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ATS Medical 10-K 2008 Documents found in this filing:
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-K
Annual Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 2007
Commission File No. 0-18602 ATS MEDICAL, INC.
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (763) 553-7736
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes o No þ
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 o No þ
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 þ No o
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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated
filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act
(Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
The aggregate market value of voting and non-voting stock held by non-affiliates of the registrant
as of June 30, 2007, was approximately $112,416,424 (based on the last sale price of such stock as
reported by the NASDAQ Global Market on such date).
The number of shares outstanding of the registrant’s common stock, $.01 par value per share, as of
March 4, 2008, was 59,768,801 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Pursuant to General Instruction G, the responses to
Items 10, 11, 12, 13 and 14 of Part III of this Form 10-K
are incorporated herein by reference to certain information
contained in the registrant’s definitive Proxy Statement for
its 2008 Annual Meeting of Shareholders.
TABLE OF CONTENTS
Table of Contents
PART I
ITEM 1. BUSINESS
OVERVIEW
ATS Medical, Inc. (hereinafter the “Company,” “ATS,” “we,” “us,” or “our”) is a Minnesota
corporation established in 1987. Our common shares are traded on the NASDAQ Global Market under
the symbol ATSI.
We develop, manufacture, and market medical devices for the treatment of structural heart disease.
Our product offerings are focused on heart valve therapy and the surgical treatment of cardiac
arrhythmias. Our core mission is to build a company with a diversified product portfolio focused
exclusively on the cardiac surgeon. Our objectives are to establish ATS products as the standard
of care for patients with structural heart disease.
From our founding until 2004, 100% of our revenue was from our first product – a mechanical heart
valve. Sales of our mechanical heart valves represented approximately 72% of our revenue in 2007,
compared to 82% and 90% of revenue in 2006 and 2005, respectively. Beginning in 2004, we began to
execute our diversification strategy and since have added several product lines through
distribution agreements or acquisitions. The most significant of these transactions are:
The marketing and sales of these new non-mechanical valve products leverage both our sales and
marketing infrastructure and broaden our relationships with cardiac surgeons. Sales from these and
other new products have grown over the last four years from no revenue in 2004 to 28% of our total
revenue in 2007.
Heart valve therapy revenue consists of revenue from the sale of our mechanical heart valves,
tissue heart valves, heart valve repair products and allograft tissue valves. These products
primarily relate to the repair or replacement of the aortic or mitral valves.
Surgical treatment of atrial fibrillation products consist of tools used to create lesions on
cardiac tissue to inhibit abnormal electrical impulses in the upper chambers of the heart.
Net sales by product group for 2007, 2006 and 2005 are discussed in Item 7 of this Form 10-K.
BUSINESS STRATEGY
The key components of our business strategy to create a profitable, diversified, cardiac
surgery-focused company include:
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OUR MARKETS AND PRODUCTS
Heart Valve Therapy
Heart valve therapy revenue consists of prosthetic heart valves (both mechanical and tissue heart
valves), and heart valve repair products. For 2007, heart valve therapy revenue was $38.6 million,
or 78% of revenue, compared to $35.3 million, or 87% of revenue, in 2006 and $31.7 million, or 91%
of revenue, in 2005. Based on data from Millennium Research Group
2007 and Piper Jaffray Equity Research, the current total
worldwide heart valve market approximates $1.2 billion.
Prosthetic Heart Valve Market
Overview
There are two types of replacement heart valves: tissue and mechanical. Mechanical valves are made
from highly durable materials such as metals and pyrolytic carbon with implant longevity well in
excess of any patient’s lifetime. Tissue valves are made from animal or cadaver tissue or, in
some cases, the patient’s own tissue. Tissue valves have a finite durability and may experience
structural valve deterioration requiring a re-operation to replace the failed valve. They are
suitable for patients less able to tolerate anti-coagulants, those who have a life expectancy less
than the projected longevity of tissue valves, or women in their childbearing years.
Cardiac surgeons choose a valve through consideration of valve selection criteria and a patient’s
life expectancy, medical conditions, and lifestyle preferences. Besides durability, a valve’s
design and materials determine its thrombogenicity, which is the tendency to contribute to the
formation of thrombus or blood clots. Thrombus can impair the performance of a valve. If the
thrombus detaches and begins to move through the bloodstream (embolus), it may create an arterial
blockage leading to stroke or infarction. Mechanical valve recipients must take anticoagulants to
reduce and control thrombogenicity, while tissue valves do not usually require anticoagulant
therapy. Hemodynamics, the measure of how efficiently blood flows through a prosthetic valve, is
an important selection criteria. Blood must flow easily through the valve with minimal pressure
required to open the valve leaflets and limited backflow of blood when the leaflets close. The
valve should exert minimal force on the blood so that damage to fragile blood cells is limited.
Other factors that are important in a surgeon’s choice of a prosthetic valve are the ease of
implantation, patient quality of life and the physician’s familiarity with and confidence in the
valve.
In addition to cardiac surgeons, administrators or business managers at hospitals and clinics have
become increasingly influential in the purchase decision-making process in recent years. The
increasing emphasis on medical cost containment in most world markets has elevated the
decision-making power of the administrator. The administrator tends to focus on cost-effectiveness
and, in some markets, primarily on the cost of the valve.
The worldwide market for prosthetic heart valves is $1.06 billion and in aggregate is projected to
grow at 2% per year. Over time, the mix between mechanical and tissue prosthesis has varied
significantly. It is estimated that the current prosthesis market consists of a worldwide
mechanical heart valve market of $330 million declining at 5% year-over-year, and a worldwide
tissue heart valve market of $730 million growing at 6% year-over-year, per Millennium Research
Group 2007 and Piper Jaffray Equity Research.
Our Mechanical Heart Valve Products
Our ATS Open Pivot Heart Valve was designed to improve upon existing mechanical heart valves
by combining a proprietary open pivot design and other innovative features with the widely accepted
biocompatibility and durability of pyrolytic carbon.
The major design features of the ATS Open Pivot Heart Valve include:
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The ATS Open Pivot Heart Valve provides the following advantages over other currently available
mechanical heart valves:
CarboMedics, Inc. (“CarboMedics,” f/k/a Sulzer CarboMedics) developed the basic design from which
the ATS Open Pivot Heart Valve evolved. In September 1990 we entered into a license agreement with
CarboMedics under which we eventually held an exclusive, royalty-free, worldwide license to
CarboMedic’s open pivot, bileaflet mechanical heart valve design. After making some design changes
in the valve, we finalized the design of the ATS Open Pivot Heart Valve and filed and received our
own U.S. patent covering the design of the ATS Open Pivot Heart Valve. The design modifications
and the resulting U.S. patent covering the new design are the exclusive property of ATS.
In connection with the execution of the license agreement, we were also required to enter into a
long-term supply agreement with CarboMedics in September 1990 under which we were obligated to
purchase pyrolytic carbon components for the ATS Open Pivot Heart Valve from CarboMedics. In
December 1999, we entered into a carbon technology agreement with CarboMedics under which we
obtained an exclusive, worldwide right and license to use CarboMedics’ pyrolytic carbon technology
to manufacture components for the ATS Open Pivot Heart Valve. Under the agreement, CarboMedics
also assisted us in establishing our own pyrolytic carbon component production facility in
Minneapolis, Minnesota.
In June 2002, the long-term supply agreement with CarboMedics was amended to suspend our purchase
obligations for the remainder of 2002 and all of 2003, 2004, 2005 and 2006. The 2002 through 2006
purchase obligations were scheduled to resume, beginning in 2007; however, we believe that
CarboMedics subsequently repudiated and breached the agreement. In January 2007, CarboMedics
served a complaint on us, seeking to enforce the contractual purchase obligations and monetary
damages. This litigation is described in this Form 10-K under Part I, Item 3. “Legal Proceedings.”
Our Tissue Heart Valve Products
In September 2006, ATS Medical acquired 3F Therapeutics, a medical device company based in Lake
Forest, California. 3F was an early stage medical device company at the forefront of the emerging
field of less invasive and minimally invasive closed chest tissue valve replacement. We view the
acquisition of 3F as a major step in executing our long-standing vision of obtaining a leadership
position in all segments of the cardiac surgery market.
ATS 3F Aortic Bioprosthesis
We have completed the development of our first generation tissue valve product, the ATS 3F Aortic
Bioprosthesis. This prosthesis is a biological replacement aortic heart valve that has received
the CE Mark and is available for commercial release in Europe and other foreign countries. In our
premarket approval study conducted for purposes of obtaining approval of the Food and Drug
Administration (“FDA”) for this valve in the United States, over 400 patients were implanted,
totaling over 900 patient years of data to date. The initial results have shown properties that
compare favorably with both mechanical and biological valves presently in the market. The final
clinical module of the premarket approval application to the FDA for the ATS 3F Aortic
Bioprosthesis was submitted during October 2006 and we anticipate receiving FDA approval to
commercialize this product in the second half of 2008.
The major design features of the ATS 3F Aortic Bioprosthesis include:
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The ATS 3F Aortic Bioprosthesis provides the following advantages over other currently available
tissue valves:
We believe that substantial growth in the future within the heart valve industry will be the result
of the introduction of minimally invasive and off-pump products. To address this future demand, we
are currently developing various minimally invasive and off-pump aortic valve concepts.
Our first product in this arena is the sutureless ATS 3F EnableTM Aortic Heart Valve,
which is intended to reduce surgical cross-clamp and cardio-pulmonary bypass time. The Enable
Aortic Heart Valve is designed to eliminate the traditional suturing required to replace a
patient’s diseased aortic heart valve. If suturing can be eliminated from the procedure, surgeons
can potentially reduce procedure time and offer less invasive options for the treatment of aortic
valve disease. In addition, the elimination of suturing offers the potential to significantly
improve valve related hemodynamics by allowing the surgeon to provide a replacement valve of a size
larger than what is traditionally possible with conventionally sutured heart valves. The Enable
Aortic Heart Valve is presently in clinical studies outside the United States. To date, 58
patients had undergone aortic valve replacement with the Enable. Aortic Heart Valve at
seven investigative sites in Europe within both the feasibility and pivotal clinical trial phases,
and eight patients had surpassed the two-year implant duration.
We are also developing an off-pump aortic valve, the ATS Entrata Aortic Valve System™, using
technology and intellectual property, some of which is shared co-exclusively with Edwards
Lifesciences Corporation.
Prosthetic Heart Valve Competition
The prosthetic heart valve market is highly competitive with St. Jude Medical, Inc. as the
mechanical valve market share leader and Edwards Lifesciences Corporation as the tissue valve
market leader. Other companies that sell mechanical valves include Medtronic, Inc., CarboMedics,
Sorin Biomedica sPa (only outside the United States), and Medical
Carbon Research Institute LLC. Other companies that sell tissue
valves include St. Jude Medical, Medtronic, Sorin Biomedica and CryoLife, Inc.
We are aware of several companies that are developing new prosthetic heart valves. Several
companies are developing and testing new autologous (created from the patient’s own tissue) valves,
potentially more durable tissue valves and new bileaflet and trileaflet mechanical designs. Other
companies are pursuing biocompatible coatings to be applied to mechanical valves in an effort to
reduce the incidence of thromboembolic events and to treat tissue valves to forestall or eliminate
calcific degeneration in these valves. Competition within the prosthetic heart valve market is
based on, among other things, clinical performance record, minimizing complications, ease-of-use
for the surgeon, patient comfort and quality of life and cost-effectiveness.
We believe that the most important factors in a heart surgeon’s selection of a particular
prosthetic valve are the perceived benefits of the valve and the heart surgeon’s confidence in the
valve design. As a result, valves that have developed a favorable clinical performance record have
a significant marketing advantage over new valves. In addition, negative publicity resulting from
isolated incidents can have a significant negative effect on a valve’s overall acceptance. Our
success is dependent upon the surgeon’s willingness to use a new prosthetic heart valve as well as
the future clinical performance of the ATS Open Pivot Heart Valve and the ATS 3F tissue heart
valves compared with the more established competition.
Heart Valve Repair Market
Overview
Depending on the type and severity of a patient’s heart valve disease, it may be preferable to
repair their damaged valve as opposed to complete removal and replacement with either a mechanical
or tissue heart valve. The worldwide market for heart valve repair is estimated at $142 million
and growing approximately 7% per year, according to Millennium
Research Group 2007 and Piper Jaffray Equity Research.
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Our Heart Valve Repair Products
We commenced development and manufacturing of a line of cardiac surgical products in 2005 pursuant
to our exclusive worldwide development, supply and distribution agreement with GBI. Our
partnership with GBI provides us with access to a portfolio of patents, intellectual property and
important manufacturing and product development experience specific to heart valve repair and the
related tools and accessories for entry into this segment of the heart valve therapy market.
In February 2006, we began to market and sell the first of these products, the ATS
Simulus® Flexible annuloplasty repair rings and bands. This is a fully flexible ring
that conforms to a patient’s unique anatomy. In 2007, we received FDA clearance for the ATS
Simulus® Semi-Rigid Annuloplasty Ring and our ATS Simulus® Adjustable repair
rings. The semi-rigid ring features a unique Flex-Zone™ anterior segment, which
respects the natural motion of the mitral annulus and its proximity to the aortic valve, allowing
for a safer, more physiologic valve repair. The adjustable ring incorporates many of the same
features of the flexible rings and bands while allowing the surgeon to precisely accommodate
individual patient anatomies by adjusting the positioning and shape of the ring after implantation.
The major design features of the ATS Simulus annuloplasty rings include:
The ATS Simulus annuloplasty rings provide the following advantages over other currently available
annuloplasty rings:
Heart Valve Repair Market Competition
Advancements are being made in surgical procedures such as mitral valve reconstruction, whereby the
natural mitral valve is repaired, delaying the need for a replacement valve. Developments include
continued expansion of the available repair rings and bands to fit physician needs and specific
patient anatomies and to enable less invasive surgery. The heart valve repair market is very
competitive. Edwards Lifesciences is the market leader. Medtronic, St Jude Medical and Sorin
Biomedical also participate in the heart valve repair market.
Surgical Cardiac Ablation Market
Overview
Atrial fibrillation (“AF”) is the most common type of irregular heartbeat. It is found in about
three million Americans and the incidence increases with age. When a person has AF, the electrical
impulses that control the natural heartbeat travel erratically. The result is a very rapid and
disorganized atrial heartbeat. Because the atria are beating rapidly and irregularly, blood does
not flow through the atria as quickly or efficiently. The inefficient beating can cause clots to
form. If a clot is pumped out of the heart, it can travel to the brain, resulting in a stroke. The
likelihood of a stroke in people with AF is 5 to 7 times higher than in the general population. AF
combined with a prolonged rapid heart rate can also lead to heart failure.
Cryoablation involves the use of extremely cold temperatures to stop electrical conductivity in
certain areas of the heart while leaving underlying connective tissues largely unaffected..
Additionally, by placing lines of ablation in a specific anatomic pattern, the surgeon can direct
the path of electrical impulses to restore sinus conduction.
Historically, the ablation pattern that has the greatest success in restoring sinus rhythm is the
original cut-and-sew Maze procedure established by Dr. James L. Cox. The Maze procedure has
demonstrated freedom from AF with over 15 years of follow-up data. Cryoablation allows surgeons to
perform the Maze procedure with a less invasive technique.
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The U.S. market for the surgical cardiac ablation market is estimated at $100 million, according to
Millennium Research Group 2007. The worldwide market for the surgical cardiac ablation market is
estimated at $121 million and growing approximately 17% per year, according to Millennium Research
Group 2007 and Piper Jaffray Equity Research.
Our Surgical Cryotherapy Products
We market and sell surgical cryoablation products for the treatment of cardiac arrhythmias acquired
through our June 2007 acquisition of the surgical cryoablation business of CryoCath.
We started marketing and selling this technology in the United States in the first quarter of 2005
and in markets outside of the United States in the second quarter of 2005 under a November 2004
global partnership agreement with CryoCath. Pursuant to this partnership, we were granted
co-promotion rights in the United States, earning an agency commission on sales to accounts as
specified in the partnership agreement, and distribution rights in the rest of the world. This
partnership agreement was in effect until our acquisition of CryoCath’s surgical cryoablation
business in June 2007.
We currently market and sell four surgical cryotherapy products, including the ATS CryoMaze™
Surgical Ablation Probe (7 and 10 cm sizes), the ATS FrostByte™ Surgical Ablation Clamp and the ATS
CryoMaze Surgical Ablation Console. Most of our cryotherapy product revenue is derived from
probes, which are single-use devices used for freezing tissue in seconds and which are very
malleable to conform to an individual’s anatomy. To date, the cryotherapy products we have sold
have been focused on open chest surgical procedures performed concomitantly with other cardiac
surgery procedures.
The major design features of the ATS CryoMaze products include:
Cryotherapy provides the following advantages over the more prevalent heat-based therapies:
During 2008, we plan to launch new products and protocols, which will provide us with an entrance
into the market for stand-alone surgical treatment of AF.
Advancements in the market for surgical ablation include tools to enable safer, quicker, and more
effective lesions creation in cardiac tissue. The market today consists primarily of Atrial
Fibrillation treatment in conjunction with or concomitant to another cardiac surgery procedure and
done with an open chest. We are aware of several companies that are developing new ablation tools.
The majority of these tools utilize heat-based energy and will therefore not be able to safely
complete the Maze lesion set. There has been a recent trend among cardiac surgeons to hold surgical
ablation technologies to a higher level of scrutiny with advanced long-term monitoring to ensure
freedom from Atrial Fibrillation. We believe these new tools will be held to this new standard of
scrutiny.
Significant efforts are currently being developed to enable a sole therapy solution consisting of a
full Maze lesion set that can be achieved with a closed chest with port access on a beating heart.
Surgical Cardiac Ablation Competition
Competition in the surgical AF market consists primarily of heat-based energy sources from
AtriCure, Inc. and Medtronic. ATS cryoablation products hold a third-place position in the market,
with approximately 12% of the U.S. market. Other companies that produce AF ablation technologies
include St Jude Medical and Estech.
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Boston Scientific Corporation, which previously held the
fourth-place position (Health Research International, 2006 data), has recently disbanded their
microwave-based product line.
MARKETING, SALES AND DISTRIBUTION
Overview
A key component of our business strategy is to leverage the investments we have made in our
marketing, sales and distribution resources through higher sales of new products in addition to
increased sales of our ATS Open Pivot Heart Valve. We have been steadily building both our
domestic and international sales and marketing infrastructure. Because sales prices in the United
States exceed sales prices in most other markets, we believe our future success will, in large
measure, depend on achieving increased market share and leveraging our sales force through the
introduction of new products in the United States. In 2007, our U.S. sales were 38% of overall
sales. In 2000, U.S. sales represented 4% of overall sales. See Note 15 of “Notes to Consolidated
Financial Statements” in Item 8 of this Form 10-K for more information regarding our sales to
customers.
U.S. Marketing and Sales
As of December 31, 2007, our sales organization in the United States consists of a Vice President
of Sales and three area directors managing 28 sales territories. Our representation within these
territories consists of both direct sales representatives and independent agents. We focus our
sales and marketing efforts on increasing awareness of our products in the approximately 950 U.S.
open heart centers.
International Marketing, Sales and Distribution
During 2006, we opened an administrative office in Austria, which we utilize as the European
support center for our current and future direct selling operations in Europe. We have direct
sales organizations in France (since 2003), Germany (since 2005), the United Kingdom (since 2006),
Belgium and the Netherlands (started in 2007) and Switzerland (also started in 2007) as well as
direct marketing organizations in China (since 2004) and India (since 2005). For our European
direct selling operations, we maintain consignment inventories at in-country hospitals.
We sell through independent distribution networks in other markets throughout the world. We
believe that our distribution partners have provided a rapid and cost-efficient means of increasing
market penetration and commercial acceptance of our products in key international markets. We have
been able to attract experienced medical device sales organizations and people familiar with local
markets and customs to serve as our representatives. Each of our independent distributors has the
exclusive right to sell certain ATS products within a defined territory. These distributors, in
some instances, also market other medical products, although they have agreed not to sell other
mechanical heart valves. Under most of the distributor agreements, we may, at our option, terminate
the agreement upon the departure of certain key employees of the distributor, if we experience a
change in control or if key performance criteria, including sales quotas, are not met. Our sales,
marketing and customer service personnel provide professional sales, marketing and promotional
support to our independent distributors. We sell our products to international distributors F.O.B.
Minneapolis, Minnesota, denominated in U.S. dollars. See Note 15 of “Notes to Consolidated
Financial Statements” in Item 8 of this Form 10-K for information on our net sales by geographic
region. Net sales both inside and outside the United States are also discussed in Item 7 of this
Form 10-K.
Competition
Competition in the medical device industry is intense and is characterized by extensive research
efforts and rapid technological progress. We believe the primary competitive factors include
quality, technical capability, innovation, distribution capabilities and price. Many of our
competitors in the heart valve market have greater resources, more widely-accepted products,
greater technical capabilities and stronger name recognition than we do. Our competitive
capability is affected by our ability to support our products, ensure regulatory compliance for our
products, protect the proprietary technology of our products and their manufacturing processes,
effectively market our products, and maintain and establish distribution relationships. In order
to maintain
these capabilities, ATS must continuously attract and retain skilled and dedicated employees and
develop and maintain excellent relationships with physicians and suppliers.
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Cardiac surgery products are currently being marketed to hospitals at prices that vary
significantly from country to country due to market conditions, currency valuations, distributor
mark-ups and government regulations. In many markets, government agencies are imposing or proposing
price controls or restrictions on medical products. We work with our independent distributors to
price our products in each market to meet these limitations. In addition, our primary competitors
have the ability, due to economies of scale, to manufacture their valves at a lower cost than we
can currently manufacture the ATS Open Pivot and ATS 3F heart valves. The market leader has
occasionally used price as a method to compete in several markets.
MANUFACTURING AND SUPPLY
Our mechanical heart valves are manufactured in ISO 13485:2003 certified facilities. We have two
mechanical heart valve production facilities in close proximity in Plymouth, a suburb of
Minneapolis, Minnesota, for our manufacturing activities. Our pyrolytic carbon mechanical valve
components are manufactured in one facility. In the other facility, we assemble our mechanical
valves in controlled clean room environments. Most of the materials we purchase for our products
are supplied by a limited number of vendors. We are currently operating one manufacturing shift at
our valve assembly facility. At our pyrolytic carbon facility, most processes are operating one
manufacturing shift while some operate up to three manufacturing shifts. We have been ramping up
our pyrolytic carbon manufacturing facility over the past three years under an initiative to become
a low-cost, self-supplier of the critical carbon components necessary to manufacture our mechanical
heart valves. While this initiative has resulted in ramp-up and start-up expenses, low initial
production yields, and higher-than-normal scrap costs, our gross margins have improved in 2005,
2006 and 2007.
Our ATS 3F tissue heart valves are manufactured in a controlled clean room environment in an ISO
13485:2003 certified facility in Lake Forest, California. Most of the materials used to construct
the valve are supplied by a limited number of qualified vendors. We currently operate one
manufacturing shift at the Lake Forest facility. We have been ramping up our tissue valve
production in preparation for a market launch of the ATS 3F Aortic Bioprosthesis. In addition, we
also manufacture significant quantities of our next generation tissue valves for use in
pre-clinical and clinical testing. These initiatives have resulted in low production yields and
inefficiencies. As our tissue valve volume increases, we expect our yields will increase and our
process will become more efficient.
We are currently in the process of qualifying and ramping up the production of surgical cryotherapy
products after our June 2007 acquisition of the surgical cryoablation business of CryoCath. We
anticipate we will continue to purchase inventory from CryoCath until mid-2008. The Plymouth,
Minnesota manufacturing facility has been approved by international regulatory agencies to
manufacture surgical cryotherapy products. Prior to the manufacturing transition, we anticipate we
will incur significant period costs related to under-absorption of labor and overhead costs as well
as training, testing and validation costs.
For our heart valve repair and surgical tools and accessories franchises, we do not manufacture or
produce the products we sell, and we only service some of these products.
We believe our properties are adequate to serve our business operations for the foreseeable future.
At our Plymouth, Minnesota facility and our sales offices for our foreign subsidiaries in France
and Germany, we warehouse our mechanical valve inventories and products for cardiac arrhythmias and
heart valve repair.
We maintain a comprehensive quality assurance and quality control program, which includes
documentation of all material specifications, operating procedures, equipment maintenance and
quality control test methods. Our documentation systems comply with the FDA Quality System
Regulation (“QSR”) and ISO 13485:2003 requirements.
RESEARCH AND DEVELOPMENT
Our research and development (“R & D”) activities include developing new products, improving our
current products, and the clinical and regulatory activities to support our products. These
activities are carried out in our Plymouth and Lake Forest facilities, although we work with
physicians, research hospitals and universities around the world. None of this work is funded by
customers or other outside institutions. The development process for any new product can range
from several months to several years, primarily depending on the
regulatory pathway required for approval. R & D expenses totaled $7.5 million in 2007, net of $3.5
million of in-process research and development related to the CryoCath asset acquisition, $3.4
million in 2006, net of $14.4 million of in-process research and development related to the 3F
acquisition, and $1.7 million in 2005. At December 31, 2007 our R & D headcount totaled 20
employees.
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FINANCIAL INFORMATION ABOUT SEGMENTS
Since our inception, we have operated in the single industry segment of developing, manufacturing
and marketing medical devices.
SEASONALITY
Our sales and operating results have varied and are expected to continue to vary significantly from
quarter to quarter as a result of seasonal patterns. We expect that our business will be seasonal,
with the third quarter of each year typically having the lowest sales, due to vacation and time-off
periods in our international markets, especially Europe.
PATENTS AND PROPRIETARY TECHNOLOGY
Our policy is to protect our proprietary position by securing U.S. and foreign patents that cover
the technology, inventions and improvements important to our business. The original patent
obtained by CarboMedics under which our valve was developed expired in 2004. We subsequently made
modifications to the basic design. We obtained a U.S. patent covering the improvements to the ATS
Open Pivot Heart Valve in October 1994. This patent expires in 2011. We have also obtained issued
patents in Japan, Belgium, France, Germany, the Netherlands, Spain, Switzerland and the United
Kingdom relating to these improvements. We cannot be certain that any patents will not be
challenged or circumvented by competitors.
Our ATS 3F tissue valve platforms are supported by an extensive intellectual property portfolio.
We own 65 issued U.S. and foreign patents and 49 U.S. and foreign patent applications that protect
our core technology in the tissue valve market. These patents expire on various dates ranging from
September 2011 to April 2025, with 10 of the patents expiring in 2013 and 46 of the patents
expiring in the period from 2021 to 2025. We also hold co-exclusive rights to certain intellectual
property, including the “Anderson Patents” for minimally invasive valve deployment.
Our ATS cryoablation platforms for treatment of AF are also supported by a licensed intellectual
property portfolio comprising 16 issued U.S. and foreign patents and 17 U.S. and foreign patent
applications that protect our core technology in the market. These patents expire on various dates
ranging from September 2016 to June 2023.
The effect of these patents is to give us the ability to practice certain technologies and the
right to preclude third parties from making, using, selling or offering to sell products which
infringe upon the claims made in each of these patents within the jurisdiction of the country where
the patent is issued. We believe the claims covered by the issued patents are broad and cover many
unique attributes of the products we plan for commercialization and the processes we use to
fabricate these products.
We also rely on trade secrets and technical know-how in the manufacture and marketing of both our
mechanical and tissue heart valves. We typically require our employees, consultants and
contractors to execute confidentiality agreements with respect to our proprietary information.
We claim trademark protection on ATS Medical™, ATS Open Pivot®, ATS 3F® Aortic Bioprosthesis, ATS
3F Enable™ Aortic Bioprosthesis and ATS CryoMaze™ and either claim or have applied for trademark or
tradename protection on most of our product offering names. U.S. trademark and service mark
registrations are generally for a term of 10 years, renewable every 10 years so long as the
trademark is used in the regular course of trade. We have also been granted rights by certain
partners to use their trademark(s) in our sales and marketing activities of their products and
services.
GOVERNMENT REGULATION
United States
Numerous governmental authorities, principally the FDA and corresponding state regulatory agencies,
strictly regulate our products and research and development activities. The Federal Food, Drug, and
Cosmetic Act, the regulations promulgated under this act, and other federal and state statutes and
regulations, govern, among other things, the pre-clinical and clinical testing, design,
manufacture, safety, efficacy, labeling, storage, record keeping, advertising and promotion of
medical devices. The FDA classifies our ATS heart valves as a Class III device, which is subject to
the highest level of controls.
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Generally, before we can market a new medical device, we must obtain marketing clearance through a
510(k) premarket notification, approval of a premarket approval application (“PMA”) or approval of
product development protocol (“PDP”). A PMA or PDP application must be submitted if a proposed
device does not qualify for a 510(k) premarket clearance procedure. It generally takes several
months from the date of a 510(k) submission to obtain clearance, but it may take longer,
particularly if a clinical trial is required. The PMA and PDP process can be expensive, uncertain,
require detailed and comprehensive data and generally take significantly longer than the 510(k)
process.
If human clinical trials of a device are required, either for a 510(k) submission or a PMA
application, the sponsor of the trial, usually the manufacturer or the distributor of the device,
must file an investigational device exemption (“IDE”) application prior to commencing human
clinical trials. The IDE application must be supported by data, typically including the results of
animal and/or laboratory testing. If the IDE application is approved by the FDA and one or more
appropriate institutional review boards (“IRBs”), human clinical trials may begin at a specific
number of investigational sites with a specific number of patients, as approved by the FDA. If the
device presents a non-significant risk to the patient, a sponsor may begin the clinical trial after
obtaining approval for the study by the IRBs without separate approval from the FDA. Submission of
an IDE does not give assurance that the FDA will approve the IDE and, if it is approved, there can
be no assurance the FDA will determine that the data derived from the studies support the safety
and efficacy of the device or warrant the continuation of clinical trials. An IDE supplement must
be submitted to and approved by the FDA before a sponsor or investigator may make a change to the
investigational plan that may affect its scientific soundness, study indication or the rights,
safety or welfare of human subjects.
We are also subject to the FDA QSR concerning manufacturing processes and reporting obligations.
These regulations require that manufacturing steps be performed according to FDA standards and in
accordance with documentation, control and testing standards. The FDA monitors compliance with its
good manufacturing practices regulations by conducting periodic inspections. We are required to
provide information to the FDA on adverse incidents as well as maintain a detailed record keeping
system in accordance with FDA guidelines.
The advertising of our products is also subject to both FDA and Federal Trade Commission
regulations. In addition, we will be subject to the “fraud and abuse” laws and regulations
promulgated by the U.S. Department of Health and Human Services and the U.S. Health Care Finance
Administration if we sell ATS products to Medicare or Medicaid patients. Under these regulations,
it is a criminal offense (subject to certain exceptions) to knowingly or willfully offer, pay,
solicit or receive remuneration in order to induce business for which reimbursement may be provided
under a federal healthcare program.
If the FDA believes we are not in compliance with law, it can institute proceedings to detain or
seize products, issue a recall, enjoin future violations and assess civil and criminal penalties
against us and our officers and employees. If we fail to comply with these regulatory requirements,
our business, financial condition and operating results could be harmed. In addition, regulations
regarding the manufacture and sale of our products are subject to change. We cannot predict the
effect, if any, that these changes might have on our business, financial condition and operating
results.
International
In order to market our products in European and other foreign countries, we must obtain required
regulatory approvals and comply with extensive regulations governing product safety, quality and
manufacturing processes. These regulations vary significantly from country to country and with
respect to the nature of the particular medical device. The time required to obtain these foreign
approvals to market our products may be longer or shorter than in the United States, and
requirements for licensing may differ from FDA requirements.
In order to market our products in the member countries of the European Union, we are required to
comply with the medical devices directive and obtain CE mark certification. The CE mark denotes
conformity with European standards for safety and allows certified devices to be sold in all
European Union countries.
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THIRD-PARTY REIMBURSEMENT
In the United States, healthcare providers that purchase medical devices, including our products,
generally rely on third-party payers, including Medicare, Medicaid, private health insurance
carriers and managed care organizations, to reimburse all or part of the cost and fees associated
with the procedures performed using these devices. The commercial success of the ATS heart valve,
as well as many of our other products, will depend on the ability of healthcare providers to obtain
adequate reimbursement from third-party payers for the surgical procedures in which our products
are used. Third-party payers are increasingly challenging the coverage and pricing of medical
products and procedures. Even if a procedure is eligible for reimbursement, the level of
reimbursement may not be adequate. In addition, third-party payers may deny reimbursement if they
determine that the device used in the treatment was not cost-effective or was used for a
non-approved indication.
In international markets, market acceptance of our products also depends in part upon the
availability of reimbursement from healthcare payment systems. Reimbursement and healthcare
payment systems in international markets vary significantly by country. The main types of
healthcare payment systems in international markets are government-sponsored healthcare and private
insurance. Countries with government-sponsored healthcare, such as the United Kingdom, have a
centralized, nationalized healthcare system. New devices are brought into the system through
negotiations between departments at individual hospitals at the time of budgeting. In many of the
countries where we market our products, the government sets an upper limit of reimbursement for
various valve types. In most foreign countries, there are also private insurance systems that may
offer payments for alternative devices.
We have pursued reimbursement for our products internationally through our independent
distributors. While the healthcare financing issues in these countries are substantial, we have
been able to sell our products to private clinics and nationalized hospitals in each of the
countries served by our distributors.
All third-party reimbursement programs, whether government-funded or insured commercially, inside
the United States or outside, are developing increasingly sophisticated methods of controlling
health care costs through prospective reimbursement and capitation programs, group purchasing,
redesign of benefits, second opinions required prior to major surgery, careful review of bills,
encouragement of healthier lifestyles and exploration of more cost-effective methods of delivering
healthcare. These types of programs can potentially limit the amount that healthcare providers may
be willing to pay for medical devices.
PRODUCT LIABILITY AND INSURANCE
Cardiovascular device companies are subject to an inherent risk of product liability and other
liability claims in the event that the use of their products results in personal injury. Heart
valves are life-sustaining devices, and the failure of any heart valve usually results in the death
of the patient. We have not received any reports of mechanical failure of our valves implanted to
date. Any product liability claim could subject us to costly litigation, damages and adverse
publicity.
We currently maintain a product liability insurance policy with an annual coverage limit of $25
million in the aggregate. We are financially responsible for any uninsured claims or claims which
exceed the insurance policy limits. Product liability insurance is expensive for mechanical
valves. If insurance becomes completely unavailable, we must either develop a self-insurance
program or sell without insurance. The development of a self-insurance program would require
significant capital.
EMPLOYEES
As of December 31, 2007, we employed approximately 245 full-time and part-time employees worldwide.
Our employees are vital to our success. We believe we have been successful in attracting and
retaining qualified personnel. We believe our employee relations are good.
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EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers are as follows:
Michael D. Dale has served as our Chairman of the Board since April 2003 and our, Chief Executive
Officer and President since October 2002. From 1998 to 2002, Mr. Dale was Vice President of
Worldwide Sales and Marketing at Endocardial Solutions, Inc., a company that developed and marketed
an advanced cardiac mapping and catheter navigation system for the diagnosis and treatment of
cardiac arrhythmias. From 1996 to 1998, Mr. Dale was Vice President of Global Sales for
Cyberonics, Inc., a neuromodulation medical device company, and additionally was Managing Director
of Cyberonics Europe S.A. From 1988 to 1996, Mr. Dale served in several capacities at
cardiovascular medical device manufacturer and marketer St. Jude Medical, most recently as the
Business Unit Director for St. Jude Medical Europe. Mr. Dale began his medical device career with
American Edwards Laboratories where he sold cardiovascular devices from 1983 to 1988. Mr. Dale is
on the board of directors of Neuronetics, a world leader in Transcranial Magnetic Stimulation (TMS)
Therapy, which involves the use of MRI-strength magnetic fields to stimulate nerve cells in the
brain, for the treatment of patients suffering from depression. Mr. Dale also serves on the
Advanced Medical Technology Association (AdvaMed) Board of Directors.
Jeremy J. Curtis has served as our Vice President, Worldwide Marketing since joining ATS in June
2007. Prior to joining ATS, Mr. Curtis served in a variety of capacities at GE Healthcare, a
medical imaging and diagnostics subsidiary of the General Electric Company, from August 2001 to
June 2007. Most recently he served as General Manager, Global Diagnostic Cardiology Marketing,
preceded by a role in GE Healthcare Asia as General Manager, Cardiology Systems. From 1997 to
2001, Mr. Curtis served in varying commercial roles at Chiquita Brands International, a global
producer, distributor and marketer of fresh produce and consumer package goods. Mr. Curtis’ global
marketing background includes multiple international assignments including China, Western Europe
and Latin America.
Michael R. Kramer has served as our Chief Financial Officer since August 2007. Mr. Kramer joined
ATS as our Senior Director of Finance in September 2006 and was appointed Acting Chief Financial
Officer in February 2007. During 2006, prior to joining ATS, Mr. Kramer was engaged by ATS as an
independent financial consultant. From February 2005 to May 2006, Mr. Kramer served as Controller
at CABG Medical, Inc., a cardiovascular device manufacturer. During 2004, Mr. Kramer was a
Corporate Finance Manager at Ecolab, Inc., a developer and marketer of products and services to the
hospital, foodservice, healthcare and industrial markets. From December 1999 through July 2004,
Mr. Kramer worked at Ernst & Young LLP, a global professional services firm, where he served as a
manager in the assurance and advisory services practice from September 2002 until July 2004.
David R. Elizondo has served as our Vice President of Research and Development and General Manager,
Tissue Operations, since September 2006. From July 2000 to August 2006, Mr. Elizondo served in
several capacities at Boston Scientific Corporation, a developer of technologies and products for
interventional and
surgical procedures, and most recently served as the Director of New Business Development for
Boston Scientific’s Cardiology Division.
AVAILABLE INFORMATION
Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K and amendments to those reports filed or furnished to the Securities and Exchange Commission
(the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the
“Exchange Act”) are available free of charge through our website (www.atsmedical.com) as soon as
reasonably practicable after we electronically file the material with, or furnish it to, the SEC.
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ITEM 1A. RISK FACTORS
Our business faces many risks. Any of the risks discussed below could have a material impact on
our business, financial condition or operating results
If our productse do 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 ATS’ principal
products in the United States, which is the largest revenue market in the world for medical
devices. The U.S. medical community’s acceptance of ATS’ products will depend upon our ability to
demonstrate the safety and efficacy, advantages, long-term clinical performance and
cost-effectiveness of ATS’ products as compared to other products. We cannot predict whether the
U.S. medical community will accept ATS’ products or, if accepted, the extent of its use. Negative
publicity resulting from isolated incidents involving ATS’ products or other products related to
those we sell could have a significant adverse effect on the overall acceptance of our heart valve.
If we encounter difficulties developing a market for our products in the United States, we may not
be able to increase our revenue enough to achieve profitability, and our business and operating
results will be seriously harmed.
We currently rely on the ATS mechanical heart valve as our primary source of revenue. If we are
not successful in selling this product, our operating results will be harmed.
Since 2005 we have marketed products other than mechanical heart valves. These products
represented approximately 28% of net revenues for the year ended December 31, 2007. However, there
can be no assurance that these new products will decrease our dependence on 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. 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 operating results.
The anticipated benefits associated with our recent acquisitions may not be realized.
We completed the acquisition of 3F in September 2006 and the acquisition of the surgical
cryoablation business of CryoCath in June 2007. We expect that these acquisitions will result in
several benefits, including, among others, an expanded heart value product line in connection with
the acquisition of the tissue heart valve business of 3F, an enhanced owned product portfolio and
opportunity to leverage our revenues and margins under our pre-existing distribution and agent
agreements in connection with the CryoCath acquisition, and cross-selling opportunities, enhanced
technology, cost savings and operating efficiencies in connection with both acquisitions. However,
achieving the anticipated benefits of these acquisitions is subject to a number of uncertainties,
including whether 3F’s development-stage products are ultimately marketable, whether we can
commercialize the acquired CryoCath development project related to treatment of arrhythmias on a
stand-alone minimally invasive basis, whether we are able to gain regulatory approvals to
commercialize products manufactured within our own facility, whether we are able to integrate the
businesses in an efficient and effective manner and general competitive factors in the marketplace.
Failure to achieve the anticipated benefits of these acquisitions could result in decreases in the
amount of expected revenues, increased costs and diversion of management’s time and energy, and
could materially impact our business, financial condition and operating results.
We may have difficulty integrating recently acquired businesses and may incur substantial costs in
connection with the integration process.
Integrating the operations of 3F and the surgical cryoablation business of CryoCath into our
existing business will be a complex, time-consuming and expensive process. Before these
acquisitions, ATS and 3F, as well as the surgical cryoablation assets of CryoCath, were operated
independently, each with its own products, customers, employees, culture and systems. We may
experience material unanticipated difficulties or expenses in connection with the integration of
these acquired businesses into ATS due to various factors, including:
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We have limited experience in integrating operations on the scale represented by these
acquisitions, and it is not certain that we can successfully integrate the acquired businesses in a
timely or efficient manner, or at all, or that any of the anticipated benefits of the acquisitions
will be realized. Failure to do so could have a material adverse effect on our business, financial
condition and operating results.
In addition, many of the factors listed above are outside our control. The time and expense
associated with converting the businesses into 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 occur, 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 our
business, financial condition and operating results.
In 2002, we began using a combination of direct sales persons and independent manufacturing
representatives to sell our products in the United States. If our U.S. sales strategy is not
successful, we will not be able to continue our operations as planned.
The sales approach for the sale of our products in the United States consists primarily of direct
salespersons with a few independent manufacturers’ representatives. We will need to continue to
expend significant funds and management resources to develop and maintain this hybrid sales force.
We believe that 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 our products
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 operating results.
We currently depend on the marketing and sales efforts of international independent distributors.
Our products are sold internationally through independent distributors. The loss of an
international distributor could seriously harm our business and operating results 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.
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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.
In 2007, approximately 62% of our net sales were derived outside of the United States. We expect
that international sales will account for a substantial majority of our revenue until our products
receive wider market acceptance from U.S. customers and until 3F obtains pre-market approval to
sell its 3F Aortic Bioprosthesis or other products in the United States. Accordingly, any material
decrease in foreign sales may materially and adversely affect our operating results.
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 operating results could also be harmed by risks inherent in doing business in
international markets, including:
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. We had net
losses of approximately $14.4 million for 2005, $27.7 million for 2006 and $23.0 million for 2007.
As of December 31, 2007, we had an accumulated deficit of approximately $132.6 million. We expect
to incur significant expenses over the next several years as we continue to devote substantial
resources to the commercialization and marketing 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.
In addition, if the benefits of the merger with 3F and our acquisition of the surgical cryoablation
assets of CryoCath do not exceed the associated costs, the combined company could be adversely
affected by incurring additional or even increased losses from its operations. Our ability to
succeed after the merger with 3F and the acquisition of the surgical cryoablation assets of
CryoCath depends on making our combined operations profitable through increased revenue and reduced
expenses for the combined company. If we fail to make our combined operations profitable through
increased revenue and decreased expenses, it would harm our business, financial condition and
operating results.
Purchase accounting treatment of the merger with 3F and acquisition of the surgical cryoablation
assets of CryoCath could result in net losses for the foreseeable future.
We have accounted for the merger with 3F and purchase of the surgical cryoablation assets of
CryoCath using the purchase method of accounting. For the 3F acquisition, the estimated market
value of shares of our common stock issued in the merger and the amount of the merger transaction
costs were recorded as the cost of acquiring 3F. For the acquisition of the surgical cryoablation
assets of CryoCath, the initial purchase price recorded was equal to the initial cash consideration
paid to CryoCath, plus the amount of transaction costs and the present value of the cash payment
due to CryoCath two years from closing. In each case, the cost has been allocated to the
individual assets acquired and liabilities assumed, including various identifiable intangible
assets such as acquired technology, acquired trademarks and tradenames, based on their estimated
fair values at the date of acquisition. The excess of the purchase price over the fair market
value of the net assets has been allocated as goodwill. The amount of the purchase price allocated
to goodwill and the other intangible assets in connection with the acquisition of 3F is
approximately $12.3 million. The preliminary amount of the initial purchase price currently
allocated to goodwill and other intangible assets in connection with the purchase of the surgical
cryoablation assets of CryoCath is approximately $21.8 million. Our estimates are based upon
currently available information and assumptions that we believe are reasonable. We continue the
process of gathering information to finalize the
valuation of certain assets in the CryoCath asset acquisition, primarily the valuation of acquired
intangible assets. However, there can be no assurance that the actual useful lives will not differ
significantly from the current estimates. The amortization of other intangible assets could result
in net losses for ATS for the foreseeable future, which could have a material adverse effect on the
market value of our common stock.
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If we do not receive shareholder approval to issue an equity warrant to Alta Partners VIII, L.P.
(“Alta”) in exchange for their cash warrant, our cash balances may be insufficient to settle the
cash liability upon exercise, we may need to raise additional equity or incur debt to settle this
liability and our earnings may be adversely affected.
In connection with our June 2007 equity financing, we issued a common stock warrant to Alta on
1,960,000 shares of our common stock. The form of warrant issued to Alta is that of a cash
warrant. If we do not receive shareholder approval to issue shares of common stock upon Alta’s
exercise of its warrants, then the warrants will become exercisable beginning on June 28, 2008, and
the warrant holder will be entitled to receive, upon exercise of the warrants, cash from ATS in an
amount equal to the difference between the then-current fair market value of the shares of our
common stock underlying the warrants and the aggregate exercise price of the warrants. If we
receive shareholder approval to issue shares of common stock upon exercise of the warrants, then
the warrants will become exercisable upon receipt of such shareholder approval, and the holder will
be entitled to receive shares of common stock upon exercise of the warrants. If we are unable to
obtain shareholder approval, we may need to raise additional debt or equity to settle this
liability. In addition, generally accepted accounting principles in the United States require us
to mark-to-market the value of cash warrants on a periodic basis until we obtain shareholder
approval to issue shares of our common stock upon exercise of such warrants. As a result, until we
receive shareholder approval, which cannot be assured, we will continue to recognize changes in the
fair value of the warrants in our profit and loss statement during each reporting period, which may
have an adverse impact on our earnings.
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 several 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. Furthermore, there may be delays in obtaining necessary governmental
approvals of our products or introducing products to market or other events that may cause actual
cash requirements to exceed those for which we have budgeted. In such event, we would need
additional financing. If we were unable to raise these funds, we may not be able to continue our
business as planned.
The market for prosthetic heart valves is highly competitive, and a number of our competitors are
larger and have more financial resources. If we do not compete effectively, our business will be
harmed.
The market for prosthetic heart valves is highly competitive. We expect that competition will
intensify as additional companies enter the market or modify their existing products to compete
directly with us. Our primary competitor in mechanical heart valves, St. Jude Medical, Inc.,
currently controls approximately 50% of the worldwide market. Edwards Lifesciences PVT, Inc., our
primary competitor in the tissue heart valve market, currently controls approximately 60% of the
worldwide 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 our ATS heart valve. Our primary competitor has recently used price as a method to
compete in several international markets. If heart valve prices decline significantly, we might not
be able to compete successfully, which would harm our business, financial condition and operating
results.
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Our future results will be harmed if the use of mechanical heart valves declines or if our tissue
heart valves cannot be successfully marketed.
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 20% to 65%
of all heart valve replacements, depending on the geographic market, down from 65% to 75% roughly
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. In addition, there can be no guarantee that we will be able
to successfully market and sell our tissue heart valves or that our tissue heart valves will be
approved or gain market acceptance.
Our business may be adversely affected if we are unable to maintain our strategic distribution
arrangements.
In 2007, revenues from non-mechanical heart valve products increased to 28% of total revenue from
none in 2004. Some of our distributed products contain performance criteria which we must obtain
to retain our rights under these arrangements. Additionally, these arrangements provide certain
circumstances under which our rights may be terminated. If we are unable to maintain these
arrangements, our business, financial condition and operating results may be adversely affected.
We ultimately may experience a delay in introducing, or may not successfully complete development
of, products that are currently under development, resulting in harm to our business.
We are in the process of developing certain products, including, but not limited to, the Enable and
Entrata tissue heart valve products. The Enable product is currently in the early phases of
clinical trials, and the Entrata product is still under development. Successfully completing the
development of these products and technologies presents substantial technical, medical and
engineering challenges, as well as regulatory hurdles. In 2006, ongoing clinical trial results in
Europe resulted in our undertaking a review of the Enable valve cuff design. We may not
successfully complete the development of these products, or these products may fail to work in the
manner intended. If we are unable to successfully develop the products that are currently under
development, we may suffer financial difficulties, which may have a material adverse effect on our
business, financial condition and operating results.
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 operating results or force
us to cease doing business altogether.
The acquisition of the surgical cryoablation assets of CryoCath may result in a loss of customers
and suppliers.
Some customers may seek alternative sources of products and/or services after the CryoCath asset
acquisition due to, among other reasons, a desire not to do business with the combined company or
perceived concerns that the combined company may not continue to support and develop certain
product lines. The combined company could experience some customer attrition after the
acquisition. Difficulties in combining operations also could result in the loss of providers and
potential disputes or litigation with customers, providers or others.
We license patented technology and other proprietary rights from CarboMedics. If these agreements
are breached or terminated, our right to manufacture the ATS mechanical 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 lose our right to manufacture components for the
ATS heart valve. If our inventory is exhausted and we do not have any other sources of carbon
components, we would be forced to cease selling mechanical heart valves.
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A delay or interruption in our manufacturing of pyrolytic carbon components could delay product
delivery or force us to cease operations.
Although we anticipate that our manufacturing capacity will be sufficient to meet our current and
foreseeable carbon component needs, if our inventory is exhausted and we are unable to manufacture
carbon components, it is unlikely that we will be able to obtain the necessary carbon components
from any other source. If we are unable to obtain these carbon components from other sources, we
could be forced to reduce or cease operations.
Because we have limited manufacturing experience with some of our products, we may not realize the
expected cost savings related to manufacturing our own products. In addition, we could experience
production delays and significant additional costs.
Our tissue valve manufacturing efforts to date have consisted primarily of limited quantities of
products for research and development, clinical trials and commercial sale outside the United
States. Under our manufacturing transition services agreement with CryoCath, we will purchase
products from CryoCath for the surgical cryoablation business during the manufacturing transition
period. We cannot be certain that we will be able to manufacture commercial quantities of tissue
heart valves or develop internal manufacturing capabilities in connection with the acquisition of
the CryoCath assets in a cost-effective manner. We have limited experience manufacturing tissue
heart valves and no experience manufacturing products for the surgical cryoablation business, and
our inability to manufacture these products in a cost-effective manner could adversely affect our
business and results of operations. In addition, in the future as we continue to increase
production, we may encounter difficulties in maintaining and expanding our manufacturing, including
problems involving:
Difficulties encountered by us in establishing or maintaining a commercial-scale manufacturing
facility may limit our ability to manufacture our cryoablation products and therefore could
seriously harm our business, financial condition and operating results.
We are reliant upon CryoCath for the supply of products of our surgical cryoablation business.
We currently purchase all of the products of our surgical cryoablation business from CryoCath. We
are in the process of establishing and validating manufacture of these products in our own
facility. However, if we are not successful in establishing our own manufacturing capabilities for
these products, we would continue to be reliant on CryoCath for the supply of surgical cryoablation
products. Any adverse changes in the operations, employee relations, solvency or compliance with
laws and regulations by CryoCath may have a material adverse impact on the supply of products we
purchase from them. Additionally, CryoCath manufactures their own products for commercial sale and
our products are subject to production and scheduling constraints that may be the result of growth
of their core business. If CryoCath is unable to provide product quantities in quantities
sufficient to meet our demand our business, earnings and financial position may be materially
harmed.
Our business could be seriously harmed if third-party payers do not reimburse the costs for our
products.
Our ability to successfully commercialize the ATS mechanical heart valve, our tissue heart valves,
surgical cryoablation devices and other products 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, financial condition and operating results.
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. Furthermore, 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, financial condition
and operating results.
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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 and tissue heart valves entails significant
risk of product liability claims and product recalls. Both mechanical heart valves, tissue heart
valves and valve repair products are life-sustaining devices, and the failure of any valve or
repair product 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.
We may be sued by third parties claiming that our products infringe 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:
We may encounter litigation that could have a material impact on our business.
In November 2006, CarboMedics filed a complaint against ATS alleging that we have breached certain contractual obligations, including an alleged obligation to purchase $22 million of carbon components under a long-term supply agreement with CarboMedics. The complaint initially sought specific enforcement of the supply agreement, revocation of certain intellectual property rights purchased by ATS from CarboMedics, and monetary damages in excess of $75,000. In May 2007,
CarboMedics withdrew its request for specific performance of the contract. It has also revised its damages estimate to $13.6 million before accounting for net present value adjustments, interest, attorney’s fees and costs. We believe that the complaint filed by CarboMedics is without merit. We have filed our answer to the complaint, including certain counterclaims against CarboMedics. A trial date has been set for September 2008. If we are ultimately found to be in
breach of the terms of our supply agreement with CarboMedics, we could be required to pay damages that would materially and adversely affect our financial condition.
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In addition to the CarboMedics litigation described above, we may be subject to product liability
claims, intellectual property infringement claims or other lawsuits, proceedings and claims arising
in the ordinary course of business or otherwise. Although we do not believe that any lawsuits,
claims or proceedings arising in the ordinary course of business will have a material adverse
impact on our business, operating results or financial condition, it is possible that unfavorable
resolutions of any lawsuits, claims or proceedings could have an adverse effect on our business,
results of operation or financial condition because of the uncertainty inherent in litigation.
We are subject to extensive governmental regulation, which is costly, time consuming and can
subject us to unanticipated delays or could ultimately preclude us from marketing and selling our
products.
Our heart valves, surgical cryoablation products and other products and our manufacturing
activities are subject to extensive regulation by a number of governmental agencies, including the
FDA and comparable international agencies, as well as other federal, state, local and international
authorities. We are required to:
Compliance with the regulations of these governmental authorities may delay or prevent us from
introducing any new or improved products. The governmental authorities in charge of making and
implementing these laws or related regulations may change the laws, impose additional restrictions,
or adopt interpretations of existing laws or regulations that could have a material adverse effect
on us. Violations of these laws or regulatory requirements may result in fines, marketing
restrictions, product recall, withdrawal of approvals and civil and criminal penalties. We also
may incur substantial costs associated with complying and overseeing compliance with the laws and
regulations of these governmental authorities.
We ultimately may not be able to obtain the necessary governmental approvals or clearances in the
United States or other jurisdictions, including FDA and CE approvals and clearances, for products
that are now under development, including our 3F Aortic Bioprosthesis, Enable and Entrata products
and surgical cryoablation products designed for standalone minimally invasive procedures.
Obtaining these governmental approvals or clearances is uncertain, and the regulatory approval
process is likely to be time-consuming and expensive. If we are unable to obtain such governmental
approvals or clearances, then our ability to market and sell products currently under development
may be delayed or may never occur. Our potential inability to market and sell our products
currently under development, together with the potential expenses associated with obtaining the
necessary governmental approvals or clearances, may cause us to suffer financial difficulties,
which could have a material adverse effect on our business, financial condition and prospects.
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:
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In addition, due to one or more of the foregoing factors, in future years our operating results may
fall below the expectations of securities analysts and investors. In that event, the market price
of our common stock could be materially and adversely affected. Finally, in recent years the stock
market has experienced extreme price and volume fluctuations. This volatility has had a
significant effect on the market prices of securities issued by many companies for reasons
unrelated to their operating performance. These broad market fluctuations may materially adversely
affect our stock price, regardless of our operating results.
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:
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable.
ITEM 2. PROPERTIES
We lease approximately 62,000 square feet of space in two adjacent buildings in Plymouth,
Minnesota. The first building lease, covering approximately 39,000 square feet, expires on July
31, 2010 and is used for administrative, production and engineering purposes. The lease on the
second building (23,000 square feet) also expires July 31, 2010 and is used for carbon
manufacturing. Both of our Minnesota leases carry a three-year renewal option. We also lease
approximately 16,000 square feet of space in Lake Forest, California. This lease expires on
September 30, 2009 and is used for research and development and manufacturing purposes. Outside
the United States, we lease four sales and marketing offices in China, France, Germany, and
Austria. We believe that our facilities are adequate for our current needs.
ITEM 3. LEGAL PROCEEDINGS
Abbey Litigation
On January 23, 2006, following execution of the Merger Agreement between the Company and 3F, 3F was
informed of a summons and complaint dated January 19, 2006, which was filed in the U.S. District
Court in the Southern District of New York by Arthur N. Abbey (“Abbey”) against 3F Partners Limited
Partnership II (a major stockholder of 3F, “3F Partners II”), Theodore C. Skokos (the then chairman
of the board and a stockholder of 3F), 3F Management II, LLC (the general partner of 3F Partners
II), and 3F (collectively, the “Defendants”) (the “Abbey I Litigation”). The summons and complaint
alleges that the Defendants committed fraud under federal securities laws, common law fraud and
negligent misrepresentation in connection with the purchase by Abbey of certain securities of 3F
Partners II. In particular, Abbey claims that the Defendants induced Abbey to invest $4 million in
3F Partners II, which, in turn, invested $6 million in certain preferred stock of 3F, by allegedly
causing Abbey to believe, among other things, that such investment would be short-term. Pursuant to
the complaint, Abbey is seeking rescission of his purchase of his limited partnership interest in
3F Partners II and return of the amount paid therefore (together with pre-and post-judgment
interest), compensatory damages for the alleged lost principal of his investment (together with
interest thereon and additional general, consequential and incidental damages), general damages for
all alleged injuries resulting from the alleged fraud in an amount to be determined at trial and
such other legal and equitable relief as the court may deem just and proper. Abbey did not
purchase any securities directly from 3F and is not a stockholder of 3F. On March 23, 2006, 3F
filed a motion to dismiss the complaint. Under the Private Securities Litigation Reform Act, no
discovery will be permitted until the judge rules upon the motion to dismiss. On May 15, 2006, 3F
filed and served a reply memorandum of law in further support of its motion to dismiss Abbey’s
complaint with prejudice. On August 6, 2007, the Court granted 3F’s motion to dismiss the
complaint based on plaintiff’s failure to state a claim upon which relief may be granted and the
case was closed. On August 30, 2007, Abbey filed a Notice of Appeal with the United States Court
of Appeals for the Second Circuit seeking to reverse the District Court’s August 6, 2007 Order
dismissing the case. The appeal was fully submitted on January 3, 2008. None of the parties have
requested oral argument.
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On or about June 14, 2006, Abbey commenced a second civil action in the Court of Chancery in the
State of Delaware by serving 3F with a complaint naming both 3F and Mr. Skokos as defendants (the
“Abbey II Litigation”). The complaint alleges, among other things, fraud and breach of fiduciary
duties in connection with the purchase by Abbey of his partnership interest in 3F Partners II. The
Delaware action seeks: (1) a declaration that (a) for purposes of the merger, Abbey was a record
stockholder of 3F and was thus entitled to withhold his consent to the merger and seek appraisal
rights after the merger was consummated and (b) the irrevocable stockholder consent submitted by 3F
Partners II to approve the merger be voided as unenforceable; and (2) damages based upon
allegations that 3F aided and abetted Mr. Skokos in breaching Mr. Skokos’s fiduciary duties of
loyalty and faith to Abbey. On July 17, 2006, 3F filed a motion to dismiss the complaint in the
Abbey II Litigation, or, alternatively, to stay the action pending adjudication of the Abbey I
Litigation. On October 10, 2006, the Delaware Chancery Court entered an order staying the Delaware
action pending the outcome of the Abbey I litigation. On or about August 17, 2007, the parties
informed the Delaware Chancery Court that they would consent to the continued stay of the Delaware
action pending the outcome of Abbey’s appeal of the Abbey I Litigation.
3F has been notified by its director and officer insurance carrier that such carrier will defend
and cover all defense costs as to 3F and Mr. Skokos in the Abbey I Litigation and Abbey II
Litigation, subject to policy terms and full reservation of rights. In addition, under the merger
agreement, 3F and the 3F stockholder representative have agreed that the Abbey I Litigation and
Abbey II Litigation are matters for which express indemnification is provided. As a result, the
escrow shares and milestone shares, if any, may be used by ATS to satisfy, in part, ATS’s set-off
rights and indemnification claims for damages and losses incurred by 3F or ATS, and their
directors, officers and affiliates, that are not otherwise covered by applicable insurance arising
from the Abbey I Litigation and Abbey II Litigation. See Note 2 of “Notes to Consolidated
Financial Statements” in this Form 10-K for a description of the escrow and milestone shares. The
Company believes the Abbey I Litigation and Abbey II Litigation will not result in a material
impact on the Company’s financial position or operating results.
CarboMedics Litigation
On November 22, 2006, CarboMedics filed a complaint against ATS in the U.S. District Court in the
District of Minnesota. The complaint alleges that the Company has breached certain contractual
obligations, including an alleged obligation to purchase $22 million of mechanical heart valve
carbon components under a long-term supply agreement with CarboMedics, which obligation CarboMedics
contends had been scheduled to re-commence in 2007.
CarboMedics initially sought specific performance and claimed damages of approximately $20 million.
We believe the complaint filed by CarboMedics is without merit, that CarboMedics has repudiated and
breached the long-term supply agreement, and that ATS may have affirmative claims against
CarboMedics. On February 16, 2007, we filed our answer and counterclaim to the complaint. On May
16, 2007, CarboMedics filed an amended complaint withdrawing its request for specific performance.
CarboMedics has also revised its damages estimate to $13.6 million before accounting for net
present value adjustments, interest, attorney’s fees, and costs. The case is now in the final
stages of discovery and has been scheduled for trial in September 2008.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
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PART II
Market Information
Our common stock is traded on the NASDAQ Global Market under the symbol “ATSI.” The following
table sets forth, for the periods indicated, the high and low closing sales prices per share of our
common stock as reported on the NASDAQ Global Market. These prices do not include adjustments for
retail mark-ups, mark-downs, or commissions.
Holders
As of March 4, 2008, we had approximately 494 holders of record of our common stock.
Dividends
We are currently restricted from declaring or paying dividends on our common stock under our loan
agreements with Silicon Valley Bank. We have never declared or paid cash dividends in the past and
intend to retain all future earnings for the operation and expansion of our business.
Repurchases of Common Stock
We did not repurchase any of our securities during the fourth quarter of 2007.
Sales of Unregistered Securities
We had no sales of unregistered securities during 2007 that have not been previously disclosed in a
Current Report on Form 8-K or Quarterly Report on Form 10-Q.
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Performance Graph
The graph below compares the cumulative total shareholder return on our common stock since December
31, 2002 with the cumulative return of the Standard & Poor’s 500 Stock Index and the NASDAQ Medical
Devices, Instruments and Supplies Index over the same period (assuming the investment of $100 in
each vehicle on December 31, 2002 and reinvestment of all dividends).
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ITEM 6. SELECTED FINANCIAL DATA
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Executive Overview
ATS Medical, Inc. (hereinafter the “Company”, “ATS”, “we”, “us” or “our”) develops, manufactures,
and markets medical devices. Our primary interest lies with devices used by cardiovascular
surgeons in the cardiac surgery operating theater. Currently, we participate in the markets for
mechanical bileaflet replacement heart valves, tissue heart valves, valve repair products, the
surgical treatment of atrial fibrillation, and surgical tools and accessories.
In 1990, we licensed a patented and partially developed valve from CarboMedics. Under the terms of
the license, we would complete the development of the valve and agreed to purchase carbon
components from CarboMedics. As a result, we now hold an exclusive, royalty-free, worldwide
license to an open pivot, bileaflet mechanical heart valve design owned by CarboMedics. In
addition, we have an exclusive, worldwide right and license to use CarboMedics’ pyrolytic carbon
technology to manufacture components for the ATS mechanical heart valve.
We commenced selling the ATS mechanical heart valve in international markets in 1992. In late
2000, we received FDA approval to sell the ATS Open Pivot® mechanical heart valve and commenced
sales and marketing of our valve in the United States. During 2002, we reorganized the Company and
started the process of rebuilding our sales and marketing teams, both in the United States and
internationally. This rebuilding has been a significant factor in our operating expense levels
during the last five years. During 2004 and 2005, we developed and implemented a plan to ramp-up
our own manufacturing facility for pyrolytic carbon. By the end of 2005, this process was
substantially complete.
During 2004 we made our first investments outside the mechanical heart valve market. We completed
a global partnership agreement with CryoCath to market CryoCath’s surgical cryotherapy products for
the ablation of cardiac arrhythmias. CryoCath developed a portfolio of novel products marketed
under the SurgiFrost® and FrostByte® trade names which are used by cardiac surgeons to treat
cardiac arrhythmias. Treatment is accomplished through the creation of an intricate pattern of
lesions on the surface of the heart to block inappropriate electrical conduction circuits which
cause the heart to be less effective when pumping blood and can lead to stroke, heart failure and
death. Unique to this technology is the use of cryothermy (cold) to create lesions. The agreement
with CryoCath has resulted in revenues for ATS since 2005.
During 2005 we continued to develop our business outside the mechanical heart valve market. We
entered into an exclusive development, supply and distribution agreement with GBI, under which GBI
will develop, supply, and manufacture cardiac surgical products to include annuloplasty repair
rings, c-rings and accessories, and we will have exclusive worldwide rights to market and sell such
products. Our agreement with GBI produced revenues for us in both 2006 and 2007. We also entered
into a marketing services agreement with Regeneration Technologies, Inc. – Cardiovascular
(“RTI-CV”). Under the terms of the agreement, RTI-CV appointed us as its exclusive marketing
services representative to promote, market and solicit orders for RTI-CV’s processed cardiovascular
allograft tissue from doctors, hospitals, clinics and patients throughout North America. The
agreement with RTI-CV produced revenues for us since 2005. However, the cardiovascular tissue
processing business of RTI-CV was sold during 2006 and RTI-CV is discontinuing its cardiovascular
tissue processing operations. As a result, our distribution agreement with RTI-CV terminated at
the end of 2007.
In 2006 we completed the acquisition of all the voting and non-voting stock of 3F, a privately-held
medical device company specializing in manufacturing tissue heart valves. The acquisition was
consummated pursuant to an agreement and plan of merger, as amended (“the Merger Agreement”).
Under the terms of the Merger Agreement, upon closing, we paid each 3F stockholder its pro-rata
portion of an initial payment of 9 million shares of our common stock, subject to certain
adjustments. In addition to the initial closing payment, we are obligated to make additional
contingent payments to 3F stockholders of up to 10 million shares of our common stock with shares
issuable upon obtaining each of the CE mark and FDA approval of certain key products on or prior to
December 31, 2013. Milestone share payments may be accelerated upon completion of certain
transactions involving these key products. The first generation tissue valve, the ATS 3F® Aortic
Bioprosthesis, has received CE mark and is available for sale in Europe and certain other
international markets. We expect FDA approval of this product during the second half of 2008.
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Also in 2006, we entered into an exclusive distribution agreement with Novare Surgical Systems,
Inc. (“Novare”). Novare is the owner of the Enclose II® cardiac anastomosis assist device, which
is a device used by cardiac surgeons to attach a bypass vessel to the aorta during coronary artery
bypass graft surgery. Under the terms of the
agreement, we hold the exclusive right to market, sell and distribute the Enclose II product in the
United States, Germany, France and the United Kingdom. We agreed to pay to Novare a transfer price
for each box of Enclose II product we purchase. We are also required to purchase an annual minimum
amount of Enclose II product, which increases 15% each year.
In June 2007 we acquired the assets of the surgical cryoablation business of CryoCath. The assets
acquired include the SurgiFrost, FrostByte, and SurgiFrost XL family of products for which we
served as CryoCath’s exclusive agent in the United States and distributor in certain international
markets. Under the acquisition agreements, we paid CryoCath $22.0 million upon closing of the
transaction (reduced by $0.9 million subsequent to closing), and will pay CryoCath $2.0 million
upon the achievement of certain manufacturing transition milestones, $2.0 million two years after
closing and up to $4.0 million in contingent payments based on future sales of Surgifrost XL, an
FDA cleared and CE Marked product designed to enable less-evasive ablations. Surgifrost XL was
developed to enable a minimally-invasive beating heart solution for the treatment of cardiac
arrhythmias, including atrial fibrillation without concomitant cardiac surgery. This technology
enables us to leverage our current operating infrastructure and allows us to better address the
rapidly growing $1.5 billion cardiac arrhythmia market. The transaction was financed with part of
the proceeds of an $8.6 million senior secured term loan from SVB Silicon Valley Bank and the
private placement of 9,800,000 shares of our common stock at a purchase price of $1.65 per share to
Alta, a life sciences venture capital firm. Alta also received a warrant to purchase 1,960,000
shares of our common stock at $1.65 per share.
Critical Accounting Policies and Estimates
We base our estimates on historical experience and on various other assumptions that we believe to
be reasonable under the circumstances. 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 and in our
direct European sales operations 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. These accrued rebates were not significant at either December 31, 2007 or December
31, 2006. These rebates are treated as a reduction of revenue.
The Company includes shipping and handling costs, net of shipping charges invoiced to customers, in
cost of goods sold.
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 $0.2 million and $0.5
million at December 31, 2007 and 2006, respectively. As a percentage of total accounts receivable,
the allowance was 2.0% at December 31, 2007 and 4.6% at December 31, 2006. The decrease in
allowance as a percent of total accounts receivable is due primarily to the 2007 write-off of a
large receivable from a terminated international distributor in the Middle East.
Inventory Valuation. Inventories are recorded at the lower of manufacturing cost or net realizable
value. Prior to 2006, manufacturing costs exceeded net realizable values in certain international
markets which required us to record write-downs to our inventories, as future selling prices were
lower than manufacturing costs in these markets. These write-downs resulted in
lower-of-cost-or-market (“LCM”) inventory reserves, which were used as high-cost inventory was sold
into low selling-price international markets. LCM write-downs were $0.7 million during 2005.
During the first quarter of 2006, the remaining LCM reserves were fully utilized in connection with
the depletion of our high-cost inventories of carbon components purchased from CarboMedics.
Consequently, no LCM write-downs were recorded in 2006 or 2007 and future LCM inventory write-downs
are not anticipated.
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We maintain an obsolescence allowance against certain finished goods inventories to cover
resterilization costs for expired or near-expired items. This allowance totaled $0.03 million and
$0.20 million at December 31, 2007 and 2006, respectively. In addition, we maintain a reserve
against work-in-process (“WIP”) inventories to cover scrap costs associated with the completion of
this WIP inventory. This reserve totaled $0.1 million and $0.2 million at December 31, 2007 and
2006, respectively. We also maintain finished goods obsolescence reserves against tissue heart
valve inventories with less than one year shelf-life remaining. These reserves totaled $0.5
million and $0.4 million at December 31, 2007 and 2006, respectively.
Intangible Assets. We assess the carrying value of our goodwill and other indefinite-lived
intangible assets annually in accordance with the provisions of Statement of Financial Accounting
Standard (“SFAS”) 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. During 2007, we recorded an impairment
charge of $0.8 million related to licensing fee and development milestone payments made to a
Swedish research firm related to filtration technology for cardiac surgery procedures. As of
December 31, 2007, we believe the carrying value of our intangible assets, including the
CarboMedics carbon technology license and the goodwill and definite-lived intangible assets
acquired in connection with our acquisitions of 3F and the assets of the surgical cryoablation
business of CryoCath, are recoverable and that no further impairment charges are necessary.
Deferred Tax Assets. We have incurred cumulative tax losses of approximately $152 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, 2007 we had net deferred tax assets totaling
approximately $58.9 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. The ability to utilize a portion of our cumulative tax losses to offset future
taxable income is subject to certain limitations under Section 382 and 383 of the Internal Revenue
Code due to changes in the equity ownership of the Company. In addition, 3F’s tax loss
carryforwards may also be limited by separate return limitation year rules.
Convertible Debt and Derivative Instruments. We account for embedded derivatives related to our
Convertible Senior Notes under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and related Emerging Issues Task Force (“EITF”) Interpretations and 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 our 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
us.
Stock-Based Compensation. We account for our stock-based employee compensation plans under the
recognition and measurement principles of SFAS No. 123 (Revised 2004), Share-Based Payment
(“Statement 123(R)”), which requires all share-based payments 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 using the modified prospective
transition method. Accordingly, we have not restated our consolidated financial statements
for prior periods. Under this transition method, stock-based compensation expense for 2006
includes expense related to our stock-based compensation awards granted in 2006 and those
awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant-date fair
value estimated in accordance with the provision of SFAS No. 123. Stock-based compensation expense
for all grants and awards made on or after January 1, 2006 are based on the grant-date fair value
estimated in accordance with the provisions of Statement 123(R).
During the last two years, we have issued restricted stock unit awards (“RSUs”) to our employees.
The fair value of RSUs is determined based on the closing market price on the award date.
Prior to the adoption of
Statement 123(R), we accounted for our stock-based employee compensation plans under the
recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25 and
related interpretations.
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Results of Operations
The following table provides the dollar and percentage change in our Statements of Operations for
2007 compared to 2006 and 2006 compared to 2005.
The following table presents our Statements of Operations as a percentage of net sales for 2007,
2006 and 2005.
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Net Sales. The following table provides the dollar and percentage change in our net sales inside
and outside the United States and Canada for 2007 compared to 2006 and 2006 compared to 2005.
The following table provides our net sales inside and outside the United States and Canada as a
percentage of total net sales for 2007, 2006 and 2005.
The following table provides our net sales by product group for 2007, 2006 and 2005.
Heart valve therapy sales, our largest product group, consists of mechanical and tissue heart
valves and heart valve repair products. Our mechanical heart valve products continue to be our
primary product line and comprised approximately 72% of our worldwide sales for 2007, compared to
82% for 2006 and 90% for 2005. U.S. mechanical heart valve sales revenue for 2007 declined
approximately 18% from 2006 and 2006 MHV revenue was flat compared to 2005, reflecting the
continued decline in the overall MHV market due to the encroachment of tissue valves. However,
international mechanical heart valve sales increased approximately 20% in 2007 and 9% in 2006 over
their same periods in the prior year, due primarily to the expansion of direct selling operations
in three international markets in 2007. Worldwide heart valve therapy revenue has also increased
due to sales growth of our repair ring products, which were introduced in the second quarter of
2006.
Net sales generated from surgical arrhythmia therapy products consist of cryotherapy products for
the ablation of cardiac arrhythmias. Net sales of these products prior to the third quarter of
2007 are representative of our prior distribution and agency agreements with CryoCath. Through our
acquisition of the surgical cryoablation business of CryoCath in June 2007, these sales increased
significantly in the second half of 2007 and should continue to do so in future quarters due to a
gross-up on certain sales for which we had served as an agent and received a commission and to the
addition of direct sales to other CryoCath corporate customers.
Net sales have been favorably impacted by revenue from the acquisitions, new business initiatives
and partnerships discussed above, primarily revenue derived from surgical cryotherapy products,
annuloplasty repair rings, c-rings and accessories, and cardiac anastomosis assist devices.
Approximately 28% of our worldwide revenue in 2007 was derived from products other than mechanical
heart valves, up from approximately 18% in 2006 and 10% in 2005.
Cost of Goods Sold and Gross Profit. Our gross profit has benefited from sales of lower cost
mechanical heart valves which are now manufactured entirely in our own facilities. By the middle
of the first quarter of 2006, we had substantially depleted our high-priced inventories of carbon
components purchased from CarboMedics, and had moved into lower-cost, internally-produced carbon
material cost layers. This transition to full in-house manufacture of mechanical heart valves
favorably impacted our 2007 and 2006 gross profit compared to the prior year by approximately $2.5
million and $5.3 million, respectively, and improved our gross profit percentage of net sales for
these same periods by approximately 5.0 and 13.0 percentage points, respectively, compared to the
prior year.
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Our 2007 gross profit, both in dollars and in percentage of net sales, also benefited from direct
sales of surgical cryotherapy products in the second half of 2007 resulting from our acquisition of
the surgical cryoablation business of CryoCath in June 2007. These sales include the gross-up on
certain sales for which we had served as an agent and received a commission prior to the
acquisition and the addition of direct sales to other CryoCath corporate customers.
Our 2007 gross profit percentage was negatively impacted by a shift in the mix of our mechanical
heart valve product sales. Lower U.S. mechanical heart valve unit sales volume, coupled with
higher international MHV sales at lower average selling prices and gross margins than the U.S.,
lowered our 2007 and 2006 gross profit as a percentage of net sales by approximately 0.6 and 2.5
percentage points, respectively, compared to prior year. The 2007 mix shift impact was lessened by
higher mechanical heart valve average selling prices in both U.S. and international markets
compared to 2006.
Our 2007 gross profit percentage was also negatively impacted by 3F obsolescence costs and
manufacturing variances due to low manufacturing volumes and by cryoablation manufacturing start-up
costs. These period costs lowered our 2007 and 2006 gross profit as a percentage of net sales by
approximately 2.0 and 0.3 percentage points, respectively, compared to the prior year.
Sales and Marketing. In the United States, our sales and marketing costs in 2007 increased
approximately 5% over the prior year, to $15.1 million, while 2006 U.S. sales and marketing costs
increased approximately 6% over the prior year to $14.4 million. The 2007 increase reflects the
addition of marketing expenses for 3F related to the market launch of our first generation tissue
heart valve, hiring costs for additional marketing personnel and $0.2 million of higher stock
compensation expense related primarily to accelerated vesting of restricted stock units under
contingent vesting provisions which were triggered or met, offset in part by lower spending in the
U.S. field sales force. Field selling costs in the United States were $0.6 million, or 6% lower in
2007 compared to 2006, reflecting the turnover of and reduction in field sales personnel. The 2006
increase was due primarily to $0.6 million of stock compensation expense recognized in 2006 as we
implemented Statement 123(R) effective January 1, 2006, as well as to the development of marketing
programs to support new products and services and to increase the U.S. market share of our
mechanical heart valve.
Internationally, our sales and marketing costs in 2007 and 2006 increased over the prior year
approximately 45% and 23% to $9.6 million and $6.6 million, respectively. Both increases reflect
our continued investment in international markets, including the establishment of a European
support office in the third quarter of 2006 to support the expansion of our direct sales operations
in Europe, and higher sales and marketing expenses in Eastern Europe, Asia and China. Since 2003,
we have established sales and/or distribution operations in France (2003), China (2004), Germany
(2005) and Austria (2006). In the third quarter of 2007, we began direct sales activities in
Switzerland. Our higher international sales and marketing costs in 2007 were also attributable, in
part, to rising Euro-to-U.S. dollar foreign exchange rates during 2007. More than two-thirds of
our 2007 international sales and marketing costs were denominated in Euros.
Research and Development. R & D expenses in 2007 increased 123% to
$7.5 million and increased 95% to $3.4 million in 2006, both compared to the prior year. These
increases in R & D reflect the addition of research, clinical and regulatory costs for 3F ($4.8
million in 2007 and $1.3 million in 2006) and the hiring of a Vice President of R & D during 2006.
The higher R & D spending for both years also reflects increases in the number of internal R & D
programs.
Acquired In-Process R & D. In connection with our acquisition of the assets of the surgical
cryoablation business of CryoCath, we recorded a non-recurring in-process R & D (“IPR&D”) charge of
$3.5 million in the second quarter of 2007. See Note 2 of “Notes to Consolidated Financial
Statements” in this Form 10-K for additional information regarding the CryoCath asset acquisition,
including the purchase price and the preliminary allocation of the purchase price. The IPR&D
relates to SurgiFrost XL, a product line in development to enable less invasive stand alone or sole
therapy solutions to treat AF. We used the income approach to determine the fair value of IPR&D,
applying a risk adjusted discount rate of 30% to the development project’s projected cash flows.
In connection with our acquisition of 3F, we recorded a non-recurring IPR&D charge of $14.4 million
in the third quarter of 2006. See Note 2 of “Notes to Consolidated Financial Statements” in this
Form 10-K for additional information regarding the 3F acquisition. The IPR&D relates to the Enable
sutureless tissue valve product line. We used the income approach to determine the fair value of
IPR&D, applying a risk adjusted discount rate of 37% to the development project’s projected cash
flows.
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General and Administrative. General and administrative (“G & A”) expenses for 2007 increased $1.6
million from the prior year to $10.4 million. For 2006, G & A expenses increased $1.6 million from
the prior year to $8.8 million.
Major cost increases in G & A expenses for 2007 over 2006 related to severance costs for terminated
employees of $0.7 million, corporate facilities and business development expenses of $0.7 million,
legal fees of $0.9 million, and compensation costs related primarily to staff additions of $0.3
million. These cost increases were offset, in part, by $0.5 million in lower 2007 corporate bonus
accruals, $0.4 million in lower outside services and consulting fee expenses and $0.3 million in
lower bad debt expense related to the termination in 2006 of an international distributor.
Major cost increases in G & A expenses for 2006 over 2005 were incurred for outside consulting,
legal and professional services of $0.8 million, bad debt expense of $0.5 million ($0.3 million of
which related to the international distributor termination referenced above), $0.3 million for
bonuses and incentive compensation, and $0.1 million for amortization of intangible assets acquired
in connection with our acquisition of 3F. These increases were partially offset by the allocation
of 401(k) company match expense from G & A to individual operating departments beginning in 2006.
We recognized total stock compensation expense in 2007 of $1.45 million, of which $0.65 million was
included in G & A expenses and $0.80 million in sales and marketing expenses. For 2006, we
recognized total stock compensation expense of $1.11 million, of which $0.45 million was included
in G & A expenses and $0.65 million in sales and marketing expenses. The increase in stock
compensation expense for 2007 over 2006 reflects primarily $0.25 million of accelerated vesting of
restricted stock units under contingent vesting provisions which were triggered or met.
Amortization of Intangibles. We recognized $2.5 million of amortization expense in 2007 related to
(1) initial amortization of our pyrolytic carbon technology license with CarboMedics, (2) acquired
definite-lived intangible assets connected with the September 2006 acquisition of 3F and (3)
amortization of the definite-lived intangible assets acquired in our June 2007 purchase of the
surgical cryoablation business of CryoCath. See Note 6 of “Notes to Consolidated Financial
Statements” in this Form 10-K for more information regarding the CarboMedics technology license and
its change in status from an indefinite-lived to a definite-lived intangible asset. We recognized
$0.1 million of amortization expense in 2006 related to initial amortization of acquired
definite-lived intangible assets connected with the acquisition of 3F. We estimate amortization
expense for 2008 to be approximately $3.5 million.
Impairment of Intangibles. We made licensing fee and development milestone payments to ErySave AB,
a Swedish research firm, under an exclusive development and licensing agreement, executed in 2004,
for worldwide rights to ErySave’s PARSUS filtration technology for cardiac surgery procedures. In
July 2007, we were informed that ErySave was in the process of declaring bankruptcy and they could
not continue development work. Accordingly, the $0.8 million ErySave license payments intangible
asset was written off in the second quarter of 2007.
Net Interest Expense. Net interest expense was attributable primarily to the sale, in 2005, of
$22.4 million aggregate principal amount of 6% Convertible Senior Notes (“Notes”). Interest
expense on these Notes in 2007, 2006 and 2005 was $1.9 million, $2.1 million and $0.4 million,
respectively, 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 derivative financial instruments bifurcated from the Notes. See Note 7 of “Notes to
Consolidated Financial Statements” in this Form 10-K for more information regarding these Notes and
the related derivative instruments. Interest expense was also attributable to bank notes with
Silicon Valley Bank, including the June 2007 $8.6 million Term Loan (“Term Loan”) obtained in
connection with the CryoCath asset acquisition. See “Liquidity and Capital Resources-Financing
Activities” below for a detailed discussion of the Term Loan.
Interest income for 2007, 2006 and 2005 was $0.7 million, $0.7 million and $0.3 million,
respectively, and is attributable to the investment of our cash balances.
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Net Other Income. In connection with our June 2007 private equity placement, we sold to Alta a
seven-year warrant to purchase up to 1,960,000 shares of our common stock at an exercise price of
$1.65 per share. Under the terms of the warrant, if we do not receive approval from our
shareholders at our 2008 annual meeting of shareholders (or any subsequent annual meeting) to issue
shares of common stock to Alta upon exercise of the warrant, then the warrant will become
exercisable on June 28, 2008, and Alta will be entitled to receive, upon exercise of the warrant,
cash in an amount equal to the difference between the then-current fair market value of
the shares underlying the warrant and the aggregate exercise price of the warrant. If we do
receive shareholder approval to issue shares of common stock upon exercise of the warrant, then the
warrant will become exercisable upon receipt of such shareholder approval and Alta will be entitled
to receive shares of common stock upon exercise of the warrant. Accordingly, the fair value of the
warrant has been recorded as a liability on the balance sheet and marked to market at June 30,
September 30 and December 31, 2007, resulting in a net non-operating change in valuation charge to
other expense of $0.7 million for 2007.
During 2007, 2006 and 2005 we recorded non-operating other income totaling $0.1 million, $1.5
million and $2.1 million, respectively, for the change in the Notes derivative liability to fair
value. The large decline in this other income in 2007 as compared to prior years relates to the
elimination of the largest of the embedded derivatives in the Notes (the conversion feature
derivative), which was no longer required to be accounted for as a derivative after our authorized
shares were increased at our Annual Meeting of Shareholders on September 25, 2006. See Note 7 of
“Notes to Consolidated Financial Statements” in this Form 10-K for more information regarding the
Notes derivative liability and our accounting for the related derivative financial instruments
under SFAS No.133, Accounting for Derivative Instruments and Hedging Activities.
Other income for 2007 also includes $0.6 million of net foreign currency transaction gains, which
includes $0.3 million of foreign currency gains related to short-term intercompany balances with
foreign subsidiaries.
Income Taxes. In 2007, we recognized $0.1 million of income tax expense and a related deferred
income tax liability related to the deductibility of goodwill in the CryoCath asset acquisition for
tax purposes, but not for book purposes. In future years, we will continue recognizing deferred
income tax expense related to this goodwill over its tax life as long as there is no impairment of
the goodwill’s recorded value.
Through 2007 we have accumulated approximately $152 million of net operating loss (“NOL”)
carryforwards for U.S. tax purposes ($54 million related to 3F). We believe that our ability to
fully utilize the existing NOL carryforwards could be restricted on a portion of the NOL by changes
in control that may have occurred or may occur in the future and by our ability to generate net
income. We have initiated a formal study of whether, or to what extent, past changes in control of
ATS impairs our NOL 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 losses in 2007, 2006 and 2005 were $23.0 million, $27.7 million and $14.4
million, respectively. Our decrease in net loss in 2007 compared to 2006 was due primarily to
lower acquisition-related IPR&D charges in 2007. This was partially offset by higher operating
expenses, which increased more than net sales and gross profit, and to lower non-operating other
income for 2007, all of which are described in detail above. Our increase in net loss in 2006
compared to 2005 was due primarily to the $14.4 million non-recurring IPR&D charge recorded in 2006
in connection with the 3F acquisition discussed above.
Liquidity and Capital Resources
Cash, cash equivalents, and short-term investments totaled $14.7 million and $10.7 million at
December 31, 2007 and December 31, 2006, respectively.
Operating Activities. During 2007, we received cash payments from customers of approximately $50.7
million and made payments to employees and suppliers of approximately $59.6 million. During 2006,
we received cash payments from customers of approximately $41.5 million and made payments to
employees and suppliers of approximately $49.4 million. Over the last five years, we have incurred
significant expenses to commercialize the ATS heart valve both in the United States and in many
international markets, have invested in new products and technologies and have completed strategic
acquisitions and business partnerships to diversify our product portfolio. As we build sales in
future periods and our cost of inventories decrease, we believe our operating losses will decrease
and we will move toward a cash flow breakeven on sales and eventually to profitability.
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Investing Activities. Our major investing activity during 2007 was the acquisition of the assets
of the surgical cryoablation business of CryoCath in June. We paid $22 million at the closing
(subsequently reduced by $0.9 million) and paid approximately $1.8 million in transaction costs
during 2007. See Note 2 of “Notes to Consolidated Financial Statements” in this Form 10-K for
additional details of this acquisition.
We purchased leasehold improvements, property and equipment totaling $0.7 million, $1.2 million,
and $2.3 million during 2007, 2006 and 2005, respectively. Since the beginning of 2006, our
capital spending has declined as a significant portion of our pyrolytic carbon facility was
completed by the end of 2005.
We also spent $0.3 million in 2007 for the purchase of patents, patent rights and other
intellectual property. See Note 6 of “Notes to Consolidated Financial Statements” in this Form
10-K for more information regarding these intangible asset purchases.
Financing Activities. During 2007 we raised $30.6 million, net of offering costs, through two
private placement sales of common stock. The first, in March 2007, raised $15.3 million, net of
offering costs, through the sale of 8,125,000 shares of our common stock at a price of $2.00 per
share and warrants to purchase 3,250,000 shares of our common stock at an exercise price of $2.40
per share. The second, in June 2007, raised $15.3 million, net of offering costs, through the sale
of 9,800,000 shares of our common stock at a price of $1.65 per share and a seven-year warrant to
purchase up to 1,960,000 shares of our common stock at an exercise price of $1.65 per share, as
further described in Note 5 of “Notes to Consolidated Financial Statements” in this Form 10-K. We
also received net proceeds of $0.7 million, $0.1 million and $0.5 million during 2007, 2006 and
2005, respectively, from the issuance of common stock through exercises of stock options and
purchases under our employee stock purchase plan.
Since 2004 we have maintained a Loan and Security Agreement (“Loan Agreement”) with Silicon Valley
Bank (Bank) which established, among other things, a $2.5 million three-year term loan. In March
2006, the Bank agreed to provide for additional advances of up to $1.5 million. We fully drew down
both the $2.5 million term loan and the $1.5 million advance amount, which were being repaid over
36 and 60 month periods, respectively. All ATS assets are pledged as collateral. We are also
subject to certain financial covenants under the Loan Agreement, as amended.
In June 2007, we entered into an Amendment to the Loan Agreement (“June 2007 Amendment”) whereby
the Bank consented to (1) our purchase of the surgical cryoablation assets from CryoCath (“CryoCath
Assets”) and (2) certain agreements related to the acquisition of the CryoCath Assets. The June
2007 Amendment also provided for a new $8.6 million Term Loan, which we used to repay the
outstanding term loan and advances from the Bank under the Loan Agreement and to purchase the
CryoCath Assets. Under the Term Loan, we were required to make monthly payments of interest only
from July 2007 through December 2007 and monthly payments of principal plus interest beginning
January 2008 and continuing until June 2011. In February 2008, the June 2007 Amendment was amended
to extend the principal repayment commencement date until April 2008. We have the right to prepay
all, but not less than all, of the outstanding Term Loan at any time so long as no event of default
has occurred. Interest on the Term Loan accrues at a fixed rate per annum equal to 1.25% above the
Prime Rate which was in effect as of the funding date of the Term Loan.
The June 2007 Amendment also made certain changes to the liquidity ratio test set forth in the Loan
Agreement, as amended. The liquidity ratio was changed to require that we maintain, at all times,
on a consolidated basis, a ratio of (1) the sum of (a) our unrestricted cash (and equivalents) on
deposit with the Bank plus (b) 50% of the our accounts receivable arising form the sale or lease of
goods, or provision of services, in the ordinary course of business, divided by (2) our
indebtedness to the Bank for borrowed money, of equal to or greater than 1.4 to 1.0. As of
December 31, 2007, we were in compliance with all financial covenants set forth in the Loan
Agreement, as amended.
In October 2005, we sold a combined $22.4 million aggregate principal amount of 6% Convertible
Senior Notes due in 2025, warrants to purchase 1,344,000 shares of our common stock (“Warrants”)
and certain embedded derivatives. The Warrants are exercisable at $4.40 per share and expire in
2010. We used the proceeds from the Notes for general corporate purposes, working capital, capital
expenditures and to fund business development opportunities. Interest on the Notes is due
semi-annually in April and October. The Notes are convertible into common stock at any time at a
fixed conversion price of $4.20 per share, subject to certain adjustments. If fully converted, the
Notes would convert into approximately 5,333,334 shares of our common stock. If the Notes are
converted under certain circumstances on or prior to October 15, 2008, we will pay the investors
the interest they would have received on the Notes through that date. We have the right to redeem
the Notes at 100% of the principal amount plus accrued interest at any time on or after October 20,
2008, and the investors have the right to require us to repurchase the Notes at 100% of the
principal amount plus accrued interest on October 15 in 2010, 2015 and 2020. See Note 7 of “Notes
to Consolidated Financial Statements” in this Form 10-K for a full description of the terms and
provisions of the Notes.
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Cash Management
We estimate that operating costs will remain high in comparison to sales during 2008 and will
require the use of cash to fund operations. Based upon the current forecast of sales and operating
expenses, we anticipate having cash to fund our operations through 2008. However, we may need to
raise additional cash in or after 2008 to
provide operating plan leverage, to fund our strategic investments and accelerate the development
platforms for our 3F tissue and/or surgical cryoablation technologies, or to opportunistically add
accretive products to our distribution network. As identified in Item 1A of 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. Any sale of additional equity or issuance of debt securities may result in
dilution to our stockholders, and we cannot be certain that additional public or private financing
will be available in amounts or on terms acceptable to us, or at all. If we are unable to obtain
this additional financing when needed, we may be required to delay, reduce the scope of, or
eliminate one or more aspects of our business development activities, which could harm the growth
of our business.
Off-Balance Sheet Arrangements
We do not have any “off-balance sheet arrangements” (as such term is defined in Item 303 of
Regulation S-K) that are reasonably likely to have a current or future effect on our financial
condition, changes in financial condition, revenues or expenses, operating results, liquidity,
capital expenditures or capital resources.
Contractual Obligations
The following table sets forth our future payment obligations:
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 ATS 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.
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The primary objective of our investment activities is to preserve principal while at the same
time maximizing the income we receive from our investments without significantly increasing
risk. Some of the securities that we invest in may have market risk. This means that a change
in prevailing interest rates may cause the fair market value of the principal amount of the
investment to fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then prevailing rate and the prevailing interest rate later rises, the fair
value of the principal amount of our investment will probably decline. To minimize this risk,
our portfolio of cash equivalents and short-term investments may be invested in a variety of
securities, including commercial paper, money market funds, and both government and
non-government debt securities. The average duration of all our investments has generally been
less than one year. Due to the short-term nature of these investments, we believe we have no
material exposure to interest rate risk arising from our investments.
In the United States, the United Kingdom, France, Germany, Belgium, the Netherlands and
Switzerland, we sell our products directly to hospitals. In other international markets, we
sell our products to independent distributors who, in turn, sell to medical hospitals. Loss,
termination, or ineffectiveness of distributors to effectively promote our product would have a
material adverse effect on our financial condition and results of operations.
Transactions with U.S. and non-U.S. customers and distributors, other than in our direct selling
markets in Europe, are entered into in U.S. dollars, precluding the need for foreign currency
hedges on such sales. Sales through our French and German subsidiaries, as well as through our
European export company to Belgium and the Netherlands, are in Euros. Sales to the United
Kingdom and Switzerland are made through our European export company and are denominated in
pounds and Swiss francs, respectively. Therefore, we are subject to profitability risk arising
from exchange rate movements. We have not used foreign exchange contracts or similar devices to
reduce this risk. We will evaluate the need to use foreign exchange contracts or similar
devices, if sales in our European direct markets increase substantially.
Our Consolidated Financial Statements and the reports of our registered public accounting firm
are included in this Form 10-K beginning on page F-1. The index to these reports and the
financial statements is included in Item 15 below.
Not Applicable.
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Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, which are designed to ensure that information
required to be disclosed in the reports we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the SEC’s rules and forms,
and that such information is accumulated and communicated to our management, including our chief
executive officer, or CEO, and chief financial officer, or CFO, as appropriate to allow timely
decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our CEO and CFO, we
evaluated the effectiveness of the design and operation of our disclosure controls and procedures
(as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this
annual report. Based on that evaluation, our management, including the CEO and CFO, concluded that
our disclosure controls and procedures were effective as of December 31, 2007.
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 our 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 CEO and CFO, 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 that our internal control over
financial reporting was effective as of December 31, 2007.
The effectiveness of our internal control over financial reporting as of December 31, 2007, has
been audited by Grant Thornton LLP, the independent registered public accounting firm who also has
audited our consolidated financial statements as of and for the year ended December 31, 2007,
included in this Form 10-K. Grant Thornton’s attestation report on the effectiveness of our
internal control over financial reporting appears on page F-3 of this Form 10-K.
Changes in Internal Control Over Financial Reporting
There have been no changes 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, 2007 that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
None.
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PART III
See Item 1 of this Form 10-K for certain information regarding our executive officers.
Reference is made to information contained under the headings “Proposal 1 — Election of Directors,”
“Committees of the Board of Directors and Attendance,” “Nominations,” and “Section 16(a) Beneficial
Ownership Reporting Compliance” in our definitive proxy statement for our 2008 Annual Meeting of
Shareholders to be filed with the SEC on or before April 8, 2008 (our “2008 Proxy Statement”),
which information is incorporated herein.
In 2004, we adopted a Code of Conduct for our employees, including our principal executive officer,
principal financial officer and principal accounting officer, which is posted on our website
(www.atsmedical.com). We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K
regarding an amendment to, or waiver from, a provision of the Code of Conduct by posting such
information on our website at the address specified above.
Reference is made to information contained under the headings “Executive Compensation” and
“Compensation of Directors” in our 2008 Proxy Statement, which information is incorporated herein.
Reference is made to information contained under the headings “Security Ownership of Certain
Beneficial Owners and Management” and “Equity Compensation Plans” in our 2008 Proxy Statement,
which information is incorporated herein.
Reference is made to information contained under the headings “Director Independence” and “Related
Person Transaction Policy” in our 2008 Proxy Statement, which information is incorporated herein.
Reference is made to information contained under the heading “Independent Registered Public
Accounting Firm Fees” in our 2008 Proxy Statement , which information is incorporated herein.
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PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
Financial Statements
Financial Statement Schedules
ATS MEDICAL, INC.
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (in thousands)
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.
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Exhibits
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SIGNATURES
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities indicated
on March 14, 2008.
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Report of Independent Registered Public Accounting Firm
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, 2007 and 2006, and the related consolidated statements of operations, changes in
shareholders’ equity, and cash flows for each of the two years in the period ended December 31,
2007. Our audits of the basic consolidated financial statements included the financial statement
schedule listed in the index appearing under Item 15. These financial statements and financial
statement schedule are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements and financial statement schedule 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 ATS Medical, Inc. as of December 31, 2007
and 2006, and the consolidated results of its operations and its cash flows for each of the two
years in the period ended December 31, 2007 in conformity with accounting principles generally
accepted in the United States of America. 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 1 to the consolidated financial statements, effective January 1, 2006, the
Company changed its method of accounting for share-based payments to adopt Statement of Financial
Accounting Standards No. 123(R), Share-Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), ATS Medical, Inc.’s internal control over financial reporting as of December
31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March
12, 2008 expressed an unqualified opinion on the effectiveness of the Company’s internal control
over financial reporting.
GRANT THORNTON LLP
Minneapolis, Minnesota
March 12, 2008 F - 1
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
ATS Medical, Inc. We have audited the accompanying consolidated consolidated statements of operations, changes in
shareholders’ equity and cash flows of ATS Medical, Inc. (“the Company”) for the two year ended
December 31, 2005. Our audit also included the financial statement schedule presented at Item 15.
These financial statements and schedule are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements and schedule 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 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 audit provides a reasonable basis for our opinion.
In our opinion, the 2005 consolidated financial statements referred to above present fairly, in all
material respects, the consolidated results of its operations and its cash flows for the year 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.
ERNST & YOUNG LLP
Minneapolis, Minnesota
March 6, 2006, except for Note 7, as to which the date is July 13, 2006 F - 2
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Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
ATS Medical, Inc. We have audited ATS Medical, Inc.’s (the “Company”) internal control over financial reporting as of
December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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, included in
the accompanying Management’s Report on Internal Control over Financial Reporting. Our
responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk,
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 opinion, ATS Medical, Inc. maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2007, based on criteria established in Internal
Control—Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheet of ATS Medical, Inc. as of December 31, 2007,
and the related consolidated statements of operations, changes in shareholders’ equity, and cash
flows and financial statement schedule for the year then ended, and our report dated March 12, 2008
expressed an unqualified opinion on those financial statements and financial statement schedule,
and included an explanatory paragraph related to the Company’s change, effective January 1, 2006,
in its method of accounting for share-based payments.
GRANT THORNTON LLP
Minneapolis, Minnesota
March 12, 2008 F - 3
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ATS Medical, Inc.
Consolidated Balance Sheets
(In Thousands, Except Share Data)
The accompanying notes are an integral part of the consolidated financial statements.
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ATS Medical, Inc.
Consolidated Statements of Operations
(In Thousands, Except Per Share Amounts)
The accompanying notes are an integral part of the consolidated financial statements.
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ATS Medical, Inc.
Consolidated Statement of Changes in Shareholders’ Equity
(In Thousands)
The accompanying notes are an integral part of the consolidated financial statements.
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ATS Medical, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
The accompanying notes are an integral part of the consolidated financial statements.
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ATS Medical, Inc.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Business Activity
ATS Medical, Inc. (the “Company”) develops, manufactures, and markets medical devices. The Company
operates in one business segment and its interest lies with devices used by cardiovascular surgeons
in the cardiac surgery operating theater. Currently, the Company participates in the markets for
mechanical and tissue replacement heart valves, heart valve repair, the surgical treatment of
atrial fibrillation, and other cardiac surgery devices, tools and accessories.
The Company has recognized net losses of approximately $14.4 million in 2005, $27.7 million in
2006, and $23.0 million in 2007 and has an accumulated deficit of $132.6 million at December 31,
2007. The Company believes it has sufficient cash resources to meet its cash needs through 2008.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and wholly owned sales
and distribution subsidiaries in the United States, France, Germany and Austria (since its
inception in July 2006), after elimination of intercompany accounts and transactions. Effective
January 1, 2006, the U.S. sales and distribution subsidiary 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 and include $1.5 million and $0.9 million in primarily Euro-denominated balances in
foreign banks at December 31, 2007 and 2006, respectively.
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. Prior to 2006, write-downs were 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. Write-downs totaled $0.7 million in 2005. These write-downs were included in cost of
goods sold in the statement of operations.
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At December 31, 2007 and 2006, inventories consisted of the following (in thousands):
Other Assets
Included in other assets is deferred financing costs (unamortized balance of $0.9 million at
December 31, 2007) in connection with the 6% Convertible Senior Notes, disclosed in Note 7 below,
which are being amortized over five years. Amortization of deferred financing costs will be
approximately $0.3 million per year for 2008 through 2010.
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:
Leasehold improvements are amortized over the remaining related lease term or estimated useful
life, whichever is shorter.
Indefinite-Lived Intangible Assets
Indefinite-lived intangible assets include technology licenses and agreements and goodwill (see
Note 6) and are carried at cost. The Company applies Statement of Financial Accounting Standard
(“SFAS”) No. 142, Goodwill and Other Intangible Assets, to its intangible assets, which prohibits
the amortization of intangible assets with indefinite useful lives and requires that these assets
be reviewed for impairment at least annually. Management reviews indefinite-lived intangible
assets for impairment annually as of the last day of the second quarter, or more frequently if a
change in circumstances or occurrence of events suggests the remaining value may not be
recoverable. The test for impairment requires management to make estimates about fair-value which
are based either on the expected undiscounted future cash flows or on other measures of value such
as the market capitalization of the Company. If the carrying amount of the assets is greater than
the measures of fair value, impairment is considered to have occurred and a write-down of the asset
is recorded. Management completed the annual impairment tests in the second quarter of 2007 and
determined that the Company’s intangible assets, with the exception of the ErySave license
agreement intangible discussed in Note 6, were not impaired.
Revenue Recognition
A significant portion of the Company’s revenue in the United States and direct European countries
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, net of any applicable sales and VAT taxes invoiced,
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 accrued rebates were $0.01 and $0.05 million as of
December 31, 2007 and 2006, respectively, and are treated as a reduction of revenue.
The Company includes shipping and handling costs, net of shipping charges invoiced to customers, in
cost of goods sold.
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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 2007, 2006 and 2005 were $0.1 million, $0.2 million
and $0.1 million, respectively.
Foreign Currency Translation
The financial statements for the Company’s European operations are maintained in Euros. All assets
and liabilities of the Company’s international subsidiaries are translated to U.S. dollars at
year-end exchange rates, while the statement of operations is 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. Net
gains on foreign currency transactions were $0.6 million in 2007 and were not significant during
2006 or 2005. Foreign currency transaction gains/losses includes gains/losses on the portion of
intercompany payables (denominated in U.S. dollars) determined to be short-term in nature, while
gains/losses on the long-term portion of intercompany payables are recognized in accumulated other
comprehensive income (loss).
The Company has reclassified foreign exchange transaction gains originally recorded as a reduction
of sales and marketing expenses in the first, second and third quarters of 2007 to other income.
These reclassifications totaled $0.2 million and had no impact on 2007 quarterly net losses as
previously reported.
Income Taxes
The Company accounts for income taxes under SFAS No. 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.
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation
No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), on January 1, 2007. Previously, the
Company had accounted for tax contingencies in accordance with SFAS No. 5, Accounting for
Contingencies. As required by FIN 48, which clarifies SFAS No. 109, Accounting for Income Taxes,
the Company recognizes the financial statement benefit of a tax position only after determining
that the relevant tax authority would more likely than not sustain the position. For tax positions
meeting the more likely than not threshold, the amount recognized in the financial statements is
the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate
settlement with the relevant tax authority. At the adoption date, the Company applied FIN 48 to
all tax positions for which the statute of limitations remained open.
Warranties
The Company adheres to FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect Indebtedness to Others (“FIN 45”). FIN 45 requires
disclosures concerning the Company’s obligations under certain guarantees. The Company sells
service agreements on cryoablation consoles, for which it defers the related service revenue and
recognizes over the service period. Revenue and warranty costs under these service agreements has
not been significant.
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Stock-Based Compensation
The Company has stock-based employee compensation plans, which are described more fully in Note 9.
The Company accounts for its stock-based employee compensation plans under the recognition and
measurement principles of SFAS No. 123 (Revised 2004), Share-Based Payment (“Statement 123(R)”),
which requires all share-based payments 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 using the modified prospective
transition method, Accordingly, the Company has not restated its consolidated financial statements
for prior periods. Under this transition method, stock-based compensation expense for 2006
includes expense related to the Company’s stock-based compensation awards granted in 2006 and those
awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant-date fair
value estimated in accordance with the provision of SFAS No. 123. Stock-based compensation expense
for all grants and awards made on or after January 1, 2006 are based on the grant-date fair value
estimated in accordance with the provisions of Statement 123(R).
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 restricted stock units, 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 620,000,
860,000, and 1,214,000 shares of common stock equivalents would have been included in the
computation of diluted net income per share for the years ended December 31, 2007, 2006 and 2005,
respectively.
Convertible Debt and Derivative Instruments
The Company accounts for embedded derivatives related to its convertible senior notes and certain
common stock warrants under SFAS 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 or equity 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. Acquisitions
Acquisition of Assets from CryoCath Technologies, Inc.
On June 28, 2007, the Company completed the acquisition of the cryoablation surgical device
business of CryoCath Technologies, Inc. (“CryoCath”). Pursuant to the Asset Purchase Agreement
between the Company and CryoCath, the Company paid CryoCath $22.0 million at closing and agreed to
pay an additional $2.0 million twenty-four months after closing. The Company also agreed to pay up
to an additional $6.0 million in contingent payments, $2.0 million of which is contingent on the
successful transition of manufacturing from CryoCath to the Company and $4.0 million of which is
contingent upon the Company reaching certain levels of sales in 2009 and 2010 of SurgiFrost® XL, a
product line in development.
The Company and CryoCath also entered into 1) a License Agreement, which provides the Company with
an exclusive, perpetual, royalty-free, worldwide license to use CryoCath’s intellectual property
related to the cryoablation surgical device business, 2) a Manufacturing Agreement, pursuant to
which CryoCath has agreed to manufacture, assemble and supply products relating to the cryoablation
surgical business to the Company for a period of up to one year, and 3) a Termination Agreement,
which terminated the Distribution Agreement and Agent Agreement, each dated November 9, 2004,
between the Company and CryoCath.
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Purchase Price. The Company has accounted for the CryoCath asset acquisition as a purchase under
U.S. generally accepted accounting principles. Under the purchase method of accounting, the assets
and liabilities acquired were recorded as of the acquisition date, at their respective fair values,
and consolidated with those of the Company. The purchase price allocation is based upon
preliminary estimates of the fair value of assets acquired and liabilities assumed. The Company is
finalizing its valuation of certain assets, primarily the valuation of acquired intangible assets.
The purchase price allocation will be finalized once the Company has all the necessary information
to complete its estimate, but no later than one year from the acquisition date. The valuation
requires the use of significant assumptions and estimates. Critical estimates included, but were
not limited to, future expected cash flows and the applicable discount rates. These estimates were
based on assumptions that the Company believes to be reasonable. However, actual results may
differ from these estimates.
The preliminary purchase price is as follows as of December 31, 2007 (amounts in thousands):
Preliminary Purchase Price Allocation. The following table summarizes the preliminary purchase
price allocation for the CryoCath asset acquisition as of December 31, 2007 (amounts in thousands):
The excess of the purchase price over the fair value of net tangible assets acquired was allocated
to specific intangible asset categories and in-process research and development as follows:
The Company believes the estimated intangible assets so determined represent the fair value at the
date of acquisition. The Company used the income approach to determine the fair value of the
amortizable intangible assets. The product trademarks amortization period was subsequently reduced
to 15 months in the fourth quarter of 2007, due to changing product trade names and trademarks.
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The $3.5 million acquired in-process research and development (“IPR&D”) associated with the
acquisition relates to SurgiFrost XL, a product line in development to enable less invasive stand
alone or sole therapy solutions to treat atrial fibrillation. This IPR&D was recorded as a
non-recurring charge to operations for the year ended December 31, 2007. The Company used the
income approach to determine the fair value of IPR&D, applying a risk adjusted discount rate of 30%
to the development project’s projected cash flows.
Acquisition of 3F Therapeutics, Inc.
On September 29, 2006, the Company completed the acquisition of all the voting and non-voting stock
of 3F Therapeutics, Inc. (“3F”), a privately-held medical device company specializing in
manufacturing heart tissue valve replacement components. The Company views the acquisition of 3F
as a significant step in executing its vision of obtaining a leadership position in all segments of
the cardiac surgery market.
The acquisition was consummated pursuant to an agreement and plan of merger dated January 23, 2006,
as amended (the “Merger Agreement”). Under the terms of the Merger Agreement, upon closing, the
Company paid each 3F stockholder its pro-rata portion of an initial payment of 9 million shares of
the Company’s common stock, subject to certain adjustments. The Company deposited 1,425,000 shares
of the closing payment in escrow to be held for at least 18 months (“escrow period”) after closing
of the merger to cover potential indemnification claims and certain contingencies. At the
conclusion of the escrow period, the balance of the escrow account would be distributed pro-rata to
the former holders of 3F capital stock. On February 27, 2008, the Company notified 3F stockholders
that the escrow shares would not be distributed at the end of the escrow period and would remain in
escrow pending the final outcome of certain shareholder litigation involving 3F (see “Abbey
Litigation” in Note 18 of these Notes to Consolidated Financial Statements). In addition to the
initial closing payment, the Company is obligated to make additional contingent payments to 3F
stockholders of up to 10 million shares of the Company’s common stock with 5 million shares
issuable upon obtaining each of the CE mark and FDA approval of certain key products on or prior to
December 31, 2013. Milestone share payments may be accelerated upon completion of certain
transactions involving these key products. These contingent payments are subject to certain rights
of offset for indemnification claims and certain other events.
Purchase Price. The Company accounted for the acquisition of 3F as a purchase under U.S. generally
accepted accounting principles. Under the purchase method of accounting, the assets and
liabilities of 3F were recorded as of the acquisition date, at their respective fair values, and
consolidated with those of the Company. The purchase price allocation is based upon estimates of
the fair value of assets acquired and liabilities assumed. These valuations require the use of
significant assumptions and estimates. Critical estimates included, but were not limited to,
future expected cash flows and related applicable discount rates. These estimates were based on
assumptions that the Company believes to be reasonable. However, actual results may differ from
these estimates.
The purchase price for the acquisition of 3F was as follows (amounts in thousands):
Purchase Price Allocation. The following table summarizes the purchase price allocation for the 3F
acquisition (amounts in thousands):
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The excess of the purchase price over the fair value of net tangible assets acquired was allocated
to specific intangible asset categories and in-process research and development as follows:
The Company believes that the estimated intangible assets so determined represent the fair value at
the date of acquisition. The Company used the income approach to determine the fair value of the
amortizable intangible assets.
The $14.4 million acquired IPR&D associated with the acquisition relates to the Enable sutureless
tissue valve product line and has been recorded as a non-recurring charge to operations for the
year ended December 31, 2006. The Company used the income approach to determine the fair value of
IPR&D, applying a risk adjusted discount rate of 37% to the development project’s projected cash
flows. Enable clinical trials have begun in Europe. European market approval is anticipated in
2009 or 2010 with United States approval to follow approximately 1-2 years later. The development
effort is subject to risks associated with the ultimate clinical efficacy of the Enable product
line as well as the results and high costs of the clinical trials.
The results of 3F’s operations since the acquisition have been included in the consolidated
financial statements.
Pro Forma Results of Operations
The following unaudited pro forma financial information presents a summary of consolidated results
of operations of the Company as if the acquisitions of CryoCath’s surgical cryoablation business
and of 3F Therapeutics had occurred at the beginning of the earliest period presented. The
historical consolidated financial information has been adjusted to give effect to pro forma events
that are directly attributable to the acquisitions and are factually supportable. The unaudited
pro forma condensed consolidated financial information is presented for informational purposes
only. The pro forma information is not necessarily indicative of what the results of operations
actually would have been had the acquisitions been completed at the dates indicated. In addition,
the unaudited pro forma condensed consolidated financial information does not purport to project
the future operating results of the Company after completion of the acquisitions.
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For purposes of preparing the unaudited pro forma financial information for the year ended December
31, 2007, CryoCath’s surgical cryoablation business unaudited Statement of Sales and Direct
Operating Expenses for the six-month period ended March 31, 2007 was combined with the Company’s
consolidated Statement of Operations for the year ended December 31, 2007, which includes six
months of post-CryoCath asset acquisition operating results and a full year of post-3F acquisition
operating results. For the year ended December 31, 2006, CryoCath’s surgical cryoablation business
audited Statement of Sales and Direct Operating Expenses for the fiscal year ended September 30,
2006 was combined with the unaudited pro forma combined condensed statement of operations of the
Company and 3F for the year ended December 31, 2006, which includes three months of post-3F
acquisition operating results. For the year ended December 31, 2005, CryoCath’s surgical
cryoablation business audited Statement of Sales and Direct Operating Expenses for the fiscal year
ended September 30, 2006 was combined with the unaudited pro
forma combined condensed statement of operations of the Company and 3F for the year ended December
31, 2005. All periods used in preparing the unaudited pro forma financial information represent
the most recent financial information available for each entity. The CryoCath financial statements
referenced above have been summarized in a format similar to the financial statements of the
Company and translated to U.S. dollars in accordance with U.S. generally accepted accounting
principles.
License revenue relates to license, supply and training agreements that 3F had with Edwards
Lifesciences (Edwards). The Edwards agreements were terminated in the fourth quarter of 2006 and
no additional license revenue will be recognized.
The unaudited pro forma net losses include 1) amortization of purchased intangible assets acquired
in both acquisitions, 2) an increase in depreciation expense related to the step-up of fixed assets
to fair value, 3) adjustments to eliminate intercompany sales, commission and distribution rights
income and commission expense resulting from sales of CryoCath products, 4) the elimination of
certain license amortization recorded by the surgical cryoablation division of Cryocath which does
not apply to the combined entity, 5) the estimated impact of the ongoing supply arrangement between
CryoCath and ATS Medical and 6) estimated additional interest expense on a pro forma basis due to
the additional bank borrowing completed to finance the CryoCath asset acquisition.
The unaudited pro forma financial information excludes non-recurring IPR&D charges of $3.5 million
recorded in 2007 in connection with the CryoCath asset acquisition and $14.4 million recorded in
2006 in connection with the acquisition of 3F.
3. Short-Term Investments
At December 31, 2007 and 2006, the cost of short-term investments held by the Company of $4.2
million and $6.1 million, respectively, had maturity dates of approximately one year or less,
approximated their fair value and consisted of the following (in thousands):
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4. Leasehold Improvements, Furniture, and Equipment, net
At December 31, 2007 and 2006, leasehold improvements, furniture, and equipment consisted of the
following (in thousands):
5. Private Placements of Common Stock
In March 2007, the Company sold 8,125,000 shares of its common stock to certain institutional
investors and received $15.3 million, net of offering costs. The private placement included the
issuance of warrants to purchase 3,250,000 shares of the Company’s common stock at an exercise
price of $2.40 per share, subject to adjustment upon certain events. The warrants became
exercisable in September 2007 and expire on March 15, 2012.
In June 2007, the Company sold to Alta Partners VIII, L.P. (“Alta”) 9,800,000 shares of its common
stock and a seven-year warrant to purchase up to 1,960,000 shares of Common Stock at an exercise
price of $1.65 per share. Issuance of shares related to the warrant is subject to shareholder
approval at the 2008 annual meeting of shareholders. If shareholder approval is not obtained, Alta
will be eligible to receive a cash payment, as further described below. The Company received $15.3
million, net of offering costs. In connection with the stock sale, Guy P. Nohra, a founder and one
of three managing directors of the general partner of Alta, was appointed to the Company’s Board of
Directors.
Under the terms of the Alta warrant, if the Company does not receive approval of its shareholders
at the Company’s 2008 annual meeting of shareholders (or any subsequent annual meeting) to issue
shares of common stock to Alta upon exercise of the warrant, then the warrant will become
exercisable on June 28, 2008, and Alta will be entitled to receive, upon exercise of the warrant,
cash from the Company in an amount equal to the difference between the then-current fair market
value of the shares underlying the warrant and the aggregate exercise price of the warrant. If the
Company receives shareholder approval to issue shares of common stock upon exercise of the warrant,
then the warrant will become exercisable upon receipt of such shareholder approval and Alta will be
entitled to receive shares of common stock upon exercise of the warrant. Accordingly, the fair
value of the warrant has been recorded as a liability on the date of issuance and marked to market
at each quarter-end, resulting in a change in valuation charge to other expense of $0.7 million for
the year ended December 31, 2007. If the Company receives shareholder approval to issue shares of
common stock upon exercise of the warrant, the liability will be marked-to-market through the date
of shareholder approval and the remaining liability balance will be credited to additional paid-in
capital.
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6. Goodwill and Other Intangible Assets
Goodwill and intangible assets activity is summarized as follows (in thousands):
Aggregate amortization of intangible assets over the next five years is as follows (in thousands):
Intangible Asset Purchases
As disclosed in Note 2 above, the Company acquired goodwill and certain other intangible assets in
connection with the June 2007 acquisition of the surgical cryoablation business of CryoCath and the
September 2006 acquisition of 3F.
In January 2007, the Company issued 224,416 shares of its common stock pursuant to the exercise of
its option to purchase certain assets of EM Vascular, Inc. (“EM Vascular”), under a May 2005 Option
and Asset Purchase Agreement (“Option Agreement”). The payment in shares was at the option of the
Company and was in lieu of a $0.5 million cash payment. The most significant asset acquired as
part of this purchase is technology that may potentially allow for a non-invasive, non-pharma
therapy for the treatment of such disorders as atherosclerotic plaque and blood
hyper-cholesterolemia. Under the terms of the Option Agreement, the Company will also be obligated
to make additional contingent payments to EM Vascular of up to $2.2 million in the form of ATS
common stock upon the attainment of certain milestone events and to pay royalties on applicable
product sales.
In September 2007, the Company acquired a fully paid-up license for $0.2 million related to a
thoracic port surgical device which the Company has been selling and for which the Company had
previously been paying royalties based on product sales.
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In October 2007, the Company acquired certain patent rights and intellectual property related to a
heart valve holder, a heart valve folding and delivery device, and other ancillary devices. The
Company paid an up-front license fee of $0.1 million and will be obligated to make royalty payments
on future sales of products related to certain of the patent rights transferred.
Intangible Asset Impairment
The Company made licensing fee and development milestone payments to ErySave AB (“ErySave”), a
Swedish research firm, under an exclusive development and licensing agreement, executed in 2004,
for worldwide rights to ErySave’s PARSUS filtration technology for cardiac surgery procedures. In
July 2007, the Company was informed that ErySave was in the process of declaring bankruptcy and
they could not continue development work. Accordingly, the $0.8 million ErySave license payments
intangible asset was written off during the year ended December 31, 2007.
Change in Status of Indefinite-lived Intangible Asset
The Company holds an exclusive, worldwide right and license to use CarboMedics, Inc.’s
(“CarboMedics”, f/k/a Sulzer CarboMedics) pyrolytic carbon technology. The license was originally
obtained in 1999 and had a carrying value of $18.5 million at December 31, 2006. Based on the
Company’s periodic review of its indefinite-lived intangibles, the Company determined that this
carbon technology license has a finite life and began amortizing this asset over a 15-year life
commencing January 1, 2007. The Company expects amortization expense on this technology license to
be approximately $1.2 million per year through 2021.
Agency & Distribution Agreements Intangible Tendered in Asset Acquisition
In November 2004, the Company signed an exclusive agency agreement and a distribution agreement
with CryoCath. The agreements granted 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. The Company made $1.8 million in agency and distribution license fee
payments to CryoCath during 2005 and 2006. In connection with the June 2007 acquisition of the
cryoablation surgical device business of CryoCath disclosed in Note 2, these agency and
distribution license fee payments were tendered and included as a part of the purchase price of the
CryoCath assets.
Goodwill
SFAS No. 142, Goodwill and Other Intangible Assets, guides the accounting treatment for the
Company’s intangible assets. Under SFAS 142, the goodwill acquired in the CryoCath asset and 3F
acquisitions is not subject to amortization, but must be analyzed for impairment on an annual
basis. The goodwill recognized in connection with the CryoCath asset acquisition is tax deductible
over a 15-year period, while the goodwill recognized in connection with the 3F acquisition is not
tax deductible.
7. Long-Term Debt
Convertible Notes Payable
In October 2005, the Company sold a combined $22.4 million aggregate principal amount of 6%
Convertible Senior Notes due 2025 (“Notes”), warrants to purchase 1,344,000 shares of the Company’s
common stock (“Warrants”), and embedded derivatives. Interest is payable under the Notes each
April and October.
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 and was recorded as a discount on the Notes and is being amortized to
interest expense over the 20 year life of the Notes using the effective interest method.
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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 only
19,222 authorized shares of its common stock available for the Note holders if conversion was
elected. This shortfall in authorized shares resulted in the Company having to recognize an
embedded derivative as explained further in this note.
The Note holders 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, in either cash or common stock.
The Company agreed to file a Registration Statement on Form S-3 covering the resale of all of the
shares of the Company’s common stock issuable upon conversion of the Notes and exercise of the
Warrants 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, a penalty ranging from .8% to 1.2% of the
principal amount of the Notes and Warrants would accrue to the Note holders. The Registration
Statement on Form S-3 was declared effective by the SEC on February 13, 2007; consequently, the
Company incurred approximately $0.4 million in Registration Statement penalties.
The Company analyzed all of the above provisions in the Notes and related agreements for embedded
derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and
related EITF interpretations and SEC rules. The Company has determined that four such provisions
in the convertible debt agreement are considered derivatives under SFAS No. 133:
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 on the Notes. The
discount is being amortized to interest expense over the 20 year life of the Notes, using the
effective interest method.
At its annual shareholder meeting held on September 25, 2006, the Company received approval from
its shareholders to increase its authorized shares to 100,000,000, eliminating the previous
deficiency in authorized shares. Since the Company then had sufficient authorized shares to settle
the Notes if converted, the conversion feature derivative no longer was required to be accounted
for as an embedded derivative under SFAS No. 133. The remaining conversion feature derivative
balance of $1.4 million was reclassified against the discount on the Notes for the year ended
December 31, 2006.
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The derivative liability is adjusted to fair value on a quarterly basis. The derivative liability
was adjusted to fair value at each quarter end during 2006 and 2007, resulting in $1.5 million and
$0.1 million change in valuation credits to other income for these years, respectively. The
remaining liability was $0.14 million at December 31, 2007. The derivative liability is presented
in the balance sheet within the same line as the Convertible Senior Notes payable.
Notes Payable
In July 2004, the Company entered into a Loan and Security Agreement (“Loan Agreement”) with
Silicon Valley Bank (“Bank”), establishing a secured revolving credit facility for $8.5 million
consisting of a $2.5 million three-year term loan as well as a two-year $6.0 million line of
credit. In March 2006, the Bank agreed to provide for additional advances of up to $1.5 million,
which the Company could use to finance or refinance eligible equipment purchased on or after June
1, 2005 and on or before May 31, 2006. The Company fully drew down both the $2.5 million term loan
and the $1.5 million advance amount, which were being repaid over 36 and 60 month periods,
respectively. The Company had not drawn any advances and had no outstanding balance on the $6.0
million line of credit. All Company assets are pledged as collateral on the credit facility.
The Company was subject to certain financial covenants under the Loan Agreement, as amended, to
maintain a liquidity ratio of not less than 2.0 to 1.0 and a net tangible net worth of at least $40
million. At December 31, 2006, the Company was not in compliance with the liquidity ratio
covenant. In February 2007, the Company entered into an Amendment to the Loan Agreement
(“February 2007 Amendment”) whereby, effective December 31, 2006, the liquidity ratio was decreased
to be equal to or greater than 1.6 to 1.0 and the tangible net worth requirement was eliminated,
bringing the Company into compliance with the covenants as amended. The February 2007 Amendment
also terminated the line of credit.
In June 2007, the Company entered into an Amendment to the Loan Agreement (“June 2007 Amendment”)
whereby the Bank consented to (i) the Company’s purchase of certain surgical cryoablation assets
from CryoCath (“CryoCath Assets”) and (ii) certain agreements related to the acquisition of the
CryoCath Assets. The June 2007 Amendment also provided for a new $8.6 million term loan (“Term
Loan”) to the Company, which was used to repay the outstanding term loan and advances to the
Company from the Bank under the Loan Agreement and to purchase the CryoCath Assets.
Under the Term Loan, as amended, the Company is required to make monthly payments of interest only
beginning on July 1, 2007, and continuing on the first day of each successive month until March 1,
2008, and 39 monthly payments of principal plus interest beginning on April 1, 2008 and continuing
on the first day of each successive month until June 1, 2011. The Company also has the right to
prepay all, but not less than all, of the outstanding Term Loan at any time so long as no event of
default has occurred. Interest on the Term Loan accrues at a fixed rate per annum of 9.5%, equal
to 1.25% above the Prime Rate in effect as of the funding date of the Term Loan.
The June 2007 Amendment also made certain changes to the liquidity ratio test set forth in the Loan
Agreement, as amended. The liquidity ratio was changed to require that the Company maintain, at
all times, on a consolidated basis, a ratio of (a) the sum of 1) unrestricted cash (and
equivalents) of the Company on deposit with the Bank plus 2) 50% of the Company’s accounts
receivable arising form the sale or lease of goods, or provision of services, in the ordinary
course of business, divided by (b) the indebtedness of the Company to the Bank for borrowed money,
of equal to or greater than 1.4 to 1.0. As of December 31, 2007, the Company was in compliance
with the financial covenants as set forth in the Loan Agreement, as amended.
Future maturities of bank notes payable are as follows (in thousands):
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8. Employee Stock Purchase Plan
The Company maintains an 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 Employee Stock Purchase Plan is deemed to be a
compensatory plan under Statement No. 123(R) and the related expense is included in stock
compensation expense.
The following table summarizes the shares issued and issuance prices under the Plan:
9. Stock-Based Compensation and Equity Plans
Stock-Based Compensation
The Company accounts for its stock-based employee compensation plans under the recognition and
measurement principles of SFAS No. 123 (Revised 2004), Share-Based Payment (“Statement 123(R)”),
which requires all share-based payments 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 using the modified prospective
transition method. Accordingly, the Company has not restated its consolidated financial statements
for prior periods. Under this transition method, stock-based compensation expense for 2006
includes expense related to the Company’s stock-based compensation awards granted in 2006 and those
awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant-date fair
value estimated in accordance with the provision of SFAS No. 123. Stock-based compensation expense
for all grants and awards made on or after January 1, 2006 are based on the grant-date fair value
estimated in accordance with the provisions of Statement 123(R).
Fair Value. The Company uses the Black-Scholes-Merton (“Black-Scholes”) option pricing model as
its method for determining fair value of stock option grants, which was also used by the Company
for its pro forma information disclosures of stock-based compensation expense as required under
SFAS No. 123, prior to the adoption of Statement 123(R). The weighted average per share fair value
of these option grants is shown below for 2006 and 2005 (there were no options granted in 2007) and
was estimated at the date of grant using the Black-Scholes model with the following weighted
average assumptions:
The expected volatility is a measure of the amount by which the Company’s stock price is expected
to fluctuate during the expected term of options granted. The Company determines the expected
volatility solely based upon the historical volatility of the Company’s common stock over a period
commensurate with the option’s expected life. The Company does not believe the future volatility of its common stock
over an option’s expected life is likely to differ significantly from the past. The risk-free
interest rate is the implied yield available on U.S. Treasury issues with a remaining term equal to
the option’s expected life on the grant date. The expected life of options granted represents the
period of time for which options are expected to be outstanding and is derived from the Company’s
historical stock option exercise experience and option expiration data. For purposes of estimating
the expected life, the Company has aggregated all individual option awards into one group as the
Company does not expect substantial differences in exercise behavior among its employees. The
dividend yield is zero since the Company has never declared or paid any cash dividends on its
common stock and does not expect to do so in the foreseeable future.
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The fair value of restricted stock unit awards (“RSUs”) is determined based on the closing market
price on the award date.
Stock Compensation Expense. The Company uses the single option (i.e. straight-line) method of
attributing the value of stock-based compensation expense for all stock option grants. Upon
adoption of Statement 123(R), the Company changed its method of attributing the value of
stock-based compensation expense on RSUs from the multiple-option (i.e. accelerated) approach to
the single option method. Compensation expense for RSUs awarded prior to January 1, 2006 will
continue to be subject to the accelerated multiple option method specified in FASB Interpretation
No. 28 (“FIN 28”), Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans, while compensation expense for RSUs awarded on or after January 1, 2006 will be
recognized using the single option method. Stock compensation expense for all stock-based grants
and awards is recognized over the service or vesting period of each grant or award.
The following table summarizes stock compensation expense recognized in the statements of
operations for the years ended December 31, 2007, 2006 and 2005:
Because the Company maintained a full valuation allowance on its U.S. deferred tax assets, the
Company did not recognize any net tax benefit related to its stock-based compensation expense for
the years ended December 31, 2007, 2006 and 2005.
Forfeitures. Statement 123(R) requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates in
order to derive the Company’s best estimate of awards ultimately expected to vest. Forfeitures
represent only the unvested portion of a surrendered option and are typically estimated based on
historical experience. Based on an analysis of the Company’s historical data, the Company applied
the following forfeiture rates to stock options and RSUs outstanding in determining its stock
compensation expense, which it believes are reasonable forfeiture estimates for these periods:
In the Company’s pro forma information below, required under SFAS No. 123 for the periods prior to
2006, the Company accounted for forfeitures as they occurred.
Pro Forma Information. Prior to the adoption of Statement 123(R), the Company accounted for its
stock-based employee compensation plans under the recognition and measurement principles of APB
Opinion No. 25 and related interpretations. The exercise price of the Company’s employee stock
options generally equaled the market price of the underlying stock on the date of grant for all
options granted, and thus, under APB Opinion No. 25, no compensation expense was recognized. 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.
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The following table illustrates the pro forma effect on net loss and net loss per share if the
Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee
compensation. Since stock-based compensation expense for the years ended December 31, 2007 and
2006 was calculated and recorded under the provisions of Statement 123(R), no pro forma disclosure
for these years is presented.
Equity Plans
The Company has a Stock Incentive Plan (the “Plan”) under which stock options to purchase common
stock of the Company may be granted or RSUs may be awarded to employees and non-employees of the
Company. Stock options may be granted under the Plan as incentive stock options (“ISO”) or as
non-qualified stock options (“non-ISO”). The Company also has stock options outstanding from a
previous equity compensation plan as well as free-standing options not under any plan. In
addition, the Company has an Employee Stock Purchase Plan (“ESPP”) under which employees are
eligible to purchase common stock of the Company on a quarterly basis 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.
All stock issued under options exercised, RSUs awarded or ESPP shares purchased are new shares of
the Company’s common stock. Option grants generally carry contractual terms of up to ten years.
RSU awards generally carry contractual terms of up to five years.
The Company had a total of 6,618,770 shares of common stock reserved for stock option grants and
RSU awards at December 31, 2007, of which 1,915,407 shares were available for future grants or
awards under the Plan.
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Stock Options. The following table summarizes the changes in stock options outstanding under the
Company’s stock-based compensation plans:
The following table summarizes the ranges of exercise prices for outstanding and exercisable stock
options as of December 31, 2007:
As of December 31, 2007, the aggregate intrinsic value of options outstanding and exercisable was
approximately $1.2 million. The aggregate intrinsic value of options exercised for the years ended
December 31, 2007 and 2006 was approximately $0.7 million and $0.1 million, respectively. The
aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between the
closing price of the Company’s common stock on December 31, 2007 and 2006 ($2.21 and $2.07 per
share, respectively) and the exercise price of each-in-the-money option that would have been
received by the option holders had all option holders exercised their options on those dates). As
of December 31, 2007, the Company had $0.01 million of total unrecognized compensation expense, net
of estimated forfeitures, related to stock options that will be recognized over a weighted average
period of less than one year.
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 its
Stock Incentive Plan or as a free- standing option not under any plan. Options to purchase
1,294,232 shares of common stock (affecting 86 employees) were subject to this acceleration. The
decision to accelerate vesting of these options was made primarily to minimize future compensation expense that the Company would otherwise
recognize in its consolidated statement of operations with respect to these options pursuant to Statement 123(R). The aggregate future expense eliminated as a result of the acceleration of
the vesting of these options was approximately $3.3 million.
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Restricted Stock Units. The following table summarizes RSU awards activity under the Company’s
stock-based compensation plans:
As of December 31, 2007, the aggregate intrinsic value of RSU awards outstanding was $4.5 million.
The aggregate intrinsic value represents the total pre-tax value of common stock RSU holders would
have received (based on the closing price of the Company’s common stock on December 31, 2007 of
$2.21 per share) had all RSUs vested and common stock been issued to the RSU holders on December
31, 2007. As of December 31, 2007, the Company had $2.9 million of total unrecognized compensation
expense, net of estimated forfeitures, related to RSU awards that will be recognized over a
weighted average period of approximately four years.
10. Leases
The Company has operating leases for its facilities. These leases expire at various dates through
November 2011. Future minimum lease payments under these agreements are as follows (in thousands):
Rent expense was $1.0 million, $0.7 million and $0.6 million for 2007, 2006 and 2005, respectively.
11. Income Taxes
At December 31, 2007, the Company had federal net operating loss carryforwards of approximately
$152 million ($54 million related to 3F) and credits for increasing research and development costs
of approximately $1 million ($0.8 million related to 3F). The Company also had state net operating
loss carryforwards of approximately $87.8 million ($46.9 million related to 3F) and research and
development credits of approximately $0.6 million ($0.5 million related to 3F). The net operating
loss carryforwards are available to offset future taxable income or reduce taxes payable through
2027. These loss carryforwards will begin expiring in 2008. The credits continue to expire in 2008
through 2027.
Included as part of the Company’s net operating loss carryforwards are approximately $3.8 million
in tax deductions that resulted from the exercise of stock options. Should these loss
carryforwards be realized, the corresponding change in valuation allowance will be recorded as
additional paid-in capital.
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The Company’s ability to utilize a portion of its net operating loss carryforwards and research and
development credits to offset future taxable income are subject to certain limitations under
Section 382 and 383 of the Internal Revenue Code due to changes in the equity ownership of the
Company. In addition, 3F’s net operating loss carryforwards may also be limited by separate return
limitation year rules.
In addition to the U.S. tax attributes discussed above, the Company had net operating loss
carryforwards outside the U.S. totaling $1.3 million which resulted in a deferred tax asset of $0.4
million. These international net operating loss carryforwards do not expire.
Components of deferred tax assets and liabilities are as follows (in thousands):
The valuation allowance above includes 3F net deferred tax assets (primarily net operating loss
carryforwards) of $20.0 million. If realized, 3F tax assets will be recorded first as reductions
to goodwill and intangible assets ($18.8 million at December 31, 2007), and then as income tax
benefits ($1.2 million at December 31, 2007). The Company has determined that a full valuation
allowance is appropriate given the uncertainty of the Company’s ability to utilize the deferred tax
assets.
Reconciliation of the statutory federal income tax rate to the Company’s effective tax rate is as
follows:
The Company adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes, on
January 1, 2007. Previously, the Company had accounted for tax contingencies in accordance with
SFAS No. 5, Accounting for Contingencies. As required by FIN 48, which clarifies SFAS No. 109,
Accounting for Income Taxes, the Company recognizes the financial statement benefit of a tax
position only after determining that the relevant tax authority would more likely than not sustain
the position. For tax positions meeting the more likely than not threshold, the amount recognized
in the financial statements is the largest benefit that has a greater than 50 percent likelihood of
being realized upon ultimate settlement
with the relevant tax authority. At the adoption date, the Company applied FIN 48 to all tax
positions for which the statute of limitations remained open.
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As a result of the implementation of FIN 48, the Company identified approximately $540,000 of
unrecognized tax benefits. The total gross amount of unrecognized tax benefits as of December 31,
2007 was approximately $530,000. If recognized, none of the unrecognized tax benefits would affect
the effective tax rate. A reconciliation of the beginning and ending amount of unrecognized tax
benefits is as follows:
It is the Company’s practice to recognize penalties and/or interest related to income tax matters
in interest and penalties expense. As of December 31, 2007, the Company had no accrued interest
and penalties.
The Company is subject to income taxes in the U.S. federal jurisdiction, foreign jurisdictions and
various states jurisdictions. Tax regulations within each jurisdiction are subject to the
interpretation of the related tax laws and regulations and require significant judgment to apply.
With few exceptions, the Company is no longer subject to U.S. federal, foreign, state or local
income tax examinations by tax authorities for the years before 2004. The Company is not currently
under examination by any taxing jurisdiction.
The Company does not anticipate any significant increases or decreases in unrecognized tax benefits
within the next twelve months.
12. Commitments
In 2002 the Company amended long-term supply and technology transfer agreements with CarboMedics, a
wholly owned subsidiary of Sorin, a European company based in Italy. The amendment to the supply
agreement suspended component set purchases until January 2007. This postponed component purchases
totaling approximately $21.75 million for the years ended December 31, 2002 to 2006. The 2002
through 2006 purchase obligations were to resume, beginning in 2007. In January 2007, CarboMedics
served a complaint on the Company, alleging breach of contract with respect to the long-term supply
agreement, discussed more fully in Note 18. The Company believes that the complaint filed by
CarboMedics is without merit, that CarboMedics has repudiated and breached the supply agreement,
and that the Company has affirmative claims against CarboMedics.
13. Distributor Termination
In December 2006, the Company and an international distributor in Europe executed agreements
providing for the termination of the distributor, the conversion of the distributor to a
commissioned sales representative effective January 1, 2007 and the buy-back by the Company of the
distributor’s remaining inventory stock. The value of the inventory bought back totaled
approximately $0.7 million. In addition, termination payments to the distributor totaling
approximately $0.7 million were accrued by the Company at December 31, 2006. The termination
payments are payable in two equal installments, one of which was paid in the fourth quarter of 2007
and the other of which is due in first quarter of 2008. The 2008 installment carries interest at
6%.
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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. Under the plan, the Company contributes an
amount equal to 25% of the first 12% of each employee’s contribution. The Company recognized
expense for contributions to the plan of $0.2 million for each of the three years ended December
31, 2007, 2006 and 2005.
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:
The company uses independent distributors
to sell its products in many European and all other
international markets. Sales to one distributor represented 8%, 11% and 13% of the Company’s net
sales for the years ended December 31, 2007, 2006 and 2005, respectively.
The Company had balances owing from two customers that aggregated 12% of its accounts receivable
balances at December 31, 2007. The Company had balances owing from three customers that aggregated
19% of its accounts receivable balances at December 31, 2006 and balances owing from five customers
that represented 37% of its accounts receivable balances at December 31, 2005.
16. Quarterly Financial Data (Unaudited)
Quarterly data for 2007 and 2006 was as follows (in thousands, except loss per share):
In connection with the acquisition of CryoCath assets disclosed in Note 2 above, the Company
acquired $3.5 million of IPR&D, recorded as a non-recurring charge to operations in the second
quarter of 2007. In connection with the acquisition of 3F Therapeutics, also disclosed in Note 2
above, the Company acquired $14.4 million of IPR&D, recorded as a non-recurring charge to
operations in the third quarter of 2006.
The Company recorded a $0.7 million charge related to the termination of a European distributor in
the fourth quarter of 2006, as disclosed in Note 13 above.
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The conversion feature liability related to of the Company’s Senior Convertible Notes, disclosed in
Note 7 above, was adjusted to fair value at each quarter end throughout 2006 and 2005, resulting in
a $1.2 million change in valuation credit to other income in the first quarter of 2006.
17. Recently Issued Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 establishes
a common definition for fair value to be applied to U.S. generally accepted accounting principles
and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal
years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No.
157 on its consolidated financial position and results of operations.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities. SFAS No. 159 amends SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities and permits entities to choose to measure many financial instruments and
certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. The Company is currently assessing the impact of SFAS No. 159 on its
consolidated financial position and results of operations.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS No. 141(R)”), which
establishes principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed, and any
non-controlling interest in the acquired company and the goodwill acquired. Among the changes in
SFAS No. 141(R) are: transaction related costs will be expensed; restructuring costs that the
acquirer expects but is not obligated (as of the acquisition date) to incur will not be included in
the measurement of the acquisition cost; and research and development assets will be capitalized.
SFAS No. 141(R) also establishes disclosure requirements to enable the evaluation of the nature and
financial effects of the business combination. SFAS No. 141(R) replaces SFAS No. 141 and is
effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, and
will be adopted by the Company in the first quarter of 2009.
18. Litigation
Abbey Litigation
On January 23, 2006, following execution of the Merger Agreement between the Company and 3F, 3F was
informed of a summons and complaint dated January 19, 2006, which was filed in the U.S. District
Court in the Southern District of New York by Arthur N. Abbey (“Abbey”) against 3F Partners Limited
Partnership II (a major stockholder of 3F, “3F Partners II”), Theodore C. Skokos (the then chairman
of the board and a stockholder of 3F), 3F Management II, LLC (the general partner of 3F Partners
II), and 3F (collectively, the “Defendants”) (the “Abbey I Litigation”). The summons and complaint
alleges that the Defendants committed fraud under federal securities laws, common law fraud and
negligent misrepresentation in connection with the purchase by Abbey of certain securities of 3F
Partners II. In particular, Abbey claims that the Defendants induced Abbey to invest $4 million in
3F Partners II, which, in turn, invested $6 million in certain preferred stock of 3F, by allegedly
causing Abbey to believe, among other things, that such investment would be short-term. Pursuant to
the complaint, Abbey is seeking rescission of his purchase of his limited partnership interest in
3F Partners II and return of the amount paid therefore (together with pre-and post-judgment
interest), compensatory damages for the alleged lost principal of his investment (together with
interest thereon and additional general, consequential and incidental damages), general damages for
all alleged injuries resulting from the alleged fraud in an amount to be determined at trial and
such other legal and equitable relief as the court may deem just and proper. Abbey did not
purchase any securities directly from 3F and is not a stockholder of 3F. On March 23, 2006, 3F
filed a motion to dismiss the complaint. Under the Private Securities Litigation Reform Act, no
discovery will be permitted until the judge rules upon the motion to dismiss. On May 15, 2006, 3F
filed and served a reply memorandum of law in further support of its motion to dismiss Abbey’s
complaint with prejudice. On August 6, 2007, the Court granted 3F’s motion to dismiss the
complaint based on plaintiff’s failure to state a claim upon which relief may be granted and the
case was closed. On August 30, 2007, Abbey filed a Notice of Appeal with the United States Court
of Appeals for the Second Circuit seeking to reverse the District Court’s August 6, 2007 Order
dismissing the case. The appeal was fully submitted on January 3, 2008. None of the parties have
requested oral argument.
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On or about June 14, 2006, Abbey commenced a second civil action in the Court of Chancery in the
State of Delaware by serving 3F with a complaint naming both 3F and Mr. Skokos as defendants (the
“Abbey II Litigation”). The complaint alleges, among other things, fraud and breach of fiduciary duties in
connection with the purchase by Abbey of his partnership interest in 3F Partners II. The Delaware
action seeks: (1) a declaration that (a) for purposes of the merger, Abbey was a record stockholder
of 3F and was thus entitled to withhold his consent to the merger and seek appraisal rights after
the merger was consummated and (b) the irrevocable stockholder consent submitted by 3F Partners II
to approve the merger be voided as unenforceable; and (2) damages based upon allegations that 3F
aided and abetted Mr. Skokos in breaching Mr. Skokos’s fiduciary duties of loyalty and faith to
Abbey. On July 17, 2006, 3F filed a motion to dismiss the complaint in the Abbey II Litigation,
or, alternatively, to stay the action pending adjudication of the Abbey I Litigation. On October
10, 2006, the Delaware Chancery Court entered an order staying the Delaware action pending the
outcome of the Abbey I litigation. On or about August 17, 2007, the parties informed the Delaware
Chancery Court that they would consent to the continued stay of the Delaware action pending the
outcome of Abbey’s appeal of the Abbey I Litigation.
3F has been notified by its director and officer insurance carrier that such carrier will defend
and cover all defense costs as to 3F and Mr. Skokos in the Abbey I Litigation and Abbey II
Litigation, subject to policy terms and full reservation of rights. In addition, under the merger
agreement, 3F and the 3F stockholder representative have agreed that the Abbey I Litigation and
Abbey II Litigation are matters for which express indemnification is provided. As a result, the
escrow shares and milestone shares, if any, may be used by ATS to satisfy, in part, ATS’s set-off
rights and indemnification claims for damages and losses incurred by 3F or ATS, and their
directors, officers and affiliates, that are not otherwise covered by applicable insurance arising
from the Abbey I Litigation and Abbey II Litigation. See Note 2 of “Notes to Consolidated
Financial Statements” in this report for a description of the escrow and milestone shares. The
Company believes the Abbey I Litigation and Abbey II Litigation will not result in a material
impact on the Company’s financial position or operating results.
CarboMedics Litigation
On November 22, 2006, CarboMedics filed a complaint against ATS in the U.S. District Court in the
District of Minnesota. The complaint alleges that the Company has breached certain contractual
obligations, including an alleged obligation to purchase $22 million of mechanical heart valve
carbon components under a long-term supply agreement with CarboMedics, which obligation CarboMedics
contends had been scheduled to re-commence in 2007.
CarboMedics initially sought specific performance and claimed damages of approximately $20 million.
The Company believes the complaint filed by CarboMedics is without merit, that CarboMedics has
repudiated and breached the long-term supply agreement, and that the Company may have affirmative
claims against CarboMedics. On February 16, 2007, the Company filed its answer and counterclaim to
the complaint. On May 16, 2007, CarboMedics filed an amended complaint withdrawing its request for
specific performance. CarboMedics has also revised its damages estimate to $13.6 million before
accounting for net present value adjustments, interest, attorney’s fees, and costs. The case is now
in the final stages of discovery and has been scheduled for trial in
September 2008. If the Company is ultimately found to be in breach of the terms of the supply agreement with CarboMedics, it could be required to pay damages that would materially and adversely affect the Company’s financial condition.
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