 of a large international distributor account receivable.
10
INVENTORY VALUATION. Inventories are recorded at the lower of manufacturing cost
or net realizable value. We have historically had manufacturing costs exceeding
net realizable values in certain international markets requiring us to
write-down certain inventories to expected selling prices due to high purchase
prices of pyrolytic valve components under our supply agreement with
Carbomedics. This lower of cost or market adjustment is charged to cost of sales
and is calculated by estimating future selling volume and prices by market and
comparing this to actual inventory levels, both finished goods and work in
process. An adjustment is made in those cases where our manufacturing costs are
or will be greater than our eventual selling price. If our estimates of future
selling prices or volumes prove incorrect, future adjustments to inventory
carrying values would be necessary and could have a material impact on
operations. Lower of cost or market adjustments were $0.7 million, $0.8 million,
and $4.4 million during 2005, 2004, and 2003, respectively. We believe that
future manufacturing costs will be lower as we manufacture our own pyrolytic
carbon components. This should decrease the risk of these adjustments as current
inventories are depleted.
We maintain an obsolescence allowance against certain finished goods inventories
to cover resterilization charges for expired items. This allowance totaled $0.2
million at December 31, 2005 and 2004.
A portion of inventories on hand at December 31, 2004 were not likely to be sold
in the following twelve month period and therefore were not classified as a
current asset. The estimate of inventories necessary to support current sales
includes our projections not only of sales but inventories for new consignment
accounts and contingencies; accordingly, these amounts were classified as a
current asset.
INTANGIBLE ASSETS. We assess the carrying value of our indefinite-lived
intangible assets annually in accordance with the provisions of Statement of
Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets. The
assessment of potential impairment requires certain judgments and estimates,
including the determination of an event indicating impairment, the future cash
flows to be generated by the asset, risks associated with those cash flows, and
the discount rate to be utilized. As of December 31, 2005, we believe that the
carrying value of our indefinite-lived intangible assets, specifically the
Carbomedics carbon technology license and the CryoCath agency and distribution
agreements, are recoverable and no impairment charge is currently necessary.
DEFERRED TAX ASSETS. We have incurred tax losses of approximately $81 million.
The losses are carried forward for U.S. and state corporate income taxes and can
be used to reduce future taxable income. As a result, at December 31, 2005 we
had net deferred tax assets totaling approximately $31.4 million. We have
recorded a full valuation allowance against these assets because of the limited
lives of the carryforwards and our lack of earnings history, which has resulted
in our conclusion that it is not more than likely we will be able to utilize our
loss carryforwards
CONVERTIBLE DEBT AND DERIVATIVE INSTRUMENTS. We account for embedded derivatives
related to our Convertible Senior Notes under Financial Accounting Standards
Board (FASB) Statement No.133, Accounting for Derivative Instruments and Hedging
Activities and related Emerging Issues Task Force (EITF) interpretations and
Securities and Exchange Commission (SEC) rules, which require certain embedded
derivative financial instruments to be bifurcated from the debt agreement and
accounted for as a liability. Our Convertible Senior Notes contain several
embedded derivatives. The valuation of derivatives requires management to make
certain judgments and estimates, including the potential future fair value of
the Company's common stock, the probability of a change in control of the
Company and the probability that the debt may be put back to or called by the
Company.
11
RESULTS OF OPERATIONS
The following table provides the dollar and percentage change in our Statements
of Operations for 2005 compared to 2004 and 2004 compared to 2003.
INCREASE INCREASE
2005 2004 (DECREASE) % 2004 2003 (DECREASE) %
---------- --------- ---------- ------ --------- --------- ---------- -----
(in thousands) (RESTATED)
Net sales $ 34,636 $ 28,015 $6,621 23.6% $ 28,015 $ 18,484 $ 9,531 51.6%
Cost of sales 22,828 21,227 1,601 7.5% 21,227 17,632 3,595 20.4%
--------- --------- ------ ------ --------- --------- -------- -----
Gross profit
11,808 6,788 5,020 74.0% 6,788 852 5,936 696.7%
Operating expenses:
Sales and marketing 18,948 16,520 2,428 14.7% 16,520 10,180 6,340 62.3%
Research and development 1,733 1,011 722 71.4% 1,011 1,764 (753) -42.7%
General and administrative 7,314 5,954 1,360 22.8% 5,954 4,350 1,604 36.9%
Gain on extinguishment of debt -- -- -- -- -- (2,575) 2,575 --
--------- --------- ------ ------ --------- --------- -------- -----
Total operating expenses 27,995 23,485 4,510 19.2% 23,485 13,719 9,766 71.2%
--------- --------- ------ ------ --------- --------- -------- -----
Operating loss (16,187) (16,697) 510 3.1% (16,697) (12,867) (3,830) -29.8%
Interest income (expense) (338) 54 (392) -725.9% 54 (425) 479 112.7%
Change in value of derivative
liability bifurcated from
convertible senior notes 2,131 -- 2,131 -- -- -- -- --
--------- --------- ------ ------ --------- --------- -------- -----
Net loss ($14,394) ($16,643) $2,249 13.5% ($16,643) ($13,292) ($3,351) -25.2%
========= ========= ====== ====== ========= ========= ======== =====
The following table presents the statement of operations as a percentage of
sales for 2005, 2004, and 2003.
2005 2004 2003
---------- ----- -----
(RESTATED)
Net sales 100.0% 100.0% 100.0%
Cost of sales 65.9% 75.8% 95.4%
----- ----- -----
Gross profit 34.1% 24.2% 4.6%
Operating expenses:
Sales and marketing 54.7% 59.0% 55.1%
Research and development 5.0% 3.6% 9.5%
General and administrative 21.1% 21.3% 23.5%
Gain on extinguishment of debt 0.0% 0.0% -13.9%
----- ----- -----
Total operating expenses 80.8% 83.8% 74.2%
----- ----- -----
Operating loss -46.7% -59.6% -69.6%
Interest income (expense) -1.0% 0.2% -2.3%
Change in value of convertible
senior notes derivative
liability 6.2% 0.0% 0.0%
----- ----- -----
Net loss -41.6% -59.4% -71.9%
===== ===== =====
NET SALES. The following table provides the dollar and percentage change in net
sales inside and outside the United States for 2005 compared to 2004 and 2004
compared to 2003.
2005 2004 INCREASE % 2004 2003 INCREASE %
------- ------- -------- ---- ------- ------- -------- ----
(in thousands)
United States $13,194 $ 9,330 $3,864 41.4% $ 9,330 $ 5,141 $4,189 81.5%
Outside United States 21,442 18,685 2,757 14.8% 18,685 13,343 5,342 40.0%
------- ------- ------ ---- ------- ------- ------ ----
Total $34,636 $28,015 $6,621 23.6% $28,015 $18,484 $9,531 51.6%
======= ======= ====== ==== ======= ======= ====== ====
12
The following table provides net sales inside and outside the United States as a
percentage of total net sales for 2005, 2004, and 2003.
2005 2004 2003
----- ----- -----
Share of net sales:
United States 38.1% 33.3% 27.8%
Outside United States 61.9% 66.7% 72.2%
----- ----- -----
Total 100.0% 100.0% 100.0%
===== ===== =====
The following table provides the percentage change in average sales price, unit
sales, and net sales for mechanical heart valves inside and outside the United
States for 2005 from 2004 and 2004 from 2003.
2005 2004
----------------------- -----------------------
Average Average
Sales Unit Net Sales Unit Net
Price Sales Sales Price Sales Sales
------- ----- ----- ------- ----- -----
United States 2.8% 10.2% 13.4% 2.0% 77.9% 81.5%
Outside United States -6.9% 17.3% 9.7% -4.0% 45.9% 40.0%
----- ---- ---- ----- ---- ----
Total -4.7% 16.3% 10.9% -3.2% 56.5% 51.6%
===== ==== ==== ===== ==== ====
Starting in the fourth quarter of 2002 and continuing through 2005, we have been
building a new sales organization in the United States, which has grown to four
area directors managing more than 30 sales territories. Our representation
within these territories consists of both direct sales representatives and
independent agents. This new sales organization and overall greater sales
efforts contributed to our net sales increases and to our sales within the
United States. accounting for a larger percentage of overall sales.
During the last three fiscal years, we have aggressively entered several
international markets that represented opportunities for greater mechanical
heart valve sales unit growth but at prices lower than our other markets. Prices
in some of these territories are lower than our historical manufacturing costs.
We felt this strategy was reasonable because it allowed us to increase our
market share while reducing our high priced but paid-for inventories.
Net sales in 2005 were also favorably impacted by revenue from the new business
initiatives and partnerships discussed above, mainly revenue derived from
surgical cryotherapy products and processed cardiovascular allograft tissue.
Approximately 10% of our 2005 revenue was derived from new products.
COST OF GOODS SOLD AND GROSS PROFIT. Our costs of goods sold and gross profit as
a percentage of net sales has improved over the last three years due in part to
increases in our mechanical heart valve average selling prices, which are much
higher in the United States than in international markets and are rising
modestly. Our gross profit is anticipated to continue improving as sales within
the United States. increase as a percentage of total sales and as we start
selling valves that have been entirely manufactured in our facilities.
During 2004 and 2005, we developed and implemented a plan to ramp-up our
manufacturing facility for pyrolytic carbon. By the end of 2005, this process
was substantially complete. Ramp-up costs totaled approximately $1.8 million and
$1.9 million, representing 5.1% and 6.7% of net sales, for 2005 and 2004,
respectively.
We have made write-downs to our inventories the past three years due to future
selling prices being lower than manufacturing costs in select international
markets. These write-downs have declined as our high-cost carbon components
purchased from Carbomedics have been depleted and sold, which has had favorable
year-to-year impacts on both cost of goods sold and gross profit as a percentage
of net sales. The write-downs totaled $0.7 million, $0.8 million, and $4.4
million, representing 2.0%, 2.9%, and 23.8% of net sales for 2005, 2004, and
2003, respectively.
13
Our gross profit as a percentage of net sales in 2005 was also favorably
impacted by revenue and gross profit from the new business initiatives and
partnerships discussed above, mainly revenue derived from surgical cryotherapy
products and processed cardiovascular allograft tissue. Our 2005 gross margin as
a percentage of net sales improved approximately 6.6% over 2004 due to these new
business initiatives.
The ATS valve is made of materials that do not deteriorate. Other than the need
to resterilize the valves periodically, there is no risk of perishability.
Pyrolytic carbon, which is the substrate used in manufacturing our valves, has
been the only material used to manufacture mechanical heart valves for humans
for many years and remains the most advanced raw material for our products. The
other sources of prosthetic heart valves for humans are cadaver and animal
tissues. For our heart valves, however, obsolescence issues are remote due to
certain advantages offered by mechanical heart valves, including superior
durability. Similarly, we believe that, given the lead time that would be
required, there is no material risk that there would be the introduction and FDA
approval of another substrate that would replace pyrolytic carbon prior to the
end of the period over which we expect to sell our inventory of valves.
SALES AND MARKETING. Cost increases in 2005 over 2004 and 2004 over 2003 were
for the further development of our worldwide sales and marketing organization
and the substantial increase in sales and marketing personnel.
In the United States, our sales and marketing costs rose approximately 6% in
2005 and 50% in 2004, to $13.6 million and $12.8 million, respectively. U.S.
sales and marketing costs have risen in support of an increase in sales
territories, the development of marketing programs in support of new products
and services, and new marketing programs directed at increasing the U.S. market
share of our mechanical heart valves. Starting in late 2002, we began building a
sales and marketing organization that has steadily grown to more than 30 sales
territories in the United States and has a marketing department that now
consists of 14 employees.
Internationally, our sales and marketing costs increased approximately 46% in
2005 and 128% in 2004, to $5.4 million and $3.7 million, respectively. These
increases reflect our continued investment in international markets. In 2003, we
set up direct operations in France; in 2004, we set up infrastructure to support
sales in China, and in early 2005, we set up direct sales operations in Germany.
Cost increases in 2005 also included separation costs in France and increased
sales management.
RESEARCH AND DEVELOPMENT. Research and development (R & D) expenses include the
costs to develop and improve current and future products, the costs for
regulatory and clinical activities for these products, and prior to 2004, the
costs to set up and maintain our carbon components manufacturing facility while
it was in a pre-production mode.
The following table compares the different components of R & D costs for 2005,
2004, and 2003.
Year Ended December 31,
------------------------
2005 2004 2003
------ ------ ------
(in thousands)
Costs related to manufacturing
facility $ -- $ -- $1,209
All other R & D costs 1,733 1,011 555
------ ------ ------
Total R & D costs $1,733 $1,011 $1,764
====== ====== ======
R & D expenses increased 71% in 2005 due to costs to develop and improve current
and future products and the costs for regulatory and clinical activities for
these products. The 2005 increase in R & D spending also reflects staff
additions as well as an increase in the number of R & D programs. The decrease
in R & D expenses in 2004 is attributable primarily to the plan to ramp-up our
pyrolytic carbon facility. Accordingly, beginning in 2004, these costs became
part of our manufacturing costs and inventories and will be expensed through
cost of goods sold as products are sold.
GENERAL AND ADMINISTRATIVE. During 2005, major cost increases in general and
administrative (G & A) expenses were for employee salary and benefits of $0.3
million, non-cash stock compensation and bonus expense of $0.6 million, legal
fees in support of business development of $0.3 million, corporate insurance
costs of $0.1 million and outside consulting services relating primarily to
Board of Directors fees of $0.1 million. During 2004, we experienced costs
increases of approximately $0.2 million for salaries and benefits of our
employees, $0.3 million
14
for corporate insurances, $0.3 million for bad debt expense, and $0.6 million
for outside consultants and additional audit expenses to document and test
internal controls in support of Sarbanes-Oxley.
In 2005, we granted restricted stock awards for 351,000 shares of common stock
to officers and certain employees, resulting in non-cash stock compensation
expense charged to G & A expenses of approximately $0.6 million during 2005.
The Financial Accounting Standards Board (FASB) has issued FASB Statement No.
123 (Revised 2004), Share-Based Payment, which was adopted by ATS on January 1,
2006. Statement 123(R) requires all share-based payments to employees, including
grants of employee stock options and restricted stock awards, to be recognized
in the income statement based on their fair values. Pro forma disclosure is no
longer an alternative. We are completing our evaluation of the methodology to
use in adopting Statement 123(R). We estimate that total stock compensation
expense to be recognized under stock options and restricted stock awards
outstanding at December 31, 2005, will be between $0.7 million and $0.9 million
in fiscal 2006, between $0.3 million and $0.4 million in fiscal 2007, and
approximately $0.1 million in fiscal 2008.
In December 2005, we authorized the acceleration of vesting of all otherwise
unvested stock options held by our employees with an exercise price of $3.00 or
greater granted under the 2000 Stock Incentive Plan or as a free standing option
not under any plan. Options to purchase 1,294,232 shares of common stock were
subject to this acceleration. The decision to accelerate vesting of these
underwater options was made primarily to minimize future compensation expense
that we would otherwise recognize in our consolidated statement of operations
with respect to these options pursuant to Statement 123(R). We believe that the
aggregate future expense eliminated as a result of the acceleration of the
vesting of these options is approximately $3.3 million.
GAIN ON EXTINGUISHMENT OF DEBT. In 2003, we entered into an agreement and paid
Centerpulse USA Holdings Co. (Centerpulse) $12 million in exchange for
cancellation of all of our payment obligations under our carbon technology
agreement and after which we would own a fully paid exclusive license to use the
carbon technology to produce components for our valve. Prior to this agreement,
we were obligated to pay Centerpulse an aggregate of $28 million under the
technology agreement over a period of approximately four years. These payments
were accrued as milestones were met. Of the total $28 million, there were two
uncompleted milestones totaling $12 million that were not accrued. Since the
amount accrued exceeded the amount we paid, we realized a non-cash gain on the
extinguishment of debt in the amount of $2.6 million on this transaction.
NET INTEREST INCOME (EXPENSE). In 2005, net interest expense was attributable
primarily to the October 2005 sale of $22.4 million aggregate principal amount
of 6% Convertible Senior Notes, discussed further below. Interest expense on
these Notes in 2005 was $0.4 million, which also 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 Report for more information regarding the
Convertible Senior Notes conversion feature. In both 2005 and 2004, interest
expense was also attributable to the credit facility with Silicon Valley Bank
and the amortization of the financing costs to set up this facility. Net
interest expense in 2003 was primarily attributable to the imputed interest on
our long-term debt previously owed to Centerpulse. Interest income was $0.3
million, $0.2 million and $0.1 million in 2005, 2004 and 2003, respectively, and
is attributable to the investment of our cash balances.
CHANGE IN VALUE OF CONVERTIBLE SENIOR NOTES DERIVATIVE LIABILITY. For 2005, we
recorded a non-operating gain of $2.1 million to adjust the Convertible Senior
Notes derivative liability to fair value at December 31, 2005. See Note 7 of
Notes to Consolidated Financial Statements in this Report for more information
regarding the Convertible Senior Notes derivative liability and our accounting
for the related derivative financial instruments under Financial Accounting
Standards Board (FASB) Statement No.133, Accounting for Derivative Instruments
and Hedging Activities.
INCOME TAXES. We have accumulated approximately $81 million of net operating
loss ("NOL") carryforwards for U.S. tax purposes. We believe that our ability to
fully utilize the existing NOL carryforwards could be restricted on a portion of
the NOL for changes in control that may have occurred or may occur in the
future. We have not conducted a formal study of whether a change in control of
ATS has occurred in the past that impairs our NOL carryforwards because we are
unable to utilize such NOL carryforwards until we achieve profitability and
because this study would be very expensive to complete. When we attain
profitability, we will conduct a formal study of any
15
restrictions on our carryforwards. We have not recorded any 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 net loss in 2005, which was lower than our net loss in 2004, and
the increase in net loss in 2004 compared to 2003 resulted from changes in sales
offset by changes in operating costs, all of which are described above.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents, and short-term investments totaled $21.7 million and
$16.0 million at December 31, 2005 and December 31, 2004, respectively.
OPERATING ACTIVITIES. During 2005, we received cash payments from customers of
$32.1 million and made payments to employees and suppliers of $42.5 million.
During 2004, we received cash payments from customers of $25.1 million and made
cash payments to employees and suppliers of $31.1 million. Our operating losses
during the past three fiscal years were significantly funded through the
depletion of inventories. Since 2002, we incurred significant expenses
commercializing the ATS heart valve in the United States. As we build sales in
future periods and our cost of inventories decrease, we believe our operating
losses will decrease and we will move steadily towards a cash flow breakeven on
sales and eventually to profitability. We believe our current cash balances are
adequate to fund our operating activities during 2006.
INVESTING ACTIVITIES. We purchased property and equipment of $2.3 million, $2.9
million and $0.7 million during 2005, 2004 and 2003, respectively. Capital
purchases during 2005 were mainly in support of increasing production in our
pyrolytic carbon facility. During 2006, our spending on property and equipment
should decline as a substantial portion of our 2005 purchases supported our
pyrolytic carbon facility production increase efforts, which are substantially
completed.
In November 2004, we signed a global partnership agreement with CryoCath
Technologies, Inc. to market CryoCath's surgical cryotherapy products for the
ablation of cardiac arrhythmias. For certain customers that we will market, we
agreed to make a payment to CryoCath representing a portion of the prior year's
sales to these customers and future payments of a certain percentage of the
sales occurring over the following three-year period. These payments are
refundable to us upon cancellation of the agreements. In June 2005, the Company
made $1.6 million in licensing fee payments to CryoCath under the partnership
agreement.
In April 2004, we signed an exclusive development and licensing agreement with
ErySave AB and made an initial milestone payment of approximately $0.2 million.
In July 2005, we made additional milestone payments of $0.3 million. Future
payments under this agreement, based upon the attainment of developmental
milestones, could total an additional $1.0 million. These payments are expected
to occur during 2006 and 2007.
In 2003, we paid $12.0 million of debt related to our technology agreement with
Carbomedics. We have no future payment obligations under the technology
agreement.
FINANCING ACTIVITIES. We have historically funded our operations through equity
investments. During 2004 and 2003, we raised $12.4 million and $11.4 million,
respectively, through private placement equity offerings, net of offering costs.
During 2005, 2004, and 2003, we also raised approximately $0.5 million, $0.8
million, and $0.2 million, respectively, through the issuance of common stock
through stock options and our employee stock purchase plan.
In July 2004, we entered into a secured credit facility consisting of a $2.5
million term note and a $6.0 million line of credit. We fully drew down the $2.5
million term note, which was used to fund equipment purchases for our pyrolytic
carbon facility. The term note calls for equal installment payments over 36
months which commenced in February 2005. Accordingly, during 2005 we repaid $0.8
million on the note.
Under an amendment to the secured credit facility agreement effective April 1,
2005, we are subject to certain financial covenants, including a liquidity ratio
of not less than 2.0 to 1.0 and a net tangible net worth of at least $39
16
million through June 30, 2005, and $36 million thereafter. At December 31, 2005,
the Company was in compliance with its financial covenants.
In October 2005, we sold a combined $22.4 million aggregate principal amount of
6% Convertible Senior Notes due 2025 (Notes) and issued warrants to purchase
1,344,000 shares of our common stock (Warrants). The Warrants are exercisable at
$4.40 per share and expire in 2010. We plan to use these proceeds to fund
business development opportunities.
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
and would require us to increase our authorized shares. 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. See
Note 7 of Notes to Consolidated Financial Statements in this Report for a full
description of the terms and provisions of the Notes.
CASH MANAGEMENT
During 2006, we will deplete our high priced but paid-for inventories of
pyrolytic carbon components. During the last two years we have increased
production of these components in our own factory. We estimate that operating
costs will remain high in comparison to sales during 2006 and will require the
use of cash to fund operations. We will draw down cash balances to build
inventories and fund operations during 2006.
Based upon the current forecast of sales and operating expenses, we anticipate
having cash to fund our operations through 2006. However, as identified in Item
1A of this Form 10-K, 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.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any "off-balance sheet arrangements" (as such term is defined in
Item 303 of Regulation S-K) that are reasonably likely to have a current or
future effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources.
CONTRACTUAL OBLIGATIONS
The following table sets forth our future payment obligations:
Payments Due By Period
---------------------------------------------------
Less One to Three to More than
Than Three Five Five
Total One year Years Years Years
------- -------- ------- -------- ---------
(thousands)
Convertible notes payable $22,400 -- -- $22,400 --
Bank notes payable 1,736 $ 833 $ 903 -- --
Operating leases 1,717 503 1,122 92 --
Purchase obligations 21,750 -- 15,000 6,750 --
------- ------ ------- ------- ---
Total $47,603 $1,336 $17,025 $29,242 --
======= ====== ======= ======= ===
17
CAUTIONARY STATEMENTS
This document contains forward-looking statements within the meaning of federal
securities laws that may include statements regarding intent, belief or current
expectations of our Company and our management. The Private Securities
Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking
statements to encourage companies to provide prospective information without
fear of litigation so long as those statements are identified as forward-looking
and are accompanied by meaningful cautionary statements identifying important
factors that could cause actual results to differ materially from those
projected in the statement. We desire to take advantage of these "safe harbor"
provisions. Accordingly, we have identified in Item 1A of this Form 10-K
important risk factors which could cause our actual results to differ materially
from any such results which may be projected, forecast, estimated or budgeted by
us in forward-looking statements made by us from time to time in reports, proxy
statements, registration statements and other written communications, or in oral
forward-looking statements made from time to time by our officers and agents. We
do not intend to update any of these forward-looking statements after the date
of this Form 10-K to conform them to actual results.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial Statements and the reports of our registered public
accounting firm are included in this Annual Report on Form 10-K beginning on
page F-1. The index to this report and the financial statements is included in
Item 15 below.
ITEM 9A. CONTROLS AND PROCEDURES (RESTATED)
RESTATEMENT
The Company has restated its financial statements for 2005. The determination to
restate these financial statements was made after an error was discovered in
June 2006 in the accounting for embedded derivatives related to its Convertible
Senior Notes (the Notes) under Financial Accounting Standards Board (FASB)
Statement No.133, Accounting for Derivative Instruments and Hedging Activities
and related Emerging Issues Task Force interpretations and SEC rules.
The Convertible Senior Notes agreement permits Note holders to exchange their
debt instruments for common stock at a conversion rate of $4.20 per share. The
Company had insufficient authorized common shares as of the closing date, which
requires this embedded instrument to be bifurcated from the debt agreement and
classified as a liability in accordance with EITF 00-19.
After management's review of the Note agreements, our historical accounting for
the Notes and the related derivative accounting requirements connected with the
Notes, management recommended to the Audit Committee that, based on our analysis
of the impact of the items described above, our previously filed financial
statements be restated to reflect the correction of these items. The Audit
Committee agreed with this recommendation. On July 13, 2006, the Audit Committee
approved our restated financial statements and authorized their filing in an
amendment to our Form 10-K for the year ended December 31, 2005.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
In connection with the restatement, we reevaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the
end of the period covered by this annual report. We concluded that our failure
to correctly apply FASB Statement No. 133, and its related interpretations, with
respect to the accounting for embedded derivatives related to the Notes
constituted a material weakness in our internal control over financial
reporting. Solely as a result of this material weakness, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were not effective as of December 31, 2005.
We have performed a thorough analysis of all of the provisions in the Notes and
related agreements for embedded derivatives under FASB Statement No.133 and the
related EITF interpretations and SEC rules, in an effort to ensure that the
restated financial statements and this annual report, as amended, reflect all
necessary adjustments.
18
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). Our internal control system was designed to provide reasonable
assurance to our management and board of directors regarding the preparation and
fair presentation of published financial statements. All internal control
systems, no matter how well designed, have inherent limitations. Therefore, even
those systems determined to be effective can provide only reasonable assurance
with respect to financial statement preparation and presentation.
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we conducted an
evaluation of the effectiveness of our internal control over financial reporting
based on the framework in "Internal Control -- Integrated Framework" issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Based on our evaluation under the framework in "Internal Control -- Integrated
Framework," our management concluded, in the Company's original 2005 Form 10-K,
filed on March 7, 2006, that our internal control over financial reporting was
effective as of December 31, 2005. Subsequently, management concluded that our
failure to correctly apply FASB Statement No. 133, and its related
interpretations, with respect to the accounting for embedded derivatives related
to the Notes constituted a material weakness in our internal control over
financial reporting. Solely as a result of this material weakness, our
management has revised its earlier assessment and concluded that our internal
control over financial reporting was not effective as of December 31, 2005.
This material weakness has caused us to amend our original 2005 Form 10-K, in
order to restate our consolidated financial statements as of and for the year
ended December 31, 2005.
Management's revised assessment of the effectiveness of internal control over
financial reporting as of December 31, 2005, has been audited by Ernst & Young
LLP, the independent registered public accounting firm who also has audited the
Company's restated consolidated financial statements included in this Form
10-K/A. Ernst & Young's attestation report on management's assessment of the
Company's internal control over financial reporting appears on pages F-2 and F-3
of this Form 10-K/A.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As previously reported, in connection with our assessment of the effectiveness
of our internal control over financial reporting at the end of fiscal year 2004,
we identified a material weakness in our internal control over financial
reporting. The deficiency in our internal control related to ineffective
application of inventory verification procedures, including cycle count
procedures. Historically, we had relied on cycle count procedures to
substantiate inventory quantities in lieu of taking physical inventories. During
our evaluation of internal control over our cycle counting procedures, we
determined that our processes in place during 2004 were neither sufficient nor
documented adequately to rely upon. Because of the material weakness in our
inventory verification procedures described above, management concluded that (i)
the Company did not maintain effective internal control over financial reporting
as of December 31, 2004, based on the criteria established in "Internal Control
- - Integrated Framework" issued by COSO, and (ii) as a result of this material
weakness our disclosure controls and procedures were not effective as of
December 31, 2004.
To remediate this material weakness, commencing with the first quarter of fiscal
2005 we instituted a practice of conducting periodic physical inventories
instead of relying on the cycle count procedures previously in use. We relied on
this physical inventory procedure when our management concluded as of March 31,
June 30 and September 30, 2005, that our disclosure controls and procedures were
effective. During the fourth quarter of fiscal year 2005 we completed the
development and testing of a new and more robust process for documenting and
executing our cycle counts. As a result, in September, 2005 we stopped
conducting physical inventories and commenced using this new cycle count
procedure to verify our inventory.
Other than this change from physical inventory counts to the new cycle count
procedures, 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 December 31, 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
19
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
FINANCIAL STATEMENTS
Our Consolidated Financial Statements and the Independent
Auditor's Reports thereon are included herein (page numbers
refer to pages in this amended Annual Report on Form 10-K/A):
Reports of Independent Registered Public Accounting Firm Page F-1
Consolidated Balance Sheets as of December 31, 2005 (Restated)
and 2004 Page F-4
Consolidated Statements of Operations for the years ended
December 31, 2005 (Restated), 2004, and 2003 Page F-5
Consolidated Statement of Changes in Shareholders' Equity for
the years ended December 31, 2005 (Restated), 2004, and 2003 Page F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2005 (Restated), 2004, and 2003 Page F-7
Notes to Consolidated Financial Statements for the years ended Page F-8 through
December 31, 2005 (Restated), 2004, and 2003 F-23
20
FINANCIAL STATEMENT SCHEDULES
ATS MEDICAL, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(in thousands)
ADDITIONS -
--------------------------------------------------------------
CHARGED TO
BALANCE AT CHARGED TO OTHER BALANCE AT
BEGINNING COSTS AND ACCOUNTS - DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD
----------- ---------- ---------- ---------- ---------- ----------
VALUATION ACCOUNTS:
Deducted from asset accounts:
YEAR ENDED DECEMBER 31, 2005:
Allowance for doubtful accounts $388 $ 0 $0 ($28)(1) $360
Allowance for obsolete inventories $200 $ 50 $0 ($35)(2) $215
YEAR ENDED DECEMBER 31, 2004:
Allowance for doubtful accounts $270 $150 $0 ($32)(1) $388
Allowance for obsolete inventories $200 $ 0 $0 $0 $200
YEAR ENDED DECEMBER 31, 2003:
Allowance for doubtful accounts $420 $ 0 $0 ($150)(2) $270
Allowance for obsolete inventories $200 $ 0 $0 $0 $200
(1) Uncollectible accounts written off, net of recoveries.
(2) Changes in estimate recovered through a reduction in expenses.
All other schedules have been omitted because of absence of conditions under
which they are required or because the required information is included in the
financial statements or notes thereto.
21
EXHIBITS
Note: All Exhibits listed under Item 15 in the Original Filing are unchanged
except for the filing of an updated Consent of Ernst & Young LLP and updated
Certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of
2002:
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1*** Agreement and Plan of Merger, dated as of January 23, 2006, among ATS
Medical, Inc., Seabiscuit Acquisition Corp.; 3F Therapeutics, Inc.;
and Boyd D. Cox, as Stockholder Representative (Incorporated by
reference to Exhibit 10.1of the Company's Current Report on Form 8-K
filed on January 26, 2006).
3.1 Restated Articles of Incorporation, as amended to date (Incorporated
by reference to Exhibit 3.1 to the Company's Annual Report on Annual
Report on Form 10-K for the year ended December 31, 1993 (the "1993
Form 10-K")).
3.2 Bylaws of the Company, as amended to date (Incorporated by reference
to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1996 (the "1996 Form 10-K")).
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 Indenture, dated as of October 7, 2005, between ATS Medical, Inc. and
Wells Fargo Bank, National Association, as Trustee (Incorporated by
reference to Exhibit 4.1 of the Company's Current Report on Form 8-K
filed on October 12, 2005 (the "October 12, 2005 Form 8-K")).
4.3 First Supplemental Indenture, dated October 13, 2005, to the Indenture
dated as of October 7, 2005, by and between ATS Medical, Inc. and
Wells Fargo Bank, National Association, as Trustee (Incorporated by
reference to Exhibit 4.3 of the Company's October 18, 2005 Form 8-K).
4.4 Form of 6% Convertible Senior Notes due 2025 (Incorporated by
reference to Exhibit 4.1 of the Company's Current Report on Form 8-K
filed on October 18, 2005 (the "October 18, 2005 Form 8-K")).
4.5 Form of Warrant (Incorporated by reference to Exhibit 4.2 of the
Company's October 18, 2005 Form 8-K).
10.1** 1987 Stock Option and Stock Award Plan, as restated and amended to
date (Incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
10.2** ATS Medical Inc. 2000 Stock Incentive Plan (Incorporated by reference
to the appendix to the Company's Definitive Proxy Statement filed on
March 28, 2003).
10.3** Agreement between the Company and Manuel A. Villafana dated September
11, 2001 (Incorporated by reference to Exhibit 10.3 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2001 (the
"2001 Form 10-K")).
10.4 Lease Agreement between the Company and Crow Plymouth Land Limited
Partnership dated December 22, 1987 (Incorporated by reference to
Exhibit 10(d) to the Company's Registration Statement on Form S-18,
File No. 33-34785-C (the "Form S-18")).
22
10.5 Amendment No. 1 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 5, 1989 (Incorporated
by reference to Exhibit 10(e) to the Form S-18).
10.6 Amendment No. 2 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 1989 (Incorporated by
reference to Exhibit 10(f) to the Form S-18).
10.7 Amendment No. 3 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated June 14, 1989 (Incorporated
by reference to Exhibit 10(g) to the Form S-18).
10.8 Amendment No. 4 to Lease Agreement between the Company and Plymouth
Business Center Limited Partnership, dated February 10, 1992
(Incorporated by reference to Exhibit 10.8 to the 1996 Form 10-K).
10.9* O.E.M. Supply Contract dated September 24, 1990, with CarboMedics,
Inc. (Incorporated by reference to Exhibit 10.10 to the 1996 Form
10-K).
10.10* License Agreement dated September 24, 1990, with CarboMedics, Inc.
(Incorporated by reference to Exhibit 10.11 to the 1996 Form 10-K).
10.11** Employment Agreement between the Company and Michael D. Dale dated
September 18, 2002 (Incorporated by reference to Exhibit 10.12 to the
Company's Form 10-K for the year ended 2002 (the "2002 Form 10-K")).
10.12 Helix BioCore, Inc. Self-Insurance Trust Agreement dated February 28,
1991 (Incorporated by reference to Exhibit 10.13 to the 1996 Form
10-K).
10.13* Amendment 1 to License Agreement dated December 16, 1993, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.17 to the
1993 Form 10-K).
10.14* Amendment 4 to O.E.M. Supply Contract dated December 16, 1993, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.18 to the
1993 Form 10-K).
10.15* Amendment 5 to O.E.M. Supply Contract dated September 1, 1994, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.19 to the
1994 Form 10-K).
10.16 Letter Agreement between the Company and Sulzer Carbomedics, Inc.,
dated June 27, 2002 (Incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 20,
2002).
10.17 Form of International Distributor Agreement (Incorporated by reference
to Exhibit 10.22 to the 1994 Form 10-K).
10.18** ATS Medical, Inc. Change in Control Severance Pay Plan (Incorporated
by reference to Exhibit 10.24 to the Company's Annual Report on Form
10-K for the year ended December 31, 1995).
10.19 Amendment No. 5 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated May 30, 1996 (Incorporated by reference to
Exhibit 10.22 to the 1996 Form 10-K).
10.20** Letter Agreement dated November 1, 2002, extending the agreement dated
September 11, 2001 between the Company and Manuel A. Villafana
(Incorporated by reference to Exhibit 10.23 to the 2002 Form 10-K).
10.21 Amendment No. 6 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated November 25, 1997 (Incorporated by reference
to Exhibit 10.23 to the 1997 Form 10-K).
10.22 1998 Employee Stock Purchase Plan (Incorporated by reference to
Exhibit 4 to the Company's Registration Statement on Form S-8, File
No. 333-57527).
23
10.23** 1998 Management Incentive Compensation Plan (Incorporated by reference
to Exhibit 10.25 to the Annual Report on Form 10-K for the year ended
December 31, 1998).
10.24* Carbon Agreement by and between Sulzer Carbomedics, Inc. and ATS
Medical, Inc., dated December 29, 1999 (Incorporated by reference to
Exhibit 99.1 to the Current Report on Form 8-K filed on January 13,
2000 (the "January 2000 Form 8-K").
10.25* Amendment 7 to OEM Supply Contract by and between Sulzer Carbomedics,
Inc. and ATS Medical, Inc., dated December 29, 1999 (Incorporated by
reference to Exhibit 99.2 to the January 2000 Form 8-K).
10.26* Amendment 2 to License Agreement by and between Sulzer Carbomedics,
Inc. and ATS Medical, Inc., dated December 29, 1999 (Incorporated by
reference to Exhibit 99.3 to the January 2000 Form 8-K).
10.27 Amendment No. 7 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated May 18, 2000 (Incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2000).
10.28 Lease Agreement between the Company and St. Paul Properties, Inc.,
dated April 29, 2000 (Incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
2000).
10.29 Amendment No. 8 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated December 14, 2000 (Incorporated by reference
to Exhibit 10.32 to the Company's Annual Report on Form 10-K for the
year ended December 31, 2000 (the "2000 Form 10-K")).
10.30* Amendment 8 to OEM Supply Contract by and between Sulzer Carbomedics,
Inc. and ATS Medical, Inc., dated November 3, 2000 (Incorporated by
reference to Exhibit 10.33 to the 2000 Form 10-K).
10.31 Form of U.S. Distribution Agreement (Incorporated by reference to
Exhibit 10.34 to the 2002 Form 10-K).
10.32 Amendment No. 9 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated September 8, 2003 (Incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003).
10.33 Form of Employee Stock Option Agreement under the company's 2000 Stock
Incentive Plan (Incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report of Form 10-Q for the quarter ended
September 30, 2004 (the "September 2004 Form 10-Q")).
10.34 Form of Non-Qualified Stock Option Agreement under the Company's 2000
Stock Incentive Plan (Incorporated by reference to Exhibit 10.3 to the
Company's September 2004 Form 10-Q).
10.35 Form of Non-Plan Non-Qualified Stock Option Agreement (Incorporated by
reference to Exhibit 10.4 to the Company's September 2004 Form 10-Q).
10.36* Development and License Agreement dated as of April 26, 2004 between
the Company and ErySave AB (Incorporated by reference to Exhibit 10.1
to the Company's September 2004 Form 10-Q).
10.37 Credit Agreement between Silicon Valley Bank and the Company, dated
July 28, 2004 (Incorporated by reference to Exhibit 10.1 to the
Company's September 2004 Form 10-Q).
24
10.38 Amendment No. 10 to Lease Agreement between the Company and St. Paul
Properties, Inc. dated as of October 1, 2004 (Incorporated by
reference to Exhibit 10.40 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2004 (the "2004 Form 10-K")).
10.39* Agent Agreement dated November 9, 2004 between the Company and
CryoCath Technologies, Inc. (Incorporated by reference to Exhibit 10.1
to the Company's Current Report on Form 8-K filed on May 10, 2005).
10.40* Distribution Agreement dated November 9, 2004 between the Company and
CryoCath Technologies, Inc. (Incorporated by reference to Exhibit 10.2
to the Company's Current Report on Form 8-K filed on May 10, 2005).
10.41 Letter Agreement between the Company and Centerpulse USA Holding Co.
dated July 9, 2003 (Incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed on September 26, 2003).
10.42 Amendment dated June 22, 2005, to Development and License Agreement
between the Company and ErySave AB (Incorporated by reference to
Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the
quarter June 30, 2005 (the "June 2005 Form 10-Q")).
10.43* Marketing Services Agreement with Alabama Tissue Center, Inc. (also
known as Regeneration Technologies, Inc. - Cardiovascular), a
subsidiary of Regeneration Technologies, Inc., effective as of July
21, 2005.
10.44* Exclusive Development, Supply and Distribution Agreement with Genesee
BioMedical, Inc., dated June 23, 2005.
10.45 Amendment Agreement, dated March 24, 2005, to the Credit Agreement
between Silicon Valley Bank and the Company, dated July 28, 2004
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on March 30, 2005).
10.46** 2005 ATS Medical Management Incentive Compensation Plan (Incorporated
by reference to Exhibit 10.2 of the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 2005).
10.47 Securities Purchase Agreement, dated as of October 6, 2005, by and
among ATS Medical, Inc. and the Buyers listed on the Schedule of
Buyers attached thereto as Exhibit A (Incorporated by reference to
Exhibit 10.1 of the Company's October 12, 2005 Form 8-K).
10.48 Amendment No. 1, dated October 12, 2005, to the Securities Purchase
Agreement by and among ATS Medical, Inc. and the Buyers listed
therein, dated as of October 6, 2005 (Incorporated by reference to
Exhibit 10.1 of the Company's October 18, 2005 Form 8-K).
10.49 Registration Rights Agreement, dated as of October 7, 2005, by and
among ATS Medical, Inc. and the Buyers listed on the Schedule of
Buyers attached thereto as Exhibit A (Incorporated by reference to
Exhibit 10.2 of the Company's October 12, 2005 Form 8-K).
10.50 Amendment No. 1, dated October 13, 2005, to the Registration Rights
Agreement by and among ATS Medical, Inc. and the Buyers listed
therein, dated as of October 7, 2005 (Incorporated by reference to
Exhibit 10.2 of the Company's October 18, 2005 Form 8-K).
10.51 Warrant Agent Agreement, dated as of October 7, 2005, between ATS
Medical, Inc. and Wells Fargo Bank, National Association, as Warrant
Agent (Incorporated by reference to Exhibit 10.3 of the Company's
October 12, 2005 Form 8-K).
10.52** Form of Lock-Up Agreement with Executive Officers (Incorporated by
reference to Exhibit 99.1 of the Company's Current Report on Form 8-K
filed on December 29, 2005).
25
10.53** Form of Restricted Stock Unit Agreement under the Company's 2000 Stock
Incentive Plan.
21 List of Subsidiaries.
23 Consent of Ernst & Young LLP.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1 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.
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
- ----------
* Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended,
confidential portions of these exhibits have been deleted and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment.
** Represents a management contract or compensatory plan or arrangement
required to be filed as an exhibit pursuant to Item 15 of Form 10-K.
*** Exhibits and Schedules to the Merger Agreement have been omitted but will
be provided supplementally to the Securities and Exchange Commission upon
request.
26
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: July 17, 2006 ATS MEDICAL, INC.
By /s/ Michael D. Dale
-------------------------------------
Michael D. Dale
Chief Executive Officer
27
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
2.1*** Agreement and Plan of Merger, dated as of January 23, 2006, among ATS
Medical, Inc., Seabiscuit Acquisition Corp.; 3F Therapeutics, Inc.;
and Boyd D. Cox, as Stockholder Representative (Incorporated by
reference to Exhibit 10.1of the Company's Current Report on Form 8-K
filed on January 26, 2006).
3.1 Restated Articles of Incorporation, as amended to date (Incorporated
by reference to Exhibit 3.1 to the Company's Annual Report on Annual
Report on Form 10-K for the year ended December 31, 1993 (the "1993
Form 10-K")).
3.2 Bylaws of the Company, as amended to date (Incorporated by reference
to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1996 (the "1996 Form 10-K")).
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 Indenture, dated as of October 7, 2005, between ATS Medical, Inc. and
Wells Fargo Bank, National Association, as Trustee (Incorporated by
reference to Exhibit 4.1 of the Company's Current Report on Form 8-K
filed on October 12, 2005 (the "October 12, 2005 Form 8-K")).
4.3 First Supplemental Indenture, dated October 13, 2005, to the Indenture
dated as of October 7, 2005, by and between ATS Medical, Inc. and
Wells Fargo Bank, National Association, as Trustee (Incorporated by
reference to Exhibit 4.3 of the Company's October 18, 2005 Form 8-K).
4.4 Form of 6% Convertible Senior Notes due 2025 (Incorporated by
reference to Exhibit 4.1 of the Company's Current Report on Form 8-K
filed on October 18, 2005 (the "October 18, 2005 Form 8-K")).
4.5 Form of Warrant (Incorporated by reference to Exhibit 4.2 of the
Company's October 18, 2005 Form 8-K).
10.1** 1987 Stock Option and Stock Award Plan, as restated and amended to
date (Incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
10.2** ATS Medical Inc. 2000 Stock Incentive Plan (Incorporated by reference
to the appendix to the Company's Definitive Proxy Statement filed on
March 28, 2003).
10.3** Agreement between the Company and Manuel A. Villafana dated September
11, 2001 (Incorporated by reference to Exhibit 10.3 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2001 (the
"2001 Form 10-K")).
10.4 Lease Agreement between the Company and Crow Plymouth Land Limited
Partnership dated December 22, 1987 (Incorporated by reference to
Exhibit 10(d) to the Company's Registration Statement on Form S-18,
File No. 33-34785-C (the "Form S-18")).
10.5 Amendment No. 1 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 5, 1989 (Incorporated
by reference to Exhibit 10(e) to the Form S-18).
28
10.6 Amendment No. 2 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated January 1989 (Incorporated by
reference to Exhibit 10(f) to the Form S-18).
10.7 Amendment No. 3 to Lease Agreement between the Company and Crow
Plymouth Land Limited Partnership, dated June 14, 1989 (Incorporated
by reference to Exhibit 10(g) to the Form S-18).
10.8 Amendment No. 4 to Lease Agreement between the Company and Plymouth
Business Center Limited Partnership, dated February 10, 1992
(Incorporated by reference to Exhibit 10.8 to the 1996 Form 10-K).
10.9* O.E.M. Supply Contract dated September 24, 1990, with CarboMedics,
Inc. (Incorporated by reference to Exhibit 10.10 to the 1996 Form
10-K).
10.10* License Agreement dated September 24, 1990, with CarboMedics, Inc.
(Incorporated by reference to Exhibit 10.11 to the 1996 Form 10-K).
10.11** Employment Agreement between the Company and Michael D. Dale dated
September 18, 2002 (Incorporated by reference to Exhibit 10.12 to the
Company's Form 10-K for the year ended 2002 (the "2002 Form 10-K")).
10.12 Helix BioCore, Inc. Self-Insurance Trust Agreement dated February 28,
1991 (Incorporated by reference to Exhibit 10.13 to the 1996 Form
10-K).
10.13* Amendment 1 to License Agreement dated December 16, 1993, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.17 to the
1993 Form 10-K).
10.14* Amendment 4 to O.E.M. Supply Contract dated December 16, 1993, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.18 to the
1993 Form 10-K).
10.15* Amendment 5 to O.E.M. Supply Contract dated September 1, 1994, with
CarboMedics, Inc. (Incorporated by reference to Exhibit 10.19 to the
1994 Form 10-K).
10.16 Letter Agreement between the Company and Sulzer Carbomedics, Inc.,
dated June 27, 2002 (Incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 20,
2002).
10.17 Form of International Distributor Agreement (Incorporated by reference
to Exhibit 10.22 to the 1994 Form 10-K).
10.18** ATS Medical, Inc. Change in Control Severance Pay Plan (Incorporated
by reference to Exhibit 10.24 to the Company's Annual Report on Form
10-K for the year ended December 31, 1995).
10.19 Amendment No. 5 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated May 30, 1996 (Incorporated by reference to
Exhibit 10.22 to the 1996 Form 10-K).
10.20** Letter Agreement dated November 1, 2002, extending the agreement dated
September 11, 2001 between the Company and Manuel A. Villafana
(Incorporated by reference to Exhibit 10.23 to the 2002 Form 10-K).
10.21 Amendment No. 6 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated November 25, 1997 (Incorporated by reference
to Exhibit 10.23 to the 1997 Form 10-K).
10.22 1998 Employee Stock Purchase Plan (Incorporated by reference to
Exhibit 4 to the Company's Registration Statement on Form S-8, File
No. 333-57527).
10.23** 1998 Management Incentive Compensation Plan (Incorporated by reference
to Exhibit 10.25 to the Annual Report on Form 10-K for the year ended
December 31, 1998).
29
10.24* Carbon Agreement by and between Sulzer Carbomedics, Inc. and ATS
Medical, Inc., dated December 29, 1999 (Incorporated by reference to
Exhibit 99.1 to the Current Report on Form 8-K filed on January 13,
2000 (the "January 2000 Form 8-K").
10.25* Amendment 7 to OEM Supply Contract by and between Sulzer Carbomedics,
Inc. and ATS Medical, Inc., dated December 29, 1999 (Incorporated by
reference to Exhibit 99.2 to the January 2000 Form 8-K).
10.26* Amendment 2 to License Agreement by and between Sulzer Carbomedics,
Inc. and ATS Medical, Inc., dated December 29, 1999 (Incorporated by
reference to Exhibit 99.3 to the January 2000 Form 8-K).
10.27 Amendment No. 7 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated May 18, 2000 (Incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2000).
10.28 Lease Agreement between the Company and St. Paul Properties, Inc.,
dated April 29, 2000 (Incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30,
2000).
10.29 Amendment No. 8 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated December 14, 2000 (Incorporated by reference
to Exhibit 10.32 to the Company's Annual Report on Form 10-K for the
year ended December 31, 2000 (the "2000 Form 10-K")).
10.30* Amendment 8 to OEM Supply Contract by and between Sulzer Carbomedics,
Inc. and ATS Medical, Inc., dated November 3, 2000 (Incorporated by
reference to Exhibit 10.33 to the 2000 Form 10-K).
10.31 Form of U.S. Distribution Agreement (Incorporated by reference to
Exhibit 10.34 to the 2002 Form 10-K).
10.32 Amendment No. 9 to Lease Agreement between the Company and St. Paul
Properties, Inc., dated September 8, 2003 (Incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003).
10.33 Form of Employee Stock Option Agreement under the company's 2000 Stock
Incentive Plan (Incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report of Form 10-Q for the quarter ended
September 30, 2004 (the "September 2004 Form 10-Q")).
10.34 Form of Non-Qualified Stock Option Agreement under the Company's 2000
Stock Incentive Plan (Incorporated by reference to Exhibit 10.3 to the
Company's September 2004 Form 10-Q).
10.35 Form of Non-Plan Non-Qualified Stock Option Agreement (Incorporated by
reference to Exhibit 10.4 to the Company's September 2004 Form 10-Q).
10.36* Development and License Agreement dated as of April 26, 2004 between
the Company and ErySave AB (Incorporated by reference to Exhibit 10.1
to the Company's September 2004 Form 10-Q).
10.37 Credit Agreement between Silicon Valley Bank and the Company, dated
July 28, 2004 (Incorporated by reference to Exhibit 10.1 to the
Company's September 2004 Form 10-Q).
10.38 Amendment No. 10 to Lease Agreement between the Company and St. Paul
Properties, Inc. dated as of October 1, 2004 (Incorporated by
reference to Exhibit 10.40 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2004 (the "2004 Form 10-K")).
30
10.39* Agent Agreement dated November 9, 2004 between the Company and
CryoCath Technologies, Inc. (Incorporated by reference to Exhibit 10.1
to the Company's Current Report on Form 8-K filed on May 10, 2005).
10.40* Distribution Agreement dated November 9, 2004 between the Company and
CryoCath Technologies, Inc. (Incorporated by reference to Exhibit 10.2
to the Company's Current Report on Form 8-K filed on May 10, 2005).
10.41 Letter Agreement between the Company and Centerpulse USA Holding Co.
dated July 9, 2003 (Incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed on September 26, 2003).
10.42 Amendment dated June 22, 2005, to Development and License Agreement
between the Company and ErySave AB (Incorporated by reference to
Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the
quarter June 30, 2005 (the "June 2005 Form 10-Q")).
10.43* Marketing Services Agreement with Alabama Tissue Center, Inc. (also
known as Regeneration Technologies, Inc. - Cardiovascular), a
subsidiary of Regeneration Technologies, Inc., effective as of July
21, 2005.
10.44* Exclusive Development, Supply and Distribution Agreement with Genesee
BioMedical, Inc., dated June 23, 2005.
10.45 Amendment Agreement, dated March 24, 2005, to the Credit Agreement
between Silicon Valley Bank and the Company, dated July 28, 2004
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on March 30, 2005).
10.46** 2005 ATS Medical Management Incentive Compensation Plan (Incorporated
by reference to Exhibit 10.2 of the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 2005).
10.47 Securities Purchase Agreement, dated as of October 6, 2005, by and
among ATS Medical, Inc. and the Buyers listed on the Schedule of
Buyers attached thereto as Exhibit A (Incorporated by reference to
Exhibit 10.1 of the Company's October 12, 2005 Form 8-K).
10.48 Amendment No. 1, dated October 12, 2005, to the Securities Purchase
Agreement by and among ATS Medical, Inc. and the Buyers listed
therein, dated as of October 6, 2005 (Incorporated by reference to
Exhibit 10.1 of the Company's October 18, 2005 Form 8-K).
10.49 Registration Rights Agreement, dated as of October 7, 2005, by and
among ATS Medical, Inc. and the Buyers listed on the Schedule of
Buyers attached thereto as Exhibit A (Incorporated by reference to
Exhibit 10.2 of the Company's October 12, 2005 Form 8-K).
10.50 Amendment No. 1, dated October 13, 2005, to the Registration Rights
Agreement by and among ATS Medical, Inc. and the Buyers listed
therein, dated as of October 7, 2005 (Incorporated by reference to
Exhibit 10.2 of the Company's October 18, 2005 Form 8-K).
10.51 Warrant Agent Agreement, dated as of October 7, 2005, between ATS
Medical, Inc. and Wells Fargo Bank, National Association, as Warrant
Agent (Incorporated by reference to Exhibit 10.3 of the Company's
October 12, 2005 Form 8-K).
10.52** Form of Lock-Up Agreement with Executive Officers (Incorporated by
reference to Exhibit 99.1 of the Company's Current Report on Form 8-K
filed on December 29, 2005).
10.53** Form of Restricted Stock Unit Agreement under the Company's 2000 Stock
Incentive Plan.
21 List of Subsidiaries.
31
23 Consent of Ernst & Young LLP.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2 Certification of Chief financial Officer pursuant to Rule 13a-14(a)
and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1 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.
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
- ----------
* Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended,
confidential portions of these exhibits have been deleted and filed
separately with the Securities and Exchange Commission pursuant to a
request for confidential treatment.
** Represents a management contract or compensatory plan or arrangement
required to be filed as an exhibit pursuant to Item 15 of Form 10-K.
*** Exhibits and Schedules to the Merger Agreement have been omitted but will
be provided supplementally to the Securities and Exchange Commission upon
request.
32
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
ATS Medical, Inc.
We have audited the accompanying consolidated balance sheets of ATS Medical,
Inc. (the "Company") as of December 31, 2005 and 2004, and the related
consolidated statements of operations, changes in shareholders' equity and cash
flows for each of the three years in the period ended December 31, 2005. Our
audits also included the financial statement schedule presented at Item 15.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of December 31, 2005 and 2004, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2005, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the
consolidated financial statements have been restated.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission, and our report
dated March 6, 2006, except for the effects of the material weakness described
in the sixth paragraph of that report, as to which the date is July 13, 2006,
expressed an unqualified opinion on management's assessment of and an adverse
opinion on the effectiveness of internal control over financial reporting.
/s/ ERNST & YOUNG LLP
Minneapolis, Minnesota
March 6, 2006, except for Note 2,
as to which the date is July 13, 2006
F-1
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
ATS Medical, Inc.
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting (as restated),
that ATS Medical, Inc. (the "Company") did not maintain effective internal
control over financial reporting as of December 31, 2005, because of the effect
of the Company's material weakness relating to the accounting for embedded
derivatives related to its Convertible Senior Notes, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (the "COSO criteria").
The Company's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our report dated March 6, 2006, we expressed an unqualified opinion on
management's previous assessment that the Company maintained effective internal
control over financial reporting as of December 31, 2005 and an unqualified
opinion that the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2005, based on the
COSO criteria. Management has subsequently determined that a deficiency in
controls relating to the accounting for derivatives embedded in its Convertible
Senior Notes existed as of the previous assessment date, and has further
concluded that such deficiency represented a material weakness as of December
31, 2005. As a result, management has revised its assessment, as presented in
the accompanying Management's Report on Internal Control over Financial
Reporting, to conclude that the Company's internal control over financial
reporting was not effective as of December 31, 2005. Accordingly, our present
opinion on the effectiveness of the Company's internal control over financial
reporting as of December 31, 2005, as expressed herein, is different from that
expressed in our previous report.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weakness has been identified and included in
management's assessment: In its assessment as of December 31, 2005, management
identified a material weakness in the Company's accounting for embedded
derivatives related to its Convertible Senior Notes and, as a result, concluded
the Company's previously reported other income had been understated. The
insufficient controls resulted in the restatement of the Company's consolidated
financial statements as of and for the year ended December 31, 2005. This
material weakness was considered in determining the nature, timing, and extent
of audit tests applied in our audit of the 2005
F-2
consolidated financial statements, and this report does not affect our report
dated March 6, 2006 except for Note 2 as to which the date is July 13, 2006, on
those consolidated financial statements (as restated).
In our opinion, management's assessment that the Company did not maintain
effective internal control over financial reporting as of December 31, 2005, is
fairly stated, in all material respects, based on the COSO control criteria.
Also, in our opinion, because of the effect of the material weakness described
above on the achievement of the objectives of the control criteria, the Company
has not maintained effective internal control over financial reporting as of
December 31, 2005, based on the COSO control criteria.
/s/ ERNST & YOUNG LLP
Minneapolis, Minnesota
March 6, 2006, except for the effects of the material
weakness described in the sixth paragraph above,
as to which the date is July 13, 2006
F-3
ATS Medical, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Data)
DECEMBER 31
---------------------
2005 2004
---------- --------
(RESTATED)
ASSETS
Current assets:
Cash and cash equivalents $ 16,620 $ 8,302
Short-term investments 5,089 7,692
-------- --------
21,709 15,994
Accounts receivable, less allowance of $360 in 2005
and $388 in 2004 10,453 7,893
Inventories, net 21,286 24,303
Prepaid expenses 1,204 1,053
-------- --------
Total current assets 54,652 49,243
Leasehold improvements, furniture, and equipment, net 8,330 7,650
Inventories -- 3,000
Intangible assets 22,015 18,720
Other assets 446 438
-------- --------
Total assets $ 85,443 $ 79,051
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,598 $ 4,049
Due to related party 90 217
Accrued compensation 2,394 1,797
Accrued distributor liabilities 752 527
Other accrued liabilities 568 430
Current maturities of note payable 833 764
-------- --------
Total current liabilities 8,235 7,784
Convertible senior notes payable, net of unamortized
discounts and bifurcated derivatives of $3,624 18,776 --
Note payable 903 1,736
Due to related party -- 90
Shareholders' equity:
Common Stock, $0.01 par value:
Authorized shares - 40,000,000
Issued and outstanding shares - 31,114,131 in
2005 and 30,889,637 in 2004 311 309
Additional paid-in capital 139,743 136,562
Accumulated deficit (81,895) (67,501)
Accumulated other comprehensive income (loss) (64) 95
Deferred compensation (566) (24)
-------- --------
Total shareholders' equity 57,529 69,441
-------- --------
Total liabilities and shareholders' equity $ 85,443 $ 79,051
======== ========
See accompanying notes.
F-4
ATS Medical, Inc.
Consolidated Statements of Operations
(In Thousands, Except Per Share Amounts)
YEAR ENDED DECEMBER 31
--------------------------------
2005 2004 2003
---------- -------- --------
(RESTATED)
Net sales $ 34,636 $ 28,015 $ 18,484
Cost of goods sold 22,828 21,227 17,632
-------- -------- --------
Gross profit 11,808 6,788 852
Operating expenses:
Sales and marketing 18,948 16,520 10,180
Research and development 1,733 1,011 1,764
General and administrative 7,314 5,954 4,350
Gain on extinguishment of debt -- -- (2,575)
-------- -------- --------
Total operating expenses 27,995 23,485 13,719
-------- -------- --------
Operating loss (16,187) (16,697) (12,867)
Interest income 323 156 81
Interest expense (661) (102) (506)
Change in value of derivative liability bifurcated
from convertible senior notes 2,131 -- --
-------- -------- --------
Net loss $(14,394) $(16,643) $(13,292)
======== ======== ========
Net loss per share:
Basic and diluted $ (0.46) $ (0.58) $ (0.55)
Weighted average number of shares outstanding:
Basic and diluted 31,009 28,856 24,076
See accompanying notes.
F-5
ATS Medical, Inc.
Consolidated Statement of Changes in Shareholders' Equity
(In Thousands)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
--------------- PAID-IN COMPREHENSIVE DEFERRED ACCUMULATED
SHARES AMOUNT CAPITAL INCOME (LOSS) COMPENSATION DEFICIT TOTAL
------ ------ ---------- -------------- ------------ ----------- --------
Balance at December 31, 2002 22,306 $223 $111,474 $ (4) -- $(37,566) $ 74,127
Common Stock issued under the
Employee Stock Purchase Plan 37 1 55 -- -- -- 56
Stock options exercised 36 -- 111 -- -- -- 111
Common stock issued in
private placement, net of
offering costs 4,400 44 11,381 -- -- -- 11,425
Stock option issued for services -- -- 218 -- -- -- 218
Deferred compensation related
to stock options -- -- 173 -- (173) -- --
Amortization of deferred
compensation -- -- -- -- 103 -- 103
Change in foreign currency
translation -- -- -- 55 -- -- 55
Net loss for the year -- -- -- -- -- (13,292) (13,292)
--------
Comprehensive loss (13,237)
------ ---- -------- ----- ------- -------- --------
Balance at December 31, 2003 26,779 268 123,412 51 (70) (50,858) 72,803
Common Stock issued under the
Employee Stock Purchase Plan 90 1 297 -- -- -- 298
Stock options exercised 334 3 458 -- -- -- 461
Common stock issued in private
placement, net of offering
costs 3,687 37 12,381 -- -- -- 12,418
Deferred compensation related
to stock options -- -- 14 -- (14) -- --
Amortization of deferred
compensation -- -- -- -- 60 -- 60
Change in foreign currency
translation -- -- -- 44 -- -- 44
Net loss for the year -- -- -- -- -- (16,643) (16,643)
--------
Comprehensive loss (16,599)
------ ---- -------- ----- ------- -------- --------
Balance at December 31, 2004 30,890 309 136,562 95 (24) (67,501) 69,441
Common Stock issued under the
Employee Stock Purchase Plan 120 1 347 -- -- -- 348
Stock options exercised 104 1 185 -- -- -- 186
Warrants issued in connection
with sale of convertible
debt securities -- -- 1,522 -- -- -- 1,522
Deferred compensation related
to stock options and awards -- -- 1,127 -- (1,127) -- --
Amortization of deferred
compensation -- -- -- -- 585 -- 585
Change in foreign currency
translation -- -- -- (159) -- -- (159)
Net loss for the year -- -- -- -- -- (14,394) (14,394)
--------
Comprehensive loss -- -- -- -- -- -- (14,553)
------ ---- -------- ----- ------- -------- --------
BALANCE AT DECEMBER 31, 2005
(RESTATED) 31,114 $311 $139,743 $ (64) $ (566) $(81,895) $ 57,529
====== ==== ======== ===== ======= ======== ========
See accompanying notes.
F-6
ATS Medical, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
YEAR ENDED DECEMBER 31
--------------------------------
2005 2004 2003
---------- -------- --------
(RESTATED)
OPERATING ACTIVITIES
Net loss $(14,394) $(16,643) $(13,292)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 1,563 1,088 792
Loss on disposal of equipment 35 17 4
Non-cash interest expense 138 12 320
Compensation expense related to stock options 585 60 321
Change in value of convertible senior notes
derivative liability (2,131) -- --
Gain on extinguishment of debt -- -- (2,575)
Lower of cost or market adjustment 700 819 4,400
Changes in operating assets and liabilities:
Accounts receivable (2,560) (2,954) (1,382)
Inventories 5,317 9,255 11,099
Accounts payable and accrued expenses 292 3,779 (42)
Other (163) (543) (125)
-------- -------- --------
Net cash used in operating activities (10,618) (5,110) (480)
INVESTING ACTIVITIES
Purchases of short-term investments (5,503) (8,688) (5,231)
Maturities of short-term investments 8,106 2,999 5,729
Payments for technology license -- -- (12,000)
Payments for other intangibles (1,817) (232) --
Purchases of leasehold improvements, furniture, and
equipment (2,278) (2,860) (665)
-------- -------- --------
Net cash used in investing activities (1,492) (8,781) (12,167)
FINANCING ACTIVITIES
Sale of convertible senior notes, net of financing costs 20,817 -- --
Advances (payments) on note payable (764) 2,500 --
Net proceeds from issuance of common stock 534 13,177 11,592
-------- -------- --------
Net cash provided by financing activities 20,587 15,677 11,592
Effect of exchange rate changes (159) 44 55
-------- -------- --------
Increase (decrease) in cash and cash equivalents 8,318 1,830 (1,000)
Cash and cash equivalents at beginning of year 8,302 6,472 7,472
-------- -------- --------
Cash and cash equivalents at end of year $ 16,620 $ 8,302 $ 6,472
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Net cash paid during the year for:
Interest $ 201 $ 82 $ 11
======== ======== ========
See accompanying notes.
F-7
ATS Medical, Inc.
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (RESTATED)
BUSINESS ACTIVITY
ATS Medical, Inc. (the Company) develops, manufactures, and markets medical
devices. The Company's interest lies with devices used by cardiovascular
surgeons in the cardiac surgery operating theater. Currently, the Company
participates in the markets for mechanical bileaflet replacement heart valves,
allograft tissues, the surgical treatment of atrial fibrillation, and surgical
tools and accessories.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
both of its wholly owned subsidiaries, ATS Medical Sales, Inc., ATS Medical
France SARL, and ATS Germany Gmbh (since its inception in February 2005), after
elimination of intercompany accounts and transactions. Effective January 1,
2006, ATS Medical Sales, Inc. was merged into ATS Medical, Inc.
CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three
months or less at the time of purchase to be cash equivalents. Cash equivalents
are carried at cost which approximates market value.
SHORT-TERM INVESTMENTS
Short-term investments are comprised of debt securities and are classified as
available-for-sale. Available-for-sale securities are carried at cost which
approximates fair value.
ACCOUNTS RECEIVABLE
Credit is extended based on evaluation of a customer's financial condition and,
generally, collateral is not required. Accounts receivable are generally due
within 30-180 days and are stated at amounts due from customers net of an
allowance for doubtful accounts. Accounts receivable outstanding longer than the
contractual payment terms are considered past due. The Company determines its
allowance by considering a number of factors, including the length of time trade
accounts receivable are past due, the Company's previous loss history, the
customer's current ability to pay its obligation to the Company, and the
condition of the general economy and the industry as a whole. The Company writes
off accounts receivable when they become uncollectible, and payments
subsequently received on such receivables are credited to the allowance for
doubtful accounts.
INVENTORIES
The Company carries and relieves inventories at the lower of cost (first-in,
first-out basis) or market. The Company has recorded a valuation reserve against
inventories of $0.2 million at December 31, 2005 and 2004. Write-downs have been
recorded on a portion of its inventories to provide for the lower of cost or
market value expected to be realized on future sales in lesser-developed
countries. The write-downs were $0.7 million in 2005, $0.8 in 2004, and $4.4
million in 2003. These write-downs were included in cost of goods sold in the
statements of operations
F-8
ATS Medical, Inc.
Notes to Consolidated Financial Statements
At December 31, 2005 and 2004, inventories consisted of the following (in
thousands):
2005 2004
------- -------
Raw materials $ 5,047 $ 6,640
Work-in-process 4,462 8,398
Finished goods 11,992 12,465
Obsolescence reserve (215) (200)
------- -------
$21,286 $27,303
======= =======
At December 31, 2004, the Company's inventory was in excess of its current
requirements based on the historical and anticipated level of sales. Management
believes that excess quantities will be utilized over several years. The Company
therefore classified $3.0 million of inventories as non-current assets at
December 31, 2004.
OTHER ASSETS
Prior to obtaining directors' and officers' liability insurance, the Company had
placed monies into a self-insurance trust to provide coverage for potential
issues. At December 31, 2005 and 2004, the deposits within the trust amounted to
$0.4 million.
LEASEHOLD IMPROVEMENTS, FURNITURE, AND EQUIPMENT
Leasehold improvements, furniture, and equipment are stated at cost.
Depreciation is provided using the straight-line method over the estimated
useful lives of the assets as follows:
Furniture and fixtures 7 years
Equipment 5 to 7 years
Computers 2 years
Leasehold improvements are amortized over the related lease term or estimated
useful life, whichever is shorter.
TECHNOLOGY LICENSES
The Company holds various technology licenses (see Note 5) which are included in
intangible assets and which are tested annually for impairment in accordance
with Statement of Financial Accounting Standard 142 (SFAS 142) "Goodwill and
Other Intangible Assets".
INDEFINITE-LIVED INTANGIBLE ASSETS
Indefinite-lived intangible assets are carried at cost. The Company applies
Statement of Financial Accounting Standard 142 (SFAS 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
the annual impairment tests in the second quarter of 2005 and determined that
the Company's indefinite-lived intangible assets were not impaired.
F-9
ATS Medical, Inc.
Notes to Consolidated Financial Statements
REVENUE RECOGNITION
A significant portion of the Company's revenue in the United States, Canada,
France and Germany is generated from consigned inventory maintained at hospitals
or with field representatives. In these situations, revenue is recognized at the
time that the product has been implanted or used. In all other instances,
revenue is recognized at the time product is shipped. Certain independent
distributors in select international markets receive rebates against invoiced
sales amounts. In these situations, the Company accrues for these rebates at the
time of the original sale. These rebates are treated as a reduction of revenue.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
ADVERTISING AND PROMOTIONAL COSTS
Advertising and promotional costs are charged to operations in the year
incurred. Advertising and promotional costs charged to operations during 2005,
2004, and 2003 were $0.1 million each year.
FOREIGN CURRENCY TRANSLATION
The financial statements for operations outside the United States are maintained
in their local currency. All assets and liabilities of the Company's
international subsidiary are translated to United States dollars at year-end
exchange rates, while elements of the statement of operations are translated at
average exchange rates in effect during the year. Translation adjustments
arising from the use of differing exchange rates are included in accumulated
other comprehensive income (loss) in shareholders' equity. Gains and losses on
foreign currency transactions were not significant during 2005, 2004, or 2003.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting
Standards 109 (SFAS 109) "Accounting for Income Taxes". Deferred taxes are
provided on an asset and liability method whereby deferred tax assets are
recognized for deductible temporary differences and operating loss and tax
credit carry forwards and deferred tax liabilities are recognized for taxable
temporary differences. Temporary differences are the differences between the
amounts of assets and liabilities recorded for income tax and financial
reporting purposes. Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.
WARRANTIES
The Company adopted Financial Accounting Standards Board Interpretation No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Indebtedness to Others (FIN 45), during the first quarter of 2003. FIN
45 requires disclosures concerning the Company's obligations under certain
guarantees.
The Company has indemnified the supplier of its valve components against claims
made or damages assessed as the result of the supplier's manufacture of the
valve components. The Company has determined that given its history of no
reports of product failures or liability claims, the likelihood of claims and
subsequent payments is remote, and accordingly, no liabilities in conjunction
with this indemnification have been accrued.
F-10
ATS Medical, Inc.
Notes to Consolidated Financial Statements
STOCK-BASED COMPENSATION
The Company has stock-based employee compensation plans, which are described
more fully in Note 9. The plans are accounted for under the recognition and
measurement principles of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. Under APB
No. 25, when the exercise price of stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
The following table illustrates the effect on net loss and net loss per share if
the Company had applied the fair value recognition provisions of SFAS No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation
(in thousands, except per share amounts):
2005 2004 2003
---------- -------- --------
(RESTATED)
Net loss as reported $(14,394) $(16,643) $(13,292)
Deduct total stock-based employee compensation
expense determined under fair value-based
method for all awards (5,301) (2,350) (1,357)
-------- -------- --------
Pro forma net loss $(19,695) $(18,993) $(14,649)
======== ======== ========
Net loss per share:
Basic and diluted - as reported $ (0.46) $ (0.58) $ (0.55)
Basic and diluted - pro forma $ (0.64) $ (0.66) $ (0.61)
Pro forma information regarding net loss and net loss per share is required by
SFAS No. 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS No. 123. The fair
value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
2005 2004 2003
------- ------- -------
Assumptions used:
Volatility 0.87 0.89 0.93
Risk-free interest rate 3.8% 4.0% 3.7%
Expected life 7 YEARS 7 years 8 years
Dividend yield 0% 0% 0%
The pro forma effect on net loss is not representative of the pro forma effect
on net income (loss) in future years.
In December 2005, the Company authorized the acceleration of vesting of all
otherwise unvested stock options held by its employees with an exercise price of
$3.00 or greater granted under the Company's 2000 Stock Incentive Plan or as a
free standing option not under any plan. Options to purchase 1,294,232 shares of
the Company's common stock were subject to this acceleration. The decision to
accelerate vesting of these underwater options was made primarily to minimize
certain future compensation expense that the Company would otherwise recognize
in its consolidated statement of operations with respect to these options
pursuant to Financial Accounting Standards Board Statement No. 123 (revised
2004), "Share-Based Payment" (FAS 123R), which the Company has adopted effective
January 1, 2006. The Company believes that the aggregate future expense that
will be eliminated as a result of the acceleration of the vesting of these
options is approximately $3.3 million.
F-11
ATS Medical, Inc.
Notes to Consolidated Financial Statements
NET LOSS PER SHARE
Basic net loss per share is computed by dividing net loss by the weighted
average shares outstanding and excludes any dilutive effects of options,
warrants, and convertible securities. For all periods presented, diluted net
loss per share is equal to basic net loss per share because the effect of
including potential common shares for stock options outstanding would have been
anti-dilutive. Had net income been achieved, approximately 1,214,000 of common
stock equivalents would have been included in the computation of diluted net
income per share for the year ended December 31, 2005.
CONVERTIBLE DEBT AND DERIVATIVE INSTRUMENTS
The Company accounts for embedded derivatives related to its convertible senior
notes under Financial Accounting Standards Board (FASB) Statement No.133,
Accounting for Derivative Instruments and Hedging Activities and related
Emerging Issues Task Force (EITF) and Securities and Exchange Commission (SEC)
rules, which require certain embedded derivative financial instruments to be
bifurcated from the debt agreement and accounted for as a liability. The Company
determines the value of these derivatives by making judgments and estimates of
the probability that future conditions giving rise to such derivatives may
occur.
2. RESTATEMENT OF FINANCIAL STATEMENTS
The Company has restated its financial statements for 2005. In addition, certain
disclosures in notes 1, 7, 12 and 17 of the notes to the consolidated financial
statements in this report have been revised to reflect the restatement
adjustments. The determination to restate these financial statements was made
after an error was discovered in June 2006 in the accounting for embedded
derivatives related to its Convertible Senior Notes (the Notes) under Financial
Accounting Standards Board (FASB) Statement No.133, Accounting for Derivative
Instruments and Hedging Activities and related Emerging Issues Task Force (EITF)
interpretations and Securities and Exchange Commission (SEC) rules.
The Convertible Senior Notes agreement permits Note holders to exchange their
debt instruments for common stock at a conversion rate of $4.20 per share. The
Company had insufficient authorized common shares as of the closing date, which
requires this embedded instrument to be bifurcated from the debt agreement and
classified as a liability in accordance with EITF 00-19. In addition, certain
other features have been identified as derivatives and included in the liability
as described in Note 7. The adjustments made to restate the financial statements
as of and for the year ended December 31, 2005 were:
(a) Establish the beginning value ($5.5 million) of the derivative
liability bifurcated from the Notes and the offsetting discount.
(b) Amortize the discount to interest expense from the date of
issuance of the Notes and adjust amortization on the discount
related to warrants issued with the Notes, resulting in a net
reduction to interest expense.
(c) Adjust the Notes bifurcated derivative liability to fair value at
December 31, 2005, resulting in non-operating other income of
$2.1 million.
The following table presents the effect of the restatement on the balance sheet
(dollars in thousands):
DECEMBER 31, 2005
-------------------------------------------------------
AS PREVIOUSLY ADJUSTMENT
REPORTED ADJUSTMENTS DESCRIPTION AS RESTATED
------------- ----------- ----------- -----------
Convertible senior notes payable, net of
unamortized discount and bifurcated
derivatives of $3,624 $ 20,945 $(2,169) (a)(b)(c) $ 18,776
Accumulated deficit $(84,064) $ 2,169 (b)(c) $(81,895)
F-12
ATS Medical, Inc.
Notes to Consolidated Financial Statements
The following table presents the effect of the restatement on the statement of
operations (dollars in thousands):
YEAR ENDED DECEMBER 31, 2005
-------------------------------------------------------
AS PREVIOUSLY ADJUSTMENT
REPORTED ADJUSTMENTS DESCRIPTION AS RESTATED
------------- ----------- ----------- -----------
Operating loss $(16,187) $(16,187)
Interest income 323 323
Interest expense (699) 38 (b) (661)
Change in value of derivative liability
bifurcated from convertible senior
notes -- 2,131 (c) 2,131
-------- ------ --------
Net loss $(16,563) $2,169 $(14,394)
======== ====== ========
Net loss per share:
Basic and diluted $ (0.53) $ 0.07 $ (0.46)
Weighted average number of shares
outstanding:
Basic and diluted 31,009 -- 31,009
The following table presents the effect of the restatement on the statement of
cash flows (dollars in thousands):
YEAR ENDED DECEMBER 31, 2005
-------------------------------------------------------
AS PREVIOUSLY ADJUSTMENT
REPORTED ADJUSTMENTS DESCRIPTION AS RESTATED
------------- ----------- ----------- -----------
OPERATING ACTIVITIES
Net loss $(16,563) $ 2,169 (b) (c) $(14,394)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 1,563 1,563
Loss on disposal of equipment 35 35
Non-cash interest expense 176 (38) (b) 138
Compensation expense related to
stock options 585 585
Change in value of convertible
senior notes derivative liability -- (2,131) (c) (2,131)
Lower of cost or market adjustment 700 700
Changes in operating assets and
liabilities:
Accounts receivable (2,560) (2,560)
Inventories 5,317 5,317
Accounts payable and accrued
expenses 292 292
Other (163) (163)
-------- ------- --------
Net cash used in operating activities $(10,618) -- $(10,618)
F-13
ATS Medical, Inc.
Notes to Consolidated Financial Statements
3. SHORT-TERM INVESTMENTS
At December 31, 2005 and 2004, the cost of short-term investments held by the
Company of $5.1 million and $7.7 million, respectively, had maturity dates of
approximately one year or less, approximated their fair value and consisted of
the following (in thousands):
2005 2004
------ ------
Corporate Bonds $2,008 $1,061
Certificates of Deposit 1,367 --
U.S. Agency 1,008 3,566
Commercial Paper 706 3,065
------ ------
$5,089 $7,692
====== ======
4. LEASEHOLD IMPROVEMENTS, FURNITURE, AND EQUIPMENT, NET
At December 31, 2005 and 2004, leasehold improvements, furniture, and equipment
consisted of the following (in thousands):
2005 2004
------- -------
Furniture and fixtures $ 625 $ 577
Equipment 9,674 6,601
Leasehold improvements 3,346 3,294
Construction in progress 810 2,080
------- -------
14,455 12,552
Less accumulated depreciation 6,125 4,902
------- -------
$ 8,330 $ 7,650
======= =======
5. PRIVATE PLACEMENTS OF COMMON STOCK
In August 2003, the Company completed a private placement of common stock
selling 4.4 million shares at $2.80 a share for gross proceeds of $12.3 million.
The proceeds were used to pay Centerpulse USA Holdings, Co. in conjunction with
the agreement reached in July 2003 for the cancellation of remaining obligations
under the carbon technology agreement discussed below in Note 7.
In June 2004, the Company completed a private placement of common stock selling
3.7 million shares at $3.55 a share for gross proceeds of $13.1 million. The
proceeds were used for general working capital purposes.
F-14
ATS Medical, Inc.
Notes to Consolidated Financial Statements
6. INTANGIBLE ASSETS
Intangible assets activity is summarized as follows (in thousands):
ASSETS SUBJECT ASSETS NOT SUBJECT
TO AMORTIZATION TO AMORTIZATION
------------------------- -------------------------
ERYSAVE CRYOCATH
DEFERRED DEVELOPMENT & AGENCY AND CARBON
FINANCING LICENSING DISTRIBUTION TECHNOLOGY
COSTS AGREEMENT AGREEMENTS LICENSE TOTAL
--------- ------------- ------------ ---------- -------
Balance at December 31, 2003 -- -- -- $18,500 $18,500
Payments $ 44 $188 -- -- 232
Amortization (12) -- -- -- (12)
------ ---- ------ ------- -------
Balance at December 31, 2004 32 188 -- 18,500 $18,720
Payments 1,583 262 1,555 -- 3,400
Amortization (105) -- -- -- (105)
------ ---- ------ ------- -------
BALANCE AT DECEMBER 31, 2005 $1,510 $450 $1,555 $18,500 $22,015
====== ==== ====== ======= =======
The deferred financing costs at December 31, 2005 are in connection with the 6%
Convertible Senior Notes discussed in Note 6 below and are being amortized over
five years. Amortization of deferred financing costs is estimated at $0.3
million per year for 2006 through 2010.
In April 2004, the Company signed an exclusive development and licensing
agreement with ErySave AB and made an initial milestone licensing fee payment of
approximately $0.2 million. The agreement grants the Company worldwide rights
for ErySave's filtration technology for cardiac surgery procedures. In July
2005, the Company made additional licensing fee payments of $0.3 million to
ErySave. Future payments under this agreement, based upon the attainment of
developmental milestones, could total an additional $1.0 million. Upon payment
of all milestones, an evaluation of the life of the technology will be made and
an amortization period will be set.
In November 2004, the Company signed an exclusive agency agreement and a
distribution agreement with Canadian-based CryoCath Technologies, Inc. The
agreements grant the Company co-promotion rights in the United States as well as
exclusive distribution rights in the rest of the world including Europe and Asia
for CryoCath's cryotherapy products for the ablation of cardiac arrhythmias.
During the quarter ended June 30, 2005, the Company made $1.6 million in
licensing fee payments to CryoCath under the agreements. These payments are
refundable upon cancellation of the agreements.
The Company holds an exclusive, worldwide right and license to use Sulzer
Carbomedics, Inc. pyrolytic carbon technology. The license was originally
obtained in 1999. License fee milestone payments were made or accrued from 1999
through 2002, totaling $29 million. An impairment charge of $8.1 million and
imputed interest of $2.4 million were charged against the carrying value of the
license in 2002.
Statement of Financial Accounting Standard No. 142, Goodwill and Other
Intangible Assets (SFAS 142), guides the accounting treatment for the Company's
intangible assets. Under SFAS 142, the Sulzer Carbomedics license and the
exclusive distribution and agency agreements with CryoCath Technologies are
considered indefinite-lived assets and are therefore not subject to
amortization. These intangible assets are considered indefinite-lived due, in
the case of the Sulzer Carbomedics license, to the broad scope and general
nature of the technology licensed and, in the case of the CryoCath agreements,
to unique contract provisions which encourages renewal of the agreements and
provides for agreement cancellation payments which would likely exceed the
original license payments made by the Company.
F-15
ATS Medical, Inc.
Notes to Consolidated Financial Statements
7. LONG-TERM DEBT (RESTATED)
On October 7, 2005 and October 12, 2005, the Company sold a combined $22.4
million aggregate principal amount of 6% Convertible Senior Notes due 2025
(Notes) and issued warrants to purchase 1,344,000 shares of the Company's common
stock (Warrants). Interest is payable under the Notes each April and October,
beginning in 2006.
The Warrants are exercisable at $4.40 per share and expire in 2010. The Company
has reserved 105% of the shares necessary for the exercise of the Warrants. The
Warrants were valued at $1.13 per share using the Black-Scholes valuation model.
The total value of the Warrants on the date of issuance was $1.5 million, is
treated as a discount to the Convertible Senior Notes and is amortized to
interest expense over the 20 year life of the Notes using the effective interest
method.
The Notes are convertible into common stock at any time at a fixed conversion
price of $4.20 per share, subject to adjustment under certain circumstances
including, but not limited to, the payment of cash dividends on common stock. If
fully converted, the Notes would convert into 5,333,334 shares of the Company's
common stock. At the date of issuance of the Notes, the Company had 19,222
shares of its common stock available for the Note holders if conversion was
elected. The Company has agreed to ask its shareholders for approval to increase
its authorized shares at its next regularly scheduled shareholder meeting. If
the Note holders convert their notes prior to receiving approval for additional
authorized shares, the Company has the right to make settlement in cash, or at
the Company's option, with a combination of cash and shares.
The Note holders also have the right to require the Company to repurchase the
Notes at 100% of the principal amount plus accrued and unpaid interest on
October 15 in 2010, 2015 and 2020 or in connection with certain corporate change
of control transactions. If the Note holders elect to convert the Notes prior to
October 15, 2010 in connection with certain corporate change of control
transactions, the Company will increase the conversion rate for the notes
surrendered for conversion by a number of additional shares based on the stock
price of the Company on the date of the change of control.
The Company has the right to redeem the Notes at 100% of the principal amount
plus accrued and unpaid interest at any time on or after October 20, 2008. At
any time prior to maturity, the Company may also elect to automatically convert
some or all of the Notes into shares of its common stock if the closing price of
the common stock exceeds $6.40 for a period as specified in the indenture. If an
automatic conversion of the Notes occurs prior to October 15, 2008, the Company
will make an additional payment to the Note holders equal to three full years of
interest, less any interest actually paid or provided for prior to the
conversion date. This payment can be made, at the option of the Company, either
in cash or common stock.
The Company agreed to file a Registration Statement on Form S-3 covering the
resale of all of the Registrable Securities using its best efforts to have the
Registration Statement declared effective within 120 days of the closing.
Depending on the length of time after this 120 day period for the Registration
Statement to be declared effective, the penalty can range from .8% to 1.2% of
the principal amount of the Notes and Warrants. The maximum penalty that may be
incurred is approximately $0.6 million.
The Company has analyzed all of the above provisions in the Convertible Notes
and related agreements for embedded derivatives under FASB Statement No.133,
Accounting for Derivative Instruments and Hedging Activities and related
Emerging Issues Task Force (EITF) interpretations and Securities and Exchange
Commission (SEC) rules. The Company has determined that four such provisions in
the convertible debt agreement are considered derivatives under FASB Statement
No. 133:
- The embedded written option relating to the common stock that may be
potentially issuable upon conversion
- The option for Note holders to put back debt to the Company in
connection with certain corporate change of control transactions
F-16
ATS Medical, Inc.
Notes to Consolidated Financial Statements
- The provision relating to an additional payment in connection with the
automatic conversion of the Notes prior to October 15, 2008
- The provision to increase the conversion rate in the event of a change
in control transaction
The Company prepared valuations of each of the above derivatives and recorded a
$5.5 million liability on the date of issuance of the Notes, with an offsetting
discount to the Convertible Senior Notes.
The derivative liability was adjusted to fair value at December 31, 2005, with
the resulting $2.1 million change in valuation credited to other income. The
liability was $3.4 million at December 31, 2005. The derivative liability is
presented in the balance sheet in the same line as the Convertible Senior Notes
The discount related to the derivative liability is being amortized to interest
expense using the effective interest method over 20 years. At December 31, 2005,
the remaining unamortized discount relating to the Warrants and the derivative
liability was $7.0 million.
In July 2004 the Company entered into an agreement with Silicon Valley Bank to
establish a secured revolving credit facility for $8.5 million. Under terms of
the agreement, the Company received a $2.5 million three-year term loan as well
as a two-year $6.0 million line of credit. Borrowings available under the line
of credit are based on certain receivable and inventory balances. At December
31, 2005, the Company is eligible to borrow $4.4 million on the line of credit.
The term loan carries an interest rate of prime plus 1.0% with a minimum of
5.25%. At December 31, 2005, the actual rate was 8.25%. The line of credit
carries an interest rate of prime plus 1.5% with a minimum rate of 5.75%. The
credit facility contains two financial covenants, a liquidity ratio and a
minimum tangible net worth. Under an amendment to the secured credit facility
agreement effective April 1, 2005, the financial covenants were amended to
require a liquidity ratio of not less than 2.0 to 1.0 and a tangible net worth
of at least $39 million through June 30, 2005, and $36 million thereafter. At
December 31, 2005, the Company was in compliance with its financial covenants.
During 2004 the Company drew down all $2.5 million of the three-year term loan.
The term loan carries 36 equal installment payments which began in February
2005. The future maturities of the long-term debt are $0.8 million in 2006 and
2007 and $0.1 million in 2008. The Company has not drawn any advances and
accordingly has no outstanding balances on the line of credit at December 31,
2005.
8. EXTINGUISHMENT OF DEBT
In July 2003, the Company entered into an agreement with Centerpulse USA
Holdings, Co. (Centerpulse) under which the Company would pay Centerpulse $12
million in exchange for cancellation of all of the Company's payment obligations
under its carbon technology license agreement with Sulzer Carbomedics, Inc. and
provide for Company ownership of the technology license. Prior to this
agreement, the Company was obligated to pay Centerpulse an aggregate of
approximately $28 million under the technology agreement over a period of
approximately four years. The obligations per the agreement were accrued as
specific criteria were met. Of the total $28 million, there were two uncompleted
milestones totaling $12 million not accrued at the time of the agreement. As the
$12 million payment made under the agreement was exceeded by the Company's
accrued liability by approximately $2.6 million, the Company recognized a gain
during the year ended December 31, 2003.
F-17
ATS Medical, Inc.
Notes to Consolidated Financial Statements
9. EMPLOYEE STOCK PURCHASE PLAN
In May 1998, the Company implemented the 1998 ATS Medical, Inc. Employee Stock
Purchase Plan. Under the terms of the plan, employees are eligible to purchase
common stock of the Company on a quarterly basis. Employees can purchase common
stock at 85% of the lesser of the market price of the common stock on the first
day of the quarter or the last day of the quarter. The following table
summarizes the shares issued and issuance prices under the Plan:
FISCAL YEAR NUMBER OF SHARES PRICE RANGE
- ----------- ---------------- -------------
2005 120,465 $2.54 - $3.14
2004 90,203 $2.93 - $4.34
2003 36,762 $0.41 - $2.72
10. COMMON STOCK AND STOCK OPTIONS
The Company has a Stock Option Plan and a Stock Award Plan (the Plans) under
which options to purchase Common Stock of the Company may be awarded to
employees and non-employees of the Company. The options may be granted under the
Plans as incentive stock options (ISO) or as non-qualified stock options
(non-ISO).
The following tables summarize the options to purchase shares of the Company's
Common Stock under the Plans:
STOCK OPTIONS OUTSTANDING
UNDER THE PLANS
-------------------------
WEIGHTED AVERAGE
NON-PLAN OPTION EXERCISE
ISO NON-ISO OPTIONS PRICE PER SHARE
--------- -------- --------- ----------------
Balance at December 31, 2002 758,127 997,667 325,000 5.07
Increase in shares reserved for grant -- -- -- --
Options granted 828,448 20,000 2,500,000 2.49
Options exercised (5,875) (30,000) -- 3.11
Options canceled (285,404) (99,167) (100,000) 5.34
--------- -------- --------- ----
Balance at December 31, 2003 1,295,296 888,500 2,725,000 3.32
Options granted 25,000 50,000 916,000 4.30
Options exercised (45,750) (120,000) (167,944) 1.38
Options canceled (34,596) (358,000) (487,500) 5.43
--------- -------- --------- ----
Balance at December 31, 2004 1,239,950 460,500 2,985,556 3.27
Increase in shares reserved for grant -- -- -- --
Options granted 750 15,000 293,000 3.49
Options exercised (52,125) (2,500) (49,404) 1.82
Options canceled (181,875) (123,000) (331,250) 4.78
--------- -------- --------- ----
Balance at December 31, 2005 1,006,700 350,000 2,897,902 3.09
========= ======== =========
F-18
ATS Medical, Inc.
Notes to Consolidated Financial Statements
OPTIONS OUTSTANDING AT OPTIONS EXERCISABLE AT
DECEMBER 31, 2005: DECEMBER 31, 2005:
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- --------------- ----------- ----------- -------- ----------- --------
$0.37 - $ 0.52 790,291 6.89 years $0.44 516,166 $0.44
0.79 - 2.51 900,036 7.28 years $1.72 398,036 $1.74
2.70 - 3.60 796,700 7.89 years $3.35 731,700 $3.36
3.64 - 3.80 879,000 7.70 years $3.74 879,000 $3.74
3.99 - 8.19 749,075 6.31 years $5.34 749,075 $5.34
8.50 - 12.44 139,500 3.91 years $9.37 139,500 $9.37
- -------------- --------- ---------- ----- --------- -----
$0.37 - $12.44 4,254,602 7.13 years $3.09 3,413,477 $3.51
========= =========
The weighted average fair value of options granted during the years ended
December 31, 2005, 2004, and 2003, was $3.49, $3.32, and $2.05, respectively.
At December 31, 2005, 2004, and 2003, Plan and non-Plan options for 3,413,477,
1,398,293, and 1,045,851 shares of Common Stock, respectively, were exercisable
at weighted average prices of $3.51, $4.33, and $6.35 per share, respectively.
Options can be exercised by tendering shares previously acquired.
In 2002, 50,000 non-Plan options were granted to a non-employee, vesting over
three years to coincide with the period of service. As such, these options were
revalued at each reporting date using an accelerated expense attribution method
and expensed over the vesting periods, which ended in 2005. In 2003, 120,000
non-Plan options were granted to non-employees for prior services rendered,
vesting ratably over two to four year periods. During 2003, the Company
recognized $0.2 million of deferred compensation and $0.1 million of expense
related to these non-Plan, non-employee options. During 2004 and 2005, the costs
recognized by the Company for deferred compensation and expense related to these
non-Plan, non-employee options were not significant.
During the year ended December 31, 2005, restricted stock awards for 351,000
shares of common stock were granted to certain employees. Restricted stock
awards are grants that entitle the holder to shares of common stock as the award
vests. The value of such stock was established by the market price on the date
of the grants. Compensation expense is being recorded over the applicable
restricted stock vesting periods, generally four years. Compensation expense
charged to general and administrative expense related to restricted stock awards
granted was $0.6 million during 2005.
The following table summarizes restricted stock awards activity:
WEIGHTED
WEIGHTED AVERAGE
AVERAGE REMAINING
GRANT DATE CONTRACTUAL
NO. OF SHARES FAIR VALUE TERM
------------- ---------- -----------
Unvested at December 31, 2004 -- -- --
Awards granted 351,000 $3.37 --
Awards vested -- -- --
Awards forfeited (3,000) 3.66 --
------- ----- ----------
Unvested at December 31, 2005 348,000 $3.25 1.53 years
=======
At December 31, 2005, the Company had 6,517,852 shares of Common Stock reserved
for issuance under stock option and award grants, of which 1,915,250 shares were
available for future grants or awards.
F-19
ATS Medical, Inc.
Notes to Consolidated Financial Statements
11. LEASES
The Company has operating leases for its facilities in Plymouth, Minnesota as
well as France, Germany and China. These leases expire at various dates through
November 2011. Future minimum lease payments under these agreements are as
follows (in thousands):
Year ending December 31:
2006 $ 503
2007 511
2008 461
2009 150
2010 and thereafter 92
------
$1,717
======
Rent expense was $0.5 million, $0.4 million, and $0.3 million for 2005, 2004 and
2003, respectively.
12. INCOME TAXES (RESTATED)
At December 31, 2005, the Company had net operating loss carryforwards of
approximately $81 million and credits for increasing research and development
costs of approximately $0.3 million, which are available to offset future
taxable income or reduce taxes payable through 2025. These loss carryforwards
will begin expiring in 2006. The credits continue to expire in 2006 through
2018.
Included as part of the Company's net operating loss carryforwards are
approximately $3.4 million in tax deductions that resulted from the exercise of
stock options. When these loss carryforwards are realized, the corresponding
change in valuation allowance will be recorded as additional paid-in capital.
Components of deferred tax assets and liabilities are as follows (in thousands):
DECEMBER 31
---------------------
2005 2004
---------- --------
(RESTATED)
Deferred tax assets (liabilities):
Net operating loss carryforwards $ 29,886 $ 23,085
Foreign net operating loss caryforwards 832 --
Research and development credits 285 416
Alternative minimum tax credits 31 --
Inventory reserves 80 1,062
Depreciation 847 701
Convertible senior notes derivatives (779) --
Technology license amortization (456) (2,624)
Compensation reserves 460 179
Other 259 313
-------- --------
Net deferred tax assets before valuation allowance 31,445 23,132
Less valuation allowance (31,445) (23,132)
-------- --------
Net deferred tax assets $ -- $ --
======== ========
The Company's ability to utilize its net operating loss carryforwards to offset
future taxable income is subject to certain limitations under Section 382 of the
Internal Revenue Code due to changes in the equity ownership of the Company.
F-20
ATS Medical, Inc.
Notes to Consolidated Financial Statements
Reconciliation of the statutory federal income tax rate to the Company's
effective tax rate is as follows:
2005 2004 2003
----- ----- -----
Tax at statutory rate (34.0)% (34.0)% (34.0)%
State income taxes (4.0) (4.0) (4.0)
Impact of changes in valuation allowance 38.0 38.0 38.0
----- ----- -----
--% --% --%
===== ===== =====
13. COMMITMENTS
In 2002 the Company amended the supply and technology transfer agreements with
Sulzer Carbomedics. The amendment to the supply agreement suspended component
set purchases until January 2007. This postpones component purchases totaling
approximately $21.5 million for the years ended December 31, 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.
14. BENEFIT PLAN
The Company has a defined contribution salary deferral plan covering
substantially all employees under Section 401(k) of the Internal Revenue Code.
The plan allows eligible employees to contribute up to 12% of their annual
compensation, with the Company contributing an amount equal to 25% of each
employee's contribution. The Company recognized expense for contributions to the
plan of $0.2 million in 2005 and $0.1 million in both 2004 and 2003.
15. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK
Since its inception, the Company has operated in a single industry segment:
developing, manufacturing, and marketing medical devices. As a result, the
information disclosed herein materially represents all of the financial
information related to the Company's principal operating segment. The Company
derived the following percentages of its net sales from the following geographic
regions:
2005 2004 2003
---- ---- ----
United States 38% 33% 28%
Europe 28 28 29
Asia Pacific 26 33 32
Other Markets 8 6 11
Sales to one customer, Century Medical-Japan, represented 13%, 16%, and 21% of
the Company's net sales for the years ended December 31, 2005, 2004, and 2003,
respectively.
The Company had balances owing from five customers which aggregated 37% of its
accounts receivable balances at December 31, 2005. The Company had balances
owing from two customers which represented 24% and 11% of its outstanding
accounts receivable balances, respectively, at December 31, 2004 and 2003.
16. RELATED-PARTY TRANSACTION
The Company has a consulting agreement with a former director of the Company
which provides for future compensation through May 2006. An expense for a
substantial portion of the compensation was recognized at the time the agreement
was signed as the Company deferred only the fair value of expected services to
be received under the agreement. The expense related to this agreement has not
been significant for either 2005 or 2004. An expense of $0.1 million was
recognized as a result of this agreement during 2003.
F-21
ATS Medical, Inc.
Notes to Consolidated Financial Statements
17. QUARTERLY FINANCIAL DATA (UNAUDITED AND RESTATED)
Quarterly data for 2005 and 2004 was as follows (in thousands, except loss per
share):
QUARTER
----------------------------------------
FIRST SECOND THIRD FOURTH
------- ------- ------- ----------
(RESTATED)
YEAR ENDED DECEMBER 31, 2005
Net sales $ 7,063 $ 9,307 $ 8,333 $ 9,933
Gross profit 2,762 3,833 2,619 2,594
Net loss (3,959) (3,133) (4,078) (3,224)
Net basic and diluted loss per share $ (0.13) $ (0.10) $ (0.13) $ (0.10)
YEAR ENDED DECEMBER 31, 2004
Net sales $ 6,694 $ 7,548 $ 6,547 $ 7,226
Gross profit 1,927 2,120 1,369 1,371
Net loss (3,305) (3,368) (4,526) (5,444)
Net basic and diluted loss per share $ (0.12) $ (0.12) $ (0.15) $ (0.18)
The conversion feature liability of the Company's Senior Convertible Notes was
adjusted to fair value at December 31, 2005, resulting in a $2.1 million change
in valuation credited to other income, as more fully described in Note 7 above.
The Company charged $1.8 million of production variances and ramp-up costs
related to its pyrolytic carbon manufacturing activities to cost of goods sold
in the fourth quarter of 2005. The Company recorded lower of cost or market
value adjustments against inventories of $0.7 million in the third quarter of
2005 and $0.8 million in the fourth quarter of 2004.
18. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 123 (Revised 2004), Share-Based Payment, which is a revision
of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement
123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees,
and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the
approach in Statement 123(R) is similar to the approach described in Statement
123. However, Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an
alternative.
Statement 123(R) was adopted by the Company on January 1, 2006. The Company is
completing its evaluation of the methodology to use in adopting Statement 123(R)
and estimates that stock compensation expense to be recognized in future years
due to the adoption of Statement 123(R) will be between $0.4 million and $0.6
million in fiscal 2006 and between $0.1 million and $0.2 million in fiscal 2007.
In December 2004, the FASB issued FASB Statement No. 151, Inventory Costs.
Statement 151 requires abnormal amounts of inventory costs related to idle
facility, freight handling, and wasted material expenses to be recognized as
current period charges. Additionally, Statement 151 requires that allocation of
fixed production overheads to the costs of conversion be based on the normal
capacity of the production facilities. The standard is effective for fiscal
years beginning after June 15, 2005. The Company believes the adoption of FASB
Statement No. 151 will not have a material impact on its consolidated financial
results.
F-22
ATS Medical, Inc.
Notes to Consolidated Financial Statements
19. SUBSEQUENT EVENT
On January 23, 2006, the Company entered into an agreement and plan of merger
with 3F Therapeutics, Inc. ("3F"). Under the terms of the Merger Agreement, upon
closing the Company will pay each 3F stockholder its pro-rata portion of an
initial payment of 9,000,000 shares of the Company's common stock, subject to
certain adjustments. The Company will deposit 900,000 shares of the closing
payment in escrow to be held for at least 18 months after closing of the merger
to cover indemnification claims and certain contingencies, and the balance will
be distributed pro-rata to holders of 3F capital stock. In addition to the
initial closing payment, the Company will be obligated to make additional
contingent payments to 3F stockholders of up to 5,000,000 shares of the
Company's common stock upon obtaining either CE mark or FDA approval for 3F's
key products on or prior to December 31, 2013, up to an aggregate of 10,000,000
shares of the Company's common stock. Milestone events also include certain
transactions involving these key products. These contingent payments are subject
to certain rights of set-off for indemnification claims and certain other
events.
The consummation of the merger is subject to customary conditions, and the
Merger Agreement is subject to approval by the Company's shareholders. The
Merger Agreement has already been approved by the requisite number of 3F
stockholders. Subject to these conditions being resolved, the Company
anticipates that the merger will close in the second quarter of fiscal 2006.
F-23